Finance Questions
1. Tax loss carry-forward
I don't think our tax loss carry-forward is correct.
Answer
Thanks for your question about the tax loss carry-forward. I regret
that the calculations do not show on your reports because it would be
easier to see the effects.
Your parent company's tax bill is based on consolidated income, rather
than only the income in the home area. Taxes paid by subsidiaries
constitute a credit to the parent company tax bill. Current period
income is reduced by a tax loss carry-forward, if any, from the
previous quarter.
The calculation is easy to see when there is a consolidated net loss,
as you had in Year 3, Quarter 1.
Consolidated Net Loss Before Tax $-101
Less Income Tax paid by subsidiaries - 60
Net Loss after tax $-161
Note that this is not the same as the loss in Area 1 ($-206),
attributed to the parent company. The subsidiaries paid $60 tax on
$154 income (60/.39). This income, already taxed to the subsidiary,
reduces the consolidated loss. Adding it back establishes the tax
loss carry-forward for the parent:
Consolidated Net Loss Before Tax $-101
Less Subsidiary Income already taxed -154
Parent tax-loss carry-forward $-255
Then, in Year 3, Quarter 2,
Consolidated Net Profit Before Tax $ 188
Less tax loss carry-forward -255
Consolidated Taxable Income $ -67
Taxes paid by subsidiaries -85
Less subsidiary income -218
Parent tax-loss carry-forward $-285
Note that there is a tax loss carry-forward, even though there was a
profit of $207 in Area 1, due to the loss in Sereno.
Then, in Year 3, Quarter 3:
Consolidated Net Loss Before Tax $-138
Less tax loss carry-forward -285
Consolidated Taxable Income $-423
Taxes paid by subsidiaries -101
Less subsidiary income -259
Parent tax-loss carry-forward $-682
In Year 3, Quarter 4 there was a consolidated profit
Consolidated Net Profit Before Tax $ 437
Less tax loss carry-forward -682
Consolidated Taxable Income $-245
Taxes paid by subsidiaries -226
Less subsidiary income -579
Parent tax loss carry-forward $-824
During Year 4, your firm had a consolidated net profit each quarter,
including untaxed profits in Sereno (not taxed because of a peso tax
loss carry-forward). It may be instructive for you to "do the sums"
for the first three quarters of Year 4. At the end of Quarter 3, the
tax loss carry-forward was $169 thousand.
For Year 4, Quarter 4:
Consolidated Net Profit Before Tax $1456
Less tax loss carry-forward -169
Consolidated Taxable Income $1287
Tax at 39% 502
Less taxes paid by subsidiaries -370
Net tax bill for parent company $ 132
2. Depreciation expense
To calculate depreciation expense per quarter for equipment: What is
the depreciation ($ or P) amount for equipment in Sereno?
Answer
Equipment is depreciated on a straight-line basis over 7 years.
So depreciation charges each quarter are calculated as 1/28th (3.5714
percent) of the original book value of all equipment in place during
the quarter. This applies both to peso values in Sereno and dollar
values in Merica.
Equipment depreciation is covered in more detail on pages 111-112
of the BPG Player's Manual.
3. Inflation
Is maintenance expense subject to inflation?
Answer
Maintenance costs, along with virtually all other costs and expenses
in the simulation are subject to the effect of inflation.
4. ROI calculation
On page F1 of the Quarterly Industry Report, we are curious as to
how "Investor ROI" is calculated. How might we estimate future ROIs?
Can you please enlighten us?
Answer
The formula for calculating Investor's ROI is on page 55 of the BPG
Player's Manual. The ROI is, essentially, an IRR calculated with
a quarterly compounding period, adjusted to an annual rate. The
investment is the amount put up for a share of stock in Year 2,
Quarter 4. The "cash inflows" are the dividend payments each
quarter plus the ending stock price. Your finance VP is on his
own to estimate stock price. It is determined by the types of
things investors use in the market, plus changes in the market itself.
5. Affiliate purchase costs
When a company has a plant in Merica and Sereno, what is the best way
to determine the purchase costs that the affiliates have to pay?
Should we take the average production cost of the units available
after local sales office orders have been fulfilled by the factories?
Answer
The average production cost (shown in Report D) plus 20 percent is the
transfer price of goods sold to affiliates.
6. Stock price calculation
Can you give us any insight into how the "Stock Price" is arrived at?
With a large swing in Net Income, from -649 to +336, and a positive
Earnings, we thought that our stock price would have improved. Can
you tell us what factors go into figuring Stock Price?
Answer
Stock price is from a simulated market where investors are using
earnings, dividends, market factors, and other investment measures to
determine the amount they would be willing to pay (or receive) to buy
(or sell) a company's shares.
7. Executive compensation
We would like to have clarification of the executive compensation
policy. we have been charged with inflation adjusted compensation for
a plant that is under construction. It would seem that a plant under
construction. would not have executives working it? Shouldn't
executive compensation be charged only during quarters that the plant
is operational.
Answer
Top executives for a plant need to be aboard starting with the time
the construction contract is let. They are charged with supervision
of construction, organizing things for future operations, hiring and
training employees, etc. So executive compensation is part of the
cost of opening a new plant.
8. Credit rating determination
We are curious about how the Credit Rating is arrived at in the
simulation. We have shown positives in every category for at least
the last two quarters but yet we have a credit rating of 3. Can you
please shed some light on this for us?
Answer
An emergency loan from the bank will qualify a company for a number 3
credit rating. Otherwise, ratings are evaluated by credit analysts at
the end of each year. Generally, a company with an emergency loan
during the past year or two will not be upgraded. The factors
affecting credit ratings are shown on page 57, but only three or four
quarter's performance on most of them will not have much impact.
9. Credit rating
Is there a way to tell if a competitor took out a short term loan when
it shows a negative cash balance on the industry report? The real
reason I am asking is to find out why credit ratings haven't changed
for some people in our world yet? Is the credit rating only updated
yearly?
Answer
Credit ratings are calculated by credit analysts in the 4th quarter of
each year based upon a firm's performance over an extended period of
time. However emergency borrowing will normally trigger a reduction
in a firm's credit rating in the quarter the emergency borrowing
occurred. See pages 56 and 57 of the Player's Manual for more
information.
10. Cash management
Last year teams had significant troubles with cash management in the
later stages of the game. The industry appeared to still be in
significant growth stages at the end of the competition. Our
understanding of cash management and dividend policy is that rapid
growth industries typically do not issue frequent dividends - the cash
should be reinvested to strengthen the position of the firm. However,
last year the teams with exorbitant amounts of cash at the end were
issuing large dividends each quarter.
This seemed to help their stock price immensely, though as a policy it
doesn't seem to match what we have learned. Is this a symptom of the
simulation? Or is there some better way to manage our cash, should we
be in the same situation this year?
Answer
Dividends to shareholders is a decision variable that your team will
have to decide. BPG shareholders like dividends, and a regular
dividend policy that allows payment of 30% to 60% of earnings may
enhance your stock price. But not if the result is insufficient cash
and inability to invest in profitable projects. It is best to develop
your strategy and policy, and stick with it.
11. Dividends
Our accountants are having trouble understanding the dividends paid to
parent and dividends paid to subsidiaries. We have all read the book,
and we are still vague as to how we calculate the exact dividends. As
you know, accountants need exact numbers and they are confused.
Answer
Dividends are not paid to subsidiaries, as they do not invest in the
stock of other companies.
Dividends paid by the parent company to stockholders result from your
decisions. Your team is in complete control of the amount of the
payment, as entered on your decision form.
Dividends paid by subsidiaries to the parent are described in the
Player's Manual on page 130. Until the retained earnings have been
built up to at least 50% of the value of common stock, only 80% of
earnings are paid to the parent company. After that, all profits
are paid to the parent as dividends.
Dividend payments to the parent are subject, of course, to the
availability of cash in the subsidiary's bank account--after payment,
there must still be one million pesos in the Sereno subsidiary, or
$100,000 in Merican subsidiaries.
The parent company's account "Dividends from Subsidiaries" reflects
how much is received by the parent and the sum of subsidiary dividends
paid to the parent should equal the amount of "Dividends from
Subsidiaries." As Internal transfers, these amounts net out and do
not show on the consolidated statements.
12. Credit rating
During quarter 4, year 3, our credit rating fell to level 3, along
with the rest of our world. We would like to question the reasoning
behind this. We had a credit rating of 2 prior to fourth quarter,
when we had the high sales in the industry at 5.1 million dollars, and
we ended with the highest cash balance of 983,000 dollars with no
loans. We are hoping this was a fluke and can be appealed. We have
worked very hard to manage our finances as we have made long term
improvements to our plant and product. What has happened to our
credit rating? We were hoping for, and honestly expecting, our credit
rating to move to 1 very soon.
Answer
The factors that are considered by credit analysts in their year-end
review are outlined on page 57, and are considered for an extended
period rather than just for a single quarter. As this is the first
year of the competition, the period is for the entire Year 4. Credit
analysts do not usually divulge the specific values of different
variables that they consider, but to have an average credit rating
generally expect your company to at least meet industry standards and
excel in relation to other companies in the industry.
Your company certainly met repayment obligations and had no
emergency borrowing, and from the Annual Industry Report showed an
increase in market share of about 1.6 percentage points. You might
wish to check out the other factors noted on page 57 in relation to
general industry standards and other companies in your industry. For
example, no one in your industry paid any dividends during the year.
Your debt ratio (bonds/equity) exceeded the maximum permitted by your
bond indenture. Partly as a result of the high amount of long-term
debt, your interest coverage ratio is a little low by most industry
standards. Please consider each of the factors listed.
And remember that credit rating is not the only measure to judge business
success. It does affect your borrowing costs and ability to raise funds with
new stock offerings.