ENGINEERING FINANCE
CSE 8363 / EF 720-N
Summer 2001
Notes # 1
ST- !
I have a question about self test problem #1. I don't know how to do part
e. of ST-1. The appendix B states that Net investment in operating capital
= 25,000,000 - 24,000,000. Where does 25,000,000 come from?
Net investment in Op. Capital = Op. Capital this year - Op. Capital prev. year
Op. capital this year = Net Op. working capital + net fixed assets
Net fixed assets = 15 M (given)
Net op. working cap =Non-interest bearing current assets - Non interest bearing current liabilities
Also = (Cash+A/R+Inventory) - (A/P + Accruals) ( Text page 44)
=$14M- $4M = $10M
Therefore, Op. capital this year = $10M + $15M = $25M
Note # 2
Submitted by: Lance Thompson, a class student.
On the CEO compensation, I believe it is reaching an outrageous proportions. The June
25, edition of Fortune magazine had a great article about CEO pay as its cover story. It is
an excellent expose on the madness regarding CEO pay. Steve Jobs was paid
$872,000,000 this year for his role as CEO of Apple. In my opinion, this is insane. The
CEO role is becoming a wealthy club of which only a select few get to participate. In
addition, you do not have to even be successful to become wealthy as a CEO these days.
The exit packages given to CEOs on the way out is ridiculous as well. The Fortune article
points out that cycle has been created that may never end. Paraphrased from Fortune, the
cycle goes like this:
1)
2)
3)
4)
Fire your poorly performing CEO
New CEO argues he/she worth more than previously ousted CEO
New CEO’s salary enters compensation consultants database, raises industry standard
As new CEO under performs, he/she receives even more options and restricted stock
to give him/her more incentive to improve
5) All this info is public so other CEOs use this info to get more options for themselves
6) Eventually, the company fires its poor performing CEO and repeats the process all
over again.
In addition, in lecture 3 you mentioned stock options during your lecture. Fortune
magazine plus the Motley Fool web page have both recently done pieces on the scam of
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stock options to the shareholders. Because of the loopholes available today, companies do
not have to show options as compensation. Instead, they can hide the costs of stock
options in the footnotes of their financial statements. This is why stock options have
become the primary compensation vehicle for CEOs. No company would pay a CEO
$872 million if it had to report that amount in its annual report subtracted straight out of
the earnings.
Note # 3:
Submitted by: Jarnail Bassi, a class student
Dr. Harpavat, I noticed the article below posted here
http://dailynews.yahoo.com/h/nm/20010705/wr/column_nettrends_dc_6.html
It makes some good points regarding company earning and impact of stock options. You
may want to share it with rest of the class. Thanks, Jarnail
NetTrends: Hidden Costs of High-Tech Stock Options By Andrea Orr PALO ALTO
(Reuters) - Would investors have shown quite so much interest in a company had they
known that the $10 million profit it reported last year should have been only $4 million?
Would they have bought shares in a small technology startup that said it earned a few
hundred thousand dollars, but was really, by stricter accounting standards, still in the red?
And what about an Internet business that earned the distinction of being consistently
profitable while many of its peers were racking up losses? What if it turned out that the
company had never shown an actual profit? For many of the people who invested in hightech companies last year, these are not rhetorical questions. Virtually all these companies
gave stock options to a large number, if not all, of their employees. Yet, virtually none of
them expensed these options on their income statements. It has long been recognized that
stock options, which companies do not have to account for the way they do cash salaries,
probably increase earnings, to some degree. To what degree was never clear until last
month, when Merrill Lynch took a closer look at 37 major high-tech and Internet
companies, including Amazon.com Inc. (NasdaqNM:AMZN
<http://finance.yahoo.com/q?s=amzn&d=t> - news
<http://biz.yahoo.com/n/a/amzn.html>), Microsoft Corp. (NasdaqNM:MSFT
<http://finance.yahoo.com/q?s=msft&d=t> - news
<http://biz.yahoo.com/n/m/msft.html>) and Hewlett-Packard Co(NYSE:HWP
<http://finance.yahoo.com/q?s=hwp&d=t> - news <http://biz.yahoo.com/n/h/hwp.html>).
YAHOO BENEFITED THE MOST The Merrill study found that if these companies had
expensed all the stock options they gave their employees, their year 2000 earnings, on
average, would have been some 60 percent lower than reported. That average does not
include the Internet media company Yahoo! Inc (NasdaqNM:YHOO
<http://finance.yahoo.com/q?s=yhoo&d=t> - news
<http://biz.yahoo.com/n/y/yhoo.html>), noted in more prosperous times for turning more
than a few employees into millionaires with stock options. Merrill said that Yahoo's
earnings last year were some 1,887 percent higher than they would have been had it
included the stock option expense. ``It is highly unlikely that Yahoo would have ever
reported a profit had they been required to expense stock options,'' said Gary
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Schieneman, who conducted the study for Merrill Lynch, before leaving to join the
Financial Accounting Standards Board (FASB). Many other companies, including eBay
Inc. (NasdaqNM:EBAY <http://finance.yahoo.com/q?s=ebay&d=t> - news
<http://biz.yahoo.com/n/e/ebay.html>), Exodus Communications Inc. (NasdaqNM:EXDS
<http://finance.yahoo.com/q?s=exds&d=t> - news <http://biz.yahoo.com/n/e/exds.html>)
and Juniper Networks Inc. (NasdaqNM:JNPR <http://finance.yahoo.com/q?s=jnpr&d=t>
- news <http://biz.yahoo.com/n/j/jnpr.html>), saw earnings benefits of more than 100
percent from excluding some business expenses, primarily stock options, from their
results. Most of them declined to discuss the stock option benefit. Yahoo said only that it
follows standard accounting procedures. And it does. To be clear, companies are not
required to include the stock option expense in their earnings, other than in footnotes that
appear at the very end of the report and are often overlooked by investors. Still, many
accountants think that the practice is less than forthcoming. After a year of unprecedented
interest in high-tech stocks, one can only wonder whether the investor stampede would
have been quite so strong had corporate earnings been considerably lower. TECH
COMPANIES FIGHT TO KEEP THE OLD RULES ``Many companies claim stock
options are not really an expense since they are not transferring actual cash,'' said Jeff
Mahoney, a project manager at the Financial Accounting Standards Board in
Washington, DC. ``We argue that it is compensation. Whether it is cash or toothpicks,
there is value being transferred.'' Since most companies from traditional industries like
car or consumer goods manufacturers issue stock options only to certain top managers,
accounting for these options has not always been a big issue. But as more Silicon Valley
companies started to grant options to even the lowest ranking employees, FASB, which
sets accounting standards, has considered changing the rules. There is a compelling
argument in favor of doing so, since workers would probably demand higher salaries if
options were not part of the compensation package. But FASB said that each time it has
proposed new rules, the objections from companies have been overwhelming. ``The last
time we issued a proposal, we received over 1,000 letters, and almost every one said that
we shouldn't change the rules,'' said FASB's Mahoney. ``If you talk to most analysts and
investors, they believe all stock options ought to be shown as a compensation expense,
but every letter we got objected to doing that,'' he said. Steve Milunovich, the Merrill
Lynch analyst who issued the report and reignited the debate, pointed out that there are
some reasonable arguments for letting existing policies stand. More than many
businesses, high-tech company assets are heavy on ``intangible'' things, such as
intellectual property, that are not always fully reflected in income statements. The stock
option benefit may help to offset the costs companies inadvertently show by not being
able to account for all their intangibles. Still, he said the stock option impact is a ``big
deal,'' that can further cloud a company's true performance.
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