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# Economic Concepts & Theory Elasticity -Price elasticity of demand (Ed) = (% in Qd)/( % in \$) Ed > 1 Ed < 1 Elastic demand Inelastic

## ic demand Price : Qd: TR Price : Qd little: TR

Ed > 0 Ed < 1

Substitute complement

PriceY : Qd X Price X : Qd Y

MPS -Marginal propensity to consume (MPC) : % of next \$ of income that the consumer would be expected to spend = in spending/ in income (1-MPC = MPS). -Marginal propensity to save (MPS): % of next \$ of income that the consumer would be expected to save = in savings/ in income Supply Curve Factors, other than \$, which causes an in Qs: -# of producers -govn subsidies cost which production - price expectations - tech. advances -cost which production

-Income elasticity of demand (Ei) (% in Qd)/( % in Income) Ed > 0 Ed < 1 Normal good Inferior good Income : Qd Income : Qd

## Cross-elasticity of demand = (% in Qd of x)/( % in \$ of y)

Factors, other than \$, which causes an in Qs: -production costs -prices of other goods Market Equilibrium (Eq)

RTS = % in output/ % in input -Economies of scale: as output : Unit cost -Diseconomies of scale: as output : Unit cost Market Structure & Industry Analysis

-point at which D and S curve crosses -rep. price at which all goods offered f/ sale will be sold -Price ceiling (setting \$ below Eq ) shortages occurs as Qd > Qs -Price fllors (setting \$ above Eq) surpluses as Qd < Qs. Production Costs -A good should be produced + sold as long as MC of producing good < MR from sale of that good. -Over long periods of time, all costs are variable. -Return to scale: in units produced that results from an In production costs.

-Perfect/Pure Competition - large # of buyers/sellers - no barriers to entry/exist - homogenized product - absence of non-price competition - Ex. Mkt for commodities (i.e. wheat, rice) -firms demand curve is perfectly elastic (horizontal) -Pure monopoly -there is generally one producer -no close substitutes are available -there is blocked entry (patent) or govn franchise (public utility) -firms demand curve is negatively sloping

-Monopolistic competition -consists of multiple suppiers -heterogenous products -lots of non-price competition (advertising) -easy entry + exist to mkt -firms demand curve is negatively sloping -Ex. Retail industry -Oligopoly -a few large sellers -heterogenous or homogenous products -barriers to entry -non-price competition exists -rival actions are observed -firms demand curve is kinked Macroeconomics -Gross domestic product (GDP): price of all goods + services produced by a domestic economy for a yr at crt market prices.

-Real GDP - price of all goods + services produced by a domestic economy for a yr at price level adjusted prices. -Gross natl product (GNP): price of all goods + services produced by labor + property supplied by nations residents. Inflation -rise in \$ and interest rate -demand pull inflation: higher prices caused by increase in spending/demand. -cost-push inflation: higher prices caused by decrease in Qs when production costs increases -increase in Eq GDP due to multiplier effect: in spending/ MPS Busn Cycle -Expansion: periods of aggregate spending -Contraction: periods of aggregate spending -Recession: 2 consecutive period of negative GDP growth; potential natl income > actual natl income

-Depression: a deep + long-lasting recession -Panic: a severe contraction of GDP occurring w/I a very short time frame -Recovery: period of expansion that follows the end of a contraction -Leading indicator: indicators used to try to predict recoveries or recessions -starts moving up mo. Before an actual recovery begins; starts moving down mo. Before actual recession begins -Ex. Stock mkt prices, avg hrs worked per week, new orders f/ durable goods -Coincident indictor: measure that moves up/down simultaneously w/ economic recoveries and recessions. -use to det. if economy is expanding/contracting at present time -Ex. Industrial production, mfg & trade sales -Lagging indicators

-ex. Avg prime rate for bank loans, avg duration of unemployment, unemployment rate Types of unemployment 1) frictional: refer to time period which ppl are unemployed due to changing jobs or newly entering the workforce 2) structural: rep. Potential workers whose job skills do not match the needs of the work force 3) cyclical: rep. Unemployment caused by varations in the busn cycle Govt involvement in the economy Fiscal Policy -govt attempts to influence the economy thru taxes, subsidies, govnt spending -fiscal expansion/deficit spending: raising spending levels w/o an equal increase in taxes, or lowering taxes w/o an equal decrease in spending

Monetary Policy -Federal reserve system has control over the \$ supply -Reserve requirements: reserve ratio: \$ supply : interest rate -Open mkt operations -buy gov securities: \$ supply: interest rate -Disct rate: Fed can change the cost of \$ to banks and thereby cause a change in interst rate throughout the economy - disct rate: \$ supply: interest rate Intl Trade -Balance of trade: difference btw goods imported and goods exported -export > import: trade surplus -export < import: trade deficit

-Spot rate: ER for currencies that will be immediately delivered -Fwd rate: rate at which 2 parties agree they will exchange currencies at a specific future date Factors affecting Foreign ER 1) inflation: currency w/ higher inflation will fall in value relative to the other 2) Interest rates: currency in the nation w/ higher interest rates will rise in value. 3) Balance of pymts: currency of the country that is a net exporter will rise in value. 4) Govt intervention 5) Political & economic stability

Decision Making -primary purpose of cost measurement is to allocate the costs of production to units produced -TC = fixed + var (x) -High-low method -Var cost = delta = y/ x -Prime cost: DM + DL -Conversion cost: DL + OH -OH includes both indirect materials/labor Flow of a cost system mfg company RM WIP FG COGS Beg. RM Beg WIP Beg FG GOS +P +DM used +CGM +underap = avail +DL used =FG avail (overapp) (ending) +Applied (end FG) =CGS MOH =DM used =WIP avail =COGS (end WIP) =CGM

Variable & Absorption Costing Absorption/Full Costing -Product costs: includes BOTH var + fixed COGS -Fixed MOH is allocated to product cost based on units sold; rest is absorbed into EI Sales > Prod (i.e. EI<BI) NI will be understated as more Fixed MOH gets assigned to COGS Direct/Variable/CM -Product costs: includes only variable COGS -100% of Fixed MOH is expensed as period cost Sales < Prod (i.e.EI>BI): income is understated

Cost-Volume-Profit analysis -sales variable FC = operating income -CM= sales - variable -BEU: FC + Profit/Loss / CMU -BE\$: FC + Profit/Los/ CMR

-Margin of safety: excess of budgeted sales over BE volume of sales; measures the amt by which sales can drop before losses begin to incur. -Total sales BE sales = MOS -MS\$/total sales = MS % Financial Mgmt & Capital Budgeting Working Capital Mgm -primary focus is to manage inventories + receivables -working capital: CA CL -current ratio: CA/CL -quick acid test ratio: (\$+mkt securities+net AR)/CL -CCC= ICP + RCP PDP -ICP = avg inventory/ sales per day time reqd to convert inventory to sales -RCP = avg receivable/ sales per day time reqd to collect AR -PDP = avg payable/ purchases per day (COGS/365)

-time btw purchase of inventory + pymt for them Cash Mgmt -mgmts goal is to maximize float on cash disbursement & minimize float on cash receipt Receivables Mgmt - 2/10, net 30 2% discount if paid within 10 days, otherwise full amt due within 30days -AR t/o = net credit sales/ avg AR -Avg collection period (ACP) = 360/ AR t/o Inventory Mgmt -EOQ how much to order? = 2AP/S -A= annual demand -P=cost to place an order -S=cost to store inventory

-Reorder pt: when to order ? = avg daily demand * avg lead time # when reorder + safety stock =reorder point -JIT is used when: -order cost is low -lead time is low -storage cost is high -has good relationship w/ supplier -Inventory t/o = COGS/ avg inventory -ICP = 360 days/ inventory t/o RATIOS Capital Budgeting -refers to budgets related to LT investment decisions

1) Payback period: investment/annual CF = # of yrs -CF over entire life of proj is not considered since calc ends once initial outlay is recovered. 2) IRR = Investment/ annual CF = PV factor -rate at which investment = annual CF -accept project only if IRR > cost of capital 3) ARR = actg income* / avg investment = ROI *CF depn expense 4) NPV PV Cash inflows -PV Cash outflows Net P.V. + good - bad -Inventory t/o = COGS/ avg inventory

-ICP = 360 days/ inventory t/o -AR t/o = net credit sales/ avg AR -Avg collection period (ACP) = 360/ AR t/o -Annual financing cost (AFC)= [disct% / (100-disct%)] * [365 / (total pay period disct period)] -Cost of loan = interest paid / net funds avail (prin comp. Bal) -operating leverage: the degree to which a firm has built FC into its operations DOL% = (% in EBIT)/ (% in sales volume) -Financial leverage: degree to which a firm uses debt financing in its busn DFL= (% in EPS)/ (% in EBIT)

Cost of Existing C/S 1.) CAPM: volatility of stock price relative to avg stock CAPM= RFR + (ER RFR)B -Beta = measures correlation btw stocks price + price of the overall mkt 2) Dividend Yield Plus Growth Rate (Next expected dividend/crt stock price) + expected growth in earnings Cost of new c/s (Next expected dividend/crt stock price floatation costs) + expected growth in earnings

Profitability Ratios -ROI = NI/ TA -Dupont ROI analysis: ROI= ROS * Asset t/o -ROS= NI/Sales -Asset t/o = Sales / TA -Residual Income = Operating profit interest on investment* *invested capital * ROR -Economic value added (EVA) Net operating profit after taxes (NOPAT) cost of financing* *(TA-CL) * wtg avg cost of capital -Free CF= NOPAT + Depn + Amort Cap expenditures Net increase in working capital* *CA CL -Gross margin = gross profit/net sales -Operating Profit Margin = operating profit / net sales -ROA = NI/ Avg TA -ROE = NI/ Avg c/s holder equity

-Receivable t/o = Net credit sales/ avg AR -RCP = avg AR/ Avg credit sales per day -Inventory t/o = COGS/ avg inventory -ICP = avg inventory / avg CGS per day Debt Utilization Ratios -debt to total asset = TL/TA -debt to equity = total debt / total equity -times interest earned ratio = EBIT/ Interest Expense Market Ratios -Price/Earnings Ratio = C/S price per share / EPS -BV per share = (c/s equity)* / (c/s shares os) *stockholder equity ps liquidation value -Mkt capitalization = cs price per share * cs shares os

-Mkt/Book Ratio = 1) c/s price per share / bv per sare 2) mkt cap / c/s equity Info. Tech Common forms of mgmt reporting system: 1) Mgmt IS: provides info. to mgmt which may utilize it in decision-making 2) Decision support system: combines models + data to help in prb solving but w/ extensive user interpretation needed 3) Expert system: uses reasoning methods + data to render advice + rec. in structured sitatuations where human interpretation isnt nec. 4) Executive IS: systems designed to support executive work.

Processing of txns can take place either thru: 1) online, real-time (OLRT), 2) batch processing DBs should 1) provide depts. w/ appro. Info. 2) prevent access to inappro. Info. -primary goal of DBMS is to minimize the repetition + redundancy in the DB, both to enhance efficiency + remove danger of info. being stored in inconsistent places Network configures include: 1) LANs: transmits info. thru physical transmission media 2) WANs - use of phone lines, satellite transmission 3) VAN -link different companies computer files 2gether

Different ways communication is org: 1) Bus 2) Star 3) Ring 4) Tree Special considerations related to EDI: 1) Strict stds reqd for the form of data 2) Translation softwarwe is needed 3) unauthorized access Hardware: -CPU: principal hardware component that processes programs -Memory: internal storage space -Offline storage: devices used to store data/program externally, including floppy disks, DVd, etc. -File server: a computer w/ a large internal memory used to store programs + data that can be accessed by all workstations in the network.

-Router: a specialized device that receives info. from 1 computer and send it toward its destination in the most efficient manner possible. -Gateway: a computer that links 1 network to another. Software -either system or application software -system software: comprise of operating systems + utility programs -application software: designed to perform specific tasks for the company -heuristic: refers to software that can learn + modify its operations (i.e. spell checking pogrom) Programming language -source program: language written by programmer -object program: language in a form the m/c can understand (on-off, or 1-0)

-compiler: a program that converts source program into m/c language. Data Structure Size in increasing order: Bit Byte Field Record Filed DB Order Record Process Update Report Operations in an IT function -data entry clerk: converts data into computer readable form -computer operator: runs programs on the computer -program + file librarians: responsible for the custody of computer programs, master files, txns files, & other records -data control: responsible for reviewing + testing input procedures, monitoring processing, + reviewing + distributing outputs

General Controls -relate to the overall integrity of the system -involves segregation of the incompatible duties of authorization, recording, & custody (ARC) Hardware controls: -parity check -echo check Application Controls -designed to ensure that an individual computer application program performs properly -application controls related to data input, data processing, and data output

General controls overall environ 1) Personnel Policies Segregate authorization, recording, & custody functions

## 2) File security -backup, lockout, read-only

Application (program controls) 1) Input -check digit inputed correctly -validity check (valid SSN) -Edit Test #s in SS not letters -Limit Test -Financial total -Record count -Hash = a meaningless total -Nonfinancial total 2) Processing -system + software doc -error-checking compiler -test data -system testing

3) Contingency planning diaster recovery (hot/cold site) 4) Computer facilities fire/insurance 5) access controls

## 3) Output - accurate -distribution list -shredders -system testing

Cost Actg & Measurement -Variance analysis SAD Std Actual = Difference DM DL DM Price Var DM Usage Var DL rate var DL usage var AQ(SP-AP) SP (SQ-AQ) AH(SR-AR) SR (SH-AH)

Costing Systems

-Job-order costing: expensive, heterogeneous products- cost based per job -Process costing: inexpensive, homogenous costs per Period 2 method of applying process costing to production: 1) Wtg avg a. Cost per unit = TC/ Total E.U. (including BI) 2) FIFO a. Cost per unit = Costs this period/ Units worked on this period Format: FIFO Units Beg +Started Units to act for Completed Spoilage EI % EU Costs

Units to act for Joint Product Costing 1) Sales Value at split-off -allocate joint cost to only primary products, not by-product -revenue from sale of by-product can be used to reduce joint cost Planning, Control, & Analysis -Strategic planning: setting of LT overall goals + policies -Tactical planning: focuses on ST objective + temporary tech. -Master budget: summarizes the results of all the firms individual budgets (operating + financial) into a set of projected f/s + schedules.

-Static budget: budget at a specific level of activity -can be for a division of a company or company as whole -advantage of flexible budget is that it can adapt to changes in VC that result from changes in sales levels -regression analysis: used to det. relationship btw x and y, as indicated by a correlation coefficient (R) Activity Based Costing (ABC) -allocate costs base on activities/cost-drivers -enables mgrs to segregate cost into valueadded or non-value added costs -costs can be allocated in 2 ways: 1) direct allocation: cost is allocated from each service dept directly to, and only to, the producing depts.

2) Step allocation: costs from a service dpet may be allocated to the other service dept, as well as producing dept Risk Mgmt -Gordon growth model: assumption that reinvested assets will increase distribution by the amt of reinvestment, so that the growth in the assets will the the growth rate of future dividends -Std deviation: most common measurement of investment risk To calculate: 1) det. arithmetic avg return 2) calculate the difference from the avg for each indivd period 3) square the differences 4) det avg of the squared values 5) calculate sq root of this avg -a return w/ higher Stdev = higher return

-unsystematic (uniqe) risk: risk that exists for one particular investment -systematic risk: risk that relates to mkt factors that cannot be diversified away or avoided (i.e. inflation, interest rates) -Beta: estimates an investments systematic risk mkt risk that is unavoidable -Efficient mkt hypothesis: belief that individs cannot outperform mkt avgs over long periods of time except by luck -LT loans will typically offer higher yield b/c they are less liquid and are subject to more rate risks, and vice versa for ST loans. -Bank favor ST loans, savings & loans favor intermediate, and life insurance companies LT.