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

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

3. 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

4. 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

5. 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)

6. 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

7. 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.

8. The End