1.

What is the possible meaning of the changes in stock price for GEICO and Berkshire Hathaway on the day of the
acquisition announcement? What does the change in Berkshire share price imply about the intrinsic value of GEICO

2. Based on the value line forecast information, what is the range of possible values for GEICO?
Cost of equity of 11
 3. What is “intrinsic value” in warren Buffett’s view point? What do you think of Buffett’s investment philosophy?

Intrinsic value : Present value vs future cash flow (intrinsic value). The present value of future expected performance.

Philosophy:

a. Economic reality of a business, not accounting reality

i. Reputation, intangible assets such as patents.- flows of cash
1. Profit and cash not the same thing,
2. Get cash flow not rely accounting profit
3. We determine who is winning the game
4. We extrapolate future cfs

b. Opportunity cost: next best thing you can do with your money , better than the second alternative
i. Either or decision rather than yes no decision.
ii. An important standard of comparision in testing which one is the best option was rate of return from
investing in the stock.
𝑁
𝐶𝐹𝑡
iii. NPV= ∑ ( 1+𝑟
− 𝑐𝑜𝑠𝑡0)
𝑡=1
iv. Two projects , control the risk, if +NPV, take it. Control r??
c. Value creation: time is money
i. Intrinsic value as the present value of future expected performance
ii. Education as example, book value and intrinsic value
iii. positive NPV, provide manger to determine what thing should add value, what thing destroy the
value . determine something has econimc value
iv. IRR > hurdle rate (important, most useful, than NPV)
v. P= PV(CFs from existing assets) + PV(net CFs from growth opportunities)
d. Performance, measured by gain in intrinsic value, not by accounting profits.
i. The ability to earn returns in excess of cost of capital

e. Risk + return (sharp)

i.More risk, we want more expected return

ii.CAMP E(rj)= rf+ bj[E(rm)-rf] risk free- pays what is contract for
iii.Why do you look at risk free asset if you focus risky asset
iv. If you cannot earn at least risk free rate, you’re done, get out of here
v. E(rm)-rf : market risk premium – premium for being in the market place(market return)
1. S&P is proxy
2. Should be always positive , should always greater than risk free rate , can never be negative.
This is expected return, not actual .
vi. Beta, is the risk
 1. Correlataion, .2<=corr<= .8 in U.S.
a. Beta never be negative
b. Think about risk,
c. Buy thing always make money.

f. Diversification :Spreading investment in diff areas to reduce the risk

i. Market risk refers sysmtatic risk, not diversifiable risk
ii. Company is diversifiable risk
iii. Randomly 20 to 40 selected securities consider to be diversify
g. EMH: Investing behavior should be driven by information, analysis, not by emotion or hunch.
i. Rational vs fashionable
ii. Not time to market, long term investing, a trategy of patient
h. Agents: what do agents do? Act behalf someone else. Act as principle. Act in best interest to the principle.
i. Why do we care about that? Shareholders is principle, management is the agent
1. What management support to do?
a. Maximize present shareholder wealth- max share price
i. Indicate how well they’re doing, objective outcome
ii. What warrants want ? happy when they happy , make stakeholder happy.
Employer, suppliy, commentity and environment. How do we make them
happy at the same time? i cannot.
iii. In the long run, they will reasonable happy if i max share price. Mutually
beneficial transaction -both party satistify
iv. How do them compensate them, make them owners, in line with you to act
best interest
v. Earnings can be manipulate. You need to pay what you want them to do.
1. Warrants buffet: buy company with a good management, he doesn’t
want to run management
2. Borrow money to buy shares. Buy back from share should, make it
more efficient. Reorganized . LBO

4. Should Berkshire Hathaway’s shareholders support the acquisition of GEICO?