15: Financial Mathematics Used In Decision Making Flashcards

1
Q

To be relevant, the resulting cash flow must meet what three tests?

A
  1. Incremental and avoidable cash flows - incremental = incurred only if proposal goes ahead. If cost otherwise avoidable, then should be ignored e.g. rent= irrelevant
  2. Cash flows not already been incurred (sunk costs - alrdy incurred) = irrelevant e.g. R&D costs to date
  3. Revenue or cost must actually impact a cash flow - if not then it’s irrelevant e.g. depreciation
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2
Q

Opportunity cost

A

Must include lost revenue and associated variable costs (I.e. contribution) that will not be incurred as a result of pursuing the proposal. (Value of next best alternative foregone)

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3
Q

Break even formula

A

Revenue- VC - FC = 0

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4
Q

Contribution per unit

A

Revenue per unit - Total variable costs per unit

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5
Q

Break even output formula

A

Total FC / Contribution per unit

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6
Q

Margin of safety formula

A

Planned sales - Breakeven sales / Planned sales x100%

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7
Q

Output to hit a target profit

A

(Total fixed costs + target profit ) / contribution per unit

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8
Q

What are issues with break-even analysis

A
  1. assumes revenue and variable costs change proportionally with volume
  2. Some fixed costs are stepped fixed costs - additional cost incurred once certain threshold is reached
  3. For Multi product businesses, hard to identify which costs are attributable to what products being manufactured
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9
Q

What is sensitivity analysis

A

Involves changing value of one variable in order to test its impact on the final result

Allows an org to consider range of possible outcomes by asking what if? Questions

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10
Q

Formula for probability of achieving desired result

A

Number of ways of achieving desired result / Total number of possible outcomes

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11
Q

What is expected values

A

Sum of probability of the outcome occurring x acc outcome

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12
Q

Limitations of expected values

A
  • Probabilities used when calculating ev’s are likely to be estimates; unreliable/innacurate
  • do not consider attitudes to risk
  • does not consider time value of money (inflation)
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13
Q

How do decision trees work - Right to left

A

Work out cost based on probabilities and units n then add the two calculations together to find the budget used e.g. 79200 (6.90 x 12000 units)
Vs 99000(6.60 x 150000 units)
79200 x 0.8 (80% chance it will sell 12000 units) + 990000 x0.2 (20% chance) = £83160

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14
Q

Decision Trees left to right

A

Multiply each tree branch and add them up

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15
Q

Limitations of decision trees

A
  • estimates (subjective/unreliable)
  • only consider financial outcomes
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16
Q

What is Trend analysis and its uses

A

Uncovers patterns in a company’s data in order to predict future trends and support strategic decisions. Uses:
- Plotting monthly revenue and cost info
- Forecasting by extrapolating the trend line, future values could be estimated.

17
Q

Coefficient of variation

A

S.D/ Mean x100

18
Q

What is the percentage of s.d from mean normal distribution

A

34.1% either side

Therefore, 68.2% lie between one s.d below and one s.d above.

19
Q

95% of values lie within __ s.d above amd __ s.d below

A

1.96

also 99% lie within 2.58 s.d

20
Q

what is the % of 2 S.d away from mean

21
Q

what are the problems with data

A
  1. Comparability issues - data from multiple sources may be subject to differences in definition and/or measurement e.g. unemployment acoss different countries is measured differently.
  2. Outliers - observations that are outside what is normally the case.
22
Q

What are the types of data biases?

A

Selection bias - data not selected randomly enough sufficient to be representative of the population

Self-selection bias - individuals select themselves to be part of the sample

Observer bias - The researcher allows their assumptions (which may be unconscious) to
influence their observations. In a population of schoolchildren, the researcher
decides to select those that look happy.

Omitted variable bias - The researcher omits key variables that results in incorrect findings. For example, they could ask the public if they like a product but not whether they would actually be interested in buying it.

Cognitive bias - This relates to human perception and includes bias on how data is presented.
For example, a company could boast of profit growth of 20%, which sounds impressive to shareholders until they learn that the market grew by 30%!

Confirmation bias - The researcher accepts data that confirms their beliefs and ignores data that
disagrees. A car company decides to launch a radical new model despite market research suggesting it will flop in the market.

Survivorship bias - The sample contains data that has previously survived some other event. A
firm could let students sit their BST exam if they achieve over 60% in their mock exam. The firm later boasts that 95% of their students passed BST in the last sitting but can only do so because they prevented some students from taking the exam.