Frequently Asked Questions
About ENGM 401 &
ENGM 620 Section X1
Fundamentals of
Engineering Finance
Fall 2010
Instructor: M.G.
Lipsett, Department of Mechanical Engineering,
This FAQ is maintained by the course instructor, and is located at http://www.ualberta.ca/~mlipsett/ENGM401_620/FAQ.htm
How to use this FAQ?
The FAQ is organized into two parts, COURSE ADMINISTRATION QUESTIONS,
and COURSE CONTENT QUESTIONS, which
has sections that correspond to the chapters of the course text and the
timeline of the course. In each section, new entries are usually made to the
bottom of the list of questions and answers. (If there is no date, it is
probably a 2010 entry.) There are Back to Top
links to return to the top (here).
The course website is located at http://www.ualberta.ca/~mlipsett/ENGM401_620/ENGM401_620.htm
Examples are found in the directory http://www.ualberta.ca/~mlipsett/ENGM401_620/Examples
A Glossary of terms can be found at http://www.ualberta.ca/~mlipsett/ENGM401_620/Glossary_complete_ENGG_401.htm
DON’T FORGET: An updated Guide to Calculations can be found at http://www.ualberta.ca/~mlipsett/ENGM401_620/Guide_to_Calculations.pdf
If a student asks a question by
email, then the answer gets posted here on the FAQ, so that all students have
fair access to any additional information that may be provided. Other
information that will be of interest to the whole class gets posted here as
well. (Some previous questions from a previous year are posted for reference.)
Link to COURSE
ADMINISTRATION QUESTIONS (such
as: what format should I use for the assignments? Where do I hand in the assignment? And what’s on the next midterm?)
Engineering
Business & Society (Chapter One and related assignments)
Intro to Financial
Statements (Chapter Two and related assignments)
Income Statement
(Chapter Three and related assignments)
Balance Sheet (Chapter
Four and related assignments)
Statement of Cash Flow
(Chapter Five and related assignments)
Financial Ratios
(Chapter Six and related assignments)
Time Value of Money (Chapter
Seven and related assignments)
Valuation, Sale, and
Cyclic Patterns in Business (Chapter Eight)
Using Financial Statements to Manage an Operating Company (Chapter Nine)
Questions about Sample Midterms
Selected Course Content
Questions from Previous Years of ENGM 401
In assignment #1 problem #4, I am confused
whether the appeal is against the environment regulations or is it against the
extra legal cost that company had pay?
I’m
not a lawyer, but my understanding of the legal process is that a defendant
cannot appeal a law, but can appeal the decision that was based on the law. It
is up to the courts to decide whether a law is bad through judgments, which may
then require the legislative arm of government to create new (and hopefully
better) laws. (Sept 16/10)
I remember you speaking about how
''Business succeeds through the: rule of law.''
Perhaps I missed you saying it but, what exactly is
the ''rule of law?'' Is the rule simply: ''Money talks''?
The three general conditions for businesses to be successful in an economy are: the rule of law, access to fair and open markets, and technology. The rule of law simply means that there are established due legal processes that a country follows, and that you can't just get away with something because you're powerful or you know the person in charge. But now that I think of it, people with money can hire more expensive lawyers, so maybe money does talk. (Sept 6/07)
In Lecture 3 we discuss the Power of Categories in Timing of Reports. Here is a bit more of an explanation.
Sometimes things take a while to happen in a business, and so the financial report needs to show how the business is creating value, even though all the money hasn’t come in and all the bills haven’t been paid yet. For example, Work In Progress is categorized as an Asset; but it gets re-categorized as an Expense when the product is sold (when the revenue is “booked”). This accounting trick removes potential imbalances associated with reporting over a time interval.
But why do that? Isn’t all the money that is spent doing the work tracked as expenses?
(I mean, a liability, or is it equity…). That’s the potential problem. By showing money going out (expenses going up), without showing that the company is doing something that is creating value (doing work for an eventual sale) would create a distorted picture of how the company is performing. To avoid this problem, the costs associated with production are captured as work in progress (an asset account).
Think of it in terms of debits and credits:
An increase in an expense account is equivalent to an increase in an asset account, because the business is spending money to create value (in the eventual sale). Both are debits. Since assets = liabilities + equity, when the liability associated with expenses goes up, the assets have to go up by the same amount for the fundamental equation of accounting to hold true. This equation has to balance in the reporting period, so re-categorizing is used to make sure the equations balance. If this were not done, then there could be huge swings between reports. If a big sale didn’t happen until after the reporting period, then the business would appear to be in trouble because expenses (debits) would be high without the sales revenue (credits)
If expenses all got booked as liabilities with no associated sales revenue coming in, then costs would keep climbing during the period and it would look as though the company is just losing money, with (revenue - expense) going down and down (which looks like the company is just bleeding), and then a huge revenue injection later on (maybe in the next reporting period). Instead, by booking expenses as WIP (the asset going up being a debit), and then converting those costs to expenses (also a debit) at time of sale, the financial reports will show that value is being created even before the sale actually happens. Note that the company can only count the expenses as WIP assets, not the value of the eventual sale. As well as what is in the lecture notes, there is a short document that has this information plus some scruffy illustrations at http://www.ualberta.ca/~mlipsett/ENGM401_620/The_Power_of_Categories_in_Timing_of_Reports.doc
(Sept 10/07)
In Lecture #3, you show a bookkeeping
example where you make a personal withdrawal. Why is that a debit?
Let’s
start with the other side of the transaction. Money is removed from a cash
account. Since a cash account is an asset, the reduction in this account is a
credit (or a source of funds). A personal withdrawal actually takes the money
out of the company. There are a couple of ways to interpret this, but here is
the simplest and best: the personal withdrawal can be thought of as an expense
to the company, so the increase in an expense account is a debit. (A possible -
but incorrect - interpretation is to think of the personal withdrawal to be
going into a (personal) asset account that goes up, making it a debit as well,
but that’s confusing the business finances with the total of your personal
finances including the business.) The net result is that the equity of the company
goes down, and the assets of the company go down, as a result of the expense. (Sept 16/10)
I was looking at the
table on page 22 of lecture 3 on financial statements (2), which is book
keeping example #2 (3). In this table do we include $20,000 cash (that was
paid) to buy the company vehicle at the 2nd transaction?
In this case, purchasing the vehicle requires (at least) two transactions: a payment of 20k from cash and a payment of 10K from a loan each going toward the asset purchase. If you want to be really complete, the order really should be take a loan (credit) with cash account up, and then make a single 30k transaction to spend cash (asset down: credit) to purchase the vehicle (asset up: debit). This appears on the ledger as a single increase in assets by 10k and a single increase in liabilities by 10k in transaction 2 of slide 3 in the annotated slides of lecture 4. (Sept 19/10)
Why is it okay to
book a sale as revenue before you get paid?
This is an accounting convention, because the understanding is that the company will get the full value of the sale. A receivable is like an IOU: a promise to pay within a short time. BUT, shipping on consignment is NOT the same as making the sale. Consignment means that you still own the product until it is sold by someone else (and that party takes a commission on the sale when it finally happens). Afexa (the maker of Cold-FX, formerly CV Technologies) was fined for booking consignment shipments as revenue when they tried to expand into US markets. (Sept 17/09)
For Assignment 2
Problem #2, what account would show the value of the new equipment?
You can add a separate asset account called “equipment.”
In Assignment 2
Problem #2, step 9 talks about book value and asks about the cost incurred in
making it ($750) or its likely sale price ($2500). Is that a typo?
Sorry, that is a typo. It should read $850, not $750.
I am a bit confused
with some of the details about COGS, since some of it seems to contradict
what I learned in my accounting course (ACCTG 300) last year. With your Tim Hortons example during Lecture 5 you didn't include paying
for labour as you said they were salaried. This makes sense to me under the
understanding that salaried workers are paid a monthly salary that does not
depend on the hours they worked, BUT I always took this type of work (Tim Hortons) to paid hourly in which the accountant teaching my
accounting class included hourly wages but not salaries in COGS. I had the same issue with your example of a
salaried welder. I'm not sure if I am looking at the examples in too much detail,
or if you use slightly different definitions for "salary", but if you
could clarify this for me it would be much appreciated. Thank You
This is an important point. As I mentioned in class, different companies may choose to categorize costs in different ways, to summarize understanding of how the business works. In larger companies, accountants will probably include salaried workers who are part of operating divisions of the company as part of COGS. When, however, you are trying to compare products or product lines, it is important to keep all the indirect costs out of COGS; and the wage of the Tim Hortons employee can’t be split amongst products. In class I tried to show a range of examples of how costs might be categorized. That's why in some cases the answer was "maybe." One other point, which might clear things up regarding hourly/salaried: if the number of hours that a worker is employed is dependent on the amount of business that is done (which is the case for casual and temporary workers), then these are indeed variable costs that should be reported for the company as a whole as COGS. As an accountant friend of mine once said, accounting is telling a story with numbers. (Sept 17/10)
Can work-in-progress (WIP) apply to services as well as producing goods?
Yes.
What is an example of
the cost of sales?
Some examples would be: advertising and other costs of promotions, salaries of sales staff (not on commission), and market research studies to understand what sales markets may exist. (Sept 22/09)
Why can a company
that is only operating at 80% capacity sell extra product at a lower margin?
In the case of the example in Lecture 5, the company has already covered its indirect costs through regular operations (i.e. running at 80% capacity), and so the incremental production can be sold at a lower margin and still make money on those incremental sales. This is only true for circumstances when the sales are truly incremental, in other words, not part of the expected (budgeted) business activities – where there is no requirement to cover indirect costs because they have already been covered in regular operations. When we give a discount equal to margin percentage, then (assuming there’s no bad debt) we are setting the product at price equal to COGS – with no expectation of covering indirect costs.
Can a company ever
run at excess capacity?
Often a company can operate beyond its nominal capacity for a short time, with possible risks to wearing out equipment faster and incurring other costs such as overtime. For the long term, managers will continually look for opportunities to grow the business, which means increasing the capacity by removing bottlenecks that restrict production. Bottlenecks may be related to equipment-related, for example limited material handling facilities and low-capacity production units, or they may be limitations in business processes, such as sales calls and collecting receivables, engineering, etc. Removing bottlenecks makes a business more efficient and increases its nominal capacity. Larger growth in the business requires new facilities or new divisions (or acquiring facilities and people by buying another company that already has that capability).
On page 31 of the
text, Sample Problem 3.4.2 shows Potentialco with 10%
higher revenue. I don’t understand where the 20% discount appears.
This problem is correctly presented; it just looks like there’s no discount. In the following table, the first column of figures shows what the base case is, with the company running at 80% of capacity. If the company produced at 90% of capacity, with no discounting, then the income statement would look look the centre column, with the contribution margin holding at 30%. What happens is that the 20% discount happens only on the extra sales, not on the entire production. That results in the income statement of the right-hand column, as it appears in the text. (It’s just a coincidence that the numbers happen to look like a 110% of the nominal production with no discount.) From the Guide to Calculations, here is how to find Net Income before considering any interest the company has to pay, or income tax, i.e., Earnings Before Interest and Taxes (EBIT):
Net
Revenue = Gross Revenue - (Bad debt, warranty, and allowances)
Contribution
Margin = Net Revenue - COGS
Contribution
Margin (%) = (Net Revenue - COGS) / Gross Revenue
Operating
Income = Contribution Margin - SG&A (including Depreciation).
(Operating Income is usually calculated before considering any taxes.)
Net
Income = Operating Income + Other Income.
(Net Income is also called Profit or Earnings. If Net Income is negative it is a Loss.)
Note that the discounting results in a drop in the overall margin of the company. The margin on the incremental sales is much lower, but the company still makes money because there is spare capacity and indirects have been covered. (Sept 20/10, additional calculation info added Sept 23/10)
|
ENGM 401 |
Sample Problem 3.4.2 |
||
|
Potentialco |
80% production |
Additional 10% |
Additional 10% |
|
Nominal case |
(no discount) |
(discount the extra by 20%) |
|
|
Revenue |
$ 460,000 |
$ 517,500 |
$ 506,000
|
|
COGS |
$ 322,000 |
$ 362,250 |
$ 362,250
|
|
CM |
$ 138,000 |
$ 155,250 |
$ 143,750
|
|
SG&A |
$ 50,125 |
$ 50,125 |
$
50,125 |
|
Operating Income |
$ 87,875 |
$ 105,125 |
$
93,625 |
|
Other Income |
$ (1,000) |
$ (1,000) |
$
(1,000) |
|
Net Income |
$ 86,875 |
$ 104,125 |
$ 92,625 |
|
CM% |
30.0% |
30.0% |
28.4% |
In the discussion
above, you say that the company still makes money because there is spare
capacity and indirects have been covered. Why would a
company operate at less than 100% capacity, and how do you know that indirect
costs have already been covered?
The reality of business is that you make a plan for an operating period, say one year, and then you try to achieve the business plan. There are two main reasons why a company would run at less than 100% capacity. 1) You may not have enough customers for your products or services to keep the company at full capacity. It is unusual for a company to have all of its customers lined up at the beginning of the year. Usually the sales force has to find sales to meet the target. 2) The reality of operating a business is that you cannot run at full capacity all the time. There may be process interruptions, you may have to shut down part of the operation occasionally for maintenance, sometimes you have to wait for suppliers to deliver materials, etc. For these reasons, companies will maintain some inventory to handle the inevitable variability in production. This surge capacity is important for stable operations, but it also means that the company has to hold some inventory, and it has to run at less than its maximum capacity most of the time. The margin percentage is thus based on some fraction of potential production, and expected indirect costs. In this circumstance the company has some excess capacity. If a company has excess capacity and is meeting the business plan (in other words, indirect costs have already been covered), then any discount up to the contribution margin will still make money. In fact, a company will look for high margin opportunities once fixed costs are covered, because that’s when the company will make the most profit. (Sept 22,/10)
In Lecture 8 there is
a worked example of depreciation for tax purposes. Why did you use the 50% rule
when you sold the Bronco in Year 5?
Remember that the 50% rule applies to the sum of transactions for that asset class. All assets that have the same CCA rate are considered together. Even though the Bronco was sold, there were also other vehicle purchases, which meant the sum of transactions was positive for year 5, and so the 50% rule applied. (In the Examples directory, computers were part of the assets because they once had the same CCA rate. This is no longer the case: computers now have a different CCA rate. Sept 26/07, updated Sept 23/10)
What is the basis for
an asset?
The basis is the original purchase price of an asset.
What is book value?
Book value refers to how much a company considers an asset to be worth at a particular point in time. The original book value is the purchase price when the asset was bought. Book value changes as an asset depreciates. (Sept 20/10)
What is salvage
value?
Salvage value is what you estimate the residual value of the asset to be when it is at the end of its useful life for your company. It is thus the final book value of the asset. It is used to calculate depreciation. When you actually sell the asset, what you receive for selling it is the market value price. At the end of the asset's life, the book value is the same as the salvage value only if the actual salvage value at market value (what you sell the asset for) is exactly what you had estimated it would be years before; otherwise there will be either a gain or loss on sale of asset. While you still have the asset in the company, its book value cannot go below salvage value. (Sept 29/10)
What is market value?
Market price is what an asset sells for. Book value is what you have assessed its value to be within your company. If you sell an asset for less than its book value, then you receive a market value price that is lower than the book value. This is a loss on sale of assets and requires a writedown. (Sept 29/10)
Don’t computers
actually have a range of CCA rates?
Yes, that’s true. The text incorrectly shows a CCA rate of 30%, when in fact it’s much more complicated than that, as it depends on when you made the purchase. Computers and computer equipment acquired after March 18, 2007 are in CCA class 50 with a rate of 55 percent (but it can’t be used "principally as electronic process control, communications control, or monitor equipment" according to the Canada Revenue Agency). Computers purchased between Jan. 27, 2009 and Feb. 1, 2011, are subject to a 100 percent capital cost allowance (CCA) rate, and so the entire purchase price of a computer purchase can be claimed in the year of purchase (for tax years 2009 and 2010). Computer equipment and/or systems software purchased after March 22, 2004 but before March 18, 2007 are in CCA class 45 with a rate of 45 percent. Tests will avoid such errata and ambiguity as much as possible. (Sept 27/10)
What is meant by
incremental vs. ‘normal’ production?
A company will have a business plan with an expected amount of production. Its production facilities will be set up to deliver this rate of production. Management’s expectations for the contribution margin are based on meeting the business plan. Incremental production is above the business plan. If the incremental production requires more than the nominal production capability, then extra measures need to be taken beyond just ramping up to a higher production rate. If SG&A is already covered by normal production, then the contribution margin of incremental production all goes toward profit. (Sept. 30/10)
In the marking guide for Assignment #3, the
correct answer for Problem 1 i) is
false, not true. (In the circumstance described, the unit profit associated
with an incremental sale will be higher than the average unit profit, but the
contribution margin is unchanged.) (Oct 1/10)
On page 49-50 of textbook, for sample problem
3.5.1, how do we calculate the cash breakeven and book breakeven value for case
2 and case 3?
In this example
problem, the columns represent the base case, the cash breakeven, and the book breakeven.
Each case has slightly different conditions, noted in the comments column. As
it states in the text, from the given information it is simplest to set up a
spreadsheet in Excel and then use the solver or goal seek function to solve for
the sales revenue amount that will result in cash breakeven, and then do it
again to solve for book breakeven. These functions are discussed in the guide
to calculations in the section on chapter seven, and in the help for Excel.
Spreadsheets are extremely useful tools for financial analysis. (Oct 1/10)
In annotated lecture 5 slide 8, it says “%age
of revenue contributing to operations”… what does that mean?
Contribution margin
is the percentage of revenue that contributes to running the operation after
COGS and bad-debt/warranty/allowances costs are covered; that is, contribution
margin minus SG&A yields the operating income (the gross earnings from
normal business operations). This is sensitive business information, and so
companies often report more overall costs instead of COGS separate from
SG&A. (Oct 2/10)
In annotated lecture 6 slide
12, it says “margin increases as you hold price and get volume discounts on
your inputs”… what does volume discounts mean?
An example of a
volume discount is getting a thousand tonnes of steel
beams much cheaper than one steel beam. When you’re a big company raw
materials are cheaper on a unit basis. (It also applies to us as consumers.)
(Oct 2/10)
When one calculates breakeven, should one
include entries in other income, like writedowns or
one time sales? The book mentions that breakeven is when operating income is
zero, but then it also notes that the given formula works only if other income
is minor. I am wondering if usually people include or don't include other
income in this calculation.
Good question.
Breakeven is a useful quick assessment of operating health, rather than overall
financial health. Cash breakeven is when operating income (with depreciation
added back in) is zero. Book breakeven is when operating income is zero without
having to add depreciation back in. Other Income distorts the regular
(operating) income assessment. For this reason, book breakeven usually neglects
Other Income, except for writedowns (as is mentioned
in the guide to calculations and the text). (Oct 3/10)
In annotated lecture 10 slide 13, it says
“certain government charges transfer to board members”… what are these
transfers?
If the business
fails, the members of the Board of Directors may be held responsible for paying
some government charges related to the business. (A little bit more on Boards:
The Board of Directors can also each be held personally accountable in some
cases, if it can be shown that it was because the Board did not show due
diligence or did not act appropriately in guiding the business. Companies may
hold insurance to protect the members of the Board from this risk. A
shareholder cannot sue the Board simply because the business does not do well,
because the shareholder is an owner; but a voting shareholder gets to have a
say in who is on the Board.) (Oct 3/10)
In annotated lecture 10 slide 16, it says
“inventory and receivables are often measured in terms of days – as a ratio of
daily sales”… what does that mean? Could you give me an example?
Days
of Sales is a way to
express the amount of inventory, simply as the number of days of revenue that
it represents. If your sales are $1,000 per day, and you have $5,000 in
inventory, then you have 5 days of sales worth of inventory. See p 178 of the
text for more details. (Oct 3/10)
Note: Annotated Lecture 11 had a typo saying
that $30k of inventory with sales of $1k per day is 53 days of inventory. This
of course is wrong: it is 30 days of sales. The slide has been corrected and
reported. Thanks to the student who pointed this out.
Questions about problem 4.2 in the text (which are answered here not to give away the whole question, but to illustrate that it is the assumptions and interpretation of uncertain information that is the key to engineering finance):
1) I noticed you
answered a question on the website saying we could figure out STCL from looking at the
balance. The question mentions a credit
line of $3M when the company started. Is
there any way we can use this value to figure out the current credit line?
No. Remember that the balance sheet is at a point in time. Establishing a credit line simply means that the business has access to unsecured funds when necessary, and so there is likely a STCL entry on the balance sheet. This is what you will solve for based on the other entries.
2) Statement 12 says
the company is behind on its payroll. Is
there any way to figure out
what this value is based on the number of employees or do I need
the income statement?
You can make an assumption for the average salary of an employee and figure out an amount to account for the fact that people haven't been paid for the period of time. Or you can ignore it if you think that it is not material (that is, not a large enough amount to worry about for accounting purposes).
3) Statement 11 says
the company is current on taxes on a monthly basis. Can taxes be found using sales or must I use
the asset/liability balance?
This means that the company pays its taxes on time. From what is stated, do you think the company owes any taxes?
4) When they say they
left the depreciation in the company, does that mean they have let it accumulate?
You track depreciation. Unless told otherwise, you can assume straight-line depreciation.
5) What category does
rent fall under in a balance sheet? They
don't own the building so it shouldn't go under non-current assets.
If there is no information then you may choose to neglect an item.
6) I'm assuming the
company is privately owned because there is no mention of shareholders and the
owners took a dividend for themselves.
Does that mean the
initial $3.3M used to start the company is put under equity to replace capital
shares?
That is a reasonable assumption. There may also be retained earnings to consider.
Why doesn’t working
capital change when we pay off the STCL with cash?
The short term credit line (STCL) can be considered to be negative cash. If cash comes in (e.g. when a receivable is paid), a company will then use the cash to pay down the STCL. Since the current assets and the current liabilities both go down by the same amount, the net effect is that the Working Capital is unaffected. (Oct. 4/09)
I have the some
questions about the Working Capital Deficiency (Million Dollar Sale) presented
in Lecture 11:
1) How can there be a negative retained earning
when on page 98 of the textbook in the explanation of point 6 it says that : “Also note that retained earnings cannot be
negative.” For months
0-2 there is a negative retained earnings of -$95 K. Please explain how this
can be.
If a company has a loss, then the incremental contribution to retained earnings can be negative. For the purpose of this example, the retained earnings are shown separately as being negative; but in a formal set of financial statements for a real company, the shareholder equity would be reduced.
2) Where are the
accrued expenses? Isn’t this where labour costs are
supposed to go...not payables?
An accounting expense is an expense that shows in a company’s books before it is actually paid. It is a liability. In the question, it states that contract labour is used, and so this is not a salary liability.
3) There was 54 days
of sale assumed for inventory in the answer. Where did this number come from?
This number of days of sales for inventory is an assumption. The depreciation rate of $5k per month is also an assumption.
4) At the end of Month
1, I don’t see how the short term credit line got paid down by $5k. I see no
subtraction from any asset, such as cash, during this month to compensate.
Unless the STCL is adjusted, the two sides of the balance sheet would not match. Cash and the unsecured credit line are the accounts that allow the company to have funds for all of the non-cash business activities. (This is why there is an entire financial statement, the Statement of Cash Flow, dedicated to tracking sources and uses of funds.)
5) At the end of Month 2, how was $485 K
payables calculated? By my math I get $20K + $450K (materials) + $50K/2 (1/2 labour) = $495 K. Also, why was only half of the contract labour paid here? This brings up another interesting point:
When was the other half of the labour paid? I can’t
find the other payment throughout the solution anywhere.
Actually it is the STCL that has to go to $485k to balance the funding requirements of all other business activities, since there is not cash available. The STCL is different from payables, which are the direct payment obligation to suppliers of goods and services. In my explanation of the case I note that the remaining payable for contract labour is not resolved at the end of the case.
6) Why did retained
earnings go up $500K in Month 3 when none of the $1 M had been received yet?
Remember that the timing of reporting sales revenue means that income gets booked when the sale is made, NOT when the cheque finally arrives from the customer.
7) How could the
credit line go down $5K in month 3 from $485K to $480K when there seems to be
no $5K of cash available, or equity injection/long-term loan refinancing to
compensate for this $5K reduction? I have the same questions for months 4 and
5.
Again, cash and the STCL are the “float” that allow the value of business activities (assets) to equal liabilities + equity. (Oct 18/09)
I have a quick
question on interest. Do interest
payments on a long-term loan appear anywhere on the balance sheet? I feel like I keep seeing examples where it
is not located anywhere on the balance sheet and only on the income statement,
and then I see other examples where it is part of current liabilities. Just wanted some
clarification. Thanks.
In our section on Income Statements, you will recall that in our simple examples net income is actually earnings before interest and tax (EBIT). EBIT reflects earnings for operations within a division of a company, but the overall earnings have to reflect financing costs (interest on debt), and the company as a whole has to pay taxes. In the overall income statement for a real company, we would expect the income statement to include not only operational performance, but also costs associated with financing (interest) and taxes. In the section on leverage, we see that net income gets reduced if there was interest on long-term debt that had to be paid in the reporting. On the balance sheet, servicing the current portion of the long-term debt is a current liability that is owed to the lender within the coming year (principal repayment). The remaining amount of the long-term debt itself is a long-term liability that appears "below the line." Any interest that was paid in the previous reporting period would be a cost (interest paid) that reduced net income for that year. In that leverage example, net income (earnings) is after interest is paid on debt. I hope this clarifies how to interpret some of our idealized examples. (Oct. 18/09, updated Oct 6/10)
Is current portion of
the long-term debt the interest on the debt or repayment of principal?
Repayment of principal. Interest paid appears on the income statement. This is explained on p. 94 of the text. (Oct 6/10)
How can working
capital be improved?
Working capital cannot be improved by short-term tactics, unless extraordinary measures are taken, such as settling short-term debts for less than the stated amounts, Working capital can be improved by long-term strategies to reduce current liabilities, such as earning profits from operations, issuing stock to raise funds (more equity), replacing short-term debt (current liabilities) with long-term debt (loans that don’t have to be paid back for more than one year), or selling long-term assets for cash. (Oct 6/10)
Which definition of leverage should we use?
There are different debt
management ratios; but we consider only two types in this course when we
calculate leverage in the lectures. Our leverage calculations may be Bank Debt
/ Total Assets, which is
described in Lecture 13 and in the guide to calculations, or are
based on the ratio of Total Debt to Total Assets, which is the Debt Ratio. In
an assignment or test it will be specified which type of leverage is asked.
(Oct 6/10)
In assignment 4,
problem #3, BalCo’s total liability + equity is $142,000. That doesn’t match the total assets. What is
the right version?
Good observation on your part. It doesn't affect the answer to the question, but for consistency, use $60,000 for the retained earnings for BalCo so that the balance sheet actually balances!
Just
a quick question. I know the
interest on debt appears on the income statement as an expense. On the
balance sheet, however, is the total interest owed on debt included with the
long term debt? For example, if the principle is 10,000 with interest of 100 a
year for 5 years, does long term debt appear as 10,500 (before any payments are
made)?
Interest payments do not appear on the balance sheet. Interest that has been paid in the previous period appears on the income statement. Interest that will be due is something in the future, and so it generally does not appear in a financial statement.
Principal repayment (the remaining portion of the original amount of loans that has yet to be repaid) is split into the amount that is due for repayment in the coming year (the current portion of the long-term debt) and the rest goes into long-term debt. Both of these entries are liabilities on the balance sheet.
So, for a $200,000 loan with a 10% repayment schedule, in year 1 there is $180k in long-term debt and $20k in current portion of LT debt (because the company has not yet paid back any of the principal, and so it owes $200k); at the end of year 1, any interest paid is noted on the income statement, the current portion for year one has been paid, and is replaced with a new obligation to pay $20k in year 2, which brings the long-term debt on the balance sheet as of the end of year 1 to $160k (the company owes $180k). At the end of year 2, the balance sheet will show $140k in long-term debt, and $20k in current portion of LT debt (according to the agreed repayment schedule), and shows interest payments made in year 2 on the income statement. (Oct 14/10)
Here are some
clarifying comments and correction about Chapter 4 of the course text:
The text says that an asset is something that lasts longer than a year. This is not strictly accurate as written. This wording confuses fixed assets with assets. It is perfectly accurate for long term assets, often called fixed assets, but current assets are not expected to last longer than a year. Current assets are materials (inventory), cash in the bank, payments for which future value will be received, and money owing from customers, and all of these except cash are a means of time shifting expenses and revenues. Probably the best definition of an asset is something of value that you own. It can be broken into current and long-term assets, with the latter often being called fixed assets (although technically goodwill isn't a fixed asset - the language in finance is not always as precise as it could be).
Chapter 4 p. 88: the last paragraph incorrectly lists payables as a type of current asset; payables are liabilities.
Chapter 4 p 90: The last sentence of the second paragraph should read: The original cost of (fixed) assets can always be reconstructed by taking the book value and adding back accumulated depreciation plus writedowns.
(These comments also appear in the Errata section of this FAQ.)
For question 4.4 in
the text, was the equipment bought on short-term credit or do we need to
increase the accounts payable more than the 35% from sales?
In Q 4.4 we examine each of the changes in accounts, but don't necessarily know where the money came from that caused that change. Since we know that the two sides of the balance sheet must equal, once we have done all of the changes of individual accounts (or noted that no change has occurred in a few of them), then the only account that remains is the short-term credit line (STCL). This means that if we don't have enough in other liabilities and equity to equal assets, then we have to increase the STCL to make up the difference. If there is too much dependence on the STCL (and it gets too big or violates some other condition), then the lender may call the loan, which can be disastrous for a company. When we discuss sources and uses of funds, we will examine where exactly the flow of funds occurs. This is so important to a company that there is a financial statement dedicated to it: the statement of cash flow. (Oct 14/10)
When buying back
shares, is there a decrease in capital shares?
Yes. As we discussed in class, this is a use of funds which has the effect of decreasing the amount of capital shares. (Oct 14/10)
I am a bit confused
regarding calculated changes in non-cash working capital. For the example in
the text book on page 157 where it is calculating the changes in non-cash
working capital, I am wondering why it shows up on the cash flow statement as
negative 320 instead of positive. The working capital for year-end last year
was calculated to be 238, where as
WC for year-end this year is 558 (Both not including ST credit line and current
portion of LT debt). Since it is an increase in WC, shouldn't it be positive
320? Or, is there a different way that should be used to calculate changes in
non-case working capital? Thank you.
Non-cash working capital is the sum of current assets (except cash) minus the sum of current liabilities (except the short-term credit-line and the current portion of the long-term debt). Think about whether the increase in the non-cash working capital is a source or use of funds. That should make it clear why it's negative 320 on the statement of cash flow. (Oct 28/09)
I'm a little confused
about the concept of Funds Flow. I know the statement documents the changes in
a company's cash position over an accounting period, but is it good to be upper
or lower? Positive or negative?
As discussed in Lecture 15, positive funds flow (also called positive cash flow) is what a company wants. This means that the company produced more cash than it needed to run the company during the period. This is also thought of as funds flow out. When there is negative cash flow, funds have to flow in to support the company. (Think of it like being able to donate blood if you are very healthy, or needing a blood transfusion if you are in serious trouble.) Section 5.5 in the text explains the concept briefly. You might look up cash flow on a web site such as www.investopedia.com, or http://blog.accountingcoach.com, or a basic accounting book. (Oct 24/10)
In the text it says
that to make a cash flow statement you need to have balance sheet, retained earning statement and income statement while in the lecture
notes it say you need balance sheet and income statement. Please let me know
which is more correct.
Consider what is required to generate the cash flow statement, and look at the examples that are given. Two successive balance sheets with the associated income statement and statement of retained earnings are used to generate the sources and uses of funds and thus the cash flow statement. (This is from Chapter 5 section 5.2.) Notice however that two successive balance sheets will include any changes in retained earnings, and so the statement of retained earnings is not strictly necessary. Although balance sheets don't explicitly refer to the statement of retained earnings information, we can find the change in retained earnings over the period between the two balance sheets. Lecture 15, slide 6 reminds us that retained earnings changes are not shown explicitly on the statement of cash flow: net income is shown in operating activities and dividends are here in financing activities. This is why lecture 15 says that to complete a statement of cash flow (SCF), two balance sheets (start of period and end of period) and the income statement for the intervening time period are used. I trust that this answers your question. (Nov 7/10)
When calculating the
working capital ratio, does the current liabilities include
the current portion of the long-term debt?
Yes.
I’m confused about
Profit Margin on Sales. Shouldn’t the numerator be Net Income rather than
Operating Income?
This financial ratio needs to be looked at carefully for a given company. In the course text the numerator is called Operating Income, but this may not necessarily be our standard definition of Operating Income. Some companies use Earnings Before Interest and Taxes (EBIT) for the numerator (which is what we call Operating Income in our discussion of Income Statements). Some companies use After Tax Earnings; others use something in between for income. Once again, consistency by a company is what is important, and you should look at what a company or analyst uses to calculate a ratio. If you are asked to calculate Profit Margin on Sales, you will be given the context of what to use for Operating Income. (Oct. 20/07)
Is treasury stock
included in the market capitalization of a publicly traded company?
Treasury stock is stock that the company itself has purchased. It is often included in the market capitalization, but most countries have limits on the fraction of shares that a company can hold as treasury stock.
What is the
difference between total equity and shareholder’s equity?
Shareholder’s equity is the sum of the capital shares and retained earnings, minus any treasury stock that the company holds:
Shareholder’s Equity = Capital Shares + Retained Earnings - Treasury Stock.
In most cases, companies do not have treasury stock, in which case Total Equity is the same as Shareholder’s Equity:
Shareholder’s Equity = Total Assets – Total Liabilities.
I was calculating the
price to Earnings ratio for the companies we are working on for the ENGM 620
group project, and got a negative price to
Earnings
ratio. Is this actually
possible in reality? if yes, what does it actually
mean?
If a company has negative earnings, then the P/E can be negative.
Is it better to have a higher value for EV/
EBITDA ratio, or it is better if we have a lower EV/EBITDA ratio?
The EV/EBITDA ratio is used in a similar way to the P/E ratio.
The Enterprise value is calculated as the sum of:
common shares equity (at market value not par value)
+ preferred equity (at market value)
+ debt (at market value)
+ minority interest in other companies (at market value), if it exists for the company
– equity owned by an associate company (at market value), if it exists for the company
– cash and cash-equivalents. (Oct 24/10)
I have a regarding problem #5 of assignment # 6. We need to find
the stock outstanding for the companies from their annual reports, so what I
have seen in the reports that they have given weighted average of shares outstanding and they are of two types: Basic
and Diluted. Also, the annual report shows common shares outstanding. Which one
should we use?
Shares outstanding are essentially “basic shares” as defined by the Financial Accounting Standards Board in Generally Accepted Accounting Principles, which typically exclude preferred stock, stock options, convertible stock or debt, warrants, rights, equity participation units, depositary receipts, treasury stock, and restricted stock. (Some companies may have more than one type of common stock outstanding. An index such as Standard and Poor’s will base the stock price on one class, usually the most liquid, and base the share count on the total shares outstanding, and then do a weighted average.) Basic earnings per share figure is the total earnings per share, based on the number of shares that are outstanding at the time.
Dilution happens when additional shares are issued (the pie gets divided into smaller pieces). Diluted EPS is what the earnings per share would be if all the potential dilution of the stock happened (stock options, warrants, convertibles, etc.), meaning that all the possible additional shares were exercised and issued, resulting in an increase in the total shares outstanding (also referred to as common shares outstanding). You can use either basic or diluted in your assessment - diluted is the more conservative – just state why you chose one vs. the other. (Oct 26/10)
When we are finding
market ratios, we use the latest annual report for the financial information
(e.g. end of 2009) while the share price we use is as of today. Is that right?
Correct. That's why market value ratios change all the time. (It is possible to use a quarterly statement can be used for a fast-changing stock, from which pro forma annual earnings can be forecast, but this is approach is not generally accepted.) (Oct 26/10)
In Assignment #6
Problem #5 (question 6.5 from the course text), the last part of the question
states:
"
Is the ratio more valuable
than the absolute number as a management tool?"
What ratio is the
question asking about? It is hard to tell because several ratios were mentioned
before that question.
Ratios can be expressions of a trend for a single metric over time (e.g. 27% increase) or a relationship between different metrics at a particular time. The absolute number refers to a particular financial or operational metric, which you would get from financial reports or operational records, etc. (Oct 26/10)
I am confused between 3 different terms used in the time value of money
slides. Please help me out.
As stated:-
1)
The value of
money increases over time. (means if I have $10000 in
my bank account today it may not have
equal value of $10000 in future?)
2)
The worth of
money decreases over time.( means $1 today is more
than $1 in future? that is we can buy more today with $1 amount as compared to
future $1 amount?)
3)
The
purchasing power decreases over time. ( means if we are getting 1 chocolate for
$2 today maybe in future we may get 1 chocolate for $5?)
From the above 3 cases I conclude that worth of money and purchasing
power are very closely related.
Thanks for your question. It is very important to understand how future value and present value are related. Purchasing power is a time-value of money effect due to inflation.
1) Your first interpretation needs to be in context. Rather than saying "The value of money increases over time," (which is not strictly correct), I would state it in the following way: "Time-value of money dictates that if you have to wait for access to money, then you have to have a larger amount of money in the future than the amount that you would have had today." This is why interest is charged on money: to pay the “rent” for borrowing it from someone. The equivalent future value of a present sum is greater than the present value, because of interest that accumulates.
2) The corollary is that the same amount of money (say $10,000) in the future is not as valuable to you as it would be if you had that same amount today. That’s because you could use the amount today to create additional value for the future. This is true for the same purchasing power, that is, what you can buy for the money. (In other words, having a year's worth of food today is worth more than having a year's worth of food promised to you ten years from now.)
3) Purchasing power of money is a related concept, but it reflects the loss of value of the money itself over time, due to inflation. That means that having $10,000 of today's currency will buy more actual food today than a future amount of $10,000 to buy food in ten year's time.
I hope this makes the concept of time-value of money more clear. (Nov 5/10)
I have a question about Assignment #7 Question #1 iv.
When we calculate equivalence, how close do we have to be?
If two series are assessed at the same point in time, and their values are within a dollar of each other, then you can consider them to be equivalent. (Nov 1/10)
Supplemental: Is it necessary to calculate the present value of the investment in problem 1, part 4, on assignment 7? I am just thinking of how long it would take to do the question on a midterm.
If you look at the guide to calculations, you'll see that there are analytical formulae for calculating the present value or future value of some more complex time series of cash flows (such as those found in this question). By using these formulae, or combinations of formulae, you can do equivalence calculations quickly (that is, fast enough for an examination question). Of course, assignment questions are typically more challenging than examination questions, but it's good to be prepared. (Nov 3/10)
What is the market value of a bond?
A bond has a fixed coupon rate, meaning that the same amount is paid at the end of each year for a specified number of years, as a percentage of the face value of the bond (the Principal). At the end of the final period, you also get the Principal back (the original amount). The market interest rate is the discount rate that affects the future value of those amounts. In reality, the market interest rate changes all the time, but for our purposes for future value calculation we assume that it is constant, because we have no information that makes us believe the discount rate is going to be different from what it is right now. The market value of the bond now is simply the present value of the uniform series of remaining annuity amounts plus the present value of the principal repayment, using the market interest rate for the discount rate. (Annuity amounts that have already been paid in the past are not counted.) The principal repayment of the original amount at the end of the term is a future value, which is why we have to calculate its present value. This is explained in the latest version of the Guide to Calculations and in an example posted in the Examples directory. (updated Oct. 26/09)
A quick note about
mortgages (problem 7.1 in the course text):
When a loan is taken out, there is an agreed schedule for payments. Mortgage payments are done on a level payment basis. That means that means that each payment is the same; and that payment will be the sum of the interest on the remaining principal amount for the period plus some repayment of the principal. (If none of the principal were ever paid back, then the loan would go on forever!) In the initial payments, almost all of the payment goes toward paying interest on the loan, but a small amount goes toward paying down the principal. Because part of the principal gets paid off, the interest amount goes down over time. This means that, as time progresses, less of the payment is for interest and more goes toward paying down the remaining principal amount. At the end of the mortgage period, the principal has been fully repaid. You can use a spreadsheet to solve for the payment that brings the remaining principal to zero at the end of the amortization period.
This question is simplified to annual payments. In reality, most mortgages are paid on a monthly basis or even weekly (although the interest rate is still quoted as annual). How fast a mortgage is paid off depends on how fast you can repay the principal. Making more payments that are divided into smaller chunks (e.g. $1000 twice per month instead of $2000 per month) will have only a minor beneficial effect on the effective interest rate and thus the rate at which the principal is repaid. A better strategy is to make payments that go directly toward the principal (most residential mortgages will allow at least one such payment per year), or increasing the uniform payment so that there is more going regularly toward repayment of the principal.
An annuity (level-payment) calculation will yield the same result, provided that the correct interest rate is used for the compounding periods; this approach will not, however, show how how much of each payment is interest and how much is principal repayment. Also, it does not work if the payment schedule is modified to allow for additional payments.
If the mortgage rate is attractively low, then it may be to your advantage to keep paying the mortgage and to use your remaining money in other investments, provided that they give a higher return than the cost of money you borrowed for the mortgage, at an acceptable level of risk. In this way, you maximize the benefits and minimize the costs of your set of investments.
There is a more detailed explanation on pp. 199-200 in the course text.
In Problem 7.1, you
are being asked to solve for the principal of the mortgage for the following
four cases:
20-year
amortization with a mortgage interest rate of 7%
20-year
amortization with a mortgage interest rate of 11%
30-year
amortization with a mortgage interest rate of 7%
30-year amortization with a mortgage interest rate
of 11%.
The amortization period is the length of time over which you pay off the mortgage.
I have a short
question about mortgages (Problem 7.1): when is the down payment being paid?
Let's say year 1 at the beginning, down payment is made and this year do I
still have to pay yearly mortgage at the end of this year? Or we just put down
payment in the year 0, then at the end of year 1,
mortgage is due.
A down payment is paid right at the beginning, what we would refer to as
the end of year zero. There is a mortgage payment due at the end of the first
period (here, we consider annual periods, so the end of the first period is the
end of year one). A down payment puts a heavy burden on mortgage holders in the
first year, but the down payment reduces the principal directly, and so it is
worth making as much of a down payment as possible. (Nov 10/09)
For problem 7.1 in
the course text (on mortgages), do we take into account the time value of
money?
If you mean inflation, then no. We only consider inflation if it is explicitly stated in the problem. (Nov 14/09)
I don’t understand
what Problem 7.2 in the text is asking for.
Consider what the problem is fundamentally asking. Your uncle has three choices: take the $100,000 now (and invest it to get some return), take a set of $13,000 annual payments starting now, or take a set of $13,000 annual payments starting in a year from now. When making a decision like this, a person wants to know what will affect the decision. In this case, the decision variable is the interest rate (or discount rate) associated with each option, because the interest rate will affect the equivalence of the options. Problems like this require us to find the interest rate that equates two alternatives:
Once you have figured out the discount rate that would make options equivalent, then you can look at the information available to decide whether a particular option (at its associated interest rate) is more attractive than the rate at equivalence. Of course the uncle is not going to let the money sit, and so the time value of money (the interest rate) would be based on the return rate that he could get from investing in one of the options given. (Nov. 5/09)
(Supplemental) So do
we use IRR for this?
Finding the discount rate that would make a future series of receipts equivalent to an initial investment is another way to describe the IRR calculation.
What is being asked for the
effective discount rate is the interest rate at which one cash flow series is
equivalent to another. Several investment alternatives are offered, and we need
to compare them on an equivalence basis (i.e., at some point in time). The
effective discount rate tells us whether any other investment option (at a
particular interest rate) will be more or less attractive than what the one
that is offered at that effective discount rate. The latter part of the question asks you
whether there is any difference in the risk between organizations, and whether
that would affect your recommendation to your uncle. (You should note
that not all sources of funds have the same amount of risk, and so the interest
rate for a risky source of funds would be different than that from a safer
source.)
(Nov 6/09)
Why do we ignore sunk
costs when we do investment analysis?
If an investment has a poor return on investment looking forward into the future, then sunk costs would just make the return look even worse. Spending more money on a bad idea just because you’ve already wasted money on it is another bad idea. If we are doing IRR, we do have to look at the same investment interval when we are comparing different options.
When we are picking a certain point in the cash flow series as “today” (end of year 0) for an investment project, we have to consider that entire cash flow series. In such a case, the costs prior to year 0 are not sunk costs; they are part of the investment cash flow series, meaning that unless you spent that money you wouldn’t have the future benefits. (Nov 10/09)
In choosing between
two investment options, I understand that if both of their IRRs > MARR then
you must use IIRR to determine which option.
However, if the cheaper option has the higher IRR, why wouldn't you
choose that immediately?
Because you might not make as much in total. Here’s a simple example. If a $10 investment makes 20%, you’d make $2. If a $20 investment makes 15%, you’d make $3. The incremental investment of that extra $10 makes you an extra $1. If your minimum acceptable rate of return is 10%, then you should invest the extra money, i.e., if the higher cost option yields an IIRR that is over the MARR, then the incremental investment is worth the extra money you spent. (Nov 14/09)
In problem 7.5 in the
course text, do we do the same analysis as shown in class but what do we use as
the discount rate to solve for the charge-out rate? Should we use 8.5%?
MARR for a project needs to be higher than the WACC. Why would a company borrow money at 8.5% to make an investment that will only have a return of 8.5%? Consider what a reasonable discount rate might be. (Nov. 14/09)
Here is an additional note for the solution of Problem
7.5 in the text, provided by the author, Peter Flynn:
"Note that cash
flow is lower in years one and two than in subsequent years because the
customer base using the machine is growing.
Should one charge more per hour in these years to offset lower
hours? The answer is no: the worst way
to build up usage of a service is to overcharge for it during early years. The pursuit of financial objectives has to be
tempered by the reality of customer behavior." (Nov 19/09)
For problem 7.9 in
the textbook, the cash flow starts from year -1. It seems as though the capital cost is spread
out over 2 years, so do
I take the year 0
back to year -1 in order to set NPV of the project equal to 0 to find the IRR?
You can assume that today is the end of year 0, which is our convention; please note, however, that the equivalence calculation would give the same decision recommendation at a different point in time for the same interest rate, which we saw in lecture 19 (but the numbers would of course be different). When we do IRR (and IIRR) we are considering the entire cash flow series to find the rate of return that would make the overall present value equal to zero. This is different from present worth analysis of an investment on a go-forward basis, where we ignore sunk costs to decide whether to continue with the investment from today onward. (You do the present worth calculation based on the point in time when you are making the decision.)
You are correct that the capital cost occurs over two years, and so by that reckoning the initial year of costs are tallied at the end of year -1, the second year of capital costs are finished at the end of year 0 ("today"), and then the project begins earning money in year 1.
In an upcoming lecture, we will see that when we are calculating payback we start the clock in the first year in which earnings occur. Until then, it is project development (spending money rather than making money). (Nov 9/10)
I am bit confused
about IRR. As mentioned in the lectures and text that IRR is the rate of
interest at which cost equals benefits of an investment. Now in real life we
would prefer benefits to be more than cost then why we consider IRR to select
between two options of investment while it shows the rate at which cost=
benefits. I would appreciate it if you would please explain this.
You are right, in that IRR is the rate of interest for the discounted set of costs and benefits being equal. As such, IRR is a direct measure of the earning power of the investment, which is why we use it to assess options that meet our non-financial criteria, AND which at least meets and hopefully exceeds the MARR (otherwise the investment is not worthwhile). We don’t select investments unless the IRR is high enough to meet the MARR requirement. IRR is an alternative to thinking about what the NPV would be at a particular interest rate. I hope this clarifies IRR for you. (Nov 16/09)
When we're
considering if an investment is worth it we usually look at whether the IRR
> MARR, and if this is the case then we go ahead with the investment. Is this also true if we compare IRR to
WACC?
Yes. IRR must be greater than the hurdle rate for the investment to be worthwhile. A company can have a number of hurdle rates, including using WACC. Recall that WACC is the return that represents the overall return associated with a company's financing, thus the company's risk tolerance. Management might set MARR for a specific investment opportunity higher than WACC because the opportunity has more risk. If an investment opportunity is considered to have the same level of risk as overall, then IRR > WACC would be used as the hurdle rate.
(Supplemental)
Another question is that the NPV must be greater than zero for a specific MARR
in order for the investment to be acceptable, does this also hold true for WACC
since it is also a hurdle rate?
Yes.
(Supplemental) Thanks
for your reply, so in other words WACC will either be less than or equal to MARR since MARR is the
minimum allowable rate of return?
So if you were to
have
MARR = 25%
WACC = 20%
you would compare the IRR or IIRR to the MARR
and not the WACC right? Thanks again.
In the scenario you describe, MARR for the investment would be set above WACC if the investment were higher risk than the average risk of other investments the company had. MARR may be less than WACC if the investment is lower risk than average for the company. In these scenarios, the investment is gauged against the MARR that is set for it. (Dec. 2/07)
When we are doing an
investment analysis, what do we include in the cash flow series? Should we
include any non-cash expenses?
We use the expected cash flows. In the most realistic case, we would use after-tax income, which includes any taxes that have to be paid (and any allowable deductions such as CCA). In any case, we don’t include allowances or non-cash expenses such as depreciation. These are accounting creations that are charged against earnings so that operations managers can free up money for investment purposes, including eventually replacing worn out assets. If assets are bought or replaced, then they should appear explicitly as part of the cash flow series. (Nov 15/10)
The last slide of
Lecture 26 has an accompanying spreadsheet in the http://www.ualberta.ca/~mlipsett/ENGM401_620/Examples directory. It shows the solution for a
breakeven analysis problem by interpolating to solve for the number of
years. How did that interpolation work?
What we are trying to solve for in Lecture 26 (slide 19) problem #2 is how many years would the corrosion-resistant part have to last to have the equivalent uniform annual cost of the untreated part. The cost of the untreated part is $350 x (A|P,10%,6) = $80.36. The corrosion-resistant part equivalent uniform annual cost (Option B) must be at least this low, so we have to find the number of years that will give the same amount, that is $500 (A|P,10%, n) = $80.36. So now we know that (A|P,10%, n) = $80.36 / $500 = 0.1607, and we look in the Uniform Series Capital Recovery Table (on slide 10 of Lecture 21) and find that in the column for (A|P,10%,n) the value 0.1627 for n = 10 (barely visible) and 0.1540 for n =11. That means that the solution lies somewhere between 10 and 11 years. By interpolation, we can solve n = 10 + (0.1627 - 0.1607)/(0.1607 b- 0.1540) = 10.23 years. It is possible to solve for n from the analytical formula with minor algebraic effort (or by doing an iterative solution, because n appears as an exponent in two parts of the equation). In this case, we can solve for n directly by a simple transformation of variables: he uniform series capital recovery factor formula is A = P[i(1+i) n]/[(1+i)n – 1] which solves as n = [ln(A) – ln (A – Pi)]/[ln(1+i)]. (originally posted Nov. 14/07, updated Nov 22/10)
I was wondering if
you would be able to explain how you got the answer for the example on Slide 2
of Lecture 26.
This is the equivalent annual interest rate (what is actually being charged for interest annually), which requires daily compounding, as opposed to the nominal annual rate. (Nov 29/09)
I'm reviewing lecture
27 on Inflation - unfortunately I was sick this day and missed class. Can you explain slide 2 regarding the payback
period? When I went through the
annotated slides it says the answer is just over 7 years. Don't we look at the Sum of PV and say that
the payback is where this number becomes positive?
The crossover from negative to positive cumulative sum is the point in time at which payback occurs; but we calculate the payback period from the point at which a project or investment begins to provide a return. Simple payback uses the series of future cash flows, and so the answer in this case is approximately 9 minus 2 (just over seven years). Often payback is stated as the full number of years, rounding up, and so if you were asked for an exact number you would say it was eight years.
I checked the examples of lecture 29. I think the second
example from the top is not the same as your lecture in class.
The posted example
shows only the initial set-up; it solves this way:
|
|
|
i =15% |
|
end of year |
FV |
PV |
|
0 |
-$100.00 |
-$100.00 |
|
1 |
-$153.90 |
-$133.83 |
|
2 |
$40.00 |
$30.25 |
|
3 |
$60.00 |
$39.45 |
|
4 |
$60.00 |
$34.31 |
|
5 |
$60.00 |
$29.83 |
|
6 |
$60.00 |
$25.94 |
|
7 |
$60.00 |
$22.56 |
|
8 |
$60.00 |
$19.61 |
|
9 |
$60.00 |
$17.06 |
|
10 |
$60.00 |
$14.83 |
|
|
NPV |
$0.00 |
The posted version shows
the NPV at MARR before adjusting the value of the cost at the end of year 1,
rather than the full solution of the sensitivity of that parameter when IRR =
MARR. The sensitivity of the cost at the end of year 1 is $53.90, which is the
difference between the initial value and the value that would cause the
decision to change to not invest because the IRR has reached MARR, and
any further change would make IRR < MARR. (Nov 19/09)
How is the real interest derived?
The contribution of
nominal interest rate to compounding can be expressed this way as a function of
inflation rate f and real interest rate ir:
(1+ in) =
(1+f)(1+ ir)
from which we get the stated formula for the real
interest rate ir. (This formula is also
given in the guide to calculations.)
I am not sure how to
do a problem with uncertainty. Do I find the expected value of the uncertain
parameter and then do the calculation, or do I do a set of solutions (each
using one of the different possible values) and then calculate the expected
value from the set of solutions? I get different answers depending on what
order I use!
If you have only a single parameter that is uncertain, then you should find the expected value of the parameter and then do the calculation. If you are doing a set of scenarios (best/most-likely/worst cases) then you’ll use the set of parameters for each scenario, and do the calculations for that scenario. Once you have found the result for each scenario, then find the expected value of the results. In the first approach, we are using the probabilities of the parameter. In the second approach, we are using the probability of the scenarios. (When our calculations are nonlinear, the order of operations is important.) (Nov 29/10)
I'm wondering how you
got the Book Value in lecture 28, PP.18(what about
salvage value?). you used $29716, and I just don't get
it. Also, why is it that the actual value is considered as the inflated one? the reason why I'm asking is because actual value uses
nominal interest only, so my understanding here is that no inflation is applied
on the actual value.
Lecture 28 Slide 18 illustrates the disposal tax effect,
based on the book value at the end of year 10 coming from the calculations of
example 1 in that lecture. While we are dealing with future values in the cash
flow series, in this lecture we are not dealing with adjustments for inflation.
(Dec 5/10)
While reviewing the
marking guide, I am confused about the first questions of assignment 9. I used the
"Benefit-Cost Analysis" section of the Calculation Guide, and chose
the option with the highest of acceptable IBCRs. Therefore, the answer is
Option C. Why isn’t that right?
That statement is actually a bit ambiguous. You want to
choose the most expensive option that has is acceptable (IBCR > 1) as
illustrated in Lecture 26. I have changed the guide to calculations to remove
this ambiguity. (Dec 5/10)
No questions so far.
No questions so far.
Is the project due on Wednesday or Thursday?
It is due on Wednesday. The word
Thursday on the title page is a typo. Sorry for getting your hopes up.
I have done all the necessary calculations on spreadsheets, but
the project handout asks us to attach the calculations. Should I do all the
calculation again on the paper to show my work?
Please show your answers legibly on
the project handout, as per the instructions. If the TA has to search for your
answers, then it adds a lot of work and increases the chances of error. It is
up to you to make sure that the spreadsheets are well laid out so that the TA
can follow your reasoning (if it’s necessary to find part marks.) Thank you for your consideration.
For problem#1:
1. Depending on what assumptions we use, and how the entries on
the proforma are calculated, won’t we end up with a different
analysis for the health of the company? If the combination of assumptions were
any other way, we would have a totally different pro forma. So my question is, how do we make sure of our assumption's validity??
Yes, the specific result will
depend on the assumptions that you make about how the business performs. A
number of different solution cases have been worked out for this problem, and
so it is important that you state your assumptions and that
they are reasonable.
Sometimes, things can change
quickly in a business, although from the numbers, it looks as though things are
fairly stable. You will have to make some assumptions about how to project your
forecast, and state them.
2. For question 1, can you please confirm whether or not the
SG&A value
given for quarters 1 and 2 includes or excludes the depreciation amount of
$250,000/month?
Depreciation is a non-cash charge
that is part of SG&A. By looking carefully at the given income statement
information you’ll be able to tell whether it was included or not in the
SG&A entry.
For problem #2:
1. Do we have to include deferred taxes or do other calculations
to find taxable income?
It is clearly stated in the problem
that for this simple analysis, taxes are just the taxable income times the
corporate tax rate. In reality, calculating after-tax income is much more
complex.
2. the interest of the LT debt can show up both on other income
or on SG&A( as a -'ve
value), but the question is, how to measure this interest?
Do we even need to do so??
Interest = interest rate x (amount
on which interest is currently calculated).
Of course we have to track this
interest. We can't calculate taxable income without it. While it is true that
interest on LT debt can appear in different places on the income statement, in
this case the interest is in fact shown explicitly.
3. On the balance sheet, to get total
equity, do we just subtract total liabilities from total assets?
Think about it. I'm sure you will
realize what the answer is. (A balance sheet does have to balance. Just because
something is not mentioned in the information given in the question does not
mean that it does not appear on the balance sheet.)
4. In question 2, it is not clear whether or not the taxes
calculated for the income statement have been included in the current
liabilities of the balance sheet as taxes payable. Is it left to us to include this ourselves?
You will want to check the
difference between taxes payable (a liability) and taxes paid (as an expense),
and then consider whether you would add that account or not.
In Project #2 Problem
#1, I do not understand the difference between questions 1a and 1b.
A cash flow series may include a range of benefits and costs over the time period of the investment. Part a asks only for the benefit that will be derived from operating the new asset. (Nov 18/10)
In Problem #1, I am
having trouble understanding how the costs escalate over time. Is it 1.3%, then
3.3%, 5.3%? It looks awfully big after 20 years.
The first annual maintenance cost is 1.3% of the installation cost (original capital cost). Each year the annual cost grows to 1.02 times the previous annual cost. This is a typical progression for maintenance costs. (Nov 19/10)
For Problem 3 of the
project, do you want us to do anything with the 60 day period after approval
but before purchase, such as pro-rate the depreciation?
In problem #3, when you are considering when to start the clock, think carefully about the end of the second paragraph in the problem statement. Depreciation is a non-cash expense. Think about whether that gets included in a cash flow series (and maybe look elsewhere in this FAQ in the section on Chapter 7). (Nov 18/10)
In Problem #3, what
does a “base case” mean? Is it just the future values cash flow rate without
any discount? If so, can parts a and b be done in the
same spreadsheet table, side by side?
A base case is a description of the expected scenario, that is, a sequence of conditions that are expected to occur for the potential investment, excluding any unlikely events. (A base case for an investment generally includes time-value of money considerations, and so it is not just the series of future values.) (Nov 16/10)
Do we include
inflation in Problem #3?
No, we are not given any indication of what effect inflation might have, and so we neglect it. The future cash flow series are thus inflation-free values. The reclamation cost thus does not change, and is counted on the series at the time that it would occur. (Nov 22/10)
Sample Midterm #1:
I have a question
about Sample Midterm #1. Part I, #5: (My initial answer was B.) To get the
answer A, I would need to subtract Depreciation as well - as a rule of thumb,
do you take depreciation into account when calculating operating income?
Yes, Operating Income includes all SG&A – in other words, it does include depreciation. (This formula is given in the Guide to Calculations.) That’s why the answer is A. (Sept 29/09)
Sample Midterm #2:
For question 7, what is Current Assets minus Current Liabilities minus cash equal
to?
7 e: this fictitious formula does not represent anything of particular financial interest. (Nov 7/10)
For question 11, why is the answer c
and not b?
The Debt Ratio is Total Liabilities / Total Assets. In the information available, we calculate Total liabilities = Total assets - Total equity, where total equity is capital shares + retained earnings (at the end of the period, i.e., the most recent point of time), which yields a debt ratio of [7500 - (2,890.00 + 2,420.26)]/7500 = 0.292 or 29.2% . Answer b is the leverage based on long-term debt only, not the debt ratio. (Nov 9/10)
For question 17, why
choice b is incorrect? I thought the answer would be b, because the market
capitalization has grown so much.
17 c: this answer is more correct than b. The market capitalization has grown a lot, but it is not the only reason that an investor might be interested. There are many reasons for market cap growth that may not be sustainable. The speculative investor will also look at growth indicators. (This question is one of the most difficult on this sample test.) (Nov 7/10)
In question 20, I am
not sure how to obtain the answer from the information given. Some
clarification would be much appreciated. Thanks!
Here is some information on interpreting the choices in this question:
20. A company has negative cash flow, a low times interest earned ratio, market capitalization of $16M, total liabilities of $9M, capital shares of $19M, retained earnings of $24M, and dividend yield of 3%. What is your assessment of the company?
a) This company’s stock is over-valued. (N: the stock is not overvalued, as the market to book value is less than 1.)
b) This company may be worth more by stopping its operations and selling off the assets. (Yes: from the given information we can calculate enterprise value to be $25M, and total assets to be $50M, so there is a lot of potential value in the assets, whereas the company itself has negative cash flow.)
c) This company can be profitable if it can reduce its leverage. (No: no leverage information available to assess whether this is correct, other than times interest earned is low, which does not by itself indicate excessive leverage – although it is a possible indicator. Without information on the earnings (profits), we don’t know what it would take to be profitable – and where the changes need to be made. In fact, the company may be making a profit , even with negative cash flow. Also, the company is paying dividends, despite having negative cash flow.)
d) This company’s stock is attractive because it has a low price to earnings ratio. (No: we do not know what the earnings are, so we can't assess P/E.)
Don’t expect many questions of this level of sophistication on the actual midterm. But do expect to have to do some interpretation of financial information on the test. (Nov 4/10)
For question 32,
since the price to earnings ratio is high, the investors would expect a growth
on earning, so why might they sell the stock?
32 True: once a stock price gets to be high, investors may decide to sell the stock (rather than keep it in the expectation of further growth). (Nov 7/10)
For question 35, why
is this statement incorrect?
35 False: The conventional definition of one day of inventory is equal to the sales revenue for one day of production. This is a conservative estimate for inventory because of course COGS would be the more accurate metric to use. (Nov 7/10)
For question 36, all
things being equal, the desire for the investor is to buy a stock with a low
P/E ratio. That is why in the sample midterm, the answer to No. 32 is True: the investor may decide to sell a stock that has a
high P/E ratio to get more stocks at a low price for a given rate of earnings.
In this regard, I would expect that the answer to question no 36, should be false. Why is the answer true when the desire
is to have a low P/E ratio?
The desire for the investor is to "buy low" and "sell high" so the investor wants to buy at a low P/E (although this may also show some risk if the stock is too cheap...), and may then sell once the price goes high enough that the investor no longer believes that the stock price will continue to go up. The company wants to have a high P/E ratio, which is only attractive to an investor if there is the prospect of further growth. (Nov 8/10)
For question 42, who
can receive a preferred dividend?
42 False: Owners of preferred stock receive a dividend ahead of common stock holders under certain conditions, but these conditions are not based on the owner's credit rating. (Nov 7/10)
Sample Midterm #3:
Question 3,
"Project payback is calculated differently than payback for a general
investment.", may I ask what the difference would
be ?
Projects are not managed the same way as operations. Project payback is sometimes calculated using future value series (simple payback). In general financial investment analysis we don’t use simple payback.
Question
8, "Stock values are changed by interest rates, profitability, and
prospectus." Why is this not true ?
The prospectus is an original description. Stocks change all the time.
Questions 17 Capitalized cost
is the NPV of a perpetual series of cash flows. choice
B, why this is not right ? I think that might derive from a conflict in the
note, since the note actually gives the same definition while the attendant
example gives capitalized cost is the sum of capital cost plus the series.
17 b is the correct answer. The capitalized cost is the original cost of the asset (present cost), plus the present value of an infinite number of replacements (which would also include related asset maintenance costs in perpetuity, although we did not include those in our example).
Question 20: What I
did was to plug in the given answers into the equations and see if it gives the
correct answer; is there any other option to figure out IRR during midterm?
That's how I'd do it. You would not be expected to do a
detailed solution for IRR in a test situation.
Question 24: UCC is carried forward, but it is not
converted to a discounted present value.
Question 25: Does
this property apply to other calculation? Could I have 150(F/A,10%,4)=200(F/A,10%,4)-50(F/A,10%,4)?
You can check and see for yourself. It is simply the
associative property.
Question 29: A
project with no return on investment (no benefits, just costs), then it will
have no solution for IRR or payback.
Question 35: In this
question, "factors" is a verb. Payback does not factor into the
return calculation.
Question 37: A
variation in a parameter can affect a decision, but a decision factor does not
affect a constant.
Question 40 , "Cash flow forecasts use actual cash flows that
are expected to occur, not accounting allowances." what's accounting
allowance ? does it mean that the cast flow being
adjusted by accounting rules ?
We covered allowances earlier in the course: they spread costs over a set of reporting periods to avoid sudden swings in earnings from periodic big events.
Question 41: Interest
payments and tax are paid with future dollars, which are inflated if counting
inflation. Principal repayment is done after tax, not before tax.
Page 25, Paragraph 3.4, the third line from the bottom, "a payable is recorded"
should be " a receivable is recorded"
(Recall that when a sale is booked, two sets of transactions occur:
WIP (asset) goes down (credit) and COGS (expense) goes up (debit)
And
Revenue goes up (credit) and Receivables (asset) goes up debit.)
Page 25, Paragraph 3.4.1, the definition of bad debt is given as a payable that can not be collected.
The company that has the bad debt on its books has a receivable that it can’t act on, and so it has to have an artificial expense payable (called bad debt) to get the value off the books.
<Thank you to the student who pointed out these errors, for helping to improve the quality of the course and the instructional material.>
In Chapter 4 the text says that an asset is something that lasts longer than a year. This is not strictly accurate as written. This wording confuses fixed assets with assets. It is perfectly accurate for long term assets, often called fixed assets, but current assets are not expected to last longer than a year. Current assets are materials (inventory), cash in the bank, payments for which future value will be received, and money owing from customers, and all of these except cash are a means of time shifting expenses and revenues. Probably the best definition of an asset is something of value that you own. It can be broken into current and long-term assets, with the latter often being called fixed assets (although technically goodwill isn't a fixed asset - the language in finance is not always as precise as it could be).
Chapter 4 p. 88: the last paragraph incorrectly lists payables as a type of current asset; payables are liabilities.
Chapter 4 p 90: The last sentence of the second paragraph should read: The original cost of (fixed) assets can always be reconstructed by taking the book value and adding back accumulated depreciation plus writedowns.
I am tossing a
hypothetical scenario. Suppose we lived
in a country that doesn’t deal in interest (or suppose that lending money to
the bank with interest is not an option for an individual). How would one then compare the worth of two
different investment options?
Even if there is no potential to earn interest in this hypothetical situation, money will still be worth more to you today than in the future. What it means is that you will have to discount future earnings by your own personal “inflation rate,” in other words your own WACC. Then each different investment option will have a MARR that reflects the extra value that each will create. I’m speculating now, but I guess in this situation you’d be willing to accept more risk in other ventures to create wealth (because there’s no easy alternative of just putting money in a financial institution to accumulate some interest). When governments reduce interest rates (the prime lending rate), this stimulates investment, for the same reason. (Dec. 2/07, Nov. 26/09)
Today in class when
you talked about the stock market I started to wonder more about it. I was
wondering if you could either talk about the stock market a bit more in class,
or post some resources on the course website.
Thank you for your email asking about how financial markets works. Here is a really brief and simplified explanation, and a few links that may be useful.
Companies need access to funds to be able to run their business. If they do not have enough funds within the company, they basically have two financing options to bring funds into the company.
The first option is to take on debt. The company can borrow money from a bank or other lender, which the company then has to pay back with interest. Alternatively, if the company meets certain conditions, it will be allowed to issue bonds on one of the bond exchanges, which is a type of financial market. The company can then issue a bond offering, which means that it will sell bonds to people (or other companies) which have a schedule for repayment with interest. Each bond is in effect a lending contract, a loan that the company must pay back. Those who buy the bonds will make money on the interest, and get their original payment back as well (the principal). The bond market is the mechanism for selling and buying bonds, which people access through financial institutions (such as banks).
The second option is to sell an equity share in the company to raise funds. If the company meets certain conditions, it will be allowed to sell stock on one of the stock exchanges. The company issues stock, which other people and companies buy through brokers. Those stocks continue to trade on the exchange, and if someone buys the stock they now have an ownership share in the company. Market forces of supply and demand determine the stock price. The current stock price times the number of shares in the company gives the current market capitalization for that company. If people think the stock is a good buy, then lots of people will try to buy it, and the price gets driven upward (because there are fewer people willing to sell the stock at the current price, but they are willing to sell at a higher price). If people aren’t willing to buy the stock at the current price, then they might offer a lower price, which sellers can either accept (and sell the stock) or reject (and keep the stock). Investors and traders use financial ratios and other relevant information to decide on the prices at which they would buy or sell a stock. Sometimes apparently irrelevant circumstances can really affect a stock. No one can predict how a stock will actually perform, but comparative analyses are useful. There are very severe penalties for using inside information to gain an unfair advantage in the market - that’s why Martha Stewart went to jail.
Here are some web sites that discuss a range of investing issues, including financial terms and how the stock market and other financial markets work:
http://googolplex.cuna.org/23314/ajsmall/story.html?doc_id=378
http://www.straightdope.com/mailbag/mstockmarket.html
The book “Investing for Canadians for Dummies” is a worthwhile introduction to investment, and includes a short explanation of financial markets. The book “The Investment Zoo” is also well worth reading. There are other types of markets as well, for more specialized trading such as currencies. The website http://blog.accountingcoach.com is a good place to get more information on basic accounting definitions and practices.
Near the end of the course we will discuss valuation, which is the process of evaluating the worth of companies (Chapter 8 in the text). Some of the financial ratios we’ve discussed are used in valuation. The course syllabus for ENGM 401 doesn’t go into the structure of financial markets in any detail or how they actually work. Professor Peter Flynn will be giving a guest lecture on the last day of class to talk about personal finance for engineers, which will talk a bit about personal investing strategies, but not about the stock market per se.
I’m glad that you are enjoying the “Other Topics,” which is stuff that I wish someone had told me at the beginning of my career. This sounds like a topic that it worth adding to the list. If others are interested in how markets work, they should let me know and I’ll add it to the list of Other Topics for discussion. (Oct. 20/07, updated Oct. 4/09)
Could you please give me the final answers to the two examples on
slides 17 and 18 of lecture 21 (Interest Calculation 2)?
Thanks for pointing out that this info was missing from the annotated deck. (it’s been reposted). Here is the material that had been missing:
Slide 17:
P = A(P|A,i,n) = 140 (P|A,1%,60) (1% per month compounded for 60 months)
= 140(44.955)
= $6293.70
Slide 18:
If all we wanted was the annuity amount per quarter:
i=2% per quarter; n = 20 quarters
A = P(A|P,i,n)=5000(A|P,2%,20) = 5000(0.0612)= $306 But we actually want the desired equivalent annual withdrawal W at the end of the 4th quarter, which repeats over and over so we only have to calculate it once, so we calculate the future value of four annuity amounts:
W = A(F|A,i,n) = 306(F|A,2%,4) = 306(4.122) = $1260 (Oct 28/09)
11) Why do the slides
all have that green bar across the top. It wastes a
lot of ink when I print the slides. Can you change that?
Thanks for the suggestion. This will require all of the slide decks to be reformatted, so it’s actually a lot of work. I’ll see what can be done to make the slide decks for your use less ink-intensive than the presentation slides (which I think are more appealing with the title block) . Another option is to borrow a printout of the annotated slides and then photocopy them. Still as much ink but less expensive than using your personal printer. (Sept 17/10)
10) What course
material will the third midterm cover, and what’s the
format?
Midterm #3 will cover lectures 18 to 32 inclusive, and chapters 7, 8, and 9 of the course text. The midterm will be in the same multiple choice format as midterms 1 and 2, with 20 5-choice questions and 25 true-false questions. (The sample midterm #3 is in this format.) The test will be open-book and open-notes (including resources such as lecture notes, your own notes, the guide to calculations, etc.). Some questions will require simple calculations, so make sure that you bring a calculator. Interest tables are NOT provided.
9) What course
material will the second midterm cover, and what’s the
format?
Midterm #2 will cover lectures 11 to 22 inclusive, and chapters 4, 5, and 6 of the text, as well as material on time-value of money in Chapter 7 to the end of lecture 22 on interest calculations (to the end of section 7.2, but some concepts introduced in this section such as IRR and WACC are covered later in the course and are not tested on midterm #2). Midterms are not cumulative, but some concepts that were covered earlier in the course are necessary to understanding this material (for example, you can’t do a statement of cash flow unless you under state what an income statement is). The midterm will be in the same multiple choice format as midterm #1, with 20 5-choice questions and 25 true-false questions. It will be open-book and open-notes (including resources such as lecture notes, your own notes, the guide to calculations, etc.). Some questions will require simple calculations, so make sure that you bring a calculator. Interest tables are NOT provided. (update Oct 29, 2010)
8) I was wondering if
we could get a copy of the midterm for studying purposes.
Midterms are not distributed in any of the sections of ENGM 401. That's why there is a special sample midterm, which has questions of similar content and style for study purposes. There are tips on how to study for the midterm and what to expect on the test. Note that midterms in ENGM 401 are non cumulative, with only a slight overlap in content for midterms 2 and 3. If you would like to review your midterm with me and check which questions you had trouble with, I'd be happy to do so. (Dec. 8/08).
7) What are the
differences amongst the different editions of the text? Can I use an older
edition?
The short answer is that you should use the fourth edition. Each subsequent edition has substantial changes to the text, and a number of minor errata have been corrected. Many "insert boxes" have been added to break up the monotony of the flow of the text. Some additional material of interest has been added, along with more examples in the text. The first edition has no glossary. The chapter on the Balance Sheet was rewritten for the 2nd Ed, so that virtually all discussion of debt, leverage and preferred shares is now moved up into this chapter, rather than being in chapter 6 (Ratios). The 2nd edition text moved what was problem 6.6 into what is now problem 4.5. The fourth edition has been changed significantly from the third edition, including the problems. Students are responsible for any errors arising from using an obsolete text or course notes package. (Dec. 8/08, Sept. 16/09)
6)
Why aren’t the actual excel
spreadsheets posted?
Sometimes in class spreadsheets are displayed. In most cases, the key information is given on a lecture slide (or written in during the class for students to copy down), and a pdf version of the spreadsheet is posted on the course website (and included in the course pack). The examples are meant to be illustrations for your understanding. You’ll actually learn more by examining the pdfs and creating your own spreadsheets than you would merely plugging numbers into a template. The calculation procedures are described in the guide to calculations. If any of the information is not clear about where the data come from or how calculations are done, then please contact the instructor. (Dec. 8/08)
5) What course
material will the first midterm cover, and what’s the format?
Midterm #1 will cover chapters 1, 2, and 3, as well as section 1 and 2 of Chapter 4 of the course text. This corresponds to Lectures 1 to 10 inclusive. The midterm will be in multiple choice format, with 20 5-choice questions and 25 true-false questions. It will be open-book (including your own notes but not a computer). Bring a calculator. The 5-choice questions will be weighted higher than the true-false questions. Some questions (not many) will require simple calculations.
Note that midterm problems in general cover:
• defining terms and activities in engineering management,
• identifying quantitative financial information in the context of business situations,
• filling out or interpreting financial information on statements,
• calculating and interpreting metrics (such as financial ratios) that pertain to engineering finance and engineering management scenarios, and
• analyzing engineering financial situations such the time-value of money and interest calculations.
There are a number of worked examples in directory http://www.ualberta.ca/~mlipsett/ENGM401/Examples/ including pdfs of spreadsheets from the lectures. There is a sample midterm #1 posted on the website. You might want to use these samples to make up your own questions for studying. Definitions of terms sometimes depend on the circumstances, so read the questions carefully and choose the most correct answer. (updated Sept 25/10)
4) Can we hand in the assignment outside of class?
After the solutions have been posted, no assignment will be accepted. You can always hand in and assignment early to the instructor or a TA, or put it in the marking box labeled ENGM 401 X1 outside the Mechanical Engineering office (and it is also for ENGM 620 X1). You can make arrangements with the instructor in advance to hand it in late if there’s a compelling reason, on a case-by-case basis. (Sept 15/10)
3) What format is required for the assignments? Do I have to write on engineering paper? Do I have to type the assignment?
There is no specific format for assignment submissions: typed and handwritten are both acceptable. Neatness counts! (That’s part of being a professional.) If the TA can not read your writing, or follow the logic of your solution, then you will likely lose marks. Make sure that you put your name and student number on your assignment so that you get credit for the work. (Sept 15/10)
2) When’s the final?
There are three midterms in this course, which will be held in class. The exam schedule is set up so that finals won’t be double-booked; but as the course outline states, there is no final exam in this section of ENGM 401. (Dec. 8/08)
1) How do I print the lecture slides?
One of the reasons for posting the slides on the website early is so that students can bring copies to class to annotate. Not all of the lecture information is printed on the slides - there is blank space provided for additional notes. Please note that these slides are copyrighted, and can not be distributed or modified without the copyright holder’s permission. The slides that are posted so far for the lectures are in pdf format with two slides per page. (Last year the slides were also available in other formats but students preferred this format.) On a PC, you can view them directly in Internet Explorer with the Adobe plug-in, and then print from there. You can save a copy on your own computer and use Acrobat Reader to view and print the slides (respecting copyright, of course). If you have trouble printing, first make sure that you have the latest update of Reader. If all else fails, you are welcome to stop by my office to borrow a set of hard copies of lectures to date, which you may photocopy once for personal use, and then return my set. Please let me know if you have continuing trouble printing the slides, or if the URL is a broken link. (Dec. 8/08)