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- 1. Finance: Week 3Synthesis and Exam Review Professor Whitaker Sotheby’s Institute New York Principles of Business I October 12, 2011
- 2. Agenda• After-lunch Film (risk, return, uncertainty, hope)• Expected Value• Split Assignments – (a) Review of NPV – (b) Research Projects• “Teach us Something in 3 Minutes”
- 3. Midterm• Wednesday, October 26, 1-4pm in Lex 1• Open book, open notes, bring computer or calculator• Review session Friday, October 21, 12:30- 2pm, Lex 1• Problem Set Review
- 4. Film of the Day
- 5. Expected ValueIf I play poker with Bob and Anne, these three things could happen:• A 50% chance of making $20• A 30% chance of losing $20• A 20% chance of breaking evenExpected value = the probability of an outcome x the value of the outcomeWhat is the expected value of each outcome?50% chance of $20 = .5 x $20 = +$1030% chance of $20 = .3 x -$20 = -$620% chance of zero = .2 x $0 = 0Sum these: the game overall has an EV of +$4 © Amy Whitaker amy.whitaker@gmail.com
- 6. Expected ValueExample 2:I am going to teach a class and charge $30.• If I get great attendance, 100 people will come. ($30 x 100 people = $3,000)• If I get poor attendance, 20 people will come. ($30 x 20 people = $600)At 50/50 odds, that is $1500 + $300 = $1800At 20/80 odds, that is $600 + 480 = $1080 © Amy Whitaker amy.whitaker@gmail.com
- 7. Breakeven AnalysisAt what point to I recoup my costs and start making a profit?Example:To start a school, I need $5000 for rent, supplies, equipment. For eachstudent, a foundation gives me $150. I have to spend $50 of that on suppliesfor that student. At what point do I break even? Break Even = Total Fixed Cost = 5000 = 5000 = Revenue – Variable Cost 150 – 50 100 50 students © Amy Whitaker amy.whitaker@gmail.com
- 8. “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.”
- 9. Compounding and Discounting (moving money through time)
- 10. Lottery TicketYou have won the lottery!Would you rather have alump sum payment of$10 million, or $1.2million every year for 10years?
- 11. 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?
- 12. 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?
- 13. 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?
- 14. The Balance Sheet A = L+E LIABILITIESASSETS = [Credit: Katie Neff] SHAREHOLDERS’ EQUITY
- 15. 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]
- 16. Income StatementIncome = Revenue - Expenses
- 17. 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]
- 18. 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]
- 19. 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]

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