Texas Tech Econ lesson 5 Chapter 10 sections 1 & 2

1. Lesson 5
Introduction
Page 172
Lesson 5
Introduction
Page 172
Continued look at MICROECONOMICS
?
small units such as individuals & firms

2. We’ll look at:
1. How businesses FINANCE, MARKET & DISTRIBUTE
their PRODUCTS.

3. We’ll also have a look at:
2. The American Labor Force
3. Worker & Company Relations
4. Cost-Benefit Analysis

4. After studying L. 5, we’ll be able to
Explain how a firm decides whether to expand
Describe how technology changed production methods
Understand the change in ROLE of MARKETING in USA
Identify worker categories according to skills & training
Explain ROLE of Unions in the workplace
Describe COLLECTIVE BARGAINING procedures

5. CHAPTER 10: Financing & Producing
Section 1
Investing in the Free Enterprise System
Page 173

6. WHY do entrepreneurs need
financing?
1. For C_____ Needs
2. For L___ Term Needs
1. For Current Needs
2. For Long Term Needs
Examples for each
Parts, Tools, Supplies
Growth
Getting funds or
money capital for
business expansion
Duh, what’s
financing?
Duh, what’s
financing?

7. I don’t know!I don’t know!
What’s a big part of our Free Enterprise System?
Financing
business ops & growth
Financing
business ops & growth
But how does
it work?
But how does
it work?
Folks save by
depositing in places…
Folks save by
depositing in places…
then these institutions
lend $ out to firms to
grow and expand
then these institutions
lend $ out to firms to
grow and expand

8. Figure page 174
Financing Business Expansion

9. People save money -> resources for
financing of business expansions
Folks get
interest on
savings
Folks get
interest on
savings
PUT YOUR $$$
in Banks,
Savings & Loan,
Credit Union,
Mutual Funds,
Retirement

10. They lend savings $ -> businesses
for INTEREST

11. Expand & Improve
HOW?
Trucks/Equipment/Plant/Computers

12. I have a hardware store, a corporation.
OPPORTUNITY POPS UP
to open MORE stores
Bummer. No
cash to invest
in expansion.
Bummer. No
cash to invest
in expansion.
What are my
options?
What are my
options?

13. Dig into my savings
Ask friends/family to lend firm $$$
Take out a loan
Sell more stock

14. & THINK
But the question remains, SHOULD I EXPAND?
I know what you
need to do,
kiddo!
I know what you
need to do,
kiddo!
A COST-
BENEFIT
ANALYSIS!
A COST-
BENEFIT
ANALYSIS!

15. 1
2
3
4
5 Wonder how observant
they are?
Wonder how observant
they are?
Estimate expansion costs
Calculate expected revenues (total income from sales)
Calculate expected profits (revenues – costs)
Calculate cost of financing
5Expected profits > cost of financing expansion, okay.

16. A million-dollar loan will cost 10%/year
Cost/year = ?$100,000
Would it be worthwhile
If expected profits/year = $50,000?
$200,000?
NO WAY
Yes!
In short, additional benefit must = additional cost
Additional benefit is + profits. Additional cost is interest paid.Additional benefit is + profits. Additional cost is interest paid.

17. 5 Steps of Cost-Benefit Analysis p. 175
1.Estimate expansion costs
Rent/new stores
New employees’ training
Extra bookkeeping
Opportunity cost of time/checking new stores
Utilities
More insurance
New taxes
Meeting government regulations
More inventory

18. 2.Calculate Expected Revenues
3.Calculate Expected Profits
4. Calculate Monthly Cost of Loan +
Interest
5.Expected Profits > Expansion Costs

19. Now, let’s get this straight.
A cost-benefit analysis compares the
estimated cost of whatever action with
WHAT?
A cost-benefit analysis compares the
estimated cost of whatever action with
WHAT?
Its benefits,
of course!
Its benefits,
of course!
And what are
REVENUES & PROFITS?
And what are
REVENUES & PROFITS?
Income of
sales & money
left after costs
Income of
sales & money
left after costs

20. Section
Types of Financing for Business Ops
p. 176

21. A Credit Check
?Firms must prove creditworthiness
Credit ratings: Good, Average, Poor
Firms must pay interest on loan/repay it within a specific period
DEBT FINANCING = ?Raising $ for business through borrowing

22. 3 Types of Financing
• Short-term
• Intermediate-term
• Long-term

23. SHORT-TERM?SHORT-TERM?
Financing
< a year
Example?Example?
Firm’s doing well, but will only be paid next mo.
Needs $ for payroll & bills
Farmer needs $ during growing season
To pay for seed, repairs, wages

24. EXAMPLES of Short-term Financing
The 1st is
TRADE
CREDIT
The 1st is
TRADE
CREDIT
That’s when your
company buys goods
from mine & I give
you 30-90 days to
pay.
That’s when your
company buys goods
from mine & I give
you 30-90 days to
pay.
If bill’s unpaid in 10 days, in effect, interest is paid for use of the trade credit.
Firms often get a discount if bill is paid in 10 days.

25. 2nd type of Short-term Financing
UNSECURED LOANS
That’s the type most
short-term bank credit
for businesses is.
That’s the type most
short-term bank credit
for businesses is.
What’s the
guarantee
?
What’s the
guarantee
?
Nothing
but the promise to
pay it back.
Nothing
but the promise to
pay it back.
No
way!
No
way!
Well, the borrower signs a
PROMISSORY NOTE. It says
the $ must be repaid in full
with interest.
Well, the borrower signs a
PROMISSORY NOTE. It says
the $ must be repaid in full
with interest.
Oh, right.
Usually within
a year.
Oh, right.
Usually within
a year.

26. SECURED LOANS
Backed by COLLATERAL ?
That’s something
of value you will
lose if loan isn’t
repaid!
That’s something
of value you will
lose if loan isn’t
repaid!
Like property,
machinery,
inventory or
accounts receivable.
Like property,
machinery,
inventory or
accounts receivable.
ACCOUNTS
RECEIVABLE =
$ owed to firm
by customers.
ACCOUNTS
RECEIVABLE =
$ owed to firm
by customers.
3rd Type of Short-Term Financing

27. 4th Type of Short-Term Financing
LINE OF CREDIT
That’s the maximum amount of
money a firm can borrow from a
bank during a period of time,
usually a year.
That’s the maximum amount of
money a firm can borrow from a
bank during a period of time,
usually a year.
So they don’t
have to
reapply for a
loan every
single time.
So they don’t
have to
reapply for a
loan every
single time.

28. INTERMEDIATE-TERM FINANCING
That’s for borrowing
money for 1-10
years.
That’s for borrowing
money for 1-10
years.
Example: for expansion; opening another store
A 90-day loan
wouldn’t help.
A 90-day loan
wouldn’t help.
If I wanted to
open another
shop, I’d go for
intermediate-term
financing.
If I wanted to
open another
shop, I’d go for
intermediate-term
financing.

29. Table
p.178
EXAMPLES of
Intermediate-Term
Financing
EXAMPLES of
Intermediate-Term
Financing

30. INTERMEDIATE-TERM FINANCING
R
E
P
A
Y
M
E
N
T
1 to 10 years
1.
Generally requires COLLATERAL
MORTGAGE = secured by property
Big, solid firms
may get
unsecured
intermediate-
term loans.

31. INTERMEDIATE-TERM FINANCING
2.LEASING = renting instead
of buying
Advantages? 1. Leaser gives cheap repair service
2. Part of leasing costs can be deducted before
figuring income taxes
DISADVANTAGE?
More expensive than borrowing $ to buy item

32. LONG-TERM FINANCING
> 10 years
Used for ?major expansion. Examples?
Build a new plant
Replace equipment
What do corporations do to finance 10 to 15-yr. debts?
Issue stock OR
Sell Bonds
Who sells
bonds to
finance
long- term
debts?
Who sells
bonds to
finance
long- term
debts?
Big
corporations
Big
corporations
Yep, they
appeal more
to investors
wanting to
buy bonds.
Yep, they
appeal more
to investors
wanting to
buy bonds.
`Cause the risk
is better?
`Cause the risk
is better?
Yup, corps
have huge
assets,
unlike
smaller
companies.
Yup, corps
have huge
assets,
unlike
smaller
companies.

33. Table P
a
g
e
1
7
9
Examples:
Long-Term Financing

34. BONDS
Promise to pay a
certain amount of
interest over a specific
period of time, & to
repay the full amount
borrowed at the end
of that time.
S
T
O
C
K
S
EQUITY MGMT
= selling stock,
since partial
ownership, or
equity is being
sold. Corps. sell
common or
preferred stock.
What are the differences
between common &
preferred stock.

35. COMMON STOCK
Issued by ALL public corps
PREFERRED STOCKMany corps don’t issue
The stock most often bought & sold

36. COMMON STOCKholders vote
Elect the board of directors
PREFERRED STOCKholders don’t.

37. COMMON STOCK may pay dividends based on corp performance.
Good -> high dividends / Poor -> low or no dividends
PREFERRED STOCK pays a fixed dividend
Is paid before common stockholders get dividend.
If company doesn’t pay on time, it must be paid at a later date.

38. Value of COMMON STOCK rises & falls
depending on performance & what investors expect it to do in the future.
Value of PREFERRED STOCK
changes according to company performance.

39. IF a corporation FAILS
COMMON STOCKHOLDERS are the last to be paid
with money left after paying creditors.
PREFERRED STOCKHOLDERS are paid before COMMON
BONDHOLDERS are paid before stockholders

40. Choosing the RIGHT FINANCING
Financial MGRS try to get capital at minimum cost
They try to get the best mix of financing.
Length of loan OR
Selling bonds
depends on
4 factors

41. They 4 factors are:
1. Interest costs
2. Firm’s financial shape
3. Economic climate
4. Firm’s owners’ opinions

42. INTEREST COSTS
High rates -> companies reluctant to expand
May take out short=term loans, hoping rates drop
Interest rates affect decision to issue bonds
High Rates -> Corps must offer high interest rates on bonds
Rates drop, corps offer lower return on bonds

43. FIRM’S FINANCIAL CONDITION
COMPANIES with STABLE SALES & PROFITS,
or with expectations to increase
CAN SAFELY TAKE ON MORE DEBT
IF current debt’s not BIG
Financial Mgrs use cost-benefit analyses to figure if potential
profits will cover financing cost of expansion

44. MARKET CLIMATE
Financial Mgrs must be aware of this when
deciding whether to SELL BONDS or
ISSUE STOCK to raise financing.
High Interest Rates + Slow Economy = Disaster
for a firm interested in expansion
If economic growth in market is slow, investors
may prefer the fixed rate of return of bonds or
preferred stock to the unknown return of
common stock.

45. CONTROL OF THE COMPANY
Bonds don’t have voting rights attached to them.
Neither do most preferred stocks
COMMON STOCKHOLDERS can vote.
Financial Managers MAY need to get
common stockholders’ approval before
taking action.

46. COMING UP in the NEXT class
The Production Process

47. THE