Lecture 10

Lecture 10--Retrenchment

Objective:

To examine some of the issues involved in retrenchment (Please concentrate on the Chabotar & Honen article)

10.0 Topics

10.1 DCF and NPV analysis

	contribution analysis identifies the cash inflows and outflows associated with programming alternatives
	when these alternatives occur over more than one period, we need to take into account the time value of money
	the time value of money refers to the fact that the value of a dollar today is worth more than the value of a dollar in the future

10.2 The Time Value of Money

	when we want to borrow or lend money, it is common that a usage charge (interest) is levied on the borrower
	this usage charge recognizes that there is an opportunity cost to the borrower of not having the money
	over time, this usage charge is compounded because there is a usage charge on the usage charge (compounded interest)
	the present value (PV) is simply "interest turned on its head" in that it refers to the present value that a future stream of cash receipts or payments are worth
	the PV of a future stream of cash depends on the interest rate (or opportunity cost) attached to the stream

10.3 Simple Case: Cash stream in perpetuity

	suppose that someone offered you a cash flow of $100 in perpetuity, what would this stream of cash flows be worth?
	to come up with an answer, we need to know the time value of money (the interest rate)

PRESENT VALUE = (CASHFLOW)/(INTEREST RATE)

10.4 Less Simple Case: Limited or uneven cashflows

	suppose we have a case where we can invest in a particular piece of equipment today that is expected to generate cash inflows over the next 10 years
	in this case, we need to evaluate the PV of each of the parts of the cash inflows and outflows to determine the NPV
	calculating these PVs is easy because there are generic PV tables that tell us the PV of different cash streams depending on whether they are a one-time payment (PV of a single payment) or a stream of payments (PV of an annuity) and depending on the assumed interest rate

10.5 Evaluating Projects Using DCF

	prepare a table showing the cash flows during each year of the proposed project
	compute the PV of each cash flow using a discount rate (interest rate) that reflects the cost of acquiring the investment capital
	compute the NPV of the total project
	if the NPV is positive, accept the project

generally the interest rate that we use is assumed to be: interest rate = risk free interest rate (bank prime rate) + a risk premium

To illustrate these techniques we will work through an example in class!

10.6 Retrenchment Strategies--How to Retrench

	strong organizations need retrenchment as much as declining organizations
	reconsideration of mission precedes retrenchment
	retrenchment must consider the possibility of future growth
	decreasing expenses has a more predictable impact on financial condition than increasing revenues
	across-the-board reductions should be minimized
	more revenues often mean more costs
	issues of quality should be as important as issues of revenues/costs

10.7 Strategic versus Tactical Strategies

	a strategic perspective is mission oriented in that it reconsiders the primary functions of the organization and how they can be expanded/contracted
	a tactical perspective aims to gain new resources for the institution's current mission or to make more efficient use of existing resources

10.8 More "Effective" retrenchment strategies

Strategic Actions	Tactical Actions
-add income increasing progams	-increase student recruitment
-modernize existing programs	-increase student retention
-increase community support	-increase student body size
-increase adult and evening courses	-increase presidential public relations
-eliminate unprofitable programs	-lay-off faculty
-	-increase class size
	-increase budget control

10.9 Less "Effective" Retrenchment Strategies

Strategic Actions	Tactical Actions
-add new vocational programs	-decrease tuition to recruit students
-improve relations with local businesses	-decrease fees to recruit students
-decrease athletic programs	-lay-off administrative staff
-decrease community services	-decrease plant maintenance
	-decrease salaries
	-decrease student recruitment