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When Regina McDermott opened her auto repair shop, she thought her 15 years of experience with cars was all she would need. To a degree, she was right—within six months, her shop had more work than it could handle, thanks to her widening reputation. At the same time, however, Regina has found it necessary to spend more and more time dealing with financial planning.
Three weeks ago, her accountant came by to discuss a number of finance-related matters. One of these is the need for cash budgeting. “I can work up a cash budget for you,” he explained. “However, I think you should understand what I am doing so you will realize the importance of the cash budget and be able to visualize your cash inflows and outflows. I think you also need to make a decision regarding the new equipment you are planning to purchase. This machinery is state of the art, but, as we discussed last week, you can buy a number of different types of machinery. You are going to have to decide which is the best choice.”
Regina explained to her accountant that she was indifferent about which equipment to buy. “All of this machinery is good. Perhaps I should purchase the cheapest.” At this point, the accountant explained to her that she could use a number of ways to evaluate this type of decision. “You can base your choice on the payback method—how long it takes to recover your investment in each of these pieces of equipment. You can base it on net present value by discounting future cash flows to the present. Or you can base it on internal rate of return under which the cash flows are discounted at a rate that makes the net present value of the project equal to zero.”
Regina listened quietly; when the accountant was finished, she said, “Let me think about the various ways of evaluating my capital investment, and I will get back to you. Then, perhaps you and I can work out the numbers together.” Her accountant said this sounded fine to him and he left. Regina began to wish she had taken more accounting courses while in college. As she explained to her husband, “When the accountant begins to talk, it is all Greek to me.”
Case Study II: It’s Just a Matter of Time
Pedro Santini has been a computer analyst for five years. In his spare time, he has developed a word processing software program that is more comprehensive and powerful than any on the market. Because he does not have a great deal of money, Pedro believes that the first step in producing and marketing this product should be to obtain the necessary venture capital.
The software program has been written and trial-tested by Pedro and a handful of friends to whom he gave the material. Two of these friends are computer word processors who told him that the program is faster and easier to use than anything on the market. Pedro believes that these kinds of testimonials point out the profit potential of the product. However, he still needs to get financial support. One of Pedro’s friends has suggested a meeting with a venture capitalist. “These guys have all sorts of money to invest for new ventures,” the friend told Pedro. “All you have to do is explain your ideas and sell them on giving you the money. They are always looking to back a profitable idea, and yours is certain to be one of the best they have seen in a long time.”
Pedro agrees with his friend, but believes he should not discuss the matter with a venture capitalist until he has thought through answers to the various types of questions likely to be asked. In particular, Pedro believes he should be able to provide the venture capitalist with projected sales for the first three years and be able to explain the types of expenses that would be incurred. Once he has done this, Pedro feels that he will be ready to talk to the individual. “Right now,” he tells his friends, “it is just a matter of time. I think that, within seven to ten days, I will be ready to present my ideas and discuss financial needs.”
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