Weekly Discussion Questions for Financial Systems Management

Week 1 Question 1: Which three areas discussed in Chapter 1 are most important to you?  Why are they important to you?

The first area in Chapter 1 that I found most important was the key question, “Will your decision create value”?  A manager that makes decisions that doesn't create value will not have a successful firm.  As an owner of a business you must possess the creativity and the drive to make your firm work.  As an owner this key question should be kept in mind when making every decision.  The outcome of the decision not only has an effect on you, but it affects all employees, vendors, and stockholders.  The outcome of a decision that does not create value could be detrimental to the firm. I feel that asking this key question is very important because if you don't have all the information, data, goal, and a plan you will not be successful in your firm.  Decisions that have value are they key to success.

The second area that is important to me is how profitable a firm is.  It is extremely important that a company is profitable in order to expand operations into new marketplaces and gain an increase in market share.  The more profitable a company is the greater return on shareholders’ equity; the main goal of management should be to increase shareholder wealth.  I feel how profitable a firm is determines how successful the firm is.  When a firm is profitable they are able to expand, stay competitive and be successful, without profit, you are unable to keep the firm growing.

The third area that I found important is how risky a firm is.  The economic environment must be taken into account when running a firm.  Without taking risk in a high risk economic world, a firm will fall behind.  Questions that a firm’s owner might ask themselves:  Is the economy strong enough to support the business model?  Is the product in demand and is it affordable to the public?  Are there other companies that produce products similar to yours?  All these factors can increase the risk to the owner and the firm’s shareholder but if the firm is not willing to take risk and be competitive it will hurt the overall profit of the firm.  It is scary to take risk, but I feel in order for a firm to be successful and competitive they must take risk. 

Reply: Jessica, I feel that making decisions that build value not just for the business but within the employees, suppliers, and stockholders are very important.  When I worked construction all of my vendors were always happy to bend over backwards for me as I was one that made ethical choices, paid my bills on time, and created value for their business as well.  I knew of several business that made poor decisions that did not create value for the organization which in the long term caused them to have to close their business and file bankruptcy.  With a large firm it can cause for high turnover rate, poor quality workmanship from their employees as well as their suppliers, and a decrease in customer base.  This is why I feel that creating value in all of these areas are important for success. I agree that a business needs to be profitable but those that are too greedy and grow too fast too quick can be in trouble as well.  There have been many businesses that were successful but became greedy.  When a business takes on more work than what it can handle it will be late for deliveries, quality of craftsmanship will decrease as

employees are rushed through their jobs, and customers will begin to look elsewhere.  An organization needs to know how much to grow and at what pace.  When a new business is formed the owner is taking the risk but based on the size of the organization other peoples money may be invested as well.  The real question is how much and what level of risk is one willing to take?  We talk about this at work especially in our work conditions.  Some of my fellow co-workers wife's have issues with what we do and ask if the risk is worth it.  I have spoken with my family and explained to them that chances of something horrible happening here are less likely than me driving down the highway everyday for work.

Question 2: The first area in Chapter 2 that I find most difficult to understand is the accrual accounting.  I understand what the realization principle is and how the revenue is recorded on the balance sheet, but the matching principle is what I am getting caught up on.  I have re-read the information in the chapter and researched it on the internet in an attempt to have a better understanding of what an accrual accounting is.  The second area that I am having difficulty understanding is the operating profit.  I understand what the basics of what an operating profit is but the special items that fall under the operating profit is confusing me.  In order to better understand an operating profit I have read the chapter, searched the internet, had a conversation with a business major, and viewed the presentation in week 1 on chapter 2.  I am hoping once I get more familiar with the income statement during the class, I will gain a better understanding.The third area that I lack understanding is accrued expenses.  I understand the definition of what accrued expenses are and how they fall into the balance sheet, but I have a hard time making a distinction between what constitutes an accrued expense and  what would constitute an account payable or short term debt.  I understand the definitions just have a hard time placing them in the balance sheet.  They just seem to be very closely related in nature.  Again, I have read the chapter and searched the internet for clarification.  I am hoping this course will provide me with a better understanding of how accrued expenses fall on the balance sheet. Hello Jess,Thank you for a concise discussion!  The accrued expenses are often confusing to people; so you are not alone.  For example, a company purchased a one-year real estate property insurance at $1,200.  So the monthly insurance premium expense is $100 ($1,200/12=$100).  Say after Month 1, nothing bad happened so the firm did not make any claim.  But you still accrued $100 in insurance expense.

Week 2Question 1: The first concept I found important was the operating activities and operating cycle.  I found these two things to go together.  An operating activity is the sales and profits from the firm’s assets.  There are four stages that make up the operating cycle.  They are as follows:  procurement, production, sales and cash (Hawawini & Viallet, 2011, p.68).  A firm’s balance sheet is directly related to the operating cycle. 

The second concept in chapter 3 I found important was the managerial balance sheet.  Items that are listed on the managerial balance sheet are cash, required assets to support the firms, and fixed assets.  The managerial balance sheet allows the firm to keep track of what assets the managers.  I found this tool important because it helps to demonstrate the difference between the investments made by the firm’s owners and the contributions that managers make to the firm.  The chart on page 66 of the textbook does a great job showing the differences between a managerial and standard balance sheet.

The third concept that I found to be important was the inventory turnover also referred to as the inventory turns.  The formula and definition is as follows:

     Inventory turnover = Cost of goods sold                                 ___________________                                                                                                                                                                                                                            Ending inventories                                                                 

I feel this is important because when a firm has a large amount of inventory turnover, they are doing good business and making profits.  It is not good business having inventory sitting around and not being sold; overtime items can depreciate in value or go bad.   

Hawawini, G., & Viallet, C.  (2011). Finance for executives: Managing for value creation. Mason, OH: South-Western Cengage Learning.

The managerial balance sheet in my work experience seems to be equivalent to a business plan and operating plan.  The business plan is what the plant is working towards.  The operating plan is what is actually being spent.  We recently had an issue where the business plan was missing two key transactions.  When the operating plan was reviewed the transactions were added based on a forecast of purchasing a new products from a new vendor.  This led to quite a discussion amongst management because of the extreme cost.  This was a lesson learned for me, the cost was driven by plant management, but was not communicated to his management.  So when the higher up was reviewing this was questioned and an answer was required.  So in short, the new vendor was canceled and now no product is received a cancelation cost is being incurred.  So if a managerial balance sheet was not used this excess cost would not have been caught.  So now I can see the importance of a managerial balance sheet to provide managers with the information required to make the appropriate decisions that can positively or negatively affect the company.

Question 2: Which three areas discussed in Chapter 4 are most difficult for you to understand? What have you tried to understand these materials?

The first area in chapter 4 that I found difficult to understand was cash flow from assets or free cash flow.  According to Hawawini & Viallet (2011), it is defined as, “a measure of the total net cash flow generated by the firm excluding all financing transactions” (p. 120).  I am not sure what this definition means, but I am re-reading the textbook and searching on the internet as well.  The equation provided in the chapter totally threw me off as well. 

The second issue that I had trouble understanding was cash outflow SG&A and tax expenses.  I understand what the definition means, but I am having trouble putting it all together when I look at the formula that is provided in the textbook.  What exactly does a change in prepaid expenses and a change in accrued expenses mean?  Does it mean just that, things have changed, there is either more or less of them?  I am going to continue to look for explanations and hope to get a better understanding.  The third item I am having a hard time understanding is the indirect method of cash flows.  I have read the text book a few times and still do not understand this method.  How do the earnings after taxes and other adjustments not relate to the operating activities of the firm?  I will continue to read the chapter and search on line for other definitions and examples.  This one really has me stumped. 

Hawawini, G., & Viallet, C.  (2011). Finance for executives: Managing for value creation.

Mason, OH: South-Western Cengage Learning.

Gross profit (Gross margin)= Revenues - COGS

Operating profit (operating margin) = Revenues - COGS - SG&A= Gross margin - SG&A= EBITDA [Earnings Before Interest, Taxes, Depreciation and Amortization]

EBITDA - D&A= EBIT

EBIT - I= EBT(Earnings Before Taxes)

EBT - T= NI [Net Income]= EAT [Earnings After Taxes]

Week 3: Question 1: Which three areas discussed in Chapter 5 are most familiar (or least challenging) to you?  Why?

The first area in chapter 5 that was most familiar to me was return on sales (ROS).  According to Hawawini & Viallet (2011), ROS is used to, “measure the profit generated by one dollar of sales; used to measure the ability of managers to generate profits from the firms sales”. (p. 145).  I found ROS to be very easy to calculate using the equation that is shown in the textbook.  I also found ROC easy to understand and the concept didn’t overwhelm me, it seems pretty straight forward.The second area in chapter 5 I was familiar with was the financial structure ratio.  This ratio calculates the ratio of, “invested capital to the firm’s owners’ equity” (Hawawini & Viallet, 2011, p. 152).  This ratio was easy for me to understand and easy for me to put into use.  Every organization will have a different financial structure ratio based on the needs and demands of the company (Investopedia).  The ratio is as follows:

                               Financial Structure Ratio = Invested Capital /Owner’s Equity

 

The third area that I am feeling comfortable with was the debt –to-equity ratio.  I found this ratio very easy to understand and it makes sense to me when I put it into practice.  The debt –to-equity ratio is simply the debt divided by the owner of the firm’s equity.  I think the text book and other internet sites I have look at do a great job explaining how these three areas work and where they fall in a firms financing. 

Hawawini, G. & Viallet, C. (2001).  Finance for executives:  Managing for value creation.  Mason, OH: South-Western Cengage Learning.Financial structure (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/f/financial-structure.asp

Professor Dishman,The advantage of using this expanded version of the ROE formula versus the simplified version which is net income divided by the total equity is that the expanded version provides more insight into a firm's operation. 

ROE= PM x TATO x EM

PM reflects the efficiency of the firms operationsTATO measures the ability of operationsEM reflects the use of leverage, using other's money to make money.

Question 2: Which three areas discussed in Chapter 9, Sections 1 - 3 (pages 277 - 294) are most important to you?  Why are they important to you?The first area in chapter 9 that I found important was the way in which a firm estimates the amount of external funds that they will need for the next financial period; this is called the funding needs.  The funding needs calculation is as follows:  “Funding needs= a change in cash + a change in WCR+ a change in fixed assets” (Hawawini & Viallet, 2011, p.278).  There are two reasons that a firm must estimate a funding need.   A firm must know, “the amount by that its investments are expected to grow and the amount of internal funds the firm expects to

generate in the coming year” (p.278).  This is important to an organization because they will use this to help figure out their finances for the upcoming year.The second area in chapter 9 I found important was domestic versus international markets.  This is very important because the United States conducts a large amount of business with domestic and international markets.  Before reading about this in the textbook I had a good understanding of what the concept of domestic and international markets were.  Domestic and international markets allow firms and organizations to increase their sales by opening up their selling fields.  These are important to me because they have an effect on the economy and my financial investments.The third area of chapter 9 I found to be important was direct and indirect financing.  These were pretty easy to understand.  Indirect financing has a more difficult time selling their goods directly to investors; this is not the case with direct financing.  Direct financing has a direct relationship with the financial markets and transactions take place directly.  Direct and indirect financing are important to me because they can play a role in the economy and effect different things that play a part in my life.Hawawini, G. & Viallet, C. (2001).  Finance for executives:  Managing for value creation.  Mason, OH: South-Western Cengage Learning.

In healthcare, the whole exercise of forecasting year-end results has been and is continuing to be very challenging. Patient volume assumptions (and the corresponding revenue) we all made at the beginning of the major economic downturn a couple years ago were significantly off target since most of us didn’t predict how the economy would behave. Luckily my hospital  was at least smart enough have developed contingency plans that allowed us to mitigate some of the losses through strictly staffing to volume and severely limiting capital expenditure. This helped us minimize the cash outflow.

As difficult as predicting the economy is, it’s probably even harder to predict the effects of possible changes in the CMS payment structure, changes in revenue from ICD -10 adoption,  and if  certain elements of the Accountable Care Act (ACA) will come to pass. For instance, if the individual mandate actually takes effect, this will probably significantly drive up volumes since a whole new group of people will have insurance coverage.

As an example of how unexpected changes in CMS reimbursements can affect hospitals, let me just relay an experience our hospital had 3 years ago. Our Cath Labs were a high volume high profit part of our business. A major part of this business came from procedures cardiologists were ordering. One of those procedures was used as a rule-out procedure for certain heart conditions. However, unexpectantly, midway through our fiscal year, CMS quit reimbursing the cardiologist for this procedure as an appropriate rule-out test. All of the sudden the cardiologists stopped ordering this procedure and our volume dropped considerably.

For hospitals, projecting what external funds will be needed throughout the upcoming year is a very uncertain process. I suspect what this does is drive hospitals to increase their cash reserves to hedge against

Week 4:

Question 1: 1. Which three concepts discussed in Chapter 6 are most unclear to you? Why?

2. What are the differences between a single amount (lump sum) and an annuity? Please explain the differences through examples.

The first concept in chapter 6 that is most unclear to me is the discounted value or present value (PV).  This concept is totally foreign to me as I have never had any experience with this type of financial things.  I did more reading on it and according to Investopedia, “present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows”(Present Value, Investopedia).  After reading this it makes a little more sense, but not a lot. 

The second concept that is unclear to me is the net present value rule.  I am at a total loss with the two-period investment without an intermediate cash flow and with a cash flow, and then the multiple-period investments.  I look at those equations and I don’t even know where to start.  I am sure the more experience and the more I learn about them they will become clearer, I hope!

The third concept that is unclear to me is the constant annual-equivalent cash flow or annuity-equivalent cash flow.  According Invesopedia, Equivalent Annual Annuity (EAA) is one of two methods used in capital budgeting to compare mutually exclusive projects with unequal lives. The equivalent annual annuity (EAA) approach calculates the constant annual cash flow generated by a project over its lifespan if it was an annuity” (Equivalent Annual Annuity, Invesopedia).  Investopedia offers a great example of EAA with a three step process to compare projects: 

1. Calculate each project's NPV over its lifetime.

2. Compute each project's EAA, such that the present value the annuities is exactly equal to the project NPV.

3. Compare each project's EAA and select the one with the highest EAA.

 

Present Value. (n.d.). Investopedia.  Retrieved from http://www.investopedia.com/terms/p/presentvalue.asp

Equivalent Annual Annuity. (n.d). Investopedia.  Retrieved from http://www.investopedia.com/terms/e/equivalent-annual-annuity-approach.asp

The difference between a single amount (lump sum) and an annuity is that a lump sum is a one-time payment for the total or partial value of an asset. “A lump-sum payment is usually taken in lieu of recurring payments that would otherwise be received over a period of time” (Lump Sum, Investopedia).  An example of lump sum is retirement packages.

 An annuity is a contract between you and an insurance company in which you make a lump sum payment or series of payments and in return obtain regular disbursements beginning either immediately or at some point in the future.  A bond is an example of an annuity (Annuity, Invesopedia).

The difference between the two is with a lump sum, the payment is taken at one time and with an annuity the payments are made in a series. 

 

Annuity. (n.d). Investopedia.  Retrieved from http://www.investopedia.com/terms/o/ordinaryannuity.asp

Lump Sum. (n.d). Investopedia.  Retrieved from http://www.investopedia.com/terms/l/lump-sum-payment.asp

I am also finding chapter 6 challenging. The examples provided especially for compounding multiple period investments is extremely confusing to me. It seems like we are not getting all the information to be able to properly use Excel. It would be nice to just have a listing of the exact formulas we will need to know for our practice questions and our exams with an example of how that formula was found in the spreadsheet to help with the understanding of this chapter. I continue to work on the self test questions, struggling to find the solutions listed using excel. I hope Saturday's VC provides clarification and help in the set up and use of formulas that will help with our exams.

Question 2: What are the differences between an ordinary annuity and an annuity due? Please explain the differences through examples.

According to Investopedia, the difference between an ordinary annuity and an annuity due is “an ordinary annuity is a series of equal payments made at the end of each period over a fixed amount of time and can be paid every week if wanted”.  Unlike an ordinary annuity, “an annuity due payment is due right away, not at the end of the period” (Ordinary annuity and An Annuity, Investopedia).An example of an ordinary annuity is the interest payments from bond issuers and quarterly dividends.  An annuity example is that of a lease agreement, the first payment is due right away and the remainders are due at the end of the month (Ordinary annuity and An Annuity, Investopedia).

Ordinary Annuity.  (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/o/ordinaryannuity.aspAn Annuity. (n.d.)  Investiopedia.  Retrieved from http://www.investopedia.com/terms/a/annuity.asp

What does our text say about the differences between an ordinary annuity (OA) and annuity due (AD)?

One way to describe an annuity as "equally sized" is: Equal amount and equal interval (year, quarter, month, week, day). From this description, you can expand to OA and AD.

Also, in TVOM calculations, PMT is always part of the equation. When you calculate PV or FV of a single amount, PMT = 0. Thus you will enter PMT = 0 in your formula.

Suppose your friend just had a baby. Here is a question for her. And you will solve the problem on her behave.

To save for your baby's college education, you invest $100 a month at the end of each month in a stock mutual fund. Assume you can earn 12% a year and do not withdraw any funds. After you make these end-of-month investments for 18 years, how much is there in the account for the baby?

Professor Dishman,Correction, the correct answer is

$76,543.92This is for the Beginning  (AD).

Week 5

Question 1: Which three concepts discussed in Chapter 6 are most unclear to you? Why?

Which three computations demonstrated in the TVOM Excel file (see Doc Sharing) are most challenging to you? Why?The first concept in chapter 6 that is most unclear to me is the discounted value or present value (PV).  This concept is totally foreign to me as I have never had any experience with this type of financial things.  I did more reading on it and according to Investopedia, “present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows”(Present Value, Investopedia).  After reading this it makes a little more sense, but not a lot. 

The second concept that is unclear to me is the net present value rule.  I am at a total loss with the two-period investment without an intermediate cash flow and with a cash flow, and then the multiple-period investments.  I look at those equations and I don’t even know where to start.  I am sure the more experience and the more I learn about them they will become clearer, I hope!

The third concept that is unclear to me is the constant annual-equivalent cash flow or annuity-equivalent cash flow.  According Invesopedia, Equivalent Annual Annuity (EAA) is one of two methods used in capital budgeting to compare mutually exclusive projects with unequal lives. The equivalent annual annuity (EAA) approach calculates the constant annual cash flow generated by a project over its lifespan if it was an annuity” (Equivalent Annual Annuity, Invesopedia).  Investopedia offers a great example of EAA with a three step process to compare projects: 

1. Calculate each project's NPV over its lifetime.

2. Compute each project's EAA, such that the present value the annuities is exactly equal to the project NPV.

3. Compare each project's EAA and select the one with the highest EAA.

 

Present Value. (n.d.). Investopedia.  Retrieved from http://www.investopedia.com/terms/p/presentvalue.asp

Equivalent Annual Annuity. (n.d). Investopedia.  Retrieved from http://www.investopedia.com/terms/e/equivalent-annual-annuity-approach.asp

The first computation that is demonstrated in the TVOM Excel file that was most challenging for me was the Uneven Cash Flows.  I found this to be challenging because I do not understand how you’re coming up with the PV from the numbers that are given.  I don’t understand how the values change from stream A to stream B.  I am going to try and do some more reading on uneven cash flows and play around with Excel to see if I can understand it better. 

The second computation that I found most challenging in the TVOM Excel file was Effective vs. Nominal Rate.  I keep reviewing the spreadsheet and it is just not making sense to me.  How do you calculate the EAR?  And I have absolutely no idea what the chart below means?  I will keep trying to understand, but I am going to need some help on this one!

EAR= (1 + 3.5%/365)365 - 1= (1 + 0.035/365)365 - 1= (1 + 0.00009589)365 - 1= (1.00009589)365 - 1= (1.00009589)365 - 1= 1.035618 - 1= 0.035618= 3.5618%

 

The third computation that I am having a hard time understanding is Reaching a Financial Goal.  Again, I am lost on where some of the values are generated.  For example, what is PMT last and how to you get that value?  This is going to take some time for me to understand.  I have tried to figure out the example on the excel sheet and I am not having any luck, but I will keep at it and look forward to any input and advice.

Jessica,

with regard to nominal and effective annual rates (EAR), simply use the Excel formula =EFF. If you put in your nominal rate and the number of periods, it gives you the effective rate. So, for instance,   if you have a nominal rate of 12% and you want to find out what the EAR is if interest was compounded monthly for 12 months, the Excel  entry would be =EFF(.12,12) and the result is .126825. The effective rate is always more then the nominal rate since, when compounding monthly, your monthly interest income is earning interest in each subsequent month as the year goes on. The chart you posted is just the actual math that happens for that particular example and although it does illustrate what is actually happening when the =EFF formula is used, you don't have to understand what is happening with the math(although sure, that would be better)  to use

the =EFF and get the answer.

With PV of uneven cash flows, what you are doing is essentially calculating the PV of each future cash flow individually and adding them together to get the total combined PV of all the cash flows.  So if you have cash flows of 100, 200, 300  for  the next three years, you are calculating the PV of 100 in one year, 200 in two years, 300 in three years and adding them together. In Excel you want to use the formula =NPV in which you enter the discount rate and then all of the individual cash flows. So in this example and using a 12% discount rate, the Excel entry would be =NPV(.12, 100,200,300). What you will notice in Dr Dishman's example in the TVOM spreadsheet is that instead of entering the actual cash flow values, she entered the range of cells where the values are found. So in her example A, her entry of =EFF(.08,B9:B13), the B9:B13 refer to the values in those cells...100,400,400,400,300. You can actually just enter the numbers individually and get the same answer. Using a range of cells is just quicker, especially when there are a lot of them.  So just remember, if calculating PV of uneven cash flows, just use the Excel formula =NPV.

Now to extend this concept, if you had to make an initial investment in order to generate these future cash flows, you would want to add that investment amount into the formula. So, let's say that you invested  $500 with 12% discount rate to generate three years of cash flow of 100,200,300. Now the formula would be = -500+NPV(.12, 100,200,300) = -37.74. notice the 500 is negative since that is your  cash outflow used for the investment. The -37.74 is the difference between the PV of the future cash flows and the initial investment cost...$462.26 and $500. In this case, the NPV is negative so it's not a good investment. So again, to calculate the NPV of an investment with variable future cash flows, use the Excel formula =X+NPV where X is the initial investment.

Question 2: How much do you need to save each month for your retirement? This calculation is based on your unique (1) amount of money already saved (PV), (2) time horizon – number of years until retirement (N = Years), (3) expected annual investment return (I/Y), and (4) retirement savings goal (FV).

Here is my financial calculation on how much I will need to save for my retirement.

(PV)- The amount of money already saved up       = - $32,0000

Rate (Interest per period) = 12% / 12 = 1%

Nper (Number of periods) (years) (PMTs) = 27 x 12 = 324

FV (Retirement Savings Goal)  = $100,000.0

PMT = $83.23

This is what I came up with on Excel.  Doesn't sound too bad!  If I ever get to retire that is!

Week 6

Question 6: 1. How would you evaluate capital investment projects with different life span and different sizes of initial investments by using Payback Period (PP), Net Present Value (NPV) methods? Describe one example for each scenario to substantiate your point of view.

2. How would you evaluate capital investment projects with different life span and different sizes of initial investments by using Internal Rate of Return (IRR), and Profitability Index (PI) methods? Describe one example for each scenario to substantiate your point of view.

According to Investopedia, the payback period is, “the length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions”(Payback period, Investopedia).  From my calculations I found that Project A has a shorter payback period than that of Project B and therefor is a better investment for the organization.  Payback Period = Cost of Project/ Annual Cash Inflows

 

The following is an example of an organization’s Project A and B.

Project A Project B

Year 0 $-2,000.00 $-5,000.00Year 1 $1,000.00 $3,000.00

Year 2 $500.00 $2000.00Year 3 $150.00 $800.00

Year 4 $50 $500.00

Year 5 0 $375.00The Net Present Value (NPV) is defined as “the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project” (Net Present Value, Investopedia). NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. 

 

Using Excel in TVOM and assuming the discount rate is 10% and the annual cash flows are at the years end, the PV of Project B is the greater future cash flow and has a greater value that the initial investment, the organization should invest in Project B. 

NPV for Project A = $1469.16   =NPV (10%, 1000, 500, 150, 50, 0)NPV for Project B = $5555.57   = NPV (10%, 3000, 2000,800,500,375)

Payback Period (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/p/paybackperiod.asp

Net Present Value(n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/n/npv/asp

Question 2: What are the three most difficult concepts or calculations in Chapter 8 from your perspective?  What learning strategies or methods did you use to overcome the challenge and gain an understanding of the materials? 

The first difficult concept and calculation in chapter 8 for me was NPV project.  Again, like other equations and calculations that I have read about in our text book, I understand for the most part the definition of NPV project, but the calculation has me beyond confused.  According to Investopedia here is a great definition and the equation for NPV:  “The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.  NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield” (Net Present Value, Invesopedia).   To attempt to better understand NPV and NPV project I will continue to look for clarifications and examples on the internet and re-read my text book.  I will also attempt to use the calculation in Excel. 

The second concept and calculation that I found difficult was how to measure the cash flows that are generated by a project.  Investopedia provided the following calculation for measuring cash flow generated by a project:  EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure.  The equation doesn’t appear to be too difficult to figure out the cash flows generated, but the concept doesn’t really make much sense to me.  Again, I will continue to use the internet and our textbook to better understand the cash flows generated by a project.   

The third concept and calculation that I found to be a little difficult is a projects terminal cash flow.  I really appreciated the definition and explanation, example that Investopedia provides.  “This is the final cash flow, both the inflows and outflows, at the end of the project's life; for example, potential salvage value at the end of a machine's life”(Terminal cash flow, Investopedia).  The calculation process that was shown in our text book totally confused me.  Like concepts 1 and 2, I will be re-reading and using excel to try and attempt to gain a better understanding of these concepts and calculations.  Investopedia is a great web site that I will also be using as a reference. 

Net Present Value (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/n/npv.asp

Free Cash Flow (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/f/freecashflow.asp

Terminal cash flow (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/walkthrough/corporate-finance/4/capital-investment-decisions/project-cash-flows.aspx

Jessica, regarding your struggle with NPV of project cash flows, maybe let’s think of it this way…

From a cash perspective, a project is just a combination of cash inflows and outflows. You have to invest some cash to get started, you are going to generate income along the way, but you will

(usually) also have to invest additional funds along the way to buy materials and pay wages, etc., and then if a project has a fixed life, there will be the terminal cash flow…the income/expenses that result from the project ending. These terminal cash flows may include cash inflows such as the  liquidation of assets, but also possibly cash outflows if for instance, you were leasing a building for the project that you had renovated and were obligated to return it to its original state after the lease expired.

So again, project cash flows are just a series of cash inflows and outflows. Setting NPV aside for a moment, it would be pretty easy to figure out the profitability of a project…just add up all the cash inflows and outflows and see what the balance was at the end…just like you do in your personal checkbook. You can look at the balance at the beginning of the year (your initial investment) do the math for all of your deposits and checks, and then compare the ending balance to the beginning balance to see if you had a net gain or loss for the year.

But we know based on the TVOM concept that $1 in the future has less value than $1 today. So basically we have to convert all those future cash inflows and outflows into today’s dollars. This is the discounting process. And then, since we know that PV’s are additive we simply add together all of the PV’s of all the cash flows. At the end of this process we are going to either have a positive or negative number. Positive is good, we made money. The more positive the better. A negative result is bad, we lost money.

So that is it conceptually. Now, the text typically walks you through all the actual math so you could do all the calculations by hand. But we are never going to do that so you can sort of just ignore the math in the book (not sure that would be Dr Dishman’s advice though, haha). Excel does all the math for you. All you have to do is tell Excel that you want to calculate the NPV (=NPV) of a series of periodic net cash flows, tell it what discount rate to use, and away you go. What you must remember is to make sure your cash outflows are negative and inflows are positive.

My sense is that although you say you are having trouble with the calculation, you are probably just having a hard time getting the right data into the Excel formula correctly. After all, Excel does all the calculations.

For almost all of the calculations that we have to make related to PV, NVP, other TVOM related equations, IRR, PI, etc., Dr Dishman has provided Excel examples to follow so you can basically follow her template and plug in your numbers.

Week 7

Question 1: 1. Which three areas discussed in Chapter 10 are most difficult for you to understand? What questions do you have?

2. Which three areas discussed in Chapter 11 are most difficult for you to understand? What questions do you have?

 

The first area in chapter 10 that is most difficult for me to understand is the dividend discount model (DDM).  According to our text book it is defined as, “the price of a share should be equal to the present (discounted) value of the stream of cash dividends shareholders are expected to receive” (Hawawini & Viallet, 2011, p. 325).  I have re-read the definition and understand what it is explaining and I have reviewed the equation on page 325, but I do not understand how to calculate the dividend discount.  Do you use excel to calculate this equation?  I went through the financial formulas on excel and do not see a formula for DDM.   

The second area of chapter 10 that is difficult for me to understand is the asset beta and market beta.  I understand what the definitions are about; asset beta is “the beta of a stock when the firm is all-equity financed” (Hawawini & Viallet, 2001, p. 333). This makes sense to me. Market beta is defined as, “the beta of a stock when the firm has borrowed” (Hawawini & Viallet, 2001, p. 333).  This also makes sense to me; it is when I get to the equations I get confused and it doesn’t make sense to me.  How do you calculate these equations?   Are asset beta and market beta used frequently in the financial world?  The third area of chapter 10 that is difficult for me to understand is weighted average cost of capital (WACC).  According to Investopedia, weighted average cost of capital is defined as “a calculation of a firm's cost of capital in which each category of capital is proportionately weighted.  All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation”(Weighted Average Cost of Capital, Investopedia).Here is the equation:

WACC=  E                      D             ____   * RE + ____  *  RD  (1-Tc)

               V                       VI have no idea where to start trying to calculate this equation.  I understand the meaning behind the equation, but I am lost with the equation.  Again, I did not see a financial formula in excel so I am assuming WACC needs to be calculated by hand?

 

Hawawini, G., & Viallet, C. (2011). Finance for executives: Managing for value creation. Manson, OH: South-Western Cengage Learning Weighted Average Cost of Capital (n.d.). Investopedia.  Retrieved from http://www.investopedia.com/terms/w/wacc.asp

Jessica,

The DDM is just one way to approximate the cost of equity which is a component of WACC. Unfortunately, it is not a very useful one and Hawawini and Viallet (2011) suggest it is rather unrealistic and unhelpful for most companies (Hawawini & Viallet, 2011). I suspect that it is mostly discussed as a way to provide some foundational construct to better understand the more useful techniques for calculating cost of equity such as the capital asset pricing model (Hawawini & Viallet, 2011). That is my take on it anyway.

My suggesting is that you don’t try to calculate the beta or even worry about how it is calculated or about the equations. A public company’s beta has already been calculated for you and is available on any number of financial information websites.  It seems the   important thing is to know what the beta value represents which is the level of stock price variability that will occur due to systemic risk as compared to the overall market. Basically, if the beta is over 1 then the stock price will experience greater variability and when the beta is under 1, it will be more stable and immune from systemic risk (Hawawini & Viallet, 2011). 

WACC is just a little math and all you need to do is plug values into the variables of the equation. The amount of debt, equity and tax rate are usually known so that is easy. Once you know the amount of debt and equity, you can then figure out what percentage of capital each accounts for (For instance, % debt = debt/debt +equity). Plug the corporate tax rate into the (1-tax rate) portion of the equation. Then you move to the harder steps of calculating the individual cost of debt and equity as described by Hawawini and Viallet (2011).

Hawawini, G., & Viallet, C., (2011). Finance for executives: Managing for value creation. Manson, OH: South-Western Cengage Learning

Question 2: Which three calculations discussed in Chapter 9, Sections 4 and 5 (pages 294 - 314) can be linked to your learning in preceding chapters?  How has your prior learning in this course and elsewhere prepared you to learn the materials in these sections?

The first calculation from chapter 9 that I can link to other chapters of our text book is the present value of the cash flows expected from the bond.  I found through excel how to calculate this equation and was able to come up with the correct answer while doing so.The second calculation that I can link from chapter 9 to other chapters is the Zero Coupon Bond price.  To calculate the Zero Coupon Bond price you will need to the PV (Present Value) function of the spreadsheet.  According to Investopedia, Zero Coupon Bond is, “A debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value, also known as an accrual bond”(Zero Coupon Bond, Investopedia).The third calculation that can be linked from chapter 9 to previous chapters is the dividend discount model (DDM).  The sum of the present value is needed in this equation to calculate the equation and get your results.   

I can relate all three of these equations from chapter 9 to previous chapters because they all need and use the Present Value (PV) to get the result from the equation.  My prior learning in this course thus far has helped me have a better understanding of how the results are obtained from these equations in chapter 9.  It seems that the present value is a large part of many financial equations and I am glad I have an understanding of what present value is and it has really helped me learn and be able to relate to the equations better in chapter 9.  I have a few savings bonds and have purchased savings bonds for my nieces and nephews in the past and I understood how they worked a little, but now after reading chapter 9, I have a better understanding of them and their values. 

Jessica the present value equation has helped me in this chapter as well. PV is one formula that I know well and since the instructor has given us a calculation page that has also helped me out a lot with these equations.

Week 8

Question 1: What are the three most difficult concepts or calculations in Chapter 12 from your perspective? What learning strategies or methods did you use to overcome the challenge and gain an understanding of the materials?

The first most difficult calculation from chapter 12 for me was the DCF value.  According to Investopedia, Discounted Cash Flow( DCF) value is defined as “a valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital to arrive at a present value, which is used to evaluate the potential for investment” (Discounted Cash Flow, Investopedia). The learning strategy that I used to overcome this learning challenge was our textbook and Investopedia.  Although I do not have a good understanding on how to use the financial formula, I do understand the meaning of DCF.  The second most difficult calculation that I found in chapter 12 was the Asset Beta.  I am still struggling with understanding how to perform the equation from chapter 10.  According to our textbook, Asset beta is defined as, “the beta of a firm’s stock if the firm is all equity financed” (Hawawini & Viallet, 2011, p. 616).  The learning strategy that I used to understand this difficult calculation was our textbook.  I re-read the definition and studied the equation, but I still don’t have a great understanding on how to do the calculation.  I am hoping with our discussions and our class live on Saturday night I will get a better understanding.The third difficult calculation from chapter 12 I found was how to estimate the cash flow from the business assets up to a certain year.  I do not really understand why a business would use this financial formula and what benefit they would get from using it.  The learning strategy that I used was reading our textbook and searched the internet.  I am looking forward to our class discussions in hopes my classmates can shine some light on this for me. 

Discounted Cash Flow. (n.d.).  Investopedia.  Retrieved from

http://www.investopedia.com/terms/d/dcf.asp 

Hawawini, G., & Viallet, C. (2011). Finance for executives: Managing for value creation. Manson, OH: South-Western Cengage Learning

The DCF is an application of PV of uneven cash flows.  There is one tab in my TVOM Excel template that provided to you in Week 4.

Week 9

Question 1: In connection with Chapter 13, which three economic, business, and financial risks can you identify based on your professional experiences thus far? How these risks have affected the financial outcomes of the organizations with which you have been associated?

The first risk that I could identify based on my professional experience from Chapter 13 was foreign risk.  According to Investopedia, a foreign risk is, “a risk that usually affects businesses that export and/or import, but it can also affect investors making international investments” (Foreign risk, Investopedia).  Although I really have no direct connection as far as the financial decision making goes in my institution, I am sure the financial team keeps a close eye on what is happening with their foreign investments. The second risk that I have identified from Chapter 13 is a business risk.  A business risk is defined as “The cumulative effect of macro risk, strategic risk, and operational risk, stemming from the firm’s inability to know for certain the outcome of its current investing and operating activities and decisions”(Hawawini & Viallet, 2011. P. 617).  An operational risk would be the one that I am most familiar with.  This is a level 2 risk and there are many level 3 risk that fall under an operational risk.  Under the level 3, I am most familiar personally and professionally with the fiscal risk, legal risk, and the property damage risk.The third risk that I have identified from Chapter 13 is the financial investment risk.  A financial investment risk is defined as “a risk that is associated with the firms holding of financial investments such as shares and bonds of other companies as well as cash and marketable securities” (Hawawini & Viallet, 2001, p. 621).  I have personal and professional experience with this type of risk. 

I am not sure how these risks are affecting the institution that I work for.  It is a very large institution and I am not involved in any of the financial or business decisions that are made.  But I would imagine that if a financial investment risk was not done correct or with a bad decision, the institution would suffer.  I can speak personally about some of the financial risk that I have taken before.  I have watched my husband move our money around into higher risk. 

 

Foreign Risk. (n.d.).  Investopedia.  Retrieved from http://www.investopedia.com/terms/f/foreignexchangerisk.asp

Hawawini, G., & Viallet, C. (2011). Finance for executives: Managing for value creation. Manson, OH: South-Western Cengage Learning

When comes to foreign risks, I always think about the vacation trips overseas.  In addition to be aware of host country's political stability and weather conditions, we need to worry about the exchange rates.

Now, imagine you operate overseas or just do business with a foreign entity.  Many students in this forum discussed about acquiring medical equipment pieces, many of them are made in Germany and Japan.

Question 2: In connection with Chapter 14, how do you link globalization to leadership then to financial management in your profession? What is the main impact of globalization on leadership decision making concerning financial matters?

The main impact of globalization on leadership decision making concerning financial matters is that leaders need to constantly be aware of what is going on with globalization so they can use strategic planning to do their budget.  The benefit of keeping an eye on globalization is that leaders can make the right decisions which in turn will make their organization a successful one.  They can make the appropriate trades, sell and buy the right stocks.  Globalization is very important for a leader that is making financial decisions.  Again, in my profession, I am not sure how much globalization affects the hospital.  To my knowledge, global decisions have not put the hospital I work for at any risk.