Koop Balitaan Dec 3, 2021 A project of CDA R1 Extension Office

2. Financial
Management
for
Cooperatives

3. Topics Covered
Cost of
Capital
Relevant
Costing
Capital
Budgeting
1 2
3

4. Cost
of
Capital
1

5. Cost of Capital
- is the minimum rate of return that a business must
earn before generating value.
- is a company's calculation of the minimum return
that would be necessary in order to justify
undertaking a capital budgeting project.

6. Sources of Long Term- Capital
A. Long-term Debt
B. Preferred Stock
C1. Retained Earnings
C2. New Common Stock
Source of Funds Cost of Capital
A. Interest
B. Dividends
C1. Dividends and Growth
C2. Dividends and Growth

7. Computation of Cost of Capital
A. Long-term Debt
B. *Preferred Stock
C1. *Retained Earnings
C2. *New Common Stock
Source of Funds Formula
Interest Rate x (1 – Tax Rate)
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠, 𝑛𝑒𝑡 𝑜𝑓 𝑓𝑙𝑜𝑡𝑎𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠
+ Growth
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠,𝑛𝑒𝑡 𝑜𝑓 𝑓𝑙𝑜𝑡𝑎𝑡𝑖𝑜𝑛
+ Growth

8. Weighted Average Cost of Capital
- The weighted average cost of capital (WACC)
represents a firm's average cost of capital from all
sources, including common stock, preferred stock,
bonds, and other forms of debt.
- WACC is commonly used as a hurdle rate against
which companies and investors can gauge the
desirability of a given project or acquisition.

9. Weighted Average Cost of Capital
= (Wdebt x Kdebt) + (Wpreferred x Kpreferred) + (Wcommon x Kcommon)
W – refers to the firm’s capital structure weight
K – refers to the computed cost of each component

10. WACC Example
Johnson Industries finances its projects with 40 percent debt, 10 percent
preferred stock, and 50 percent common stock.
• The company can issue bonds at a yield to maturity of 8.4 percent.
• The cost of preferred stock is 9 percent.
• The company's common stock currently sells for $30 a share.
• The company's dividend is currently $2.00 a share (D0 = $2.00), and is expected
to grow at a constant rate of 6 percent per year.
• Assume that the flotation cost on debt and preferred stock is zero, and no new
stock will be issued.
• The company’s tax rate is 30 percent.
What is the company’s weighted average cost of capital (WACC)?

11. WACC - Solution
Source Cost of Weight Weighted COC
Capital
- Common Stock 13.067% 50% 6.53%
- Preferred Stock 9.000% 10% 0.90%
- Long-term Debt 5.880% 40% 2.35%
WACC 9.785%

12. Capital
Budgeting
2

13. Capital Budgeting
- is the process of making capital investment decisions.
- is the process a business undertakes to evaluate potential major
projects or investments. Construction of a new plant or a big
investment in an outside venture are examples of projects that would
require capital budgeting before they are approved or rejected.

14. Capital Budgeting Techniques
1.) Non-discounting Techniques – ignores the time value of money
a. Payback Period
b. Accounting Rate of Return
2.) Discounting Techniques – considers the time value of money
a. Net Present Value
b. Internal Rate of Return

15. Non-Discounting Techniques
1.) Payback Period
- the length of time required for an investment to recover its initial outlay in
terms of profits or savings.
- under uniform and even cash flows, it may be calculated as
Initial investment / annual cash flow.
2.) Accounting Rate of Return
- reflects the percentage rate of return expected on an investment or asset,
compared to the initial investment's cost.
- is calculated as average annual profit / initial investment.

16. Example
Pinoy Cooperative incurred an initial outlay of P200,000 for
its capital investment project. The projected future cash flows of the
entity is expected to be as follows:
Year 1 – P60,000
Year 2 – P80,000
Year 3 – P60,000
Year 4 – P120,000
Year 5 – P140,000
How long will it take to recover its initial investment?

17. Payback Period
Year Unrecovered Investment Cash Flows
0 P200,000 -0-
1 140,000 60,000
2 60,000 80,000
3 ---- 60,000
4 ----
5 ----

18. Discounting Techniques
1.) Net Present Value
- is the difference between the present value of cash inflows and the present
value of cash outflows over a period of time.
2.) Internal Rate of Return
- is a metric used in financial analysis to estimate the profitability of
potential investments.
- is a discount rate that makes the net present value (NPV) of all cash flows
equal to zero in a discounted cash flow analysis.

19. Discounting Techniques
Pareko Cooperatives has provided the following data concerning a proposed
investment project:
Initial investment P960,000
Life of the project 6 years
Working capital required P20,000
Annual net cash inflows P288,000
Salvage value P144,000
The company uses a discount rate of 16%. The working capital would be released at the
end of the project.

20. Net Present Value
Present Value of Cash Inflows @16%
Amount Year(s) PV Factor Present Value
Annual Net Cash Inflows P288,000 1-6 3.685 P1,061,280
Salvage Value 144,000 6 .410 59,040
Working Capital Released 20,000 6 .410 8,200
P1,128,520
Present Value of Cash Outflows
Initial Investment P960,000 Now 1.000 P960,000
Working Capital Invested 20,000 Now 1.000 20,000
(P980,000)
Net Present Value P148,250

21. Internal Rate of Return
Present Value of Cash Inflows @21.265%
Amount Year(s) PV Factor Present Value
Annual Net Cash Inflows P288,000 1-6 3.224 P928,432
Salvage Value 144,000 6 .314 45,285
Working Capital Released 20,000 6 .314 6,283
P980,000
Present Value of Cash Outflows
Initial Investment P960,000 Now 1.000 P960,000
Working Capital Invested 20,000 Now 1.000 20,000
(P980,000)
Net Present Value -0-

22. Differential
Analysis
3

23. Relevant Costs
- are future costs that differs across alternatives.
- must be both:
a.) future cost
b.) differential cost

24. Relevant Costs Analysis
Step 1: Eliminate costs and benefits that do not differ
between two alternatives
Step 2: Use the remaining costs and benefits that do
differ between alternatives in making the decision. The
costs that remain are the differential, or avoidable costs.

25. Relevant Cost Example
Agripino, a student from Pangasinan, is considering
visiting his friend in Manila. He can drive or take a bus. By
car it is 230 kilometers to his friend’s apartment. He is
trying to decide which alternative is less expensive and
has gathered the following information:

26. Relevant Cost Example
Annual Cost Cost per Kilometer
1.) Annual SL depreciation P100,000
2.) Cost of gasoline P6
3.) Maintenance and repairs P2.5
4.) Parking fees at school P360
5.)ReductioninresalevalueperKM P2
6.)Round-tripspecialservice P3,000

27. Relevant Cost Example
Relevant Financial Cost of Driving
Gasoline (6 x 230KM) P1,380
Maintenance (2.5 x 230KM) 575
Reduction in resale (2 x 230KM) 460
Total P2,415
Relevant Financial Cost of Special Service
Round trip Fare P3,000
Total P3,000

28. Relevant Cost Applications
Business Applications of Relevant Costing:
a.) Adding/Dropping Segments
b.) Make/Buy Decision
c.) Special Orders
d.) Others

29. Adding/Dropping Segments
Due to the declining popularity of digital watches,
DanielGonzales’ digital watch line has not reported a profit for
several years. DanielGonzales is considering dropping this
product line.

30. Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales P 500,000
Less: variable expenses
Variable manufacturing costs P 120,000
Variable shipping costs 5,000
Commissions 75,000 200,000
Contribution margin P 300,000
Less: fixed expenses
General factory overhead P 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Advertising - direct 100,000
Rent - factory space 70,000
General admin. expenses 30,000 400,000
Net operating loss P (100,000)

31. Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales P 500,000
Less: variable expenses
Variable manufacturing costs P 120,000
Variable shipping costs 5,000
Commissions 75,000 200,000
Contribution margin P 300,000
Less: fixed expenses
General factory overhead P 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Advertising - direct 100,000
Rent - factory space 70,000
General admin. expenses 30,000 400,000
Net operating loss P (100,000)
Investigation has revealed that total fixed
general factory overhead and general
administrative expenses would not be affected
if the digital watch line is dropped. The fixed
general factory overhead and general
administrative expenses assigned to this
product would be reallocated to other product
lines.

32. Adding/Dropping Segments
Contribution Margin
Solution
Contribution margin lost if digital watches
are dropped P (300,000)
Less fixed costs that can be avoided
Salary of the line manager P 90,000
Advertising - direct 100,000
Rent - factory space 70,000 260,000
Net disadvantage P (40,000)

33. Adding/Dropping Segments
Comparative Income Approach
Keep Digital
Watches
Drop Digital
Watches Difference
Sales P 500,000 P - P (500,000)
Less variable expenses: -
Manufacturing expenses 120,000 - 120,000
Shipping 5,000 - 5,000
Commissions 75,000 - 75,000
Total variable expenses 200,000 - 200,000
Contribution margin 300,000 - (300,000)
Less fixed expenses:
General factory overhead 60,000 60,000 -
Salary of line manager 90,000 - 90,000
Depreciation 50,000 50,000 -
Advertising - direct 100,000 - 100,000
Rent - factory space 70,000 - 70,000
General admin. expenses 30,000 30,000 -
Total fixed expenses 400,000 140,000 260,000
Net operating loss P (100,000) P (140,000) P (40,000)

34. “Financial prosperity is
impossible without
constant planning and
management of money”
- Sunday Adelaja