MBA Boot Camp: Financial Decision Making (3.5)

Concepts & Vocabulary

• Fixed Costs: Costs that do not change based on how many products you sell (e.g., rent, corporate salaries).

• Variable Costs: Costs that increase directly with the number of products you sell (e.g., the cardboard boxes for shipping, raw materials).

• Break-Even Point: The exact moment when your Total Revenue equals your Total Costs (Fixed + Variable). You aren't losing money, but you aren't making a profit yet.

Core Lesson: Greenlighting the Project

When you pitch a new product or marketing campaign, finance will ask two questions: "When do we break even?" and "What is the NPV?"

1. Break-Even Analysis: If you spend $100,000 building a software app (Fixed Cost), and it costs you $0 to distribute it (Variable Cost), and you sell it for $10, your break-even point is 10,000 units. Unit 10,001 is pure profit.

2. Net Present Value (NPV): This is the holy grail of corporate finance. NPV combines everything we learned this week. It takes all the cash a project will generate in the future, uses the discount rate (Cost of Capital) to translate those future dollars into Present Value, and subtracts the initial cost.

• Rule of thumb: If the NPV is greater than $0, the project creates value. Do it. If the NPV is negative, the project destroys value. Reject it.

Application & Reflection

Calculate a Break-Even: You want to launch a new premium library tote bag to raise funds.

• The graphic designer charges a one-time fee of $500 (Fixed Cost).

• Each bag costs $5 to manufacture (Variable Cost).

• You will sell the bags for $15. (Your profit per bag is $10). How many bags do you have to sell to break even on the graphic designer's fee?