Is selling the bookstore really ‘bad business’? Maybe not
By Andrew Allison, December 14 2021—
After delaying the decision to sell the University of Calgary bookstore to a private American company, Follett, the university now faces backlash from various on-campus groups.
One such group, the Alberta Union of Provincial Employment (AUPE) has advertisements around campus as well as on their website — recently limited to being viewed by AUPE members only — which deplore the university, a supposed “leader in business learning”, for failing to recognize basic good business practices. It would seem, however, that the AUPE have not attended their Management or Finance classes because their business advice leaves a lot to be desired.
On posters across campus, AUPE claims that during a time of budget cuts, “it makes no sense to give away revenue.” And, on their website, AUPE claimed that, “It’s not good business to give away revenue.”
These claims should be taken as absurd from the outset. If it were always the case that “It’s not good business to give away revenue,” then no business would ever sell any revenue-producing asset. Obviously, this is not the case. Businesses sell revenue-producing assets all the time, even in cases in which they are losing other revenue streams.
One reason for this might be that while the asset produces revenue, it may still be operating at a net loss. Consider a diner that has an electric arcade machine. Suppose that the machine garners $5 a month from people inserting quarters to play but it costs the diner $10 a month in electricity to keep the machine running. Would it be “bad business” for the diner to get rid of this machine and “give away revenue”? Certainly not! It would be bad business to continue to hold onto and operate this revenue-producing asset.
The university has cited this as their reason for wanting to privatize the bookstore. But, as some have pointed out, it appears that the bookstore was once operating at a net loss but that is no longer the case since the bookstore came under new management.
However, an asset operating at a net loss may not be the only reason for doing away with that asset. It may also be the case that an asset produces a net profit, but the money earned from selling that asset is greater than the present value of its future cash inflows from it.
What do I mean by ‘present value’? Since AUPE seems to have forgotten to attend its business classes, I will do them the favour of enlightening them. Money today is worth more than money at some point in the future. Don’t believe me? Then I’ll offer you a trade — you give me $1,000 today and I will return $1,001 to you in thirty years. Sweet deal for you, huh? You earn a free buck! Of course, this is a terrible deal for you since $1,000 today is worth a lot more than $1,001 in thirty years.
But how much more is money today worth than money in the future? There’s a way to calculate that. It’s called a present value of money calculation. In case AUPE wasn’t aware, you can learn all about this in FNCE 317 right here at the Haskayne School of Business. For this article, I can only give you one of the many formulas on how to calculate the present value of money — the perpetuity calculation. The formula to calculate the present value of a perpetuity, or a payment that is made at regular intervals an infinite number of times, is as follows:
where PV = Present Value, D = Annual Cash Inflow and r = Discount Rate.
Assuming that the university can hold onto the bookstore forever, the present value of a perpetuity calculation tells us how valuable cash inflows from the bookstore for the rest of time are today. Each year, the bookstore pays rent to the school as well as earns the school revenue through sales. Using these payments as the future cash inflows, we can calculate the value keeping of the bookstore today.
Let’s take AUPE’s referred to numbers and put them into our calculation. They explain that “the bookstore paid over $400,000 that year in rent alone — on top of credible reports that it also earned hundreds of thousands more for the university through sales.”
Suppose that the bookstore paid $200,000 in sales, totalling $600,000 a year in revenue to the university. (Don’t like my numbers? Plug your own into the formula!) And further, suppose that the going discount rate today is 2 per cent — this is just higher than the long-term yields on Bank of Canada bonds, so I’m being conservative — but if you smell an impending plummet in the going interest rate, again, use your numbers. Go ahead, “Plug and chug” as my accounting professors used to say. If you insert these numbers, you will see that the present value of all future cash inflows from the bookstore is $30 million.
What does this tell us about “good” business practices for the university? It means that if they sell the Bookstore for more than $30 million, they will be coming out on top. They will be “giving away revenue”, yes but they will get more money than that future revenue is worth.
Similarly, it gives us a benchmark for properly criticizing the university for selling the bookstore at too low a price. Assuming we have the correct annual revenue that the bookstore produces for the university and have correctly established an interest rate at which the university could invest money from the sale of the bookstore — two numbers which were herein estimated — then we know the number at which it would be bad business to sell the bookstore.
While AUPE thinks that selling the bookstore is bad business, the answer is not so simple. Instead, the AUPE might benefit from attending a few business courses before criticizing the school as not being a proper “leader in business learning.”
This article is part of our Opinions section and does not necessarily reflect the views of the Gauntlet’s editorial board.