Making
Financial
Decisions
Final Exam
,Table of Contents
Table of Contents ___________________________________________________________ 2
LU 5: Prospecting For Value-Adding Investments __________________________________ 4
Difference between Accounting and Financing _______________________________________ 4
Investing vs. Financing Activities ___________________________________________________ 4
Main Characteristics of the Hospitality Industry ______________________________________ 4
The two categories of financial capital (where the money for your company can come from) _ 4
Ways to reduce conflict between owner and manager _________________________________ 5
Owner’s present value of a company _______________________________________________ 5
Dividend Discount Model_________________________________________________________ 6
How to improve your Operating Cash Flow (Asset Structure) ____________________________ 7
How to improve your Capital Structure _____________________________________________ 7
Asset Structure vs. Capital Structure ________________________________________________ 8
Why focusing too much on Return on Equity (ROE) is bad ______________________________ 8
Operational Risk vs. Financial Risk _________________________________________________ 8
Feasibility Studies _______________________________________________________________ 8
Types of Feasibility Studies _______________________________________________________ 9
Conducting a Feasibility Study _____________________________________________________ 9
The Setup of a Feasibility Study ___________________________________________________ 10
Limitations of a Feasibility Study __________________________________________________ 10
Calculating Market Size and Fair Share _____________________________________________ 11
LU6: Capital Budgeting ______________________________________________________ 11
Introduction to Capital Budgeting _________________________________________________ 11
Decision Areas of Capital Budgets _________________________________________________ 11
Typical Reasons why you want to invest in Assets ____________________________________ 11
The Time Value of Money _______________________________________________________ 11
The Future Value of Money ______________________________________________________ 12
Nominal vs. Effective Interest Rate ________________________________________________ 12
Annuity ______________________________________________________________________ 12
Link between Cash Flow and Capital Budgeting ______________________________________ 12
Overview Capital Budgeting Models _______________________________________________ 13
Project Income vs. Cashflow _____________________________________________________ 13
Carry Forward Principle on Taxes and Losses ________________________________________ 13
Accounting Rate of Return (ARR) _________________________________________________ 14
Payback Period ________________________________________________________________ 14
2
, Net Present Value (NPV) ________________________________________________________ 15
Profitability Index (PI) __________________________________________________________ 16
Internal Rate of Return _________________________________________________________ 16
NPV or IRR, which one to choose? ________________________________________________ 17
Mutually Exclusive Projects, what does that mean? __________________________________ 17
Net. Income, Cash Flow or Present Value? __________________________________________ 18
Recommended Template when doing IRR, Payback, Pi & NPV __________________________ 18
Capital Rationing ______________________________________________________________ 19
LU7: Selecting the Best Investments ___________________________________________ 19
Some Definitions to start with____________________________________________________ 19
The Charm and the Curse of Debt _________________________________________________ 19
What Costs are associated with Capital? ___________________________________________ 19
Introduction to WACC __________________________________________________________ 20
Preparing the Cash Flow for WACC ________________________________________________ 20
The WACC Formulas ____________________________________________________________ 20
How to make a decision now???? _________________________________________________ 21
LU8: Funding your Investments _______________________________________________ 21
Real vs. Financial Assets _________________________________________________________ 21
The role of Financial Markets and Financial Intermediaries ____________________________ 21
The Three Main Finance Markets _________________________________________________ 22
The Money Market ___________________________________________________________________ 22
The Capital Market ___________________________________________________________________ 22
The Mortgage Market _________________________________________________________________ 23
Some other Terminology you want to use __________________________________________ 23
Interpreting a Stock Report ______________________________________________________ 24
Interpreting a Bond Report ______________________________________________________ 24
Bond Credit Ratings ____________________________________________________________ 25
Financial Intermediaries you should know for Hotels _________________________________ 26
Foreign Exchange Markets and Int. Hospitality Firms _________________________________ 28
Hedging, Price Risk and Commodity Future Markets __________________________________ 28
Some Last Definitions you should know ____________________________________________ 28
What to do if you have excess cash and want to get rid of it? __________________________ 29
Some Formulas to know when making calculations __________________________________ 29
Appendix A: More details and calculations with NPV _____________________________ 31
3
, LU 5: Prospecting For Value-Adding Investments
Difference between Accounting and Financing
Typical Accounting Functions Typical Finance Functions
Recording business transactions & Evaluate if capital expenditure are
information worthwhile
Compiling financial statements (budget Determining strategies for raising new
sheet and income statements) capital
Filing tax returns Assess and negotiate interest on loans
Preparing budgets Negotiating building leases
Analyzing budget variances Determining dividend policies
Invest excess cash
Purchasing land
Investing vs. Financing Activities
¯ Investing Activities look at how the firm should invest & for how much, thus affecting
its assets (AKA asset structure)
¯ Financing Activities looks at how the firm will raise the funds for those investments,
mostly affecting the liabilities and equity (AKA capital structure)
Main Characteristics of the Hospitality Industry
U Seasonality and time of year (political conventions, high season vs. low season,
special events such as King’s Day)
U Major Investments in fixed assets (up to 85%), such as buildings and land
U Short distribution chain, rapid turnover, relatively high labor cost (because its labor
intensive), relatively low inventory (working capital)
Whenever a decision needs to be made that affects the firm, it should be taken into
consideration whether it serves the best interest of those providing funds for that decision
(shareholders, lenders etc.), otherwise they will invest it somewhere else
The two categories of financial capital (where the money for your
company can come from)
µ Debt: provided by creditors or lenders to the hospitality firm (banks, suppliers etc.)
µ Equity: provided by the owners of the hospitality firm (shareholders, owners)
Quick Recap:
Assets = Debt (Liability) + Equity
Assets: Resources used to operate the firm, provided or purchased by the money of
creditors and/or owners
Debt: Creditors claim to the assets that resulted from the money they provided
Creditors
Equity:(debt providers)
Owner’s claim tohave a legally
the assets protected
that resultedprior
from claim to thethey
the money income and assets of
provided
the firm, owners (equity providers) do not (governments as well)
4
Financial
Decisions
Final Exam
,Table of Contents
Table of Contents ___________________________________________________________ 2
LU 5: Prospecting For Value-Adding Investments __________________________________ 4
Difference between Accounting and Financing _______________________________________ 4
Investing vs. Financing Activities ___________________________________________________ 4
Main Characteristics of the Hospitality Industry ______________________________________ 4
The two categories of financial capital (where the money for your company can come from) _ 4
Ways to reduce conflict between owner and manager _________________________________ 5
Owner’s present value of a company _______________________________________________ 5
Dividend Discount Model_________________________________________________________ 6
How to improve your Operating Cash Flow (Asset Structure) ____________________________ 7
How to improve your Capital Structure _____________________________________________ 7
Asset Structure vs. Capital Structure ________________________________________________ 8
Why focusing too much on Return on Equity (ROE) is bad ______________________________ 8
Operational Risk vs. Financial Risk _________________________________________________ 8
Feasibility Studies _______________________________________________________________ 8
Types of Feasibility Studies _______________________________________________________ 9
Conducting a Feasibility Study _____________________________________________________ 9
The Setup of a Feasibility Study ___________________________________________________ 10
Limitations of a Feasibility Study __________________________________________________ 10
Calculating Market Size and Fair Share _____________________________________________ 11
LU6: Capital Budgeting ______________________________________________________ 11
Introduction to Capital Budgeting _________________________________________________ 11
Decision Areas of Capital Budgets _________________________________________________ 11
Typical Reasons why you want to invest in Assets ____________________________________ 11
The Time Value of Money _______________________________________________________ 11
The Future Value of Money ______________________________________________________ 12
Nominal vs. Effective Interest Rate ________________________________________________ 12
Annuity ______________________________________________________________________ 12
Link between Cash Flow and Capital Budgeting ______________________________________ 12
Overview Capital Budgeting Models _______________________________________________ 13
Project Income vs. Cashflow _____________________________________________________ 13
Carry Forward Principle on Taxes and Losses ________________________________________ 13
Accounting Rate of Return (ARR) _________________________________________________ 14
Payback Period ________________________________________________________________ 14
2
, Net Present Value (NPV) ________________________________________________________ 15
Profitability Index (PI) __________________________________________________________ 16
Internal Rate of Return _________________________________________________________ 16
NPV or IRR, which one to choose? ________________________________________________ 17
Mutually Exclusive Projects, what does that mean? __________________________________ 17
Net. Income, Cash Flow or Present Value? __________________________________________ 18
Recommended Template when doing IRR, Payback, Pi & NPV __________________________ 18
Capital Rationing ______________________________________________________________ 19
LU7: Selecting the Best Investments ___________________________________________ 19
Some Definitions to start with____________________________________________________ 19
The Charm and the Curse of Debt _________________________________________________ 19
What Costs are associated with Capital? ___________________________________________ 19
Introduction to WACC __________________________________________________________ 20
Preparing the Cash Flow for WACC ________________________________________________ 20
The WACC Formulas ____________________________________________________________ 20
How to make a decision now???? _________________________________________________ 21
LU8: Funding your Investments _______________________________________________ 21
Real vs. Financial Assets _________________________________________________________ 21
The role of Financial Markets and Financial Intermediaries ____________________________ 21
The Three Main Finance Markets _________________________________________________ 22
The Money Market ___________________________________________________________________ 22
The Capital Market ___________________________________________________________________ 22
The Mortgage Market _________________________________________________________________ 23
Some other Terminology you want to use __________________________________________ 23
Interpreting a Stock Report ______________________________________________________ 24
Interpreting a Bond Report ______________________________________________________ 24
Bond Credit Ratings ____________________________________________________________ 25
Financial Intermediaries you should know for Hotels _________________________________ 26
Foreign Exchange Markets and Int. Hospitality Firms _________________________________ 28
Hedging, Price Risk and Commodity Future Markets __________________________________ 28
Some Last Definitions you should know ____________________________________________ 28
What to do if you have excess cash and want to get rid of it? __________________________ 29
Some Formulas to know when making calculations __________________________________ 29
Appendix A: More details and calculations with NPV _____________________________ 31
3
, LU 5: Prospecting For Value-Adding Investments
Difference between Accounting and Financing
Typical Accounting Functions Typical Finance Functions
Recording business transactions & Evaluate if capital expenditure are
information worthwhile
Compiling financial statements (budget Determining strategies for raising new
sheet and income statements) capital
Filing tax returns Assess and negotiate interest on loans
Preparing budgets Negotiating building leases
Analyzing budget variances Determining dividend policies
Invest excess cash
Purchasing land
Investing vs. Financing Activities
¯ Investing Activities look at how the firm should invest & for how much, thus affecting
its assets (AKA asset structure)
¯ Financing Activities looks at how the firm will raise the funds for those investments,
mostly affecting the liabilities and equity (AKA capital structure)
Main Characteristics of the Hospitality Industry
U Seasonality and time of year (political conventions, high season vs. low season,
special events such as King’s Day)
U Major Investments in fixed assets (up to 85%), such as buildings and land
U Short distribution chain, rapid turnover, relatively high labor cost (because its labor
intensive), relatively low inventory (working capital)
Whenever a decision needs to be made that affects the firm, it should be taken into
consideration whether it serves the best interest of those providing funds for that decision
(shareholders, lenders etc.), otherwise they will invest it somewhere else
The two categories of financial capital (where the money for your
company can come from)
µ Debt: provided by creditors or lenders to the hospitality firm (banks, suppliers etc.)
µ Equity: provided by the owners of the hospitality firm (shareholders, owners)
Quick Recap:
Assets = Debt (Liability) + Equity
Assets: Resources used to operate the firm, provided or purchased by the money of
creditors and/or owners
Debt: Creditors claim to the assets that resulted from the money they provided
Creditors
Equity:(debt providers)
Owner’s claim tohave a legally
the assets protected
that resultedprior
from claim to thethey
the money income and assets of
provided
the firm, owners (equity providers) do not (governments as well)
4
