Thursday, January 31, 2013

Why Study Finance?

For those outside Finance, it is often viewed as a necessary evil that is irrelevant to other areas of the corporation such as technology. A recent survey by CFO Publishing discusses nonfinancial risk for technology companies. These risks include items such as the ability to hire and retain quality employees, performance failure of vendors and suppliers, the breach of the company’s electronic or online data, and the failure to meet targets for business/customer growth. While you might think that such risks have no relation to Finance, there is in fact a relationship to Finance for every one of these risks. As Bob George, the CFO of the aerospace and defense components manufacturer Esterline Corporation, states “Even though we label these nonfinancial risks, ultimately they will impact the company’s balance sheet and income statement in very significant ways. The financial community must be active in those processes, even if they’re not influencing them on a day-to-day, decision-making basis.” No matter what area of a corporation you examine, every risk or opportunity has a financial impact that will ultimately affect the success or failure of a business.

Tuesday, January 29, 2013

When Receivables Rise

One way that many companies have increased cash conversion cycles is to increase the accounts payable period. While this helps the company, it also means that the supplier now has a longer accounts receivable period. Large companies will often unilaterally inform small suppliers that they will increase the payables period. For small companies, the resulting increase in the receivables period can be devastating. During the recent recession, many small suppliers accepted the new terms forced on them because they were afraid of losing business. But many small suppliers are starting to fight back. For example, when one company was informed by a customer that they would be increasing the payables period from 30 days to 45 days, the supplier stated that their quote was based on 30 days, not 45 days. An increase in the payables period would have to result in a 10 percent price increase. The payables period went back to 30 days. Although many small suppliers feel trapped by large customers, there are often ways to reach a compromise that satisfies both parties.

Thursday, January 24, 2013

It's Market Efficiency By A Length

Five years ago, famed investor Warren Buffett placed a bet with the founders of the Protégé Partners hedge fund that the S&P 500 would outperform a hedge fund index chosen by Protégé partners over a 10-year period. At its heart, the bet was about market efficiency, that a group of most well compensated investment gurus could not outperform the broad stock market. At the five-year mark, the S&P 500 is up 8.69 percent, while the five hedge funds picked by Protégé are up only .13 percent. This marks the first time in the past five years that the S&P 500 is ahead of the hedge funds. The winner gets to choose the charity that will receive the $1 million plus prize. What does this bet mean for you? A former investment banker gives her view.

The Driverless Car And Capital Budgeting

With any capital budgeting process, estimates of sales, costs, etc., are important, as is the recognition that there can be significant external forces that affect your estimates. A recent article in Forbes discusses the side effects of Google's driverless car. For example, governments will lose revenue from the elimination of speeding tickets, red light violations, and other traffic tickets, but may save since fewer police officers will be needed to oversee traffic violations. Gasoline sales would plummet, hospitals would have fewer patients, and auto and health insurance premiums would fall drastically since there would be fewer accidents. In any capital budgeting process, you should be aware of external factors that could affect your projections for a project since these factors can affect your analysis. Of course, you also need to be aware that there may be disagreements in these projections. For example, the article assumes that if driverless cars do become available that auto sales will fall since there will be a fleet of cars used for everyone, not private ownership of an individual car as is the current model. There is a good chance that the fleet option is idealized and that even with driverless cars, there will still be a large number of individual owners. In any case, in the textbook we discussed using scenario analysis for base-case, best-case, and worst-case projections. Including external factors such as the possible changes caused by driverless cars is another scenario that could be examined in any industry affected by the driveless car.

Inflation In The Afterlife

Our textbook discusses how to deal with inflation in cash flows, namely, discount real cash flows at the real interest rate or discount nominal cash flows at the nominal interest rate. Since our focus is corporate finance, we do not deal with possible causes of inflation. A recent presentation by economist Yoram Bauman may lead to a better understanding of hyperinflation in the afterlife.

Nokia Stock Down On Dividend Cut

Finnish cell phone maker Nokia is expected to suspend its annual dividend payment. The dividend, which Nokia had been paying for over 20 years, cost the company €750 million ($996 million) per year. The company stated that the savings would give it flexibility. Nokia has €4.4 billion ($5.87 billion) in cash, a 22 percent decrease from the previous year.  The announcement resulted in an 8.2 percent stock price decline.

Wednesday, January 23, 2013

Boise Cascade's Green Shoe

Wood and building materials company Boise Cascade announced that it will undergo an IPO, offering 11.8 million shares of stock. The IPO allows the underwriters a 30-day Green Shoe provision to purchase and additional 1.8 million shares, about 15 percent of the original shares offered.

Overseas Cash

It is well-known that U.S. based multinational companies often hold large amounts of cash overseas to avoid income tax when repatriating foreign earnings. Current estimates are that U.S. companies hold $1.7 trillion "permanently" invested overseas. What is not well-known is that much of this amount is actually in U.S. dollars. For example, more than 93 percent of Microsoft's $58 billion in overseas cash is invested in U.S. government bonds, U.S. corporate bonds and U.S. mortgage-based securities, and most of that amount is held in accounts in the U.S. However, for accounting and tax purposes, the cash and investments are owned by a foreign subsidiary. The reason for holding U.S. dollar denominated investments is that it eliminates the possibility of a currency related loss. Of course, the money can be repatriated to the U.S parent whenever the company decides they are willing to take the tax hit, which can be substantial. United Technologies estimates that it would pay $4 billion in taxes if it repatriated all of its foreign cash holdings. One thing to keep in mind in all of this: The U.S. is the only major country to tax a domestic company's profits no matter where the profit is earned.

Sunday, January 20, 2013

Legal But Not Ethical?

There are many screens that investors use to select investments. One screen is socially responsible, or ethical, investing. For example, socially responsible investors typically avoid companies in the alcohol, tobacco, or firearms industries. Now, some socially responsible mutual funds are looking at tax avoidance. Tax avoidance, which has been a hot topic in the news recently, means that companies are moving profits from a high tax country to a low tax country. However, tax avoidance does not imply that the company is breaking the law. The FTSE, which creates popular stock indices around the world, is considering eliminating companies with aggressive tax strategies from its socially responsible index, FTSE4Good. Maybe the new tax strategy should be to move income to the country with the highest tax rate?

Friday, January 18, 2013

Volkswagen Bonds

Volkswagen AG sold Europe's first corporate bonds of the year, The company sold €9.8 billion ($12.8 billion) worth of bonds. The bond sale came at a time when the yield to maturity of European corporate bonds had fallen to 137 basis points above government bonds. This yield spread is an indicator of the relative level of risk between the two different bonds. The falling yield spread is an indication of a lower default risk premium, which is the result of a smaller default risk in the market or a lower risk premium required by investors.

Wednesday, January 16, 2013

The Efficient Markets Hypothesis and Cats

In his book A Random Walk Down Wall Street, Burton Malkiel, a Princeton University professor, discussed the Efficient Market Hypothesis (EMH). A famous quote in the book is "a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts." While we greatly respect Professor Malkiel, we feel that his statement unfairly excludes our feline friends. During 2012, the Observer, a London-based newspaper, ran a contest that pitted a group of professional investment managers, a group of students, and a cat. At the beginning of the year each group was given £5,000. The cat's investment strategy was to throw his favorite mouse on a grid with numbers assigned to companies. For the record, Orlando the cat's return for the year was 10.84 percent, the pros gained 3.53 percent, and the students lost 3.2. percent. Where can we find the newly opened Tabby Growth mutual fund?

Monday, January 14, 2013

The Check Is In The Mail

If you have looked at your billing statements, many companies are now asking you to sign up for auto billing, which allows them to withdraw the amount of your bill from your checking account, or automatic payment by credit card. The push for such payment plans reduces postage and processing costs for the companies, but as importantly, also means that the company gets the cash quicker. On the other side, companies like to pay as slowly as possible. Cox Communications has a unique way of accomplishing the delay in payments to customers. As a customer reports, Cox accepted a deposit to set up an account on a credit card. However, when the account was closed, Cox insisted on mailing a check. Although Cox denied that a delay was the reason for the paper check, this allows Cox time for processing and mailing, which keeps the money in Cox's cash account longer. And, since many people who cancel an account are moving, the mailing time is likely doubled.

Which Risk?

In the textbook, we concentrate on risk based on the volatility of an asset. However, there is also purchasing power risk, that is, the return on your investment won't keep pace with inflation. To give you an idea of purchasing power risk, 20 years ago a gallon of gas cost $1.36. As an investor, you may not like the volatility of stock investments, but, over the long-term, investments in safer asset classes such as Treasury bills, CDs, and savings accounts have barely outpaced inflation.

Thursday, January 10, 2013

Middle Class Tax Break?

One thing that really bothers us is when popular press financial writers do not understand basic finance. For example, this article argues that the deductibility of 401k deposits decreases tax revenue by $163 billion. While we are sure that the author got the numbers used from another source, the fact that this number is used shows little understanding of finance. In fact, the deductibility of retirement account deposits actually increases tax receipts. Suppose you deposit $5,000 into a 401k. In the 30 percent tax bracket you would save $1,500 in taxes today. In 30 years at a 10 percent interest rate you would have $87,247. If you withdraw all of the money, you would pay $26,174 in taxes at the same 30 percent tax rate. Guess what the future value of $1,500 today for 30 years at 10 percent is? You got it --- $26,174! The tax deductibility of the deposit does not affect the tax receipts, only the timing of the tax receipts. At a 10 percent interest rate the NPV of the taxes is zero. Further, compared to a taxable account, the tax deductibility and tax deferral in a 401k actually increases tax receipts in the long run. The reason is that in a taxable account, all capital gains would be taxed at the capital gains tax rate, which is lower than the income tax rate for most people. In a 401k, the capital gains are taxed at the higher income tax rate, resulting in greater tax receipts.

Monday, January 7, 2013

A Yen For A Stronger/Weaker Yen

Japanese executives have been arguing that the yen has been too strong in recent months. The strong yen hurts Japanese exporters. Toyota says that a single yen change against the U.S. dollar over a full year changes operating profit by ¥35 billion ($397 million). For Nissan and Honda, the operating profit changes are ¥20 billion ($227 million) and ¥16 billion ($182 million), respectively. The downside is that a weaker yen increases energy prices since Japan imports most of its energy needs. Now, executives are worried that the weakening of the yen could go too far, eroding confidence in both Japan and the yen, resulting in a further weakening of the yen.

Thursday, January 3, 2013

Risk And Reward In Capital Budgeting

One of the problems in capital budgeting is that we are dealing with projections about the future, which are particularly troublesome. Scenario analysis allows us to examine the best-case and worst-case values of a project. In a recent article, two questions are posed about a new project or acquisition: 1) How much can the firm afford to invest to achieve its goals? and 2) How much is the firm prepared to lose? Both of these must be answered before a firm undertakes a new project. Importantly, the firm must to be able to accurately estimate potential losses and be aware that these losses may be realized.

Wednesday, January 2, 2013

2012 Stock Picks

In 2012, the major U.S. stock market indices were all up. The Dow Jones gained about 5 percent, the S&P 500 about 11 percent, and the NASDAQ about 15 percent. The real winners, at least of those invested in S&P 1,500 stocks, were those who bought Headwaters Inc., up 273 percent for the year. And 3D Systems Corp. investors had their pockets bulge with a 260 percent return.

India's IPO Refund

India's IPO market has been one of the wildest in the world. In 2011, a number of IPOs jumped as much as 100 percent on the first day, only to fall shortly afterwards, giving rise to concerns about market manipulation. In an effort to alleviate these concerns, India has implemented a change in the way trades are settled in IPOs. Traditionally, say you buy 100 shares of stock for $4,000, sell the shares for $4,100, and then buy another 100 shares for $4,020, the sell would cancel $4,100 since you received the money and you would only need to deposit $3,920 at the end of the day. Under the new rules, buys and sells are settled separately so you would have to deposit $8,020 in the first 10 days of an IPO. This makes investors tie up more capital, allowing for less trading. A second proposed rule would require the company to reimburse investors up to 50,000 rupees (about $920) if the stock falls more than 20 percent in the first 3 months of listing in a rising or flat market, or falls 20 percent more than a market decline in a falling market.