Post mortem: Corporate Finance

Executive Summary: Either I failed the exam, or the airline in Section B got a real bargain on leasing its planes!

That’s the central problem with Corporate Finance: you can’t really tell if the numbers emerging from the equations ‘feel right’. A discount factor of .8972 or .7118 – both are on the table, both are plausible, but put the first in Year 0 instead of Year 1 and you’re screwed by multiple tenths of a percent in the final cost-of-capital figure. Of such mistakes are global economic meltdowns made.

There are other bad luck questions: the very first multiple-choice is on mortgage payback periods, the simplest equation in all of Corporate Finance, and it’s NOT ON THE FORMULA SHEET. Bad start, bad start. But even worse, the temperature of the Sports Hall was a fraction of a degree above Absolute Zero. (When people from Siberia say it’s cold, it MUST be true.)

But the basic issue remains: the intractibility of applying Corporate Finance to the real world. I’m a real-world person with an interest in the inchoate; does that explain why the subject interests me, but also why I’m so monumentally crap at it?

The problem with Corporate Finance is that it’s a shared delusion: only real as long as enough people are willing to suspend their disbelief. It’s why the whole subprime mortgage mess – which now threatens to tip the entire world economy into a slump – is happening. Because a rich white guy on Wall Street thought an unemployed guy in a rotting crackhouse on the bum side of Alabama could, properly spun, be an insanely great financial asset. He didn’t think once of how his spreadsheets and sliced-and-diced CDOs applied to the real world.

The CFO of Goldman Sachs – presumably the smartest financial guy at the smartest financial group in the world – explained away such vast errors of judgement as ’25-standard-deviation events, happening several days in a row.’ Look buddy, 25 S.D. events just DON’T HAPPEN. Britain’s recent earthquake – the first in decades – was perhaps a 2 S.D. event, and on the asymptotic scale of the Normal Distribution, 25 S.D’s would’ve happened about once since Ug the Caveman was the man of the moment. For such events to have happened on several consecutive days – well, it’d be less surprising if a herd of Aptosaurii materialised in Hyde Park and started dancing the timewarp.

What happened, but which CFO Vinar didn’t understand, was that his complex financial models were simply wrong. Not even in approximation, but in fundamental assumptions. Just – wrong. Yet to him – and to a thousand other City and Street movers and shakers – they represented reality better than reality itself.

[AAAARGH! I’ve just realised I forgot to add back the initial cost of the planes in both instances, which would have made A2 and B4 planes much closer competitors!!!] (But this illustrates my point: I’m applying my models to the real world. At least when I’m wrong I KNOW I’m wrong.)

I don’t know if I’ve passed or failed Corporate Finance, but if I fail, it’s because of those bloody aircraft. Well, I suppose that’s appropriate given that ‘winging it‘ is the only life philosophy I’ve ever had any success with.

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