Week 9: Marketing and Finance

Accounting

Return on Sales (%) (ROS) = Net Profit/ Sales Revenue => measure of profitability and efficiency of a firm

For firm with multiple divisions, division level profitability might not give a clear picture of overall firm profitability

ROS limitations

it doesn't account for future performance

doesn't take capital investment into account

EBITDA

EBITDA = Net Profit + Interest Payments + Taxes + Depreciation and Authorization charges

a rough measure of operating cashflows (page 6)

Return on Investment (ROI)

ROI = Net Profit/ Investment

measures the profitability adjusted for investment

Multi- period investments

Payback (#): number of periods required to payback the initial investment (undiscounted) (example: page 9)

NPV (example: page 10)

Internal Rate of Return (IRR): discount rate that results in an NPV of 0 . If IRR > hurdle rate => go ahead with investment (example: page 11)

Return on Marketing Investment (ROMI)

ROMI (%) = (Gross Margin - Marketing Investment)/ Marketing Investment

Gross Margin = Revenue - Cost of goods sold (COGS)

Revenue refers to additional revenue generated as a result of marketing investment

does not included future impact of marketing investment

example: page 13 (take into account the hurdle rate)

ROMI hurdle rate

Gross Margin = Marketing Investment x (ROMI + 1)

example: page 14

Incremental ROI (page 16)

further example: page 17 - calculate each stage independently

Scalability of Marketing Investment (p.18 - 20): take into account the incremental values

Optimal Investment Theory

with every $ invest, return on investment increases at diminishing rate

additional ROMI associated with each additional $ invested will decrease

diagram: page 22

Incremental ROMI = H (hurdle rate) (at optimal)

ROMI = a + bI

Optimal Investment: I = (H-a)/ 2b

At optimal: ROMI = (H + a)/ 2

Return at optimal: R = (H^2 - a^2)/ 4b = ROMI x I

Rational behind (page 24) - consider the return investment graph

graph: page 25

example: page 26 - 29

Profitability comparison (p.30)

Management implications (p.31)