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Finance: What is Fisher's Separation Theorem? 33 Views
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Transcript
- 00:00
and finance Allah shmoop What is Fisher's separation syrup Fisher
- 00:08
separation The're um like you have to keep your tuna
- 00:11
away from your marlin and they're not quite well The
- 00:14
separation serum was first proposed by economist Irving Fisher Nothing
- 00:19
to do with the seafood It has to do with
Full Transcript
- 00:21
corporate decision making so a bit about how running a
- 00:24
big corporation works While a corporation has two sets of
- 00:28
bosses you've got the owners and then you've got the
- 00:30
manager In small companies these were often the same people
- 00:33
The guy who owns the Sneaker Repair Pagoda at the
- 00:37
mall probably owns 100% of the stock in that company
- 00:40
and works full time as the manager and probably is
- 00:43
the only employee to butt in large corporations A separation
- 00:46
comes into play There are shareholders right people who on
- 00:49
the common stock And there are the managers People like
- 00:51
the CEO CFO CEO ahead of technology and so on
- 00:55
The people who run the Company day today there can
- 00:57
be overlap like managers often own stock but for the
- 01:00
most part the rules operate separately Fisher's separation serum deals
- 01:05
with the fact that a corporation has run by the
- 01:07
manager's acts separately from the wishes of its shareholders like
- 01:11
they're not perfectly parallel The best thing for the company
- 01:14
is often different than the best thing for shareholders at
- 01:16
least in the short term Each entity the shareholders and
- 01:19
the corporate managers responds to different forces and thinks differently
- 01:23
about the best uses of the company's precious resource is
- 01:26
or assets or money Will the fissure separation Throughem says
- 01:30
these differences don't really matter at least in terms of
- 01:33
making corporate decisions The theory states that a corporation should
- 01:36
maximize its present value regardless of what its shareholders want
- 01:43
You run treat not Trick Ink a company that makes
- 01:47
tiny X ray devices to check Halloween candy for razor
- 01:50
blades You made 10,000,000 box in profit last year You
- 01:53
have two fundamental choices You can use that money to
- 01:56
invest in the business things like expanding your X ray
- 01:59
mine or running in R and D Yet to make
- 02:01
a better caramel density ofthe center Or you can give
- 02:04
the money to shareholders in the form of a special
- 02:07
dividend which means giving them cash as a reward for
- 02:10
well holding the stock So what do your shareholders think
- 02:13
you should do with your 10,000,000 bucks in profit Well
- 02:16
one of your shareholders Polly Favor is sitting pretty Her
- 02:20
other investments are going well Her second trust fund just
- 02:23
vested and she miraculously just won the national lottery in
- 02:27
Mozambique She doesn't need the money She tells you to
- 02:29
invest the full $10,000,000 in the company to grow it
- 02:33
Meanwhile another shareholder Artie Loot Flush isn't doing so well
- 02:37
He got divorced last year and owes a lot of
- 02:39
child support both to his ex wife and his former
- 02:42
mistress Meanwhile his other investments have all gone south and
- 02:45
he lost a ton of money in an unsuccessful attempt
- 02:48
Teo Rig the National Lottery of Mozambique He really needs
- 02:52
the money The cash Today baby He asks you to
- 02:55
turn the full $10,000,000 a profit into a special dividend
- 02:59
The fissure separation throughem suggests that you'll ignore them both
- 03:02
that you'll figure out what projects makes sense to invest
- 03:05
in and commit whatever profit is needed to run those
- 03:08
programs Whatever's leftover well then you'll give it out as
- 03:11
a dividend so your staff crunches the numbers and decides
- 03:14
that well If you buy another Ray excrete ER for
- 02:57
1,000,000 bucks it'll have a return on investment of 25%
- 03:21
next year like 250 grand And meanwhile if you invest
- 03:23
$4,000,000 in developing a new product for checking Valentine's Day
- 03:27
candy for poison it'll show a return of 15% Every
- 03:30
other possible project has unexpected return of only 7% or
- 03:34
less Well meanwhile your nerd crew determines that capital markets
- 03:38
would return 8% over the coming year And all this
- 03:41
means that if you borrow money you'll have to pay
- 03:43
8% interest on that loan Or if you loaned money
- 03:47
out while you'd get a return of 8% right so
- 03:49
there's your cut off If you can't get more than
- 03:51
8% return on your money well you might as well
- 03:54
just loan the money out or give in to your
- 03:55
shareholders as a dividend So that's what you do You
- 03:58
invest 1,000,000 box in a ray excrete er it has
- 04:01
a 25% of year return for a long time I
- 04:03
mean it gets you 250 grand by the end of
- 04:06
the year and then another 200 50 grand then next
- 04:08
year in 2 50 the next In the meantime you're
- 04:10
Ray X Streeter has all kinds of other values for
- 04:12
it However you do the calculation It's a really good
- 04:15
return 25 per cent away better than eight You also
- 04:17
invest 4,000,000 box in the Valentine's Day Poison prevention project
- 04:22
the VD three p As you call it you expect
- 04:25
it to return 15% meaning you'll wind up with 600
- 04:28
grand in profits next year and then 600 next and
- 04:32
600 than next And then the value will go up
- 04:34
and however you do the math at 15% is way
- 04:37
better than 8% kind of returns you invested then 5,000,000
- 04:40
ofyour 10,000,000 in high yield high return projects You have
- 04:44
5,000,000 bucks left Well what do you do with it
- 04:46
You give that out in dividends So Polly is a
- 04:49
little disappointed because she wanted to keep the money and
- 04:52
invested But she takes the extra money you give her
- 04:54
and loans it out on her own at 8% interest
- 04:57
It therefore gives her the same return as she would
- 04:59
have gotten from keeping the money with your company You
- 05:02
already invested in all your high return projects The best
- 05:05
the company could have done with that money is earned
- 05:07
8% at least return in the capital markets The same
- 05:10
thing that Polly is going to get returned to her
- 05:12
with her investing it in the capital markets It doesn't
- 05:15
matter whether she has the money or the company has
- 05:18
the money Meanwhile already is bummed He needed that extra
- 05:21
money bad but he still has access to the money
- 05:24
he needs He can go into the capital markets and
- 05:26
borrow it at 8% interest He can just give Holly
- 05:29
a call and Violet from her like why not Okay
- 05:32
but how is already gonna pay the money back Wealthy
- 05:34
company that he invests in took $5,000,000 turned it into
- 05:38
a 5.8 5,000,000 in a year Right That's the 1,000,000
- 05:42
invested A 25% return and the 4,000,000 invested A 15%
- 05:46
return What blended together That's a 17% return on the
- 05:49
$5,000,000 investment Much more than that 8% interest or 8%
- 05:54
return would have returned to them had they invested it
- 05:56
in a lesser return project So next year come dividend
- 05:59
time he'll get that additional amount paid out which he
- 06:02
can use to pay down debt Unless the company can
- 06:04
invested at a higher rate than the vanilla capital market
- 06:07
rate at which point then already will just roll over
- 06:09
his loan or his investment turn he'll sell for another
- 06:12
year and let the company or in a higher return
- 06:14
again So that's the math behind the fissure separation serum
- 06:18
The company will take a CZ much profit as it
- 06:20
needs to run its high return projects anything more than
- 06:23
it could get by just loaning out the money at
- 06:25
interest rates or investing it in some analogous project Everything
- 06:29
else then goes to shareholders with shareholders Stay happy because
- 06:32
they can just use the capital markets to make up
- 06:34
the difference in investment returns If they wanted less money
- 06:37
they could loan out the extra if they wanted more
- 06:40
than they can borrow what they need Meanwhile if company
- 06:42
needs more money it can borrow it as well Like
- 06:45
say next year you bring in 7,000,000 in profit in
- 06:48
the capital markets are paying 8% again but you have
- 06:49
$10,000,000 in projects that can make more than a 15%
- 06:54
return For that extra 3,000,000 bucks you'll borrow the funds
- 06:57
at 8% interest and pay it back after the investments
- 07:01
return At least 15% right borrow it ate Earn it
- 07:04
15 You end up pocketing 7% on the plus side
- 07:07
So in that year shareholders won't get any dividends All
- 07:10
the money plus extra that's been borrowed gets reinvested in
- 07:13
the company But shareholders don't mind because they can also
- 07:16
borrow money if they need it Meanwhile the money invested
- 07:19
with you makes an above market return and a key
- 07:21
here is that it makes no difference how the firm's
- 07:24
investments are finance whether by dead or cash or stock
- 07:27
whatever it is they have in their coffers And if
- 07:29
things get too bad for Artie well he can always
- 07:32
sell his stock and treat not trick ink right Well
- 07:35
the sale will give him plenty of money for child
- 07:37
support and for legal costs related to the charges of
- 07:40
lottery tampering he faces in Mozambique But that's a separate
- 07:43
story
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