1. Economics 410 Managerial Economics Tuesday September 28, 1999

2. I. Incentive Contracting Game Theory concepts –Asymmetric Information –Moral Hazard –Adverse Selection Economics of Uncertainty Pure Theory of Insurance Preliminaries W =  +  (e + x +  y) Main Topic

3. II. Financial Accounting The Search for Value Accounting is the “language of business” Main Concept –Present Value –Of Future Benefits

4. The Classic Paradigm Discount Future Dividends

5. Div(1) Div(2) Div(3) ……. (1 + r) (1 + r) 2 (1 + r ) 3 …… Where do you get the Div(?) estimates? What are the r’s? Are they the same? What if the company doesn’t pay divds?

6. Back to Basics Income Statements Balance Sheets

7. Balance Sheet Assesses value at a particular moment in time Answers: –What do you own? –What do you owe? –What are you worth?

8. Balance Sheet Date: September 28, 1999 AssetsLiabilities Net Worth Assets = Liabilities + Net Worth

9. Balance Sheet Start Business With $ 1,000 AssetsLiabilities Net Worth Cash….$ 1,000 $ 1,000

10. Balance Sheet AssetsLiabilities Net Worth Cash….$ 1,000 $ 1,000 Buy Equipment for $ 500 ! Cash….$ 500 Eqpt….$ 500

11. Balance Sheet AssetsLiabilities Net Worth $ 1,000 Cash….$ 500 Eqpt….$ 500 Finance the equipment! Owed to bank…$ 400

12. Balance Sheet AssetsLiabilities Net Worth $ 1,000 Cash….$ 900 Eqpt….$ 500 Finance the equipment! Owed to bank…$ 400

13. Balance Sheet AssetsLiabilities Net Worth $ 1,000 Cash….$ 900 Eqpt….$ 500 Owed to bank…$ 400 Go Public ! Sell $ 10,000 in stock! + $ 10,000 Cash + $ 10,000

14. Balance Sheet AssetsLiabilities Net Worth $ 11,000 Cash….$ 10,900 Eqpt….$ 500 Owed to bank…$ 400

15. And So Forth Main Principle: Double Entry Accounting Everything As of Some Particular Date

16. Balance Sheet AssetsLiabilities Net Worth $ 11,000 Cash….$ 10,900 Eqpt….$ 500 Owed to bank…$ 400 Suppose a year goes by !

17. Balance Sheet AssetsLiabilities Net Worth $ 11,000 Cash….$ 10,900 Eqpt….$ 500 Owed to bank…$ 400 Suppose a year goes by ! Less Depr $ 100 Less $ 100

18. Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 10,900 Eqpt….$ 500 Less $ 100 Depr Owed to bank…$ 400 Buy another company for $ 2,000 - $ 2,000 Cash + $ 2,000 ?

19. Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 10,900 Eqpt….$ 500 Less Depr $ 100 Owed to bank…$ 400 Buy another company for $ 2,000 - $ 2,000 Cash + $ 1,000 Eqpt + $ 1,000 Goodwill?

20. Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 8,900 Eqpt….$ 1,500 Less Depr $ 100 Goodwill $ 1,000 Owed to bank…$ 400

21. Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 18,900 Eqpt….$ 1,500 Less Depr $ 100 Goodwill $ 1,000 Owed to bank…$ 400 Let a year go by

22. Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 18,900 Eqpt….$ 1,500 Less $ 300 Depr Goodwill $ 1,000 Less $ 100 Amort Owed to bank…$ 400 Let a year go by $ 200 in Depr and $ 100 in Amortization !

23. Goodwill and Depreciable Assets Create Expense Items Reduce reported income each period But no effect on cash flow How to minimize these items on the books is a big issue for public companies

24. Income Statement For quarter ended Sept 28, 1999 Revenues Less: Expenses Operating Income Less Interest Less Taxes Net Operating Income Plus or Minus Extraordinary Items Reported Net Income After Taxes

25. EBIT Earnings Before Interest and Taxes Add back in interest and taxes

26. EBITDA Add back in Depreciation Amortization Cash Flow????

27. The End