FinanceSim

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FinanceSim

• A Business Simulation for Corporate Finance
  Courses

Fernando Arellano, Ph.D.
2
What is FinanceSim?

• Business simulation in which decisions are mostly
  related to topics covered in a corporate finance
  or financial management course.

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What topics can be covered with FinanceSim?

• Time value of money
• Financial statement analysis
• Pro-forma analysis
• Working capital management
• Operating and financial leverage
• Capital structure
• Capital budgeting

4
What are the firms characteristics?

• Firms manufacture three products. Each product
  has its own variable and fixed costs, and demand
  characteristics.
• Firms can fund their operations through loans,
  bonds, and stock.
• Excess cash can be invested in short-term CDs.
• Dividends can be distributed.
• There are transaction costs on financial
  operations.
• Plant capacity can be increased or reduced (per
  product).

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What are the firms characteristics?

• The following variables can be controled in
  setting up the initial firm and the economic
  environment during the simulation
• Sales and inventory volumes and prices.
• Cost structure and profit margin for each product
• Overall firm profitability.
• Financial leverage, including the proportion of
  different debt and investment instruments.
• Behavior of GDP, CPI, and interest rates during
  simulation.
• Transaction costs on loans, CDs, bonds, and stock
  operations.
• Price and promotional elasticities.
• Level of inflation affecting prices and costs.

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What are the firms characteristics?

• Current and potential profitability is defined
  by
• Current and future sales volumes and prices
• Current and future costs
• Variable and fixed cost structure
• Current and future cost of debt
• Transaction costs
• Capital structure
• Current capacity utilization and future cost of
  equipment

7
What are the firms characteristics?

• Current and potential cash position is defined by
  (in addition to preceding factors)
• Level of depreciation costs.
• Initial cash.

8
What are other characteristics?

• Each simulated period represents one quarter.
• Up to twelve quarters can be simulated.
• Students work in teams. Up to sixteen teams can
  participate.
• In addition to financial statements and
  supplementary information, teams receive
  historical information on sales volumes, prices,
  GDP, CPI, and interest rates.

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What decisions are made?

• In the finance area
• Request 90-day , 1-year and 5-year term loans.
• Invest in 90-day, 180-day, and 270-day
  certificates of deposit.
• Issue and recall 10-year bonds.
• Issue and repurchase stock.
• Distribute dividends.
• In addition, participants have to forecast cash
  balances and after-tax earnings.

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What decisions are made?

• In the production area
• Order production.
• Select between two suppliers of raw material that
  offer different terms of payment.
• Increase or decrease plant capacity.

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What decisions are made?

• In the marketing area
• Set price and promotional expenditures
• Offer price discounts for prompt payments
• In addition, participants may be asked to
  forecast sales volumes.
• At the beginning of the simulations participants
  may be provided with sales volumes and prices in
  order to focus on financial decisions.

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How is firm performance evaluated?

• Firm performance is evaluated on the basis of
  firm profitability, product contribution margin,
  and forecast errors.
• Forecast errors that are measured and reported to
  participants include
• End of quarter cash balance.
• End of quarter after tax earnings.
• Sales volumes (if participants were required to
  make sales forecasts).

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What do students learn?

• They apply time value of money concepts and
  techniques when they make the decision on whether
  to
• Purchase raw material using cash or taking credit
  from the bank or from the supplier.
• Offer discounts to clients who pay in cash rather
  than take the 90-day credit.
• Calculate the effective interest rate of
  different loan terms, including fixed and
  variable commissions.
• Request loans and schedule their reimbursements.

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What do students learn?

• They learn cash budgeting when they
• Do pro-forma analysis every quarter to determine
  their funding needs or their excess cash.

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What do students learn?

• They appreciate the importance of accurate cash
  management when they
• Underestimate their funding needs and receive
  emergency funding with interest rate penalty.
• Insufficient funding was requested.
• Too much was invested in CDs.
• Overestimate their funding needs and sacrifice
  the opportunity cost of cash surplus.
• Too much funding was requested.
• Insufficient amount was invested in CDs.

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What do students learn?

• They appreciate the importance of inventory
  management when their forecasts
• Overestimate sales and they are left with
  inventory.
• Underestimate sales and they lose sales.
• The instructor can set different storage costs
  per product so as to make the carry-on of
  inventory profitable or unprofitable.

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What do students learn?

• They learn the techniques of capital budgeting
  when they
• Reach full capacity utilization and have to
  decide on acquisition of new equipment.
• They have to forecast sales.
• Different capacities can be purchased.
• Investment cost per unit varies with equipment
  size.

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What do students learn?

• They appreciate the importance of adequate and
  timely long-term planning when they
• Decide to expand production and invest in
  additional equipment.
• Plan one quarter ahead and issue bonds or stock
  to fund the purchase of new equipment. Otherwise,
  they will have to fund the acquisition with
  short-term funding.

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What do students learn?

• They observe the impact of financial leverage on
  profits
• When they observe the impact of increased sales
  on profits.
• After they request loans, issue or repurchase
  stock, issue or recall bonds, or distribute
  dividends.

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What do students learn?

• They appreciate the importance of operating
  leverage when they
• Observe impacts in profits when sales increase or
  decrease.
• The three products have different cost structures
• Decide on plant expansion.
• Different equipment sizes result in different
  fixed costs.

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What do students learn?

• They appreciate the importance of capital
  structure when they
• Decide on how to fund operations or plant
  expansion.
• They can
• Issue common stock.
• Issue 10-year bonds.
• Request 1-year and 5-year loans.
• Use trade credit.
• Offer discounts for prompt payment.

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What do students learn?

• They appreciate the importance of financial
  analysis when they
• Track the evolution of their financial ratios
  quarter after quarter.
• Compare their ratios with other participants in
  the simulation.

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How are decisions scheduled?

• To accomplish the objectives presented before,
  decisions are scheduled in a way that precludes
  complexity at the beginning and allows for
  concentration on specific topics.
• The number of decisions allowed are sequentially
  increased quarter by quarter.

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How are decisions scheduled?

• First decision Participants are asked to do a
  cash budget and submit their short-term funding
  needs.
• Sales forecasts, prices, and costs are furnished
  to the participants.
• Raw materials are paid in cash.
• Sales proceeds are collected in 90 days.
• Accurate budgeting depends on the understanding
  of how a cash flow statement is constructed.

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How are decisions scheduled?

• Their report for the quarter will show a forecast
  error in their projection of their cash balance
  at the end of the quarter.

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How are decisions scheduled?

• Second decision participants are asked to select
  between two suppliers. One collects cash, the
  other collects in 90 days. They are also asked to
  forecast after-tax earnings for the next quarter.
• Each supplier charges different prices.
• Participants can choose to
• pay cash.
• get credit from supplier.
• get 90-day bank loan.

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How are decisions scheduled?

• In addition to their forecast error and end of
  quarter cash balance, their report will show
  their forecast error in their after-tax earnings.
• First decision conditions still apply. They still
  have to project cash flows and look for adequate
  funding for the firms overall operations.

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How are decisions scheduled?

• Third decision participants have the option of
  offering price discounts to clients that make
  prompt payments.
• They have three preset options i.e. 5, 8, 12.
• Each option has a corresponding percentage of
  sales (in units) that will be paid in cash.
• Demand is not affected by the discounts.
• First and second quarter decision conditions
  still apply.

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How are decisions scheduled?

• Fourth decision Prices and sales forecasts are
  provided, but the latter are no longer accurate.
• It forces participants to set production levels
  and determine if they want to run the risk of
  running out of inventory or being left with
  excess inventory.
• Storage cost, contribution margin, and financial
  cost will determine the convenience of either
  strategy.

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How are decisions scheduled?

• Fifth decision Participants are allowed (or
  required) to distribute dividends.
• In addition they can expand their options of
  funding and investing. They can
• Request 90-day, 1-year, and 5 year loans.
• Invest in 90-day, 180-day, and 270-day CDs.
• Issue bonds and stock.
• For better decision making, they have to forecast
  sales and project cash flows at least four
  quarters ahead.

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How are decisions scheduled?

• Fifth decision (cont.)
• Participants are informed that they will be
  allowed to increase plant capacity in the
  following quarter.
• If they decide to purchase equipment, this
  announcement will require them to issue bonds or
  stock in this quarter.

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How are decisions scheduled?

• Sixth decision Participants are allowed to
  increase plant capacity.
• If they didnt decide to issue bond or stock in
  the previous quarter they will have to pay for
  the equipment using other means of funding.
• They can still issue bond and stock but will not
  receive the funds until the following quarter.

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How are decisions scheduled?

• Seventh decision No sales forecasts are
  furnished to participants. They can prepay loans
  or sell CDs before maturing. They can recall
  bonds and repurchase stock.
• This allows participants to correct errors made
  in prior quarters.
• Prices are furnished to participants.
• Participants have to make sales forecasts.
• Forecast errors will be notified in their
  reports.

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How are decisions scheduled?

• Eigth decision Prices are no longer fixed.
  Participants are allowed to change prices and
  promotional expenditures.
• They are also allowed to invest in expansion or
  reduction of plant capacity.
• In the following four quarters they will make the
  same decisions.
• The cost structure and price and promotional
  elasticities will play a major role in their
  pricing strategy.

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Summary

• In summary, participants acquire or develop
  abilities and skills in financial management.
• Note The decision schedule can be changed to
  accommodate the objectives and syllabus of the
  course.