Unit 2

General Objective

At the end of the study of this chapter, the

student will understand what are the
elements and information necessary to
apply in an economic analysis.

U2_Financial
information
for project
evaluation

By: Professor E stefania Lopez

 Breakeven (Punto de equilibrio) Let’s watch de video:
Introduction
https://www.youtube.com/watch?v=AsHjjRKeHkg

Break-even analysis is a useful technique for studying the relationships between fixed costs, variable
costs, and revenues.
If the costs of a company were only variable, there would be no problem to calculate the breakeven point

The breakeven point is the level of production at which the sales revenue is exactly equal to the
sum of the fixed and variable costs.

1.- NOTE: In the first place, it should be mentioned that this is not a technique to
evaluate the profitability of an investment, but that it is only an important reference to
take into account; In addition, it has the following disadvantages:

b) It is difficult to define c) a) It is inflexible in time,

a) For its calculation, the
initial investment that gives
rise to the projected benefits
is not considered, so it is not
an economic evaluation tool.
exactly whether certain costs
are classified as fixed or
variable, and this is very
important, because the lower
the fixed costs, the faster the
break-even point will be
reached.
that is, equilibrium is
calculated with given costs,
but if these change, so does
the equilibrium point. With
the unstable situation in many
countries, and especially in
Mexico, this tool becomes
impractical for evaluation
purposes.

It is generally understood that fixed costs are those independent of the volume of
production, and that direct or variable costs are those that vary directly with the volume
of production; although some costs, such as salaries and office expenses, can be assigned
to both categories.
However, the general utility that is given is that it is
possible to calculate very easily the minimum point
Ingresos
y costos Ingreso of production at which it must be operated in order
Beneficio
total
not to incur losses, without this meaning that even if
Punto de equilibrio
Costo total there are profits, these are sufficient to make the
project profitable.

Costos variables It is also useful in the case of a company that

produces a large number of products and that can
manufacture others without additional investment,
Costos fijos
as is the case of publishing companies, bakeries and
factories of electrical parts, which, with this method,
Unidades producidas y vendidas easily evaluate what is the minimum production that
Figura: Gráfica del punto de
equilibrio
must be achieved in the elaboration of a new article
to achieve the equilibrium point.

If more than breakeven is sold, the new product will

have made a marginal contribution to the company's
total profit.

..
.
 The breakeven point can be calculated in the graph as it appears in the figure, or, in mathematical form, as
described below

• The income is calculated as the product of the volume sold by its price, income =
P + Q.
• CF is designated by fixed costs, and variable costs are designated by CV.
• At breakeven, revenue equals total costs:
P × Q = CF + CV (4.3)
• But since variable costs are always a constant percentage of sales, then breakeven is mathematically defined as:

The breakeven point can show other valuable information, if it is used to represent the likely
profits of a highly automated plant compared to a nearly manually operated plant.

Consider the following example:

EXAMPLE:
You want to install a manufacturing plant and the alternatives are a highly automated plant
and a plant with very little automation.
Projections of probable sales, income and costs have been made, the data of which are
shown in tables 4.1 and 4.2.

Little automated plant

The product has a selling price of P = $ 2 per unit, with fixed costs of CF = $ 10,000 and a
variable cost CV = 1.5 Q. The total cost is obtained by adding to the fixed cost the product of
multiplying the variable cost by Q. Net income is the result of subtracting gross income minus
total cost.

Highly automated plant

The product has a selling price of P = $ 2 per unit, since it is exactly the same as that
produced in the plant with little automation, with fixed costs of CF = $ 30,000 and a variable
cost CV = 1.0 Q.

300
Ingresos
y Tabla 4.1
costos 250 Unidades Ingreso Costo Ingreso
producidas Q bruto total neto
200 5 000 10 000 17 500 −7 500
15 000 30 000 32 500 −2 500
150 30 000 60 000 55 000 5 000
45 000 90 000 77 500 12 500
60 000 120 000 100 000 20 000
100 PE 75 000 150 000 122 500 27 500
90 000 180 000 145 000 35 000
50 105 000 210 000 167 500 42 500
150 000 300 000 235 000 65 000

25 50 75 100 125 150

unidades producidas Q
(miles)
Figura 4.3

Ingresos 300
y Tabla 4.2
costos 250 Unidades Ingreso Costo Ingreso
producidas Q bruto total neto
200 5 000 10 000 35 000 −25 000
15 000 30 000 45 000 −15 000
150 30 000 60 000 60 000 0
45 000 90 000 75 000 15 000
PE
60 000 120 000 90 000 30 000
100
75 000 150 000 105 000 45 000
90 000 180 000 120 000 60 000
50 105 000 210 000 135 000 75 000
150 000 300 000 180 000 110 000
25 50 75 100 125 150
unidades producidas Q
(miles)
Figura 4.4
 The total cost is obtained by adding to the fixed cost the product of multiplying the variable
cost by Q.
The net income results from subtracting the gross income minus the total cost.

➢ Note that the cost is lower in the lower automation alternative,

➢ The depreciation cost, which is a fixed cost, is not very high, which indicates that
there is not much production equipment

➢ It should also be noted that the variable cost is higher in the alternative of lower
automation, than the one who has the alternative of greater automation; This indicates that the
use of labor is more intensive in the less automated alternative.

Alternative formulas for calculating the breakeven point are:

For the little automated alternative

For the highly automated alternative:

❖ Also note the shaded area in both graphs, which indicates earnings as
production increases.

❖ It is very clear that in the poorly automated plant, if it is produced

below the equilibrium point, very little money is lost, and if it is above
the equilibrium point, it is also gained, but not much money.

❖ In the highly automated plant the situation is the opposite: if it is

produced above the equilibrium point, the gains are much higher than
those produced by the poorly automated plant.

❖ The reason for these results is obvious: the highly automated plant
invested more, so you are risking more money and if you can sell a
large volume of product your profits will be higher.
➢ The conclusion of this example is that if the investor has enough money, he will be able to invest in a highly
automated plant, as long as the market is wide, otherwise he will have a large investment in equipment, but
with few sales, which will cause him a substantial loss.

➢ Also if the unit cost of the product is obtained, making 150 thousand units, which is the maximum capacity in
both plants, it will be observed that for the little automated plant, the unit cost is $ 1.56 / unit, while for the
highly automated plant automated unit cost is only $ 1.2 / unit.

➢ This suggests that the highly automated plant has a competitive advantage, being able to produce the product
at a lower unit cost and in this way it could sell the product in the market at a price of less than $ 2 per unit,
which would make it more competitive.

Pro forma income statement

https://www.youtube.com/watch?v=D4dSEoLyNCA
https://www.youtube.com/watch?v=39VcG6S8r8Y

The purpose of the analysis of the income statement or profit and loss is to calculate the net
income and net cash flows of the project,
which are, in general, the actual profit from plant operation, obtained by subtracting all costs
incurred by the plant and taxes payable from income.

This definition is not very complete, since it will be necessary to clarify that income can be derived
from external and internal sources and not only from the sale of products.

To make an adequate income statement, the evaluator must be based on the tax law,
in the sections referring to the determination of income and tax-deductible costs,
although it should not be forgotten that in the evaluation of projects the probable
results are planned and predicted. that you will have a productive entity, and this, in
fact, simplifies the presentation of the income statement.

It is called pro-forma because this means projected, what the evaluator actually does:
project (usually five years) the economic results that the company assumes will have.

➢ Table 4.3 shows that the income statement is a table that synthesizes the information
obtained in previous sections.

➢ Although the income has not been explicitly calculated previously, the bases for it
have been given

These are calculated as the product of the unit sales price multiplied by the quantity sold. The
sale price was calculated in "Projection of the price to the product", and in "Determination of the
optimal size of the plant", it is possible to present a brief production program, in which, of course,
the quantity to be produced and sold in each of the years.

In this way, the calculation of income is simplified to the maximum. Only if the plant studied
had a production of several articles that were essentially different in use and price, would it be
necessary to make a separate and detailed calculation of the income from the sale of these
products. Another case that would merit the separate presentation of income is when there is a by-
product or waste in production, which can be sold and which also represents a considerable
percentage of income.
 Tabla 4.3 Estado de resultados
Flujo Concepto Observaciones En la tabla 4.3 aparecen tres
+ Ingresos Precio de venta multiplicado por el número columnas:
− Costo de producción de unidades vendidas Véase “Costos de ➢ the left, which says flow,
= Utilidad marginal producción” indicates the direction of
− Costos de administración cash flow; that is, if there is
− Costos de venta Véase an income for the company,
− Costos financieros “Costos de the flow is positive, and if it
administra
is expenditure, it is negative,
= Utilidad bruta ción”
like all costs and the
– ISR (42%) Véase
“Costos payment of taxes.
− RUT (10%)
= Utilidad neta de venta”
+ Depreciación y amortización Véanse las secciones “Costos financieros y ➢ The central column indicates
− Pago a principal Financiamiento. Tabla depago de deuda” the concept or item
= Flujo neto de efectivo (FNE) Impuesto sobre la renta
Reparto de utilidades a los trabajadores ➢ and the right column is for
observations.
Véase “Depreciaciones y amortizaciones”
Véase “Financiamiento.
Tabla de pago de deuda”
Nota: La política impositiva es variable en cualquier país. En la tabla 4.3 aparece una tasa del ISR (impuesto sobre la renta) de
42%. El lector debe estar consciente de que esa tasa va a variar con el tiempo y con las circunstancias económicas del país.

On the other hand, the importance of calculating the income statement lies
in the possibility of determining the net cash flows, which are the amounts
used in the economic evaluation.

The higher the net cash flows (FNE), the better the economic profitability
of the company or the project in question

The actual FNE of a project in progress does contain the amounts of

depreciation and amortization, since in reality they do represent surplus
money, but the fact that in the economic evaluation the FNE is inflated with
money that does not come from the operations of the the company, but
comes from the fiscal route; That is, if the depreciation and amortization
charges were not added to the FNE, they would be lower, and the same
would happen with the profitability of the project, but it would be a more
realistic profitability, since only the FNE from the operations of the
company would be considered. company. Despite the above, the most usual
thing is to add the depreciation and amortization charges.

• Other items that appear in the income statement are the taxes that must be paid.

• The tax percentage considered in the practical case is just an example.

• The percentages paid

• The concepts for which taxes are paid may vary from one year to another. This
depends on the fiscal policy that governments apply to control a country's economy.
Tax policy is variable in any country.
 Balance sheet
https://www.youtube.com/watch?v=ixCPM5HznRU

• Active, for a company, means any tangible or intangible property;

• liability means any type of obligation or debt that is owed to third parties.
• Capital means the assets, represented in money or in securities, that are owned by the shareholders or
direct owners of the company.

The fundamental equality of the balance sheet:

Assets = Liabilities + Capital

de la empresa ➢ It means, therefore, that everything that the

company has of value (fixed assets, deferred
assets and working capital) belongs to someone.
Activo fijo ➢ This someone can be third parties (such as banking
y largo plazos
or credit institutions)
Otros activos ➢ what the company does not owe, then, is owned by
directos de la empresa the owners or shareholders.
This is why equality must always be fulfilled. Everything
in the company will always belong to someone
Figura 4.5 Balance general esquematizado.
Regarding liabilities, it is possible to have a certain
number of short-term debts, mainly with suppliers, or in the
medium and long terms, especially with credit institutions.

➢ When the economic analysis of a project is carried out and the balance sheet must be presented,
it is recommended, only refer to the initial balance sheet; In other words, it would be convenient to present a balance
over each of the years considered in the study (five years), but because when a company begins to generate profits,
the destination of the same is not known with all certainty, you can decide in practice to distribute the majority of
the profits, to reinvest in the business itself, to invest in other companies through shares, or to invest in any other
alternative. As when making the balance sheet it is not possible to specify the above, since it would be as much as
assuming most of the data without a really firm basis, then the recommendation is to present only the initial balance
sheet.

➢ On the other hand, the main objective of the balance sheets is to determine annually what is considered to
be the real value of the company at that time. Here the problem of asset revaluation arises. In many
countries, the practice of revaluing assets according to the inflation of the previous year has become
widespread, which helps to have a more real value of the company year after year.

➢ As can be seen, a general balance in practice is a very dynamic accounting aspect and, therefore, very
difficult to carry out adequately, especially if the high inflation rates that countries suffer each year are
taken into account, which provokes heated debates. in accounting circles about the best way to present
year-end balance sheets so that they indicate, in the most realistic way, the value of the company. An initial
balance (in time zero) presented in the evaluation of a project, given that the data recorded is very recent, it
is likely that it does reveal the real value of the company at the time of the start of its operations.
 -------------------------

Cost of capital or minimum acceptable rate of return

To form any company you must make an initial investment. The capital that forms this
investment can come from several sources: only from individuals (investors), from these
with legal entities (other companies), from investors and credit institutions (banks) or from a
mix of investors, legal entities and banks. . Regardless of the capital contribution, each of
them will have a cost associated with the capital contributed, and the new company thus
formed will have its own capital cost. Next, we will analyze in detail how this cost would be
calculated when capital mixes such as those mentioned are presented.

Suppose the simplest case, when the capital necessary to carry out a project is provided
entirely by a natural person. Before investing, a person always has in mind a minimum rate of
return on the proposed investment, called the minimum acceptable rate of return (TMAR).
The question would be on what should an individual rely to set his own MARR?

It is a common belief that the reference MARR should be the maximum rate that
banks offer for a fixed-term investment. When making a net balance between bank
performance and inflation, there will always be a net loss of purchasing power or real
value of the currency if the money invested in a bank is kept; This is logical, since a
bank cannot, simply by investing in it, enrich anyone.

Now it is known that the bank should not be the reference. What is it then? In the previous
paragraph, it was said that the bank rate of return is always lower than the current inflationary
index, which produces a loss of purchasing power of money deposited in a bank. This leads to the
reflection that if a return equal to the inflationary index were earned, the invested capital would
maintain its purchasing power, then, the reference should be the inflationary index.

The firm reference is, therefore, the inflationary index. However, when an investor risks his
money, it is not attractive for him to maintain the purchasing power of his investment, but for it
to have real growth; that is, he is interested in a return that makes his money grow beyond
having offset the effects of inflation
.
Si se define a la TMAR como:
TMAR = i + f + if ; i = premio al riesgo; f = inflación

This means that the TMAR that an investor would ask of an investment must calculate it by
adding two factors: first, its profit must be such that it compensates for the inflationary effects and,
secondly, it must be a premium or surcharge for risking their money in a certain investment. When
evaluating a project over a five-year time horizon, the calculated MARR must be valid not only at
the time of the evaluation, but throughout the five years. The inflation index to calculate the
MARR of the formula must be the average of the inflation index predicted for the next five years.
The forecasts can be from various sources, national (such as the Banco de México forecasts) or
foreign (such as the Ciemex-Wefa forecasts and others).

Now we know how to calculate the first term of the two that make up the TMAR and we
only need to ask, what should be the value of the risk premium to be won? The answer is not
easy, but in general terms it is considered that a risk premium, now considered as the real
growth rate of the money invested, having offset the inflationary effects, should be between
10 and 15%. This is not totally satisfactory, since its value must depend on the risk incurred
when making that investment and, in fact, each investment is different.
 A first reference to get an idea of the risk-return relationship is the stock market (stock
exchange). There are different types of risk in investments, depending on the type of share that has
been acquired and, of course, different returns. An analysis of activities by type of actions can be
carried out.

For example, if you were to invest in a company that manufactures finished chemical
products, you would analyze the common stock, and the activity of preparing finished
chemical products. Its evolution and the performance per share of this activity are observed in
the present. This could be a reference to set the risk premium, since it is assumed that the new
company will be part of that activity and will be subject to conditions (and returns on
investment) similar to those of the industries that carry out this activity.

The way to use the data of a stock exchange, to infer what could be the TMAR assigned
to the company, is shown with the following example. The text presents the project of a
company that makes jams and a company that is listed on the Mexican stock exchange
and that makes jams among many other products, which is Grupo Herdez.

The following information is public and can be consulted on the page of the
Mexican Stock Exchange, in Issuing Companies, where when consulting the annual
financial results of Grupo Herdez, the information on the right is displayed.
Where:
• Gross margin or gross profit.
It is the result of subtracting the income from sales from the cost of sales or production costs.
• Operating margin
rrrr or operating profit. It is the result

from subtracting operating expenses, that is, administrative and sales expenses, from the profit or
gross margin.
• UAFIDA. It is the operating income plus depreciation and amortization, but before
financial expenses and taxes; it is slightly higher than the operating margin, because
it adds depreciation and amortization.
• Majority net margin. It refers to the subsidiaries of the company and the way in which
the shares are distributed.

This data can be useful to help determine the value of the TMAR of a new company that has
the same manufacturing activity as Herdez, such as the jam company. So, if Herdez is a well-
managed company, which has had international success, has achieved annualized returns in
the indicated years from 13.5% to 19.8%, it can be deduced that a new production unit,
designed and structured, having optimized all its inputs, you can get similar returns, no matter
how small.
The TMAR is not determined by calculating the average profit for the three years indicated,
because more historical years could be added, which could change the average, but what is
done is to deduce that if Herdez has not achieved an annual profit greater than 20% ,
including inflation, but not a gain of less than 13%, then in the new production unit, results
should not be expected either far below or far above these gains.
Another good reference to get an idea of risk is the market
study itself, in which with good information from
secondary sources it is possible to realize the real market Tabla 4.4
conditions and, of course, the risk that one has when trying
to enter at. In the case study presented at the end of this Año 2010 2009 2008
chapter, a 15% premium is considered satisfactory. Do not Margen bruto 39.0% 36.0% 33.4%
forget that the higher the risk, the higher the rate of return. Margen de operación 18.4% 15.5% 11.9%
An unstable historical consumption of the product indicates Margen UAFIDA 19.8% 17.0% 13.6%
Margen neto mayoritario 8.9% 9.0% 8.0%
a high risk. The recommended win rates are: low risk 1 to
10%; medium risk 11-20%; high risk, ARR greater than Fuente: Reporte anual de resultados financieros de Grupo Herdez. BMV.2011

20% with no upper limit.

Now analyze the case when a capital comes from several sources. Assume the following situation: $ 200,000,000 capital is required to
carry out a project. Investors contribute 50%, other companies contribute 25%, and a financial institution contributes the remainder.
The TMAR of each one are:

Inversionistas: TMAR = 12% inflación + 10% premio al riesgo + 0.12 × 0.1 = 0.232
Otras empresas: TMAR = 12% inflación + 12% premio al riesgo + 0.12 × 0.12 = 0.2544
Banco TMAR = 25%

The TMAR of investors and other companies that will contribute capital are very similar, since they
consider the investment from a private point of view, that is, the TMAR that they require for their
planning horizon, which is five years, they plan to compensate for inflation. ; To do this, they have
calculated that the average inflationary index for that period is 12%. The risk premium of the other
companies is slightly higher (two percentage points) than the premium demanded by the majority
investors, which is normal, since private financing is always more expensive than bank financing.
The bank's TMAR is very low. The bank TMAR is simply the interest that the institution charges
for making a loan, and here a prime interest rate is being assumed. With these data, the TMAR of
the total capital can be calculated, which is obtained with a weighting of the percentage of
contribution and the TMAR required by each one.

Accionista % aportación TMAR Ponderación

Inversionista privado 0.50 × 0.232 = 0.116
Otras empresas 0.25 × 0.2544 = 0.0636
Institución financiera 0.25 × 0.25 = 0.0625
—————————— ———
TMAR global mixta 0.2421
The MARR of the total capital ($ 200,000,000) turned out to be 24.21%; This means that it is
the minimum return that the company must earn to pay 23.2% interest on $ 100,000,000
contributed by the majority investors; 25.44% interest on $ 50,000,000 contributed by other
companies and 25% interest on the bank contribution of $ 50,000,000. Here it seems clearer why it
is called TMAR. If the yield of this company were not 24.21% (the minimum that it can earn to
operate) it would not be enough to cover the payment of interest to the other shareholders or its
own TMAR, and that is why it is called the minimum acceptable rate.
In conclusion, it can be said that whenever there is a mix of capital (or mixed capital) to
form a company, the TMAR of that company must be calculated as the weighted average of
the percentage contributions and TMAR required individually.

Bibliography

Fundamentals of Corporate Finance, Third Edition by Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus by The
McGraw-Hill Companies, Inc. ( 2016)-
Jhonny de Jesús Meza Orozco. Financial evaluation of projects.
Baca Urbina Gabriel. (2016). Project evaluation. México: McGRAW-HILL.