CHAPTER 19 Mastering Financial Management 19.7 TEXTBOOK ANSWER KEYS 19.7a Return to Inside Business The J. M. Smucker Company 1. Why would Smucker prefer to issue more than $1 billion in bonds over 18 months, rather than issuing common or preferred stock? By issuing more stock, Smucker would spread corporate ownership among more shareholders, which it might not want to do. Also, Smucker would be expected (but not legally required) to pay dividends to holders of preferred stock and, in the event of bankruptcy, it would have to pay holders of preferred stock after creditors but before owners of common stock. In contrast, issuing corporate bonds over a period of 18 months allowed Smucker to take advantage of low interest rates and have the money available for immediate use when it identified a suitable acquisition target or decided to make other investments with the potential for future return. Ask students if they would want to own Smucker stock or invest in its bonds, and why. 2. What do you think of Smucker’s deal to spread $50 million in payments to Sara Lee over 10 years after paying $350 up front for the liquid coffee concentrate business? Explain your answer. Smucker’s deal to spread payments over 10 years was a good financial decision because it allowed the company to make the acquisition right away without paying the entire purchase price right away. Although Smucker has to pay the entire $50 million over time, its yearly payments are manageable and the company can budget accordingly, which helps in its long-term financial planning. 19.7b Review Questions 1. For a business firm, what type of activities does financial management involve? Financial management consists of all the activities concerned with obtaining money and using it effectively. This includes activities such as determining that the original investment by the owners is adequate, ensuring that sales revenues are sufficient to pay the firm’s expenses, ensuring short-term financing is available when needed, and providing for long-term financing for expansion to mention a few. 2. How does short-term financing differ from long-term financing? Give two business uses for each type of financing. Short-term financing is money that will be used for one year or less and then repaid. Long-term financing is money that will be used for longer than one year. Short-term financing would be used for a new advertising campaign or a new computer to ease the workload in the budgeting department. Long-term financing would be used for beginning a business or for introducing a new line of products. 3. In your own words, describe the risk–return ratio. The risk–return ratio is based on the premise that high-risk decisions should generate higher financial returns, whereas more conservative decisions often generate lesser returns. 4. What is the function of a cash budget? A capital budget? A cash budget estimates cash receipts and cash expenditures over a specified period. Using this information, it is possible to calculate any anticipated cash gain or loss. A capital budget is a financial statement that estimates a firm’s expenditures for major assets, including new product development, expansion of facilities, replacement of obsolete equipment, and mergers and acquisitions. It helps develop a plan for long-term financing needs. 5. What is zero-base budgeting? How does it differ from the traditional concept of budgeting? In zero-base budgeting, every expense must be justified in every budget. In the traditional approach, each new budget is based on the dollar amounts contained in the budget for the previous year. When zero-base budgeting is used, a manager must justify every expense; he or she cannot assume that because a budget item was in last year’s budget it is a justified expense in the current year. 6. What are four general sources of funds? The four general sources of funds are (1) sales revenues, (2) equity capital, (3) debt financing, and (4) proceeds from the sale of assets. 7. How does a financial manager monitor and evaluate a firm’s financing? A financial manager may prepare interim budgets for sales and expenses as a means of monitoring and evaluating a firm’s financing. These interim reports can be compared to budgeted amounts, and the comparisons may point to areas that require more careful investigation. 8. How important is trade credit as a source of short-term financing? Trade credit is a very important source of short-term financing; in fact, between 80 and 90 percent of all transactions between businesses involve some trade credit. Trade credit differs from other types of short-term financing in that no interest is involved. It is merely a delayed payment and may even involve a discount if payment is made promptly. 9. Why would a supplier require a customer to sign a promissory note? A promissory note is a pledge by the buyer to pay a specified amount of money to the creditor at a specified future date. The promissory note is a legally binding and enforceable document; most promissory notes can be sold when money is needed immediately. The payee also earns interest. 10. What is the prime rate? Who gets the prime rate? The prime interest rate is the lowest rate charged by a bank for a short-term loan. The lowest rate is generally reserved for large corporations with excellent credit ratings. Organizations with good to high credit ratings may pay the prime rate plus 2 percent. Firms with questionable credit ratings may have to pay the prime rate plus 4 percent. Of course, if the banker believes loan repayment may be a problem, the borrower’s loan application may well be rejected. 11. Explain how factoring works. Of what benefit is factoring to a firm that sells its receivables? A factor, or factoring company, buys other firms’ accounts receivable. The factor buys the accounts receivable for less than their face value but collects the full dollar amount on each receivable, thereby earning a profit. The firm that sells its accounts receivables benefits by receiving needed cash immediately and by shifting the risk of nonpayment and the task of collecting to the factor. 12. What are the advantages of financing through the sale of stock? There are several advantages. First, the corporation does not have to repay money obtained from the sale of stock because the corporation is under no legal obligation to do so. A second advantage of selling stock is that a corporation is under no legal obligation to pay dividends to stockholders. Earnings from the sale of stock can then be used for funding business operations if the company wishes. 13. From a corporation’s point of view, how does preferred stock differ from common stock? When a corporation issues preferred stock, it makes a commitment to pay dividends to preferred stockholders before any dividends are paid to common stockholders. Preferred stockholders also have first claim (after creditors) on corporate assets if the firm is dissolved or declares bankruptcy. A corporation can call in or buy back preferred stock when it feels it can issue new preferred stock at a lower dividend rate or common stock with no specified dividend. 14. Where do a corporation’s retained earnings come from? What are the advantages of this type of financing? A corporation’s retained earnings are the portion of the firm’s profits that is not distributed to stockholders. This type of financing is advantageous because it does not have to be repaid, and reinvestment of these earnings into the corporation tends to increase the value of the stock while it provides essentially cost-free financing for the company. 15. For a corporation, what are the advantages of corporate bonds over long-term loans? Corporations sell bonds to borrow a lot of money from a lot of different bondholders and to raise larger amounts of money than could be borrowed from one lender. Usually, the repayment period for corporate bonds is longer (10 to 30 years) than that for long-term loans (three to seven years). Also, the interest rates for corporate bonds are usually lower than those for long-term loans. Finally, corporate bonds that are debentures are unsecured, whereas most long-term loans are usually secured with some type of collateral. 16. Describe the three methods used to ensure that funds are available to redeem corporate bonds at maturity. First, the bonds can be issued as serial bonds—bonds of a single issue that mature on different dates. Second, a sinking fund can be established into which deposits are made each year for the purpose of redeeming a bond issue. Third, a corporation can pay off an old bond issue with a new bond issue. 19.7c Discussion Questions 1. During the recent economic crisis, many financial managers and corporate officers have been criticized for (a) poor decisions, (b) lack of ethical behavior, (c) large salaries, (d) lucrative severance packages worth millions of dollars, and (e) extravagant lifestyles. Is this criticism justified? Justify your opinion. Clearly, the criticism is justified in some cases. Poor management decisions were made by executives at the Detroit auto companies, AIG (discussed in this chapter), Lehman Brothers, and Washington Mutual savings bank to mention a few. In the financial area, loans were given to people who couldn’t afford them. Bad mortgages were tied to securities that were presented as good investments to investors but were flawed. Was this due to unethical behavior or exuberance to succeed? It is a question that needs to be answered but will take time to determine. Executive salaries and severance packages in the United States are substantially higher than other countries, and the differential is hard to justify by performance. It is important however to understand that these problems are not common across all U.S. or international companies. Despite these problems, all financial managers and corporate officers should not be painted by the same brush. Most U.S. companies are well run by able and ethical executives. 2. If you were the financial manager of Stars and Stripes Clothing, what would you do with the excess cash that the firm expects in the second and fourth quarters? (See Figure 19.4.) Some of the cash could be reinvested in the store’s operations and used to cover any unexpected financial loss (e.g., loss due to a fire). The rest might be used to enhance the store’s image through ads, repairs, and so on. 3. Develop a personal cash budget for the next six months. Explain what you would do if there are budget shortfalls or excess cash amounts at the end of any month during the six-month period. While student answers will vary, you may want to use this discussion question to stress the importance of personal financial planning. You may also want to talk about what impact budget shortfalls or excess cash amounts can mean to an individual’s financial health. Budget shortfalls must be corrected by reducing expenses or increasing income. Excess cash amounts can be used to establish an emergency fund or begin an investment program. While most people would like to solve their financial problems immediately, the fact is that they didn’t get in financial trouble overnight and corrective action takes time. The old adage, “a long journey begins with the first step,” might apply to a person who is experiencing personal financial problems. 4. Why would a lender offer unsecured short-term loans when it could demand collateral? A lender would offer unsecured short-term loans to accommodate small companies that do not have collateral, are just starting out, or would go under without a loan. Such loans give the lender an opportunity to make money because, more often than not, short-term loans will be repaid. In addition, many lenders do not want the extra “hassle” associated with collateral. 5. How can a small-business owner or corporate manager use financial leverage to improve the firm’s profits and return on owners’ equity? Financial leverage is the use of borrowed funds to increase the return on owners’ equity. The principle of financial leverage works as long as a firm’s earnings are larger than the interest charged for the borrowed money. Of course, if the firm’s earnings should drop below the interest cost of the borrowed money, the return on owners’ equity would decrease. A small business can use financial leverage to improve a firm’s profits and return on owners’ equity, but it must be able to borrow the money needed to take advantage of financial leverage. Typically, small businesses have a harder time acquiring debt capital than do their larger counterparts. 6. In what circumstances might a large corporation sell stock rather than bonds to obtain long-term financing? In what circumstances would it sell bonds rather than stock? All factors considered, corporations would prefer to sell stocks. The main reasons include the fact that money from stock does not have to be repaid and dividends are not mandatory. Other factors to consider include the fact that a large corporation might sell stock rather than bonds after it has already become an established company and can offer stability to the stockholders. And if a large corporation is just starting out, or is on slightly shaky ground, it may sell bonds rather than stock to guarantee some return to the investors. 19.7d Comments on Video Case 19.1 Suggestions for using this video case are provided in the Pride/Hughes/Kapoor Video Guide. Financial Planning Equals Profits for Nederlander Concerts 1. Here’s what Nederlander’s chief operating officer has to say about its business model: “A show has a short lifetime. You go and sell two months out, and the tickets have no value on any day but the day of the show. So it’s a very interesting model in that sense.” How do you think the short life of the company’s products affects its financial planning? Nederlander cannot hold inventory the way goods producers can—it is essentially a service business—so while it can try to get the best possible terms from artists and agents when booking shows, it can’t take advantage of low supplier prices to stock up on raw materials the way goods producers can. And since each artist is a unique “good,” Nederlander has limited ability to leverage one supplier against another for more favorable deals. It is also vulnerable to cancellations and the risk that all tickets for a given show might have to be refunded with resulting loss of profit (or the show might have to be rescheduled at additional cost with no additional revenue). And while the company must plan bookings well in advance of the show date, it can’t collect ticket revenue until a few weeks before the show when seats go on sale. So it incurs costs for each show long before it earns back a profit. Finally, unsold tickets have no value after the show, so the company has no opportunity to earn back a profit from empty seats. 2. The company uses its own arenas and theaters about 90 percent of the time. What are some of the possible disadvantages of owning its own venues? Owning its own theaters gives Nederlander more control over its facilities, but it also incurs fixed cost for upkeep, maintenance, staffing, security, utilities, and taxes. The company will incur these fixed costs even when it doesn’t book a show or rent the facility out, so it must fill its theaters on as many nights of the year as possible. 3. Why would Nederlander choose to sometimes borrow funds for expansion if it has capital of its own? Like any company, Nederlander might choose to use long-term financing when a capital improvement, such as the purchase or renovation of a theater, will cost more money than the firm has available or draw the treasury down below where the owners want it to be. It might use short-term financing if revenues are down due to temporarily lower profits—say, during a recession—as long as earnings are still high enough to more than cover the cost of borrowing. 19.7e Comments on Case 19.2 Darden Restaurants Serve Up Long-Term Growth 1. Darden is spending heavily to upgrade the interior of many of its Red Lobster and LongHorn Steakhouse restaurants. How would you suggest that the company measure the financial results of this remodeling program? Students may offer various suggestions. For example, Darden might compare the monthly sales results of renovated restaurants with the sales results of unrenovated restaurants. It might also compare the sales results of the renovated restaurants before and after the interiors have been upgraded. 2. Why would Darden issue corporate bonds with maturities of 5, 10, 20 years or even longer maturities? By staggering the maturity dates of its corporate bonds, Darden ensures that it has enough cash on hand to redeem them over time. If all of its bonds matured at the same time, Darden might have difficulty meeting its repayment obligations. Ask students whether they think Darden would gain any financial management benefit from issuing bonds with a wider variety of maturity dates after the current set of bonds is redeemed. 3. If Darden needs cash to remodel existing restaurants and open new restaurants, as well as to pay down debt, why would it increase its stock dividend that is paid to its stockholders? By increasing its dividend, Darden makes the stock more attractive to investors. Should Darden decide to issue additional stock, this is an incentive for current investors to buy more shares (or for investors to buy Darden stock for the first time). Darden also wants to demonstrate to financial analysts that its cash flow is solid and dependable enough to bear the cost of raising the dividend rate. 19.7f Building Skills for Career Success 1. Social Media Exercise 1. Visit the YouTube channel for Turbo Tax (www.youtube.com/user/TurboTax/ videos). Do you think social media is an effective method of obtaining the tax information you might need to prepare your taxes? Students’ answers may vary, but many may suggest that YouTube videos (even those on Turbo Tax’s channel) might not be considered reliable information. Others might suggest that it would be easier if Turbo Tax simply had a FAQ list so that you could read the answer to the question quickly, instead of looking up and playing a two- to three-minute video. On the other hand, students who like videos as a way of learning might find this to be helpful. 2. Can you think of other companies that could use videos on a YouTube channel to share information that their customers could use? Students’ answers will vary. Some logical uses might be companies that manufacture products that require some assembly by consumers, because consumers might find it more helpful to watch someone putting the product together instead of trying to follow a complicated assembly instruction manual. Companies that manufacture paint or stain could also have YouTube videos that show how to paint a room or stain furniture. Wallpaper companies can have YouTube videos that show how to hang wallpaper. 2. Journaling for Success This exercise is intended to help students understand (1) how they manage their credit cards and (2) what steps they can take to improve their personal finances. 1. How many credit cards do you have? The answer to this question is highly individualized. 2. Based on the information on your monthly credit card statements, what types of credit card purchases do you make? Again, the answers will be highly individualized. Some students will have credits cards their parents pay that are to be used for specific purchases only such as books or for emergencies. Yet others will have a card or two used for eating out and clothing purchases. Still others will have a full set of cards. 3. Do you pay your balance in full each month or make minimum payments on your credit cards? Again, students will have highly individualized answers. 4. Most experts recommend that you have one or two credit cards that you use only if you are in an emergency situation. The experts also recommend that you avoid using credit cards to make inexpensive purchases on a daily basis. Finally, the experts recommend that you pay your balance in full each month. 5. Based on the preceding information, what steps can you take to better manage your personal finances? Those students who do make extensive usage of cards may indicate a desire to move to more cash-based purchases, while others may develop strategies for paying off certain higher-interest cards. 3. Developing Critical-Thinking Skills Your objectives should: a. Be realistic. b. Be achievable. c. Be acceptable. d. Specifically identify what is to be accomplished. e. List a time frame for accomplishment. f. Describe the criteria for measurement. The amount of money required should be stated in dollars and cents and the specific sources for getting the money should be identified. Students often have a hard time thinking of ways to access money. The following exercise can help students think beyond the traditional financial resources—bank, credit union, and friends. Make a list of potential financial resources. Do not stop until at least ten financial sources are listed. Do not restrict the list to the most obvious sources. Unrealistic sources can trigger the mind to think of additional realistic sources, and often this is where the funds are found. 4. Building Team Skills Several things to consider: Funds will be needed for: a. Rent, utilities, and insurance on a new location b. Moving costs c. Inventory parts for appliances d. Tools e. A vehicle for making service calls f. Salaries g. Benefits/insurance Sources of short-term funds include: a. A bank (The owner must have a good personal financial credit history. Also, the owner must provide a plan and show evidence of projections for assets, liabilities, income, expenses, cash flow, and profit projections.) b. Friends c. Investors, a partner (The owner must find the correct person.) d. The Small Business Administration (SBA) (The process may be too slow to pay for current obligations.) e. Collateral in the owner’s home Suggestions for increasing the chances of securing the funds include: a. Prepare a business plan. b. Have a good personal credit record. c. Have assets to pledge against the loan. d. Establish a relationship with the local banker (networking). Ideas on how to repay the money include: a. Increase repair charges. b. Increase the volume of repairs. c. Extend the work hours. 5. Researching Different Careers One source for learning about the job of financial manager is to search the Occupational Outlook Handbook online at http://www.bls.gov/ooh/management/financial-managers.htm. Another source is the printed copy of the Occupational Outlook Handbook in the library. Financial managers are responsible for the financial health of an organization. They produce financial reports, direct investment activities, and develop strategies and plans for the long-term financial goals of their organizations. The role of the financial manager, particularly in business, is changing in response to technological advances that have significantly reduced the amount of time it takes to produce financial reports. Financial managers’ main responsibility used to be monitoring a company’s finances, but they now do more data analysis and advise senior managers on ideas to maximize profits. A bachelor’s degree in finance, accounting, economics, or business administration is often the minimum education needed for financial managers. However, many employers now seek candidates with a master’s degree, preferably in business administration, finance, or economics. The median annual wage of financial managers in 2010 was $103,910. The lowest 10 percent earned less than $56,120, and the top 10 percent earned more than $166,400. Employment among financial managers is expected to grow 9 percent from 2010–2020, slower than the average for all occupations. Financial managers work in many places, including banks and insurance companies. The finance and insurance industry employed the most financial managers in 2010 (29%). 19.8 QUIZZES I AND II Quiz I True-False Questions Select the correct answer. 1. T F Speculative production is an example of a long-term financial need. 2. T F A budget is a financial statement that projects income and/or expenditures over a specified future period. 3. T F Trade credit is the least popular form of short-term financing. 4. T F Debt capital is money obtained from the sale of shares of ownership in a business. 5. T F Typically, long-term loans are normally repaid in three to seven years. Multiple-Choice Questions Circle the letter before the most accurate answer. 6. A __________ budget estimates a firm’s expenditures for major assets. a. cash b. capital c. long-term needs d. traditional e. zero-base 7. The prime interest rate is the a. highest rate charged by a commercial bank. b. average rate charged by a commercial bank. c. lowest rate charged by a commercial bank. d. rate charged by the Federal Reserve Bank for business loans. e. rate charged by the SEC for business loans. 8. The most basic form of corporate ownership is a. long-term equity loans. b. SEC-qualified stock. c. preferred stock. d. common stock. e. corporate bonds. 9. Which of the following would be paid first? a. Dividends paid on common stock b. Dividends paid on preferred stock c. Interest on corporate bonds d. Bonuses paid to stockholders e. Contributions to retained earnings 10. The use of borrowed funds to increase the return on owners’ equity is a. equity capital. b. Fed financing. c. common stock financing. d. financial suicide. e. financial leverage. Quiz II True-False Questions Select the correct answer. 1. T F Financial planning begins with establishing a set of valid goals and objectives. 2. T F Debt capital is financing provided by the owner or owners of the business. 3. T F Commercial paper is a short-term promissory note issued by a small business. 4. T F When compared to other forms of short-term financing, factoring is relatively inexpensive. 5. T F An IPO occurs when a corporation sells common stock to the general public for the first time. Multiple-Choice Questions Circle the letter before the most accurate answer. 6. A budgeting approach in which every expense in every budget must be justified is referred to as __________ budgeting. a. zero-base b. financial-based c. traditional d. TQM e. efficient-market 7. The most popular and inexpensive form of short-term financing is a. factoring. b. promissory notes. c. commercial paper. d. unsecured bank notes. e. trade credit. 8. Selling stock a. is a form of financing that must be repaid at maturity. b. requires the payment of interest every three months. c. is a form of equity financing. d. is a form of debt financing. e. is a form of financing that has low flotation costs. 9. Which of the following would be allowed to elect a corporation’s board of directors? a. Corporate management b. Common stockholders c. Corporate bondholders d. Long-term lenders e. Suppliers 10. A __________ is a bond backed only by the reputation of the issuing corporation. a. registered bond b. convertible bond c. mortgage bond d. debenture bond e. serial bond 19.9 ANSWER KEY FOR QUIZZES I AND II Quiz I True-False Multiple-Choice 1. F 6. b 2. T 7. c 3. F 8. d 4. F 9. c 5. T 10. e Quiz II True-False Multiple-Choice 1. T 6. a 2. F 7. e 3. F 8. c 4. F 9. b 5. T 10. a 19.10 CLASSROOM ACTIVITIES 19.10a Homework Activities • Have students bring in an article that shows an example of an entrepreneur financing his or her business. • Researching and Following a Company Throughout the Course (continuing assignment). Have students describe how someone could invest in the company. • Have students keep track of how they spend their money and what money they earn during a specified period of time. • Have students interview a local small-business owner to find out how the owner deals with budgeting. • Have students research an upcoming IPO and prepare a report about it. The report should include an indication of whether students think the IPO would make a good investment and why. • Homework for Financial Management Class Group Activity. This homework is to be done in conjunction with an in-class group exercise. See handout for homework detail. The purpose of the homework is to have students research federal government financial management issues prior to developing recommendations for improvement based on sound business strategies. Students are to be instructed to bring the results of their research as well as their texts to the next class. • Cash Flow Simulation Game. This interactive online game (available at http://www.bized.co .uk/learn/business/accounting/cashflow/simulation/game.htm) asks students to calculate their cash flow forecast based on predicted sales for a fictional company. When they have completed the forecast, they look at the position that the business finds itself in and make changes to the business to ensure that they are able to carry on trading throughout the year. Students must try to ensure that money coming into the business from sales and other sources is sufficient to cover the costs of inputs used in the business. After students have completed the game, ask them to write a brief (one- to two-page) summary of their experience. How did the company fare under their leadership? What did they learn from playing the game? (Note: This exercise is based on a fictional company in the United Kingdom so figures are shown in British pounds, rather than U.S. dollars. However, the principle of cash flow is the same, no matter what currency is used.) 19.10b Classroom Activities • Have students work in groups to contact one or two local banks to find out the terms of different kinds of loans. Have them compile the information so that they can look at differences between sources of loans as well as differences depending on what the loan is for, how much money is being borrowed, and the length of repayment period. • Cupcakes for All Exercise. Just as all good, organized sole proprietors should, Marti, owner of Cupcakes for All created a cash budget for 2013. Unfortunately, though not unusual, revenue and expenses were somewhat different than budgeted. Place students in groups of four to five and pass out at least one handout to each group. Provide approximately 20 minutes for this exercise. • It Takes Money to Make Money Exercise. Ask students to assemble into groups of three to five and provide a handout to each student. Ask each group to complete the assignment. Provide approximately 20 minutes. • Guess the Stock Trend Exercise. While 2011 wasn’t a great year for stock growth, it wasn’t too bad, either. Divide students into groups of five to seven and pass out the “Guess the Stock Trend” sheet to each student. Ask students to discuss the industry of each company and, from their group analysis, determine if they think each company’s stock price improved, declined, or remained relatively stagnant for 2011. Ask them to complete the two questions at the bottom of the sheet as well. This exercise should take approximately 15 minutes. As an extra assignment, each student could take the exercise sheet home and find the exact percentage of stock price change for 2011. • To Lease or to Buy—That Is the Question Exercise. Place students into groups and pass out enough copies of the handout for each student. The purpose of the activity is to have students evaluate the pros and cons of leasing versus buying as a business strategy. • Financial Management Class Activity. Having been placed into groups to research government financial management issues, students are to regroup and combine the results of their research. Based on the research and text concepts, they are to develop recommendations for the federal government to improve management of finances. The handout includes a format for the recommendation. This will take 30 minutes or more. • Financial Management Jeopardy. Use the online jeopardy game that is available at http://jeopardylabs.com/play/chapter-19-mastering-financial-management. This is a jeopardy game that can be played during class, and it is intended to reinforce the key terms covered in this chapter. You can divide students into teams and give a prize (or bonus points) to the winning team. 19.10c Exercise Handouts Follow on Next Pages CUPCAKES FOR ALL Although carefully thought through and researched, the actual sales and expenses for Cupcakes for All came out slightly different than the projected cash budget. The following numbers were the primary culprits: • Cash sales and collections for fourth quarter: $89,000 (instead of $132,000) • Purchases for third quarter: $75,500 (instead of $68,000); fourth quarter: $77,000 (instead of $70,500) • Other expenses for fourth quarter: $18,000 (instead of $7,950) Discuss the potential causes for these discrepancies—be creative but practical and logical in your ideas. In an independent, small sole proprietorship like Cupcakes for All, which of the four primary sources of funds will most likely provide the firm’s financing? During particularly problematic times like the third and primarily the fourth quarter, what short-term plan can your group devise that may get Cupcakes for All through its crisis? Cupcakes for All Instructor Notes Potential causes for the discrepancies can be: • Fourth quarter sales crash: Severe economic downturn as in 2009; failure of sales promotion; one or two large accounts failed to pay their account • Purchases for third and fourth quarter: significant increase in cost of flour, butter, etc.; change in suppliers • Other expense increase in fourth quarter: machine breakdown, expansion of tables, failure of heating system The four primary sources of funds are sales revenue, equity capital, debt capital, and proceeds from the sale of assets. Cupcakes for All likely survives on sales revenue but with a drastic failure of revenue for the fourth quarter, it may have to rely on equity capital—savings or assets of the sole proprietor. A plan could include unsecured or secured short-term financing. It Takes Money to Make Money The owner of Pooch It Doggie Daycare and Groomery, Jan Michaels, is well aware that it takes money to make money. She’s working on a plan to expand her facility and the services she offers but cannot finance the expansion without outside financing. She’s not completely clear on the benefits and drawbacks of each of her financing options so she’s enlisting the help of a group of friends who are in a business class and have a clearer understanding of her viable financing options (that would be YOU!). Jan has about half of the money necessary but is looking for the best option for the other half—which she plans to pay back in about 11 to 12 months. Complete the following table from the perspective of Jan, the business owner. Type of Financing Advantages Disadvantages How viable of an option is this? Why? Trade Credit Promissory Note Unsecured Bank Loan Loans Secured by Inventory Factoring As a group, decide what the most appropriate option would be for Jan. Justify your decision. ____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________ It Takes Money to Make Money Instructor Notes Answers will vary, but possible answers are shown below. Students will likely justify an unsecured bank loan as the most viable option. Type of Financing Advantages Disadvantages How viable of an option is this? Why? Trade Credit No interest charges Very short term—usually 30 to 60 days Not very viable; too short term Promissory Note Usually acquired from suppliers through a relationship and thus easier to obtain Interest paid; usually for 60 to 180 days Not very viable; does not need supplier merchandise; needs outside funding Unsecured Bank Loan Interest rate varies with borrower’s credit rating—could be very high; no collateral needed Interest rate varies with borrower’s credit rating—could be reasonable; could be difficult to obtain on short notice Likely option if Jan’s credit rating is good Loans Secured by Inventory Interest paid; storage of public warehouse may be expensive; more expensive than unsecured short-term loan Not very viable as finished goods inventory in Jan’s type of business is unlikely Factoring If high accounts receivable are owed the business, can use this as collateral Expensive Somewhat viable; Jan’s type of business likely does not have high accounts receivable GUESS THE STOCK TREND Although everyone knows that the past history of a stock does not adequately predict the future of that same stock, knowing the history may help you analyze the possibility of a positive future return. As a group, see if you know the direction of the following stocks from January 1, 2011, to December 31, 2011. Indicate your guess of the trend of the price for a share of each stock in the third column of the chart. Company Stock Trader Symbol 2011 Return Apple Inc. AAPL Intel Corp. INTC Whole Foods Market WFM General Electric Co. GE Starbucks Corp. SBUX Costco Wholesale Corp. COST Home Depot Inc. HD New York Times Co. NYT Toyota Motor Co. TM Among your group members, discuss which two companies you suspect had the strongest percentage of stock price growth for 2011 and which two had the lowest (or negative) return. List the top two and lowest two below. Top two: #1 #2 Lowest two: #1 #2 Guess the Stock Trend Instructor Notes Company Stock Trader Symbol 2011 Return Actual Percentage of Price Change for 2011 Apple Inc. AAPL 22.9% Intel Corp. INTC 16.3% Whole Foods Market WFM 37.1% General Electric Co. GE –2.0% Starbucks Corp. SBUX 43.2% Costco Wholesale Corp. COST 15.0% Home Depot Inc. HD 19.1% New York Times Co. NYT –21.6% Toyota Motor Co. TM –16.7% Among your group members, discuss which two companies you suspect had the strongest percentage of stock price growth for 2011 and which two had the lowest (or negative) return. List the top two and lowest two below. Top two: #1 Starbucks #2 Whole Foods Market Lowest two: #1 New York Times Co. #2 Toyota Motor Co. To Lease or to Buy—That Is the Question Technology is necessary but expensive for businesses. When computers, networking equipment, and other items are needed, should a business buy or lease them? Consider the following: Leasing—Pros Leasing—Cons Keeps equipment up to date Predictable monthly expenses Pay nothing up front Able to more easily keep up with competitors Pay more in the long run Obligated to pay even if stop using equipment Buying—Pros Buying—Cons Easier than leasing You determine maintenance Equipment is deductible from taxes Initial outlay may be too much Eventually stuck with outdated equipment Clearly, this is not a clear-cut or easy decision. While leasing has many advantages, there are a number of questions that the potential lessor needs to ask. If your needs are modest, you might just want to purchase outright. If, on the other hand, you have significant equipment needs that require major investment, leasing might be the way to go. In your groups, make a list of questions you might want to ask before you sign a lease for equipment. To Lease or to Buy—That Is the Question Instructor Notes Questions that should be asked prior to equipment being leased include the following: • For how long is the lease? • Can the lease be terminated early? • Is there a penalty for early termination? • Is there a buyout option? • Does the equipment have to be insured? • Can items or equipment be added at a later date to the lease? Financial Management Group Homework Project: Part I You will be working with the members of your assigned group on this combination homework and classroom activity project. The objectives of the project are to (1) briefly assess the financial management of the federal government and (2) make recommendations as to financial principles the government should consider implementing. Part I of your homework assignment is to use the Internet and periodicals to research current issues with government finance management. You should summarize your research and bring it with you to the next class. Plan on bringing your text as well. You may also wish to print out any exceptional articles you find. Part II will consist of the recommendations you and your team develop upon pooling your research. As you research, consider the following: • When was the last time the United States had a balanced budget? • How big is the current deficit? • What are the current future deficit projections? • Budgeting for programs is often based on the previous year’s spending as opposed to zero-base budgeting. • Government procurement spending has been riddled with problems such as the purchase of $600 toilet seats and $400 hammers. • Then, there is pork barrel spending such as: • $489,000 for swine waste management in North Carolina; • $661,000 for Alaskan Groundfish Surveys; • $225,000 for hoop barns in Iowa; • $273,000 to help Blue Springs, Missouri, combat teenage “Goth culture;” • $1,500,000 for a statue of the Roman god Vulcan in Birmingham, Alabama; • $1,000,000 for an “Intelligent Transportation” grant for Moscow, Idaho—population 22,000; • $50,000 to fund a tattoo removal program in San Luis Obispo County, California; • $26,000 to study how thoroughly Americans rinse their dishes; and • $4,572 to Las Vegas Helicopters (LVH), which performs airborne weddings officiated by Elvis Presley impersonators, as part of the post-September 11 package of aid to airlines. • And of course, waste such as “The Missing $25 Billion.” (The Department of the Treasury’s 2003 Financial Report of the United States Government contains a short section titled “Unreconciled Transactions Affecting the Change in Net Position,” which explains that these unreconciled transactions totaled $24.5 billion in 2003. The unreconciled transactions are funds for which auditors cannot account: The government knows that $25 billion was spent by someone, somewhere, on something, but auditors do not know who spent it, where it was spent, or on what it was spent.) Sources: Bryan Reidl, “Ten Guidelines for Reducing Wasteful Government Spending,” The Heritage Foundation, February 12, 2003, www.heritage.org/Research/Budget/bg1622.cfm, accessed November 2, 2006; Bryan Reidl, “Top 10 Examples of Government Waste,” The Heritage Foundation, April 4, 2005, www.heritage.org/Research/Budget/bg1840.cfm, accessed November 2, 2006. Financial Management Group Homework Project: Part II Congratulations! You have done the necessary homework and are ready to write down your recommendations. Use as many of the concepts outlined in Chapter 19 as you can to support your recommendations. Among the ideas you may consider are zero-base budgeting, collateral for loans, etc. Be sure to establish priorities. For the purpose of this exercise, do not be concerned with political issues. Use the following format: To: The Federal Government From: ___________________________________________ (List all your names) Subject: Financial Management This forwards a brief analysis and recommendations for financial management of the government. Situation Analysis (Briefly summarize your research and conclusions here.) Recommendations (List in order of priority—remember to use Chapter 19 concepts.) Chapter 19 Video Case: Financial Planning Equals Profits for Nederlander Concerts RUNNING TIME: 10:51 Chapter 19 discusses financial management, which consists of all activities concerned with obtaining money and using it effectively. A financial plan begins with an organization’s goals. Next, these goals are “translated” into departmental budgets that detail expected income and expenses. From these budgets, which may be combined into an overall cash budget, the financial manager determines what funding will be needed and where it may be obtained. Most short-term financing is unsecured; that is, no collateral is required. Sources of unsecured short-term financing include trade credit, promissory notes issued to suppliers, unsecured bank loans, and commercial paper. A corporation can raise equity capital by selling either common or preferred stock. For a small business, debt financing is generally limited to loans. Large corporations have the additional option of issuing corporate bonds. Concepts Illustrated in the Video • Annual Plan • Assets • Debt Financing • Direct Costs • Fixed Overhead • Growth Orientation • Payroll • Price Sensitivity • Profitability • Real Estate • Sales Assessment • Variable Costs VIDEO CASE SUMMARY Nederlander Concerts is in the business of booking, promoting, and producing live music shows in the western United States. The company represents artists from James Taylor to Flogging Molly, Bruce Springsteen, Bonnie Raitt, and the Allman Brothers Band. Nederlander seeks out opportunities that fit within its existing portfolio of small- to mid-size venues. It is in a strong financial position, so it can afford to fund its own growth and expansion, or it can borrow on favorable terms. Nederlander assesses at the beginning of the year not only concert revenue and expenses, but also special event revenue. Every event has its own profit and loss statement, which is a mini version of the company’s annual plan. In addition to daily, weekly, and quarterly event reports, Nederlander’s financial team generates daily and weekly reports of ticket sales. Monthly reports on company-wide performance feed into quarterly and annual reports, and each annual report is compared to that year’s budget. Critical-Thinking Questions Using information from the case and the video, answer the following questions: 1. Here’s what Nederlander’s chief operating officer has to say about its business model: “A show has a short lifetime. You go and sell two months out, and the tickets have no value on any day but the day of the show. So it’s a very interesting model in that sense.” How do you think the short life of the company’s products affects its financial planning? The short lifespan of Nederlander products means that the company has to hold hundreds of events any given year just to turn a profit. Demand is different for each event, and yet it is the company’s responsibility to ensure that events sell out. With a diverse portfolio of artists performing in a given year, there is a high proportion of variable costs. This makes it even more difficult to track expenses and profitability. The complexity of the event industry makes it extremely important to track finances on an ongoing basis. 2. The company uses its own arenas and theaters about 90 percent of the time. What are some of the possible disadvantages of owning its own venues? Three potential disadvantages of owning its own venues involve costs, risks, and flexibility. Because of the high cost of living in southern California, the company likely pays a great deal in real estate taxes and has a large amount of money tied up in long-term debt. Nederlander takes on a significant amount of business risk through real estate ownership and likely pays high insurance premiums to compensate for that risk. Even so, in the event of a natural disaster that damages real estate, Nederlander’s entire business model could change significantly. Because the company owns its own venues, it has less flexibility than those competitors that rent facilities. Therefore, the company books shows that work for its venues, which may limit opportunities for bigger artists and locations. 3. Why would Nederlander choose to sometimes borrow funds for expansion if it has capital of its own? Nederlander may choose to borrow funds for expansion rather than use its own capital to obtain financial leverage. As long as the company’s earnings are larger than the interest charged for money that is borrowed, the company’s return on equity increases. Because Nederlander has established strong relationships with its banking partners, the company is able to secure favorable loans at low interest rates. As a result, the company’s earnings easily exceed interest, which leads to greater profitability in the long run. Chapter 19 Lecture Launcher: It’s Just Part of Being in Business VIDEO SUMMARY Dan, who has been brought on as Urban Farmz’s new chief financial officer, asks Jake and Caleb what kind of access the business has to credit. “We have some low-interest credit cards and accounts with some of our vendors, but frankly, I’m a little freaked that we’re getting in too deep [in debt],” Jake tells him. “Every company finances its growth with debt. It’s just a part of being in business,” Dan explains to him and Caleb. “A ten-year loan to pay for capital improvements the company desperately needs and a line of credit to meet its short-term cash flow requirements would be cheaper than using a credit card,” he says. Caleb wonders if the debt will ruin his and Jake’s credit. Solution Manual for Business William M. Pride, Robert J. Hughes, Jack R. Kapoor 9781133595854, 9780538478083, 9781285095158, 9781285555485, 9781133936671, 9781305037083
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