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Experience Requirements
Exam format
3 hrs - 100 multiple choice questions = approx. 1.5 minutes per question
(on average).
Find ways to bank time
Look for short-cuts
You will find that you most question do not seem easy, dont get
discouraged
You earn points for each question answered correctly
Some questions are test questions that carry no point value. You will not
know which ones they are
Extra time can be carried forward to the Essay portion
Exam format
Topics
Financial Statement Analysis
Corporate Finance
Decision Analysis and Risk Management
Investment Decisions
Ethics
25%
25%
25%
20%
5%
Relax - NO ONE HAS DIED FROM FAILING THE CMA EXAM, there is life beyond and we will help
you pass it!!!!
Exam
Budget your time, know your time hacks
See how many Essay sub-questions you will be given.
There are two parts with different amounts of subparts
Answer the questions in consecutive order, and limit
the number you want to come back to no more than
say 10, but make sure you answer it before going on to
the next.
Never leave a question unanswered, score is based on
number of correct answers.
Do not allow the answer choices to affect your reading
of the question
4.
5.
6.
7.
8.
The essays
The CMA exam uses essays to reflect a more "real-world" environment in which
candidates must apply the knowledge they have acquired. Essays are graded on
both writing skills and subject matter. Partial credit IS available for essays that have
some correct and some incorrect points. Finally, it is important to remember that
essays are not intended to test typing ability, so the time you allocated for essay
response is adequate to complete the questions even if you do not have the best
typing skills.
Ethics
Ethics is tested from:
Individual Perspective Part 1
Organizational Perspective Part 2
Types of stock
Additional paid in capital
Reasons for equity to restricted
Treasury stock (def., affect on equity)
SU 1 - Statement of Cashflows
Understand:
Purpose
Indirect method vs. Direct method
Categories
Operating Activities direct and indirect
Investing Activities
Financing Activities
See questions
31 page 53
33 page 54
34 page 55
S
SU 1 Statement of Income and Statement of
Retained Earnings
Other Expenses
S, G & A
G & A incurred for the benefit of the organization as a
whole
Interest Expenses based on passage of time; effective
interest rate method
Irregular Items
Discontinued Operations = Income from operations, and gain/loss
from disposal of operations
Extraordinary Items = both usual in nature and infrequent in
occurrence in the environment in which the organization operates
Continued
Comprehensive Income
Exclude from NI but included in OCI
Fair value changes of available-for-sale securities
Currency translations
Service cost, gains and losses not prev. recognized in
pension exp.
SU 2 - Ratio Analysis
You need to understand what effects typical
business transactions have on a firms
liquidity, rather than on the mechanics of
calculating the ratios.
What is the importance of Ratio Analysis?
Remember
Common-size statement s recast all items in a particular financial
statement as a percentage of a selected (usually the largest and most
important) item on the statement.
These statements can be used to:
Compare elements in a single years financial statements.
Analyze trends across a number of years for one business.
Compare businesses of differing sizes within an industry (such as WalMart to Target).
Compare the companys performance and position with an industry
average.
Common-size statements are useful when comparing businesses of
different sizes because the financial statements of a variety of companies
can be recast into the uniform common-size format regardless of the size
of individual elements.
SU 2 - Liquidity Ratios
Liquidity is the firms ability to pay its current
obligations as they come due. - Short run
How easy is it to convert assets to cash.
Remember!
Current assets are defined as cash or other
liquid investments, such as inventory and
accounts receivable (A/R), that can be converted
to cash within a year.
Current liabilities are obligations that will be
paid within a year, such as accounts payable and
notes and interest payable.
Activity Measures
Another way to analyze liquidity is to focus on the
management of key current assets, namely inventory and A/R.
A manager successfully managing inventory and collecting A/R
in a timely manner also will be improving liquidity.
Operating activity analysis is done over a period of an
operating cyclethe time elapsed between when goods are
acquired and when cash is received from the sale of the
goods.
Measures how quickly noncash assets are converted to cash.
Over a period of time. Includes I/S data.
The Balance Sheet data should always be an average
One of the assumption of this ratio is that sales occur evenly throughout the
year, therefore average A/R can be estimated using the average of beginning
and ending A/R balances.
When sales are seasonal or uneven, the beginning and ending balances may
not be indicative of the average A/R balance. This is one of the reasons that
most retailers have a fiscal year ending on January 31 and not December 31,
because the sales in that industry are seasonal.
Activity Measures
A/R turnover also can be analyzed in days instead
of times
Days Sales Outstanding (DSO)
DSO = Days in year / AR turnover
Average collection period in days.
May use 365, 360 or 300 days
Compared to credit terms to determine if customers
pay within terms.
Activity Measures
Inventory turnover = COGS / Ave. Inventory
Measures efficiency of inventory management.
High ratio : Quicker inventory turns
Inventory not obsolete, not carrying excess.
Activity Measures
Operating Cycle = DSI + DSO
The amount of time to convert inventory to cash.
Figure 2-2 Page 67
Activity Measures
Fixed Assets Turnover Ratio = Net Sales / Ave. Net PP&E
How efficiently the company deploys its investment in plant
assets to generate revenues.
Higher turnover is preferable.
Affected by the capital intensiveness of the company and its
industry, by the age of the assets, and by depreciation
method used.
2.4 Solvency
Solvency is a firms ability to pay its noncurrent obligations
as they come due
Long-run as opposed to liquidity which focuses on short-term (current
items)
2.4 Solvency
Debt = creditors interest
= contractual obligations
Ret > cost of debt = > equity
2.4 Solvency
Long-term debt/Equity
??? which is better, increase or decrease of Long-term Debt to Equity Ratio, year over year?
Debt to Total Asset Ratio
2.4 Solvency
Earnings Coverage
Times interest earned ratio
EBIT/Interest Expense
2.4 Solvency
Cash Flow to Fixed Charges Ratio
Pre-tax operating cash flow/Int. exp. + Int. portion of
operating leases + Div. on Pre. Stock
Eliminates issues associated with accrual accounting
2.5 Leverage
Types of Leverage
A company uses leverage in two ways: financial and operating.
Financial leverage is raising capital through debt rather than equity. While
debt holders are entitled to interest, the owners share the earnings of the
company. Hence, when a company can earn a higher rate of return on its
invested capital through its operations than the interest rate on its debt, it
could increase the return for its investors by financing the growth of
company operations through borrowed capital.
Operating leverage is the existence of fixed operating costs. Because
these costs are fixed, the higher the percentage of operating leverage, the
greater the effect changes in sales revenues have on operating income.
The focus on leverage in this section is on financial leverage. The cost of
financial leverage is interest costs, which must be paid regardless of sales.
2.5 Leverage
Leverage = relative of fixed cost
??? which fixed cost?
??? what financial statement do we find on?
2.5 Leverage
Distinguish between variable costing and full-costing
Why do we have to have variable costing for measuring
the DOL
Degree of Op. Lev. Single-Period Version
DOL = Contribution Margin/Operating Income or EBIT
Contribution Margin = ???
Example page 72
2.5 Leverage
Degree of Operating Leverage Perc.-Change Version
%Chng. in Op. Inc. or EBIT/%Chng. in Sales
Example page 72
Quiz
Firms usually use leases to get use of an asset without having to show it on the balance sheet
as an asset and the corresponding liability. If the firm were to purchase the asset, it might
have to use cash, thus converting short-term assets into long-term assets and worsening
short-term liquidity ratio. Purchasing the asset on credit would increase the firms accounts
payable, again worsening its short-term liquidity ratios. If the firm were to use long-term
financing to purchase, it would worsen the debt to equity or other solvency ratios.
A way to avoid any of these adverse consequences on the balance sheet, firms sometimes
lease the asset. Generally accepted accounting principles require that a determination be
made on whether the lease is an operating lease or a capital lease. When the lease meets
one of the four conditions established for capital leases, the lease payments are accounted
for as a long-term liability.
However, sometimes firms are able to structure a lease so as not to meet any of the four
conditions. It can then classify the lease as an operating lease. With an operating lease, the
firm is able to obtain the use of the asset without having to record its obligation to pay, thus
obtaining off-balance sheet financing.
Profitability Analysis
Profitability is a firms ability to generate earnings over a period of time with a given
set of resources. It is analyzed by examining the elements of revenues, the cost of
sales, and operating and other expenses.
There are a number of ways an investor can look at return on his or her investment.
Some returns involve the price of the stock as it trades in the securities markets.
Although there are actions a company can take to make its stock more attractive to
investors, return on market price depends on when each investor purchases and sells
the stock. Thus, the analyst of a companys financial and operating
performance cannot make this calculation for the individual investor. An analyst, can,
however, examine how the investors contribution to the company performed on a
per-share basis. This can be done by measuring earnings per share and the dividend
yield.
Profitability Analysis
The numerator of the return ratio is some measure of earnings or profits. The measure selected
for the numerator should match the investment base in the denominator. For example, if total
assets are used in the denominator, the income to all providers of the capital ought to be
included in the numerator, which includes interest. Thus, interest usually is added back to the net
income when computing the ROA. This leads to a popular measure known as earnings before
interest, taxes, depreciation, and amortization (EBITDA).
When return on common equity capital is computed, net income after deductions for interest
and preferred dividends is used. The final ROI always must reflect all applicable costs and
expenses, including income taxes, particularly when the return on shareholders equity is
computed. Profit, or the profit motive, is realized when an organization is generating more
resources than it consumes during the course of a year. That is, profit is the amount by which
revenue from sales exceeds the costs required to achieve those sales. And the profit margin is the
percentage of revenues represented by that excess of revenues over costs. Revenues and costs,
however, are measured by diverse criteria.
Profitability Analysis
Profit margins commonly are calculated using one of
three different profit measures:
1. Gross profit , which equals net sales revenue minus the
cost of goods sold (COGS).
2. Operating income , which equals gross profit minus
various administrative expenses, not including interest or
taxes (because they are not part of operations). Operating
income is sometimes called earnings before interest and
taxes (EBIT).
3. Net income , which reduces revenues by all expenses
cost of goods, operating expenses, and interest and taxes.
Profitability Analysis
Gross profit margin is what percentage of gross revenues remains with the firm after
paying for merchandise.
Revenue COGS = GP
As with all financial ratios, the gross margin derives its meaning by comparison to
performance of the company in past years as well as by comparison to industry
averages. One of the things an analyst looks for is the trend of the gross profit margin:
Is it increasing, decreasing, or remaining steady?
Key That the percentage of GP remains or increases with sales.
GP SG&A = Operating Profit
Profitability Analysis
Gross Profit Margin = Gross Profit / Net Sales
= Net Sales COGS / Net Sales
Profit Margin = Net Income / Net Sales
= Net Sales COGS G&A Fixed costs Tax
Interest
What is left to be reinvested or distributed?
Net Profit Margin and Profit Margin are the same
Difference between Operating Income and EBIT
OTHER
Other Income
Other Loss
Profitability considerations
Financial analyst must also look for reasons that explain
changes. Here are some reasons that gross profit margin
may change:
Sales prices have not increased at the same rate as the
change in inventory costs.
Sales prices have declined due to competition.
The mix of products sold has changed to more
products with lower profit margins.
Inventory is being stolen. (If this is the case, the cost of
goods will be higher against the same sales.)
Profitability Analysis
EBITDA performance measure that approximates accrual-basis
profits from ongoing operations
EBITDA / Net Sales adding back 2 major noncash expenses to
EBIT
The difference between the two are Liabilities, which is why ROE is
always larger than ROA
Key Take-Away
CMA are expected to be able to determine the
profitability of a business by calculating ROA /
ROE using the DuPont Model and explain how it
helps analysis
Demonstrate:
That you know the formulas
That you are able to properly apply and analyze and
evaluate
Discussion on inconsistent definitions and what
factors contribute to inconsistency
DUPONT Analysis
Developed in 1919 as a way to better
understand return ratios and why they change
over time.
The bases for this approach are the linkages
made through financial ratios between the
Balance Sheet and the I/S
Breaking returns into their components
DuPont Model
Profitability
Operating
Efficiency
Financial
Leverage
Tax Burden
Interest Burden
ROCE
Return on Common Equity = Net Income Preferred
Dividends / AVG Common Equity
ROCE = IACS / Net Sales X Net Sales / AVG Ttl Assets X
Leverage
The equity multiplier measures a companys financial
leverage
High financial leverage means that the company relies more
on debt to finance its assets
Raising capital with debt, the company can increase its
equity multiplier and improve its ROE
However, on the other hand, taking on additional debt may
worsen the companys solvency and increase the risk of
going bankrupt
Other measures
Sustainable Equity Growth rate = ROCE x (1
Dividend Payout)
Plowback rate
SU 3 - Effects of Off-Balance-Sheet
Financing
Purpose Reduce a companies debt load and
thereby improving the ratios
Examples include:
Unconsolidated subsidiaries
Special Purpose Entities
Operating Leases
Factoring Receivables with Recourse
Income
Revenues
Receivables and Inventories
Recognition Principles
SU 4 - CAPM
In order to measure how a particular security
contributes to the risk and return of a diversified
portfolio, investors can use CAPM.
CAPM quantifies the required return on a security by
relating the securitys level of risk to the average return
available in the market (portfolio)
Investors must be compensated for their investment in
2 ways:
Time value of money
Risk
Know the CAPM formula!
Financial Risk
Indifference Curve
SU 4 - Standard Deviation
It measures the tightness of the distribution and
the riskiness of the investment
A large deviation reflects a broadly dispersed
probability distribution meaning the range of
possible returns is wide
The smaller the deviation, the tighter the
probability distribution and the lower the risk
The greater the deviation the riskier the
investment
SU 4 - Coefficients
It measures the degree to which any 2 variables
are related
Perfect positive correlation = +1 means that 2
variables always move together
Given perfect negative correlation, risk would in
theory be eliminated
In practice, the existence of market risk makes
the perfect correlation nearly impossible
The normal range for the correlation of 2
randomly selected stocks is 0.5 to 0.7. the result
is a reduction in risk, not elimination.
SU 4 - Covariance
Correlation coefficient of 2 securities can be
combined with their standard deviations to
arrive at their covariance
Covariance = measure of mutual volatility
SU 4 - Portfolio Management
4 important decisions are involved (not only 2)
Amount of money to invest
Securities in which to invest (expected net cash
flows)
Time scale (Liquidity) = maturity matching
Objectives: what for? = will dictate appetite for
risk
Others: transaction costs
SU 5 - Bonds
Term structure of interest rates
There are three main types of yield curve shapes:
Normal
Inverted
and flat (or humped). A normal yield curve (upward sloping) is
one in which longer maturity bonds have a higher yield
compared to shorter-term bonds due to the risks associated
with time.
The slope of the yield curve is also seen as important: the
greater the slope, the greater the gap between short- and
long-term rates.
SU 5 - Bonds
When plotting yield curves we hold the following
constant:
Default risk
Taxability
Callability
Sinking fund
SU 5 - Bonds
Features of Bonds
Par Value = Maturity amount = Face Amount
State rate = Coupon rate
Indenture = Terms
SU 5 - Bonds
Following are means to reduce the required
rate of return for bonds:
Sinking Fund payments to a segregated fund
which will equal the maturity value
Insured
Secured
SU 5 - Bonds
Advantages of Bonds
Interest is tax deductible
Retain corporate control
Disadvantages of Bonds
SU 5 - Bonds
Types of Bonds
Maturity
Term bond single maturity
Serial bond
Valuation
Variable rate
Zero-coupon or deep-discount bonds
Commodity-backed bonds
Redemption Provisions
Callable bonds by the issuer
Convertible bonds into equities
Securitization
Mortgage bonds specific
Debentures borrowers general credit but not specific collateral
SU 5 - Bonds
Bond valuation and sales price
Several components to determining the fair price of a bond:
Risk
Duration
Face amount
Interest payment
Other features such as callable, convertibility
SU 5 Equity
Common Stock
Advantages to the issuer
No fixed dividend (Common Stock only)
No maturity date
Increases creditworthiness
SU 5 Equity
Preferred Stock = hybrid of debt and equity
Advantages to the issuer
Form of equity
Does not dilute control
Superior earning still go to CS
SU 5 Equity
Characteristics of Preferred Stock
Stock Valuations
Preferred is similar to Bonds in valuation
Discount rate will probably be higher then bonds due to riskiness
Common stock valued also the same way except based on earnings (per share)
SU 5 Corporate/Stock Valuation
Methods
Dividend Discount Model
Based on PV of expected dividends per share
Can only be used when dividends are expected to
grow at constant rate
SU 5 Corporate/Stock Valuation
Methods
Preferred Stock Valuation
Dividend per share
Cost of Capital
SU 5 Corporate/Stock Valuation
Methods
Common Stock with Variable Dividend Growth
3 Step process
Step 1 Calculate and sum the PV of Dividends in the period
of high growth
Step 2 Calculate the PV of the stock based on the period of
steady growth discounted back to year 1 using the dividend
discount method.
Step 3 Sum the totals from Step 1 and 2
SU 6 Working Capital
Working capital and types of capital policies?
Working capital (or current capital) generally refers to the funds
a company holds in current (short-term) asset accounts, and
includes cash, marketable securities, receivables, and
inventories.
Net working capital provides a measure of immediate liquidity
and indicates how much cash a firm has available to sustain and
build its business, and refers specifically (from an accounting
perspective ) to the difference between a firms current assets
and its current liabilities. Depending on a firms level of current
liabilities, the number may be positive or negative.
SU 6 Working Capital
Working Capital policies include:
Conservative = minimize risk = Higher current ratio & acid test ratio focuses on low-risk, low return working capital investment and
financing greater proportion of capital in liquid assets but at the
sacrifice of some profitability; uses higher-cost capital but
postpones the principal repayment of debt or avoids it entirely by
using equity; current assets will be much greater than current
liabilities.
Moderate = average risk - uses risk and return and financing
strategies that match the maturity of the assets with the maturity of
the financing; seeks a balance between current assets and current
liabilities.
Aggressive = more (max) risk = Lower current ratio & acid test ratio focuses on high profitability potential, despite the cost of high risk
and low liquidity. Capital being minimized in current assets versus
long-term investments ; higher levels of lower-cost short-term debt
and less long-term capital investments. With an aggressive policy,
current assets will be less than current liabilities.
SU 6 Working Capital
What is the optimal level of working capital?
Varies with industry!
Contrast a grocery chain which has to rotate its inventory
and probably has no receivables versus a manufacturer
Consequently ratios are only meaningful in terms of norms
and trends and relative its competitors or the industry it
which it operates
SU 6 Cash Management
Managing the cash levels
What are the motives for holding cash?
Transactional
Precautionary
Speculative
SU 6 Cash Management
Cash Management EOQ Model P. 218
Review examples forecasting future cash
flows (see examples on page 219, very typical
test questions!)
Lockbox benefit analysis = Net Benefit from
Lockbox = Reduction in Float Opportunity Cost
+ Reduction in Internal Processing Costs Lockbox Processing Costs
SU 6 Marketable Securities
Management
Remember!
Companies invest in marketable securities for three main
reasons:
1.
2.
3.
SU 6 Receivable Management
Overview
A firm must balance default risk and sales
maximization
SU 6 Inventory Management
Inventory management refers to the process of
determining and maintaining the required level of
inventory that will ensure that customer orders
are properly filled on time.
1.
2.
3.
SU 6 Inventory Management
Inventory costs
Purchase cost actual invoice amounts
Carrying cost incl. Storage, Insurance, Security,
Inventory taxes, Depreciation or rent, Interest,
Obsolescence and/or spoilage and Opportunity
cost.
SU 6 Inventory Management
Inventory Replenishment Models
With Certainty = Average daily demand X Lead time in days
Without Certainty = Average daily demand X Lead time in days) + Safety Stock
SU 6 - Short-term Financing
Sources
Trade credit
Accrued expenses
Simple interest loans Interest paid at the end of the term; statet is same as nominal
SU 6 - Short-term Financing
Discounted Loans
Amount needed
(1.0 Stated rate)
Money Markets
Dealer driven Dealer buy and sell at their own risk.
Dealer is principal in transaction vs. stockbroker is an
agent
Short term and marketable
Low default risk
Exist in New York, London, & Tokyo
Government T-bills, T-notes and bonds, Federal agency and S-T
tax exempt securities, Commercial paper, CDs US and
Eurodollar, Repurchase agreements, Bankers acceptances
Cons
Reporting requirement
Hostile takeovers
2) Semi-strong form
All publicly available data are reflected in security price, but private or
insider data are not immediately reflected.
Insider trading can result in abnormal returns.
3) Weak form
Prices reflect all recent past price movement data.
Technical analysis will not provide a basis for abnormal returns.
Disadvantages
Costs, data public, shareholder information public, insider limitations,
earning growth pressure, stock price doesnt reflect firm net worth, loss of
control, growth brings move management control, shareholder costs
Repurchase
Treasury shares
Mergers, Share options, Stock dividends, Tax reasons,
increase EPS, prevent hostile takeovers, eliminate a
particular ownership interest
Leases
Other Restructurings
Spin off, divestiture, asset liquidation, carve-outs, Letter stock- separate
valuation
Undervaluation of firm
Managerial motivation
Break up Parts are worth more than the whole.
Diversification
Synergies
Combined firms are worth more than separate.
Operational
Financial
Reduced competition Antitrust
Strategic position
Tax benefits
Sales volume
Sales price
Product mixes
What else?
Monthly Basic
Telephone Bill
Total Costs
Minutes Talked
Minutes Talked
Scatter Diagrams
Draw a line through the plotted data points so that about equal
numbers of points fall above and below the line.
Total Cost in
1,000s of Dollars
20
* ** *
**
* *
* *
10
Scatter Diagrams
in cost
in units
Total Cost in
1,000s of Dollars
20
* ** *
**
* *
* *
10
Vertical
distance is
the change
in cost.
High-low method
The following is not in this Study Unit, but it is
important to know and be able to calculate.
CVP Graph
Break-Even Point
Sensitivity analysis (See slide 12) Examines the effect on the outcome of not
achieving the original forecast or of changing an assumption. Since many
decisions must be made due to uncertainty, probabilities can be assigned to
different outcomes (what-if).
Unit Contribution Margin (UCM) is an important term used with break-even point
or break-even analysis is contribution margin. In equation format it is defined as
follows:
Contribution Margin = Revenues Variable Expenses
The contribution margin for one unit of product or one unit of service is defined
as:
Contribution Margin per Unit = Revenues per Unit (Sales price) Variable
Expenses per Unit
Remember
Computing the Break-Even Point
We have just seen one of the basic CVP relationships
the break-even computation.
Fixed costs
Break-even point in units =
Contribution margin per unit
REMEMBER
COMPUTING THE BREAK-EVEN POINT
The break-even formula may also be
expressed in sales dollars.
Break-even point in dollars =
Fixed costs
Contribution margin ratio
Computing a Multiproduct
Break-Even Point
The CVP formulas can be modified for use
when a company sells more than one product.
The unit contribution margin is replaced with the
contribution margin for a composite unit.
A composite unit is composed of specific numbers
of each product in proportion to the product sales
mix.
Sales mix is the ratio of the volumes of the various
products.
SU 8 - Marginal Analysis
Economic Costs = The economic cost of a decision depends on both the cost of the
alternative chosen and the benefit that the best alternative would have provided if
chosen. Economic cost differs from accounting cost because it includes
opportunity cost.
As an example, consider the economic cost of attending college. The accounting cost of attending college
includes tuition, room and board, books, food, and other incidental expenditures while there. The
opportunity cost of college also includes the salary or wage that otherwise could be earning during the
period. So for the two to four years an individual spends in school, the opportunity cost includes the money
that one could have been making at the best possible job. The economic cost of college is the accounting
cost plus the opportunity cost.
Thus, if attending college has a direct cost of $20,000 dollars a year for four years, and the lost wages from
not working during that period equals $25,000 dollars a year, then the total economic cost of going to
college would be $180,000 dollars ($20,000 x 4 years + the interest of $20,000 for 4 years + $25,000 x 4
years).
SU 8 - Marginal Analysis
Explicit vs. Implicit Costs
Implicit Costs = implicit cost, also called an
imputed cost, implied cost, or notional cost, is
the opportunity cost equal to what a firm must
give up in order to use factors which it neither
purchases nor hires.
Explicit Costs = An explicit cost is a direct payment
made to others in the course of running a
business, such as wage, rent and materials.
SU 8 - Marginal Analysis
Accounting vs. Economic Profit
See Utorial at http://www.khanacademy.org/economics-finance-domain/microeconomics/firmeconomic-profit/economic-profit-tutorial/v/economic-profit-vs-accounting-profit
SU 8 - Marginal Analysis
Marginal Revenue and Marginal Cost
Marginal Revenue is the additional or incremental revenue
of one additional unit of output. See page 321
See that Marginal Revenue is $540 between generating 4 vs. 5
units of output.
SU 8 - Marginal Analysis
Short-Run Cost Relationship See graph on page 323
Other considerations/applications of CVP
Make-or-Buy
Capacity Constraints and Product Mix
Disinvestments
Sell-or-Process further
Pure Competition - A market structure in which a very large number of firms sell a
standardized product into which entry is very easy in which the individual seller
has no control over the product price and in which there is no nonprice
competition; a market characterized by a very large number of buyers and sellers.
Oligopoly - A market structure in which a few firms sell either a standardized or differentiated product into which entry is difficult in
which the firm has limited control over product price because of mutual interdependence (except when there is collusion among firms)
and in which there is typically non-price competition.
Law of Demand - Law of demand states that ' all other things remaining unchanged,
people demand (buy) more of any good / service if the price of that good / service falls
and demand (buy) less if the price increases.
Elasticity of demand measures how responsive a products demand is to changes in its
price level.
When we have inelastic demand, a consumer will pay almost any price for the
good.
Generally goods which have elastic demand tend to have many substitutes
Price elasticity of demand is calculated as the percentage change in quantity demanded
divided by the percentage change in price.
Elasticity > 1 : elastic (% change in demand is greater than % change in price e.g. luxury
goods such as cars etc.)
Elasticity < 1 : inelastic (% change in demand is less than % change in price e.g.
essential goods such as food)
Elasticity = 1 : unitary elastic (% change in demand is equal to the % change in price)
4 Steps to be taken:
1/ Identify fixed costs that will be eliminated if disinvesting
2/ Determine the revenue needed to justify continuing operations
3/ Establish the opportunity cost of funds that will be received
4/ Determine whether the carrying amount of the asset = economic
value. If not revalue use market fair value and not carrying amount
Cost of idle capacity is relevant cost.
SU 9 - Pricing Theory
Pricing Objectives: profit maximization / target
margin / forecasted volume / image (segmentation
positioning) / stabilization
Price-setting factors
Supply & Demand = Economic (external factors)
Type of market
Customer perceptions
Elasticity
Competition
Internal Factors
SU 9 - Pricing Theory
External Factors
Type of market (pure competition, monopolistic,
oligopolistic or monopoly)
Customer perceptions of price and value
Price / demand relationship
Competitors products, costs, prices and amount
supplied.
Timing of demand
Cartels = illegal practice except in international
markets
Cartel = collusive oligopoly restrict output, charge
higher $$
SU 9 - Pricing Theory
Geographical pricing
Discounts & Allowances
Discriminatory pricing
Psychological pricing
Promotional pricing
Value Pricing
International pricing
SU 9 - Pricing Theory
Product-mix pricing
Product line
Optional product
Captive product
By-product
Product bundle
Illegal pricing
SU 9 - Pricing Theory
Exercise page 376
Questions 10 to 12
SU 9 - Risk Management
4 Types of Risk:
SU 9 - Risk Management
Residual risk The risk that remains after the effects of
avoidance, sharing, or mitigation efforts.
Inherent risk The risk that arises for the activity itself.
Benefits:
- Efficient use of resources
- Fewer surprises
- Reassuring investors
Risk appetite
SU 9 - Risk Management
Hazard risk management
Insurance
Inflation
Interest rates
Cash availability
Market demands
Buying equipment
Building facilities
Acquiring a business
Developing a product of product line
Expanding into new markets
Cash flow0
(1 + r)0
NPV and IRR are most sound decision making tools for wealth maximization.
NPV profile Page 401