Most people’s understanding of auctions comes from personal experience, such as buying on eBay, at a live auction, or perhaps from seeing some of those fun BBC or PBS programs about buying and selling antiques.

But auctions aren’t just a way for people to find an old item on sale, or sell an old item for profit. They serve an important and interesting economic system at the business level as well. There are many, many types of auctions, but I’ll go through just a few of them here. Different types of auctions can even be combined to effectively change the results of the auction and bidding war due to the presence of information asymmetry (where one party may know something the other doesn’t).

So, to make the examples I’ll be giving clearer, I’ve chosen to illustrate them a bit unrealistically by using an envelope containing a $20 as the item up for bid. That way, there’s no doubt as to how much the item is worth, even though in real life, the absolute value of the item is seldom known ahead of time, if at all.

• English auction: This is the auction described above, where participants can openly see each others’ bids. Once a bid for an item is reached that isn’t countered by another bidder, the auction is over. Only the winning bidder pays the amount he bid for the item. Another name for this type of auction in economics is the “ascending-bid auction.”

  Example: Suppose I announce that I have an envelope with a $20 bill inside that I’m auctioning. People start bidding for it, maybe starting with $1. Others are willing to pay $5 for the $20 bill, etc. Pretty soon, someone might be willing to pay something close to $20 for that bill, say $19.50. If most people are rational, it’s unlikely that someone would be willing to bid higher than $20 for the $20 bill, let’s suppose the bidding stops at $19.50. The bidder of that amount pays me $19.50 and walks off with the $20.

• Dutch auction: In this type of auction, the selling price for a large amount of the same item is determined by the market (or bidders at an auction). The auction begins with a suggested, usually high price for the entire lot that descends until it reaches a price point at which a bidder is interested in buying at least a partial number of the item. This auction is also known as a “descending-bid auction”.

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(Note: This post is based on content from a Microsoft Excel 2003 Assistance page that does a good job of going through the step-by-step regression process in Excel, but a poor one of explaining the finance behind the example. To do this yourself, you’ll need to follow instructions to load the Analysis Tool-pak Add-In, which should already come installed with Excel.)

Imagine that you run a factory producing cool little widgets. You have the monthly data on the number of widgets you produced last year and how much it cost to produce them. How would you find out your variable and fixed costs for producing each widget? Management wants to know how much it will cost to double last year’s production numbers. What would you tell them?

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One of the most common mistakes made in when calculating DCFs and seen all too often in corporate finance analyses is forgetting to properly adjust an annual percentage rate for the period in question.

For example, if your cost of capital is 12% on an annual basis, and you’re valuing a project that lasts only a quarter, then the discount rate you use in your DCF analysis shouldn’t be 12% (the most common mistake), or even 3% (e.g. 12% / 4 quarters), but 2.87%.

Likewise, if you have a loan with an annual percentage rate of 6% and want to calculate the amount you’re paying each month, your effective rate each month isn’t 0.5% but 0.486%. Effective rates take the impact of compounding into account, whereas simply dividing one rate by the number of periods ignores this factor.

The formula for changing from an annual percentage rate to a semiannual, quarterly, or monthly one is straightforward. In general, given an annual rate:

So for monthly, quarterly, and semiannual rates, the math becomes:

Suppose I offered to give you either $1000 in June 2006 or $150 every June for the next 10 years, starting in 2007. Which offer is worth more? How would you figure this out? The answer is: by calculating discounted cash flows.

Discounted Cash Flow or DCF analysis is one of the first things taught in finance class in an MBA program. It’s a natural consequence of the time value of money, which states essentially that a dollar today is not worth the same as a dollar in the future. Discounted Cash Flow analysis is most commonly used to value a project or company (or lottery payout, as in the simple example above) using a discount rate or weighted average cost of capital, also abbreviated as WACC. (Did I forget to mention finance is big on acronyms?)

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For some time now, I’ve been considering adding corporate finance topics to the list of categories on this site. A little more than 20% of my traffic comes from corporate sites looking to calculate CAGR in Excel, of all things. To be sure, I spent less time and effort writing that post than many others and therefore was surprised when it became such a big hit (in all senses of the word).

Today, I went through all my old posts and cleaned up their categorizations. Next week, I’ve decided to start writing some posts and refreshers on tools, calculations, and methods useful to those who work in corporate finance and related areas, together with some less serious posts that may interest the same audience. Sort of an MBA-in-a-box type of thing, since I can relate to starting a new job and having to dig through old class notes to remember how to calculate and apply EVA(r) or other common three-letter finance acronyms to whatever project I was working on.

For me, this is a fairly ambitious project since corporate finance topics are, for the most part, dry and only of interest to people who are in the field. Coming up with interesting and helpful posts will be a definite challenge. Anyone in my target audience who’s reading this, I welcome suggestions!