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“Breakeven” thinking in NPVIn the homework, you bought a Picasso for$10mn, and you knew you could sell it for $14mn in10 years.PV = 14mn / (1.05)^10 = $8.59mnIf I invested the $10mn in a bond yielding 5%, in 10years, I would have 10mn x (1.05)^10 = $16.3mn.This is your mental investment “hurdle.”
Compounding and Discounting (moving money through time)
Lottery TicketYou have won the lottery!Would you rather have alump sum payment of$10 million, or $1.2million every year for 10years?
Artist’s RetainerThere is a hot young artist you really want to sign toyour gallery. It is the 1980s and people are payingartists retainers.If you pay this artist, Fred Lois Smith, $40,000 permonth for a year, he will make work you can sell inyour gallery in one year’s time. Because of Fred’scost of materials, he requests that you pay theamount up front at the start of the year. How muchdo you have to make from Fred’s show for this to beworth it?
A Friend in Need. . .• You loan $10,000 to your best friend Jane who is in dire straights. Your friend is good to her word though and does return the money to you, five years later. You don’t mind, but your other friend Ned insists this isn’t really $10,000. You appease Ned by doing a present value calculation at 5%. Obviously, Ned is an insensitive clod, but is he right?
A New Museum in LichtensteinThe government of Lichtenstein tells theGuggenheim that they would like to experiencethe ‘Bilbao Effect’ in their tiny nation state.They will pay the Guggenheim a $20mn licensingfee but only if the project is successful. If 3million visitors have come to the museum eachyear starting in years 5 to 10, then in year 10,the government will pay the Guggenheim$20mn. What is the Gugg’s max budget at thebeginning of year 1?
The Balance Sheet A = L+E LIABILITIESASSETS = [Credit: Katie Neff] SHAREHOLDERS’ EQUITY
Balance Sheet ComponentsShort-term Assets Short-term Liabilities Inventories Accounts Payable Accounts Receivables Income Taxes Payable Cash Short-term borrowing (within 1 year) Financial investments held for short- Long-term Liabilities term Long-term Assets Long-term borrowings (more than 1 year)• Property Shareholders’ Equity• Plant and Machinery Retained Earnings• Patents Capital invested / Common Stock• Goodwill [Credit: Katie Neff]
Income StatementSales $1,000 Cost of Goods Sold (COGS) (500)Gross Profit 500 Selling, General & Administrative (SG&A) (200)Operating Profit 300 Interest Cost (50)Profit Before Taxes 250 Tax Cost (40)Net Income $210 [Credit: Katie Neff]
Income Statement Example: Create an Income Statement for the Month of May• During the month of May, Bryan Inc. sold 100 products at a price of $100 each.• 20% of these customers paid in cash.• Each product costs Bryan Inc. $50 each to procure (Bryan Inc. is a reseller, not a manufacturer)• The total monthly cost of the two employees (one for sales and one for administration) is $1,500.• The monthly rental cost of the small office space they use is $1,000• They do not need any warehouse space since they deliver direct from their supplier to the customer.• The average monthly cost of the utilities is $500.• Bryan Inc. has a bank loan of $10,000 incurring a monthly interest rate of 1.0%.• The tax rate is 30% of profits [Credit: Katie Neff]
Income Statement Example: Sales 10,000 Cost of Goods Sold (5,000) Gross Profit 5,000 Sales, General & Administrative (SG&A) (3,000) Operating Profit 2,000 Interest Cost (100) Profit Before Taxes 1,900 Tax Cost (570) Net Income 1,330Sales: 100*$100 = $10,000 Whether they have been paid in cash or not is irrelevant forthe purposes of building the income statementCOGS: 100*$50 = $5,000SG&A: ($1,500+$1,000+$500) = $3,000Interest Expense: ($10,000*.01) = $100 [Credit:Tax Expense: ($1,900*.30) = $570 Katie Neff]