ShmoopTube

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Principles of finance ah la shmoop break even and pay

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back time it's pay back time would be shmoop sounds

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like a schwarzenegger line but it's not it's Really not

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like what a simple concept when you invest in a

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project or stock or a whatever dot com you want

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to know when and or how to get your money

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back And then ideally a good bit more than that

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amount of money afterwards to pay you back for the

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risk you took in the time you had the dough

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in the pot So popular exercise in accounting land is

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to calculate the amount of time it takes on a

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given investment to simply get paid back the initial capital

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you laid out for say that cup stamper That cost

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you though three million bucks all paid up front with

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your cash Well that stamper saves you a nickel a

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cup versus having toe by cops from cups are us

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So you have two stamp three million cops divided by

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point zero five or sixty million cups to break even

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Sort of You sell a million cops of laminate a

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month Steadily so easy calculation Right in sixty months the

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three million boxes paid back and everything from there is

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profit contribution right Wrong The machine doesn't just maintain or

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insure itself So in reality it costs another penny A

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cop toe Look after that stamp for a machine thing

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Oil it and you know pay the robot to run

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it and wipe it off When it's bill's what union

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Robots they make bank So in reality it's not five

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cents a cup You save in running that machine It's

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really Four cents and it's not sixty million cups to

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pay it back It's really Three million divided by four

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cents a cut or seventy five million cups to pay

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it back Oh and one other little thing Capital isn't

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free Remember you took three million box out of your

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two percent a year earning money market account to pay

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for that stamping factory thing Well the three million bucks

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earned you a very safe sixty grand a year That

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money was vastly more rock solid safe than your entire

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absence Lemonade stand business Yeah When you spent three million

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bucks on the machine you made this huge risky bet

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with your capital that the business would be around long

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Enough to pay back the value of the machine and

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then some shouldn't leave value of that capital at some

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rate higher than the super safe Two percent bank returns

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well if you had to go out into the market

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and borrow money pledging that stamper as collateral on the

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market would price it much higher More like on ten

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fifteen twenty percent let's pick ten percent now because the

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math is easy is ten percent a fair number to

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use for the opportunity cost for your capital being spent

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on the cup Stamper Well you're the one controlling the

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process it's not a cold arm's length transaction done with

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a vendor who doesn't actually know you and your fine

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work ethic there since it's all your money and your

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time and attention on this one process well your risk

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should certainly be less than the and percent market price

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sitting out there So for lack of a better process

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and you split the difference and call the cost of

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your capital the opportunity cost and risk adjusted Numbers 6

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percent c had the two percent risk free money market

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price thing going on then the ten percent mark pricing

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there again it took the average ten plus two is

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twelve in the ice bye bye to highly scientific And

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normally you need a phd to do all this arithmetic

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So anyway now on top of everything you have the

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six percent a year to cover the risk of using

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your own capital versus just buying cups Ala carte from

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cups are us as you go along well that six

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percent on three million box is one hundred eighty grand

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a year to rent and that's an ongoing costs like

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every year as the quote principal unquote is aid off

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the extra hundred eighty grand in costs at four cents

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a cop net savings Well then that's one hundred eighty

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grand divided by point zero four or an additional four

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and a half million cops a year at least in

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your one So let's say you continue to sell a

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million cups of absence lemonade a month with no wasted

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your breakage or other forces like a union robot strike

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You know that's the thing Well after one year we've

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sold twelve million cups as part of your absence lemonade

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sales and those twelve million cops have saved you now

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For sensei so four cents times twelve million is total

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savings this year of four hundred eighty grand and let's

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say you pay off an annual chunks notionally the quote

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debt you borrowed from yourself and that four hundred eighty

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grand gets one hundred eighty grand taken out of it

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to rent the three million dollars risk adjusted to have

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bought that stamper Don't leave you three hundred grand to

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pay down your loan to being now essentially two point

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seven million Well you have less notional principal outstanding now

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so less to pay down unless to pay off your

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a reducing risk here And certainly the risk of the

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machine is lower because you've used it a year and

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it generally works and well you know it's good to

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control your own stamping Those cups are an integral part

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of your business and it's important to have them stamped

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with pithy sayings like absence makes the brain grow foggier

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The rest of this exercise revolves around how many cups

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a year you sell saving you four cents each and

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then how quickly you pay off your notional quote debt

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unquote back to yourself regardless this capital expenditure when given

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the full set of inspection numbers however is way more

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complex and it initially appeared to be and way less

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of a boon to our business Why Because we have

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to account for the cost of our capital like we

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could've put it elsewhere We could've bought marketing with him

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He could have bought back our own stock and in

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addition all of this there lies the specter out there

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that absence lemonade sales could actually declined to say ano

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eight hundred thousand five hundred thousand then maybe three hundred

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thousand a month At that point buying your own stamper

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was a total waste of your capital You should have

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just paid up for the outside vendor at whatever since

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it was per cup and not tried to save the

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four cents But on the other hand if sales skyrocket

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thanks to the kitschy sayings on your cups and you

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grow to selling two million and three million cups a

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month and maybe four five then in a year you

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would have sold us a forty million cops and save

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those four cents And yeah that would be a total

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savings just in that year of one point six million

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Bucks by virtue of having your own stamper and wow

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then your machines value will have paid off handsomely You

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got big numbers toe warrant spending your precious capital on

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stuff like this The big notion here is that break

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even analysis and payback have to consider exogenous or none

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obvious things like the risk of the investment being a

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total bust or the opportunity cost loss for what else

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a company could have done with that capital including nothing

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It's got also include the maintenance insurance and other costs

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associated with a purchase The risk of you know robot

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union strikes are rebelling on you including taxable things like

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gains from depreciating that asset meaning you kind of got

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paid in tax by having spent the capital then being

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allowed to depreciate it against profits You didn't think about

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that one did you So yeah there's the tax help

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hereand appreciating that machine three hundred grand a year over

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ten years to then be zero The tax savings would

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have been worth some one hundred grand or so or

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two point five million cups worth a year But okay

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enough absent for one day we know you miss your 00:06:54.894 --> [endTime] drones

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