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Principles of Finance: Unit 7, Breakeven and Payback Time 4 Views
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Description:
Everything you’ve ever wanted to know about breaking even and payback time, served with a cup of refreshing absinthe lemonade.
Transcript
- 00:00
Principles of finance ah la shmoop break even and pay
- 00:05
back time it's pay back time would be shmoop sounds
- 00:09
like a schwarzenegger line but it's not it's Really not
- 00:14
like what a simple concept when you invest in a
- 00:16
project or stock or a whatever dot com you want
Full Transcript
- 00:19
to know when and or how to get your money
- 00:21
back And then ideally a good bit more than that
- 00:24
amount of money afterwards to pay you back for the
- 00:26
risk you took in the time you had the dough
- 00:28
in the pot So popular exercise in accounting land is
- 00:31
to calculate the amount of time it takes on a
- 00:33
given investment to simply get paid back the initial capital
- 00:36
you laid out for say that cup stamper That cost
- 00:39
you though three million bucks all paid up front with
- 00:42
your cash Well that stamper saves you a nickel a
- 00:45
cup versus having toe by cops from cups are us
- 00:48
So you have two stamp three million cops divided by
- 00:52
point zero five or sixty million cups to break even
- 00:56
Sort of You sell a million cops of laminate a
- 00:58
month Steadily so easy calculation Right in sixty months the
- 01:02
three million boxes paid back and everything from there is
- 01:05
profit contribution right Wrong The machine doesn't just maintain or
- 01:09
insure itself So in reality it costs another penny A
- 01:13
cop toe Look after that stamp for a machine thing
- 01:15
Oil it and you know pay the robot to run
- 01:18
it and wipe it off When it's bill's what union
- 01:21
Robots they make bank So in reality it's not five
- 01:24
cents a cup You save in running that machine It's
- 01:26
really Four cents and it's not sixty million cups to
- 01:29
pay it back It's really Three million divided by four
- 01:33
cents a cut or seventy five million cups to pay
- 01:35
it back Oh and one other little thing Capital isn't
- 01:39
free Remember you took three million box out of your
- 01:42
two percent a year earning money market account to pay
- 01:45
for that stamping factory thing Well the three million bucks
- 01:48
earned you a very safe sixty grand a year That
- 01:52
money was vastly more rock solid safe than your entire
- 01:55
absence Lemonade stand business Yeah When you spent three million
- 01:59
bucks on the machine you made this huge risky bet
- 02:03
with your capital that the business would be around long
- 02:06
Enough to pay back the value of the machine and
- 02:08
then some shouldn't leave value of that capital at some
- 02:12
rate higher than the super safe Two percent bank returns
- 02:15
well if you had to go out into the market
- 02:17
and borrow money pledging that stamper as collateral on the
- 02:20
market would price it much higher More like on ten
- 02:23
fifteen twenty percent let's pick ten percent now because the
- 02:26
math is easy is ten percent a fair number to
- 02:28
use for the opportunity cost for your capital being spent
- 02:31
on the cup Stamper Well you're the one controlling the
- 02:34
process it's not a cold arm's length transaction done with
- 02:37
a vendor who doesn't actually know you and your fine
- 02:40
work ethic there since it's all your money and your
- 02:42
time and attention on this one process well your risk
- 02:45
should certainly be less than the and percent market price
- 02:48
sitting out there So for lack of a better process
- 02:51
and you split the difference and call the cost of
- 02:53
your capital the opportunity cost and risk adjusted Numbers 6
- 02:56
percent c had the two percent risk free money market
- 02:59
price thing going on then the ten percent mark pricing
- 03:01
there again it took the average ten plus two is
- 03:04
twelve in the ice bye bye to highly scientific And
- 03:06
normally you need a phd to do all this arithmetic
- 03:09
So anyway now on top of everything you have the
- 03:12
six percent a year to cover the risk of using
- 03:15
your own capital versus just buying cups Ala carte from
- 03:18
cups are us as you go along well that six
- 03:21
percent on three million box is one hundred eighty grand
- 03:24
a year to rent and that's an ongoing costs like
- 03:27
every year as the quote principal unquote is aid off
- 03:30
the extra hundred eighty grand in costs at four cents
- 03:34
a cop net savings Well then that's one hundred eighty
- 03:36
grand divided by point zero four or an additional four
- 03:40
and a half million cops a year at least in
- 03:42
your one So let's say you continue to sell a
- 03:45
million cups of absence lemonade a month with no wasted
- 03:48
your breakage or other forces like a union robot strike
- 03:52
You know that's the thing Well after one year we've
- 03:54
sold twelve million cups as part of your absence lemonade
- 03:57
sales and those twelve million cops have saved you now
- 04:00
For sensei so four cents times twelve million is total
- 04:04
savings this year of four hundred eighty grand and let's
- 04:07
say you pay off an annual chunks notionally the quote
- 04:10
debt you borrowed from yourself and that four hundred eighty
- 04:13
grand gets one hundred eighty grand taken out of it
- 04:15
to rent the three million dollars risk adjusted to have
- 04:18
bought that stamper Don't leave you three hundred grand to
- 04:21
pay down your loan to being now essentially two point
- 04:23
seven million Well you have less notional principal outstanding now
- 04:27
so less to pay down unless to pay off your
- 04:30
a reducing risk here And certainly the risk of the
- 04:32
machine is lower because you've used it a year and
- 04:35
it generally works and well you know it's good to
- 04:37
control your own stamping Those cups are an integral part
- 04:40
of your business and it's important to have them stamped
- 04:42
with pithy sayings like absence makes the brain grow foggier
- 04:47
The rest of this exercise revolves around how many cups
- 04:49
a year you sell saving you four cents each and
- 04:51
then how quickly you pay off your notional quote debt
- 04:54
unquote back to yourself regardless this capital expenditure when given
- 04:58
the full set of inspection numbers however is way more
- 05:00
complex and it initially appeared to be and way less
- 05:04
of a boon to our business Why Because we have
- 05:07
to account for the cost of our capital like we
- 05:09
could've put it elsewhere We could've bought marketing with him
- 05:11
He could have bought back our own stock and in
- 05:14
addition all of this there lies the specter out there
- 05:17
that absence lemonade sales could actually declined to say ano
- 05:21
eight hundred thousand five hundred thousand then maybe three hundred
- 05:24
thousand a month At that point buying your own stamper
- 05:27
was a total waste of your capital You should have
- 05:29
just paid up for the outside vendor at whatever since
- 05:32
it was per cup and not tried to save the
- 05:35
four cents But on the other hand if sales skyrocket
- 05:38
thanks to the kitschy sayings on your cups and you
- 05:41
grow to selling two million and three million cups a
- 05:44
month and maybe four five then in a year you
- 05:47
would have sold us a forty million cops and save
- 05:49
those four cents And yeah that would be a total
- 05:51
savings just in that year of one point six million
- 05:55
Bucks by virtue of having your own stamper and wow
- 05:58
then your machines value will have paid off handsomely You
- 06:01
got big numbers toe warrant spending your precious capital on
- 06:04
stuff like this The big notion here is that break
- 06:07
even analysis and payback have to consider exogenous or none
- 06:11
obvious things like the risk of the investment being a
- 06:14
total bust or the opportunity cost loss for what else
- 06:17
a company could have done with that capital including nothing
- 06:21
It's got also include the maintenance insurance and other costs
- 06:24
associated with a purchase The risk of you know robot
- 06:26
union strikes are rebelling on you including taxable things like
- 06:30
gains from depreciating that asset meaning you kind of got
- 06:33
paid in tax by having spent the capital then being
- 06:36
allowed to depreciate it against profits You didn't think about
- 06:39
that one did you So yeah there's the tax help
- 06:41
hereand appreciating that machine three hundred grand a year over
- 06:44
ten years to then be zero The tax savings would
- 06:47
have been worth some one hundred grand or so or
- 06:49
two point five million cups worth a year But okay
- 06:52
enough absent for one day we know you miss your 00:06:54.894 --> [endTime] drones
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