Multidisciplinary Thinking by Sanjay Bakshi via Slide Share
Why am I here?
To teach you Behavioral Finance?
To teach you Business Valuation?
That’s just an excuse!
A means to an end
But what is the end?
To Teach you to be like HIM & To Acquire Worldly Wisdom – Charlie Munger
How will I do that?
A different way to view the world
A rational way to think about things
I am here to rewire your brain!
Tell me a story: Timeless folktales from around the world
Cost of machinery: Rs 10 cr.
Expected life of machine: 10 years
Annual savings: Rs 2.50 cr. p.a.
Expected residual value of the machine: Rs 1 cr.
Cost of capital: 15% p.a.
Accept or reject?
You are the CFO of a textile company which manufactures commodity yarn and operates in an extremely competitive market. Both industry, and your company, earns sub par return on capital.
A textile machinery manufacturer approaches you with a proposal to sell you a new type of textile machine, which is more efficient than any machine invented till date.
What does DCF teach you?
Accept or reject?
Which Tool Did You Use?
Where discipline does DCF belong to?
What did he do?
Protagonist is the chief actor in this story
He SHUT DOWN the Textile Operation!
Is he crazy? Who is this guy?
Warren Edward Buffett
And he will be your teacher for a good part of this course.
Why did he do it?
Buffett does not have an MBA :-)
How did he solve the problem? Let’s read his own words. And as I read the words, focus a bit on the highlighted text.
“The domestic textile industry operates in a commodity business, competing in a world market in which substantial excess capacity exists.
“Much of the trouble we experienced was attributable, both directly and indirectly, to competition from foreign countries whose workers are paid a small fraction of the U.S. minimum wage…
Commodity + Excess Capacity due to Competition = Perfect Competition [Microeconomics]
“Over the years we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs… Each proposal to do so looked like an immediate winner…
“Measured by standard return-on-investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly- pro?table candy and newspaper businesses…
“But the promised benefits from these textile investments were illusory…
“Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industry wide…
“Viewed individually, each company’s capital investment decision appeared cost- effective and rational..
“Viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes)…
“Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever- growing amounts of capital…
“After the investment, moreover, the foreign competition would still have retained a major, continuing advantage in labor costs…
“A refusal to invest, however, would make us increasingly non-competitive, even measured against domestic textile manufacturers…
And so, Mr. Buffett shut down the textile business of Berkshire Hathaway But what about cost accountants and their idea of “shut down point?”
What’s the problem with people who only use DCF or Cost Accounting concepts like “shut down point?
To a Man with a Hammer, Everything Looks Like a Nail
“[Buffett] knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product…
“would all go to the benefit of the buyers of the textiles. Nothing was going to [come to us] as owners…
“That’s such an obvious concept – that there are all kinds of wonderful new inventions that give you nothing as owners…
“except the opportunity to spend a lot more money in a business that’s still going to be lousy…
“The money still won’t come to you. All of the advantages from great improvements are going to?ow through to the customers…
See full slides below.