This will link you to an article in the Indepenedent. I have written several comments (at the end of the article). If you have worked at UNL or LondonMet I  think you may find my comments interesting. Many lies have been told; in my comments I set the record straight.

http://www.independent.co.uk/news/education/education-news/now-senior-staff-face-action-at-london-met-1843955.html

The book review below should give you some idea of my reasons for criticising Humphrey Shaw's books. They are grotesque, in places gruesome.

Please forward this blog to anyone you think might be interested.

A review of “Strategic Financial Management”, ISBN 1 85450 042 2, Humphrey Shaw, Elm.
Amazon Listing:
http://www.amazon.co.uk/Strategic-Financial-Management-Managing-Finance/dp/1854500422/ref=sr_1_1?ie=UTF8&s=books&qid=1266603593&sr=8-1-spell

The Author is a Principal Lecturer in Finance at London Metropolitan University. He teaches Research Methods.

Throughout I have shown my comments in italics. Any text NOT in italics is as written in the book.

NOTE: Formatting lost in Blogger. If in "  " it is from book, if not it is my comments (with perhaps a few errors. I will edit it later..it will take some time.

I believe the book may be the most seriously flawed text book ever written. In places it is grotesquely flawed.

It contains many very serious errors. It contains some clearly plagiarised material (I have the original material as proof).
The book is poorly written; it contains many grammatical errors.
Many of the diagrams are poorly presented.
The book contains many technical errors. Many are very serious;
Some of the errors are grotesque.
The book seems a little like a jigsaw puzzle, with pieces from different puzzles haphazardly combined.

Pages to 30 are discursive. They are poorly written.
p31.
"M = d/r Market Value = Dividend/Rate of Return."

So it seems d = Dividend, r = Rate of Return and M = Market Value.
Then
“...dividend of £225,000 …..cost of capital is 15%

MV = £225,000/1.15 + £225,000/(1.15)2 + £225,000/(1.15)3 in perpetuity."
( From where? It isn't M = d/r. What is MV? No explanation. The relevant theory is not discussed until chapter 5, later in the book.).
Then "£225,000 x 1/(0.15) = £1,500,000."
(What does it mean? No explanation is given).
P32
" For constant growth
MV = Do(1 + g) /(r – g) = Market Value = Dividend in current year/Expected future dividend in year one."
The last part  "Dividend in current year etc". is Absolute Nonsense.

“Do” should be “last year's dividend”, not current year's, “g” is not defined in the book (it usually means “annual growth rate of dividends). “r” was earlier defined (implicitly) as Rate of return (it should be “Required Rate of return). In an example that follows (it is technically correct) “r” becomes “The shareholders cost of capital” with no explanation. “Dividend in current year/Expected future dividend in year one” is 1/(1 + g), given the usual meaning of “g” and assuming the “current year” means year 0). It is incoherent and nonsense.
P34
Figure 3:7 is “The pattern of a Random Walk”.
“Pattern”...Doesn't “random” mean (roughly) without pattern? So what is the "pattern of"
P 35 it says
“If share prices are patternless then it would appear that they are not bound by the “laws of supply and demand”.
That does not follow, not in any way. It makes no sense at all.
Then it says “The random walk theory is consistent with the fair game model”.
No explanation of “fair game model”. Then there is reference to
“the martingale and submartingale theories”
again no explanation what they are(and they are not everyday terms, do you know them?).
Then: “For prices to conform to a random walk they must show all the parameters of a distribution, mean, variance, skewness and kurtosis”.
Again, no explanation. (I'm not sure there is one!).
“It is because not all of the measures of distribution can be found that a further explanation of price movements is found in the fair game and martingale models”
Again, no explanation.
The book was written for non-specialists and was “to provide a mainly qualitative explanation” page xi. Would such readers have an understanding of “Fair Game” and (sub)Martingales? It seems the book may not be suitable for its target readership.
P41
“In the real economy it is only possible for an investment to yield a positive net present value because of real market imperfections”.
No explanation of “real economy”*, “net present value” or “market imperfection”. The only stated pre-requisite was a basic introduction to accounting. (The author recommends another of his own books. It does introduce the idea of present value and net present value; it often confuses the two.).
P57 “management are expected to know their opportunity cost of capital which may be reflected in the firms weighted cost of capital”.
No explanation of the terms “opportunity cost of capital” and “weighted cost of capital”. To say it “may be” begs the question, “under what circumstances?”. No mention of that.
P 58 The Pay Back Method.
P59 “By dividing the investment by the cash flows the pay back time can be calculated.
It can not, that is nonsense (as the example that follows clearly shows!) (In unrealistically restricted circumstances it is correct; there is neither explanation nor mention of those circumstances, just examples where it is not correct..)
“Unless the the cash inflows exactly equal the outflows, it is best to construct a cumulative cash flow table so that the precise pay back time in years and months can be ascertained.”
That makes no sense at all. If the cash inflows exactly equal the outflows and you already know they are equal, you already know the payback period, so no calculation is required. Throughout, the cumulative cash flow tables are poorly presented and confusing.
P60 The Accounting Rate of Return: “This is another popular method used by managers. As a result the ARR and the Pay Back method are often referred to as traditional methods of investment appraisal”.
Why “As A result” ? Does “popularity” equate with “traditional”? Clearly not.
(The book contains many instances where the author says “so”, “therefore” or “as a result” and follows with a non sequitur statement. It is confusing to the reader; the book appears somewhat incoherent, in places, a bit jumbled.
The calculation of ARR (p60) in the example given is based entirely on cash flows, even though:
On p61 it says “Firstly it (ARR) uses accounting profits and not cash flows”.
No explanation. ( The answer given is “correct”. A knowledgeable reader could work it out but there should be an explanation. It might confuse a student reader.).
“...a firm would prefer to receive money today rather than in the future..” and “...most firms will have a preference for immediate rather than delayed consumption.”
That is very confused (and confusing). We can say people have such a (time) preference (for consumption) but never firms [clearly consumption is done by consumers, not firms, which are producers.
P62 “Any investment which has a net present value greater than zero should be accepted. This can be seen in the following example.”
I think it must be immediately obvious a general statement (“any etc.”) can not be “seen” in a single example. It is an absurd claim. There are numerous places where the author has said “This can be seen”..or similar..where what follows bears little relation to what is to be “seen”. It is very confusing, especially for a novice reader, who should expect to be able to rely on the author's competence. The table of data for the example is very shoddily drawn (throughout the book, material is very shoddily presented.).
P64 The calculation of IRR is very messy and confusing (inter alia, because parts are incorrect, [e.g. (11% = £262); it means “at a discount rate of 11% the NPV = £262. Sloppy presentation].
P66 After several pages referring to cash flows there is the question “What are cash flows?”. I think that is a little late ? There are several places where the book seems to run out of sequence. A bit like a haphazardly created jigsaw puzzle
P67 “To the economist a firm makes a profit whenever its average rates of return are greater than its risk adjusted cost of capital. This definition corresponds with the dividends which a firm pays to its shareholders and is, therefore, different from the accountants definition of profit.”
There is no explanation of “risk adjusted cost of capital”. The suggestion of some sort of correspondence between with dividends paid to shareholders and economic profit is incorrect* (as is fairly clear from the “dividend growth model” the presented earlier in the book. It seems like a jumble of unrelated statements. It is followed by some unrelated and slightly bizarre words (p68) about depreciation and cash flows.
(* it might possible to say something like that at liquidation, adjusted for capital contributions and time (value). It might make sense in a different context but not here, where there is no mention of liquidation or either adjustment.)
P69 “by discounting forecast cash flows at the firm's risk adjusted cost of capital, it is possible to to see whether or not an investment will increase shareholder wealth”.
Most financial theorists would argue the firm's cost is not, in general, appropriate for specific projects (and later in the book the author says that. Unfortunately, a few line later he contradicts himself (p198)). It seems to be very confused and confusing.
Most of chapter 6 pp 57-79 discusses issues of investment appraisal. It is unclear to me why it is called “Managing Investment Programmes”. It is silent on that topic.
The next chapter (7) is called “Managing Risk”.It is silent on that topic. It is so seriously flawed (it is a jumble of incoherent nonsense, other experts have reviewed the chapter and their comments support my opinion.). It is difficult to review it. I will write comments as best I am able.
On page 80 it says “government securities where the returns are risk free. “.
Wrong. They (e.g.) bear inflation risk and interest rate risk. Gilts (as such Govt. securities are called) can lose value unexpectedly if interest rates rise unexpectedly. The purchasing power of the returns can be unexpectedly eroded by unexpected inflation. The possibility of unexpected changes creates risk. Gilt prices can, and sometimes do, fall sharply. Gilts are not risk free. Treasury Bills (short maturity) are almost risk free. The book mentions only Gilts.
It is a very serious error.
P81 “the returns from most investment projects can be predicted and this is...”
That is seriously in error. One of the main problems in investment appraisal is returns can not be predicted (reliably).
P82 there is data for an investment project where the outcomes are 1,2,4,2,1.
That makes no sense at all.
P83 there is a “probability histogram”..(I don't think there is such a thing.).
However, I can see how similar diagrams might be used in presentations.
It is said to be based on the outcomes and nothing else.. It says nothing about them, they are not shown anywhere on the diagram. Instead it shows “sales prices”, which were not given in the data (and bear no obvious relation to it. It seems that perhaps two different examples have been combined.). It then says “the probability distribution enables management to assess real life outcomes.” How can an ex ante probability distribution be used to assess “real life outcomes” (which are inherently ex post)? Clearly it can not, the claim is absurd. Also, “The area underneath a probability histogram is always unity or 100%. In the example, the area of just one bar is £1,000, which contradicts the author's claim.
“And the greater the number of possible probable outcomes the more the histogram resembles the normal distribution of a bell shaped curve.”
That is absolute nonsense, it contains three absurdities:
“possible probable”,
“resembles the normal distribution” and
“the normal distribution of a bell shaped curve”...the other way round perhaps?)
“Standard deviation...shows how closely the mean represents the data being studied”.
It doesn't.(Though one could say (roughly) a small Std. Dev. means all possible outcomes lie close to the mean.
P84 there is a diagram of a pdf for a standard normal distribution. It seems to appear for no obvious reason. It is not properly labelled. The text says
“it is symetrical (sic) and ….as a result 68.26% of the total area of the curve will be between plus and minus one standard deviation.”
How could that follow “as a result”. It is nonsense.(Another case of a non sequitur statement).
It then discusses applying the information to a business problem; about making women's skirts. It has nothing to do with managing risk, nor anything else in the chapter, not even in the whole book! It is utterly bizarre.
On p85 “It must be remembered that there are a number of symetrical (sic) distributions which although bell shaped and symetrical (sic) will have different standard deviations and so cannot be said to be a normal distribution.”
Just plain nonsense.
“Statisticians use the word skewness to describe the symmetry or asymmetry (deviation from the normal curve) of a distribution.
Symmetry or Asymmetry? Which?
Clearly not both (though one might argue that lack of skewness implies symmetry; just as one might argue “not no” could mean“yes”!) The idea that asymmetry means deviation from the normal curve is wrong (e.g. . a rectangular distribution). (Also, there is not just one normal curve, there is an infinity* of them, so which one?). (*Is it a double infinity? That's a bit too philosophical for me! It is definitely more than one!)
P86 “Medi Health”, a venture capital investment project. In this example the outcomes are 1,2,4,2,1 again ......until page 87 where they change to one, two, three, four, five. Now the original outcomes seem to be the basis for the probabilities.
“The standard deviation of the rate of return is useful in assessing risk because it is a measure of all possible outcomes”.
It isn't a “measure” of any one of them, let alone all. (It is a measure of their dispersion).
What follows is so gruesome I cannot easily explain; you have to see it to believe it.
There is a table of numbers which bear no relation to the original example, just numbers seemingly from somewhere else. The outcomes are -.60, -.20, .20, .60 and 1.00 (remember what they were before?). Returns which were 20%, 18%, 16%, 12% and 6% are now .80, .40,, .0, .40, .80. It is just utterly bizarre. There is a column of probabilities associated with the possible outcomes. Their sum is 1.6!!!!!!!! (The sum must be 1.0, by definition.) Quite why the probabilities are the squares of the returns that appeared from nowhere I do not know.
(Perhaps Frank Blewett might explain; he pronounced the book “competent” and suitable for use on several degree programmes in the University of North London).
P88 we see Variance = Standard deviation/return.
More than once. It is nonsense. (Variance = Std.Dev. squared.)
The next chapter is “Pricing Strategies”.
There is an attempt to apply the logic of “profit is maximised when MR = MC” (true, with qualification). It is an mess, pure and simple, a mess. After maximising profits, the firm in the example makes a loss of £9,375 in the year! There is no comment on that. (In spite of the mess, it is mathematically correct....it is the minimum loss ).)
PP97/98 seem mostly a jumble of largely unrelated quotes; perhaps because the text jumps from page 95 to 98 and back again, with something else in the middle.
P99 there is a diagram showing Total cost and revenue curves. The explanation says “To begin with the firm's costs rise steeply, whereas the revenue rises slowly...” Just the opposite of the diagram. There is no explanation for the shape of the curves.
“.....total variable cost will be linear. In the short term this is likely to be the case because the firm will experience constant returns to scale. This is why economists show a firm's total variable cost as curvelinear (sic) whereas accountants show them to be linear.”
Now, “returns to scale” do not arise in the “short term (sic)”; scale changes can occur only in the “long run”. Very confused and confusing. (There are several places where the idea of economies of scale is misused.)
If it is true
“...total variable cost will be linear. In the short term this is likely to be the case”,
how does that explain
“This is why economists show a firm's total variable cost as curvelinear (sic)”?
Not only is that non sequitur (again) it is nonsense. Very confused and confusing.
Chapter 9 has so many errors it would take a very long time to list them I will pick out just a few obvious examples.
P110 “Florence Bonnet owns a truck and regularly drives to Istanbul”
Summarising, Florence wishes to set prices to improve her chances of getting a load for her return journey. She decides to calculate her “Incremental Cost”. According to the book, that is made up of fuel and repair costs (clearly both are distance related). But neither is incremental* because Florence will drive her truck home with or without a load and so use fuel and incur wear and tear to her truck . Just plain nonsense.
(*unless Florence can sling her truck across her shoulders and hitch back!). Also, if Florence can easily find jobs back in the UK, the opportunity cost of time in Istanbul seeking a load might be high. It was not mentioned.
p113There is a section on “Opportunity Costs of Decision Making”
“The opportunity cost of capital is particularly relevant (to) cost reduction schemes...maintenance spending. This is illustrated in the following example.”
Cost of capital is not in any way relevant to the example; perhaps that is why it is NOT mentioned!! (another example of incoherence).
Nor are opportunity costs, except where the solution says
“opportunity cost MUST be considered before they decide to invest”
(and there is no investment). Of course, the statement is correct, it bears no relation to THIS example. Perhaps a different example?
P114 Golden Valley Dairies.
The example involves comparing maintenance plans; more maintenance reduces breakdowns. Both maintenance and repairs give rise to costs (including the costs of lost production). The essence is to find the optimal trade-off. It comes down to(as presented):
Breakdowns per week 1hr 6hrs 12hrs 18hrs
Lost Contribution - 11,400 22,800 34,200
Maintenance (M) 25,000 19,000 16,000 11,000
Repairs (R) 500 2,500 4,000 5,000
___________________________________________________________________________
Net Cost 25,500 10,100 2,800 18,200
Why no lost contribution at 1 hr? In column 6hr the Net Cost is the sum of the two costs (M + R) minus the Lost Contribution. In column 18hrs Net Cost is the Lost contribution minus the sum of the two costs (M + R). Which is correct? Neither! (It should be the sum of all three). That just scratches the surface, the exercise has other flaws, such as no mention of either of the two concepts (cost of capital and opportunity cost) it purportedly explained. (One might argue opportunity costs saved were proxied by reduced labour costs. There is no explanation of that.).
The “Hand Luggage Company” (p 115) is massively flawed. (though the results are mathematically correct. It is the diagrams, description, explanations, terminology, presentation and some bizarre statements that are in error.)
“Its two best selling products are codenamed A and B”
Why? What is the secret if they are the best selling products?
“The company employs 25 people and they work 3000 per quarter. “
That averages to about 10 hours per week per employee.
“The company can obtain 3,000 hides per quarter” (remember, “hides”).
“Management's objective is to maximise the contribution which can be earned from making the two products. The aim is to find a constant contribution line.”
(Isn't is to maximise contribution?) An absurd statement.
“The travel case can be represented as model A”.
What travel case? There is no mention of a travel case (until later).
P 117
Graph one is sensible, a bit sloppy but not incorrect. The text says
“The graph can only show feasible solutions to non-negative numbers, and so the shaded area (of the graph) shows the values of model A and B etc.).
Just plain utter nonsense. What are “solutions to non-negative numbers”? It is Meaningless.. “The second graph considers the first constraint”. What is a constraint? (not defined). In any case, it introduces the second. On the graph there are references to inequalities. There was no mention before. Nor explanation. There is an arrow pointing to one of the lines on the graph with a label “non-feasible”. Why? (it is wrong)“
The third and final graph shows the effect of the last constraint”.
Since there are just two constraints, and both have been introduced, that makes no sense. All that is added is a solid triangle labelled “Profit Line”.
“ it takes two metres of material to make model A and 6 metres to make model B”.
Metres? How can anyone make travel luggage from metres of leather (Square metres, perhaps or metres length of a standard width.). What happened to the hides (remember from above?)? There is an algebraic solution; it is mathematically correct but poorly and confusingly presented.
P123 “The Northern Pump Company”.
The solution is too confusingly wrong for me to explain here in words. It is a short example but seriously wrong in many ways.
Canvas Shoe Company is fairly straightforward; the solution is almost correct. Firstly I note Variable overhead is quoted at £20,000 per year. That is not sensible; Variable Expenses are always per unit, not per period . That may have been the cause of the problem later where variable overheads for an extra shift were calculated as £11,765, when clearly they should be £14,000.
Chapter 10 p 131 “The Strategic Management of Working Capital”, Figure 10:1 “Types of Capital”
Bizarrely Working Capital is ADDED to Share capital (equity) and Long Term capital (loans) as if it were a type of capital. Working capital is NOT a type of capital (easy to see why a financially naïve person would think it was. Most accountants now use the term “Net Current Assets” which avoids the confusion) and can NEVER be added to Equity and Loans, NEVER. . (It is that part of current assets financed by long term funds), . Later we shall see another grotesque error about working capital.
P137 “Overtrading is a term used by accountants to describe a business which is financing too high a level of activity with insufficient working capital”.
NONSENSE. It is a situation in which a firm has too little long term funding to meet working capital needs and is relying on short term credit. That is very different. It is meaningless to talk of “financing...activity...with...working capital”. The the same mistake appears in many places (in this book and others by the same author). Working capital is Net Current Assets, it is NOT a source of finance.
The book's author makes a similar mistake elsewhere (p 510 of “Accounting and Finance in Organisations”) , saying “working capital is short term money used to finance a business.”. It is NOT a source of finance (it does not finance anything, it is financed by...), it is NOT short term (though components are short term*) and working capital is FINANCED BY LONG TERM funds. It can be defined as “long term claims less current liabilities”..that is unusual but equivalent to the more usual CA -CL. In a book on Strategic Finance it is sensible to think that way; it shows overtrading to be a strategic finance issue, not just an operating one.
(* As with a river, where the water flows to the sea but the river remains, so stock items (e.g.) flow through to customers but the working capital remains.).
The Country Garden Collection on page 138 is rather silly. It just shows that if a business expands but cannot purchase on normal credit terms it is likely to run short of cash. That is not explained. Instead there are several apparently irrelevant points. . (If you get chance to check, if creditors rose in the same ratio as stock (which one might expect) there would be an extra £7,000 to pay off the overdraft and have £4,000 in the bank. In the context of the business, that is plenty, no problem.
P141 “Forecasting Working Capital Requirements”.
The first thing I noticed was the sum of costs as % of Sales = 100%. That would leave very little profit! Most of the “sums” seem OK (the assumption of marginal cost stock valuation was a bit naughty; illegal in the UK?).
The author calculates Working Capital as £238,333. OK. And note, “the firm has stable sales”. (which means cash receipts will tend to match payments fairly closely day by day, given costs = sales, as shown).
It is then divided by 12 to get £19,861.08 per month as the “minimum amount of money which the company must hold to cover monthly transactions”.
Allied to the repeated reference to “working capital” as a source of funds to be added to long term debt and equity I find it extremely worrying. It might very seriously mislead readers.
P 151 “A company has two long term sources of finance”
NO (there other sources, one of which is the most important source in the UK.). They are shows to be “Share Capital” and “Loan Capital”. In spite of the fact there is elsewhere , see below:
“retained earnings are the major source of finance in the UK”. Share Capital is shown as a high risk source of finance and Loan Capital a low risk source.
It is the other way round, as sources (as they are presented in the text).
P151 WACC is calculated using book values. It MUST ALWAYS be based on market values, ALWAYS. Using book values produces a completely meaningless number. Quite seriously, you would just as well use my hat size, waist size, inside leg measurements and the age of my sister's cat! WACC based on book values is meaningless.
[Think of this.* You purchased shares for £10,000 20 years ago. They are now worth £100,000. A safe investment promises a 5% p.a. return. Would you want 5% of the original (historical cost as per book value ) investment of £10,000 or 5% of the current £100,000? I think the answer is obvious. (*Based on an explanation given by Professor Robert C Higgins)]
P156 there is a diagram, 11:2, that shows a “Risk Free Premium” as a component of the cost of capital. Nonsense. There could be a Risk Free Rate or a Risk Premium, never a “Risk Free Premium”.
The example on p 157 is seriously in error. Earnings per share is defined as as
Earnings/ Number of Shareholders.
Clearly wrong. The same error occurs many times (and in other books by the same author). It then says “As long as Geared Company can earn a higher return than its cost of debt it will be able to increase its earnings per share. “ Plain nonsense. If it earns, say, 17%, which is higher than its cost of debt given as 15%, its EPS will fall to 18.33 p. (you need to have the book to see that).
p 160 “If a company was financed only by share capital then its cost of capital would be the dividends paid to shareholders.”
Absolutely NOT TRUE, NONSENSE. Possibly dangerous nonsense (if cost of capital is used for investment appraisal). Think this way. The directors of a limited company have the right to say “no dividend” this year (and sometimes do). If the claim on p160 were true, they could force their cost of capital to zero by declaring no dividend. That would lead to some silly investment decisions.
p161 “Chem Drug”.
Just impossible to explain what is wrong. It is just a total mess of nonsense. Everything that could be wrong is. Beyond anything you could ever imagine. Trying to explain what is wrong would be like trying to explain what is wrong with a bombed out building, a pile of burnt remains and rubble. The example is a jumble of nonsense.
P 166. Modigliani &Miller on debt. (MM1).
At d) it says “no taxation” It compares two hypothetical companies. It turns out one is more valuable than the other because of the “tax advantage”....with “no taxation” Clearly that makes no sense. It is as if it were two different explanations joined together, the first half a a no tax case and the other a with taxes case (M & M later looked at tax effects).
P176 “Capital Markets allow people to chose (sic) how and when they wish to consume.”
Capital markets create lending opportunities (for consumers). They create choices for “when” but absolutely not “how”; those choices are available in the goods markets.
“If individuals decide to defer their consumption by saving some of their monetary wealth they are in fact investing.”.
Clearly not; if they are saving they are saving!. If they choose to lend to others, those others may invest.
“This choice between consumption and investment is known as the Fisher (1930) equation and etc.”
How can a choice between consumption and investment be an equation? Clearly it can not. Totally confused nonsense. The Fisher equation relates nominal and real interest rates and expected inflation. (Ex Ante. It can be applied Ex. Post, using actual inflation).
As best I can tell, it is a bizarre mixing of the Fisher equation and part of the Fisher (sometimes Hirshleifer) separation theorem. How such confusion can arise I do not know.
P177
“Those individuals who actively seek risk such as speculators...”
In general, speculators do NOT SEEK risk. They are willing to bear it in return for high expected gains. (There may be some who actively seek risk, most investors are risk averse.)
(Below is exactly what is written in the book....emphases added).
Part (a) Risk Free.
“Before a person can consider investing in a financial security they need to know when a return will be paid and what is the likelihood or probability of them receiving it. If the investor can calculate the probability of the return together with the likelihood of uncertain events happening in the world such as war or peace it is possible to calculate the risk involved in holding such a security.”
And this was under “Risk Free” !! .
It then goes on to “Business Risk” and “Financial Risk”. Under Business risk it begins
“Investing in any business exposes an investor to financial risk”.
P184 “Market efficiency and the Financial Manager”.
“The most important outcome of the efficient capital markets hypothesis is that if they place the correct valuation on a company's shares the firm knows its true cost of equity capital”
It seems obvious that is not true. How could a single number be sufficient to know something else? (Share prices are NOT the cost of capital). IF the firm had a known finite life and ALL future dividends were known it would be possible to infer an average cost of capital (similar to a yield to maturity) but the actual cost could vary from year to year. And that was a VERY BIG IF!.
A firm might use the share price to estimate the cost of equity; it requires assumption of other factors. It is a very imprecise art.
“in an efficient capital market a share can never have a positive net present value because the share price already reflects the company's true worth”.
Makes no sense at all, it is nonsense. A shares price is its present value (in an efficient market).
“In an efficient capital market there is also no advantage to be gained from diversification as this cannot be achieved by trying to purchase the shares in another company with the aim of acquiring it.”
Yes it can. Of course it can. It may not be a good idea (no advantage) to do it, but it can be done. (The real point is it may not be in the interests of shareholders, for whom portfolio diversification could create the same advantage at lower cost and with greater choice. There is more to consider before reaching a conclusion and the jury may still be out.)
“If the shares are correctly valued then there is no gain to be made in purchasing them. The shares already have a negative net present value...”
That is as barmy as it gets. SHARES CAN NEVER HAVE NEGATIVE NPV, just plain impossible...because of limited liability. Why do millions of people buy shares if there is no gain to be made? All over the world? Why do shares have positive values if they “already have a negative present value”? Just plain barmy, all of it. AND IT DOES NOT SEEM LIKE A SLIP OR TYPO, it is too strongly stated.
Market efficiency does NOT mean securities are “correctly valued”...just ask people who bought just before “Black Monday”, 1987*. It is a naïve misunderstanding that is common amongst people who do not understand. (Roughly, efficiency implies an unbiased estimate of value that is as likely to be too high as too low...and nobody knows which, at the time.).
(It is hard to believe shares were “correctly” valued both before AND after the crash).
P187 “Portfolio Theory and the Capital Asset Pricing Model.”
“If an investor holds shares in just one company there is a greater risk of loss than if the same sum was invested in two separate companies engaged in different sectors. This is because, even if the one investment proves poor, there is every likelihood that the other one will one may be successful and so, etc.”
Nonsense...as the author explains on the next page!!
“The problem for investors is that most financial assets are positively correlated..”
(Often very highly).
p189 “Markowitz realised that it was possible to measure risk by using the statistical concept of variance ...”
Later on the same page “Risk is the measure of the probability of an event happening based on a scale from 0-1”.
(Seems to say, the higher the risk, the more likely the event will happen. What is the event? Makes no sense without that.
Later: “Risk can be defined (to quote Van Horne) as 'the possibility that actual returns will deviate from that which was expected'.”
That is three different (and conflicting) definitions of risk on one page. Very confusing.
“The risk is greatest to an investor whenever there is a high probability of a distribution with a high standard deviation in relation to its expected value.”
I cannot make any sense of that. I don't think it makes sense at all.
P 190 “The risk to an investor of holding a portfolio of financial securities is made up of two parts. “Firstly, the the risks involved in holding the securities and, secondly, the risk which is referred to as the relationship between the securities.”
The first highlighted clause makes no sense, in context, The second is nonsense; there is no risk that is referred to as “the relationship etc.”
In the second paragraph it says “This book will use the terms specific and systematic risk.....”. But in several places it doesn't!
“Specific risk can be reduced once investments form part of a portfolio. This is because the gains which accrue to an investor from holding shares in one particular company are cancelled out by the losses made by another. As gains and losses cancel each other out, the portfolio should be more stable.”
If gains are cancelled out by losses... , what is the point of investing?
P191 “Any investor faces two problems. Firstly, which securities should be placed in the portfolio...”
“The” portfolio.....what portfolio? (There are many similar errors in the book. It is rather shoddy.)
“....and secondly, what returns can be earned from such combinations?”
“Such” combinations…..What combinations?
P192
I think the second question would have to be answered before the the first question.!! There is still the question of “How much of each security?” to answer.
It says the question (above): “what returns can be earned from such combinations …...will depend upon an investors utility function which can be measured by constructing an indifference curve.”
The matter of “what returns can be earned....” is NOT in any way influenced by “an investors utility function. The very idea is utterly absurd...like expecting the mountain to come to Mohammad.
Then “an investors utility function can be measured by constructing an indifference curve. This can be seen in Figure 13:3 “An investors Indifference Curve”.
(Where there a re three curves).
The idea that an investor's utility function can be measured is absurd (nobody has a precise understanding of what “utility” is). One of the reasons economists use indifference curves is to avoid using the ill-defined concept “utility”.
“An indifference curve shows a line joining points where an investor obtains the same level of satisfaction for any two combinations of investments.” .
It has nothing at all to do with “combinations of investments”. It would make no difference if there were no such things as investments. It is just a depiction of an individuals attitudes to hypothetical risk and expected return choices.
P192 Figure 13:4a
A Diagram appears without explanation. The explanation required is fairly complex. It would be impossible to make sense of it without explanation. The axes are labelled “Return” and “Risk”; Should be “Expected Return” “Standard Deviation of Distribution of Possible Returns” The “efficient frontier” is correctly labelled but no explanation why it is called that is given.
In 13:4b Indifference curves are correctly added. Then there is an arrow pointing to what seems to be an arbitrary point on the efficient frontier. Wrong and no explanation.
P193 The Capital Asset Pricing Model.
Figure 13:5 “The Components of Risk” Uses the term “Systematic Risk”...not “specific risk as said earlier”.
Figure 13: 6 “A securities Excess Return etc.” is plagiarised. Traced dot for dot from VanHorne.
It says “By drawing a line of best fit between the crosses....”
There are NO crosses. There were in Van Hornes work that was traced.
Fig 13:6 The label “Alpha” points to nothing. Again there is “Unsystematic Risk” (not specific). The line is labelled “Characteristic Line”. In Fig 13:7 a completely different line is similarly labelled. They cannot both be the “Characteristic Line”. (13:6 is correct). 13: 7 isn't labelled properly so it is impossible to know what it is.
There are two versions of the “Characteristic Line” (as labelled.... really only one). The CRUCIAL Capital Market line is missing. The useful (though not essential) securities market line is missing. There is no discussion why the optimal risky portfolio is the “market portfolio, regardless of individual preferences (AND THAT WAS PERHAPS THE MOST SIGNIFICANT STEP FORWARD FROM PORTFOLIO THEORY, IT IS WHY THE COVARIANCE BASED BETA IS USEFUL).. There is no discussion of the crucial role of a risk free asset (and so it follows there is no discussion of the problem with that). ALL THE CRUCIAL POINTS ABOUT CAPM ARE ALL MISSING.
P195 “A slope (beta) of one shows that the returns of the security vary proportionately with those of the market”
No, it does not. In practical terms it means for a forecast of the value of the excess return on the market index, the Expected return on the security is the same. Beta relates only to (conditional) expected returns. It ignores specific/non-systematic risk, which may be very high.
P196 Micro Tech.
Once again, the example bears no relation to what is to be “seen”. Nothing like it.
P197 “A beta of 0 means the security is risk free, such as British or U.S. Government loan stock.”
NO IT DOES NOT. The claim ignores specific/non-systematic risk. It means it does not have market/systematic risk; that is very different.
Also, the loan stock is NOT risk free. That claim is nonsense.
P198 “A firm's products and future investment programmes can be similarly viewed as a portfolio, and so the capital asset pricing model can be applied to investment decisions.”.........
“..change in share price share in relation to market changes can be measured by using betas..”
Seems out of sequence.(as well as wrong, it ignores unexplained variation/ specific risk)
….....“The returns from any investment must yield a positive net present value, after the net cash flows have been discounted at the firm's risk adjusted cost of capital.”
That totally contradicts the idea of viewing investments as a portfolio of investments, in which each has its own beta (as implied in the book).It can lead to rejection of viable projects and acceptance of non-viable projects.
p205 on mergers and acquisitions:
“ The problem with using accounting measures of profit is they are based on based on accounting definitions of profit, and so they are not the best measure.”
Seems true. Not the best measure of what?
P206 “There are three main methods of valuing a business based on accounting information. They are valuations based on earnings per share, the net assets of the business and a valuation based on its future earnings growth often referred to as super profits.
Earnings per share
a few lines down
EPS = Earnings per share/ Issued Share Capital....
No. that says EPS = EPS/Issued share capital. Nonsense.
Also, it is assumed that 1,000,000 have a nominal value of £1,000,000. Only if the face value of a share is £1.00. That could be true, could be false. No Mention of the value in the text.
The same incorrect formula is repeated on page 207.
In an example “Penn Group” Earnings = £100,000. Price to earnings ratio (P/E) is 8.1 (meaning 8 to 1). It takes seven lines, including the incorrect formula, to work out Price is £800,000.....( P/E x Earnings...8 X £100,000). It is absurd.
(still mergers and acquisitions)
P209 “If the business is trading as a going concern, a market value must be placed on all of the business's assets.”
That is contradictory to conventional reasoning. Why does “going concern” suggest market values of assets (that are not to be sold on the market)?
“The firm's value is then calculated by dividing the number of shares by the agreed value of the net assets.”
That makes no sense at all. It gives the reciprocal of the value of a single share!! (which is otherwise meaningless).
Clonara Group Motor vehicles valued at £12,000, Stock at £54,000 and Debtors at £42,500 are “lost”. Over £100,000 is just lost!
We then see “Valuation of net assets: Net Assets/Share Capital.
(i.e. Net Assets is its own value divided by something else. That is silly! (And even if it meant “share value” it should have been “number of shares” as the denominator. Similar to the many other errors in choosing a denominator).
It looks as if it meant to be a share price, even though it was headed “Valuation of net Assets”. Can't see a good reason for that, it is about a takeover of the whole business, not shares in it. So we have a numerically incorrect value to the wrong question from an incorrect formula!
P212. Valuation based on earnings
Pride of the Glens Hotel
There are 2.5 pages to work out Average( £35,000;£29,000;£42,000;£38,000) is £36,000 and then
£(36,000/0.1) – £252,00) = £108,000. (which isn't required anyway! Just the £36,000/0.1 = £360,000
and then (£36,000 x 100)/12 = £300,000. Also, there is no comment on the reasons for two different values (£300,000 and £360,000). It is slightly farcical.
P216 Still on Mergers and acquisitions..how to finance the deal.
“Whatever method is used to finance the purchase, management must consider the effect on the firm's overall risk adjusted cost of capital , thereby ensuring that the investment can show a positive net present value”.
Pure gobbledygook.
P 216 still on mergers:
“If there is no increase in wealth, then there is no economic justification for stock market acquisitions and it would suggest that the capital markets are inefficient.”
Why “stock market acquisitions”? What does it mean? The chapter is about acquiring “businesses”. Why does it suggest the capital markets are efficient? (And that contradicts what was written earlier on the PV of shares and the futility of buying them..) It might suggest takeovers are often planned for reasons other than shareholder wealth but not in any way that the markets are inefficient.
P225 Forest Timber and Managed Woodlands
It is an attempt to show that paying dividends and replacing the funds by issuing shares has no effect on shareholder wealth (MM dividend irrelevance hypothesis).. Unfortunately the shares are sold Ex. Div at the Cum. Div price, and it seems the (new,) purchasers are quite happy to pay £5.00 per share (Cum Div price) , knowing they will be worth only £4.63 Ex Div and after issue. Of course, the existing shareholders lost no wealth! I could get rich if I could find a few like that!
Glossary
Acid test Ratio Cash and near cash such as debtors less current liabilities.
WRONG.
Beta A measure of how volatile a stock is compared with the market as a whole.
NO. A stock PRICE can be highly volatile, even wit a zero Beta.
Business Risk The risk from investing in a business.
NO. It the risk the business faces because because of its product market risk and cost structure. It excludes the effects of financial gearing.
Current Ratio Current Assets less Current Liabilities.
WRONG (That is working capital..............!!!)
Direct Cost A cost that can be associated wholly and specifically with a cost unit, e.g. machine, department or individual.
WRONG; The three items are not Cost Units.
Dividend Yield The return which a shareholder will earn from owning a share.
VERY WRONG. It ignores capital gain. (it is consistent with many errors in the main text).
Efficient Portfolio A portfolio that offers an investor a maximum return for a minimum level of return!!!
(It would still be nonsense, even without the howler. If it were possible to maximise return and simultaneously minimise risk. There would be no risk-v- return trade off.)
EMH A market.....
Clearly the EMH is NOT a market. It is a hypothesis.
Equity Another term for share capital.
Wrong, equity includes reserves. Share Cap. does not.
Fair Game The theory that investing in shares is unbiased, hence a fair game!! [see Random Walk]
Wrong. The idea of a fair game might be applied to investing, that is not what it is.
Future Value WRONG: makes no reference to Future Value
Gilt WRONG, as in the main text.
Market Portfolio A diversified portfolio of financial securities.
Yes, but misses the CRUCIAL point, it contains ALL securities in proportion to their capitalisations. (Hence Market).
Opportunity Cost The cost foregone.....
I wish I could have a few opportunity costs like that!
Random Walk The Theory that share prices resemble the random walk of a drunk. [see fair game]
Do you believe that? Is it real?
Abbreviations.
Most of them are not used in the book. Perhaps copied from a different book.
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