Final Term MADS 6601 Financial Administration

Fairleigh Dickenson University
MADS 6601 Financial Administration

Finance Chapter 4
Financial Planning - Pro Forma Financial Statements
The Role of Pro-forma Financial Statements
• describe the predicted financial outcome of a particular course of action (Strategic)
• By showing the financial implications of certain decisions, managers should be able
to allocate resources in a more efficient and effective manner
Chapter 5 - 1 © 2012 Pearson Canada Inc.
1
Preparing the Pro forma Financial Statement
Involves four major steps:
1. Identify the factors that will affect the pro forma statements
2. Forecast the sales for the period
3. Forecast the remaining elements of the financial statements (Assets, Liabilities, and Capital – Net Working Capital)
 An increase in the level of sales is likely to lead to a need for:
o An increase in cash, accounts receivable, and an increase in inventory to meet the increase in demand (Working
Capital)
 An increase in the level of sales should also lead to:
o An increase in accounts payable as a result of increased purchases, and an increase in accrued expenses as a result
of increased costs
4. Prepare the pro forma financial statements.

2
PRO FORMA INCOME STATEMENT
A pro forma income statement provides insight into the anticipated level of future profits or
losses, which can be defined as the difference between the anticipated levels of sales and
expenses.
PRO FORMA STATEMENT OF RETAINED EARNINGS
• Computes the closing balance in retained earnings
• It uses the opening balance in the retained earnings account, adds the net income from the pro
forma income statement, and deducts the projected level of dividends that will be paid to
shareholders
• Arrive at the closing balance in retained earnings.
3
PRO FORMA BALANCE SHEET
• The pro forma balance sheet reveals the end-of-period balances for assets,
liabilities, and shareholders’ equity
• It should normally be the last of the four statements to be prepared.
• This is because the other statements will produce information to be used when
preparing the pro forma balance sheet.
PERCENT-OF-SALES METHOD
• An alternative
Chapter 5 - 4 ©approach
2012 Pearson Canada Inc.
to preparing a forecast income statement and balance
4
sheet is the percent-of-sales method
Income Statement
The percent-of-sales method assumes that the following income statement items can be expressed
as a percentage of sales:
• All operating expenses
• The net profit figure, which is the difference between sales and expenses
However:
• Corporate tax and dividends are assumed to vary with the level of net profit and so are expressed
as a percentage of the net profit figure
5
Balance Sheet
The percent-of-sales method assumes that the following balance sheet items can be
expressed as a percentage of sales:
•Current assets that increase with sales, such as inventory and accounts receivable
•Current liabilities that increase with sales, such as accounts payable and accrued
expenses
•Cash (as a pro forma cash budget is not prepared to provide a more accurate
measure of cash).
However:
•Property, plant, and equipment will only be expressed as a percentage of sales if 6

Identifying the Financing Gap
•When sales increase, there is a risk that the business will outgrow its current financing.
•The forecast increase in assets may exceed the forecast increase in liabilities and the retained
earnings
•A financing gap may arise because the initial pro forma balance sheet does not balance.
•The additional financing required by the business will be the amount necessary to make the
balance sheet balance, and includes obtaining new loans and issuing new equity (shares).
7
Chapter 5
The Time Value of Money
LEARNING OUTCOMES
1 Explain the time value of money and how it is affected by interest
rates, risk, and inflation.
2 Calculate the future value (tn) of an investment today (t0) and

calculate the present value of a future payment or future receipt.
3 Calculate the present value of a series of equal future payments

and calculate the future value (tn) of a series of equal investments
(an annuity).
4 Calculate the present value of a series of unequal future payments

and calculate
Chapter the Canada
5 - 8 © 2012 Pearson future
Inc.value (tn) of a series of unequal
investments. 8
The Time Value of Money, Interest Rates,
Risk and Inflation
The main factors affecting the value of money
over time:
• Interest Lost: opportunity cost
• Risk: things may not turn out as expected
• Inflation: the loss of purchasing power of
money over time
9
All
LOs Basic Definitions
• Present Value – earlier money on a time line

• Future Value – later money on a time line
• Interest rate – “exchange rate” between earlier
money and later money
– Discount rate
– Cost of capital
– Opportunity cost of capital
– Required return
5-10 © 2013 McGraw-Hill Ryerson Limited

Compound Interest
• Compound interest is earned on the interest as

well as on the principal.
• When you “move” money to the right it is
called COMPOUNDING.
PV FV
• When you “move” money to the LEFT it is

called DISCOUNTING.

PV FV 11
1.Pearson Calculator Tutorial 1:General TVM Buttons
12
1.Pearson Calculator Tutorial 2: Future Value of a Lump Sum (Annual
Compounding)
2.Exercise 1: Calculate the Future Values of the following Cash Flows
13
1.Pearson Calculator Tutorial 3: Future Value of an Annuity
2.Exercise 2: Calculate the Future Values of the following Annuities
14
1.Pearson Calculator Tutorial 4: Present Value of a Lump Sum (Annual
Compounding)
2.Pearson Calculator Tutorial 5: Present Value of a Lump Sum (Monthly
Compounding)

3.Exercise 3: Calculate the Present Values of the following Cash Flows
15
1.Pearson Calculator Tutorial 6: Present Value of an Annuity
2.Exercise 4: Calculate the Present Values of the following Annuities
16
Pearson Calculator Tutorials
1.General TVM Buttons
2.Future Value of a Lump Sum (Annual Compounding)
3.Future Value of an Annuity
4.Present Value of a Lump Sum (Annual Compounding)
5.Present Value of a Lump Sum (Monthly Compounding)
6.Present Value of an Annuity
7.
8.Bond Valuation
9.
10.Yield to Maturity of a Bond 17

Chapter 6
BONDS
• A bond is a promise to pay a series of payments over time (the

interest component) and a fixed amount at maturity (the face
amount). Thus it is blend of an annuity (the interest) and lump
sum payment (the face value).
• To determine the amount an investor is willing to pay for a

bond requires present value computations to determine the
current worth of the future payments.
• Pearson Calculator Tutorial 8: Bond Valuation (Semiannual

Interest)
18
• Bonds are sensitive to interest rates, which in turn are affected by
inflation.
• Rising interest rates cause the market price of all bonds to fall
because the fixed coupon rates make the old bonds less valuable.
• Conversely, falling interest rates cause all existing bond prices to

rise.
• So, bond prices rise and fall in a similar fashion to stock prices,
although usually they are not as volatile
19
• Assume that Shultz Company issues a 5-year, 8% bonds
with a face value of $1,000, and interest paid every six
months. Using these assumptions, consider the
following three alternative scenarios:
• Par
• Premium
• Discount
20
BONDS AT PAR VALUE
WHEN THE MARKET RATE OF INTEREST IS 8%
If the market rate of interest for companies like Schultz (ie:

companies having the same perceived integrity and risk)
then Schultz’s bonds should sell at face value (also known
as par).
That is to say, that investors will pay $1,000 today for a

bond that will return $40 every six months and will get the
face value at maturity (10 years) of $1,000.
Thus, the bond would yield 8%.

21
See: Homework Par
BONDS AT A PREMIUM
IF THE MARKET RATE OF INTEREST IS 6%
If the market rate of interest is 6%, the Shultz bonds are attractive
to the investor because they will be paid 8% on their investment
while other investments of similar integrity and risk are paying 6%.
The question becomes: How much will the investor pay for
Shultz’s 8% bonds?
The answer is that investors will bid up the price of the bond
(arbitrage) until the effective yield rate drops to 6%.
22
BONDS AT A PREMIUM
In other words, the price of the bond would have to be high

enough so that the $40 semiannual payment and the $1,000 face
value (at maturity) would yield 6%
The exact amount they would be willing to pay is determined by

discounting the cash flow stream at the market rate of interest.
See: Homework Premium
23
BONDS AT A DISCOUNT
If the market rate of interest is 10%, the Shultz bonds are NOT
attractive to the investor because they will be paid 8% on their
investment while other investments of similar integrity and risk
are paying 10%.
The question becomes: How much will the investor pay for
Shultz’s 8% bonds?
The answer is that investors will bid down the price of the bond
(arbitrage) until the effective yield rate increases to 10%.
24
BONDS AT A DISCOUNT
In other words, the price of the bond would have to be low enough
so that the $40 semiannual payment and the $1,000 face value (at
maturity) would yield 10%
The exact amount they would be willing to pay is determined by

discounting the cash flow stream at the market rate of interest.
See: Homework Discount
25
Week 10 Capital Investment Decisions
Accrual Accounting Rate of Return (AARR), Payback Period
(PP), and Discounted Payback Period (DPP)
An investment is typically one large amount and

the benefits arrive as a series of smaller
amounts over a fairly protracted period.
Investment decisions are very important
because:
• Large amounts of resources are often involved.
• It is often difficult and/or expensive to bail
out of an investment once it has been
undertaken.
26
Methods of Investment Appraisal
Four methods are used in practice by businesses

throughout the world to evaluate investment
opportunities:
• Accrual Accounting rate of return (AARR)

• Payback period (PP)
• Discounted Payback Period (DPP)
• Net present value (NPV)
•Chapter
Internal rate of return (IRR).
5 - 27 © 2012 Pearson Canada Inc.
27
Accrual Accounting Rate of Return
(AARR)
• (AARR) method takes the average accounting
profit that the investment will generate and
expresses it as a percentage of the average
investment made over the life of the project.
28
Accrual Accounting Rate of Return
Manitoba Railway Ltd. (MRL) is considering spending $650 million to add new
rolling stock. It is estimated that the trains will last 15 years and have a salvage
value at the end of 15 years of $50 million, and the Expected Annual Revenue
Increase before depreciation is $75 million. If MRL's cost of capital (Interest or
Discount rate) is 7%. Calculate the Accrual Accounting Rate of Return
a) Average Annual Profit = Expected Annual Revenue Increase - Annual Depreciation
= $75 - ($650-$50) / 15
= $75 - $40
= $35
b) Average Annual Investment = (Initial Investment + Scrap Value) / 2
= ($650 + $50) / 2
Chapter 5 -=29 © 2012

$350
Pearson Canada Inc.
AARR = $35 / $350 10.0% 29

Problems with AARR
1. AARR Ignores TIME VALUE of Money

2. AARR Can Lead to an Illogical Decision
3. AARR Is Based on the Accounting PROFITS, Not
the Future Cash Flows.
4. AARR Measures Relative Size and Not Absolute
Size of the Return (Ballpark).
30
Payback Period (PP)
• The length of time it takes for an initial investment to

be repaid out of the net cash inflows from a project
• A manager using PP would need to have a maximum
payback period in mind.
The decision rules to be used are:
1. For any project to be acceptable, it must fall within
the REQUIRED payback period.
2. Where there are competing projects that meet the
REQUIRED payback period requirement, the project
with the SMALLEST payback period should be
selected.
31
Payback Period
Manitoba Railroad Limited (MRL) is considering spending $450 million to add new rolling stock. It is
estimated that the trains will last 15 years and the expected annual revenue increases are $55
million. MRL’s cost of capital (the interest or discount rate) is 7%. Calculate the Payback Period.
Discount Discount
Cash Cash Cumulative Cash Cash Rate @ ed Cash Cumulative
Year Outflows Inflows Cash Flows Year Outflows Inflows 7% Table Flows Cash Flows
0 (450) (450) 0 (450) (450)
1 55 (395) 1 55 0.9346 51 (399)
2 55 (340) 2 55 0.8734 48 (351)
3 55 (285) 3 55 0.8163 45 (306)
4 55 (230) 4 55 0.7629 42 (264)
5 55 (175) 5 55 0.7130 39 (224)
6 55 (120) 6 55 0.6663 37 (188)
7 55 (65) 7 55 0.6227 34 (154)
8 55 (10) 8 55 0.5820 32 (122)
9 55 45 9 55 0.5439 30 (92)
10 55 100 10 55 0.5083 28 (64)
11 55 155 11 55 0.4751 26 (38)
12 55 210 12 55 0.4440 24 (13)
13 55 265 13 55 0.4150 23 10
14 55 320 14 55 0.3878 21 3231
15 55 375 15 55 0.3624 20 51
Advantages of Payback Period Method
• Quick and easy to calculate
• Can easily be understood by managers
• Emphasizes liquidity
33
Problems with Payback Period Method
• Cash flows arising beyond the payback period

are ignored.
• PP only looks at the risk that the project will

end earlier than expected.
• PP is not linked to promoting increases in the

wealth of the business.
34
Week 11: Making Capital Investment Decisions:
Discounted Cash Flow Methods (DCF)
There are two superior methods of estimating the

results of investing in risky capital projects:
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
35
Net Present Value (NVP)
• Considers all of the incremental costs and incremental
benefits of each investment opportunity.
• Makes a logical allowance for the timing of those costs

and benefits.
The decision rules are:

• For any project to be acceptable, the NPV must be
positive.
• Where there are competing projects with positive

NPVs, the one that gives the highest positive NPV
should be accepted. 36
Net Present Value
Manitoba Railroad Limited (MRL) is considering spending $450 million to add new rolling stock.
It is estimated that the trains will last 15 years and the expected annual revenue increases are
$55 million. MRL’s cost of capital or discount rate is 7%. Calculate the Net Present Value.
a) By Calculator
CFo (450,000)
CF1 55,000
FOI 15
I/Y 7%
NPV $50,935
b) By Tables
I/Y 7%
N 15
PVIFA (Table A4) 9.1079
Annuity 55,000
PVo $ 500,935
CFo (450,000)
NPV $ 50,935
37
The Discount Rate and the Cost of Capital
• The appropriate discount rate to use in NPV

assessments is the opportunity cost of funds.
• This will normally be the cost of the mixture of

funds (shareholders’ funds and debt) used by
the business usually known as the weighted
average cost of capital.
38
Why NPV Is Superior to ARR and PP
NPV is a better method of appraising potential

investment opportunities than either ARR or PP
because it fully takes account of each of the
following:
1. The timing of the cash flows.
2. The whole of the relevant cash flows.
3. The objectives of the business.
39
Internal Rate of Return (IRR)
• Closely related to the NPV method in that, like NPV, it also
involves discounting future cash flows.
• The internal rate of return (IRR) is the breakeven discount rate

that makes NPV = 0.
• If the discount rate is higher than the IRR, then the NPV will be
negative.
• If the discount rate is lower than the IRR, then the NPV will be
positive.
• Chapter
IRR 5expressed as aCanada
- 40 © 2012 Pearson percentage.
Inc.
40
IRR continued
• The minimum required IRR is often referred to as the hurdle rate.
• It is usually the firm’s weighted average cost of capital (WACC).
The following decision rules should be applied:

• For any project to be acceptable, it must exceed the IRR
requirement.
• Where there are competing projects, the one with the highest IRR
should be selected.
41
Internal Rate of Return
Manitoba Railroad Limited (MRL) is considering spending $450 million to add new rolling stock.
It is estimated that the trains will last 15 years and the expected annual revenue increases are
$55 million. MRL’s cost of capital (the interest or discount rate) is 7%. Calculate the Internal
Rate of Return.
a) By Calculator
CFo (450,000)
CF1 (55,000)
FOI 15
I/Y 7%
IRR 8.75%
b) By Tables - By Extrapolation
I/Y 7%
N 15
PVIFA (Table A4) 9.1079
42
Week 12: Weighted Average Cost of
Capital
• The cost of capital is an essential element of
investment appraisal.
• The cost of capital is an opportunity cost that

reflects the returns that investors would expect to
earn from investments with the same level of risk.
43
The Firm’s Capital Structure:
Types of Capital
All of the items on the right-hand side of the
firm’s balance sheet, excluding current liabilities,
are sources of capital. The following simplified
balance sheet illustrates the basic breakdown of
total capital into its two components, debt
capital and equity capital.

Types of Capital – Debt Capital
• The cost of debt is lower than the cost of other
forms of financing.
• Lenders demand relatively lower returns
because they take the least risk of any
contributors of long-term capital.
• Lenders have a higher priority of claim against
any earnings or assets available for payment,
and they can exert far greater legal pressure
against the company to make payment than can
owners
Chapter ofPearson
5 - 45 © 2012 preferred
Canada Inc. or common stock.
• The tax deductibility of interest payments also
Types of Capital – Equity Capital
• Unlike debt capital, which the firm must
eventually repay, equity capital remains invested
in the firm indefinitely—it has no maturity date.
• The two basic sources of equity capital are (1)
preferred stock and (2) common stock equity,
which includes common stock and retained
earnings.
• Common stock is typically the most expensive
form of equity, followed by retained earnings and
then preferred stock.
• Chapter
Whether the firm borrows very little or a great
deal, it is always true that the claims of common

External Assessment of Capital
• A direct measure ofStructure
the degree of indebtedness is
the debt ratio (total liabilities ÷ total assets).
– The higher this ratio is, the greater the relative
amount of debt (or financial leverage) in the firm’s
capital structure.
• Measures of the firm’s ability to meet contractual

payments associated with debt include the times
interest earned ratio (EBIT ÷ interest) and the
fixed-payment coverage ratio.
• The level of debt (financial leverage) that is

The Risk/Return (CAPM) Approach to
the Valuation of Common Shares
• The risk/return approach is based on the idea
that the cost of a common share is made up of a

risk-free rate of return plus a risk premium.
• The risk premium is calculated by measuring the risk

premium for the market as a whole, then measuring
the returns from a particular share in relation to the
market, and applying this measure to the market risk
premium.
48
Calculating the Cost of Capital for Common
Shares Using CAPM
49
Risk Premium Calculation
Risk Premium Calculation
50
Capital Asset Pricing Model (CAPM) - Example
Blackbird Investments Ltd. Has recently obtained a measure of its Beta from a business information website. The beta
obtained is 1.2. The expected returns to the market for the next period are 15% and the risk-free rate on government
securities is 3%. What is the cost of capital of the common shares to the business?
Solution:
Ks = (Krf + ß(Km - Krf)
Ks = 3% + 1.2(15% - 3%)
Ks = 17.40%
51
Cost of Preferred Shares
• The cost of preferred shares can be derived in a

similar way to that of common shares where
the dividend stays constant:
52
Cost of Preferred Shares- Example
Blackbird Investments Ltd. has 12% preferred shares outstanding with a nominal
(par) value of $100. The shares have a current market price of $90. What is the
component cost of the preferred shares to the buiness.
Kp = Dp / Pp
Kp = 12%/(90/100)
Kp = 13.3%
53
After-Tax Cost of Bonds (Debt)
The after-tax cost of perpetual debt can be

derived in a similar way to that of common
shares where the dividend stays constant:
54
After-Tax Cost of Debt (Bonds) - Example
Blackbird Investments Ltd. Has a bond outstanding on which it pays an

annual interest of 10%. The current market value of the bond is $88 per
$100 of nominal value and the income tax rate is 20%. What is the capital
cost of the bond to the business?
Solution:
Kd = I * (1 - t) / Pd
Kd = 0.10 * (1 - .20) / ($88/ $100)
Kd = 0.091 or 9.1%
55
Weighted Average Cost of Capital
The weighted average cost of capital (WACC) is

derived by taking the cost of each element of
capital and weighting each element in
proportion to the target capital structure.
56
Calculating WACC
57
Weighted Average Cost of Capital – Example
Blackbird Investments Ltd. Has the following current Capital Structure. Calculate the firm's
weighted Average Cost of Capital.
Market Proportion of
Value Total Market Component
Capital Structure ($'millions) Value Cost WACC
Common Stock 20 0.44 0.174 7.7%
Preferred Stock 9 0.20 0.133 2.7%
Debt (Bonds) 16 0.36 0.091 3.2%
Total Capital Structure 45 1.00 13.6%
58
Weighted Average Cost of Capital –
Example
Common Stock Kcs = (Krf + ß(Km - Krf)
Kcs = 3% + 1.2*(15% - 3%)
Kcs = 17.40%
Preferred Shares Kps = Dp / Pp

Kps = (12% / ($90/100)
Kps = 13.3%
Debt Kd = I * (1 - t) / Pd
Kd = 10% * (1 - 20%) / $88/100
Kd = 9.1%
Market Value ($ Proprtion of Total

Capital Structure millions) Market Value Component Cost WACC
Common Stock 20 44.4% 17.4% 7.7%
Preferred Stock 9 20.0% 13.3% 2.7%
Debt 16 35.6% 9.1% 3.2%
Total Capital
ChapterStructure
5 - 59 © 2012 Pearson Canada Inc. 45 1.00 13.6%
59
Week 13a: Working Capital Management
The Main Elements of Working Capital
• Net Working capital is usually defined as

current assets less current liabilities:
• Net Working Capital = Current Assets – Current

Liabilities
60
Review - The Major Elements of
Working Capital
Current Assets
• Cash
• Accounts receivable
• Inventories
Current Liabilities
• Bank Overdrafts
• Trade Accounts Payable
•Chapter
Other Payables (payroll, taxes, etc.)
• Revolving Lines of Credit 61

Rick’s Third Fundamental Law of Finance
Matching (Hedging) Principle
Permanent investments in assets should be

financed with permanent sources of financing; and
Temporary investments in assets should be

financed with temporary sources of financing
62
Nature and Purpose of
The Working Capital Cycle
• Working capital represents a NET investment in short-term assets.
• These assets are continually flowing into and out of the business,
and are essential for day-to-day operations.
• The various elements of working capital are interrelated, and can

be seen as part of a short-term cycle
• The management of working capital is an essential part of the

business’s short-term planning process.
• It is necessary for management to decide how much of each

element
Chapter 5 - 63 ©should beCanada
2012 Pearson held. Inc.
63
The Working Capital Cycle
(for a Manufacturing Company)
64
Operating Cash Cycle
65
Calculating the Operating Cash Cycle
66
Example
GIVEN:
• All purchase and sales are on credit.
• WACC is 8%
• The corporate tax rate is 35%.
2014 2015
($'000,000) ($'000,000)
Accounts Receivable 175 160
Inventory 325 390
Accounts Payable 150 85
Credit Sales 2,681 1,775
Credit Purchases 2,378 1,000
Cost of Goods Sold 2,272 925
Required:
1. Calculate the Operating Cash Cycle
2.Chapter
Calculate the
5 - 67 © 2012 after-tax
Pearson Canada Inc.Cost of the Operating Cash Cycle.
3. Suggest ways the business might reduce this cost.

67
Using Financial Ratios from Chapter 4
Average Inventory Turnover Period
= (Average Inventory Held / Cost of Goods Sold) * 365
= ((Open. Inventory + End Inventory)/2/Cost of Goods Sold) * 365
= (($325+$390) / 2 / $925) * 365
= 141 Days
68
Using Financial Ratios from Week 6
Average Collection Period
= (Average Accounts Receivables/ Credit Sales) * 365
= ((Open. Accts Receivables + End. Accts Receivables) / 2 / Credit Sales) * 365
= (($175 + $160) /2 / $1,175) * 365
= 34 Days
69
Average Payment Period for Accounts Payable
= ((Open. Accounts Payables + End Accounts Payables) / 2 / Credit Purchases) *

365
= (($150+$85) /2 / $1,000) * 365
= 43 Days
70
Operating Cash Cycle

=
(Average Inventory Turnover Period)
+
(Average Collection Period for Accounts Receivable)
-
(Average payment Period for Payments)
= 141 + 34 – 43
Chapter 5 - 71
= 132 Days
© 2012 Pearson Canada Inc.
71
Calculating the Cost of the Operating Cash Cycle
1.Calculate the Operating Cash Cycle for 2015. # of Days
Average Inventory Turnover Period $358 925 141
Average Collection Period $168 1,775 34
Average Payment Period $118 1,000 -43
Operating Cash Cycle 133
2.Calculate the after-tax Cost of the 2015 Operating Cash Cycle.
Average $ Resources
% of Year Invested Invested
Average Inventory Turnover Period 38.6% $358 $138.2
Average Collection Period 9.4% $168 $15.8
Average Payment Period -11.8% $118 $(13.8)
Total Resources Invested $140.2

Chapter
Cost of 5 - 72Cash
Operating © 2012 Pearson
Cycle Canada
Before Inc.
Taxes WACC = 8% $11.2
Cost of Operating Cash Cycle After Taxes T = 35% $7.3

72
Calculating the Cost of the Operating Cash Cycle
What should the Firm do to improve the performance of the Firm?
73
Week 13b: Breakeven Analysis
• A company’s breakeven point occurs when its
sales equal its costs
• Often useful to determine the breakeven point
for a particular product line
• The breakeven point can be determined as
dollars of sales, but often helpful to divide the
sales by the selling price to obtain the number
of units the company must sell to break even
• Breakeven analysis is especially useful in
determining whether a new product for the
company might be successful
74
• Breakeven analysis is used to indicate the level
of operations necessary to cover all costs and to
evaluate the profitability associated with various
levels of sales; also called cost-volume-profit
analysis.
• The operating breakeven point is the level of

sales necessary to cover all operating costs; the
point at©which
Chapter 5 - 75 EBIT
2012 Pearson Canada Inc. = $0.
75
The first step in finding the operating breakeven
point is to divide the cost of goods sold and
operating expenses into fixed (FC) and variable
(VC) operating costs.
76
• Fixed costs (FC) are costs that the firm must pay in
a given period regardless of the sales volume
achieved during that period.
• Variable costs (VC) vary directly with sales volume.
• The difference between the selling price (SP) and

the variable cost (VC) per unit is called the
contribution margin (CM). 77

Assume that Cheryl’s Posters, a small poster
retailer, has fixed operating costs of $2,500. Its sale
price is $10 per poster, and its variable operating
cost is $5 per poster. What is the firm’s:
• SP
• FC
• VC
• CM
• Breakeven Point in units (BEPu)
78
BEPu = S / FC-VC
BEPu = S / CM
BEPu = $2,500 / $10 - $5
BEPu = $2,500 / 5
BEPu = 500 units
79
80
See Homework Exercises 1 – 5
81

Final Term MADS 6601 Financial Administration

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Final Term MADS 6601 Financial Administration

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Fairleigh Dickenson University

MADS 6601 Financial Administration

The Role of Pro-forma Financial Statements

• describe the predicted financial outcome of a particular course of action (Strategic)

• By showing the financial implications of certain decisions, managers should be able

to allocate resources in a more efficient and effective manner

Chapter 5 - 1 © 2012 Pearson Canada Inc.

Involves four major steps:

2. Forecast the sales for the period

 An increase in the level of sales is likely to lead to a need for:

 An increase in the level of sales should also lead to:

4. Prepare the pro forma financial statements.

PRO FORMA STATEMENT OF RETAINED EARNINGS

• Computes the closing balance in retained earnings

liabilities, and shareholders’ equity

• It should normally be the last of the four statements to be prepared.

preparing the pro forma balance sheet.

• All operating expenses

as a percentage of the net profit figure

Chapter 5 - 5 © 2012 Pearson Canada Inc.

expressed as a percentage of sales:

•Property, plant, and equipment will only be expressed as a percentage of sales if 6

Chapter 5 - 7 © 2012 Pearson Canada Inc.

2 Calculate the future value (tn) of an investment today (t0) and

3 Calculate the present value of a series of equal future payments

4 Calculate the present value of a series of unequal future payments

Chapter 5 - 9 © 2012 Pearson Canada Inc.

• Present Value – earlier money on a time line

Chapter 5 - 10 © 2012 Pearson Canada Inc.

5-10 © 2013 McGraw-Hill Ryerson Limited

• Compound interest is earned on the interest as

• When you “move” money to the LEFT it is

Chapter 5 - 11 © 2012 Pearson Canada Inc.

Chapter 5 - 12 © 2012 Pearson Canada Inc.

2.Exercise 1: Calculate the Future Values of the following Cash Flows

Chapter 5 - 13 © 2012 Pearson Canada Inc.

2.Exercise 2: Calculate the Future Values of the following Annuities

Chapter 5 - 14 © 2012 Pearson Canada Inc.

2.Pearson Calculator Tutorial 5: Present Value of a Lump Sum (Monthly

Chapter 5 - 15 © 2012 Pearson Canada Inc.

2.Exercise 4: Calculate the Present Values of the following Annuities

Chapter 5 - 16 © 2012 Pearson Canada Inc.

1.General TVM Buttons

2.Future Value of a Lump Sum (Annual Compounding)

3.Future Value of an Annuity

4.Present Value of a Lump Sum (Annual Compounding)

5.Present Value of a Lump Sum (Monthly Compounding)

6.Present Value of an Annuity

10.Yield to Maturity of a Bond 17

• A bond is a promise to pay a series of payments over time (the

• To determine the amount an investor is willing to pay for a

• Pearson Calculator Tutorial 8: Bond Valuation (Semiannual

• Conversely, falling interest rates cause all existing bond prices to

Chapter 5 - 19 © 2012 Pearson Canada Inc.

with a face value of $1,000, and interest paid every six

months. Using these assumptions, consider the

following three alternative scenarios:

If the market rate of interest for companies like Schultz (ie:

That is to say, that investors will pay $1,000 today for a

Thus, the bond would yield 8%.

Chapter 5 - 22 © 2012 Pearson Canada Inc.

In other words, the price of the bond would have to be high

The exact amount they would be willing to pay is determined by

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