2008 Consulting Club

Week 4
Math !
October 2, 2008

These written materials are not complete without accompanying verbal comments
Agenda

Why Do They Try to Trick Us with Math?

Fundamental Math Concepts

Intermediate Math Concepts

Advanced Math Concepts

Group Casing Exercises

1
Why numbers matter in the case interview

“I know that numbers mean everything in business. But why

are math skills important in interviews if I’ll have a
calculator at work?”

– Basic skills demonstrate that you can think methodically and

understand mathematical relationships
– Firms want to see if you can apply numerical data to clarify a
business story and substantiate a set of recommendations
– Interviews force you to articulate the logic of your
calculations
– Tedious math problems test your poise under pressure

2
So You Don’t Like Math.

How often do the more complex math concepts

really show up in cases?
Answer: Complex math shows up less often
than basic division, percents, etc. BUT, you
never know whey you will get a case with
tricky math

How should you prepare?

• Practice basic math – multiplication, division, decimals, percentages
• Get familiar with the basic equations for a short list of more complex concepts
• Develop an understanding of the purpose of more complex math concepts, and
know the general impact of answers of different magnitude

3
Agenda

Why Do They Try to Trick Us with Math?

Fundamental Math Concepts

Intermediate Math Concepts

Advanced Math Concepts

Group Casing Exercises

4
Fundamental Math Techniques

You MUST know these and practice them:

– Long division
– Multiplication
– Addition
– Subtraction
– Basic fractions and simplification
– Percentages
– Algebra, solving for X

5
Large Numbers

Difficulty:
– Easy to make mistakes (especially number of zeroes)
– Time-consuming to write (e.g. $25,000,000)

Solution:
– Symbol of magnitude: $25M
– Scientific notation: $2.5 x 107
– 1K = 1.0 x 103 … 1M = 1.0 x 106 … 1B = 1.0 x 109
– Working with scientific notation:
• Multiplying: Multiply coefficients and add exponents.
• Adding: Exponents must be equal!

6
Percentages

Difficulty:
– Takes different forms, each using similar language

Solution:
– Part/whole concept (% = part/whole)
– Understand “percent of” and “percent increase”
– Understand markup and margin

Tips:
– Practice!
– Purplemath.com covers all the bases

7
Percentages: you thought they were easy?

Question:
– Your company sells ice cream in a market where customers are
segmented by favorite flavor. 70% of your customers belong to the vanilla
segment. Your customers make up 3.6% of the market. 10% of the
customers in the market prefer vanilla ice cream. What percentage of the
vanilla customers in the market does your company serve?

8
Percentages: you thought they were easy?

Question:
– Your company sells ice cream in a market where customers are
segmented by favorite flavor. 70% of your customers belong to the vanilla
segment. Your customers make up 3.6% of the market. 10% of the
customers in the market prefer vanilla ice cream. What percentage of the
vanilla customers in the market does your company serve?

Answer:
– 0.7 * 0.036 / 0.1 = 0.252
We are introduced to three overlapping groups of people: “your
customers,” “vanilla customers,” and “the market.” We are asked how a
particular overlap – the intersection of all three groups – compares to
one of the groups – the vanilla customers. Note: everything is in percent
terms relative to the market.
– Step 1: find the “part”: 70% of 3.6% = 2.52%. Step 2: find the “whole”:
we already know it‟s 10%. Step 3: divide part/whole: 2.52% / 10% = 25.2%

9
Agenda

Why Do They Try to Trick Us with Math?

Fundamental Math Concepts

Intermediate Math Concepts

Advanced Math Concepts

Group Casing Exercises

10
Market Sizing - Segmentation

Difficulty:
– How do you size a market quickly and sensibly?

Solution:
– Start with a known population
– Divide the population into segments according to [age,income,etc]
– Pick percentages of each segment who belongs in your market

Tips:
– Use 300M for US Population
– Use manageable round numbers for bracket sizes and percentages
• 300/4 = 75 … 75/3 = 25

11
Market Sizing – Segmentation Example

Question:
– How many cups of coffee are sold in the US every year?

Answer:
– Total cups/day * days/year
– The US Pop is 300M. Let‟s bracket by age in groups of 20-year spans and
assume an even distribution (75M in each bracket).

age pop % drink coffee subtotal cups/day total

0-20 75M 1/10 7.5M 1 7.5M
20-40 75M 2/3 50M 2 100M
40-60 75M 1/3 25M 2 50M
60+ 75M 1/3 25M 1 25M
182.5M 182.5M * 365 =
66.6B cups/yr

12
Market Sizing

Start

Determine the estimated

number of customers in Number of customers
your market segment targeted
x
Number of purchases
made per period
Think about how this = Total revenue in
differs when you consider x
different groups within market
your market segment
Number of units per
purchase Finish
x
What price are the different
segments/consumer groups Price per unit
willing to pay?

13
Rule of 72

Rule of 72 helps to answer the following questions

 How long it takes to double your savings (approximately) for a given saving rate

Start with the number 72.

Divide by the rate of return you expect to earn

You will get your investment horizon, or number of years you need to double your investments

 What rate of return should you get if you want to double your money in a given
number of years

Start with 72.

Divide by the number of years your want to have your return doubled

You will get the AFTER-TAX COMPOUND ANNUAL RATE OF RETURN you would have to earn

14
Question

In investor knows she can earn 16% of return on her money. How long it
will take to double the investment?

In investor needs to double his money in 3 years (legally). What is the rate
of return must he earn to do this successfully?

15
Solution

In investor knows she can earn 16% of return on her money. How long it
will take to double the investment?

72/16 = 4.5 years

In investor needs to double his money in 3 years (legally). What is the rate
of return must he earn to do this successfully?

72/3 = 24%

16
Estimation

What‟s 14% of 2.3 million?

17
Solution

 Estimation
– Look for 15% of 2.3MM
– 10% of 2.3MM = 230K
– 50% of 230K = 115K
– Answer ~ 345K
– (You could then easily reduce your estimate to 325K by subtracting 20K.)

 Calculation
– Scale down and scale up
– 10% of 2.3MM = 230K
– 1% of 2.3MM = 23K
– 4% of 2.3MM = 92K
– 230K + 92K = 322K

18
Zeros and Decimals

What‟s .0003% of 2.6 billion?

19
Solution

 Estimate/Calculation

– Where does the decimal go?

– Find .0001% and scale up.
– Dividing .0001 by 100 gives a % multiplier of:

– . 0 0 0 0 0 1

– From R to L, the decimal point has moved 6 places.

– Moving the decimal point left 6 places in 2.6 billion = 2,600
– 2,600 x 3 = 7,800

20
Percentage

What‟s 14% of 2.3 million?

21
Percentage Solution

 What‟s 14% of 2.3 million?

 Estimate
– Look for 15% of 2.3MM
– 10% of 2.3MM = 230K
– 50% of 230K = 115K
– Answer ~ 345K
– (You could then easily reduce your estimate to 325K by subtracting 20K.)
 Calculation
– Scale down and scale up
– 10% of 2.3MM = 230K
– 1% of 2.3MM = 23K
– 4% of 2.3MM = 92K
– 230K + 92K = 322K

22
Problem

In 2030 the world will have 1.2 billion cars. This is one
vehicle for every 6.7 people projected to be on the
planet at 2030. This is also 92% more cars then we have
on the road today.

How many vehicles are on the road today?

If the ration of cars to people will be half of the one we

have today, how many people are in the world today?

23
Solution

Solve: 625 million cars

X*1.92 = 1,200,000,000

Estimate: 1,200,000,000/2 = 600 million , You are dividing by a little less then 2, so it
will be a little more then 600. Estimate solution is 630,000,000.

Solve: 6.979 Billion

X*1.92=6.7*2

X=13.4/1.92 = 6.9

Estimate: From (X*1.92=6.7*2) you should see that the number a little higher then
6.7. Estimate solution is 7 billion.

(Btw, current world population is 6.7 billion)

24
Gross Margin

• Gross margin tells us how much of every dollar earned by the firm, after
paying direct fixed and variable costs, is available to cover overhead costs
CONCEPT and serve as a buffer to unknown items
• More simply, GM tells us how many of our sales dollars are profit

Gross Margin Equation Components of the GM Equation

Gross Profit = Revenues – (FC + VC)

(Revenue – Costs)
GM =
Revenue Gross Profit
GM =
Revenue

25
GM

Revenue = 3.5MM. Cost = 2.1MM. Find GM.

26
Solution

GM = (R – C) / R
 Estimate
– 1.5 / 3.5 is a little under 50%.
– Answer ~ 45%

 Calculation
– (3.5 – 2.1) / 3.5
– 1.4 / 3.5
– Answer = 40%

27
Agenda

Why Do They Try to Trick Us with Math?

Fundamental Math Concepts

Intermediate Math Concepts

Advanced Math Concepts

Group Casing Exercises

28
Net Present Value

• Net present value tells us whether a particular investment will add value
to our company. If NPV is positive, make the investment
CONCEPT • Literally, NPV is a comparison of the expected future cash inflows from an
investment to the expected cash outlay(s) needed to finance the project

Step 1: PV of Cash Inflows Step 2: Find NPV

PV of Cash Inflows
Cash Flow - Initial Investment
Present Value =
(1 + r)t = NPV
* Initial Investment represents the PV of all cash
outflows needed to finance the project

29
Example of Present Value Discounting

Common discount rates and periods Remember:

that show up in cases • The larger the discount rate,
Number of periods the smaller the present value

• The greater the number of

$100 1 2 3 4 5 periods, the smaller the
3% 97.1 94.3 91.5 88.8 86.3 present value
Discount rate

5% 95.2 90.7 86.4 82.3 78.4 • The larger the discount rate,
the greater the risk premium
7% 93.5 87.3 81.6 76.3 71.3 applied to the potential
investment
10% 90.9 82.6 75.1 68.3 62.1
• Use the Rule of 72 when
12% 89.3 79.7 71.2 63.6 56.7
possible

• Round and estimate when

possible

30
Present Value of an Annuity

• The present value of an annuity, also known as the perpetual growth

formula, tells us the value today of a series of cash flows that expect to
CONCEPT last forever into the future
• The perpetual growth formula can help us value a company

Basic Equation Definition of Terms

Coupon = the regular cash flow

Coupon payment
Present Value =
r-g r = discount rate
g = growth rate

31
Customer Lifetime Value

• Customer Lifetime Value is the present value of all future streams of

profits that a customer generates over the life of his/her business with
CONCEPT the firm
• CLV tells us how much we can spend to “acquire” a new customer

Basic Equation Definition of Terms

m = margin from each customer

r
CLV = m r = retention rate
1+i-r
i = discount rate

32
ACCOUNTING RATIOS

Why it is important to know the key ratios:

 Used to evaluate the overall financial condition of a corporation

 Financial ratios allow for comparisons

• between companies (when firms use the same accounting methods)
• between industries
• between different time periods for one company
• between a single company and its industry average

33
What do you want to remember

 SOLVENCY

 LIQUIDITY

 PROFITABILITY

 OPERATING EFFICIENCY

 FINANCIAL LEVERAGE

Values used in calculating financial ratios are taken mostly from the

BALANCE SHEET, INCOME STATEMENT, CASH FLOW STATEMENT!

34
When to use in a case

 When you are given financial statements to analyze

 When you are trying to decide whether a company should invest in a new project
now (a liquidity issue) or will it stay in business or be able to take on some extra
debt (solvency issue)

35
Solvency Measurements

WHY?

To be able to assess the ability of a corporation to meet its long-term fixed expenses
and to accomplish long-term expansion and growth.

 A ratio used to measure a company's ability to meet long-term obligations. The

solvency ratio measures the size of a company's after-tax income, excluding non-cash
depreciation expenses, as compared to the firm's total debt obligations. It provides a
measurement of how likely a company will be to continue meeting its debt
obligations.

36
Liquidity Measurements

 Current Ratio answers the question whether the firm can meet its short term
obligations.

 Quick Ratio answers the question whether a firm can meet short term obligations
tomorrow.

37
Problem

 At December 31 a company's records show the following information:

• Cash $ 10,000
• Accounts Receivable 30,000
• Inventory 80,000
• Prepaid Insurance 6,000
• Long-term Assets 200,000
• Accounts Payable 30,000
• Note Payable due in 10 months 25,000
• Wages Payable 5,000
• Long-term Liabilities 70,000
• Stockholders' (Owner's) Equity 196,000

What are the Current Ratio and the Quick Ratio?

38
Solution

 Current Assets - $126,000:

• Cash $ 10,000
• Accounts Receivable 30,000
• Inventory 80,000
• Prepaid Insurance 6,000

 Current Liabilities
• Accounts Payable 30,000
• Note Payable due in 10 months 25,000
• Wages Payable 5,000

 126,000/60,000 = 2.1

39
Liquidity measurements cont.

 The larger the ratio, the shorter the collection period is for receivables, meaning
that the company gets cash more quickly

Account receivable collection period = 365 days/accounts

receivable turnover ratio
 Reflects the number of days on average it takes the company to collect accounts
receivables

40
Profitability Measurements

Why?
Give an idea of how likely it is that a company will turn a profit, as well as
how that profit relates to other important information about the company.

Decreasing profit margins year over year - changing market conditions,

increasing competition , rising costs. Also, if a company's profit margin is
out of line compared to the rest of its industry, it is worth the extra effort
to find out why.

41
Profitability Measurements cont.

 Operating margin is a measurement of what proportion of a company's revenue is left

over after paying for variable costs of production such as wages, raw materials, etc.

 look at the change in operating margin over time and to compare the company's
yearly or quarterly figures to those of its competitors. If a company's margin is
increasing, it is earning more per dollar of sales. The higher the margin, the better.

For example, if a company has an operating margin of 12%, this means that it makes
$0.12 (before interest and taxes) for every dollar of sales.

42
Operating Efficiency Measurements

WHY?

Asset Turnover Ratio = Net Sales/Average Total Assets

 The higher is the ratio, the more efficiently a firm is using its assets

Rate of Return on Investments (known as ROI) = Net Income/Total

Average Assets

ROI = Profit Margin*Asset Turnover Ratio

43
Financial Leverage

WHY?
To increase return on Equity

Financial Leverage = Average Total Assets/Average

Common Stockholder‟s Equity
 Amount of assets financed by stockholders

44
Rate of Return

Rate of return on common stockholder „s equity

Net Income/Average Common Stockholder‟s Equity

Profit margin*Asset turnover*Leverage

45
Agenda

Why Do They Try to Trick Us with Math?

Fundamental Math Concepts

Intermediate Math Concepts

Advanced Math Concepts

Group Casing Exercises

46