I confess. I send out a lot of emails and I am sure that you don't read some of them. Since they sometimes contain important information as well as clues to my thinking (deranged though it might be), I will try to put all of the emails into this file. They are in chronological order, starting with the earliest one. So, scroll down to your desired email and read on...
January 14, 2008
Hi!
Happy new year! I hope you have have a wonderful break and that you will come
back tanned, rested and ready to go.... This is the first of many, many emails
that you will get for me. You can view that either as a promise or a threat...
I am delighted that you have decided to take the corporate finance class this
spring with me and especially so if you are not a finance major and have never
worked in finance. I am an evangelist when it comes to the importance of corporate
finance and I will try very hard to convert you to my faith. I also know that
some of you may be worried about the class and the tool set that you will bring
to it. I cannot alleviate all your fears now, but here are a few things that
you can do to get an early jump.
a. Get a financial calculator and do not throw away the manual.
b. The only prior knowledge that I will draw on will be in basic accounting,
statistics and present value. If you feel insecure about any of these areas,
I have short primers on my web site that you can download by going to
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/primer.html
c. If you are taking the Foundations in Finance class simultaneously, don't panic.
There will be 150 others in the same position and you will not be at any special
disadvantage. And trust me... We will get through this together... Having got
these thoughts out of the way, let me get down to business. You can find out
all you need to know about the class (for the moment) by going to the web site
for the class:
http://www.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html
The syllabus has been updated and you will be getting a hard copy of it on the
first day of class but the quiz dates are specified online. If you click on the
calendar link, you will be taken to a Google calendar of everything related to
this class. You will note references to a project which will be consuming your
lives for the next four months. This project will essentially require you to
do a full corporate financial analysis of a company. While there is nothing you
need to do at the moment for the project, you can start thinking about a company
you would like to analyze and a group that you want to be part of (or at least
start listing off people that you do not want to be in a group with, based upon
prior experience).
Now for the material for the class. The first set of lecture notes for the class
are available as a pdf file that you can download and print.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cflect.htm
If you prefer a copied package, the first part (of two) should be in the bookstore
in about a week. The book for the class is "Applied Corporate Finance",
the second edition. I believe the bookstore already has copies. You can also
get it Amazon.... probably at a lower price...
That is about it. I am looking forward to this class. It has always been one
of my favorite classes to teach and I would like to make it the best class you
have ever taken... I know that this is going to be tough to pull off but I will
really try. I hope to see you in a few weeks in class. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
January 25, 2008
Hi!
I am sorry to send you another email before class even gets started but I might
as well set the stage for the grand opening. First, the bookstore now has the
lecture notes but they seem to have run out of the textbook for the class (Applied
Corporate Finance by yours truly...) They have ordered more copies and you
can wait for them to arrive. Alternatively, you can go online and order the
book from Amazon or Barnes and Noble or Walmart... You may get speedier service
from the latter. Make sure you do get the second edition, though... Second,
you can buy the lecture note packet or print off the pdf version that is online.
As my last email noted, everything you need for the class should be online
at
http://www.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html
If you blew off my first email (and I would not blame you), take a look at the
site before class on Monday. If you are asking yourself, "What first email?",
check out the email chronicles on the site since it will have all past emails
. In particular, check the Google calendar for the class since it lists all the
quizzes and project due dates for the classes - there should be no surprises.
I have received a few emails in the last few days from those of you who plan
to miss the first class because of interviews. (I am a little surprised not only
that the interviews are spilling into the next week but also that there are firms
still hiring. From the news stories in the business pages, you would thing we
were in a full fledged depression and that no one was hiring... but then again...)
The material for the first class (syllabus, project description etc.) are already
online and you can download them. In addition, the first class (and all subsequent
classes) will be webcast about an hour or two after the class ends. While the
webcast will not capture the magic of actually being there, it will do.
One final point. We live in exciting (and scary) times. Today, we discovered
how much money one person can lose (See the SocGen trader story) and we have
already seen evidence that smart people with sophisticated models can make incredibly
stupid judgment calls. I am sure that this will be grist for the mill in the
coming weeks. Hope to see you in class on Monday!
Aswath Damodaran
adamodar@stern.nyu.edu
January 28, 2008
Hi!
I promised you with a ton of emails and I always deliver on my promises... Here
is the first of many, many missives that you will receive for me.....
1. Please pick a group as soon as you can and get started on picking companies
(Avoid money losing companies, financial service firms and firms with capital
arms like GE and GM). Once you have your group nailed down, let me know the names
of the people in your group and, if possible, the companies you have picked.
I will set up a Blackboard group account for you and you can exchange data and
files. In picking a company, pick a theme that is fairly broad and pick companies
that match this. Thus, if your theme is entertainment, you can analyze Sony,
Time Warner, Netflix and even Apple. I would encourage getting diverse companies
in your group - large and small, focused and diversified, and even non-US companies.
(In other words, you don't want five companies that are carbon copies of each
other. There is little that you will interesting to say about differences across
companies, if there are none)
2. Once you pick your company, you can start collecting the data. You should
begin by accessing basic data on your company . Much of it comes from the Bloomberg
terminals (there is one on the second floor in the reading room and there should
be one downstairs in the computer room) and if you have never used a Bloomberg
before, it can be daunting.... Let me know if you get stuck (You can also get
a manual on using Bloomberg data written by yours truly u on my web site.)
http://pages.stern.nyu.edu/~adamodar/pdfiles/Bloombergfull.pdf
Look under Collecting Data... it is towards the top of the page.
3. If you do pick a company by Wednesday, print off the HDS page (just page 1)
for your company and visit the SEC site at
http://www.sec.gov
and print off the latest 14-DEF for your firm. If you cannot pick a company by
then, just pick a company that you are interested in and print these two items
off for the class...
4. The web cast for the first class is up and running...
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr08.htm
Try it out and let me know what you think. I have been told that it come through
best if you have a 50 inch flat panel TV and surround sound. You will also find
the syllabus and project description in pdf format to download and print on this
page. The lecture note packet is also on this page.
5. I know this is a large class but I would really like to meet you at some point
in time personally. So, drop by when you get chance... I don't bite....
6. I seem to have thoroughly confused people about the text book. Let me be clearer.
For this class, you don't need the book but I think it will be useful, if you
can afford it. In fact, please try to read chapter 2 for class on Wednesday.
Until next time...
P.S: If you have registered late for this class and did not get the previous
emails, you can see all past emails under email chronicles
on my web site
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html
Aswath Damodaran
adamodar@stern.nyu.edu
January 29, 2008
Hi!
I will try to keep this short but there are four items that I would like to draw
your attention to before class tomorrow:
1. Lecture notes for class: Please bring the first lecture note packet to class
tomorrow. Obviously, this is not an issue if you are printing off the pdf file.
If you are planning on buying the packet, I do not know whether it has made it
to the book store. If it has, great. If it has not, could you please print off
the first 25 pages of the packet for class tomorrow?
2. Group stuff: I hope that the process of forming groups and picking companies
is moving smoothly.... If you are having trouble finding kindred spirits, I will
start tomorrow's class with a call for the groupless... I will also send an email
listing those who are not in a group yet. If you are truly having trouble connecting,
let me know and I will start the orphan list going.
3. Companies: I know you will not believe me on this one but try, anyway. There
are no good or bad companies to pick for the project. Every company is interesting
(on one dimension or the other). Pick a company, as soon as you can and get the
process rolling. If you truly have buyer's remorse, you can change your company
any time in the next few weeks.
4. Class attendance/participation: While I do not require attendance or grade
based on participation, I would like to see you in class, if you can make it.
I know there is a webcast of the class but... I will try my best not to bore
you!]
See you in class! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
January 30, 2008
Hi!
First, on the question of picking companies for your group, some (unsolicited)
advice: (1) Define your theme broadly: In other words, don't pick five money-losing
airlines as your group. Pick Continental Airlines, Southwest, Ryan Air, Travelocity
and Embraer.... Three very different airline firms, a travel service and a
company that supplies aircraft to the airlines.
(2) Do not worry about making a mistake: If you pick a company that you regret
picking later, you can go back and change your pick.... If you do it in the first
5 weeks, it will not be the end of the world.
(3) If you are leery about picking a foreign company, pick one that has ADRs
listed in the US. It will make your life a little easier. You should still use
the information related to the local listing (rather than the ADR).
(4) If you want to sound me out on your picks, go ahead. I have to tell you up
front that I think that there is some aspect that will be interesting no matter
what company you pick. So, do not avoid a company simply because it pays no dividends
or has no debt.
(5) If you want to kill two birds with one stone, pick a company that you already
own stock in or plan to work for or with .....
Second, once you have picked your company, start by assessing the board of directors
(and making judgments on how effective or ineffective it is likely to be). To
help in this process, I am attaching the original article in 1997 that covered
the best and the worst boards as well as a more recent article detailing what
Business Week looks at in assessing boards.
There are a number of interesting sites that keep track of directors and their
workings. I have listed a few below:
http://www.corpgov.net/links/links.html : This is a general site listing corporate
governance links
http://www.ecgi.org/ : Covers corporate governance in Europe
Institutional Shareholder Services is an outfit that measures corporate governance
scores for individual firms (which Yahoo! Finance reports for companies).Here
is the link to their site:
http://www.issproxy.com/
Look under articles... They have a few interesting ones.
Here is a fun site that allows you to look at individuals who sit on multiple
boards.
http://www.theyrule.net/
For a site that takes a particularly cynical and negative view of what boards
do - they are even more dyspeptic in their assessments of directors than I am
- try the following:
http://www.concernedshareholders.com
They provide all the dirt you will ever want to read about directors and their
limitations.
You can find out more about your company by going to the SEC site (http://www.sec.gov)
and looking up the 14-DEF for your company.. As I noted in class today, you may
not be able to find a 14-DEF (or its equivalent) for a foreign company, but the
difficulty of finding this information may be more revealing than any information
that you may have unearthed.
Until next time...
P.S: If you have trouble with the attachments, check under readings (under the corporate finance class) for the articles. (Even if you can read the articles, check under readings for more articles...)
Aswath Damodaran
adamodar@stern.nyu.edu
February 1, 2008
Hi!
As promised, the first newsletter is attached. Browse through it if you get
a chance. It will also be online.... Other than that, have a great weekend
and don't forget to watch "Other People's Money"....
Aswath Damodaran
adamodar@stern.nyu.edu
February 4, 2008
Hi!
I am sorry to be sending this out this close to class but I was betting that
most of you would not be checking your email last night. I know that many of
you are still in the process of picking companies. If you have picked a company,
however, and have been able to print off the HDS page from Bloomberg (If you
have no idea what this is, try the description of the Bloomberg data under
updated data on my website), please bring that page with you to class. If you
have not picked a company, just bring yourself... See you in class shortly!
Aswath Damodaran
adamodar@stern.nyu.edu
February 4, 2008
Hi!
Just a couple of notes about class today. First, the webcast is up and running
and I have also attached the holdings page that were handed out in class today.
I have also attached the HDS page for Disney from 2006, with Steve Jobs as
a big holder. If you missed the class for any reason or did not get the handouts,
you can download them from the webcast page. Second, I will stop harassing
you about finding a group and picking a company but I have three unattached
people (for a group that needs added hands on dec) and I would really, really
like you to do the analysis of the top 17 holdings in your company, using the
framework we developed in class today.
As for the next class, I have a couple of items on the agenda and neither requires
extensive reading or research. I would like you to think about market efficiency
without any preconceptions. You may believe that markets are short term, volatile
and over react, but I would like you to consider the basis of these beliefs.
Is it because you have anecdotal evidence or because you have been told it is
so or is it based upon something more concrete? We will start the next class
with this question. I would also like you to consider the delicate balance between
social and financial responsibility that every firm faces in making decisions
and how you would settle this balance.
Final notes. The webcasts are up and running... and the email chronicles have
been updated (they will be every Monday from now on..)
Aswath Damodaran
adamodar@stern.nyu.edu
February 5, 2008
Hi!
I went back and forth on the subject and I think "whom" is the grammatically
correct word to use. Enough about grammar, though! As those of you who have been
scanning the newspapers have already noted, everything in the paper seems relevant
to corporate finance (thus making my point that everything is a subset of corporate
finance). Many of have emailed me articles that you have come across and I appreciate
the links (it does help... I am not being facetious). Aditi Chandarana emailed
me this article from the FT that I cannot resist passing on to you because it
dovetails so perfectly with the question that I left you with at the end of the
class - who should you trust: markets or managers?- that is almost eerie. Anyway,
take a look at the article and forgive the author for his incapacity to decide
who to trust. He is a lawyer...
The gamble of short-term pain for long-term gain
By Frank Partnoy
Published: February 4 2008 02:00 | Last updated: February 4 2008 02:00
Last Thursday night, when Steve Ballmer, chief executive officer of Microsoft,
signed a letter announcing its proposal to acquire Yahoo, he probably knew
the markets would punish his company's shares. When bold acquisitions are announced,
the acquirer's shares typically decline. Indeed, although the markets were
up on Friday, Microsoft shares tumbled 6.6 per cent, or more than $20bn. Mr
Ballmer's personal stake in Microsoft lost nearly $900m.
Why would a smart leader agree to sacrifice so much of Microsoft's, and his own, share value? Although the deal raises many interesting antitrust, economic and technology issues, it also illustrates the central conundrum of modern business strategy: should corporations focus more on short-term share prices or long-term value? Put another way, the question is: should we trust markets or managers?
Whereas finance theory posits that managers should focus on share prices, today's managers see radical stock price volatility as a source of danger, not discipline.
According to this view, modern CEOs are like sailors in Greek mythology: they must shoot the gap between a high perch of mania and a whirlpool of panic. To maximise the long-term value, they must steer clear of short-term price pressures.
Last year, many managers sought private equity buyers, in part to avoid market over- and under-reaction. Now that the credit crisis has decimated those deals, the tables have been turned: fully-financed strategic buyers are hovering over companies, ready to pounce when prices fall. Microsoft's move is just the start. For example, consider MBIA, the multibillion dollar insurance company whose share price recently swung through a one-week trapeze act from $16 down to $7 and back to $16 again. What if an acquirer had offered to pay double for MBIA's shares when they hit $7?
As for Microsoft, its managers have cited an opportunity "to drive long-term economic value for our shareholders". Mr Ballmer wrote that: "Microsoft's consistent belief has been that the combination of Microsoft and Yahoo clearly represents the best way to deliver maximum value to our respective shareholders." Yet market reaction was that this belief is wrong, and that Microsoft is digging a massive financial hole by overpaying for Yahoo. Microsoft's chief financial officer has alluded to an "opportunity to drive at least $1bn of synergies". Even $1bn of synergies would recoup just 5 per cent of Friday's loss.
Microsoft shareholders must trust these words, and hope the directors' big ownership stakes are enough to align their incentives. Because Microsoft is much larger than Yahoo, the proposal was not significant enough to require shareholder approval. More-over, the board's decision to make the proposal will probably be protected by the business judgment rule, a judicial presumption that courts will not scrutinise the actions of directors unless they involve gross negligence or self-dealing.
Yahoo's shareholders are in a different boat. The markets say Microsoft's $31-per-share offer is a good one. On Friday morning, that offer was at a 62 per cent premium to Yahoo's then share price. A year, or even three months ago, when Yahoo's price was much higher, $31 per share would have been laughable. Yet even after traders digested the offer, Yahoo's closing price on Friday was below $29, reflecting an expectation that Microsoft's proposal might be the best Yahoo could do. Risk arbitrageurs have bought Yahoo and shorted Microsoft, expressing their belief that Microsoft will succeed.
Interestingly, Yahoo's board already has parroted Microsoft's "long-term" mantra, saying it will "pursue the best course of action to maximise long-term value for shareholders".
The language is stan-dard, but also ironic. If Yahoo's directors are so inclined, they can reject Microsoft's proposal as inadequate to maximise long-term value. Indeed, if "long-term" means what Microsoft says it means, Yahoo should hold out.
Its board has adopted a "poison pill" shareholder rights plan, which provides defensive leverage against unwelcome acquisitions, and its shareholders have the right to vote against Microsoft's proposal, if they believe the board can do better. Moreover, because the proposal is life-changing for Yahoo, its directors will be held to a higher standard than Microsoft's. They will feel pressure to get a better deal.
The most likely outcome is that the companies will combine, perhaps with Microsoft paying an even higher price. As other strategic ac-qui-rers opportunistically seek targets with depressed share prices, they also will suffer short-term declines in exchange for potential long-term gains. The markets will punish them, just as they reward targets. Meanwhile, shareholders will continue to be baffled about who they should trust.
The writer is a law professor at the University of San Diego and author of The Match King: One Bullet and the Financial Scandal of the Century, forthcoming from Profile Books
Aswath Damodaran
adamodar@stern.nyu.edu
February 6, 2008
Hi!
Let me start off by fulfilling my "nagging" responsibilities. Have
you found a group yet? Picked a company? Cleaned your room? Made your bed? Called
your mother? (Even if you have not done the last three, do the first two..) The
objective function matters, and there are no perfect objectives. That is the
message of the last two classes. Once you have absorbed that, I am willing to
accept the fact that you still don't quite buy into the "maximize value" objective.
That is fine and I would like you to keep thinking about a better alternative
with two caveats. First, you cannot cop out and give me multiple objectives -
I too would like to maximize stockholder wealth, maximize customer satisfaction,
maximize social welfare and employee benefits at the same time but it is just
not doable. Second, your objective function has to be measurable. In other words,
if you define your objective as maximizing the social good, how would you measure
social good? I have attached an article on stock price maximization and alternatives
to it.
Building on the theme of social good and stockholder wealth a little more, there
are a number of fascinating moral and ethical issues that arise when you are
the manager in a publicly traded firm. Is your first duty to society (to which
we all belong) or to the stockholders (who are your ultimate employers)? If you
have to pick between the two and you choose the former, do you have an obligation
to be honest and let the latter know? What if you believed that the market was
overvaluing your stock? Should you sit back and let it happen, since it is good
for your stockholders, or should you try to talk the stock price down?
If you have picked a company, there are two orders of business you have for this
weekend:
a. How much power do you as an individual stockholder have over the management
of this company?
To make this assessment, you want to start by looking at the board of directors
and examining it for independence and competence. I know that there are lots
of unknowns here, but work with at least what you know - the size of the board,
the appearance of independence, the (perceived) quality of these directors. With
US companies, you can get more information about the directors from the DEF14
(a filing with the SEC that you can get from the SEC website). With non-US companies,
you may sometimes find yourself lacking information about potential conflicts
of interests, but what you cannot find is often more revealing than what you
can find out; it points to how little power stockholders have in these companies.
Also look at subtle ways in which power is shifted to managers at the expense
of stockholders including anti-takeover amendments (poison pills, golden parachutes),
if you can find reference to them.
b. Are there other potential conflicts of interests between inside stockholders
and outside stockholders?
In some companies, you will find that there are large stockholders in the company
who also play a role in running the company. While this may make you feel a little
more at ease about managers being held in check (by these large stockholders),
consider who these large stockholders are and whether their interests may diverge
from yours. In particular, the largest stockholder in your company can be a founder/CEO,
a family holding, the government or even employees in the company. What they
might want managers to do may be very different from what you would want managers
to do... Look for ways in which these inside stockholders may leverage their
holdings to get even more power (voting and non-voting shares for inside stockholders,
veto powers for the government...)
While it may seem like we are paying far too much attention to these minor issues,
I think that understanding who has the power to make decisions in a company will
have significant consequences for how the company approaches every aspect of
corporate finance - which projects it takes, how it funds them and how much it
pays in dividends. So, give it your best shot... On a different note, we will
be beginning our discussion of risk on Monday. As part of that discussion, we
will confront the question of who the marginal investor in your company is. Assuming
that you have picked your company, could you please take a couple of minutes
and go to Yahoo! Finance and look up the percent of stock in your company held
by institutions:
http://finance.yahoo.com
Enter the symbol for your firm and click on major holders. Please take note of
the percent of stock in your firm held by institutions and insiders and bring
it to class with you on Monday. If you have a non-US company, you may not be
able to get this information but that is okay.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 8, 2008
Hi!
Hope that you are preparing for a relaxing weekend (Enjoy these early weekends...
the ones to come always have long to-do lists). Anyway, a few quick notes:
1. Groups and companies: I am assuming, given the absence of recent emails on
the subject, that everyone is now attached to a group. I also hope that you have
picked a company to analyze and are well on your way to collecting the information
you need on the company.
2. TAs for the class: While we have not quite started on the nuts and bolts of
corporate finance, we will begin next week with our first analysis of risk and
how it affects hurdle rates. For some of you, this will create anxiety. You have
three choices. First, take some Valium and hope to drift along. Second, start
working through some numbers and see if that alleviates the problem. Third, you
can visit me or one of the three TAs for the class:
Alberto Bonilla, alberto.bonilla@stern.nyu.edu, Monday 3-5
Anurag Poddar, anurag.poddar@stern.nyu.edu, Thursday, 10.30-12.30
Ignacio Diezhandino, id382@stern.nyu.edu, Wednesday 3-5 (or 4-6).
All three have taken corporate finance and valuation from me in a prior semester and know this class really well. I am sure that they will welcome your queries. In addition, if you run into Bloomberg problems, they will be helpful. Needless to say, I am just as eager to answer your questions.
3. Tying up the first section: The first part of the class - laying the philosophical foundations for corporate finance - is not behind us. If you are truly on the ball - I know I am dreaming here - you can start doing the first section of your report, where you will be assessing the links between stockholders, managers, lenders, markets and society. Thus, you will be addressing the question of how much power you as a stockholder can expect to have in your chosen firm and how your firm interacts with financial markets (by looking at equity research analysts tracking the firm). You will also be trying to get a sense of how your firm is viewed by society; in other words, is it viewed as socially responsible or a social outcast?... This is the question on which you may find the least public information since only the very best and the very worst firms seem to get press mention. I am attaching an article from Business Week that may help you. In particular, focus on the section on Innovest, an agency that rates companies on corporate responsibility from AAA to C. interesting. I found their web site and while much of the stuff they do is for sale (Ironic, in a way, that a company that evaluates social responsibility is also an old-fashioned business))
Beyond The Green Corporation
Jan 29, 2007
Imagine a world in which eco-friendly and socially responsible practices actually help a company's bottom line. It's closer than you think
Under conventional notions of how to run a conglomerate like Unilever, CEO Patrick Cescau should wake up each morning with a laserlike focus: how to sell more soap and shampoo than Procter & Gamble Co. (PG ) But ask Cescau about the $52 billion Dutch-British giant's biggest strategic challenges for the 21st century, and the conversation roams from water-deprived villages in Africa to the planet's warming climate.
The world is Unilever's laboratory. In Brazil, the company operates a free community laundry in a S‹o Paulo slum, provides financing to help tomato growers convert to eco-friendly "drip" irrigation, and recycles 17 tons of waste annually at a toothpaste factory. Unilever funds a floating hospital that offers free medical care in Bangladesh, a nation with just 20 doctors for every 10,000 people. In Ghana, it teaches palm oil producers to reuse plant waste while providing potable water to deprived communities. In India, Unilever staff help thousands of women in remote villages start micro-enterprises. And responding to green activists, the company discloses how much carbon dioxide and hazardous waste its factories spew out around the world.
As Cescau sees it, helping such nations wrestle with poverty, water scarcity, and the effects of climate change is vital to staying competitive in coming decades. Some 40% of the company's sales and most of its growth now take place in developing nations. Unilever food products account for roughly 10% of the world's crops of tea and 30% of all spinach. It is also one of the world's biggest buyers of fish. As environmental regulations grow tighter around the world, Unilever must invest in green technologies or its leadership in packaged foods, soaps, and other goods could be imperiled. "You can't ignore the impact your company has on the community and environment," Cescau says. CEOs used to frame thoughts like these in the context of moral responsibility, he adds. But now, "it's also about growth and innovation. In the future, it will be the only way to do business."
A remarkable number of CEOs have begun to commit themselves to the same kind of sustainability goals Cescau has pinpointed, even in profit- obsessed America. For years, the term "sustainability" has carried a lot of baggage. Put simply, it's about meeting humanity's needs without harming future generations. It was a favorite cause among economic development experts, human rights activists, and conservationists. But to many U.S. business leaders, sustainability just meant higher costs and smacked of earnest U.N. corporate- responsibility conferences and the utopian idealism of Western Europe. Now, sustainability is "right at the top of the agendas" of more U.S. CEOs, especially young ones, says McKinsey Global Institute Chairman Lenny Mendonca.
MORE THAN PR
You can tell something is up just wading through the voluminous sustainability
reports most big corporations post on their Web sites. These lay out efforts
to cut toxic emissions, create eco-friendly products, help the poor, and
cooperate with nonprofit groups. As recently as five years ago, such reportsÑif
they appeared at allÑwere usually transparent efforts to polish the
corporate image. Now there's a more sophisticated understanding that environmental
and social practices can yield strategic advantages in an interconnected
world of shifting customer loyalties and regulatory regimes.
Embracing sustainability can help avert costly setbacks from environmental disasters, political protests, and human rights or workplace abusesÑthe kinds of debacles suffered by Royal Dutch Shell PLC (RDS ) in Nigeria and Unocal in Burma. "Nobody has an idea when such events can hit a balance sheet, so companies must stay ahead of the curve," says Matthew J. Kiernan, CEO of Innovest Strategic Value Advisors. Innovest is an international research and advisory firm whose clients include large institutional investors. It supplied the data for this BusinessWeek Special Report and prepared a list of the world's 100 most sustainable corporations, to be presented at the Jan. 24-28 World Economic Forum in Davos, Switzerland.
The roster of advocates includes Jeffrey Immelt, CEO of General Electric Co. (GE ), who is betting billions to position GE as a leading innovator in everything from wind power to hybrid engines. Wal-Mart Stores Inc. (WMT ), long assailed for its labor and global sourcing practices, has made a series of high-profile promises to slash energy use overall, from its stores to its vast trucking fleets, and purchase more electricity derived from renewable sources. GlaxoSmithKline (GSK ) discovered that, by investing to develop drugs for poor nations, it can work more effectively with those governments to make sure its patents are protected. Dow Chemical Co. (DOW ) is increasing R&D in products such as roof tiles that deliver solar power to buildings and water treatment technologies for regions short of clean water. "There is 100% overlap between our business drivers and social and environmental interests," says Dow CEO Andrew N. Liveris.
Striking that balance is not easy. Many noble efforts fail because they are poorly executed or never made sense to begin with. "If there's no connection to a company's business, it doesn't have much leverage to make an impact," says Harvard University business guru Michael Porter. Sustainability can be a hard proposition for investors, too. Decades of experience show that it's risky to pick stocks based mainly on a company's long-term environmental or social-responsibility targets.
Nevertheless, new sets of metrics, which Innovest and others designed to measure sustainability efforts, have helped convince CEOs and boards that they pay off. Few Wall Street analysts, for example, have tried to assess how much damage Wal-Mart's reputation for poor labor and environmental practices did to the stock price. But New York's Communications Consulting Worldwide (CCW), which studies issues such as reputation, puts it in stark dollars and cents. CCW calculates that if Wal-Mart had a reputation like that of rival Target Corp. (TGT ), its stock would be worth 8.4% more, adding $16 billion in market capitalization.
Serious money is lining up behind the sustainability agenda. Assets of mutual funds that are designed to invest in companies meeting social responsibility criteria have swelled from $12 billion in 1995 to $178 billion in 2005, estimates trade association Social Investment Forum. Boston's State Street Global Advisors alone handles $77 billion in such funds. And institutions with $4 trillion in assets, including charitable trusts and government pension funds in Europe and states such as California, pledge to weigh sustainability factors in investment decisions.
Why the sudden urgency? The growing clout of watchdog groups making savvy use of the Internet is one factor. New environmental regulations also play a powerful role. Electronics manufacturers slow to wean their factories and products off toxic materials, for example, could be at a serious disadvantage as Europe adopts additional, stringent restrictions. American energy and utility companies that don't cut fossil fuel reliance could lose if Washington joins the rest of the industrialized world in ordering curbs on greenhouse gas emissions. Such developments help explain why Exxon Mobil Corp. (XOM ), long opposed to linking government policies with global warming theories, is now taking part in meetings to figure out what the U.S. should do to cut emissions.
Investors who think about these issues obviously have long time horizons. But they encounter knotty problems when trying to peer beyond the next quarter's results to a future years down the road. Corporations disclose the value of physical assets and investments in equipment and property. But U.S. regulators don't require them to quantify environmental, social, or labor practices. Accountants call such squishy factors "intangibles." These items aren't found on a corporate balance sheet, yet can be powerful indicators of future performance.
If a company is at the leading edge of understanding and preparing for megatrends taking shape in key markets, this could constitute a valuable intangible asset. By being the first fast-food chain to stop using unhealthy trans fats, Wendy's International Inc. (WEN ) may have a competitive edge now that New York City has banned the additives in restaurants. McDonald's Corp. (MCD ), which failed to do so, could have a future problem.
Rising investor demand for information on sustainability has spurred a flood of new research. Goldman Sachs, Deutsche Bank Securities (DB ), ubs (UBS ), Citigroup (C ), Morgan Stanley, and other brokerages have formed dedicated teams assessing how companies are affected by everything from climate change and social pressures in emerging markets to governance records. "The difference in interest between three years ago and now is extraordinary," says former Goldman Sachs (GS ) Asset Management CEO David Blood, who heads the Enhanced Analytics Initiative, a research effort on intangibles by 22 brokerages. He also leads Generation Investment Management, co-founded in 2004 with former Vice-President Al Gore, which uses sustainability as an investment criterion.
Perhaps the most ambitious effort is by Innovest, founded in 1995 by Kiernan, a former KPMG senior partner. Besides conventional financial performance metrics, Innovest studies 120 different factors, such as energy use, health and safety records, litigation, employee practices, regulatory history, and management systems for dealing with supplier problems. It uses these measures to assign grades ranging from AAA to CCC, much like a bond rating, to 2,200 listed companies. Companies on the Global 100 list on BusinessWeek's Web site include Nokia Corp. (NOK ) and Ericsson (ERICY ), which excel at tailoring products for developing nations, and banks such as hsbc Holdings (HBC ) and abn-Amro (ABN ) that study the environmental impact of projects they help finance.
Some of Innovest's conclusions are counterintuitive. Hewlett-Packard (HPQ ) and Dell (DELL ) both rate AAA, for example; market darling Apple (AAPL ) gets a middling BBB on the grounds of weaker oversight of offshore factories and lack of a "clear environmental business strategy." An Apple spokesman contests that it is a laggard, citing the company's leadership in energy-efficient products and in cutting toxic substances. Then there's Sony Corp. (SNE ) vs. Nintendo. Wall Street loves the latter for a host of reasons, not least that its Wii video game system, the first to let users simulate actions such as swinging a sword or tennis racket, was a Christmas blockbuster. Sony, meanwhile, has a famously dysfunctional home electronics arm, and was embarrassed by exploding laptop batteries and long delays in bringing out its PlayStation 3 game console. Nintendo's stock has more than tripled in three years; Sony's has languished.
WEIGHING THE EFFORTS
Viewed through the lens of sustainability, however, Sony looks like the better
bet. It is an industry leader in developing energy-efficient appliances.
It also learned from a 2001 fiasco, when illegal cadmium was found in PlayStation
cables bought from outside suppliers. That cost Sony $85 million, says Hidemi
Tomita, Sony's corporate responsibility general manager. Now, Sony has a
whole corporate infrastructure for controlling its vast supplier network,
helping it avert or quickly fix problems. Nintendo, a smaller Kyoto-based
company focused on games, shows less evidence of the global management systems
needed to cope with sudden regulatory shifts or supplier problems, says Innovest.
A Nintendo spokesman says it meets all environmental rules and is "always
reviewing and considering" the merits of new global sustainability guidelines.
BP seems to disprove the sustainability thesis altogether. CEO John Browne has preached environmentalism for a decade, and BP consistently ranked atop most sustainability indexes. Yet in the past two years it has been hit with a refinery explosion that killed 15 in Texas, a fine for safety violations at a refinery in Ohio, a major oil pipeline leak in Alaska, and a U.S. Justice Dept. probe into suspected manipulation of oil prices.Browne has recently announced his retirement. BP's shares have slid 10% since late April. Exxon's are up around 12%.
Innovest still rates BP a solid AA, while labeling Exxon a riskier BB. And PetroChina? Innovest gives it a CCC. Here's why: BP wins points for plowing $8 billion into alternative energies to diversify away from oil and engages community and environmental groups. Exxon has done less to curb greenhouse gas emissions and promote renewables and has big projects in trouble spots like Chad. "I would still say Exxon is a bigger long-term risk," says Innovest's Kiernan. Petro- China is easier to justify. Begin with its safety record: A gas well explosion killed 243 people in 2003; another fatal explosion in 2005 spewed toxic benzene into a river, leaving millions temporarily without water. PetroChina has been slow to invest in alternative energy, Innovest says, and its parent company has big bets in the Sudan.
Do Innovest's metrics make a reliable guide for picking stocks? Dozens of studies have looked for direct relationships between a company's social and environmental practices and its financial performance. So far the results are mixed, and Kiernan admits Innovest can't prove a causal link. That's little help to portfolio managers who must post good numbers by yearend. "The crux of the problem is that we are looking at things from the long term, but we're still under short-term review from our clients," says William H. Page, who oversees socially responsible investing for State Street Global Advisors.
TALKING A GOOD FIGHT
Yet Kiernan and many other experts maintain sustainability factors are good
proxies of management quality. "They show that companies tend to be
more strategic, nimble, and better equipped to compete in the complex, high-velocity
global environment," Kiernan explains. That also is the logic behind
Goldman Sachs's intangibles research. In its thick annual assessments of
global energy and mining companies, for example, it ranks companies on the
basis of sustainability factors, financial returns, and access to new resource
reserves. Top-ranking companies, such as British Gas, Shell, and Brazil's
Petrobras (PBR ), are leaders in all three categories. For the past two years,
the stocks of elite companies on its list bested their industry peers by
more than 5%Ñwhile laggards underperformed, Goldman says.
Still, BP's (BP ) woeful performance highlights a serious caveat to the corporate responsibility crusade. Companies that talk the most about sustainability aren't always the best at executing. Ford Motor Co. (F ) is another case in point. Former CEO William C. Ford Jr. has championed green causes for years. He famously spent $2 billion overhauling the sprawling River Rouge (Mich.) complex, putting on a 10-acre grass roof to capture rainwater. Ford also donated $25 million to Conservation International for an environmental center.
But Ford was flat-footed in the area most important to its business: It kept churning out gas-guzzling SUVs and pickups. "Having a green factory was not Ford's core issue. It was fuel economy," says Andrew S. Winston, director of a Yale University corporate environmental strategy project and co-author of the book Green to Gold.
The corporate responsibility field is littered with lofty intentions that don't pay off. As a result, many CEOs are unsure what to do exactly. In a recent McKinsey & Co. study of 1,144 top global executives, 79% predicted at least some responsibility for dealing with future social and political issues would fall on corporations. Three of four said such issues should be addressed by the CEO. But only 3% said they do a good job dealing with social pressures. "This is uncomfortable territory because most CEOs have not been trained to sense or react to the broader landscape," says McKinsey's Mendonca. "For the first time, they are expected to be statesmen as much as they are functional business leaders." Adding to the complexity, says Harvard's Porter, each company must custom-design initiatives that fit its own objectives.
Dow Chemical is looking at the big picture. It sees a market in the need for low-cost housing and is developing technologies such as eco-friendly Styrofoam used for walls. CEO Liveris also cites global water scarcity as a field in which Dow can "marry planetary issues with market opportunity." The U.N. figures 1.2 billion people lack access to clean water. Dow says financial solutions could help 300 million of them. That could translate into up to $3 billion in sales for Dow, which has a portfolio of cutting-edge systems for filtering minute contaminants from water. To reach the poor, Dow is working with foundations and the U.N. to raise funds for projects.
Philips Electronics (PHG ) also is building strategies around global megatrends. By 2050, the U.N. predicts, 85% of people will live in developing nations. But shortages of health care are acute. Among Philips' many projects are medical vans that reach remote villages, allowing urban doctors to diagnose and treat patients via satellite. Philips has also developed low-cost water-purification technology and a smokeless wood-burning stove that could reduce the 1.6 million deaths annually worldwide from pulmonary diseases linked to cooking smoke. "For us, sustainability is a business imperative," says Philips Chief Procurement Officer Barbara Kux, who chairs a sustainability board that includes managers from all business units.
Such laudable efforts, even if successful, may not help managers make their numbers next quarter. But amid turbulent global challenges, they could help investors sort long-term survivors from the dinosaurs.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 9, 2008
Hi!
As I noted in yesterday's email, next week will bring us to the first exercises
of modern finance. It is not rocket science but it can be daunting if you have
never seen it before. I will try to take it one step at a time, but you can
help your cause by doing the following in advance:
1. Read chapter 3 in the book. If you plan to go on and read chapter 4, take
it in small bites. It is a monster chapter that will cover the following two
to three weeks of classes.
2. If you have the time, try out the exercises at the end of the chapters. The
solutions are available on the website for the book (that is under books on my
site)
3. Every illustration in the book is backed up by an excel spreadsheet online.
You can download it and take a look at the mechanics behind the numbers. The
spreadsheets are also on the website for the book.
4. Nothing will reinforce what you learn more than looking at your own company.
Thus, as you read about the risk analysis of Disney and Aracruz, see if you can
find a price chart for your stock over the last few years. Yahoo! Finance has
one and you can get a sense of how volatile your stock has been over the period
and why.... You can also get a standard deviation for your stock on Morningstar
(www.morningstar.com). Enter the symbol for your stock, click on key ratios and
then on options.
Nothing more to add for the moment... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 11, 2008
Hi!
Some of you may be regretting the shift from the soft stuff (objectives, social
welfare etc.) to the hard stuff, but trust me that it is still fun.. If it
is not, keep telling yourself that it will become fun. Anyway, here are a few
thoughts about today's class.
1. The Essence of Risk: There has been risk in investments as long as there have
been investments. If you have the time, pick up a copy of Against the Gods by
Peter Bernstein, John Wiley and Sons. It is a great book and an easy read. If
you want more, you should also pick up a copy of Capital Ideas by Peter as well...
That traces out the development of the CAPM....
2. More on Models: If you want to read more about the CAPM you can begin with
the chapter in the book on risk and return models and then move on to the readings
at the end of the chapter. As you read the critiques of the CAPM, remember again
that all you have to do is outrun the guy in the sleeping bag.
3. Diversifiable versus non-diversifiable risk: The best way to understand diversifiable
and non-diversifiable risk is to take your company and consider all of the risks
that it is exposed to and then categorize these risks into whether they are likely
to affect just your company, your company and a few competitors, the entire sector
or the overall market.
One final note. If you can, try to make your assessment of whether the marginal
investors in your companies are likely to be diversified. Look at both the percent
of stock held in your company and the top 17 investors to make this judgment.
If your assessment leads you to conclude that the marginal investor is an institution
or a diversified investor, you are home free in the sense that you can now feel
comfortable using traditional risk and return models in finance. If, on the other
hand, you decide that the marginal investor is not diversified, we will come
back in a few sessions and talk about some adjustments you may want to make to
your beta calculations. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 12, 2008
Hi!
As we talk about firm specific and market risk, it is easy to get lost in abstractions.
Here are two simple ways in which you can can getting a handle on the distinction
between these risks:
1. Try to list out the risks that your firm (I hope you have picked one) is exposed
to and then start categorizing the risks into risks that will affect only the
company or a sub-set of companies and risks that will affect most companies.
That is what I was trying to do with Disney when I listed the risks:
- Risk that a movie (Pirates of the Caribbean) will not measure up to expectations
(Firm specific)
- Risk that a new theme park (California Adventure) will not deliver the visitors
that you thought it would because people do not like it (Firm specific)
- Risk that theme parks collectively will see a drop in attendance because the
economy slows (Market wide)
- Risk that theme parks in the US will see a drop in revenue because the dollar
strengthens (Gray area: depends on how many firms are affected)
- Risk that revenues at ABC will be affected by new congressional laws covering
cable access (Firm specific, since only a few companies will be impacted)
Give it your best shot. You will not be able to list every risk or categorize
it, but the process will help.
2. Take a look at the stories on the front page of the WSJ today. (I have attached
a pdf copy) Go down the list and try your best to put the story into one of three
categories: Firm specific (and diversifiable), Market risk (and non-diversifiable),
Gray area (may be one or the other depending...) The question that you are asking
with each story is whether there is information there that will affect only a
subset of companies or is there market information?
We will start Monday's class with this discussion.
Aswath Damodaran
adamodar@stern.nyu.edu
February 15, 2008
Hi!
First, the newsletter for the week is attached. Nothing earth shattering, but
take a look at it, if you get a chance. Second, as I noted in class on Wednesday,
a long weekend for no reason (Oh, come on... What were you planning go to do
to celebrate Presidents' Day? Chop down a cherry tree?) This is an incredible
opportunity to catch up on your project (or go to Florida... Just check out
the OJ futures prices before you leave...) Until next time and have a great
weekend!
Aswath Damodaran
adamodar@stern.nyu.edu
February 17, 2008
As we talk about the power we have as stockholders in companies, we sometimes miss how difficult it can be to beat a system based upon privileges - who you were born to, where you went to school.... Thought you might find this article about France interesting (I am not picking on the French... What is said in this article could be replicated in most countries...)
BUSINESS / WORLD BUSINESS | February 17, 2008
In France, the Heads No Longer Roll
By NELSON D. SCHWARTZ and KATRIN BENNHOLD
In the wake of the Société Générale scandal, France’s
business aristocracy finds itself in a place it never wants to be: the spotlight.
February 19, 2008
Hi!
I hope you had a wonderful weekend. It is my job to break the spell. Some notes
ahead of tomorrow's class:
1. Risk premiums: We ended the last session with a discussion of the historical
risk premium. Tomorrow's class will begin with an alternative approach to estimating
equity risk premiums, where we will back out the premium from the current level
of the S&P 500 index. If you want to get a jump on the process, try the attached
spreadsheet. The only numbers you will have to update is the current level of
the S&P 500 index and the treasury bond rate today (in red). I have updated
all the other numbers for you. Bring the output with you to class, if you do
it.
2. Betas: We will also begin our discussion of the conventional approach to estimating betas - running a regression of stock returns against a market index. If you can get to a Bloomberg, find your stock and print off the BETA page (you might already have done this, in which case you are all set) for it and bring it to class, it would be immensely useful. In fact, you can get part of the project done if you enter the numbers from your company's BETA page into the attached risk diagnostics sheet.
I know... I know.. You are still in weekend mode... So, do what you can and
I will see you in class tomorrow! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 21, 2008
Hi!
Hope you have had a chance to print off the beta page from Bloomberg for your
company. If you have, do try to work through the regression diagnostics that
we did for Disney in class yesterday. I know that I send the excel spreadsheet
to you on Tuesday, but I am attaching it again, just in case....As you take
a look at the output, consider the following:
1. The Slope of the regression and the standard error: for the beta and the range
on your estimate
2. The intercept: To convert it into a Jensen's alpha, you will need an average
T.Bill rate over your regression period. The spreadsheet has the T.Bill rates
at the end of each year. You can use the average annual rate over your regression
period as an approximation.
3. The R Squared: will give you a measure of the proportion of the risk in your
stock that comes from the market.
If you truly have time on your hands and can find a vacant Bloomberg, try changing
some of the defaults on your Beta page and keep track of what happens to your
beta. Try different starting points, change the weekly default to daily or monthly
and change the market index....
Aswath Damodaran
adamodar@stern.nyu.edu
February 22, 2008
Hi!
The latest newsletter is attached to this email. Hope you get a chance to get
caught up on the project over the weekend! Just as a head's up, in case you
have not been tracking the calendar, the first quiz is a week from Monday.
If you want to get started early, you can start reading chapters 1-4 and working
through the problems at the end of each chapter. The solutions are on the website
for the book on my site. If you are really on the ball, you can visit the website
for the class, download past first quizzes and try them out...
Aswath Damodaran
adamodar@stern.nyu.edu
February 24, 2008
Hi!
As you sit down to watch the Academy Awards tonight, here is the market action
to watch:
http://www.intrade.com/jsp/intrade/contractSearch/
Check your predictions (and those of other experts) against the market... See
you tomorrow (with your beta page in hand...) Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 26, 2008
Hi!
As we work our way through betas and hurdle rates, it is my dubious pleasure
to remind you that the first quiz is on Monday, March 3. As you gasp and claim
that you never saw this coming, let me hasten to add that the date has been
etched in stone from the start of the class (See syllabus and Google calendar,
if you are skeptical). Here are a few details about the quiz:
1. Quiz time: The quiz will be in the first 30 minutes of class on March 3, i.e.
from 10.30-11. It is open book, open notes but laptops are not allowed; fingers,
toes, slide rules, abacuses and calculators are all okay.. There will be three
rooms used for the quiz, and which one you will be in depends upon the first
letter of your last name. (if you are unsure about what your last name is, I
would strongly recommend that you skip the quiz and go to work at Bloomberg as
the beta calculation guy.)
Go to If your last name starts with
Schimmel A-P
UC-65 Q-T
UC-59 U-Z
2. Quiz will cover: Chapters 1, 2, 3 and much of 4 (until you get to the cost
of debt). In terms of the lecture note packet, we will get through slide 150
(give or take a couple) tomorrow and it is all fair game.
3. Pre-prep for the quiz:
Step 1: Review the lecture notes.
Step 2: Relive the excitement. Watch the webcasts, in case you missed a class
(either physically or mentally).
Step 3: Read the sections of the book, where you are still unclear about what
was said in class.
Step 4: If you are still confused, call me or or email me.
Step 5: Work through the problems at the end of chapters 2,3 and 4. You can skip
any problems that require you to compute a standard deviation, correlation, covariance
or a beta, but you do need to be able to use any of these number in analysis.
One unconventional way of preparing for the quiz is to get caught up on your
project.
4. Prepping for the quiz: All of the past quizzes I have ever given in this class
are online, in the website for the class. Just download quiz 1 and work through
as many as you can in real time conditions (give yourself 30 minutes and don't
cheat by looking at the solutions, which are also online). If you want to make
it really real, surround yourself with panicky, stressed out people (I would
suggest a really crowded dentist's office or Penn Station at the peak of commuter
hour) and then work through the quizzes.
5. Review session for the quiz: Due to reasons beyond my control, I have had
to move the review session to 12-1 on Thursday. It will be in KMEC 2-60 (I am
assuming that a lot of you will not be able to make it... If you all make it,
we will be in big trouble since 2-60 fits only about 175 people and there are
435 people registered in the class). Needless to say, the review session will
be webcast and the webcast should be available within a couple of hours of the
session. There will be a presentation for the review session that I will email
separately.
6. Missing the quiz? If for reasons beyond your control, you are unable to take
the quiz, please, please let me know before the quiz. To do so, send me an email
with "Missing Quiz 1" as the subject and give me a reason. If you are
planning to miss this quiz for strategic reasons (rather than health or other
good reasons), remember that there is a cost to quiz-missing. You lose the option
of having your worst quiz score pushed up to the average score you had on the
rest of the exams (the other quizzes and the final).
I am sorry for the long email (not really, but seems like the polite thing to
say...).... Until tomorrow!
Aswath Damodaran
adamodar@stern.nyu.edu
February 27, 2008
Hi!
I first want to spend this one talking about the determinants of betas. Before
we do that, though, there is one point worth emphasizing. Betas measure only
non-diversifiable or market risk and not total risk (explaining why Harmony
can have a negative beta and Philip Morris a very low beta).
1. Betas are determined in large part by the nature of your business. While I
am not an expert on strategy, marketing or productions, decisions that you make
in those disciplines can affect your beta. Thus, your decision to go for a price
leader as opposed to a cost leader (I hope I am getting my strategic terminology
right) or build up a brand name has implications for your beta. As some of you
probably realized today, the discussion about whether your product or service
is discretionary is tied to the elasticity of its demand (an Econ 101 concept
that turns out to have value)... Products and services with elastic demand should
have higher betas than products with inelastic demand. And if you do get a chance,
try to make that walk down Fifth Avenue...
2. Your cost structure matters. The more fixed costs you have as a firm, the
more sensitive your operating income becomes to changes in your revenues. To
see why, consider two firms with very different cost structures
Firm A Firm B
Revenues 100 100
- Fixed costs 90 0
- Variable costs 0 90
Operating income 10 10
Consider what will happen if revenues rise 10%. The first firm will see its operating
income increase to 20 (an increase of 100%) whereas the second firm will see
its operating income go up to 11 (an increase of 10%)... that is why looking
at percentage change in operating income/percentage change in revenues is a measure
of operating leverage.
3. Financial leverage can affect equity betas.... Those of you with finance classes
in your background have probably seen variants of the equation that you saw in
class today (some have tax rates and some do not...) The idea remains the same.
Finally, please do try to work through the Disney/ABC example with 100% debt
used to fund the acquisition. I will send you the solution tomorrow.
As for the review session, it will be tomorrow from 12-1 in KMEC 2-60. As I noted,
it will be webcast. I have attached the presentation for the review session to
this email. Please print it off before coming to the session or watching the
webcast...
Aswath Damodaran
adamodar@stern.nyu.edu
February 28, 2008
Hi!
I know that you are getting ready to enjoy a long weekend and I don't want to
spoil it but I am afraid that I have to. First, a reminder that the review
session webcast will be available this afternoon; if you have trouble getting
to see it, wait about 30 minutes and try again. In case, you feel completely
unprepared, here is a four step plan that may help:
Step 1: Review the lecture notes. We got through the weighted average beta page
(144) and the quiz will cover through that topic.
Step 2: Browse through chapters 1 through 4 in the text book. All of the examples
in the book are available as excel spreadsheets online in the web site for the
book. We did not cover the cost of debt and capital parts of chapter 4, but cost
of equity and betas are fair game.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/ApplCF2ed/appldCF2E.htm
Step 3: Work through the problems at the end of the chapters in the book (the
solutions are also on the web site listed above). Time is obviously a constraint
but try to avoid checking out the answers as you look at the problem. The solution
is always obvious once you see it.
Step 4: You are now ready to run an experiment. Pull up the practice quizzes
off the class web site and take a quiz. Give yourself exactly 30 minutes. (It
would be even more realistic if you could find a room packed with 250 people
with uncomfortable seats.... Perhaps on the subway). If you have serious trouble,
go back to step 3.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfprob0.html
Finally, here are two other questions about past quizzes that seem to keep coming
up:
1. Why is 5.5% the risk premium in past quizzes and problems?: As you work through
a lot of the past exams, you have probably noticed that a 5.5% risk premium magically
pops up when you look at the solutions. This is why. If you are not given a risk
premium for equity in a problem, you should look it up in your notes and use
the historical premium or the implied equity premium and specify what you did.
If you were doing that today, you would be using 4.79% (which is the geometric
premium for stocks over T.Bonds) or 4.6% (implied equity premium); check your
lecture notes to see where these numbers come from. At the time that these quizzes
were worked out, that historical premium was closer to 5.5%.
2. Is it possible that some of the problems lend themselves to multiple interpretations?
If you read a problem and are not sure about something, make an assumption and
state it. When grading the quiz, I will consider your assumption.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 28, 2008
The webcast for the review session is up.. There is only one stream working
at the moment. So, please be patient.
http://sterntv.stern.nyu.edu:8080/ramgen/faculty/adamodar/b40230220s08/022808-adamodar-b40230220s08.rm
Aswath Damodaran
adamodar@stern.nyu.edu
February 28, 2008
Hi!
As you drift away for the weekend, a few loose ends that I need to tie up.
1. If you remember, we finished the class on Wednesday with an analysis of the
beta for Disney after its acquisition of Cap Cities. The first step was assessing
the beta for Disney after the merger. That value is obtained by taking a weighted
average of the unlevered betas of the two firms using firm values (not equity)
as the weights. The resulting number was 1.026. The second step is looking at
how the acquisition is funded. We looked at an all equity and a $10 billion debt
option in class and I left you with the question of what would happen if the
acquisition were entirely funded with debt. (If you have not tried it yet, you
should perhaps hold off on reading the rest of this email right now)
Debt after the merger = 615+3186 + 18500 = $22,301 million ( Disney has to borrow
$18.5 billion to buy Cap Cities Equity)
Equity after the merger = $31,100 (Disney's equity pre-merger does not change)
D/E Ratio = 22,301/31,100= 0.708
Levered beta = 1.026 (1+ (1-.36) (0.708)) = 1.491
Note that I used a marginal tax rate of 36% for both companies - that is where
the 0.64 on the page 143 comes from
2. As you start working through past quizzes, you will find that the last question
- about betas and what happens after firms restructure - is always the toughest
one. A couple of suggestions that may ease your passage. First, separate the
effects of changes in business mix from changes in financial leveral. For the
former, you work with unlevered betas and firm values. For the latter, you look
at debt to equity ratios. For instance, divesting a business changes your business
mix because it replaces an operating asset with cash. Paying that cash out as
a dividend will affect both your business mix (by taking cash out of the business)
and reducing your equity.
3. I will check my emails off and on through the weekend and Monday. If you do
get stuck, let me know. (I will be on a plane going to California tomorrow afternoon
but will check as soon as I land... Same on Saturday night - I have red-eye back)
Have a great weekend (and I apologize if I have already ruined it)! Until next
time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 29, 2008
Hope the review session helped (the review is online). You can get to it
by going to
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfquizreview.htm
I know that Wednesday's class was dense and that I risked confusing you more,
especially with the unlevered betas corrected for cash. If you are still confused,
consider doing the following:
a. Review the class session where we estimated betas corrected for cash. Note
that we started with the regression betas for comparable firms and unlevered
those betas using the average (or median) debt to equity ratio for these firms:
Unlevered beta = Regression Beta/ (1 + (1- tax rate) (Debt/Equity))
and corrected for cash, using the following equation:
Unlevered beta for business = Unlevered beta for company / (1- Cash/Firm Value)
In this case, we were starting with regression betas which are levered betas
and worked to unleverered betas corrected for cash.
b. Take a look at the review session where we estimated the levered beta for
the tobacco company on page 21 as follows
Unlevered beta for the company = Unlevered beta for business (1 - Cash/Firm
Value)
For instance, the tobacco firm with $15 billion in tobacco assets and $ 10
billion in cash had an unlevered beta of 0.54. Correcting for the debt to equity
ratio of 100%, the levered beta was 0.864. In this case, we were starting with
the unlevered beta corrected for cash (0.90) and working to a levered beta
for the company.
To reconcile the two, assume that I had given you the regression beta for the
tobacco firm (which would have been the levered beta of 0.864) and asked you
for the beta of just the tobacco business. You would have done exactly what
we did in the Disney case, unlevering the beta (using the debt to equity ratio
of 100% which would have given you the unlevered beta of 0.54) and then dividing
by ( 1- Cash/ Firm Value) which would have given you the unlevered beta of
0.90 for the tobacco business.
In other words, we started with levered betas in the Disney case and backed into pure play or business betas, whereas we started with business betas in the review problem and worked to levered betas...
I know it is confusing to work with levered betas, unlevered betas and unlevered
betas corrected for cash. While there is no magic bullet, using the financial
balance sheet (with assets at market value on one side and debt and equity
in market value terms on the other) helps, as does the recognition that:
a. Divestitures and acquisitions, by themselves, don't affect debt or equity,
but can affect the business mix of the firm.
b. What you do with the cash from divestitures and how you raise the cash for
acquisitions can make a difference to your debt to equity ratio.
As a final note, I have attached the weekly newsletter for this week and the
answers to the last page of the review packet. Good luck and see you on Monday!
Aswath Damodaran
adamodar@stern.nyu.edu
March 2, 2008
Hi!
Well, I guess I have pretty much ruined your weekend and I am sorry. Anyway,
I hope that the quizzes a re getting a little easier as you keep at them and
that the skies are starting to open up.. In fact, the theme for this song should
be emerging:
http://www.youtube.com/watch?v=gIqLsGT2wbQ
Do hold out one exam and take it in real time (without the solutions next to
you). Relax and don't stress out too much! Until Monday!
Aswath Damodaran
adamodar@stern.nyu.edu
P.S: In case you still need a reminder, the quiz is in the first 30 minutes
of class and your room assignments are as follows:
Go to If your last name starts with
Schimmel A-P
UC-65 Q-T
UC-59 U-Z
There will be class after the quiz...
March 3, 2008
Hi!
I know that this is late in the game but I did get a few questions repeatedly
yesterday and I think it makes sense to answer them publicly:
1. Why do we use past T.Bill rates for Jensen's alpha and the current treasury
bond rate for the expected return/cost of equity calculation?
The Jensen's alpha is the excess return you made on a monthly basis over a past
time period (2 years or 5 years, depending on the regression). Since you are
looking backwards and computing short-term (monthly or weekly) returns, you need
to use a past, short-term rate; hence, the use of past T.Bill rates. The cost
of equity is your expected return on an annual basis for the long term future.
Hence, we use today's treasury bond or long term government bond rate as the
riskfree rate.
2. When do you use the arithmetic average risk premium over T.Bills as your risk
premium?
Only when you are asked to compute the expected return over the next year (a
one-year number). You will never use it to compute a long term cost of equity.
3. Why do you use the US historical risk premium for European stocks?
The US historical risk premium is used as the premium for any mature market,
because the US has the longest uninterrupted historical data on stock and treasury
bond returns. Most European markets are categorized as mature markets. Hence,
it makes sense to use the US premium.
4. How do you adjust for the additional country risk in emerging market stocks?
If the country you are analyzing is not AAA, you should adjust for the risk by
adding an "extra" premium to your cost of equity. The simplest way
to do this is to add the default spread for the country bond to the US risk premium.
This will increase your equity risk premium and when multiplied by your beta
will increase the cost of equity. A slightly more sophisticated approach is to
adjust the default spread for the relative risk of equities versus bonds (look
at the Brazil example in the notes) and adding this amount to the US premium.
This will give you a higher cost of equity. (See the Mexico example in the review
session).
5. How do you estimate a riskfree rate in an emerging market?
If you are doing your analysis in US dollars or Euros, you would use the riskfree
rates in those currencies. In the local currency, you should start with the government
bond rate in the local currency and take out of that number any default spread
that the market may be charging (see the Mexico example in the review packet)
6. Why do you use the average debt to equity ratio in the past to unlever betas?
The regression beta is based upon returns over the regression time period. Hence,
the debt to equity ratio that is built into the regression beta is the average
debt to equity ratio over the period.
7. What is the link between Debt to capital and debt to equity ratios?
If you have one, you can always get the other. For instance, the Fall 2006 quiz
gives you the average debt to capital ratio over the last 5 years of 20%. The
easiest way to convert this into a debt to equity is to set capital to 100. That
would give you debt of 20 and equity of 80, based upon the debt to capital ratio
of 20%. Divide 20 by 80 and you will get the debt to equity ratio of 25%.
8. How do you annualize non-annual numbers?
The most accurate thing to do is to compound. Thus, if 1% is your monthly rate,
the annual rate is (1.01)^12-1.... if 15% is your annual rate, the monthly rate
is (1.15)^(1/12) -1... If you have trouble or get stuck, just go with the simpler
computation; multiply or divide by 12.
That is about it... Hope I have not added to your confusion. Relax.. and I will
see you in a couple of hours. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 4, 2008
Hi!
The quizzes are done... Before you rush up, though, please do read the rest of
this email:
1. Pick up area and etiquette: The quizzes can be picked up on the ninth floor
of KMEC. As you come out of the elevator, please walk towards the door to the
department and look to your left, just before you get to the door. The quizzes
are in four NEAT piles, in alphabetical order. Please, please do not mess them
up, There are 430 quizzes and it took me a while to get them in the right order.
(If you asked me to hold your quiz, you will have to get it from me tomorrow)
2. Grading: The solutions to the quizzes are attached to this email and I have
included the grading guidelines that I followed. I have also made copies of the
solutions and left them with the quizzes.
3. Grievances: I am not a robot and I do mess up. If I have messed up, please
bring your quiz and I will fix my mistake. If you have an issue with one of my
solutions (and feel yours is better), I am willing to listen, though I may not
always respond favorably. I am also a very untidy grader; I am sorry.
4. Distribution for the quiz: I have also attached the distribution for the quiz
to this email. While I have tried to put letter grades on the quiz scores, don't
take them too seriously. After all, right now, 2 points may separate a B+ from
a C+....
Hope you get a chance to pick up your quiz soon. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 5, 2008
Hi!
I know.. I know.. I am supposed to tell you that grades don't matter and that
learning does. I do believe the latter is true but the former is not true.
Of course, you care about your grade, both for self esteem purposes and for
your resume. I know that it can be difficult figuring out where you stand
in a class of this size or how the system works, if you have a bad quiz or
a bad day. While I cannot set all your fears to rest, I have attached a spreadsheet
that you can use to extrapolate your score on the class. Right now, all you
have is one quiz score. Enter that score and your prospective scores on future
quizzes, the exam, the project and the case. If nothing else, it will show
you how your worst quiz score will be adjusted based upon the better quizzes/final.
As you get additional real scores (as opposed to hypothetical scores), you
can update the spreadsheet. Hope it helps... Until later today!
Aswath Damodaran
adamodar@stern.nyu.edu
March 5, 2008
Hi!
Now that you have had a chance to pick up your quiz (you have, haven't you?)
and gone through the requisit celebration/ mourning period, it is time to get
back to work. One small notes before I get into the topic for the day. First,
I hope you had a chance to read the Wall Street Journal's cover story on shareholder
activism in Japanese companies. It is well worth a look. Second, those of you
who have been reviewing Google calendar (for this class) have noticed that
your first case will be given to you next week. I have it almost ready and
I will email you the case on Monday. The due date is scheduled to be March
26. .. Bummer, because it hangs over your Spring break but you can always get
it done before. It is a group case and there is one grade per group.
Finally, lets talk about bottom-up betas. Here are the basis steps involved in
estimating them:
Step1: You have to get a breakdown of the businesses that your firm is in. You
can get this by downloading your firm's 10K from the SEC web site.
http://www.sec.gov/edgar/searchedgar/webusers.htm
Once you have it, browse through it (I would say read it but that would be a
painful exercise) to find the breakdown of your firm's business. Usually, the
company will give you at least revenue and operating income by business. If you
have a non-US company, you should be able to find this information in their annual
report.
Step 2: Estimate bottom-up unlevered betas for each business. There are four
routes you can follow, depending on how much time you are willing to spend on
the process-
a. The Easy Route (5 minutes): You can use the unlevered betas that I have computed
by business on my web site. You can get to it by going to updated data and looking
for levered and unlevered betas by business- I have them as separate datasets
for the US, Europe, Emerging Markets and Japan. The advantage is that it is easy
to do... The disadvantage is that you will not get the wonderful experience of
doing it yourself and the breakdown may not be detailed enough for you.
b. The Slightly more involved route (20-30 minutes): At the top of the updated
data page, you will find the complete excel datasets of the 20000+ companies
that I used to construct the industry average tables. You can download the datasets
(Do it on a high-speed line because it is a very large dataset) and then create
your own group of comparable firms. All of the raw data on the company is provided
- betas, debt, equity and cash - and you have to construct your own unlevered
beta. Try it if you have a chance.
c The online way (5 minutes): Go the Reuters web site;
http://www.reuters.com/finance/stocks
Enter the symbol for your firm and check the ratios (look under the symbol).
One of the numbers that they report is the beta for your company and the betas
for the industry and sector (they have their own categorization). The beta they
report is a levered beta but on the same page, they report a book debt to equity
ratio and a price to book ratio. You can compute an average debt to equity ratio
for the industry by dividing the book debt to equity by the price to book...
Market debt to equity = Total debt to equity/ Price to book ratio
Since the tax rate is reported for the industry, you can compute an unlevered
beta. The problem with this approach is it is difficult to do this for multiple
businesses but it works if you have a single business company.
d. The Bloomberg Way (30 minutes - 2 hours, depending): After all, real finance
mavens use Bloomberg. You can get the information to estimate unlevered betas
by getting on a Bloomberg terminal and typing QSRC. You can then screen across
markets and industries to pick firms in particular markets. Once you have your
sample ready, you can modify the output page to contain the information you need
- betas, debt, equity, cash and tax rates, for example. The advantage is that
you can do this for non-US stocks. The disadvantages is that Bloombergs are notoriously
user unfriendly and you can get only a paper printout. (We don't pay enough for
a download function)
Step 3: Compute the values of each of the businesses that your firm is in. I
would recommend using revenues as the starting point. If you are not comfortable
using pricing ratios, weight the businesses based on revenues. If you would like
a more precise estimate, go back to the comparable firms you pulled up in step
2 and compute the value to sales ratio for the industry
Enterprise Value to Sales = (Market value of Equity + Debt - Cash) / Revenues
Multiply the revenues from each of the businesses by these value to sales ratios
to get estimated values, and use them to compute weights.
Step 4: Compute a bottom-up unlevered beta for your company by taking a weighted
average of the betas in step 2 with the weights in step 3..
I have more to say about the cost of debt, but this email has reached critical
mass... So, have fun.. Until next time!
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 7, 2008
Hi!
Now that you have the bottom up beta (you cannot blame me for hopeful thinking),
I want to review some of what you will need to do to come up with a cost of
debt and perhaps come up with market values of debt and equity in advance of
Monday's class:
1. Get the raw data on interest bearing debt: In particular, take a look at the
balance sheet and identify the interest bearing debt. It is not always easy to
do since you will see ambiguous items such as long term liabilities. Include
both bank loans and corporate bonds, short term and long term debt. (It is possible
that your firm has no debt. Don't ruin your eyes looking for something that does
not exist. A clue that your firm has no debt will be in your income statement
if your interest expenses are zero).
2. Collect lease commitment data: For US companies, the lease commitments (if
any) should be in a footnote. The current year's lease payment will be in close
proximity. These lease commitments are also called rental commitments....Again,
note that not all companies have lease commitments.... and you may not be able
to find this table for non-US companies.
3. Check to see if your company is rated by S&P or Moody's: If you have access
to a Bloomberg terminal, you can do this by clicking on CORP and then typing
in the name of your company. If nothing shows up, you don't have a rating. If
something does, you can click on any of the bonds and look up the actual rating.
4. Get a synthetic rating: For firms without a rating, this will be your primary
basis for estimating the cost of debt. For firms with an actual rating, it will
give you a basis for comparison. You can continue to use the actual rating, but
be aware of the synthetic rating as well. I have attached a spreadsheet that
will do dual duty - estimate the synthetic rating and convert lease commitments
into debt for you... It also gives you the default spread to use with the rating
and thus the pre-tax cost of debt for your firm. Just make sure that the riskfree
rate you are using is the same 10-year default free rate you used earlier on
your cost of equity (Thank you...thank you... I aim to please)
5. Estimate the market value of the interest bearing debt: To do this, you will
have to figure out the average maturity of the debt. This will not be given,
but there should be a table in the footnotes specifying when the debt comes due.
Enter the face value of the debt coming due in 1 year, 2 years etc... and take
a face-value weighted average. The process of computing the market value of debt
is simple. To do so on your financial calculator, do the following:
a. Clear the registers (Sorry about stating the obvious...)
b. Enter the Financial model
c. Enter the following numbers in your PV mode:
FV = Book value of debt from step 1Ê
PMT= Interest expense in most recent year
n = Average maturity of debt
r = Pre-tax cost of debt for your firm from step 4
Hit the PV button, and presto... you should have market value.Ê
6. Get a marginal tax rate to use on your cost of debt: I have attached a link
to the page on my website that has the marginal tax rates by country
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/countrytaxrate.htm
Aswath Damodaran
adamodar@stern.nyu.edu
March 9, 2008
Hi!
One final email before the weekend runs out. I hope you have had a relaxing and
productive weekend. Just a reminder of a few things for tomorrow's class:
1. If you have the 10K for your company, please find the operating lease commitments
and bring them to class. Better still, try to use the operating lease converter
that I sent last week (I am attaching it again, just in case..) to convert the
leases into debt and to compute the synthetic rating for your firm.
2. If you
did not pick up your quiz last week, I brought them into my office for the
weekend. I will put them out again tomorrow.
3. I will be making physical copies of the case to pick up tomorrow but the
pdf file I sent on Friday is an exact replica....
4. If you want to start reading ahead for tomorrow's class, we will be beginning
chapter 5 and working our way through the Disney theme park analysis....
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 10, 2008
Hi!
I know that you have lots of other stuff on your plate right now and are not
really thinking about corporate finance (I find that hard to believe but
then again, I am biased..) In case your fascination with corporate finance
leads you to crack open the case, here are a few suggestions on dealing with
the issues. (In case, you are wondering "What case?". I have left
physical copies of the case outside the front door to the finance department
- the same place where you picked up the quizzes)
a. Do the finite life (15-year) analysis first. It is more contained and easier
to work with. Then, try the longer life analysis. It is trickier...
b. If you find yourself lacking information, make reasonable assumptions. Ignoring
something because you don't have enough information is not a good choice.
c. I think the case is self contained. For your protection, I think you should
stay with what is in the case. You are of course not restricted from wandering
off the reservation and reading whatever you want on furniture retailing and
manufacturing, but you run the risk of opening up new fronts in a war (with
other Type A personalities in other groups who may be tempted to one up by
bringing in even more outside facts to the case) that you do not want to fight.
And please do not override any information that I have given you in the case.
(I have given you a treasury bond rate and a risk premium, for instance.)
d. There are accounting and tax rules that you violate at your own risk. For
instance, investing in production capacity is always a capital expenditure.
At the same time, make your life easy when it comes to issues like depreciation.
If nothing is specified about deprecation, use the simplest method (straight
line) over a reasonable life.
e. There is no one right answer to the case. In all my years of providing variations
of this case, I have never had two groups get the same NPV for a case. There
will be variations that reflect the assumptions you make at the margin. At
the same time, there are some wrong turns you can make (and i hope you do not)
along the way.
f. Much of the material for the estimation of cash flows will be covered in
the next couple of sessions. You can get a jump on the material by reviewing
chapters 5 and 6 in the book. The material for the discount rate estimation
is already behind us and you should be able to apply what we did with Disney
to this case to arrive at the relevant numbers.
g. Do not ask what-if questions until you have your base case nailed down.
In fact, shoot anyone in the group who brings up questions like "What
will happen if the margins are different or the market share changes?" while
you are doing your initial run...
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 21, 2008
Hi!
I hope you had a great break and that you are raring to get back to class (I
know... I know...) Anyway, I was good about not harassing you during the break,
right? No emails for 9 days... That must be a record for me. Anyway, here are
some ways to hit the ground running on Monday:
1. Case: The case is due a week from Monday. If you have not read it, now is
the time to get started. (It is available online under case in the website for
the class). If you started working on it and put it aside for a few days, try
to get to it this weekend.
2. Next quiz: The next quiz is a week from Wednesday. I know that you have plenty
of time and working on the case is actually is very good preparation for the
quiz. If you do have extra time on your hands, try to read through chapter 5
and 6, which will be the primary chapters for the quiz (in conjunction with the
last part of chapter 4 on debt ratios and cost of capital) In the lecture note
packet, it is everything form page 136-end of the packet.
3. Project: If you have computed the cost of capital for your company and the
return on capital & EVA numbers, you are all set. If not, that is one more
item for your agenda.
I have also attached the latest newsletter. Browse through it when you get a
chance. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 24, 2008
Hi!
I know that you are busy on the case but I want to reinforce the lessons from
today's class while it is still timely.
1. Incremental Cash Flow: To analyze whether something is incremental, ask the
two questions: What will happen if I take this investment? What will happen if
I do not? The difference (if any) between the two answers is the incremental
effect and should be in your analysis. If the answer is the same to both questions
(as is the case with the sunk costs and fixed G&A), this cost is not incremental.
2. Time Weighting: The act of discounting cash flows is time weighting the numbers.
In assessing the discount rate and the present value, keep in mind that present
values are additive. You can discount each line item in your project analysis
separately and add up the present values and you should get the same net present
value as you would have obtained by discounting the aggregate cash flows. As
a consequence, I have found (and you can ignore this if you want) that it is
safest when doing capital budgeting to first compute the net cash flow each year
and then do the discounting at the end, .
3. NPV versus IRR: At the risk of wiping out a lot of hard work, the rule I would
adopt is as follows: When in doubt use the NPV.
4. I did rush through the last page of the presentation today in class, where
I converted the net present value of the five year project and the ten year project
into annuities. This is how I came up with the numbers.
To convert the NPV o $442 million on the five year project: PV = 442, n =5, r
=12%, PMT=?
To convert the NPV of $478 million on the ten year project:ÊÊPV =
478, n =10, r =12%, PMT=?
In effect, we are converting the NPV which is a lump-sum value and converting
it into an annual amount which can be compared across investments.
If you are working on your case or project and run into any issues or questions,
do not hesitate to bounce them off me. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 25, 2008
Hi!
What a week it has been for markets and investment banks? I know that the events
in the last few weeks have shaken quite a few of you up, especially if you
plan to work in financial markets and particularly in investment banks. I thought
I should put down my thoughts on what is happening, why it is happening and
what is coming next. Note, though, that these are my views and should not be
taken for more than what they really are - opinions. So, here goes:
1. What is happening?
This fiasco started late last summer as the sub-prime crisis. Initially, the
blame was placed almost entirely on those who had lent money to individuals with
bad credit histories at rates that were too low and the securities that were
built on those loans (mostly mortgage backed securities). Since then, it has
spread to other investors (hedge funds and private equity) and investments (high
yield bonds, equity in levered companies) and those who provide them credit (Countrywide,
CIT iand Bear Stearns). With all the blame being spread around, I think we need
to identify the true source of all of these problems and I think I have a candidate.
It is is what I call the "multiplier effect" of leverage. It begins
with a risky asset (say, a house or a operating business) that is funded with
too much debt. That debt is then packaged and sold as securities to investors
(insurance companies, pension funds,) who are attracted by the higher (but not
high enough) interest rates and their purchases are, in turn, funded with borrowings
of their own. The net effect is that the consolidated debt ratio for risky assets
became too high. At the household level, this manifested itself in loans that
were 85 or 90% (or even higher) of the estimated market value of the house at
the time of the purchase. At the portfolio manager level, it showed up (especially
in private equity and hedge funds) as extraordinary leverage (in levered beta
terms, these portfolios had monstrous exposures for equity invstors). In fact,
corporations and businesses were a lot more cautious in borrowing than investors
were, with market debt ratios at non-financial service firms remaining relatively
stagnant.
While high debt ratios by themselves are not deadly, they cannot be sustained
if the underlying asset values are volatile. Thus, when asset values (houses,
equities) decrease, they create a ripple effect. The borrowers (homeowners, hedge
funds) very quickly find that the equity in these assets is wiped out and the
lenders (commercial banks, investment banks) find that increasing proportions
of their loans are non-performing. The billions in dollars (euros) in write offs
at banks is a reflection of this reality. Since many of these loans have been
packaged and sold as securities to investors (pension funds, insurance companies,
individual investors), the pain is felt across the board.
What about commodity prices and the dollar? Here is where the Fed comes in. In
its attempt to keep financial institutions afloat and the economy from spiraling
further into a downturn, the Fed has been supplying liquidity to the market at
unprecedented levels. The best indicator of this is at the very short end of
the treasury yield curve, where 3-month yields hit historic lows. The decline
in interest rates and the flood of dollars hitting the market have put pressure
on the dollar to move lower. Since most commodities are priced in dollars, the
prices of commodities have increased to reflect the lower value of the dollar.
As evidence, note that the correlation between the dollar and commodity prices
over the last year have increased (it is a strong negative correlation - as the
dollar gets weaker, commodity prices increase.
I have attached a flow chart indicating the spiral that I have just described.
2. Why it is happening?
So, why did investors borrow too much money? The answer is simplistic but revealing.
It is because they thought that asset prices would keep going up (and that corrections
if they occurred would be mild) and lenders who were willing to lend them money
at interest rates that were too low (given the expected default risk). In other
words, both borrowers and lenders were too upbeat about the future. There are
institutional changes that added to the problem. The first is the growth of hedge
funds and private equity investors who are relatively unconstrained when it comes
to borrowing and investing. (Mutual funds, for instance, are much more constrained
in how much they can borrow). The second is the increasing securitization of
debt has made it easier to add layers of debt on top of each other in such a
way that no individual lender is aware of the risks building up but collectively
they are exposed.
3. What will happen next?
There is a disaster scenario, where the spiral continues and feeds on itself
- housing prices fall, defaults rise, economy slows, housing prices fall further....
but I think it is unlikely to occur The most likely scenario is that the spiral
will break and the process will right itself. In fact, there are internal contradictions
in this market that have to be resolved one way or the other. Consider, for instance,
the fact that gold prices have increased because investors are worried about
higher inflation in the future. This is contradicted by the fact that treasury
bond rates have come down - if inflation were as big a worry as the gold market
investors claim, treasury bond rates should have increased. Oil and commodity
prices are going up because the demand for them is supposedly spiking; at the
same time, though, there are others who are warning us that we are going to a
severe recession (where the demand for commodities will decrease). In other words,
one or the other of these fears will have to come to fruition but they cannot
all be true. In other words, we cannot be in a hyper-inflationary, slow-growth
economy with low interest rates and high commodity prices. (We will in hindsight
be able to point to the day when the spiral broke but only in hindsight. There
are some who are already pointing to the the Bear-Stearns/ Morgan deal as the
straw that broke the back of these contradictions, but it is still a little early
to be making that judgment... Suffice to say that we are in for some very interesting
times...)
4. Has it happened before?
It remains an enduring truth in markets that everything that is happening now
has happened before, albeit with slight variations. In fact, you can find parallels
to the the 1970s (high oil prices, high inflation), the 1980s (bad real estate
loans), the 1990s in Japan and 2001..... which is what makes it so difficult
to decide which way we will go next.
5. How can we stop it from happening again?
Notwithstanding all the talk about regulation and learning our lessons, I am
convinced that this is part of how markets work. Over-optimism and greed have
fueled bubbles for hundreds of years, followed by regret and promises that it
will never happen again. At the risk of being labeled insensitive, I am not sure
that it is a bad thing. Bubbles, after all, are a reflection of that optimism
that has always fueled progress for humans. A world run by actuaries (who look
at everything with a calculating eye and never over reach) would not only be
an exceptionally boring place but also would never see the advances that we have
seen.
6. How will if affect me?
After all, as self-interested beings, this is the key question. There is of course
the cliche that every threat is an opportunity, but here is what I think. The
ranks above you have been thinned out by the fall out from this crisis, which
should make it easier for you to shot up to the top. However, investment banks
are notoriously manic-depressive when it comes to hiring and firing and this
crisis has hit home. I believe that we are in for a period of consolidation with
little growth in investment banking ranks (I am including traders, investment
bankers and sales people in this group_ for the next couple of years. The pain
will be spread unevenly, with some areas of investment banking (mortgage backed
securities, real estate etc.) facing decimation and others still growing. If
you are in this game for the long term, it is better to have a skill set that
is general as opposed to one that is specific to a security or market. In other
words, knowing how to value a stock, bond or an option or how to determine the
optimal financing mix for a company is a far more durable skill than knowing
the institutional details of mezzanine financing... You may make more money in
the short term with the latter, but your long term survival is at far greater
risk.
Hope I have not depressed you too much on this bright, sunny day. If I have, try this link: http://www.youtube.com/watch?v=Nnjkb4q6FKU... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 26, 2008
Hi!
I know that you are busy and I will try to keep this short and it is pertinent
to the case.As you work through the numbers, here are some suggestions for
formatting the case report.
1. Cover page: Please include the following
- Names of group members (in alphabetical order: it makes my job of entering
grades easier)
- Cost of capital used for project analysis
- NPV, IRR and ROC (for finite life case)
- NPV (for infinite life case)
- Recommendation: Invest in this business or Don't invest in this business
2. Written analysis: Please keep brief, summarizing your numerical findings,
key assumptions and backing for your recommendation. Please make a hard copy
of the analysis....
3. Base Case analysis: Full print out of your forecasted earnings and cashflows
by year, including details on individual items (G&A, Capacity etc....)
4. Any what-if analysis, scenarios and graphs you want to add on.....If you are
interested in emulating Tufte (remember the Napoleon fiasco... ), you can find
the graph online by going here:
http://www.edwardtufte.com/tufte/posters
You can also find the book on Amazon.com.. The title is "The Visual Display
of Information". He has another book that claims that Powerpoint makes you
stupid (but I would not read that while you are taking a class where you see
550 slides...)
As a general rule, if you do not reference an item in the appendix in your written
analysis, please have mercy and do not include it.
Finally, and this is only if you can pull it off, could you please send me the
numbers from your case analysis as soon as you feel comfortable with them...
You can do this until about 9.45 am on Monday but the earlier the better... I
can pull the numbers together for the class presentation that day..
Cost of capital for project =
Average ROC for project =
NPV (finite life case) =
NPV (project lasts beyond year 15) =
The Home Depot should accept/reject the investment
I understand that you are still working on the case and that you may not be done
until later this week If you get done in time, and can spare the extra 2 minutes,
please email me the numbers for your group (One email per group will be enough)...
If you don't get around to doing it, don't lose any sleep over it... Until next
time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 27, 2008
Hi!
I know that the case is consuming your lives right now... I am getting the
spill over in the form of emails. I apologize if my response has been a little
sluggish today but my son (who is 15 and thinks that he knows it all) had
an accident on the basketball court. After several hours with him in emergency
and a few X-Rays, the diagnosis is torn ligaments but he will live to play
another day... My wife is with my 9-year old at Disneyland augmenting cashflows
and creating significant side benefits for Mickey...As I check through the
emails, these seem to be some of the issues that you are wrestling with:
1. Timing: The "end of the year" and "beginning of the year" are
tying some of you up in knots. My first suggestion is that you step back and
think about why you face this problem. In reality, cashflows occur all through
the year and not at the beginning or end of any period. Since this is an assumption
of convenience to make computation a little simpler. you have some leeway in
what you do. Any cash flows that occur more towards the beginning of the year
are assumed to occur at the start of the year (which is the end of the prior
year) and cashflows that occur later in the year ar assumed to occur at the
end of the year.
2. Allocation: Allocations are inherently subjectively. Thus, calling on me
to provide a judgment on whether you should or can allocate 10% or 20% of some
item to a project will not evoke a useful response. Make your best judgment
and move on. However, there should be no such subjective component when it
comes to incremental cashflows. Either you spend (make) a dollar or you do
not.
I am beginning to get a trickle of the numbers that I have asked for (NPV,
IRR. Decision on the project)... Thank you and keep them coming. Hope you have
a productive weekend (if not a fun one) and I will see you on Monday... Until
next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 29, 2008
I know you are busy and will make this very short. Latest newsletter is attached.
Aswath Damodaran
adamodar@stern.nyu.edu
March 31, 2008
HI!
I hope that the case discussion was not too much of a downer. I know how much
time you have spent on the quiz and I will bend over backwards to give you
the benefit of the doubt. Anyway, I am attaching a pdf version of the presentation
from class today. If you get a chance, compare it to your own numbers.... I
will be sending another email later today about the quiz but the review session
is scheduled for 12.30-1.30 tomorrow in Schimmel.
Aswath Damodaran
adamodar@stern.nyu.edu
March 31, 2008
Hi!
So, another moment of truth arrives! A few details for the quiz on Wednesday
from 10.30-11....
1. What will it cover?
It will cover everything we have done since the last quiz - cost of debt, cost
of capital and capital budgeting. In terms of the lecture notes, it will be pages
140-273, and chapters 4,5 and some of chapter 6. We will not cover project options
on the quiz.
2. When and where is the review session?
Tomorrow from 12.30 - 1.30 in Schimmel Auditorium. The review presentation is
attached.
3. How can I prepare for the quiz?
Start off by reviewing what you did for the case but then move on to working
through problems. If you have the time, work through some of the problems at
the end of chapter 5. If not, go to the past quizzes and work through quiz 2s.
4. Where should I go for the quiz?
I have three rooms and these are the room assignments:
If your last name begins with Go to
A- C T 201 (Second floor of Tisch)
D - F UC-59 (Around the corner from Schimmel in Tisch)
G - Z Schimmel
There will be class after the quiz. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 1, 2008
Hi!
If you did not make it to the review session, the webcast is up. If you have
trouble getting to it, it is probably because there are more than 50 people
trying... Give it a little while and try again... I am trying to get another
stream going.
http://sterntv.stern.nyu.edu:8080/ramgen/faculty/adamodar/b40230220s08/040108-adamodar-b40230220s08.rm
As you go through the webcast, there was an open question that I left you with
at the end of the Reader's Digest example, where I asked how the net present
value would have been different if we had a terminal value instead of a salvage
value. Let me flesh out the answer. The salvage value with the finite life is
$ 6.5 million ($ 5 million from equipment and $ 1.5 million from non-cash working
capital). The after-tax cash flows are $6.5 million a year for the next 4 years
and they are computed as follows
After-tax operating income 1.5
+ Depreciation 5.0
After-tax cash flow 6.5
The net present value = 6.5 (PV of annuity, 12.6%, 4 years) + 6.5/1.126^4 (The
latter is the salvage value)
If you decide to make this project last forever, you will have to invest in capital
maintenance to keep the project going. In fact, the cap ex has to be equal to
depreciation (at least in the zero growth scenario). That would make the after-tax
cash flow = $1.5 million
After-tax operating income 1.5
+ Depreciation 5.0
- Cap maintenance 5.0
After-tax cash flow 1.5
Terminal value = 1.5 / .126 = $11.90 million (which would replace the salvage
value of $ 6.5 million)
The net present value = 6.5 (PV of annuity, 12.6%, 4 years) + 11.9/ 1.126^4
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 2, 2008
Hi!
The cases are done and can be picked up in my office. (I am teaching from 1.30
-3 but will be in until 3).... As you pick them up, please do the following:
1. Check the inside page, where I have circled the potential errors in the analysis.
If you feel that I have overlooked something, bring your case in.
2. Let everyone else in your group know immediately that you have picked up the
case...
I have also attached a document describing what I was looking for in the case..
Hope it helps.
Aswath Damodaran
adamodar@stern.nyu.edu
April 3, 2008
Hi!
The quizzes are done and can be picked up in the usual place. i have left solutions
to both quizzes with the tests. I am also attaching them to this email:
The score on this quiz were higher than on the first quiz and the distribution is attached.
Aswath Damodaran
adamodar@stern.nyu.edu
April 5, 2008
Hi!
I know that you are using this weekend to catch up with the rest of your classes
and perhaps your life. I do have the newsletter for this week attached. We
will be beginning with packet 2 (and capital structure) next session and I
hope you have been able to either buy or print the packet. As a final note
for the weekend, I thought you might like this article. We have talked about
risk aversion and risk premiums in class and this sheds new light on what drives
those factors (at least among males)...
http://www.foxnews.com/story/0,2933,346831,00.html
Have a great weekend! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 8, 2008
Hi!
Just to get you caught up! Yesterday's discussion lays the groundwork for the
optimal capital structure discussion that is coming tomorrow. While we have
not done any quantitative analysis of how much your firm should borrow, take
it through the framework that we developed in class yesterday and consider
whether you would expect a company like yours to be a good candidate for high
financial leverage. In particular, check out
a. Marginal tax rate: Does your company operate in a low tax rate locale or does
it have any circumstances that keep the tax rate low?
b. Added discipline: is your company cash-rich, mostly equity financed and run
by managers who seem to delight in taking poor projects / do bad acquisitions?
It may be time to get them out of their Volvos and put them in Yugos.
c. Expected bankruptcy cost: Are your earnings volatile or stable? (This will
determine the probability of bankruptcy for any given level of earnings) What
are the implications of your firm being in financial trouble? (Is it likely to
lose sales or employees who may leave? This will determine indirect bankruptcy
costs.
d. Agency costs: If you were a lender, would you be worried about lending to
a firm like yours? (Are the assets easy to monitor?)
Make a qualitative assessment of these factors. Tomorrow, we will go further...
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 9, 2008
Hi!
If you feel up to it, you can compute the optimal capital structure for your
firm. Gather up your financial statements, cozy up to your computer and then
do the following.
1. Go online to
http://www.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.html
Download the excel spreadsheet called capstru.xls and save it. If you are working
on a financial service firm, you should download the other capital structure
spreadsheet (capstruo.xls) For those of you are who have trouble, I am attaching
the file, just in case...
2. Before you input any numbers, go into preferences in excel, open the calculation
option and make sure that there is a check in the iteration box.
3. Read the Read me worksheet in the spreadsheet
4. Go to the input page and input the numbers for your firm. Each input box
has a comment in it. Read the comment before you input the value. You can start
off using the most recent year's numbers but may want to come back and normalize
some of the numbers (EBITDA) later.
5. For the moment, leave the answers to the last two questions on the input
page at their default levels. (Yes and Yes)
6. Go to the output page. You should see the current and optimal debt ratio
for the firm as well as the current cost of capital and the optimal cost of
capital.Ê You will also see the entire schedule of ratings and costs
of equity for every debt ratio. I also calculate the change in value per share
for your firm and do your laundry while I am it.... (Hey... What can I say?
I am a full service operation)
7. If you find DIV/0 or VALUE! errors all over your sheet, go back to step
1... Sorry...
8. If you find yourself needing more help along the way, you can also try the
webcast that is a companion to the spreadsheet. (It is on the spreadsheet page....)
Here is the good news for those of you who are lagging on the project. This
spreadsheet will get you caught up with your hard working teammates.. I know
this violates the "little red hen" principle but better caught up
than not. For those of you who have no idea what management book, the "little
red hen principle" is in, here is a link:
http://www.amazon.com/Little-Red-Hen-Paul-Galdone/dp/0899193498/sr=8-1/qid=1163118866/ref=pd_bbs_1/104-7801449-2061545?ie=UTF8&s=books
Aswath Damodaran
adamodar@stern.nyu.edu
April 12, 2008
Hi!
Two very quick notes. The first is that I have attached the weekly newsletter
to this email. The second is a plea to run the optimal capital structure
spreadsheet for your company sometime this weekend - it really is a 15-minute
exercise - and bring the output to class with you on Monday.
Aswath Damodaran
adamodar@stern.nyu.edu
April 15, 2008
Hi!
You probably think I am harassing you (and you would be right), but please do
try to compute the optimal debt ratio for your firm using the optimal capital
structure spreadsheet. Once you get the optimal debt ratio, consider the three
questions we raised in class:
1. Why should we do it? (What is the payoff to moving to the optimal)
2. What if something goes wrong? (See how sensitive the optimal is to changing
operating income)
3. What if we want to invest rather than buying back stock?
In addition, you may want to look at why you get the optimal that you do (given
the characteristics of the firm). At the risk of repeating what we did this morning,
your optimal debt ratio will be a function of
a. Tax rate: Higher tax rates -> Higher optimal debt ratios. In fact, try
this exercise. Just change the tax rate to zero, holding all else fixed. The
optimal debt ratio for your firm should drop to zero.
b. Cash flows: Estimate your EBITDA as a percent of firm value (market cap +
market value of debt). If this ratio is low, your firm is limited in its capacity
to generate cash flows and will have a low optimal debt ratio. If it is high,
your optimal debt ratio will be high as well..
c. Uncertainty about the future: If your borrowing capacity is determined by
long term operating income (rather than just last year's numbers), you will borrow
less if you are a firm with uncertain about future prospects.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 16, 2008
Hi,
If you have estimated the optimal debt ratio for your firm and computed what
it would be with constraints with the cost of capital approach, you can move
on to the next step:
Other Capital Structure Approaches
You can try to do a relative capital structure analysis of your company by
looking at companies in your sector - in fact, use the same companies you
used for your bottom-up levered beta calculation - and run a regression of
debt ratios against fundamentals. This is similar to what I did for Disney
with entertainment companies. You can get the raw data for this regression
by going to my web site and downloading the compfirm.xls spreadsheet which
is at the top of the updated data page. Finally, I have an updated market
regression for debt ratio under updated data online (Cross sectional regression
of debt ratio)... You can plug in the numbers for your company to see what
its optimal debt ratio would be
http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html
Getting to the optimal debt ratio
Once you have the optimal debt ratio, you need to go through the framework
for getting to the optimal. Here are the steps:
Step 1: Evaluate whether you have the luxury of time. If you have an underlevered
firm, you are looking at the likelihood of being taken over in a hostile acquisition.
Make a judgment based upon
a. The market cap of the firm: The larger the market cap, the smaller the likelihood
b. Insider holdings: The greater the insider holdings, the lower the likelihood
c. Jensen's alpha: The more negative the alpha, the greater the likelihood
If you have an overlevered firm, you are looking at the likelihood of bankruptcy.
Your best assessment will come from the bond rating of the firm. If it is below
investment grade, the chance of bankruptcy is high.
Step 2: Examine whether your company has good investment opportunities. You
can get a partial picture by computing the EVA and ROC for the firm. If they
are positive and you believe that this will hold for future projects, you should
invest in projects with your excess debt capacity (if you are underlevered)
or with equity (if you are overlevered)
Step 3: Make your recommendation of the best path to the optimal debt ratio
for your firm.
Don't forget the theme song for the errant CEO (http://www.youtube.com/watch?v=yN2rdVS7T6U) though I think this song fits many of them better (http://www.youtube.com/watch?v=unBACOHFXes)
Hope this helps... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 18, 2008
Hi!
I hope that you got a chance to enjoy the weather today... Anyway, a couple of
notes ahead of the weekend:
1. Quiz: The third quiz is on Wednesday. As noted earlier, it will cover chapters
7-9 in the book, and pages 1- 130 (roughly in the lecture notes). The past third
quizzes will be good indicators of what to expect on this one.... The review
session will be on Tuesday in Schimmel Auditorium from 12.30-1.30 and the room
assignments will be sent out soon.
2. Project: Yes, the due date is just over two weeks away. I don't need to add
much more to that....
3. Newsletter: The newsletter for this week is attached.. Hope you get a chance
to browse through it...
And do enjoy the weekend (and I am not being facetious)... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 20, 2008
Hi!
It looks like this is the weekend that groups awakened to the realization that
time is running out... Anyway, here are two recurring issues that seem to be
coming up that I would like to set to rest.
First, there are a few of you wrestling with your beta section still. In particular,
there seem to be two roadblocks. The first is arising for those you working with
foreign companies with multiple listings. Since you can run regressions on any
one of the listings, and the regression betas all seem to be different, the question
that is being confronted is which regression to use. Before you spend too much
time on this issue, recognize that this "variability across regressions" is
one of the reasons we switch to bottom up betas and that you will also be doing
so at some point in time. For the Jensen's alpha analysis, you can use any one
of the regressions and take it apart but your analysis will be specific to how
that regression was run - in other words, when you use the R-squared to explain
how much of the risk is market risk, the answer will vary depending upon whether
the market