Case: Bay City Electronics

Overview of the case

Bay City Electronics introduces a new product related to home security The bank loves the idea but finds the financial analysis to be weak Bank provide forms & templates to be used Bill gets his friends help to come up with the financial analysis Bill is not very confident with his financial analysis

Did the numbers look good?

Is the proposal (figures) realistic? Year 1:
Loan Phase 1 : 100,000 (Year 1)
Profit : 31,200 Pay Back : 100,000 + 16000 = 116,000 Net Profit: (84,800) Loan Interest Per Annum: 16% Loan Penalty Per Annum: 8% Loan Duration is for 3 years

Year 2:
Loan Phase 2 : 50,000 (Year 2)
Profit : 296,000 Pay Back : 50,000 + 8000 = 58,000 Net Profit: 296,000 - [(84800) + (6784) + (58,000)] = 146,416 Loan Interest Per Annum: 16% Loan Penalty Per Annum: 8% Loan Duration is for 3 years

Year 3:
Loan Phase 3 : 45,000 (Year 3)
Profit : 648,400 Pay Back : 45,000 + 7200 = 52,200 Net Profit: 648,400 52,000 = 596200 Loan Interest Per Annum: 16% Loan Penalty Per Annum: 8% Loan Duration is for 3 years

Where were the shaky parts that the banker might give him trouble on?
The figures were built on summary data which were not complete. The figures look deceiving, because it shows good start with good profit, details were not provided. It shows negative cash flow with positive NPV His financial forecast indicates that he doesnt need the loan, looking at his beginning sales figures for example In the 5th year the working capital was negative so they cannot manage their expenses and make the bank more reluctant to give the loan as cash outflow is more than the cash inflow

Other ways to reassure the bank that the loan was a good proposition
Bay City Electronics should have: prepare another financial worksheet for his past similar project and ongoing business. Provide proof of the firms equity (ownership structure) Details of ownership of properties (equipment/building) Analysis of previous loan taken (how it was managed?)

Project Risk Pattern

The analysis assumed demand will be high. Probability of high or low demand: (Real Option Analysis) If demand is low .. What is the firms plan? Drop or continue? Variation in Payout &

Imitative competition
how will the bank recover its investment?

Use Required Rate of Return (RRR)

Sets the minimum return an investor should accept Riskier project yields higher return: the higher the risk, the higher the return.
Percent Return

RRR

Cost of cap 16% + 8%

Cost of cap: 16% Risk premium: 8%

Risk on the Proposed Average Risk of the firm product

RRR = Cost of cap + Risk Premium for the new product

Risk

Next Project: Reduced overdependence on one particular technique and consider other techniques like:
1. Regression analysis 2. econometrics analysis 3. Time Series analysis 4. Jury of executive opinion 5. Scenario writing, etc.

Thank You Comments Q&A