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The Corporate Finance (Undergraduate) Email Chronicles: Spring 2016


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, or if the scrolling will take you too long, click on the link below to go the emails, by month:

  1. January 2016
  2. February 2016
  3. March 2016
  4. April 2016
  5. May 2016
Email content

Happy new year! I hope you 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 centrality 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. I know that you feel more comfortable using Excel, but you will need a calculator for your quizzes/exams.
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
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 page for the class:
This page has everything connected to the class, including webcast links, lecture notes and project links. The syllabus has been updated:
You will be getting a hard copy of it on the first day of class but the 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.

I will also be posting the contents of the site (webcasts, lectures, posts) on iTunes U. If you have never used it, here is what you need: an Apple device (iPhone or iPad), the iTunes U app on the device and you need to link to the link below:
Like all things Apple, the set up iis very well done and it is neat, being able to catch up on a lecture you missed on your iPad, while browsing through the lecture notes on it too. I know that you are feeling overwhelmed by now, but for those of you with devices and slower broadband, I also have a YouTube Playlist for the class:
Please check it out.

Now for the material for the class. The lecture notes for the class are available as a pdf file that you can download and print. I have both a standard version (one slide per page) and an environmentally friendly version (two slides per page) to download. You can also save paper entirely and download the file to your iPad or Kindle. Make your choice.
If you prefer a copied package, the first part (of two) should be in the bookstore next week. There is a book for the class, Applied Corporate Finance, but please make sure that you get the fourth edition. It is exorbitantly over priced but you can buy, rent or download it at Amazon.com or the NYU bookstore
While I have no qualms about wasting your money, I know that some of you are budget constrained (a nice way of saying "poor") . If you really, really cannot afford the book, you should be able to live without it. I can even lend you a copy around quiz weeks.

One final point. I know that the last few years have led you to question the reach of finance (and your own career paths). I must confess that I have gone through my own share of soul searching, trying to make sense of what is going on. I will try to incorporate what I think the lessons learned, unlearned and relearned over this period are for corporate finance. There are assumptions that we have made for decades that need to be challenged and foundations that have to be reinforced. In other words, the time for cookbook and me-too finance (which is what too many firms, investment banks and consultants have indulged in) is over.

To close, I will leave you with a YouTube video that introduces you (in about 3 minutes) to the class.
I hope you enjoy it. That is about it. I am looking forward to this class. It has always been my favorite class to teach (though I love teaching valuation) and I have a singular objective. I would like to make it the best class you have ever taken, period. I know that this is going to be tough to pull off but I will really try. I hope to see you on January 25th, in class.


As the long winter break winds down, I hope you are ready to get started on classes. I also hope you got my really long email a few days back. If you did not, you can find it here:
This one, hopefully, will not be as long and has only a few items

1. Webpage for class: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
Please do try to download the first lecture note packet by Monday or buy it at the bookstore..
2. Book: I won’t put pressure on you to get the book, lest you think that I have some money making agenda here. I think that you can live without the book, though I tend to agree with its author most of the time, but if you do have money to spend, here is the link:
If you are in Asia still, you are in luck, because the Asian edition is much, much cheaper.
3. Pre-class prep: Are you kidding me? What kind of twisted mind comes up with a pre-class prep for the very first class. Just relax, have fun this weekend and try to be in class. If you cannot make it, never fear! The webcast for the class will be up a little while after the class, but it just won't be the same as being there in person.

For those of you who have not got around to checking, class is scheduled from 3.30-4.45 in Paulson Auditorium on January 25.


I hope that you are safe and warm, wherever you are. I do know that some of you are in locales far away, frantically trying to get flight home (and failing). Some of you seem to be a little freaked out about missing the first class (or two). Much as I would love to have you in person, in the class, don’t worry! Not only will you survive missing the classes, but I will make it easy for you to follow along. The class will be recorded and it will then be available to watch on three forums, the webpage for the class, iTunes U (if you have an Apple device) and YouTube. The links to all three were in your first email and are also listed below:
Webpage for class: https://www.stern.nyu.edu/~adamodar/New_Home_Page/corpfinUG.html
iTunes U: https://itunes.apple.com/us/course/id1069496444
YouTube: https://www.youtube.com/playlist?list=PLUkh9m2BorqnapcQ03A0a_jsbele2kKbp
You will also be able to download the syllabus, project description and lecture notes from the webpage. You can start forming your groups in cyber space and ask me questions about the sessions about unresolved issues. Come to think of it, I don’t see why you have to come back to New York at all, to take this class.

Incidentally, on a day like today, the blog post I wrote a few years ago after a snowstorm seems relevant:
See you when you get here!


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….. First, a quick review of what we did in today's class. I laid out the structure for the class and an agenda of what I hope to accomplish during the next 15 weeks. In addition to describing the logistical details, I presented my view that corporate finance is the ultimate big picture class because everything falls under its purview. The “big picture” of corporate finance covers the three basic decisions that every business has to make: how to allocate scarce funds across competing uses (the investment decision), how to raise funds to finance these investments (the financing decision) and how much cash to take out of the business (the dividend decision). The singular objective in corporate finance is to maximize the value of the business to its owners. This big picture was then used to emphasize three themes, with two more to come in the next class: that corporate finance is common sense, that it is focused and that the focus shifts over the life cycle.

On to housekeeping details.
1. Project Group: I have not described the project yet, but you don’t have until Wednesday to get started. For the moment, try to at least find a group that you can work with for the rest of the semester. Find people you like/trust/can get along with/ will not kill before the end of the semester. The group should be at least 4 and can be up to 8 (if you can handle the logistics). Each person will be picking a company and having a larger group will not mean less work. This group will do both a case and the project, both of which I will talk about next class.
2. Webcasts: The webcasts should be up a few hours after the class ends. Please use the webcasts as a back-up, in case you cannot make it to class or have to review something that you did not get during class, rather than as replacement for coming to class. I would really, really like to see you in class. The web cast for the first class is not up yet, but it should be soon. When it is, you should be able to find it at
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. If you were not able to come to class today, because of weather issues (or anything else), here are the links to the syllabus and project that were handed out:
Syllabus: https://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/cfUGsyllspr16.pdf
Project: https://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/cfUGproj.pdf
3. Drop by: 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....
4. Lecture note packet 1: Please bring the first lecture note packet to class on Wednesday. If you want to buy it at the bookstore and the bookstore does not have it, just print off the first 15 pages for Wednesday’s class. Here is the link to lecture note packet 1.
Lecture note packet 1: https://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/cfpacket1spr16.pdf
5. Past emails: 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
6. Post class test & solution: Each class, I will be sending out a post class test and solution for each class. This is just meant to reinforce what we did in class that day and there are no grades or prizes involved. I am attaching the ones for today's class.
7. Blog: If you are one of those people who cannot wait to get started and are interested in sports, movies or celebrities, here are a few of the blog posts that I referenced in class today:
Valuing the Star Wars Franchise: http://aswathdamodaran.blogspot.com/2013/10/game-on-tracking-stock-on-arian-foster.html
Valuing the Los Angeles Clippers: http://aswathdamodaran.blogspot.com/2014/06/ballmers-bid-for-clippers-investment.html
Valuing the Arian Foster tracking stock: http://aswathdamodaran.blogspot.com/2013/10/game-on-tracking-stock-on-arian-foster.html
Yahoo, the Walking Dead Company: http://aswathdamodaran.blogspot.com/2014/09/the-walking-dead-blackberry-yahoo-and.html
All of these readings are optional, but my objective is that you be able to do the valuations embedded in them by the end of the class.


I am sorry to hit you with a second email in one day, but since so many people were missing in class today, I thought it would be useful to let you know that the webcasts are up and running. As I mentioned in class, there are four ways you can access them:
1. As a stream
2. As a downloadable video
3. As a downloadable audio
4. As a YouTube video
You can get links to all of them on the webcast page, which is where all the videos for this class will go. So, even if you were in class today, please visit the page and just click on the links to see how they work.
In fact, if you are still bored, you can also check out the iTunes U page for the class and download the iTunes U app on to your iPad or iPhone. Once you have it, you can add this course, by entered ESM-CKF-EYD in the enroll code. You can also see the course by going to:
You will then be notified every time that something gets posted on the account. It is cool. Try it!

I also mentioned in class that I would create a Google shared spreadsheet to sign up. The link is below.
Please go in and sign up for a day that is open. You will have 2 minutes at the start of the class to make your pitch and I will assume that you will keep it relevant and focused.

1/26/16 I know that it is the first week of this class but it is never too early to start thinking creatively. This week’s puzzle is built around the corporate life cycle structure that I introduced in class yesterday, and particularly around what to do with Microsoft. Start by reading the description of the puzzle:
If you have the time, do read the two blog posts referenced in the puzzle:
Then, put yourself in the shoes of Microsoft’s CEO and think about what you would do, if you ran the company. In particular, I want you to think about what would make the most sense for Microsoft’s stockholders and then think about what would advance your personal capital the most and decide. Have fun with it. There is no right answer but I opened a discussion board on NYU Classes (now open for business) and you can go in and put your thoughts down.

In today's class, we started on what the objective in running a business should be. While corporate finance states it to be maximizing firm value, it is often practiced as maximizing stock price. To make the world safe for stock price maximization, we do have to make key assumptions: that managers act in the best interests of stockholders, that lenders are fully protected, that information flows to rational investors and that there are no social costs. Next week, we will rip these assumptions apart and look at what can go wrong.

1. Other People's Money: Just a few added notes relating to the class that I want to bring to your attention. The first is the movie Other People's Money, which is one of my favorites for illustrating the straw men that people like to set up and knock down. You can find out more about the movie here:
But I found the best part on YouTube. It is Danny DeVito's "Larry the Liquidator" speech:
Watch it when you get a chance. Not only is it entertaining but it is a learning experience (though I am not sure what you learn). Incidentally, it is much, much better than Michael Douglas's "Greed is good" speech in the first "Wall Street " which was a blatant rip-off of Ivan Boesky's graduation address to the UC Berkeley MBAs in 1986 (which I happened to be at, since I was teaching there that year).

2. DisneyWars: In next week’s session, I will be talking about the dysfunctional state of Disney in the 1990s. If you want to review these on your own, try this book written by James Stewart. It is in paperback, on Amazon:
If you are budget-constrained, you can borrow my copy and return in when you are done. (I have only one copy. First come, first served)

3. Company Choice: On the question of picking companies for your group, some (unsolicited) advice:
(1) Define your theme broadly: In other words, don't pick five airlines as your group. Pick United Airlines, Southwest, Singapore Airlines, 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 (these are Depository Receipts that are traded in US dollars) 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 .....
As a final reminder. Please pick your company soon... As you can see from today's class, we are getting started on assessing your company…

If you want to print off the financial statements for your company, I would recommend that you start with the annual report for the most recent year. You should be able to pull it off the website for the company, under investor relations. If you want to keep going, and it is a US company, go to o the SEC site (http://www.sec.gov). If it is a non-US company, you will have to find the equivalent regulatory body in your country. For some of your companies, you will find less data than on others. Don’t fret. This too shall pass.

Finally, Gloria Li, who made the announcement at the start of class today, wanted me to pass on the message about Morning Brew, which is a free e-mail newsletter with daily business-related briefs compiled by a trader at Morgan Stanley, for which she is a Campus Ambassador:

Have fun with it!


It is never too early to start nagging you about the project. So, let me get started with a checklist (which is short for this week but will get longer each week. Here is the list of things that would be nice to get behind you:
Find a group: If you have trouble finding one, I have started the orphan spreadsheet for the class. (https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1ocZS0m3Q_d08aezjVC7zSTbbD_K0KsyzHtcUoVYV3Iw/edit?usp=sharing ). Just as an example, I have entered myself as the first orphan. Please do not adopt me, since I am not interested in group work, specifically, and in doing any work, generally, preferring a life of leisure.
Pick a company/theme: This will require some coordination across the group but please pick a company and find a theme that works for the group.
Pull up an annual report: Find the most recent annual report for your company. (Website: Try the company’s own site and click on investor relations.)
SEC filings: If your company has quarterly reports or filings pull them up as well. (Website: sec.gov)

In doing all of this, you will need data and Stern subscribes to one of the two industry standards: S&P Capital IQ (the other is Factset). It is truly a remarkable dataset with hundreds of items on tens of thousands of public companies listed globally, including corporate governance measures. However, to use Capital IQ, you have to enroll and this is an email I got earlier this week about enrolling. Please, please register now. You will not regret it and it will not only save you lots of time in the future but will give you another weapon you can use in analysis. The undergraduate terminals that allow Capital IQ access are located in the computer bank near Stair Y on the LC level (I have no idea whether this still holds since I am terrified of the LC level, which (I think) is populated with vampires.. So let me know if it is not), and the graduate terminals are located on the 5th floor of KMC outside Suite 5-100. Capital IQ is accessed by clicking the Capital IQ bookmark in Firefox or a different browser.


As promised, here is the first of the weekly in-practice webcasts. These are 10-15 minute webcasts designed to work on practical issues in corporate finance. This week’s issue is a timely one, if you are working on picking companies for your project (as you should be..). It is about the process of collecting data for companies, the first step in understanding and analyzing them. The webcast link is below:
I don’t think it is too painful to watch and you may even find it useful. I have also put the link up on the webcast page for the class:
The webcasts for the first two classes should be on there, if you missed (physically, metaphysically or mentally) and the links to the project and syllabus that I handed out in the class. At the risk of nagging, please do get the lecture note packet 1 printed off or bought before Monday’s class.

In my email yesterday, I suggested that you sign up for Capital IQ. I have been told that undergraduates cannot register for Cap IQ but that you can access Capital IQ at the terminals in LC that I referenced in my email. I hope that you find those terminals and that you are able to get the company selection and data collection phase down. It may seem early, but remember that the first couple of weeks are usually the ones that have the most slack that you can use. Once classes start to heat you, your free time will also dry up. That is about it for today. Have a great weekend and don’t be surprised to hear from me both tomorrow and day after.


The weekend is here and your first newsletter is also attached. Not much news (but there never will be). This is designed more to keep you attuned to where we are in the class and where we are going. Take a look at it, when you get a chance, find a group, pick a company and let’s get started. Time is a’wasting.

Attached: Newsletter # 1


This week, we will continue with our discussion of what the end game in corporate finance is, by focusing first on where power in a company rests (stockholders, managers, labor, the government) and the consequences for corporate finance. We will then move on to lenders/bondholders and how left unprotected, they can be exploited, and on to financial markets, examining both the predilection of firms to delay/manage bad news and investor reactions to it. Having laid bare the limitations of the assumptions that underlie traditional corporate finance, we will examine alternatives to stock price maximization. If you want to get ready for the class, you can start reading chapter 2 of the book (if you have it). It is a long chapter, but it does lay out the philosophical foundation of corporate finance.

On a different note, remember the weekly puzzle built around Microsoft’s future (I know that you do not, but I have to act like you do.) The question that I posed to you is what path, you as Microsoft’s CEO, would take the company on and gave you three choices: recognize that you are an aging company, scale down ambitions, and focus on getting smaller, seek out new ways of growth and perhaps look for a rebirth or change your business to make it difficult for others to take away your growth. If you are pondering those choices, you might find this New York Times story on Microsoft’s earnings report (which came out last weeK) to be interesting:
The essence of the story is that there seems to be potential in the cloud computing business. It has to be read in context, which is that earnings and revenues dropped for Microsoft. So, put that into your decision matrix as well.

One final reminder. I think that the lecture note packets are in stock at the bookstore. So, please bring lecture note packet 1 with you to class tomorrow (either in the bookstore version, your downloaded version or a printout). See you in class tomorrow!

2/1/16 In today's class, we started to look at the what can wrong with the Utopian world that allows us to focus on stock price maximization. In particular, we examined how the mechanisms that shareholders use to keep managers in line, the annual meeting and the board of directors, are flawed. We closed with the general question of looking at how much power stockholders have to create change in corporations. 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 have posted 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 under corporate finance readings:
In fact, if you suffer from insomnia, read the Sarbanes-Oxley law, which I have also posted up there.. It will put you to sleep. There are a number of interesting sites that keep track of directors and their workings. I have listed a few below:
http://corpgov.net/: This is a general site listing corporate governance issues and links
http://www.ecgi.org/ : Covers corporate governance in Europe
ISS (Institutional Shareholder Services) also measures corporate governance for many US companies with a corporate governance score. You can find out more by going to their site: http://www.issgovernance.com
If you have used Capital IQ (and you have access to it, you can download all kinds of stuff on your company's corporate governance structure & I will send you another email later today about accessing it). I will be putting a webcast online on Friday on how to use Capital IQ to best effect to evaluate corporate governance. 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 US-based company.. You may not be able to find a 14-DEF.
More on this in tomorrow’s email. Finally, if you are interested in the Theranos story, you may be also interested in this blog post that I wrote on it a few months ago:
It is a fairy tale, but perhaps without a happy ending. More Brothers Grimm than Disney…
2/2/16 It is Tuesday and time for the second weekly challenge. n the utopian world, maximizing a company's stock price is equivalent to maximizing it's value, since markets are efficient. But what if they are not? What if markets are driven by short term considerations and investors? In that case, maximizing prices is not the same as maximizing value. This puzzle is built around a letter than Lawrence Fink, head of Blackrock, sent to the S&P 500 companies advising them to play the long game. The details of the puzzle are at the link below:
After you have read the puzzle, here are the five questions that I would like you to start thinking about, since it is a perfect preview for tomorrow’s class:
Do you think that investors are collectively guilty of being short term in their thinking? What evidence can you offer to back this up?
If yes, who do you think is more short term? Instiutitional investors or individual investors? Any evidence?
Are managers at companies more long term or more short term than investors? Why?
Mr. Fink is suggesting that if companies don't tell compelling stories about where they are going, investors will step in and fill in the details. Do you agree with this statement? If yes, what is the solution?
If your end game is a more efficient market (where value and price converge), and you were a top public policy official or a politicians running for high office, what changes would you propose to market regulations, tax laws and investor rights to make this happen?
To respond to these questions or other ones that you might come up with, I have decided to leave the safe and stifling constraints of NYU classes and put you into YellowDig, a social media based platform, where I will be posting these puzzles and the rest of the class. I sent out an invitation this morning asking you to join YellowDig. Please do so, as soon as you get a chance, and start posting. Think of it as a Facebook page for the class. Until next time!

Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to 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? i also want to think about how managers in publicly traded companies can position themselves best to consider the public good, without being charitable with other people's money. We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. We closed by looking at what we should be doing in this very imperfect world in terms of choices. As always, reading ahead in chapter 2 will be helpful.

I hope that your search for a group has ended well and that you are thinking about the companies that you would like to analyze. Better still, perhaps you have a company picked out already. If you do, try to find a Bloomberg terminal... If you do find one vacant, jump on it and try the following:
1. Press the EQUITY button
3. Type the name of your company
4. You might get multiple listings for your company, especially if it is a large company with multiple listings and securities. Try to find your local listing. For a US company, this will usually be the one with your stock symbol followed by US. For a non-US company, it will have the exchange symbol for your country (GR: Germany, FP: France, LN: UK etc...) It may take some trial and error to find the listing....
5. Type in HDS
6. Print off the first page of the HDS (it should have the top 17 investors in your company).

If you cannot find a Bloomberg terminal or don't have access to one, try going on Yahoo! Finance and type in the name or symbol for your company. Once you find your company, Click on the Holders tab. You should get a listing of the top stockholders in your company. In fact, while you are on that page, take note of the percent of your company's stock held by insiders and by institutions. I have also attached the post class test and solution for today's class.


As for the project & class, time sure does fly, when you are having fun... We are exactly one seventh of the way (4 sessions out of 28) through the class (in terms of class time) and we will kick into high gear in the next two weeks. I am going to assume for the moment that my nagging has worked and that you have picked a company to analyze. Here is what you can be doing (or better still, have done already):
1. Download the latest financials for the company: You don't have to print them off. In fact, I find it convenient to keep them in a folder in pdf format, since my computer can search the document far more quickly than I can. For all companies, this will include the latest annual report and with US companies, try to find the latest 10K and 10Q on the SEC website. If you are analyzing a private business, you will need to get the most recent financial data from the owner (who hopefully is related to you and still likes you...)
2. Put the board of directors under a microscope: The first step in understanding your company is to start at the top. Take a look at who sits on the board and how long they have been sitting there. In particular, the question that you are trying to answer is how effective this board will be in keeping any eye on the top management of the company. Start with the cosmetic measures, which is what most corporate governance services and laws focus on, but look for something more tangible. Has the board shown any backbone in stopping or slowing down management?
3. Assess the "power" structure: As Machiavelli pointed out, power abhors a vacuum (he said no such thing, but you can pretty much attribute anything to him or Confucius and sound literate). Specifically, try to find who the largest stockholders in your company are. You can get this from the Bloomberg terminals (HDS page), Capital IQ (holders) or online for free (Yahoo! Finance or Morningstar). Once you have this list, here are the questions that you should try to answer:
If you are a small stockholder in this company, do you see any likelihood that any of these stockholders will stand up for stockholder rights or are they more likely to sell and run?
Are there any stockholders on the list whose interests may lie in something other than maximizing stockholder wealth? (For instance, we talked about the government as a stockholder and how its interests may be different from that of the rest of the stockholders.. Think of an employee pension fund being on that list... Or another company being the largest stockholder...)
I will be putting up a webcast tomorrow on how to analyze the "top shareholder" list, using a range of companies. Hope you to get a chance to watch it.

On a different note, I want to update you on your TAs, their office hours and the review sessions that they have planned.
Ombretta Pettinato, opettina@stern.nyu.edu, Wednesday from 11-12
Andre Perreira, andre.pereira@stern.nyu.edu, Tuesday from 11-12
Nick McIntyre, nam530@stern.nyu.edu, Tuesday from 4-5
They plan to have a review session every week on Tuesday from 12-1 in KMEC 3-50. Since the room fits only about 60 people, I have set up a Google sign up spreadsheet for the classes, if you are interested in attending. The sessions will take problems from past quizzes and work through them in sync with what is going in class.
Google sign up sheet: https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1l4PvmAkdOyJ-2lDqoKjtdGiy3zVWj4Qqiqli6MUQF2g/edit?usp=sharing


As you get ready to enjoy your weekend, a few notes for today:
1. Lecture note packets: The bookstore has lecture note packet 1 in stock, if you are interested in buying it. The download for free on to your iPad or print if off some sucker's printer options are always available. You can get the packet by clicking on the link below:

2. Post-class tests: I posted post-class tests for both of this week's sessions and will continue to do so for all of the coming ones. If you have already worked through them, thank you. If not, just browse through them quickly to make sure that there are no loose ends. You will find them on the webcast page for the class( https://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastUGspr16.htm), the Yellowdig page for the class, on iTunes U or on the Youtube channel for the class. Take your pick.

3. Orphans: I am getting straggling emails from some of you about your sad plight as orphans. The orphan page can be found here for both listing and adoption:
Since there are now six people on the list, I will try to get you together to create an orphan group.

4. Webcast of the week: This week's In-Practice webcast is up and ready to watch. It looks at ways to assess the corporate governance at your company, using HP from 2013 as an example. I use HP's annual report, its filings with the SEC and other public information to make my assessment of the company.
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/corpgovHP.mp4
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/corpgov.ppt
HP Annual Report: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf
HP 14DEF: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf
You can find these links in all three forums (my webcast page, Yellowdig, iTunes U) and it looks at what information to use and how to use it to assess the corporate governance structure of a company. Let me know if there are "production quality" issues and I know.. I know.. That striped sweater is not camera-ready, but I forgot... Sorry!

5. Corporate finance email chronicles: I have updated the email chronicles page to reflect all the emails sent out in this class:
If you joined the class late, have short term memory loss or are nostalgic for emails from days gone by, click on the link.

6. Weekly puzzle posting: I posted the secondweekly puzzle of the week about Larry Fink’s letter to corporations asking them to focus on long term value (rather than price). If you want to participate, you can go to the discussion board on Yellowdig and post your views (with links, if you so desire). You have to be registered on Yelllowdig to do this. Only about 20% of you accepted my invitation. I will send another one out today.


I hope that your weekend is off to a good start. When you wake up today (it is Saturday and I expect that you are sleeping in..), this email should be waiting for you with the second newsletter.

Attachment: Issue 2 (February 6)

2/7/16 This week, we will complete the discussion of the objective tomorrow by examining the growth and potential dangers of morality-based investing, where social costs are front and center in decision making. We will then start on the big question that underlies so much of business and investing, which is risk, what it is, how to measure it and how to convert that measure into a hurdle rate. If you have a chance, review what you did in your foundations class on the topic or read ahead to chapter 3. I know that it is Super Bowl Sunday and I hope that you have a great time at the party. You may even be able to tear yourself away from the partying to watch some of the game.

As we take baby steps towards measuring risk, I want to review where we stand. 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 three 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? Third, take your objective (and the measurement device you have developed) and ask yourself a cynical question: How might managers game this system for maximum benefit, while hurting you as an owner? In the long term, you may almost guarantee that this will happen. On the theme of investor time horizon and stockholder composition, here is an interesting read: http://bit.ly/YrNIMX
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? On the question of socially responsibility, there are groups out there that rank companies based upon social responsibility. I have listed a few below, but they are a few of many:
Ethisphere (never heard of them): http://ethisphere.com/worlds-most-ethical/wme-honorees/
Calvert Social Index: http://www.calvert.com/sri-index.html
Domini: http://www.kld.com/indexes/ds400index/index.htm
Dow Jones Sustainability Index: http://www.sustainability-indices.com
And this is just the tip of the iceberg. Environmental organizations, labor unions and other groups all have their own corporate rankings. In other words, whatever your key social issue is, there is a way to stay true (as a consumer and investor).

If you have picked a company, there are two orders of business you have for this week:
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 continue with our discussion of risk on Wednesday (no class on Monday). As part of that discussion, we will confront the question of who the marginal investor in your company is. If you have already printed off the list of the top stockholders in your company (HDS page in Bloomberg or the Major Holders page from Yahoo! Finance), bring it with you again. If you have not, please do so before the next class. Also, watch for the in-practice webcast day after tomorrow, because I will go through how to break down the HDS page.

Finally, I mentioned a paper that related stock prices to corporate governance scores in class last Wednesday. You can find the link to the paper below:
In closing, though, I know that the sheer size of the class and the setting make it intimidating for participation. I understand but I hope that (a) you will feel comfortable enough to make your views heard, even if they are violently at odds with mine and (b) that you talk to me in person or by email about specific issues that we are covering in class that you may not understand or have a different perspective.

This email has gone on way too long already, but one final note. In talking about Vale, I mentioned the effect that a bad objective (driven by government considerations) can have on a firm. If you want to see the end result of bad focus, take a look at this post that I had on Petrobras from a while back.

I am also attaching the post-class test & solution for this session.

Attachments: Post-class test and solution


Yesterday, we discussed risk and return models in finance and how their measurement of risk is built on the presumption that marginal investors are diversified. While the argument for diversification is always a slam dunk in class rooms, with statistical evidence at its base, it is surprisingly contested. Thus, there is a significant subset of investors who believe that diversification hurts investors rather than helps them, and while it is easy to dismiss them as uninformed, I think we make a mistake by doing so. In fact, I can see why some investors may be better off with more concentrated portfolios and I captured the essence of the trade off in a blog post that I did a while back:

In this week’s challenge, I would like you to think about diversification intuitively and personally. In particular, read the full challenge here:

Then, please try to answer the following questions:
1. Both sides of this debate use overwrought claims to make their case.
- Some proponents of diversification claim that diversifying across assets and asset classes eliminates all risk from your portfolio. Explain why this is not true.
- Some proponents of concentrated portfolios claim that if you diversify, all you can ever do is keep up with the market. Explain why this is not true.
2. How many stocks/assets would you hold in your portfolio?
a. One to two stocks/assets
b. Three to five
c. Five to ten
d. Ten to Twenty
e. Twenty to Fifty
f. More than Fifty
3. Explain why you chose the number that you did in the last question and how it may change over time (as you age, gain more investing knowledge, get wealthier).
4. If you have an entrepreneurial streak and want to start your own business, you will end up undiversified, investing all your human and financial capital in that start up, at least to begin with. How do you reconcile this action with the argument for diversification?


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. We started on the question of risk free rates and how to assess them in different currencies. In particular, we noted that government bonds are not always risk free and may have to be cleansed of default risk. The rest of today's class was spent talking about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at two different ways of estimating the equity risk premium.
1. Survey Premiums: I had mentioned survey premiums in class and two in particular - one by Merrill of institutional investors and one of CFOs. You can find the Merrill survey on its research link (but you may be asked for a password). You can get the other surveys at the links below:
CFO survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2422008
Analyst survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2450452
2. Historical Premiums: We also talked about historical risk premiums. To see the raw data on historical premiums on my site (and save yourself the price you would pay for Ibbotson's data...) go to updated data on my website:
There is much more to talk about in this context and we will in the next class. Post class test and solution attached.

Attachments: Post-class test and solution


I am afraid that it is nagging time again, At the risk of sounding like a broken record, please pick a company soon. In fact, if you have a group and have picked companies, could you please enter your choices in the shared Google Spreadsheet below:
It will allow people to see the variation of companies across the class. Don’t worry! It will not be graded.

If you have picked a company, 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. There will be an in-practice webcast going up tomorrow that should help you in this task.

If you are daring, you can even try to estimate a risk free rate in the currency that you will be doing the analysis in. This will require some homework, starting with government bond rates in different currencies, which you can get here:
You have to follow up with sovereign CDS spreads, which I have attached to this email, or with a rating for the country, which is also attached. Finally, you have to try to estimate a risk free rate, based upon the spread. Give it your best shot and if you have trouble, wait for the other in-practice webcast tomorrow.

Attachments: Sovereign CDS Spreads (Feb 2016), Moody's Ratings (Feb 2016)


Since you have a long weekend with nothing to watch (at least until Sunday when the new season of The Walking Dead starts), I have two in-practice webcasts. Since these are integral parts of your project, the best way to use these webcasts is in conjunction with your project.
1. Stockholder Holding Assessment: This webcast is on assessing who the top stockholders in your company are and thinking through the potential conflicts of interest you will face as a result. The webcast went a little longer than I wanted it to (it is about 24 minutes) but if you do have the list of the top stockholders in your company (the HDS page from Bloomberg, Capital IQ, Morningstar or some other source), I think you will find it useful.
Webcast link: http://youtu.be/x_H_4KTeOkc
Presentation link: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/holders.pdf
Finally, one hopeful sign for investors is the presence of activist investors (like Carl Icahn) in your midst, not because they always do the right thing but because they put managers on notice. To help you determine whether you have an activist investor in your listing, I have a link (dated, but it is the best I could do) that lists the activist investors in the US (with phone numbers, if you ever want to call them):
2. Risk free rate: If you have picked a company, you should be able to pick a currency to do your analysis. Most of the time, the most pragmatic choice is to stick with the local currency, in which the financials are reported. Note, though, that if you have a commodity company, the conventional practice is often to report everything in US dollars, even for non-US companies. Once you pick the currency, you should try to get a risk free rate. As I promised, I do have a webcast on estimating the risk free rate that you may or may not find useful. It is posted on the webcast page for the class, Lore and iTunes U.
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/riskfree/riskfree.ppt
While the spreadsheet uses (and links) to the sovereign ratings and CDS spreads from March 2013, I sent you the updated sovereign CDS spreads and Moody’s ratings yesterday and I have attahed the updated lookup table for sovereign CDS spreads to this email. Have a great extended weekend and I will see you in class on Wednesday!

Attachment: Sovereign Rating Default Spreads (January 2016)


Hope you enjoy your long weekend. Latest newsletter attached. Find a group. Pick a company. Collect data. Get a risk free rate. (Sorry.. Went into nagging mode..)

Attachments: Issue 3 (February 13)


I hope that your long weekend went well, weather notwithstanding. Both economics and finance are built on the pillar of risk aversion, i.e., that investors need to be paid extra (over and above an expected value) to take risks. That notion of risk aversion has been challenged and modified over time, but it still is at the heart of how we measure risk and come up with expected returns. Economists agree that not only does risk aversion vary across individuals but it also varies, for the same individual, across time. In this puzzle, which has no right answer, I would like you to wrestle with the question of how risk averse you, explanations that you can offer for that risk aversion and the consequences for your business and investment decision making. You can find the full details of the puzzle here:

One of the side products of the growth of robo advisors is a proliferation of tools that investors can use to assess how risk averse they are. This article in the New York Times nicely sets the table. In the article, the writer references two services that have made their tools available for readers to try out. Here the links to the two:
Fina Metrica: riskprofiling.com/nytfreetest
Riskalyze: pro.riskalyze.com/clients/index/46021971..
Take one of the tests, both to get a measure of how risk aversion gets measured and how risk averse you are as an individual. Then, try to answer the following questions:
Consider the equity risk premium in the market today (use the implied premium from the start of this month). Given your risk aversion, do you feel this premium is sufficient given how risky you think equity is as an investment? (I know that this is subjective but make your best choice)
Do you think that your risk aversion is affected by what you read and watch? If no, why not? If yes, how?
If the market goes up strongly for the rest of the year, do your think your risk aversion will change? If so, in which direction?
If the market goes down significantly for the rest of the year, do your think your risk aversion will change? If so, in which direction?
As always it is posted on Yellowdig, which is also available as an app, if you are interested.


The bulk of today's class was spent talking about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. After briefly reviewing the weaknesses of historical premiums, we computed an implied equity risk premium for the S&P 500, using the level of the index. If you want to try your hand at it, here is my February 2015 update:
Play with the spreadsheet. Try changing the index level, for instance, and see what it does to the premium.

We then moved on to country risk premiums, using the country default spreads that we estimated for countries as a starting point and then coming up with country risk premiums for individual countries. If you are interested in the entire cross section of country risk premiums, start with this blog post that I put up at the start of the year on the topic:

Then, download the country risk premiums that I had at the start of February, by country.
As a final step, see if you can find the geographic revenue distribution for your company. You can then use my country risk premium estimates to get the ERP for your company.

Beta reminder: Pease do try to find a Bloomberg terminal. Click on Equities, find your stock (pinpoint the local listing; there can be dozens of listings....) and once you are on your stock's page of choices, type in BETA. A beta page should magically appear, with a two-year regression beta for your company. Print if off. If no one is waiting for the terminal, try these variations:
1. Time period: Change the default to make it about 5 years and the interval from weekly (W) to monthly (M). Print that page off
2. Index: The default index that Bloomberg uses is the local index (a topic for discussion next session). You can change the index. Type in NFT (Bloomberg's symbol for the MSCI Global Equity index) in the index box and rerun the regression.
Bring the beta page (s) with you to class on Monday. Let's get the project done in real time, in class.

The post class test and solution for today are attached.

2/18/16 If my nagging is paying off, you should have picked a company by now and if you have, you can move on to the equity risk premium part of your project. The first step is to review the material from yesterday’s class first, so that you understand the basics of equity risk premium estimation. Once you have done that, you should print off or download (I prefer the latter) the annual report or 10K for your company. As you browse through the document, look for any information that the company gives you on where it does business. Most companies will give you a breakdown of revenues geographically, though not always at the level of detail that you like, and some may even go further and give you EBITDA or assets geographically. Take what you can get and stick with revenues as your measure of geographic exposure. Your final task is to create a weighted average of the equity risk premiums and while you can use the equity risk premium spreadsheet below and your task can range from simple to slightly messy, depending upon your regional breakdowns:
1. If you have your company’s exposure to individual countries: Your task is simple. You can use the equity risk premiums that I have for those countries and take a weighted average.
2. If you have your company’s regional exposure and it matches my regional breakdown: I computed weighted averages for Asia, North America, South America, Western Europe, Eastern Europe/Russia, Asia and Australia/NZ. If your company breakdown is similar or close, you can use my weighted averages.
3. If you have your company’s regional exposure but it does not match mine: You will have to be ingenious, but it is not too difficult to do. Start with this spreadsheet, which has GDP and ERP for each country:
Set the GDPs of any country/ region you don’t want to count in your average to zero and the spreadsheet will compute the ERP for your designated region. Thus, if you has a US company that breaks down revenues into the US and the rest of the world, all you need to do is set the GDP for the US to zero and the global weighted average that you get will now be for the rest of the world. If you have no idea what I am talking about, watch the in-Practice webcast which will be put up tomorrow.
2/19/16 In yesterday’s email, I suggested to you that you estimate the equity risk premium for your company. Since you are so good about following my directions, I know that you have already done what you need to, but in case you run into trouble, the attached webcast might be helpful. It looks at both how I estimate equity risk premiums for countries and how to estimate the equity risk premium for an individual company, even one that uses an eclectic geographic breakdown of revenues:
Webcast: https://youtu.be/D3IGn6tH03c?list=PLUkh9m2BorqkNIdjpZY2kI0qzRbEv5F5L
Slides: https://people.stern.nyu.edu/adamodar/pdfiles/blog/ERPforCompany.pdf
ERP&GDP spreadsheet: https://www.stern.nyu.edu/~adamodar/pc/datasets/ERP&GDP.xls
I hope that you find it useful. Have a great weekend
2/20/16 The weekly newsletter is attached. If you are interested, I did three posts on my blog this week, pairing of companies: Apple vs Alphabet on Monday, Amazon and Netflix on Wednesday and Facebook and Twitter on Friday, looking at them as businesses, investments and trades.
Apple vs Alphabet: http://aswathdamodaran.blogspot.com/2016/02/race-to-top-duel-between-alphabet-and.html
Amazon vs Netflix: http://aswathdamodaran.blogspot.com/2016/02/the-disruptive-duo-amazon-and-netflix.html
Facebook vs Twitter: http://aswathdamodaran.blogspot.com/2016/02/management-matters-facebook-and-twitter.html
I hope that you enjoy them

Today's class covered the conventional approach to estimating betas, which is to run a regression of returns on a stock against returns on the market index. We first covered the estimation choices: how far back in time to go (depends on how much your company has changed), what return interval to use (weekly or monthly are better than daily), what to include in returns (dividends and price appreciation) and the market index to use (broader and wider is better). We also looked at the three key pieces of output from the regression:
1. The intercept: This is a measure of how good or bad an investment your stock was during the period of your regression. To compute the measure correctly, you net out Rf(1-Beta) from the Intercept:
Jensen's alpha = Intercept - Riskfree rate (1- Beta)
If this number is a positive (negative) number, your stock did better (worse) than expected, after adjusting for risk and market performance.
2. The slope: is the beta, albeit with standard error
3. The R squared: measures the proportion of the risk in your stock that is market risk, with the balance being firm specific/diversifiable risk.
Finally, we used the beta to come up with an expected return for stock investors/cost of equity for the company.

If you can get your hands on the beta page for your company, you should be able to make these assessments for your company. You can also get a guide to reading the Bloomberg pages for your company by clicking below:
Please try to strike while the iron is hot and get this section done for your company.

Finally, I have also attached the post-class test and solution for today.

Attachment: Post-class test and solution


I thought it would be useful to use this week’s puzzle to take a closer look at regression betas: how they are estimated, why they vary across services and what they tell us about risk in firms. I have used Volkswagen as my illustrative example, and you can see the details of the puzzle here:
In effect, I have given you four regressions (attached) that are all for the last two years of weekly returns for Volkswagen against four different indices: an Auto/Auto Parts Index, the DAX (German equities), the MSCI European index and the MSCI Global Index. I have five questions for you:
List out the key regression statistics (alpha, beta and R squared) in the four regressions. Do you notice any patterns? Can you explain them?
If you are analyzing Volkswagen and were required to use one of these regression betas, which one would you use and why?
With the beta that you decided to us, estimate the range on the beta and what it means for your estimate of cost of equity.
Volkswagen was also involved in a major scandal for much of the last eight months of the regression, where it admitted to cheating in emissions tests, lost almost half of its value, saw the resignation of its CEO and faces billions of dollars in fines and legal charges. What effect, if any, do you think this crisis has had on your estimated regression betas (increased them, decreased them, left them unchanged)? Explain why.
In class, we talked about how corporate governance is closely related to whether you will use this number as your cost of equity. If companies with weak corporate governance are more likely to treat equity as cheap or even free capital, what are the consequences for the investments that they will make? How would you test this hypothesis?
As always, I will post the puzzle on YellowDig and hope that you get a chance to comment.

Attached: Volkswagen's Betas


I want to spend this email 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 erminology 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: When you borrow money, you create a fixed cost (interest expenses) that makes your equity earnings more volatile. Thus, the equity beta in a safe business can be outlandishly high if has lots of debt. The levered beta equation we went through is a staple for this class and we will revisit it again and again. So, start getting comfortable with it.

I also introduced the notion of betas being weighted averages with the Disney - Cap Cities example. I worked out the beta for Disney under two scenarios: an all-equity funded acquisition of Cap Cities and their $10 billion debt/ $8.5 billion equity acquisition. As an exercise, please try to work out the levered beta for Disney on the assumption that they funded the entire acquisition with debt (all $18.5 billion). The answer will be in tomorrow's email.

If you are ready to get started on preparing for the first quiz, here are the links that you need:
All past Quiz 1s: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1.pdf
Solutions to all past quiz 1s: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1sol.xls

Attachments: Post-class test and solution

2/25/16 I know that you are probably putting your project to the side, while preparing for the quiz, but I would suggest that you can do both.
1. Beta regression: If you get a chance, take apart the beta regression for your company, akin to what I did, in class, with Disney. If you are still a little shaky, the in-Practice webcast tomorrow will take you through the process and it will be good preparation for the quiz.
2. Disney/Cap Cities: If you remember, we looked at the beta for Disney after its acquisition of Cap Cities in the last class. 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 issue 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 and it assumes the debt that Cap Cities used to have before the acquisition)
Equity after the merger = $31,100 (Disney's equity pre-merger does not change)
D/E Ratio = 22,301/31,100= 0.7171
Levered beta = 1.026 (1+ (1-.36) (0.7171)) = 1.497
Note that I used a marginal tax rate of 36% for both companies, which was the case in 1996.
3. Quiz Prep: The past quizzes and solutions are online and you should start trying them, when you feel ready. Make sure that you hold out a couple for a more real-time test (where you give yourself 30 minutes and don’t check the answers along the way).
2/26/16 In this week’s webcast, I take a look at Disney's 2-year weekly regression (from February 2011- February 2013). I have the Bloomberg page attached. I am also attaching the spreadsheet that I used to analyze this regression, which you are welcome to use on your company. The webcast is available at the link below:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/Regression.mp4
Disney’s Regression Bloomberg beta page: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Regression/Disneyregression.pdf
I think that this will be helpful in preparing both for the project and the quiz. So, please give it a shot! Until next time!

Two quick notes. First, the newsletter for the week is attached. Second, as you well know, the quiz is on Wednesday and I hope that you get a chance to work through some of the old quizzes today and tomorrow. I will send you a longer email tomorrow specifically about the quiz.

Attachment: Issue 5 (February 27)


I won't ask you how the weekend is going, because I may be hitting a sore spot. I did put together a list of the top ten questions that I am getting in my emails. Perhaps, you have one of these questions:

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 weekly/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. How do you decide whether to use a historical or an implied equity risk premium?
In a market like the US, with a long and uninterrupted history, the choice depends on whether you believe that things will revert back to the way they were (in which case you may decide to go with the historical premium) or that the world is a dynamic, ever-shifting place, in which case you should go with the implied premium. In most other markets, where you don't have a long history, it is not really a choice, since the historical premium is too noisy (big standard error) to even be in contention. Thus, I use a short cut. If it is a AAA rated country like Germany or Australia or Singapore, I use the US equity risk premium, arguing that mature markets need to share a common premium. If it is not a AAA rated country, see the answer to (4).

3. How do you estimate a riskfree rate for a currency in an emerging market?
If you are doing your analysis in US dollars or Euros, you would use the riskfree rates in those currencies: the US treasury bond rate for US dollars and the German Euro bond for the Euro. 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). The default spread can be obtained in one of three ways: (a) The difference between the rate on a dollar (Euro) denominated bond issued by the country and the US treasury bond rate (German Euro bond rate), (b) CDS spread for the country or (c) typical default spread given the local currency rating for the country.

4. How do you adjust for the additional country risk in companies that have operations in emerging markets?
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 Mexico example in the review) and adding this amount to the US premium. This will give you a higher cost of equity. If you are given enough information to do the latter, do it (rather than use just the default spread). When assessing the equity risk premium for a company, look past where the company is incorporated at where it does business. The equity risk premium that you use should be a weighted average of the equity risk premiums of the countries in which the company operates.

5. Why do you use revenues (rather than EBIT or EBITDA) as the basis for your weighting?
Note that what you would really like to know is the value of a company's different businesses/geographies, but since you don't have value, you look for proxies. While you may have a choice of different measures (revenues, EBITDA, EBIT etc), I prefer revenues for three reasons. First, it is always a positive number, which is good since I want weights that are greater than zero. Second, it is less susceptible to accounting allocation judgments than numbers lower down on the accounting statement. Third, I can convert it into a value by using an EV/Sales multiple, which I can get from the sector.

6. Why do you use the average debt to equity ratio in the past to unlever a regression beta?
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... When the number is low, as is usually teh case with riskfree rates, you can use the approximation of dividing by 12 (to get monthly) or 52 (to get weekly). But try to always compound the Jensen's alpha numbers, since they can be much bigger.

9. What is the cash effect on beta? Why does it sometimes get taken out and sometimes get put back in?
I know that dealing with cash is on of the more confusing aspects of beta and cost of equity. Let's start with some basics. If a company has cash on its balance sheet, that cash is an asset with a zero beta (or at least a very low one) and it will affect the beta for the company and the beta that you observe for its equity (say, from a regression). What you do with cash will therefore depend upon what beta you are starting with and what beta you want to end up with.
For the pure play or unlevered beta by business: You start with the average (or median) regression beta across the comparable companies in the business. To get to a pure play beta for the business, here are the steps:
Step 1: Unlever the regression beta, using the gross debt to equity ratio for the sector
Unlevered beta for median company in sector = Regression beta/ (1+ (1- tax rate) (Debt/Equity Ratio for the sector))
Step 2: Clean up for the cash held by the typical company in the sector, using the median cash/ firm value for the sector (see below for firm value)
Unlevered beta for the business = Unlevered beta for median company/ (1 - Cash/Firm value for the sector)
Note that you use sector averages all the way through this process, for regression betas, debt to equity ratios and cash/firm value

Alternatively, you can use the net debt to equity ratio and cut it down to one step
Net Debt to Equity = (Debt - Cash)/ Market value of equity
Unlevered beta for the business = Levered Beta for median company /(1+ (1-tax rate) (Net Debt to Equity))

To get to the bottom up equity beta for a company: You start with the unlevered betas with the businesses and work up to the equity beta in the following steps:
Step 1: Compute a weighted average of the operating business betas, using the values of the operating businesses in the company:
Unlevered beta for operating assets of the company = Pure play betas weighted by values of the operating businesses
Step 2: Compute a weighted average of all of the assets of the company, with the company's cash included (since cash has a beta of zero)
Unlevered beta for entire company = Unlevered beta for operating assets (Value of operating assets/(Cash + Value of operating assets))
Step 3: Compute a levered beta for just the operating assets of the company, using the debt to equity ratio of the company
Levered beta for operating assets of the company = Unlevered beta for operating assets (1+ (1- tax rate) Company's D/E ratio)
Step 4: Compute a levered beta for all of the assets of the company, with cash included
Levered beta for all assets of the company = Unlevered beta for entire company (1+ (1- tax rate) Company's D/E ratio)
It is the beta in step 4 that is directly comparable to your regression beta. Note that all the numbers in this part are the company's numbers - for values for the businesses, cash holdings and debt/equity.

10. Why do you weight unlevered betas by enterprise value (as you did in the Disney/Cap Cities acquisition) and in computing Disney's bottom up beta?
The unlevered beta is a beta fo the asset side of the balance sheet, right? So, when weighting these unlevered betas, you want to weight them by how much the businesses are worth (and not how much the equity is worth). That is why I used enterprise value weights in the Disney bottom up beta computation. I cheated on the Cap Cities acquisition by ignoring cash for both Disney and Cap Cities, but if cash had been provided, I would have used enterprise value. In case you are a little confused about the different values, here they are:
Market cap or Value of equity: This is the value of just equity
Firm value = Market value of Debt + Market value of Equity
Enterprise value = Market value of Debt + Market value of Equity - Cash (This of this as the value of just the operating assets of the company)
Thus, if a company has 100 million in equity, 50 million in debt and 20 million in cash:
Market cap = 100
Firm value = 150
Enterprise value = 150-20 = 130

That’s it for the moment. Sorry for the long email but I hope it helps.


Moving right along, I know that today's class was a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash). If you got lost at some stage in the class, here are some of the ways you can get unlost:
1. Review the slides that we covered today.
2. Try the post-class test and solution. I think it will really help bring together some of the mechanical issues involved in estimating betas.
3. Read this short Q&A on bottom up betas which highlights the estimation process and some of its pitfalls:
One small problem, if you missed class today. There seems to be a problem with the webcast recordings and I don’t have a link yet. Will put it up as soon as I have it.

Tomorrow’s review session is scheduled for 12-1 in KMEC 1-70 and I have attached the review presentation that I will be using. Please bring it to the review session with you. The TA session that was scheduled for the same time has been moved to 4.30-5.30 and I will send you the room number tomorrow, and it will be less of a formal review session and more of a Q&A for you to resolve your doubts.

Attachments: Post-class test and solution


I know that you are busy with the quiz, but just in case you have some time on your hands later this week, here is this week’s puzzle.
While risk and return models try to measure risk using regressions of stock returns against market indices, it is only during crisis periods that you really see the differential risk across sectors or businesses. One simple way to back out a measure of market risk exposure (an implied beta) is to take a periodwhere markets were in crisis (say January-February 2016) and look at differences in returns across sectors. It is dangerous to base everything on a month but it is an interesting technique. Here are the questions worth exploring;
1. Based upon just the YTD returns, what was the riskiest sector in the market and which one was the safest?
2. Why might you want to be cautious about generalizing this finding?
3. If you had this data for the worst 50 months in the market, would you be able to use it to get a measure of the relative risk of each sector and convert it into a number that looks like a beta?
See you at the review or at the quiz.


The quiz review is up and ready to access online on the webcast page for the class. The direct link to the webcasts are below:
Streaming: http://nyustern.mediasite.com/Mediasite/Play/3649aaff69924670969dcac7a267966f1d
Download video: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/3649aaff69924670969dcac7a267966f1d/videopodcast.mp4
Download audio: https://www.stern.nyu.edu/~adamodar/podcasts/cfUGspr16/ReviewQuiz1.mp3
The YouTube version will be up later tonight.

If you do get a chance, watch it. I am also attaching the answers to the last page of the webcast review. On a different note, the TA session from 4.30-5.30 this evening is just a Q&A session, where you can drop into the Gruber Conference room (on the 9th floor of KMEC, right by the reception area) and ask questions, if you have any. Finally, for those of you are still having issues with levered and unlevered betas, I put together an example that may or may not help you nail concepts down. I hope it helps. Until next time!

Attachment: Slides for Review Session


The quizzes are done and ready to pick up. To get them, here is what you need to do.
Step 1: Take the elevator to the ninth floor of KMEC.
Step 2: When you get off the elevator, start walking towards the front glass doors that lead into the reception area (BUT DON’T GO IN).
Step 3: Just before you get to the door, look to your right and you should see a pick-up area for stuff.
Step 4: On the top shelf, you will find your quizzes, face down and in two stacks, in alphabetical order.
Step 5: Take your quiz (and your quiz alone). Please don’t browse.
Step 6: Check your quiz against the solutions attached. If your quiz had Tesla in the last problem, your solution in to Quiz a and if your quiz had Netflix, you want the Quiz b solution.
Step 7: If you think something in the grading, please bring it in and I will fix it.
Step 8: Check your score against the attached distribution. Don’t read too much into the grade (in either direction), since this is only the first quiz and 10% of the grade.
Until next time (and it will be very soon, with news about the case)!

Attachments: Solution (a or b)as well as the distribution of grades

3/3/16 I know that you are in no mood for corporate finance, but the case for the class is ready to download at this link:
The last table can be also be downloaded as a spreadsheet (to save you the trouble of entering numbers by hand)
The case is a group project and it is due on March 30 by 10.30 am in electronic format (pdf file). It is an exercise in a number of skills, basic accounting, financial forecasting, model building in Excel and corporate finance. I know that it is work but it may be the most useful thing that you do in this class. So, please read it soon (how about today) and start thinking about it. Some of the stuff that you need to do, you can do right now. Some, you may have to wait until next week and perhaps beyond. Until next time!
3/4/16 I know that you are in no mood for in practice webcasts or working on your project, but I have a webcast on the mechanics of estimating bottom up betas. I use United Technologies to illustrate the process and I go through how to pull up companies from Capital IQ. Even if you don't get a chance to watch it today or this weekend, it may perhaps be useful later on. Here are the links:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/BottomupBeta.mp4
United Technologies 10K: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/UT10K.pdf
Spreadsheet to help compute bottom up beta: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/bottomupbeta.xls
The last spreadsheet has built into it the industry averages that I have computed for different sectors in the US in 2015. You can easily replace it with the global averages from 2016 that I also have on my site and tweak the spreadsheet. Give it a shot!

I hope that you have had a chance to pick up your quiz. If you scored well, congratulations, but don’t rest on your laurels. There is lots left to do in the class. If you scored badly, I am sorry, but remember that this can be your freebie and you can make it go away by doing well on the remaining exams. If you did not take the quiz, study the material, since we will build on it as we go through the class. I know that you have other things on your mind this weekend, but just in case it turns to corporate finance, the newsletter for the week is attached.

Attachment: Issue 6 (March 5)


I know that some of you were in Spring break mode already, but today's class represented a transition from hurdle rates to measuring returns. We started by completing the last pieces of the cost of capital puzzle: coming up with market values for equity (easy for a publicly traded company) and debt (more difficult). We then began our discussion of returns by emphasizing that the bottom line in corporate finance is cash flows, not earnings, that we care about when those cash flows occur and that we try to bring in all side costs and benefits into those cash flows. Defining investments broadly to include everything from acquisitions to big infrastructure investments to changing inventory policy, we set the table for investment analysis by setting up the Rio Disney investment. We will return to flesh out the details in the next session (after the break). The post class test and solution are attached.

I also emailed you the case on Monday. Just in case you did not get it (or skipped over that email), you can get the case by going to the link below:

Attachments: Post-class test and solution

3/8/16 Yesterday, we started on our discussion of how to measure returns. While we will lay the framework out for how best to make investment decisions, the reality is that you make the best decisions that you can, with the information that you have at the time, and the real world then delivers its own surprises. In this week’s challenge, I confront this issue head on by looking at Chevron’s $54 billion investment in a natural gas plant in Australia. The decision was made in 2009, when oil and gas prices were much higher and rising, and the plant is just going to start production. Take a look at the challenge:
Once you have read the puzzle, try to answer the following questions:
Should the analysts who looked at the plant in 2009 foreseen the oil price rout when making the investment decision?
Asssume that at today's oil prices, the present value of expected cash flows on the plant is well below the $54 billion that it cost to build the plant? Should Chevron shut the plant down today? If yes, why? If not, why not?
Assume that you are offered $25 billion by Exxon Mobil for the plant? Would you accept it? What would determine your decision?
Now that you have seen the cost of this deal, what would you do differently, if anything, on any new investments that you make as an oil company?
These are fundamental questions that get asked almost every time a big investment goes bad.

We began the class today by extending the return on capital concept to entire companies and argued that notwithstanding its accounting limitations, comparing the return on capital to the cost of capital provides us with a basis for measuring whether a company’s existing investments are good (or not). If you are interested and want some light reading material for your flight to Jamaica (which is where I am sure you are going for Spring break), try this absolutely scintillating, cannot-be-put-down, amazing (not, not and definitely not) blog post that I put up at the start of this year on the topic:
We then returned to the Rio Disney analysis and moved from earnings to cash flows, by making three standard adjustments: add back depreciation & amortization (which leaves the tax benefit of the depreciation in the cash flows), subtract out cap ex and subtract out changes in working capital. Finally, we introduced the key test for incremental cash flows by asking two questions: (1) What will happen if you take the project and (2) What will happen if you do not? If the answer is the same to both questions, the item is not incremental. That is why "sunk" costs, i.e., money already spent, should not affect investment decision making. It is also the reason that we add back the portion of allocated G&A that is fixed and thus has nothing to do with this project. I have attached the post class test for today, with the solution. Have an absolutely amazing spring break and I will see you on the other side.

Attached: Post-class test and solution


I know that spring break is not officially over but my hiatus from sending your emails is over and I do have a couple of notes on the case and the project, First, on the case. I know that most of you have not had a chance to read the case, let alone analyze it, but if you did read it, I hope that you will get started on it soon. (If your reaction is what case?, you may want to click on this link:
In case, you did download the case earlier, there is one glaring typo that I had to fix just a couple of days ago. It is on page 2, in item 2 (introductory Costs), where I had listed the salvage value for the investment at $200 billion (instead of $200 million).. I have added a couple of other clarifications, in response to questions from a few of you who have read the case already. Consequently, I would suggest downloading a fresh copy of the case with the changes.

Second, on the project. I know it has been put on the back burner and will probably stay there until the case analysis is done. Just in case, you have some extra time on your hands, it would be great if you can get the cost of capital for your company done. This will of course require that you estimate a bottom up beta for your company and compute the market value of debt (and leases). I thought that a webcast on estimating the pre-tax cost of debt and the value of debt would come in useful. The webcast is from last year but I used Home Depot as my example for the analysis and it does providing an interesting test of getting updated information. The most recent 10K for the Home Depot at the time of the webcast was as of January 29, 2012. Since a new 10K was due a few weeks after the webcast, I used the 10Q from the most recent quarter (as of the time of the webcast) to update information. (Most of you will get lucky and your most recent 10K or annual report will be ready to use, but just in case it is not...)
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/debt.mp4
Home Depot 10K: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Debt&Cost/HomeDepot10K.pdf
Home Depot 10Q: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Debt&Cost/HomeDepot10Q.pdf
The spreadsheet for computing market value of debt (with leases & synthetic ratings) is attached. While it has the Home Depot's numbers, you can use it for any company. I hope it is useful. I have also attached the newsletter for the week, in case you have completely forgotten where we were in class.

Attachments: Issue 7 (March 19)

3/20/16 I hope that you are back, rested and ready to go. I know that it has been ten days since our last class, a long enough period for you to have forgotten where we are. Well, we were just getting started on the time weighted part of the cash flow analysis. Tomorrow, we will shave numbers that you can use to decide whether Disney should open the new park. Since the case is all about a project (Netflix investing in a studio), I would suggest at least reading it before tomorrow’s class, since there might be parts of the class that you will find useful. Looking forward to tomorrow (and I hope that I am not the only one..)

In today's session, we started by looking at two measures of time-weighted cash flow returns, NPV and IRR. We then looked at three tools for dealing with uncertainty: payback, where you try to get your initial investment back as quickly as possible, what if analysis, where the key is to keep it focused on key variables, and simulations, where you input distributions for key variables rather than single inputs. Ultimately, though, you have to be willing to live with making mistakes, if you are faced with uncertainty. I also mentioned Edward Tufte's book on the visual display of information. If you are interested, you can find a copy here:
It is a great book! I also talked about Crystal Ball in class. You have access to it as a student at Stern, at least on the school computers. We then turned our attention to analyzing a project in equity terms, using a Vale iron ore mine in Canada and in the process faced the question of whether we should hedge risk either at the output or input levels.

Attachments: Post-class test and solution

3/22/16 I know that you are busy working on the case and I will keep this short. Since you have much to do, I am going to skip the weekly puzzle for this week and leave you to work on the case. Don’t worry! It will be back next week. On a different note, several of you have asked me about the final exam date. The short answer to the question of when is that I have no idea, since the university has not set a date yet. I know that many of you are trying to make plane reservations and the dates are supposed to be set by early next week. My guess is that it will be May 13 in the afternoon. No matter what that date is, I will also be offering an early exam option, with that exam scheduled for May 11. The time and the room will shortly be announced, along with a Google shared spreadsheet, where you can sign up to let me know that you want to use that option.

We started today's class by looking at whether you should hedge risk and came to a mixed conclusion about when it makes sense. We closed the investment analysis by looking at an acquisition as a big investment. We then turned our attention to mutually exclusive investments and why NPV and IRR may give you different answers: a project can have more than one IRR, IRR is biased towards smaller projects and the intermediate cash flows are assumed to be reinvested at the IRR. As to which rule is better, while NPV makes more reasonable assumptions about reinvestment (at the hurdle rate), companies that face capital rationing constraints may choose to use IRR. We closed by comparing projects with different lives and considered how best to incorporate side costs and side benefits into investment analysis.

Attachments: Post-class test and solution

3/24/16 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 work on the case, here are a few suggestions on dealing with the issues.
Do the finite life (10-year) analysis first. It is more contained and easier to work with. Then, try the longer life analysis. It is trickier...
If you find yourself lacking information, make reasonable assumptions. Ignoring something because you don't have enough information is making an assumption too, just a bad one.
When you run into an estimation question, ask yourself whether you need the answer to get accounting earnings or to get to incremental cash flows. If it is to get to earnings, and if your final decision is not going to be based on earnings, don’t waste too much time on it.
I think the case is self contained. For your protection, I think that 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 the movie business and Netflix’s future, 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 equity risk premiums, for instance.)
There are tax rules that you violate at your own risk. For instance, investing in physical facilities 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.
There is no one right answer to the case. In all my years of providing these cases, 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.
Much of the material for the estimation of cash flows was covered yesterday and in the last session. 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.
Do not ask what-if questions until you have your base case nailed down. In fact, shoot down 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…
Do not lose sight of the end game, which is that you have to decide based on all your number crunching whether Netflix should invest in this studio or not. Do not hedge, prevaricate, pass the buck or hide behind buzz words.
The case report itself should be short and to the point (if you are running past 4 or 5 pages, you either have discovered something truly profound or are talking in circles). You can always have exhibits with numbers, but make sure that you reference them in the report.
3/25/16 I know that you are working on the case right now and that the project is on the back burner. When you get back to it, though, one of the questions that you will be addressing is whether your company's existing investments pass muster. Are they good investments? Do they generate or destroy value? To answer that question, we looked at estimating accounting returns - return on invested capital for the overall quality of an investment and the return on equity, for just the equity component. By comparing the first to the cost o capital and the second to the cost of equity, we argued that you can get a snapshot (at least for the year in question) of whether existing investments are value adding. The peril with accounting returns is that you are dependent upon accounting numbers: accounting earnings and accounting book value. In the webcast for this week, I look at estimating accounting returns for Walmart in March 2013. Along the way, I talk about what to do about goodwill, cash and minority interests when computing return on capital and how leases can alter your perspective on a company. Here are the links:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/ROIC.mp4
Walmart: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10K.pdf (10K for 2012) and https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10Klast year.pdf (10K for 2011)
Spreadsheet for ROIC: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmartreturncalculator.xls
I hope you get a chance to watch the webcast. It is about 20 minutes long.

very quick notes.
Lecture Note Packet 2: Please print off lecture note packet 2, when you get a chance, or buy it at the bookstore. We will be starting on it on Monday and getting deeper into it on Wednesday. The link to the packet is below:
Lately Orphaned: I also have one more request. I do have a late addition to the orphan list, as a result of a group breaking up. If any of your groups can add a person on at this stage, I would be everlastingly grateful. This person has been working on the case and would gladly jump on board with whatever theme the group has chosen for its big project. Please let me know if you have are willing to make this addition and I will get that person in touch with you.

Attachments: Issue 8 (March 26)


In the week to come, we will complete investment analysis and packet 1. As I mentioned in my email yesterday, Packet 2 is ready to be either downloaded online or can be bought at the bookstore. To download it, go to the webcast page for the class and check towards the top of the page:
On Wednesday, we will spend the bulk of the session talking about the case but we will also start our discussion of the trade off on debt.

Anyway, speaking about the case, here are some closing instructions:
1. As you write your case analysis, keep it brief. There is no need for story telling, strategic discussions or second guessing yourself. Crunch through the numbers, pick your investment decision rule and make your decision.
2. Once you are done with the case analysis, put together a report. In the report, make sure you include a table that shows how you computed your numbers by year (operating earnings, cash flows) and a computation of your discount rate or rates.
3. On the cover page, please include the following:
Names of the group members in alphabetical order
Cost of capital for Netflix Studio
Accounting Return on Project
NPV for Studio (10-year life)
NPV for Studio (Longer life)
Decision: Accept or Reject
4. Convert your case report into a pdf file and email me the file, ccing everyone in your group. In the subject of the email, please enter “Studying the Studio"
5. If you can take the key numbers that you get, put them in the Excel spreadsheet which is attached and email them to me by Tuesday night (or earlier if you have them), I will be everlastingly grateful. I would like to show you (as a class) the distribution of findings across groups.


We talked about sunk costs in class in the last week, and how difficult it is to ignore them, when making decisions. You can start your exploration of the sunk cost fallacy with this well-done, non-technical discourse on it:
You can then follow up by reading a tortured Yankee fan's (my) blog post on the Yankee's A Rod problem and the broader lessons for organizations that have made bad decisions in the past and feel the need to stick with them.

Finally, I know that you are probably busy working on your case (spare me my illusions) but in case you have some time, I would like to pose a hypothetical, just to see how you deal with sunk costs. Before you read the hypothetical, please recognize that I am sure that the facts in this particular puzzle do not apply to you, but act like they do, at least for purposes of this exercise:
I hope you get a chance to give it a shot. It will take only a few minutes of your time (though it may take a few years off your life).

3/29/16 Just a quick reminder, if you have not done it already. Please send me your summary numbers in the attached summary sheet. And when you submit your final project, please do include “Studying the studio” in the subject. I am sorry for being nit-picky about this but I am on the verge of receiving about 130 group reports from two different classes between today and tomorrow morning at 10.30 and I want to make sure that I keep things organized.

The bulk of today's class was spent on the Netflix Studio case. While the case itself will soon be forgotten (as it should), I hope that some of the issues that we talked about today stay fresh. In particular, here were some of the central themes (most of which are not original):
Theme 1: The discount rate for a project should reflect the risk of the project, not the risk of the company looking at the project. Hence, it is the beta for movie companies that drives the cost of capital for the studio business, rather than the cost of capital for Netflix as a company. That principle will get revisited when we talk about acquisition valuation... or in any context, where risk is a consideration.
Theme 2: To get a measure of incremental cash flows, you cannot just ask the question, "What will happen if I take this investment?". You have to follow up and ask the next question: "What will happen if I don't take the investment? It is the incremental effect that you should count. That was the rationale we used for counting the savings from the server
Theme 3: If you decide to extend the life on an investment or to make earnings grow at a higher rate, you have to reinvest more to make this possible. In the context of the case, that is the rationale for investing more in capital maintenance in the longer life scenario than in the finite life scenario. Thus, I am not looking for you to make the same capital maintenance assumptions that I did but I am looking for you to differentiate between the two scenarios.

I have put the presentation and excel spreadsheet with my numbers online:
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/StudioPresentation.pdf
Excel spreadsheet with analysis: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/NetflixContentsoln.xls
Please download them. Not only will they be useful to do a comparison of why your numbers may be different from mine but also to get ready for the next quiz.

In the last part of the class, we spent a few minutes setting up the trade off between debt and equity and we will return to it in the next class. Finally, I have moved the review session from tomorrow, where I am afraid that I will have nothing to review to day after tomorrow. The review session is now scheduled for Friday from 2.30 pm - 3.30 in KMEC 2-60. Please pass the message on to those who never read my emails. Wait! Never mind! If they don’t read my emails, perhaps you should let them show up at Paulson tomorrow and wonder what’s going on. The second quiz will cover the cost of debt and capital and all of investment analysis (Packet 1, from page 150-End) If you want to try out practice quizzes and solutions, the links are below:
Past Quizzes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2.pdf
Past Quiz Solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2sol.xls
No post class test and solution for today.

3/31/16 I am about half way through the grading and some of you should have your cases back already and the rest should be on their way either today or tomorrow. As you look at the case and my grading, I will make a confession that some of the grading is subjective but I have tried my best to keep an even hand. I have put together a grading template with the ten issues that I am looking for in the case. When you get your case, you will find your grade on the cover page. You will see a line item that says issues, with a code next to it. To see what the code stands for look at the attached document. In the last column, you will see an index number of possible errors (1a, 2b etc...) with a measure of how much that particular error/omission should have cost the group. I have tried to embed the comment relevant to your case into your final grade. So, if you made a mistake on sunk cost (4, costing 1/2 a point) and allocated G&A (5, costing 1/2 a point) in your analysis. On the front page of your case, you will see something like this in your grade for the class (Overall grade; 9/10; Issues: 3b,9a) I hope that helps clarify matters. It is entirely possible that I may have missed something that you did or misunderstood it. You can always bring your case in and I will reassess it.
Finally, on how to read the scores, the case is out of 10 and the scoring is done accordingly. I hate to give letter grades on small pieces of the class, but I know that will be hounded by some until I do. So, here is a rough breakdown:
9.5-10: A
9: A-
8.5: B+
7.5-8: B
6.5-7: B-
5.5-6: C
<5.5: Hopefully no group will plumb these depths

Starting in about five minutes, the first graded cases will go out. (If you submitted early, you should get it first. If not, you may have to wait longer). As you look at the case and my grading, I will make a confession that some of the grading is subjective but I have tried my best to keep an even hand. I have put together a grading template with the ten issues that I am looking for in the case. When you get your case, you will find your grade on the cover page. You will see a line item that says issues, with a code next to it. To see what the code stands for look at the attached document. In the last column, you will see an index number of possible errors (1a, 2b etc...) with a measure of how much that particular error/omission should have cost the group. I have tried to embed the comment relevant to your case into your final grade. So, if you made a mistake on sunk cost (4, costing 1/2 a point) and allocated G&A (5, costing 1/2 a point) in your analysis. On the front page of your case, you will see something like this in your grade for the class (Overall grade; 9/10; Issues: 4,5) I hope that helps clarify matters. It is entirely possible that I may have missed something that you did or misunderstood it. You can always bring your case in and I will reassess it.
Finally, on how to read the scores, the case is out of 10 and the scoring is done accordingly. I hate to give letter grades on small pieces of the class, but I know that will be hounded by some until I do. So, here is a rough breakdown:
9.5-10: A
9: A-
8.5: B+
7.5-8: B
6.5-7: B-
5.5-6: C
See you in KMEC 2-60 for the review session from 2.30-3.30.


The latest newsletter is attached, in case you feel the urge to read something. On the quiz front, I hope that you have had a chance to watch the review session. In particular, please get comfortable with at least one way of estimating incremental cash flows and please, please, please figure out how to compute the present values of annuities on your calculator. Nothing wastes more time than computing present values of five cash flows individually and then adding them up. If you are a baseball fan, I hope that you are gearing up for opening day. I wish I could be at the Yankee game but I have more important things to do at 3.30 on Monday and so do you.

Attachment: Issue 9 (April 2)


First, my thanks for the time and sweat that went into the case reports. I appreciate it and if you are disappointed with your grade, I am truly sorry. think all the cases are done and you should have got them already. It is entirely possible that a couple slipped through my fingers. If so, please email me with your case attachment again (with no changes of course.. I will go back and find your original submission in mailbox and get it graded. I am attaching that grading code that I had sent you before, so that you can make some sense of your grade. If you feel that i have missed something in your analysis, please come by and make your argument. I am always willing to listen. After 100+ cases, I am a so sick of Netflix, I might cancel my subscription... and I am sure you are too, but I thought that it would be a good time to talk about some key aspects of the case:

1. Beta and cost of equity: The only absolute I had on this part of the case was that you could not under any conditions justify using Netflix's beta to analyze a project in a different business. However, I was pretty flexible on different approaches to estimating betas from the list of movie companies. Also, if you consolidated your cash flows from the studio and cost savings, you are using the same cost of capital on both. I did not make an issue of it in this case, since the cost savings were so small, but something to think about.

2. Cost of debt and debt ratio: If there was one number that most groups agreed on, it was that the cost of debt for Netflix was 5% (the riskfree rate + default spread). On the debt ratio, on leases, there were variations on how you dealt with content commitments. Some of you chose to ignore those commitments, albeit on shaky grounds. I would treat it as debt, but here to, I did not take any points off for not considering content commitments.

3. Cash flows in the finite life case: I won't rehash the arguments about why we need to look at the difference between investing in year 5 and year 8 for computing the server investment. Many of you either ignored the savings in year 8 or attempted to allocate a portion of the investment in year 3, a practice that is fine for accounting returns but not for cash flows. But here were some other items that did throw off your operating cash flows:
a. Interest expenses: The cash flows that you discount with the cost of capital should always be pre-debt cash flows. That is why it does not make sense to subtract out interest expenses before you compute taxes and income. If you do that, you will double count the tax benefits of interest expenses, once in your cash flows (by saving taxes) and once in your discount rate, through the use of an after-tax cost of debt.
b. Working capital: The working capital was fairly clearly delineated but there were three issues that did show up. One is that a few groups used the total working capital every year, instead of the change, which is devastating to your cash flows. The other is that the working capital itself was sometimes defined incorrectly, with accounts payable being added to accounts receivable and inventory. Third, the fact that working capital investments have to be made at the start of each year means that the change in working capital will lead revenues by a year; many of you had the change in the same year or even lagging revenues. (I did not penalize you for that because it has small effect.)
c. G&A: If you subtract out the allocated G&A to get to operating income, the difference between the allocated and the incremental G&A has to be added back to earnings. While many groups did do this, a few added back the entire amount, instead of the amount (1- tax rate). The reason you have to do this, is because if the expense is non-incremental, the tax benefit you get from it is also non-incremental. Adding back the after-tax amount eliminates both.
d. Capital maintenance: While I am glad that some of you were thinking about capital maintenance, putting in a large capital maintenance in the finite life case is unfair to that scenario. Why would you keep investing larger and larger amounts of money into a business as you approach the liquidation date? However, I allowed for some flexibility on this issue.
e. Salvage value: The salvage value should include both the working capital salvaged as well as the billion in fixed non-depreciable assets.

4. Cash flows in the infinite life case: The key in this scenario is that you need more capital maintenance, starting right now. (Here is a simple test: If your after tax cash flows from years 1-10 are identical for the 10-year life and longer life scenarios, you have a problem...) Though some groups did realize this, they often started the capital maintenance in year 11, by which point in time you are maintaining depleted assets. Those groups that did not include capital maintenance at all argued that they felt uncomfortable making estimates without information. But ignoring something is the equivalent of estimating a value of zero, which is an estimate in itself. Also, you cannot keep depreciation in your cash flows (in perpetuity) and not have capital maintenance that matches the depreciation, since you will run out of assets to depreciate, sooner rather than later. The basis for capital maintenance estimates should always be depreciation and your book capital; tying capital maintenance to revenues or earnings can be dangerous.

Finally, and this is a pet peeve of mine. So, just humor me. Please do not use the word "net income" when you really mean after-tax operating income. Not only is it not right but it will create problems for you in valuation and corporate finance. Also, try to restrain your inner accountant when it comes to capital budgeting. As a general rule, projects don't have balance sheets, retained earnings or cash balances. Also, if a project loses money, don't create deferred tax assets or loss carryforwards but use the losses to offset against earnings right now and move on.


I hope that you are having a good weekend, winds and cold notwithstanding. As you prepare for the second quiz, I think it would be useful to restate a few central themes that animate how we think about investments in corporate finance.

Theme 1: Cash flow, not earnings
Investment decisions should be based upon cash flows rather than earnings. That said, you need to understand how to compute earnings (both operating and net income, and if you still don’t grasp the difference, try my accounting primer) partly because you have to do them to compute your taxes dues (which are a cash flow) and partly because they represent the starting point for cash flow computation.
My accounting primer: https://people.stern.nyu.edu/adamodar/New_Home_Page/AccPrimer/accstate.htm

Theme 2: The Incremental test
Investment decisions should be based upon incremental cash flows, i.e., cash flows that are caused by the project. The easiest way to check to see if something is incremental is to ask two questions: What will happen if I take the project? What will happen if I don’t? If the answer is the same, it is not incremental, and it is precisely why we ignore sunk costs and reverse allocated expenses that would be there anyway. It is also the test that led us to consider not only the cost of the server in year 5, with the Netflix investment, but the savings in year 8, which is the full incremental effect.

Theme 3: Death and taxes
All analyses are done on an after-tax basis. That is why we go through the trouble of computing depreciation, even though it is a non-cash expense, because it does save taxes (which is a cash effect). In fact, with all regular income and expenses, the after-tax effect is the amount (1- tax rate). In the discount rate, it is why we use the after-tax cost of debt in the cost of capital.

Theme 4: The Essence of Risk
I hate to be a broken record on this topic, but the discount rate for a project should reflect the risk of the project. Thus, if you are in a project where the government sets a payment schedule and guarantees that payment, you would use the risk free rate as your discount rate. When a multi-business company (like Disney) looks at a project (say a theme park in Rio), it should not only use a beta that reflects the business risk (of a theme park) but the geographical risk exposure of that theme park (Brazil or perhaps even Latin American ERP).

Theme 5: Cash flow consistency
Finally, it is critical that you match your discount rate to your cash flows. Thus, if your cash flows are in Mexican peso, your discount rate has to be in pesos as well. (Get comfortable with moving from one currency to another, using the differential inflation). If your cash flows are pre-debt cash flows (before interest expenses and debt payments), your discount rate has to be the cost of capital. If they are post-debt, your discount rate has to be the cost of equity.


The quizzes are done and can be picked up in the usual spot (right after you come off the elevators and to your right) on the 9th floor of KMEC. The solutions to both quizzes are attached, as is the distribution. (If your first problem has Polygon, you have quiz 2a and if you have Gorgon, you have quiz 2b). I have also left physical copies of both the solution and the grading distribution next to your quizzes. Please bring in your quiz into me, if you have issues.

Attachments: Solution (a or b)as well as the distribution of grades for the class

4/5/16 I know what you are thinking… Right? He wants me to do a quiz after a week of working on the case and he expects me to do a puzzle on top of that! Not happening! I understand but nevertheless, just in case you feel the urge, this week’s puzzle is up and running. It revolves around the tax benefit of debt and in particular, the perversity of the US tax code. You can find the puzzle here:
As you can see the puzzle is structured around the recent attempt by the US Treasury to stop the inversion phenomenon, where US companies try to merge with foreign companies and move their domiciles to more friendly tax climates. If you get a chance, please take a look at it.
4/7/16 I know that you just got back your quiz and you are in no mood for corporate finance but this is a great weekend to get caught up with your big project. We are in the capital structure section and the first thing you can do (if you remember what company you are analyzing) is to take it through the qualitative analysis, i.e., the trade off items on capital structure:
Tax benefits: Check out your company's marginal tax rates, relative to those of others in your group. If you have the only Irish company in your group, you have the lowest marginal tax rate in your group and other things remaining equal, should have the least debt.
Added discipline: Go back and check the HDS page (with the top 17 stockholders in your company). If you don't see anyone from your management team in that list and no activist investors (Carl Icahn or Bill Ackman), your company could benefit from having more debt (to discipline management).
Bankruptcy cost: To assess your company's expected bankruptcy cost, look at two variables. The first is whether they are in a stable or risky business. If you are in a risky business, you have a much higher risk of bankruptcy than if you are in a nice safe business. The second is indirect bankruptcy cost. As I noted in class, these are the negative consequences of being viewed as being in financial trouble: customers stop buying, suppliers demand cash and customers leave. If those costs can be high at your company, you should borrow less money.
Agency costs: The more trouble lenders have in monitoring and keeping track of the money that they lend, the more borrowers will have to pay to borrow. Thus, if your company has intangible assets and difficult-to-monitor investments (R&D, for example), it should borrow less money.
Financial flexibility: If the investment needs in your company tend to be stable and predictable (a regulated utility, for instance), you should not value flexibility very much. If you grow through acquisitions and/or are in an unstable business, you will value it more and borrow less.
At the end of the qualitative assessment, you are just trying to decide whether you would expect your company to borrow no money, only some money or a lot of money.


Today's in practice webcast takes you through the process of assessing this trade off, with suggestions on variables/proxies you can use to measure each of the above factors. If you are interested, here are the links:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/tradeoffdebt.mp4
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/tradeoffdebt/debttradeoff.ppt
Spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/tradeoffdebt/tradeoffHP.xls
I am also attaching two spreadsheets: one contains the marginal tax rates by country and the other has the average effective tax rates by sector for US as well as for Global companies. Hope you find them useful!

Attachments: Marginal tax rates by country, Effective tax rates by sector (US)


I will keep this really short, since I am sure that you are sick of me. Last week, we began our discussion of capital structure by laying out the trade off between debt and equity for all businesses. That trade off, with tax benefit and added discipline as pluses and expected bankruptcy and agency costs as minuses, sets up the framework that we will build on in the coming week to find the right mix of debt and equity for any business. The newsletter is attached.

Attachment: Issue 10 (April 9)


In today's class, we  continued our discussion of the cost of capital approach to deriving an optimal financing mix: the optimal one is the debt ratio that minimizes the cost of capital. To estimate the cost of capital at different debt ratios, we estimated the levered beta/ cost of equity at each debt ratio first and then the interest coverage ratio/synthetic rating/cost of debt at each debt ratio, taking care to ensure that if the interest expenses exceeded the operating income, tax benefits would be lost. The optimal debt ratio is the point at which your cost of capital is minimized. Using this approach, we estimated optimal debt ratios for Disney (40%), Tata Motors (20%), Vale (30% with actual earnings, 50% with normalized earnings), Baidu (10%) and Bookscape (30%). Disney was underlevered, Tata Motors was over levered and Bookscape was at its optimal. We closed the class by looking at an extension of the cost of capital approach, which allowed us to bring in expected bankrutpcy costs into the discussion. 

Now, to the project, which I know has been on the back burner for a while. I know that some of you are way behind on the project, and as I mentioned in class today, I will offer you a way to catch up. In doing so, I will be violating “The Red Hen Principle”. If you have no idea what I am talking about, try this link: http://www.amazon.com/Little-Red-Hen-Golden-Book/dp/0307960307/ref=sr_1_1?s=books&ie=UTF8&qid=1460414914&sr=1-1&keywords=the+little+red+hen.  If you get a chance, please try the optimal capital structure spreadsheet (attached) for your firm and bring your output to class on Wednesday. It will help if you have a bottom up beta (based on the businesses that your company operates in) and an ERP (given the countries it gets its revenues from) but if you don’t, use a regression beta and the ERP of the country in which your company operates (for the moment).

Attachments: Post-class test and solution

4/12/16 In this week’s puzzle I decided to use Valeant to illustrate both the good side and the bad side of debt. Valeant was an obscure Canadian pharmaceutical company in 2009 but grew explosively between 2009 and 2015 to get to a market capitalization of $100 billion, primarily using debt-fueled acquisitions to deliver that growth. You can read the weekly puzzle here:
In the last year, Valeant’s fortunes have taken a turn for the worse. Not only has its business model crumbled, but it has had both managerial problems and information disclosure issues that have added to the troubles. It’s CEO is on the verge of leaving, but not before he delivers testimony in front of a Congressional committee, its lead investor, Bill Ackman, has his reputation and lots of money on the line and there is a real chance that if it does not release its long-delayed financial filing (due in February) by April 29, that debt covenants would be triggered. Its bond rating is now below investment-grade and Valeant is now seeing the other side of the debt sword. If you get a chance, take a look at the weekly challenge and please try to answer the four questions:
What role did debt play in allowing Valeant to be so successful between 2009 and 2015? Where was the value added?
What is Valeant's optimal mix of debt and equity? (Try the optimal capital structure spreadsheet)
Valeant's debt is clearly now operating more as a negative than a positive. Is there a way to estimate the costs to Valeant of having borrowed too much? (Think about the feedback effect it may be having on Valeant's operations and the indirect bankructy costs)
Assume now that the new filing is made, that revenues and earnings are down and that Valeant has too much debt. What are the options for reducing this debt load and which one would you pick?
Until next time!

In today’s class, we continued our discussion of the cost of capital approach to optimizing debt ratios by looking at the determinants of the optimal. In particular, it was differences in tax rates, cash flows (as a percent of value) and risk that determined why some companies have high optimal debt ratios and why some have low or no debt capacity. We then looked at the Adjusted Present Value (APV) approach to analyzing the effect of debt. In particular, this approach looks at the primary benefit of debt (taxes) and the primary costs (expected bankruptcy) and netted out the difference from the unlevered firm value. If you are interested in trying this out, I have attached an APV spreadsheet which you can use on your company (with your own judgment call on what the indirect bankruptcy cost is as a percent of value).

We closed the discussion of optimal by noting that many firms decide how much to borrow by looking their peer group and argued that if you decide to go this route, you should use more of the information than just the average. If you can plug in the numbers for the optimal debt ratio into the optimal capital structure, it would be a giant step forward on your project. More on the project tomorrow.. . Until next time!

Attachments: Post-class test and solution


I know that I have been sending you serial emails on the project over the whole semester and that some of you are way behind. Since it may be overwhelming to go back and review every email that I have sent out over time, I thought it would make sense to pull all the resources that I have referenced for the project into one page, which you can use as a launching pad for starting (or continuing) your work on the project.

1. Resource page: I put the link up to the corporate finance resource page, where I will collect the data, spreadsheets and webcasts that go with each section of the project in one place to save you some trouble:

2. Main project page: I had mentioned the main page for the project at the very start of the class, but I am sure that it got lost in the mix. So, just to remind you, there is an entry page for the project which describes the project tasks and provides other links for the project:

3. Project formatting: I guess some of you must be starting on writing the project report or some sections thereof. While there is no specific formatting template that I will push you towards, I do have some general advice on formatting and what I would like to see in the reports:
It also has sample projects from prior years that you can browse through.

Note, in particular, to put muscle behind my plea for brevity. I have put a page limit of 25 pages on your entire written report (You can add appendices to this, but use discretion), if you have five companies or less. If you have more than five companies, you can add 2 pages for each one.


know that I have been nagging you to get the optimal debt ratio for your firm done. To bring the nagging to a crescendo, I have done the webcast on using the cost of capital spreadsheet, using Dell as my example. You can find the webcast and the related information below:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/optdebt.mp4
Dell 10K: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/optdebt/dellcapstru.xls
Dell optimal capital structure spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/optdebt/dell10K2013.pdf
You will notice that the Dell capital structure spreadsheet which is from two years ago has a few minor tweaks that make it different from this year's version, but it is fundamentally similar. In particular, take note of the fact that the spreadsheet will not work unless you have the iteration box checked off.

In a sign that the end game is getting closer, I also have been thinking about the final exam. The final exam has finally been scheduled and the bad news is that it is very early in the exam week. In fact, the final has been scheduled for 4-5.50 on Wednesday, May 11. I know that some of you had checked about taking an early exam, but since it cannot get any earlier than May 11, let’s stick with the regular exam.


I hope that I have not ruined your entire weekend with the project, because it is way too nice a day to be stuck inside. The weekly newsletter is attached. Until next time!

Attachment: Issue 11 (April 16)


As we approach the closing weeks for the class, we will build on the optimal debt ratio that we estimated last week and look at the next step: whether to move to the optimal and if so, how quickly and what the right type of debt for a firm should look like. We will them move on to the basics of designing the perfect debt for a firm, both in intuitive terms and by using a quantitative approach. So, if you have the optimal debt ratio for your firm worked out, bring it to class with you tomorrow.

Also, in case it got lost in the email I sent on Friday, I have created a hub for all of the materials related to the project. Visit it, when you get a chance.

See you in class tomorrow.


In today's session,we looked at applying closure to the optimal debt ratio analysis by looking at how quickly you should move to the optimal and what actions to take (recap versus taking projects), drawing largely on numbers that we have estimated already for the company (Jensen's alpha, ROC - Cost of capital). We then followed up by examining the process of finding the right debt for your firm, with a single overriding principle: that the cash flows on your debt should be matched up, as best as you can, to the cash flows on your assets. The perfect security will combine the tax benefits of debt with the flexibility of equity.

At this stage in the class, we are close to done with capital structure (chapters 7,8 &9) and with all of the material that you will need for quiz 3. Thus, you can not only finish this section for your project but start preparing for the quiz at the same time. Quiz 3 and the solution to it are also up online, under exams & quizzes on the website for the class:
Past Quiz 3s: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3.pdf
Past Quiz 3s solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls

Finally, Fernando Polit made the announcement about the earthquake in Ecuador and asked for help. You can give by going to the link below:

I have also attached today's post class test & solution.

Attachments: Post-class test and solution


In today's class, we looked at the design principles for debt. In particular, we noted the allure of matching up debt cash flows to asset cash flows: it reduces default risk and increases debt capacity. We then looked at the process of designing the perfect debt for your company, starting with the assets you have, checking to see if you still get your tax deduction, keeping different interest groups happy and sugarcoating the bond enough to make it palatable to bond holders. We then went through three basic approaches to debt design: an intuitive assessment of a company's products and pricing power, an analysis of expected cash flows on a single project and a macro economic regression of firm value/operating income against interest rates, GDP, inflation and exchange rates.
Keeping in mind the objective of matching debt to assets, think about the typical investments that your firm makes and try to design the right debt for the project. If your firm has multiple businesses, design the right kind of debt for each business. In making these judgments, you should try to think about
- whether you would use short term or long term debt
- what currency your debt should be in
- whether the debt should be fixed or floating rate debt
- whether you should use straight or convertible debt
- what special features you would add to your debt to insulate the company from default
Your objective is to get the tax advantages without exposing yourself to default risk. If you want to carry this forward and do a quantitative analysis of your debt, I will send you a spreadsheet tomorrow that will help in the macro economic regressions.

In the second half of the class, we started on our discussion of dividend policy. We began by looking at some facts about dividends: they are sticky, follow earnings, are affected by tax laws, vary across countries and are increasingly being supplanted by buybacks at least in the United States. We will continue the discussion of how much companies should return to investors in the next session. The post class test & solution for today is attached.

One final note. I skipped the puzzle for yesterday on the assumption that you would be too busy, but I decided to put it back in anyway, since some of you still may be able to give it a shot, if you get some time. Specifically, the perfect financing for a firm will combine the best of equity (the flexibility it offers you to pay dividends only when you can afford them) with the best of debt (the tax advantages of borrowing). While this may seem like the impossible dream, companies and their investment bankers constantly try to create securities that can play different roles with different entities: behave like debt with the tax authorities while behaving like equity with you. In this week's puzzle, I look at one example: surplus notes. Surplus notes are issued primarily by insurance companies to raise funds. They have "fixed' interest payments, but these payments are made only if the insurance company has surplus capital (or extra earnings). Otherwise, they can be suspended without the company being pushed into default. The IRS treats it as debt and gives them a tax deduction for the interest payments, but the regulatory authorities treat it as equity and add it to their regulatory capital base. The ratings agencies used to split the difference and treat it as part debt, part equity. The accountants and equity research analysts treat it as debt. In effect, you have a complete mess, working to the insurance company's advantage.
What are surplus notes? http://en.wikipedia.org/wiki/Surplus_note">Surplus notes: What are they?
The IRS view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/taxview.pdf
The legal view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/courtview.pdf
The ratings agency view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/ratingsviewnew.pdf
The regulator's view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/regulatorview.pdf
The accountant's view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/GAAPview.pdf
After you have read all of these different views of the same security, try addressing some of the questions in the weekly challenge.

Attachments: Post-class test and solution


On the project, if you have done the intuitive analysis of what debt is right for your firm, you can try to do a quantitative analysis of your debt. I have attached the spreadsheet that has the macroeconomic data on interest rates, inflation, GDP growth and the weighted dollar from 1986 to the present (I updated it to include 2013 data. The best place to find the macro economic data, if you want to do it yourself, is to go to the Federal Reserve site in St. Louis:
Give it a shot and download the FRED app on your iPad and iPhone. You can dazzle (or bore) your acquaintances with financial trivia. You can enter the data for your firm and the spreadsheet will compute the regression coefficients against each. You can use annual data (if your firm has been around 5 years or more). If it has been listed a shorter period, you may need to use quarterly data on your firm. The data you will need on your firm are:
- Operating income each period (this is the EBIT)
- Firm value each period (Market value of equity + Total Debt); you can use book value of debt because it will be difficult to estimate market value of debt for each period. You can also enterprise value (which is market value of equity + net debt), if you are so inclined. I know that you should be including the present value of lease commitments each period, but that would require doing it each year for the last ten. The easiest way to get this data is to use the FA function in Bloomberg or from S&P Capital IQ.

I have to warn you in advance that these regressions are exceedingly noisy and the spreadsheet also includes bottom-up estimates by industry. There is one catch. When I constructed this spreadsheet, I was able to get the data broken down by SIC codes. SIC codes are four digit numbers, which correspond to different industries. The spreadsheet lists the industries that go with the SIC code, but it is a grind finding your business or businesses. I am sorry but I will try to create a bridge that makes it easier, but I have not figured it out yet. My suggestion on this spreadsheet. I think it should come in low on your priority list. In fact, focus on the intuitive analysis primarily and use this spreadsheet only if you have to the time and the inclination. My webcast for tomorrow will go through how best to use the spreadsheet.


The review session for the quiz is up and running. You can get to it by going to one of the links below:
Streaming: http://nyustern.mediasite.com/Mediasite/Play/13581fe6dff7456f935dc92336338dcf1d
Download: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/13581fe6dff7456f935dc92336338dcf1d/videopodcast.mp4
I have also posted it on iTunes U and will shortly have a version on YouTube. Slides attached.

Attachment: Attachment: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/reviewQuiz3.pdf


I know that you are busy but I have put the webcast up on debt design, using Walmart as my example, online (on the webcast page as well as on the project resource page). Here are the details on the webcast:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/debtdesign.mp4
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/debtdesign.ppt
WMT financial summary: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTFAsummary.pdf
WMT macrodur.xls spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTmacrodur.xls
The updated macroduration spreadsheet with data through 2015 was attached to yesterday’s email. I have attaching it again, just in case. I hope you get a chance to watch the webcast and design the perfect debt for your firm.

On a different front, a few of you have noticed that I have not been updating my Jensen’s alpha, by sector. One reason is that I switched to Capital IQ from Value Line and getting to a Jensen’s alpha has become much more difficult. If you want to come up with a good proxy, here is what I would suggest that you do. Pick a time period and compare the returns on your stock (total) to the returns on the sector it is in. You can get the latter online on Yahoo Finance, Google Finance and multiple other sites, like this one:


Bad news: Another weekly newsletter for you. Good news: It is the second to last one, which is my not-so-subtle way of telling you that the end of the semester is fast approaching.

Attachment: Issue 12 (April 23)


The quizzes are ready to be picked up in the usual spot. The solutions and grading template are attached. Happy Hunting!

Attachments: Solution (a or b) & distribution of grades


I hope you have had a chance to pick up your quiz. As you look at the calendar, there is some bad news and some good news. The bad news is that you have three class sessions and two weekends left in the class. I know that you may be in a bit of a panic, but here is what needs to get done on the project. (I am going to start off from the end of section 5, since I have nagged you sufficiently about the steps through that one).

1. Optimal capital structure: You need to compute the optimal debt ratio for your company
1.1: Estimate the cost of capital at different debt ratios.
Use capstru.xls, if you need to.
1.2: If you want to augment the analysis by using the APV approach (apv.xls), do so. Clearly, these approaches will add value only if you have a sense of how operating income will change as the ratings change for your company or the bankruptcy cost as a percent of firm value.
1.3: Assess how your firm's debt ratio compares to the sector. You can just compare the debt ratio for your firm to the average for the sector. If you feel up to it, you can try running a regression of debt ratios of firms in your sector against the fundamentals that drive debt ratio (Look at the entertainment sector regression I ran for Disney in the notes).

2. Debt design: As you work your way through or towards the debt design part, here are a few sundry thoughts to take away for the analysis:
2.1. The heart of debt design should be the intuitive analysis, where you look at what a typical project/investment is for your firm (perhaps in each business it is in) and design the most flexible debt you can, given the risk exposure.
2.2. The quantitative tools (the regression of firm value/ operating income versus macro variables) may or may not yield useful data. The bottom-up approach (using sector averages) offer more promise. If you have a non-US company, a US company with little history or get strange results, stick with just the intuitive approach. Use the spreadsheet at this link to do both:

2.3: Compare the actual debt to your perfect debt (either from the intuitive approach or from the quantitative approach) and make a judgment on what your company should do.

3. Dividend analysis: We developed a framework for analyzing whether your company pays out too much or too little in dividends in class yesterday. You can read ahead to chapter 11, if you want, and use the spreadsheet at the link below to examine your company.
3.1: Examine whether your company has returned cash to its stockholders over the last few years (5-10 or whatever time your firm has been in existence) and if yes, in what form (dividends or stock buybacks). The information should be in your statement of cash flows.
3.2: Assess whether your firm is holding back cash or returning in excess by running your numbers through the attached spreadsheet.
You can watch the webcast I will be posting tomorrow, if you run into questions.
3.3: Make a judgment on whether your company should return more or less cash to its stockholders.

The next section has not been covered yet in class, but you can get a jump on it now, if you want.

4. Valuation: This is a corporate finance class, with valuation at the tail end. We will look at the basics of valuation next week and you will be valuing your company. Since we will not have done much on valuation, I will cut you some slack on the valuation. It provides a capstone to your project but I promise not to look to deeply into it. Knowing how nervous some of you are about doing a valuation, I have a process to ease the valuation: Download the fcffsimpleginzu.xls spreadsheet on my website. It is a one-spreadsheet-does-all and does everything but your laundry.

You will notice that the spreadsheet has some default assumptions built in (to prevent you from creating inconsistent assumptions). I do let you change the defaults and feel free to do so, if you feel comfortable with the valuation process. If not, my suggestion is that you leave the inputs alone.

You will notice that I ask you for a cost of capital in the input page. Since you already should have this number (see the output in the optimal capital structure on section 1), you can enter it. If you want to start from scratch, there is a cost of capital worksheet embedded in the valuation spreadsheet. There is a diagnostic section that points to some inputs that may be getting you into trouble. I also ask you for information on options outstanding to employees/managers. That information is usually available for US companies in the 10K. If you cannot find it, your company may not have an option issue. Move on.

5. Project write-up and formatting: If you are thinking of the write-up for the project and formatting choices, you can look at some past group reports on my site (under the website for the class and project). I prefer brevity and have imposed a page limit of 25 pages on the report (plus 2 pages for each additional company over 5). Please keep your report to that limit. As a general rule, steer away from explaining mechanics - how you unlevered or levered betas -and spend more time analyzing your output (why should your company have a high beta? And what do you make of their really high or low return on capital?).

Ah, where is the good news? You will be done with the project exactly 11 days from today. It is due by 5 pm on May 9.


As we work through the analysis of dividend policy, you have to look at the trade off on traditional dividends (and whether your company is a good candidate for paying dividends or increasing them). The first webcast looks at the question, using Intel as an example:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/dividendtradeoff.mp4
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/dividendtradeoff.pdf

You have to follow up by assessing potential dividends and whether your company is returning more, less or just about the same amount as that potential dividends. The second webcast looks at the question, again using Intel:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/dividendassessment.mp4
Spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/IntelDividends.xls
Annual Report: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/IntelAnnualReport.pdf
Historical data: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/IntelBloomberg.pdf

The spreadsheet that goes with these webcasts is an old one. So, use the updated version that I sent you yesterday which has data through 2015:

I hope you get a chance to take a look at both webcasts.


The end is near!!! Repent, repent!!! The last newsletter is attached. Read it, if you want. Don’t, if you don’t.

Attachment: Issue 13 (April 30)


In today's class, we put the closing touched on dividend policy analysis by going through the possess of estimating FCFE, the cash flow left over after capital expenditures, working capital needs and debt payments. My suggestion is that you estimate the aggregate FCFE over 5 years (or as many years as you have data) and compare it to the cash returned. If the cash returned = FCFE, you have a rare company that pays out what it can afford in dividends. If cash returned <FCFE, your company is building up cash and you should follow through and look at how much you trust the management of the company with your cash (use the EVA and Jensen's alpha that you have estimated for your company).
If cash returned > FCFE, check to see whether the company is digging a hole for itself and whether you can find a way for them to exit as painlessly as possible. Remember that if you found your company to be under levered, you want them to pay out more than their FCFE at least in the near term.We also looked at how most companies set dividends, which is by looking at what everyone else in the sector is doing. I have attached the sector averages for dividend policy (in two files). If you want to see my dividend market regressions, click on the link below:
Note the low R-squareds before you use the regression.

In the second half of the class, we laid the foundations for valuing companies by talking about the importance of narrative and connecting them to numbers. If you are interested, here is the talk that I gave to the CFA annual conference on the topic two years ago:
It is really long, but you can watch a little bit of it, if you are so inclined. We ended the class by talking about the distinction between valuing equity and valuing an entire business and the way we estimate cash flows and discount rates in each case. Finally, the post class test and solution are attached.

Attachments: Post-class test and solution


Since the project is due in less than a week and you may still have not done the valuation part, I decided to move up the in practice webcast four days and post the links today. The spreadsheet that I used to illustrate the process is the fcffsimpleginzu.xls that I had sent in an email last week and the company I have used is Apple in May 2013. Here are the links:
Link to the webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/valuation.mp4
Valuation of Apple in May 2013: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/valuation/applevaln2013.xls
Apple 10K (September 2012): https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/valuation/apple10K.pdf
Apple 10Q (March 2013): https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/valuation/apple10Q.pdf
As I mentioned in class, spreadsheets may be all about the numbers but valuations reflect narratives. Once you have gone through the webcast, please try entering the numbers for your company into the updated version of this spreadsheet (which I have attached) and bring the output to class tomorrow. This spreadsheet does have a few more bells and whistles added to it, since the original webcast but the structure is fundamentally the same, though the numbers have all been updated.

While there are other more elaborate and involved valuation spreadsheets, this one has three advantages. First, it requires relatively few inputs to value a company. Second, it is versatile and will value companies across the life cycle, from young, money losing start ups to companies in decline. Third, I have tried to set default options in the spreadsheet that protect you from your overreaching. I know that you are capable of protecting yourself, and if you feel comfortable, please go ahead and turn off the defaults.

Attachments: Valuation Spreadsheet


In today's class, we looked at valuation as the place where all of the pieces of corporate finance come together - the end game for your investment, financing and dividend decisions. After drawing a contrast between valuation and pricing, we looked at the four drivers of value: cash flows, growth rates, discount rates and when your company will be a stable growth company. We then looked at how these numbers can be different depending on whether you take an equity or firm perspective to valuation and what causes these numbers to change. In particular, we argued that while no one can lay claim on the "right" value, we still need to be internally consistent with our assumptions. High growth generally will be accompanied by high reinvestment and high risk, and as companies mature, their growth and reinvestment characteristics should change. Ultimately, though, the best way to learn valuation is by playing with the numbers and seeing how value changes. I did talk about the presence of uncertainty and how it affects how you approach the numbers and if you are interested, you may find my latest blog post relevant for that discussion:

I hope you get done with your number crunching in the next day or two. Once you have the numbers done, could you please fill out the attached spreadsheet with your numbers and send them to me. In the last class, I hope to summarize all of your findings and present them to you - the ten most under levered companies in the class, the ten most over valued companies in the class... It is fun, but I can do it only I have your numbers. While it make the logistics easier, if you sent me the numbers for everyone in the group in one go, I will take what I can get. Thus, if four out of five members have their numbers ready, but the fifth is lagging, I will take the four companies that you have the data for. Since it will take me a little time to pull these numbers into a summary sheet and analyze them, please do get them to me by Sunday evening at the latest and earlier would be better... Post class test and solution are attached.

Attachments: Post-class test and solution


As your project winds down (or up), I am sure that there are loose ends from earlier sections that may bother you. In the interests of brevity, I have listed a few of the questions that seem to be showing up repeatedly in emails:

1a. I just discovered that my company lists revenues from "other businesses". How should I treat these in bottom-up beta computations?
If your company tells you what the other businesses are, you can try to incorporate their betas into your bottom up beta. If all you have is a nebulous 'other businesses', I would ignore it in beta computations.

1b. I just discovered that my US company has revenues from other countries (including emerging markets) and in other currencies. How does this affect my cost of equity/debt/capital?
First, if you have chosen to do your analysis in a currency (say US dollars), your riskfree rate will be the riskfree rate in that currency (US treasury bond rate), even if the company has revenues in multiple currencies. Second, your cost of debt will still be that of a domestic company. Coca Cola will not have to pay an Indian country default spread when it borrows money in rupees. If it had to, it would just borrow in the US and use currency derivatives to manage risk. Third, and this is the only place it may make a difference, it may change the equity risk premium you use. Instead of using the mature market premium, you may decide to incorporate the additional risk of some of the countries that you operate in. Note that this is likely only if you know your revenue exposure in some detail and you get significant revenues from emerging market countries (with less than AAA ratings).

1c. What should I be doing with the cash balance that my company has when computing the unlevered beta?
Adjusting betas for cash creates more headaches and confusion than perhaps any other aspect of discount rates. Back up, though. To get the unlevered betas of the businesses that your company is in, you should always start with the average regression beta for the companies in the sector, unlever the betas using the average gross D/E ratio and then adjust for the average cash balance at these companies. (That will yield the unlevered betas corrected for cash for each of the businesses that your company is in).
Now, comes the tricky part. You can compute an unlevered beta for just the operating businesses that your company is in, by taking the weighted average of the unlevered betas of the businesses. You can also compute an unlevered beta for the entire company, with cash treated as an asset/business with a beta of zero. The latter will always be lower than the former. My suggestion is that you compute both.
If you are now computing a cost of equity as an input into the cost of capital, you want to use the unlevered beta of just the operating assets of the business as your starting point for levered beta and cost of equity. That is because the cost of capital is a discount rate that we apply to operating cash flows (and to value the operating assets). In fact, we add the current cash balance to this value, because cash has been kept separated from operating assets. (If you use the lower unlevered beta that you get with cash incorporated into the calculations to get to a cost of capital, you will end up at least partially double counting cash, once by lowering the beta and the cost of capital, and again when you add cash at the end).
When would you use the beta for the company (with the cash beta of zero incorporated into your calculation)? Rarely. Here is one scenario. Let's assume that you are looking at a discounting the dividends of a company or an overall cash flow that is estimated from net income. These cash flows reflect cash flows from all of the company's assets (not just its operating assets) and it is appropriate to use the lower company beta with the cash effect built in.
(If you find this too abstract, go back to lecture note packet 1 and check out pages 160 & 161, where I estimated Disney's beta and cost of capital)

2. If I have no or little conventional debt and significant operating lease commitments with no rating, how do I compute a synthetic rating?
If you use just conventional interest expenses and operating income to compute the interest coverage ratio and the synthetic rating, you will overrate companies with lots of leases. You should try to adjust both the operating income and interest expenses for leases. Before you panic, let me hasten to add that all of the spreadsheets that incorporate leases (ratings.xls, capstru.xls and the valuation spreadsheet) do this for you already. If you did build your own spreadsheet, check and make sure that you are incorporating leases.

3. I have a negative book value of equity. How do I compute ROE and ROC?
First the book equity you should use for ROE and ROC should be the total shareholders equity, which can be a negative number. With a negative book value of equity, you cannot compute ROE. You should still be able to compute return on capital, since adding the book value of debt to negative book equity should still lead to a positive book capital. If book capital is negative, though, you cannot estimate return on capital either.

4. My ROE > Cost of equity and my ROC < Cost of capital (or vice versa). How is this possible and how do I explain it?
There are two reasons why the two measures may yield different conclusions:
1. The net income includes income/losses from non-operating assets including cross holdings in other companies. If you have cross holdings that are making you a lot of money, you can end up with a high ROE, even though ROC looks anemic. If you have cross holdings that are losing you money, the reverse can happen. Net income is also affected by other charges (restructuring, impairment etc.) and other income... I trust the ROC measure more when it comes to answering the question of whether the company takes good investments.
2. The ROE reflects the actual interest expense on debt. To the extent that you are borrowing money at rates lower than what you should be paying (given your default risk and pre-tax cost of debt), you are exploiting lenders and making equity investors better off. Thus, you can take bad projects with "cheap" debt and emerge successful as an equity investor. (Think of the LBOs done earlier this year.)

5. My Jensen's alpha is positive (negative) and my excess return is negative (positive). How do I reconcile these findings?
Market prices are based on expectations of how well or badly you will do in the future. To the extent that you beat or fail to meet these expectations, stock prices will rise or fall. Thus, if you are a company that is expected to earn a 30% ROC and you earn a 25% ROC, you will see your stock price go down (negative Jensen's alpha) even though you have a healthy positive EVA. Conversely, if you are a company that is expected to make only a 2% ROC and you make a 3% ROC, you will see your stock price go up (positive Jensen's alpha) while your EVA will be negative.

6. How do I come up with the cash flows and characteristics of a typical project?
I really do not expect you to come up with cash flows. Just describe in very general, intuitive terms what a typical project will look like for your company. For Boeing, for instance, you would describe a typical project in the aerospace business as being very long term, with a long initial period of negative cash flows (when you do R&D and set up manufacturing facilities) followed by an extended period of positive cash flows in multiple currencies.

7. The cost of capital is higher at my optimal debt ratio than at my current debt ratio. Why does that happen and what do I do?
Try the "FAQ" worksheet in the capital structure spreadsheet.

8. If my firm is already at its optimal debt ratio, do I still need to go through the debt design part?
Yes. You still have to determine whether the debt the company already has on it's books is of the right type. The only scenario where you can skip this is if both your actual and optimal debt ratios are zero percent.

9. I cannot do the macro regression (because my company has been listed only a short period or is non-US company). What do I do about debt design?
Skip the macro regression. You can still use the bottom up estimates for the sector in which your firm operates. To do this, you need an SIC code which your non-US company will not have. Look up a US competitor to your company and look up its SIC code. You can also still do the intuitive debt design. (I would do the same if you are getting absurd or meaningless results from your macro regression...)

10. My macro regression is giving me strange look output. What should I do?
Take a deep breath. The macro regression is run with 10 or 11 observations and you can get "weird" output because of outliers. That is why you should look at the bottom up estimates and bring in your views on what a typical project for a company looks like.

11. My company pays no dividends. Should I bother with dividend analysis section?
Yes. Paying no dividends is a dividend policy. You will have to estimate the FCFE to check to see if this policy makes sense. (If the FCFE <0, it does...)

12. I have a non-US company. How do I get market returns and riskfree rates for the dividend analysis section?
On this one, I am afraid that the fault is mine for not giving you a way to pull up the data on other markets. To compensate, I will be okay with you using the US data for non-US companies.

13. I am getting strange looking FCFE for my company... What's going on?
Check the signs of the numbers you are inputting into the spreadsheet. If you are entering cap ex as a negative number, for instance, I will flip the sign around and add cap ex instead of subtracting it out...

14. We have a problem group member. Are we allowed to take punitive measures?
Yes, as long as you do not violate the Geneva Conventions. If you are new to this type of business, you can review this scene from The Marathon Man for ideas (http://www.youtube.com/watch?v=dG5Qk-jB0D4). I must warn you that this may violate the Stern Honor Code.

15. My value is very different from the price. What's wrong?
First, very different is in the eye of the beholder. i have valued companies and obtained values that are less than one fifth of the price and five times more than the price. The reason is sometimes in my inputs but it can also be a massively under or over priced stock. So. check your numbers and if you feel comfortable with them, let it go.

16. When will this torture end?
Four days from today (5 pm on May 9)... but the memories will last forever…

5/5/16 In my earlier email today, I noted that you should use the most recent data for your company and for most of you that means the last 10K, if your company has a calendar year end. If it does not, you will be using trailing 12 month data, also ending about December. I am aware that some of your companies are reporting their 10Qs for the first quarter of 2016. Since I am assuming that much of your number crunching is already behind you (or hope that it is), it would be unfair of me to ask you to update everything to include this first quarter. So, if you are frantically redoing entire sections of your report, you can stop. If you have already come to the conclusion that I would never ask this of you, since I am such a compassionate and kind person, good for you. If your reaction to this email is “What’s a 10Q?”, just forget you even got this email.

As you embark on the valuation phase of the project, here are a couple of things to keep in mind:
1. Stick with the simpler version of the ginzu spreadsheet that I have created just for this class,
2. Recognize that you always have to make assumptions about the future to value companies. In other words, you will not find these numbers in 10Ks, annual reports or SEC filings. That is the bad news. The good news is that I don't have a crystal ball either. So, as long as your estimates are internally consistent, you are okay.
3. I have built the spreadsheet to protect you by setting in default settings at the safest levels. I do give you the options to release these defaults but do so only if you understand the consequences
4. Once you are done with your valuation, you will check it against the market price. If it is different, you will get the urge to go back and tweak your inputs to get your value to be closer to the price. Try to fight that impulse, though it is tough to do.

I know that this is shaping up as the weekend from hell for some of you and I share some (or all) of the blame. Anyway, it is too late for me to be offering you "substantive" help on the project, at least on a collective basis, but here is a list of "to dos" for you and me over the weekend:
For you:
1. Finish the number crunching for the project.
2. Fill in the attached summary sheet with the numbers and get them in to me in an email. In the subject heading, please list “The Fat Lady is waiting".
3. Work on writing up the project report. Don't get fixated on format or on small details. Think big picture. In fact, think of yourself as someone who has been asked to look at your company and address what it does well and badly on each dimension - investment analysis, capital structure and dividend policy. If your company is doing everything well, don't feel the urge to change it.
4. On Monday morning, around 10 am, check your email. You should find a presentation (see my tasks below) for the class attached to the email.
5. Come to class on Monday. I know that some of you have not been in class the last couple of weeks and I understand that there are finals and projects due in other classes. However, Monday's class is special. If this were a play, it would be when the fat lady sings. While I may be neither fat nor a lady nor can I hold a tune, I will do my best impersonation.
6. Turn in your project report by email by 5 pm, as an attachment (pdf preferably, though I can take MS Word). In the subject, please list "The torture ends".

For me:
1. Send nagging emails every few hours asking for your summaries and providing updates.
2. Pull your summaries together in a master spreadsheet.
3. On Sunday night, do assorted magic on the summaries
4. Put into a final presentation (see above) and send to you by Monday morning at 10 am
5. Show up in class and do the "fat lady song"
6. Wait for your final project reports
7. Start grading…

5/7/16 I will keep you updated through the weekend on the number of summaries that I have receive and the number yet to come. It is not intended to panic you or evoke guilt but to just keep you in the loop. And if you do have last minute questions or just need some handholding and therapy (It is going to be okay! This too shall pass! You are a good person, Just having a bad moment!... Just practicing my lines..), you can email me and I will try to respond as soon as I can. I have a couple of lacrosse games to get to over the weekend but I should be able to check email. My iPhone typing skills are abysmal. So, please forgive me if my replies seem abrupt or nonsensical (that spell check on the iPhone is deadly)!
Updates received so far: 6
Updates to come: 230+
If your response is what summary, I am attaching the summary sheet, just in case. When you do send your summary, please include “The Fat Lady is waiting” in the subject line. If you are sending in your final project, please list “ All good things end” in the subject.
5/8/16 Just a quick collective update on the project summaries:
Summaries received: 18
Still to come: 230
Waiting with bated breath!

Again, thank you for sending me your summaries and helping me put together the presentation for today's class. If you were not able to make it to class (and I don't blame you for not making it, especially if you were the person sending your summary in at 6.40 am), I have attached the presentation to this email as well as the summary numbers for every company in the class. In class today, we looked at the big picture of the class, using the project findings to illuminate each part from corporate governance to risk to investment analysis to capital structure, dividend policy and valuation. I have posted the summary numbers for the entire class online and attached it to this email as well. The review session for the final exam will be on tomorrow (May 10) from 3-4 in KMEC 2-60 and it will be webcast, if you cannot make it. I have attached the slides for the review session. The final exam is on Wednesday from 4-5.45.

You should also start seeing your projects returned slowly over the coming days. I will be bcc everyone on the original email that you sent me. So, everyone in the group should have the project back at about the same time. The grading for the project is out of 30 and it is subjective, but I will try to be as fair as I can. There are no letter grades attached to the numerical scores, since the entire class grade should be up by next week. I hope to get many of them done tomorrow, but if you don’t get it back tomorrow, you will probably be getting them sometime over the weekend. Until next time!

Attachments: Closing presentation & Project summaries


I am sorry but I know that some of you are waiting for the webcast. It took a long time but it is now ready.
Streaming: http://nyustern.mediasite.com/Mediasite/Play/f116088f3e2c433bbe4fa53cfa914be51d
Downloadable: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/f116088f3e2c433bbe4fa53cfa914be51d/videopodcast.mp4
The review slides are attached.

In the review, I did an example with Campbell Soup and I suggested that you try different prices for the buyback, just to see if you get it. I have attached an excel spreadsheet that you can use to check your answers. (I have worked out the solution with a $38 buyback price but you can change the price around).


Your final exams are done and can be picked up in the usual place. I am attaching the solution but no grade distribution, since the final grades will be up by later today. I will send out my final email when they are up and can be checked.

Attachments: Final Exam & Solution


The grades are officially in and you should be able to check them online soon. In the interests of transparency, I have attached a spreadsheet where you can enter your scores on the quizzes, the final exam, the case and the final project and see your final grade computation. On a more general note, I want to thank you for the incredible amount of work you put into this class. You made it easier for me to teach and I really appreciate it. I know that I buried you under emails (this is the 125th of the class), assignments, projects and weekly puzzles and I also know that most of you were unable to keep up. However, the material for the class will stay online and on iTunes U for the foreseeable future. If you want to review parts of the class, please do go back and review the lecture, look through the notes and even try that week's puzzle. If you really, really want to master corporate finance, don't waste too much time reading books & papers or listening to lectures. Pick another company (preferably as different as you can get from your project company) and take it through the project analysis. Each time you repeat this process, it will not only get easier and more intuitive, but you will always learn something new. I still do!

I hope that you have a wonderful summer planned out and that those plans come through. If you choose to continue to be tortured, I hope to see you in valuation next spring. If you decide that you have had enough, I don't blame you and I hope that you are taking something away from this class which will be useful in whatever you choose to do. That's about it for my last email. Until next time or perhaps for the last time!

Attachments: Grade Checker