Economics 410 Managerial Economics Tuesday October 26, 1999 Exam, Thursday October 28, 1999

Lingering Issues of Confusion Cash Versus Accrual Capitalization of Expenses Extraordinary Write Downs or Adjustments Leverage Forget “quasi-rents” Remember “rents”

Cash Versus Accrual Accounting You’ve spent it, but haven’t paid for it You’ve earned it, but haven’t received Problem You might not pay They might not pay Principle: Match rev with expenses

Capitalization of Expense Pay a bill Is it an asset? Or a current expense? Do you have leeway to interpret however you want? Capitalize when you need to show more income Expense when you have plenty of current income That stores up for the future

Leverage – Try an Example Buy $ 1million company Income - $ 100,000 Return – 10 % Finance 50% at 6% Equity - $ 500,000 Income $100,000 minus $ 30,000 Return 7/50 = 14 % Works as long as gross return (10%) on unlevered basis exceeds borrowing rate (6% in this case)

Extraordinary Items – Especially Write Downs Lower the value of an asset Offset is lower equity In the future Lower Depreciation Lower Amortization This strategy should not work But, it does work at the moment Won’t work long term

Review for Examination Nothing is Ruled Out Game Theory Issues Asymmetric Information Moral Hazard Adverse Selection Insurance Incentive Compensation Wage Equation Shapiro Stiglitz Random Items Coase Theorem Prisoner’s Dilemma Etc, etc., etc. Financial Accounting Valuation, etc.

The End