Negotiable Faculty

1
Negotiable Faculty

• The new clinical faculty position.
• A vague set of instructionssimilar to assignment
  2.
• Mulligan.

2
Last Week

• Address Irans question (part of it). For the
  healthcare part, read something by Regina
  Herzlinger _at_ Harvarde.g., May 06 HBR, page
  58)Michael Porter also has a fairly new
  bookcertainly hell use his five forces.
• Q Will America be able to find a reasonable
  solution to the social security funding issue?

3
Assignment

• List available data sources you would use to
  address the question and outline the analysis you
  would perform (in less than two pages).
• Dont actually perform the analysisjust outline
  relevant factors (that have available
  information).

4
Intenteffectively a PVA Problem

• Why not just say it?
• Issues
• Is the current balance really there?
• What is the time horizon?
• cash inflows and outflows
• current future working population
• current future beneficiary population
• wages
• full vesting age
• life expectancy

5
Intent

• Illustrate that relatively painless fixes
  exist.
• Segue into a discussion / debate by Glenn Hubbard
  (Bush economic advisor) and Bill Archer (former
  Ways Means chairperson)political outcomes
  cause large economic changes.

6
Internet Tangent

• Chess vs. Politics
• Generically speaking, if you believe you clearly
  won a debate, yet the other side is claiming
  victory, it is always / sometimes / never in your
  best interest to 'prove' the other side is - in
  fact - a loser.
• (Last week PCAOB backtracking vs. SEC FASB weak
  hand vs. IASB GM vs. UAW heavy-weight
  fight)political battle often has what
  economists call repeated game or supergame
  effects.

7
The Mulligan

• Much economic (and political) analysis comes from
  thinking about the facts incentives, and
  forming an argument.
• List available data sources you would use to
  address the question and outline the analysis you
  would perform (in less than two pages). Dont
  actually perform the analysisjust outline
  relevant factors (that have available
  information).

8
Results

• About 10 research paper outlines1a, 1b, 1c,
  2a, 2b, 2cetc.
• That wasnt my intentbut I can see your
  pointhowever, playing the devils advocate, you
  might ask yourself, Does my assignment make a
  lot of sense? (This is generally a good question
  to ask on an audit).

9
A Clever Idea
South Korea southkoreattu_at_hotmail.com
You might find it goofy, but I still like the
naming conventioncompare to the
three-times-a-year feedback (and after job
rotation) in public accountingthe I never knew
effect.
10
Still Learning Expectations

• I want your thoughts copying and pasting Bush
  thinks this, The Cato institute thinks this,
  etc. is not what Im looking for.
• Referencing is important (especially true on an
  audit).
• What would you do on an audit when faced with
  vague instructions?

11
There were a few excellent (in my opinion)
assignments.
The winner is
12
Check Plus to

• Chad, Morocco, Sri Lanka, and Syria.
• Otherwise Mulligan.

13
Car Financing vs. Social Security

• List available data sources you would use to
  address the question and outline the analysis you
  would perform (in less than two pages). Dont
  actually perform the analysisjust outline
  relevant factors (that have available
  information). You might argueI did the PV
  thingwheres my v?

14
Solid academic rejection I think this is a
useful and informative paper, but is not up to
the threshold of innovation that I need at
JPE. Im getting pretty warpedbecause this
rejection didnt bother meoddly, Im kind of
honored that the Freakonomics guy thought the
paper was useful and informative.
15
Another Vague Set of Instructions

• My directive Add another class specifically for
  the audit track.
• BECso far, with a heavy dose of auditing.
• Regardless of content, we can still work on
  critical thinkingexamples follow

16
McDonalds vs. Home Depot Clerks
Would it matter to Leamer?
17
Not Everyone Can

• Go to school and get good grades
• Pass the CPA exam
• Run a loom
• Tan a hat
• Transcribe a scroll

18
Disagree w/ Outsourcing Production Innovation

• Reasons
• Chinese Toy Disaster
• American Workers would not allow lead based paint
• These are not convincing counter arguments.

19
Disagree ? Dislike

• You can dislike American firms outsourcing
  mundane jobsin a patriotic way, you should
  dislike this.
• Disagreeing that such outsourcing will not happen
  because its bad for America ignores that firms
  are not in business for national well-being.
• Economic Concept Externalities

20
Things to Improve

• Freidman says X, Leamer says Y.
• I agree with Freidman is not a sufficient
  justification for your views.
• Later, well discuss the writer graders big vs.
  little errorsto me, the preceding is big.

21
Be Careful of What You Say

• I think the internet has had a positive impact
  on both consumers and businesses.
• All businesses?

22
Exactly what you say matters

• Steve Jobs Our early customers trusted us, and
  we must live up to that trust with our actions in
  moments like these (WSJ 9/7)
• In class, say what you want, but when your
  country speaks (i.e., on assignments), be more
  self-critical.

23
Examples

• SPEs illegal acts
• Anderson knew what they were doing was going to
  cause problems.
• On assignments, lets be very careful about what
  is said.
• Euphemism rules!

24
Something to Consider

• Currently, many financial companies are holding
  large portfolios of thinly traded CDOs.
• Very few investors are buying CDOs because of
  information uncertainty.
• You have two clients who hold large CDO
  positionsone, in desperate need of liquidity,
  sells 1B worth of CDOs (at a steep discount).
• You now have mark-to-market information.

25
Something to Consider

• Do you require both clients to write-down their
  entire portfolio?
• If you do, you are truly giving the kiss of death
  to your clients.
• Is right vs. wrong really a black white issue?

26
Slippery Slope
27
PETAs view of our class

• Quit Being Unfair to Monkeys
• Do lemurs really not care about mundane
  workers?
• The guy does talk about solutions involving
  compensatory training

28
Todays Topics

• Investing in losers
• the high price of oil
• Is the US in 2010 like the UK in 1930?

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31
Determining Value

• At the most fundamental level
• Company Value Stuff Owned Now PV (All the
  money you will make in the future)
• Or
• Price Assets PV (Expected Earnings)

32
Theoretically

• All valuation models must be reconcilable to the
  dividend discount model.
• In the long run, all costs are variable.
• It is impossible to prove ABC costs are better
  than simple allocations.

33
Practical (and reconcilable to the DD Model)

• If you assume current assets are completely
  devoted to future earnings and are exhausted
  while creating future earnings, you have
• Price earnings ? 1/r ? (1 - 1/(1r)n)

PV of an Annuity Formula
34
PE Ratios

• Price earnings ? 1/r ? (1 - 1/(1r)n)
• Price ? earnings ? 1/r when n is really big.
• Mathematically looking at 1 - 1/(1r)n when
  n is really big, you have one divided by a
  really big number which is essentially, zero.

35
Tangent PE Ratios

• Price ? earnings ? 1/r
• P/E (or, the PE ratio) equals 1/r in a no
  growth businessso, for a company earning 5 per
  share with a 7 required rate of return, Price
  should be 71.42 per share.

36
The Effect of Growth

• Once growth is considered, the formula becomes
• Price Earnings ? (r - growth rate)
• Expected growth has a Huge effect on Priceas
  such, every CEO promises growth (or else he/she
  is terminated).

37
A Tangent on RRR

• Accurately measuring the unmeasurable r value
  really affects fundamental analysis
• Price Earnings ? (r - growth rate)
• Side Note Some finance academics spend their
  careers in search of this unmeasurable measure.

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39
YE 2006
Home Depot PE ratio 13.52 McDonalds
18.62 13.52 (1 (r g)) 18.62 (1 (r
g)) r g .0739 r g .0537 r 10
??? r 10 ??? implied g 2.6 implied g
4.6 g 5 ??? g 5 ??? implied return
12.4 implied return 12.4
40
YE 2006
AMAZON PE ratio 78.92 EBAY 37.12 78.92 (1
(r g)) 37.12 (1 (r g)) r g
.01267 r g .0269 r 10 ??? r 10
??? implied g 8.7 implied g 7.3 g 5
??? g 5 ??? implied return 6.2 implied
return 7.7
41
The Upshot

• Fundamental models dont work with negative
  income (you must project to the futurewhere
  income turns positive).
• In the long run, fundamental models must work
  (and all costs are variable).
• Minor changes to the input factors make very big
  differences to fundamental valuation.

42
Todays Topics

• Investing in losers
• the high price of oil
• Is the US in 2010 like the UK in 1930?

43
The OPEC Oligopoly, Part 1
44
OPEC Oligopoly, Part 2

• Quantity Decisions
• Consider Demand Elasticity, Non-OPEC oil output,
  and w/in OPEC enforcement
• Solve a calculus problem (linear version)
• PQ (Est. Total Demand Q) Q

45
Important Questions for Big Oil

• Are high prices mostly a crude oil supply issue
  or a refining capacity issue?
• Big Oil has little incentive to help solve high
  prices if its a crude oil supply problembut if
  its a refining capacity issueits a big risk
  vs. return problem.

46
Todays Topics

• Investing in losers
• the high price of oil
• Is the US in 2010 like the UK in 1930?
• Like the first two topicsthe answer is who
  knowsthose who take a stab at answering the
  question will synthesize a bunch of information
  and make a projection.

47
Conversations in the Rain

• Movies, What Reasonable People Should Be Able to
  Do, and avoiding the second Mulligan.
• Week 4 assignment
• Business Question 2 Please submit before Sept
  26th (remember this must a be WSJ-based
  question).

48
Fire People on Friday

• Why?
• Discussion of Grading (documented online for
  posterity). Audit-related title of our
  discussion, The rules were insufficient to
  handle all possible contingencies.

49
Learning How This Will Go

• The writing grader and I have agreed on this
  grading scale
• v (good)
• v (okay)
• v- (bad)
• NOTE We need to agree on what a v- does to you.

50
Learning How This Will Go

• The syllabus implies this will happen
• v (increase your writing grade one notch)
• v (maintain your writing grade)
• v- (decrease your writing grade two notches?)
• Possible Syllabus Amendment We need to agree on
  what a v- does to you.

51
Some Data

• Burma and Venezuela v
• Morocco, Saudi Arabia, Sri Lanka, Syria Vietnam
  v
• Canada, Iran, Kenya, Mexico, Nepal, Russia,
  Thailand, and Turkey v- (Dont worryyou
  arent penalized during the learning
  phasewhich, from this point forward, we are out
  of).

52
Some More Information

• I will not change the writing grades (even if I
  dont completely agreein large part, I did
  agree). Why not?
• The graders first comment was, Wowthese are
  graduate students.
• Her second comment was, Tell them to quit
  handing in first drafts.

53
Some More Information

• Her third comment was, The number of marks
  doesnt map into the end grademany minor errors
  bother me less than one major error.
• There is detailed feedback on each assignment and
  general feedback on the internet.

54
Some More Information

• If your grade maxes out, Ill quit forwarding
  your assignments to the writing grader (i.e., I
  remove your risk).
• Why would I do that?

55
Majority Rules

• Option 1 If your paper is not acceptable on the
  first round, youll get it back unmarked and
  have an opportunity for revision. A second
  chance v- reduces your writing grade by two
  marks.
• Option 2 The first-round writing grade
  countsbut a v- reduces your writing grade by one
  mark.

56
Work on Improvement

• To me the worst thing seems to be for a school
  principally to work with the methods of fear,
  force, and artificial authority. Such treatment
  destroys the sound sentiments, the sincerity, and
  the self-confidence of the pupil. - Albert
  Einstein

57
No Fear Tattoos

• I dont want to work in a fearful environment
  however, I do want to work in a serious (yet
  fun!) environmentthats like the public
  accounting environment.
• Reiterate the meaning of Dont get drunk at the
  company picnicin spite of some appearances to
  the contrary, public accounting is quite serious
  (yet fun!).

58
Things to Think About

• If I ask for two pages and you give me five
  pages, that is not good.
• If I return something and say, please follow the
  directionsif you dont know what the directions
  are, ask (please dont hand in another
  non-direction-following business question).

59
An Awkward Moment

• I know its not part of the current culturebut
  try to be open with each other about what you are
  doing.
• I listed an awkward (but voluntary), Burma,
  Nepal and Syria might help comment on the
  internet.