1/19/11

Hi!
Happy new year! I hope you have have a wonderful break and that you will come back tanned, rested and ready to go.... This is the first of many, many emails that you will get for me. You can view that either as a promise or a threat...
I am delighted that you have decided to take the corporate finance class this spring with me and especially so if you are not a finance major and have never worked in finance. I am an evangelist when it comes to the importance of corporate finance and I will try very hard to convert you to my faith. I also know that some of you may be worried about the class and the tool set that you will bring to it. I cannot alleviate all your fears now, but here are a few things that you can do to get an early jump.
a. Get a financial calculator and do not throw away the manual.
b. The only prior knowledge that I will draw on will be in basic accounting, statistics and present value. If you feel insecure about any of these areas, I have short primers on my web site that you can download by going to
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/primer.html
c. If you are taking the Foundations in Finance class simultaneously, don't panic. There will be 150 others in the same position and you will not be at any special disadvantage.
d. If you are taking Valuation with me as well, you will be sick and tired of me by the time the semester ends...
And trust me... We will get through this together...
Having got these thoughts out of the way, let me get down to business. You can find out all you need to know about the class (for the moment) by going to the web site for the class:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html
The syllabus has been updated and you will be getting a hard copy of it on the first day of class but the quiz dates are specified online. If you click on the calendar link, you will be taken to a Google calendar of everything related to this class.
http://www.google.com/calendar/embed?src=2ff99445vnuielquu4tjedt65o%40group.calendar.google.com&ctz=America/New_York
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.
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. Make your choice.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cflect.htm
If you prefer a copied package, the first part (of two) should be in the bookstore in next week.
There is a book for the class, Applied Corporate Finance, but please make sure that you get the third edition. You can buy 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 couple of 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 finance (which is what too many firms, investment banks and consultants have indulged in) is over.
That is about it. I am looking forward to this class. It has always been one of my favorite classes to teach and I would like to make it the best class you have ever, ever taken... I know that this is going to be tough to pull off but I will really try. I hope to see you in a few weeks in class. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: The countdown begins

Hi!
By now, most of you have probably made your way back to New York. While the rest of the country counts down to the Super Bowl, I want to start the countdown to the first corporate finance class. Here we go:
1. How do I know if I am registered for the class? If you are getting this email, you are in the class (at least according to the computer). if you were not supposed to be in this class, think of it as destiny... If you think you should be registered in this class, but are not getting this email (here it an interesting logical question: how are you reading it then?), do something about it. I don't quite know what... but don't just sit there.
2. What is this class all about? I cannot give away the secret yet, but you will find out soon enough. The last email should have given you a flavor of what was coming... What last email you ask? You are already behind in the class and it has not even started. You can read the last email by going to
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfemail.html
3. Can I take a peek at the syllabus? Of course! I aim to please. In fact, you can browse through the entire syllabus by clicking on the link below. It describes in excruciating detail my plans to take over your life and dominate your weekends for the next 15 weeks (insert devilish laugh track in here...). Read and enjoy!!
http://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfsyll.pdf
4. I have heard that there is a group project for this class. What is that all about? Since you asked so nicely, i think I should oblige. I have attached the description of this project. Warning: As you read this, you may feel a massive sense of inadequacy. "I cannot do this. I am not even a Finance major" may be your wail. Never fear. You too can do it. This class will be to CFD (corporate finance disfunction) what Viagra is to ED.... just more effective, without the warning about four hours and an emergency room (If you have no idea what I am talking about right... go back and watch the commercial).
http://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfproj.pdf
Just a note. You will be getting hard copies of both the syllabus and the project in class. Please, please don't print these documents off. The rain forests of New Jersey (there are a couple in the malls.. though I think they are restaurants) cannot take any more wasted paper...
5. What about Blackboard? I have heard about Blackboard but I don't much use it much, since I think it some kind of secret conspiracy. However, it does have its benefits. So, I will try to stay up to date on Blackboard as well. The class site is now open for access.
6. Who else will be in this class? I have some good news. All those people you liked in your block are in this class. I have some bad news. All those people you despised are also in as well. As for that loser block you could not stand, the whole block is in there with you. As of last count, there were 381 students registered in the class, 95% of whom were first year full time MBAs. Since there were only about 391 first time MBAs, everyone who is anyone will be in the class. This will be like the Oscars... Party, party, party..
7. What do I have to do before the class? I would spend the weekend, doing silent meditation or participating in a triathlon. If you think these do not sound like good ideas, let me suggest some things that you should not do. Do not consume more than a keg of alcohol, get less than 2 hours of sleep or stand in the line at the Starbucks across the street just before class (since you will never make it to class). Please do get the lecture note packet (or print off the packet) before class. For those of you who have never been in Schimmel, this will be an eye opening experience. Think of it as Carnegie Hall without the acoustics, the charm and the history, and you pretty much have it.
Enough said... See you at 10.30 am on Monday... Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Are we having fun yet?

Hi!
I promised you with a ton of emails and I always deliver on my promises... Here is the first of many, many missives that you will receive for me.....
1. Please finda group as soon as you can: In picking the group, try to keep the following in mind. 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). This group will do both the case and the project.

2. Get started on picking companies: In picking (Avoid money losing companies, financial service firms and firms with capital arms like GE and GM). Once you have your group nailed down, let me know the names of the people in your group and, if possible, the companies you have picked. I will set up a Google Spreadsheet where you can enter your companies, once you have picked them. In picking a company, pick a theme that is fairly broad and pick companies that match this. Thus, if your theme is entertainment, you can analyze Sony, Time Warner, Netflix and even Apple. I would encourage getting diverse companies in your group - large and small, focused and diversified, and non-US companies. (In other words, you don't want five companies that are carbon copies of each other. There is little that you will interesting to say about differences across companies, if there are none)

3. Once you pick your company, you can start collecting the data. You should begin by accessing basic data on your company . You can get much of it from the Bloomberg terminals (there is one on the second floor in the reading room and there should be one downstairs in the computer room) and if you have never used a Bloomberg before, it can be daunting.... Let me know if you get stuck (You can also get a manual on using Bloomberg data written by yours truly u on my web site.)
http://pages.stern.nyu.edu/~adamodar/pdfiles/Bloombergfull.pdf
Look under Collecting Data... it is towards the top of the page. (My suggestion is that you don't print this package but save it as a pdf file on your computer)

4. If you do pick a company by Wednesday, print off the HDS (If you have no idea what an HDS page is, never fear. Read the Bloomberg handout first) page for your company on the Bloomberg terminal (just page 1 will do) for your company and visit the SEC site at
http://www.sec.gov
and print off the latest 14-DEF for your firm. If you cannot pick a company by then, just pick a company that you are interested in and print these two items off for the class...

5. I forgot to mention that all of the sessions will be webcast. 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
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr11.htm
Try it out and let me know what you think. I have been told that it come through best if you have a 50 inch flat panel TV and surround sound. You will also find the syllabus and project description in pdf format to download and print on this page. The lecture note packet is also on this page.

6. 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....

7. Please bring the first lecture note packet to class on Wednesday. I have heard that the bookstore does not have copies yet. I don't know why but I will check. Print off at least the first 25 pages, if it is not available by Wednesday.

Until next time...

P.S: If you have registered late for this class and did not get the previous emails, you can see all past emails under email chronicles
on my web site
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: I have your covered (or cornered)

Hi!
As I mentioned in class yesterday, I will haunt you and harass you all semester. Just to give you a head's up, here are the some of the tools that plan to employ:
a. Emails: The most obvious one will be the emails you get almost every day for the rest of the semester. Since they will all start melding by the time you get to about week 4, I will also be putting all of the emails into what I call an email chronicle. You can find it here:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfemail.html
b. Weekly newsletter: At the end of each week, I will send you and post online a newsletter that lists out where we are in the class and what is planned for the next week. It will also give you a reminder of where you should be on the project.
c. Google Spreadsheet: I just opened a Google spreadsheet with all of those registered for the class at the moment. When you have picked a group and companies to analyze, please go to the spreadsheet by using this link:
https://spreadsheets.google.com/ccc?key=0Alt0SdORYnWadEhEbWxDUUY3ZWNab2NZNG5CRXdfYlE&hl=en&authkey=CL_FtKsP#gid=0
Find your name on the list (if it's not there, you are not registered...), enter the company name in column B (you can change it at a later time, if you change your mind) and give your group a unique name (make sure that everyone in the group uses the same name). It can be something over the top like "Corporate Finance Gods" or something geeky like "Taylor Swift fans"... Make sure that you save the spreadsheet after you have made your entries.

If you seek more harassment, here are your choices:
a. TA hours: There are four great TAs for the class. Here are their email addresses and office hours.
–Margaret Closius < margaret.closius@stern.nyu.edu >, Tu 1-2, Wed 11-12
–Michael Tarulli < michael.tarulli@stern.nyu.edu > , Wed 1-3
–Michele Prencipe < michele.prencipe@stern.nyu.edu >, Wed 3-5
–Ricardo Saias < ricardo.saias@stern.nyu.edu >, Tu, Th 9-10.20
b. Facebook page for class: I have opened a Facebook page for the class. Not having done this before, I don't know what to expect... but if the company is really worth $50 billion, I aim to find out why. You can join the page by clicking below:
http://www.facebook.com/home.php?sk=group_197642000250359
Click on "Ask to join group" and you should hear back from me. You can post on just about any topic or news item you want.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Printing vs pdf file

Hi!
Sorry for two emails in one day but I am responding to a question that I have got more than 3 times today. (That is my threshold for a class email...) It is about whether you need to print of the DEF-14 for your company, assuming that you have picked a company and gone on to the SEC site. (yes.. yes.. there are people who are already there... scary thought, right?) I would suggest just downloading the file as a pdf file on to your computer and not printing any of it. It saves paper and it is easier to search an online pdf file...

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Picking your company and assessing your board...

Hi!
First, on the question of picking companies for your group, some (unsolicited) advice: (1) Define your theme broadly: In other words, don't pick five money-losing airlines as your group. Pick Continental Airlines, Southwest, Ryan Air, Travelocity and Embraer.... Three very different airline firms, a travel service and a company that supplies aircraft to the airlines.
(2) Do not worry about making a mistake: If you pick a company that you regret picking later, you can go back and change your pick.... If you do it in the first 5 weeks, it will not be the end of the world.
(3) If you are leery about picking a foreign company, pick one that has ADRs listed in the US. It will make your life a little easier. You should still use the information related to the local listing (rather than the ADR).
(4) If you want to sound me out on your picks, go ahead. I have to tell you up front that I think that there is some aspect that will be interesting no matter what company you pick. So, do not avoid a company simply because it pays no dividends or has no debt.
(5) If you want to kill two birds with one stone, pick a company that you already own stock in or plan to work for or with .....
As a final reminder. Please pick your company soon and don't forget to enter in the google spreadsheet... As you can see from today's class, we are getting started on assessing your company...

Second, once you have picked your company, start by assessing the board of directors (and making judgments on how effective or ineffective it is likely to be). To help in this process, I am attaching the original article in 1997 that covered the best and the worst boards as well as a more recent article detailing what Business Week looks at in assessing boards.
There are a number of interesting sites that keep track of directors and their workings. I have listed a few below:
http://corpgov.net/: This is a general site listing corporate governance issues and links
http://www.ecgi.org/ : Covers corporate governance in Europe
Yahoo! finance reports corporate governance scores for individual companies...
http://finance.yahoo.com/
Type in the symbol for the company that you want to look up and check under profile.
Here is a fun site that allows you to look at individuals who sit on multiple boards.
http://www.theyrule.net
Type in George Mitchell, for instance, and see which boards of directors he sits on... Finally, 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).

You can find out more about your company by going to the SEC site (http://www.sec.gov) and looking up the 14-DEF for your company.. As I noted in class today, you may not be able to find a 14-DEF (or its equivalent) for a foreign company, but the difficulty of finding this information may be more revealing than any information that you may have unearthed.
Until next time...

P.S: If you have trouble with the attachments, check under readings (under the corporate finance class) for the articles. (Even if you can read the articles, check under readings for more articles...)

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Business Week article on board of directors

Subject: Disneywar, orphan list and odds and ends...

Hi!
I am sorry that it took me a while to post the webcasts from yesterday's class but they were having technical problems in the Media center. Hopefully, it will not happen again. A few quick notes.
1. Larry the Liquidator: I posted the Danny Devito "Larry the Liquidator" speech from Youtube on the Facebook page for the class. (http://www.facebook.com/home.php?sk=group_197642000250359)
Watch it when you get a chance. Not only is it entertaining but it is a learning experience. 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. DisneyWar: I mentioned this book in class yesterday, written by James Stewart. It is in paperback, on Amazon:
http://www.amazon.com/DisneyWar-James-B-Stewart/dp/B000W3W6NO
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. Orphan list: I had promised to start an orphan list. I have the first orphans listed below. Please give them a good home. (If you are an undeclared orphan, either let me know, or put up your request on Facebook or Blackboard. Try not to use the email alias for the class, since it is really not supposed to be used for that purpose.
joshua.jacoby@stern.nyu.edu (MBA2)
Heather Jack <heather.angeli@gmail.com> (Joint degree MBA/MFA)

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: First newsletter & task for Monday's class

Hi,
I had mentioned in class that I would be sending you a newsletter at the end of every week for the entire semester. I am sure that you have been waiting with bated breath for the first newsletter and I am obliging you by attaching it to this email. Make sure you read this absolutely dazzling, mind-blowing screed. It could change your life forever (not!).
On a different note, 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 on campus (as I mentioned in an earlier email, there is one in the MBA lounge and there used to be one in the basement)... If you do find one vacant, jump on it and try the following:
1. Press the EQUITY button
2. Choose FIND YOUR SECURITY
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 have not picked a company yet, don't worry... Time is still your ally... for the moment...

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Weekend update

Hi!
Hope you are watching the Super Bowl! I have to tell you that having watched the Black Eyed Peas sing, those synthesizers they use in the studios must be the secret to their success. They sound far better on radio than they do in person.. but then again, what do I know? Two very quick notes before I get to the game:

1. A reading suggestion: If you are looking for a good book to read that combines sports and numbers (two things I love) here is my suggestion.
http://www.amazon.com/Scorecasting-Hidden-Influences-Behind-Sports/dp/0307591794
Tobias is a behavioral economist from the University of Chicago, where fun goes to die, but don't hold it against him. This is truly a fun book to read.

2. Three more orphans for the list. Please be kind.
Masa (Masakazu Ikeda) ???? <mikeda81@gmail.com>
Kiwon Joh <kiwon.joh@stern.nyu.edu>
Harper Matheson <hbm205@stern.nyu.edu>

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Supplementary presentation

Hi!
I am sorry about sending this to you so late, but I have a segue presentation that I will be using today to illustrate potential conflicts of interest that arise from who holds stock in a company. You don't have to print off a copy. Just save it and look at it later, if you so desire. If you have a company and an HDS page, take a look at page 2 of the presentation and see if you can classify your company into one of the 8 groups that I have... See you in class!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: HDS analysis

Subject: Hakuna Matata!

Hi!
Hope you have had a chance to download the HDS presentation from today and start work on your company... If you have not picked a company yet, consider this a nag... Anyway, a few notes about the class:

1. Today's class: Today's class extended the discussion of everything that can wrong in the real world. Relating back to clas 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, bondholders get ripped off and society is unprotected. In the next class, we will take a more prescriptive look at what we should be doing in this very imperfect world. As always, reading ahead in chapter 2 will be helpful.

2. Classroom experience: As I noted in my first email, I know that Schimmel is not the most comfortable setting for taking a class. In fact, I know that I have the most comfortable spot in the whole room - up front and I can move around. There is not much I can do about the physical limitations (this semester), though I am working on it for the future. I can, however, fix the audio/video components. Therefore, here are a few questions:
a. Is the audio setting okay? Can you hear me well in the last rows?
b. Is the font big enough on the slides that you can read them from anywhere in the room?
c. Is the light setting too low (and putting you to sleep) or too high (making it difficult to read the slides)
Obviously, there are other things that would make your classes more enjoyable: a barrista delivering espressos to you in your seat, pillows for more comfortable napping and noise canceling headphones to shut out the lectures... but I am afraid that you will have to deliver these on your own.

3. Webcasts: If any of you have had a chance to watch the webcasts, please let me know how they sound. In particular, we have had some issues with audio before and I want to make sure that the audio is clear. If you have downloaded a podcast, is it working on your iPhone, iPad or iPod? If you have an Android, is there another file type that will work better for you?

4. TA hours: I made a mistake on the office hours of Margaret Closius. Her office hours will be from Tuesday 1-3.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Closing the books on the objective function

Hi!
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? I have attached an article on stock price maximization and alternatives to it. 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.

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, I mentioned that there were groups out there that ranked companies based upon social responsibility. I have listed a few below, but they are a few of many:
Calvert Social Index: http://www.calvert.com/sri-index.html
Domini: http://www.kld.com/indexes/ds400index/index.ht
Dow Jones Sustainability Index:http://www.sustainability-index.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). I had also mentioned CRO magazine in class and their top hundred. In case you are interested, here is the link:
http://www.thecro.com/content/100-best-corporate-citizens
| will put it up on the Facebook page. Feel free to discuss and disagree.

If you have picked a company, there are two orders of business you have for this weekend:
a. How much power do you as an individual stockholder have over the management of this company?
To make this assessment, you want to start by looking at the board of directors and examining it for independence and competence. I know that there are lots of unknowns here, but work with at least what you know - the size of the board, the appearance of independence, the (perceived) quality of these directors. With US companies, you can get more information about the directors from the DEF14 (a filing with the SEC that you can get from the SEC website). With non-US companies, you may sometimes find yourself lacking information about potential conflicts of interests, but what you cannot find is often more revealing than what you can find out; it points to how little power stockholders have in these companies. Also look at subtle ways in which power is shifted to managers at the expense of stockholders including anti-takeover amendments (poison pills, golden parachutes), if you can find reference to them.
b. Are there other potential conflicts of interests between inside stockholders and outside stockholders?
In some companies, you will find that there are large stockholders in the company who also play a role in running the company. While this may make you feel a little more at ease about managers being held in check (by these large stockholders), consider who these large stockholders are and whether their interests may diverge from yours. In particular, the largest stockholder in your company can be a founder/CEO, a family holding, the government or even employees in the company. What they might want managers to do may be very different from what you would want managers to do... Look for ways in which these inside stockholders may leverage their holdings to get even more power (voting and non-voting shares for inside stockholders, veto powers for the government...)

While it may seem like we are paying far too much attention to these minor issues, I think that understanding who has the power to make decisions in a company will have significant consequences for how the company approaches every aspect of corporate finance - which projects it takes, how it funds them and how much it pays in dividends. So, give it your best shot... On a different note, we will be beginning our discussion of risk on Monday. As part of that discussion, we will confront the question of who the marginal investor in your company is. Assuming that you have picked your company, could you please take a couple of minutes and go to Yahoo! Finance and look up the percent of stock in your company held by institutions:
http://finance.yahoo.com
Enter the symbol for your firm and click on major holders. Please take note of the percent of stock in your firm held by institutions and insiders and bring it to class with you on Monday. If you have a non-US company, you may not be able to get this information but that is okay.

P.S: I had mentioned a paper that related stock prices to corporate governance scores in class today. You can find the link to the paper below:
http://pages.stern.nyu.edu/~adamodar/pdfiles/articles/corpgovstockprice.pdf

I am off to balmy Edmonton now (just kidding about balmy... Might as well be going to Siberia) Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Second newsletter and a prod

Hi folks!
I have been exploring the northern confines of Canada in Edmonton.. Very cold...Not my cup of tea...
Two quick notes:
1. The newsletter for the week is attached. Browse through it when you get a chance.
2. For those of you who have entered your company names in the Google spreadsheet for the class, thank you. I have added a couple of columns in that spreadsheet - one for the number of directors on your board of directors and the other for a corporate governance score (if you can find one). If you have the information, please go to the spreadsheet and enter the numbers.
https://spreadsheets.google.com/ccc?key=0Alt0SdORYnWadEhEbWxDUUY3ZWNab2NZNG5CRXdfYlE&hl=en&authkey=CL_FtKsP#gid=0

Hope you have a great weekend! Until next time!
Aswath Damodaran

Attached: Weekly newsletter #2

Subject: Odds. ends and tomorrow's class

!
Just checked on the Google spreadsheet for the class... and am glad to see some of you on there entering the board size and the corporate governance scores... When you do get a chance, please do input those items. Moving right along, next week should be the week we turn our focus to risk and here are some things that you may want to do to get a headstart:
1. Read chapter 3 in the book (if you have trouble sleeping, this may do the trick...)
2. For your firm (see why I have been nagging you all this time):
- list the biggest risks that you see the firm facing (this is called a risk profile)
- think about whether these risks are ones that will affect just the firm or the entire market
- print off the HDS page for your company (you may have done this already)
- see if you can find out how much of the stock in your company is held by institutions. For US companies, this information is on Yahoo! Finance. For non-US companies, this information may be more difficult to find but it is available on Bloomberg or Capital IQ.

Oh... one more thing... I have attached the news items on the business summary of the front page of the WSJ. Please read each news item and think about whether this risk
a. is a story that is likely to affect one or only a few firms (firm specific risk)
b. is a story that is likely to affect many or most firms (market or macro risk)
c. is a story that is about a few firms but could have wider implications (uncertain)
Trust me.. this is not complicated. It will take five minutes at the most. We will start class with it.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: WSJ Front page

Subject: The Marginal Investor

Hi!
Some of you may be regretting the shift from the soft stuff (objectives, social welfare etc.) to the hard stuff, but trust me that it is still fun.. If it is not, keep telling yourself that it will become fun. Anyway, here are a few thoughts about today's class.
1. The Essence of Risk: There has been risk in investments as long as there have been investments. If you have the time, pick up a copy of Against the Gods by Peter Bernstein, John Wiley and Sons. It is a great book and an easy read. If you want more, you should also pick up a copy of Capital Ideas by Peter as well... That traces out the development of the CAPM....
2. More on Models: If you want to read more about the CAPM, you can begin with chapter 3 in the book. It provides an extended discussion of what we talked about in class today....
3. Diversifiable versus non-diversifiable risk: The best way to understand diversifiable and non-diversifiable risk is to take your company and consider all of the risks that it is exposed to and then categorize these risks into whether they are likely to affect just your company, your company and a few competitors, the entire sector or the overall market.

One final note. If you can, try to make your assessment of whether the marginal investors in your companies are likely to be diversified. Look at both the percent of stock held in your company and the top 17 investors to make this judgment. If your assessment leads you to conclude that the marginal investor is an institution or a diversified investor, you are home free in the sense that you can now feel comfortable using traditional risk and return models in finance. If, on the other hand, you decide that the marginal investor is not diversified, we will come back in a few sessions and talk about some adjustments you may want to make to your beta calculations. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: To start tomorrow's class

Hi!
Two things. One is that I have updated the Google spreadsheet and added a column for riskfree rates. Assuming you have picked a company, I am asking you to pick a currency that you will be using for your analysis. While the most obvious currency to pick is the one for the country in which the company is incorporated and where it files the bulk of its financial statements, you may decide to set it aside (because of your concerns about estimating a riskfree rate) and choose an alternate currency (Dollars instead of rubles to analyze Gazprom). Once you have the currency picked, find a riskfree rate in that currency: you are looking for a long term, default free rate. With US$, this can be the ten-year treasury bond rate today. With Euros, it will be the German 10-year rate... With British pounds, Swiss francs and most of the krona/kroner of Northern Europe, you can look up the ten year rate of a government bond issued in that currency (The FT has a listing of benchmark government bond rates for most countries. I have attached today's listings... Use the yield) If you have a troublesome currency (true for almost any emerging market), you will have to adjust the government bond rate in that currency for the default spread. I used 3% for India, based on the rating, but was opaque about how I got it. We will start tomorrow's class looking at how best to estimate that number. I have attached a three page handout that we will start with tomorrow. Please download it and save it or print it off....

Aswath Damodaran
adamodar@stern.nyu.edu

Attached:

Attached: Default Spreads handout

Hi!
I hope that you are gearing up for an extended weekend of fun (and catching up on corporate finance.. but the two are not mutually exclusive). I have several orders of business:

1. Riskfree rates: The riskfree rate should be the easiest of all inputs to get, but as I noted in class this morning, it is not that easy to get in markets like Brazil and Russia. I had mentioned the riskfree rate in Euros and how different governments issues ten-year bonds denominated in Euros, but with different rates. If you are truly interested in delving deeper on the topic (you must be sick), I have a paper (I know that I need some psychological counseling) on risk free rates that you can read this weekend:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1317436
This is a truly spell binding piece, one that will keep you up at nights..... or put you to sleep... Close call!

2. Risk premiums: We started on our discussion of risk premiums today, I had mentioned survey premiums in class and two in particular - one by Merrill of institutional investors and one of CFOs. I have attached the links to both:
Merrill survey: http://newsroom.bankofamerica.com/index.php?s=43&item=8619
CFO survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1654026
Analyst survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1609563 (My revenge on Ibbotson is on page 7 of the downloaded paper... Petty, I know...)
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:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html
On the same page, you can pull up country risk premiums for about 90+ countries.

3. Emerging Market Political Risk: As we talking about the blooming of India and China as global economies, let us not forget that the political class has not really kept up. At least in India, we still manage to send some real idiots to places where they can be visible. Here is a story that is funny and disquieting (from a country risk standpoint) at the same time:
http://turtlebay.foreignpolicy.com/posts/2011/02/14/indias_foreign_minister_inadvertently_reads_portuguese_statement_at_the_un
As one of my favorite cartoon characters would put it... http://www.youtube.com/watch?v=C_Kh7nLplWo

4. As Stern's Valentine, I have been taking a little bit of a ribbing today. Perhaps, I should respond like Sally Fields at the Academy Awards... I am just glad that I am not Stern's Ruby Rubacuori...http://www.aolnews.com/2011/01/14/ruby-rubacuori-5-facts-on-the-belly-dancer-in-the-silvio-berlus/

More to come in my next email...

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Feedback

Hi!
In response to an email that I sent out last week on improving the classroom experience, I got back several responses, some of which I can do something about:
(1) The webcasts end abruptly at 11.50 and I sometimes spill over and go an extra two minutes or so. I have asked the recording people to add an additional 5 minutes to the recording time. That should resolve the problem.
(2) The font size on the slides is a little small and is difficult to see, if you are towards the back. This is unfortunately something I cannot do much about, since it is a trade off: I could have increased font size but that would add more bulk to the lecture note packet. (For instance, at 20 font size, the number of pages in packet 1 increases from 300 to 360 pages. All I can suggest is that you bring your lecture note packets with you to class and use them, when you cannot see the slides on the screen.
(3) Last minute add-ons: Some of you are being thrown off by the additional slides I start the class with. These slides are not by design. After every class, I usually think about a message that did not fully get through and try to get some slides together to reinforce that message. Also, this is my only way to give you updated information (like the Egypt CDS). I will try to send you the slides as a pdf file the day before class to ensure that you have the material. I will also post the slides on the webcast page.
There were a number of requests that the barrista service be instituted and I have passed them on to the Dean's office. (One more thing: I did get some mixed signals on whether the downloadable versions of the webcasts were working or not. If any of you have had success or failure on this count, please let me know). In addition, if there is anything else that you can think off that will improve the classroom experience, please let me know.

Now to the serious stuff. Hi! In yesterday's class, we considered a forward looking estimate of the equity risk premium, i.e, the implied equity risk premium. In effect, we look at the level of equity prices today (S&P 500 Index) and expected cash flows from dividends & stock buybacks in the future to back out an internal rate of return on stocks. Subtracting out the riskfree rate gives you the implied equity risk premium. As you review your notes (and I hope you have been able to watch the webcast, in case you missed the class), here are some questions that may come up:
1. How do get the expected cash flows from stocks?
Unlike a bond, stocks do not come with promised cash flows. All you can do is look at the past and make your best estimates for the future. he best source for the cash flows on the S&P 500 is S&P. Every three months, they release an update on dividends and buybacks on the S&P 500 stocks. Here, for instance, is their December 15, 2010 update.
Attachment: S&P document on buybacks

The next update will be on March 15, 2011.
I then looked up the growth rate that equity research analysts were estimating for earnings for the next 5 years (5%) and used it to get expected cash flows for the next 5 years. The best source for expected growth on the S&P 500 is zacks.com, a service that collects and reports on analyst estimates of growth for companies. While the premium edition requires a paid subscription, there is enough on the site which is free, for you to get this input. You can also get the growth rate from Yahoo! Finance, by looking up any company, and then clicking on estimates. The only problem with the Yahoo estimates is that they average out the expected growth rate from analysts following individual companies and are biased upwards.

2. What happens after year 5?
Stocks, in theory, can generate cash flows forever. However, since we are looking at the largest companies in the market, the growth rate has to subside to the nominal growth rate of the economy. I used the riskfree rate as a proxy for this growth rate. Here is my reasoning:
Nominal growth rate in economy = Expected inflation + Expected real growth rate in economy
Riskfree rate= Expected inflation + Expected real interest rate
In the long term, expected real interest rate = expected real growth rate. To deliver a real interest rate of 2%, the economy has to generate 2% more in goods and services or it will operate at a deficit.

3. What next?
Once you have the expected cash flows and the current level of the index, it is trial and error to arrive at the internal rate of return. Alternatively, you can use the solver function in excel.

I know that the concept is complex but it is well worth understanding. If you are up to it, try computing today's implied equity risk premium in the attached spreadsheet (which has the implied premium from January 30, 2011).

Initially just update the index and the ten year treasury bond rate and follow the instructions in the spreadsheet to solve for the implied premium. Leave all of the other inputs untouched. Then, you can get inventive and start playing with the inputs.

Until next time!

Your valentine!
Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Calm before the storm

Hi!
I hope you have a great extended weekend planned. If you don't have too much fun stuff to do, please do catch up with your corporate finance material. The pace will be picking up - you probably did not notice but it did last week already - and we will be moving into more dangerous territory. The best pre-work you can do is to start reading ahead to chapter 4 in the book; if you have not read chapter 3 already, you may want to do that first. Chapter 4 is an exceptionally long (and some say torturous) chapter but it is the heart of the book. So, read it in small chunks and try to work through some of the problems at the end of the chapter as you go through. I know it sounds like its a long time off, but the first quiz is two weeks from Monday... and it will cover much of chapter 4 (the entire cost of equity section).
Second, I don't know whether you have had a chance to try the implied equity risk premium spreadsheet that I sent out yesterday... but please give it a shot. It will literally take 3 minutes of your time. Once you have an implied premium, it is time to take the "Deep Thinker" pose and think about what number you are going to use as your equity risk premium for your group. For mature market companies, you have two choices: you can go with the historical premium for the US (4.31%) or the updated equity risk premium (about 5%). I can live with either choice, but I would like everyone within a group to use the same number for mature markets. So, that may need a discussion (online... at least)... If you have an emerging market company, you have to add on the country risk premium. Here is my latest update, based upon a 5% mature market premium:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html
If you go on to my site, you can download this file in excel, if you prefer.
Third, this is an extended weekend, since we have no class on Monday. In Wednesday's class, we will turn our attention to the third and final input to the CAPM. It will help immensely, if you can get to a Bloomberg terminal before then, find your company under equities (this presumes that you are not still vacillating about which company to analyze) and print off the BETA page. For the moment, just print whatever the default page is and we will talk about estimation choices.
Finally, the newsletter for this week is attached...

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attached: Newsletter for week 3

Subject: :Lady Gaga

Hi!
Just a couple of quick notes/ reminders. The first is to remind you that you should be updating your riskfree rate and choosing an equity risk premium to use for your corporate finance analysis. (I know that is exactly what you have been spending the last 48 hours doing.. but just in case... ) When you have chosen your numbers, go into the Google spreadsheet and enter those numbers. The second is another reminder: please print off the beta sheet for your firm from a Bloomberg terminal for Wednesday's class. Hope you have a great rest of the extended weekend. I am off to my 11-year old's basketball game... He thinks he is Blake Griffin, but height and heft don't exactly run in my genes... or his...

Just to make the subject matter fit, here is a link: http://www.youtube.com/watch?v=2V3AvTknX6c. Watch for me to make a similar entrance for Wednesday's class.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Back to the Grind

Hi!
Hope you had a relaxing extended weekend but it is time to get back to work. Just a few notes ahead of tomorrow's class:
1. Beta page: Please do try to print off the beta page for your company before class tomorrow. It is not "essential" but it will be very useful. Since you need to get to a Bloomberg terminal to do this, please don't try at 10.10... there may be a line ahead of you.

2. Solutions to end-of-chapter problems: I am glad to see that some of you are working on the problems at the end of each chapter of the book. If you are looking for the solutions, you can find them by going to my website, clicking on books and clicking on the applied corporate finance book (make sure that you have the 3rd edition). You will see material organized by chapter. Within each chapter, you will see the answers not only to the problems at the end of each chapter but also the assorted questions that are posed during the chapter. If you have no idea what I am talking, act like you did not read this bullet. You will feel much better.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/ACF3E/appldCF3E.htm
When you are on this site, check it out. The excel spreadsheets behind every problem in the book can be downloaded...

3. Google spreadsheet: Hate to be a nag about this, but when you get a chance make your riskfree rate and equity risk premium entries in the google spreadsheet. On the latter, go back and review the choices you have and what might determine your choices. Of course, if you are one the handful, you have not picked your company yet...you are getting to the point of "beyond redemption"...

Until next time,
The Lady Gaga of Finance

Subject: Beta page

Hi!
Let's trace our way back through today's class. We first discussed picking an equity risk premium. While I emphasized that you need to be pick "one" mature market premium (4.31%: historical, 5.20%: implied on jan 1, 2011, 4.94%: implied as of yesterday and 4.25%: average implied premium between 1960-2010), I recognize that you will have different equity risk premiums within your group, if you have a mix of mature market and emerging market companies. Thus, if you have 2 US companies, 1 German company, 1 Brazilian company and 1 Indian company in your group, here is what you may end up with: 4.94% as your risk premium for the mature market companies (the 2 US companies and the German company), 7.94% as your premium for the Brazilian company (4.94% + Country risk premium of 3.00% for Brazil based upon its rating and relative equity market volatility) and 8.54% for the Indian company (4.94% + 3.60% for India). These country risk premiums come from my website and are based upon the ratings for Brazil and India.
Now, on to betas. If you have picked your company (you have, right?) and found a vacant Bloomberg terminal (you have, right?), you can move on to the next step, which is replicating what I did in class with Disney with your company. Following the steps (forgive me but I am a linear thinker, for the most part),:
Step 1: Get on a Bloomberg, click on Equities, find the local listing of your company (this may take a good 20 minutes).
Step 2: Type in BETA
Step 3: You will get a Beta page for your company. Since this may be your first shot at working your way through a page such as this, I printed off the EXXON MOBIL beta page and have annotated it so that you can make sense of the page.
Attachment: Bloomberg beta page

Step 4: Use the Bloomberg beta page to analyze the company.
a. Check out the obvious output:
a.1. The raw beta is your regression beta
a.2: The adjusted beta = 2/3 (Raw beta) + 1/3 (1). Thus, if your raw beta is 1.20, the adjusted beta will be (2/3) (1.20) + (1/3) (1.00) = 1.13
a.3. The R-squared should be listed in decimals. Thus a 0.30 R-squared tells you that have an R-squared of 30%.
b. Compute your Jensen's alpha
b.1: Start with the intercept on the beta page. It is already in percent. Thus, an intercept of 0.22 is 0.22% (Notice the inconsistency with how R-squared is reported)
b.2: You need the average riskfree rate for last 2 (5) years if you have a 2-year (5-year) regression. Since this a bit of a pain to look up,especially for non-US $ analyses, I have made the estimates for you for a few currencies:
Currency Average riskfree rate - last 2 years Average riskfree rate- last 5 years
US $ 1.00% 1.50%
Euro 1.40% 2.00%
£ 2.00% 3.00%
Yen 0.60% 0.80%
Brazilian Reai' 5.00% 8.00%
Indian Rupee 6.00% 7.00%
Chinese Yuan 3.00% 4.00%
Swiss Franc 0.80% 1.00%
b.3: Convert the riskfree rate (which is always reported in annualized terms) to a weekly or monthly riskfree rate by dividing by 52 or 12.
b.4: Jensen's alpha = Intercept - Riskfree rate (`1- Raw Beta). Keep your units straight.

Step 5: I have an excel spreadsheet that you can use to check to see if your computations are right. (I used the Exxon numbers so that you can check)
Attachment: Risk Checker spreadsheet

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Newsletter, ERP and other stuff

Hi!
I have three very quick notes to add to what I am sure is a busy weekend.
1. Equity Risk Premiums: As you have probably guessed my now, I think that the equity risk premium number is a big number in both corporate finance and valuation and that analysts are cavalier in their estimates. To compensate, I have been doing annual updates on the equity risk premium, where I update both the theory and practice on estimation. My latest update for 2011 is online:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1769064
Feel free to ignore this paper. It is long but it is written for practitioners. If you get a chance, read it.
2. Newsletter: The newsletter for this week is attached.

3. Coming up next week: Last week, we argued that the regression betas are untrustworthy, because they are backward looking. Next week, we will look at how best to estimate betas and costs of capital.

Aswath Damodaran
adamodar@stern.nyu.edu

Attached: Newsletter # 4

Subject: Determinants of betas

Hi!
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 strategic terminology right) or build up a brand name has implications for your beta. As some of you probably realized today, the discussion about whether your product or service is discretionary is tied to the elasticity of its demand (an Econ 101 concept that turns out to have value)... Products and services with elastic demand should have higher betas than products with inelastic demand. And if you do get a chance, try to make that walk down Fifth Avenue...

2. Your cost structure matters. The more fixed costs you have as a firm, the more sensitive your operating income becomes to changes in your revenues. To see why, consider two firms with very different cost structures
Firm A Firm B
Revenues 100 100
- Fixed costs 90 0
- Variable costs 0 90
Operating income 10 10
Consider what will happen if revenues rise 10%. The first firm will see its operating income increase to 20 (an increase of 100%) whereas the second firm will see its operating income go up to 11 (an increase of 10%)... that is why looking at percentage change in operating income/percentage change in revenues is a measure of operating leverage.

3. Financial leverage: 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.
All in all, please do think about betas as more than statistical numbers. When companies make production, operating and marketing decisions, they are affecting their betas. More to come in the next few days.

I will be sending out a missive tomorrow, with the review presentation and more about the quiz. For the moment, though, please do try to print off the beta page and do the diagnostics. Use the email from last week, if you get stuck. I have added columns for the Jensen's alpha, R-squared and beta in the Google spreadsheet. Visit it when you have the numbers. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: The quiz... review packet and seating arrangements

Hi!
I may be jumping the gun here, but I thought I should set the table for what is coming this week.
1. Class tomorrow: We will extend our discussion of betas by looking at a process that I call "bottom up" betas and how this can help overcome the problems of regression betas. Two words of warning. There will be a lot of numbers flying at you during the session and it is easy to get lost. I would suggest reading the first two thirds of chapter 4 (it is a long, long chapter), if you feel worried about keeping up. The second is that this session will have a disproportionate impact on your quiz: about 40% of the quiz rests on getting the concepts from tomorrow's class nailed down.

2. Past quizzes: All of the past quizzes from this class are online, with solutions. You can find them by going to
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfprob0.html
If you click on Quiz 1, a pdf file should download. If you can, please try not to print off the file. It is 28 pages long and 400*28 = One less rain forest in Brazil.... The solutions are in an excel spreadsheet. (As you work through the earlier quizzes, you will notice an equity risk premium of 5.5% popping up in the solution without being given in the problem. Prior to 2000, I allowed quiz takers to look up the equity risk premium from the lecture notes and use it. I have learned my lesson now.. and give the equity risk premium in the problem)

3. Quiz review: The review session for the quiz will be in KMEC 2-60 from 11-12 on Thursday, March 3rd. I know that this conflicts with other classes and commitments that you may have. Please do not miss classes to come to the review session. I will make sure that it is webcast and available to you by later in the afternoon on Thursday. I am attaching the review session presentation to this email.

4. Weekend: I will not be in my office on Friday; I have to take my son (a senior in high school) to visit a college in North Carolina. I will check my emails when I am away. So, if you get stuck, don't be shy about emailing. You can also draw on the exceptionally brilliant and helpful TAs for the class:
–Margaret Closius < margaret.closius@stern.nyu.edu >, Tu 1-2, Wed 11-12
–Michael Tarulli < michael.tarulli@stern.nyu.edu > , Wed 1-3
–Michele Prencipe < michele.prencipe@stern.nyu.edu >, Wed 3-5
–Ricardo Saias < ricardo.saias@stern.nyu.edu >, Tu, Th 9-10.20

5. Monday: The quiz will be in the first 30 minutes of class (10.30-11). We did go over the house rules in the first session but they are worth reviewing:
a. There are no make-up quizzes. If you have to miss the quiz, let me know before 10.30 am on Monday.
b. If you miss a quiz, the 10% will get loaded on to the remaining quizzes and the final. (The other quizzes will now be worth 12% each and the final will be 36%). You will lose the option of having your worst quiz score marked up to the average on the other exams.
c. The quiz is open book, open notes. However, you cannot use smart phones, iPads or laptops, since there is no way that they can be made secure.
d. Since it is a little cramped in Schimmel, I have been able to throw my considerable weight around (I do weigh 1000 lbs) and have been able to get two other rooms for the quiz. Here are the seating arrangements (please try to stick with them)
If your last name begins with Go to
A - G KMEC 2-60
H-K KMEC 2-70
L-Z Schimmel Auditorium
Not sure A Psychologist
e. There will be class after the quiz. So, please find your way back to Schimmel by 11.05.

Hope that I have not scared you with this email... Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Review presentation for quiz 1

Subject: First steps to bottom up beta

Hi!
I know that yesterday's class was full of details and I would not be surprised if some of the details skipped by you. While each piece is not complicated, the combination of pieces that you need to reconstruct the beta of a company like Disney can make your head spin. Since this process is so critical not just for the quiz but also for your project and future in corporate finance, I thought it might make sense to give you some crutches that you can use to make sense of why and how best to estimate bottom up betas.
1. Disney numbers: While I provided you with the summary numbers for Disney, you can look at the underlying data of the companies used in each business line and how I came up with the final numbers by going to the website for the book and clicking on the illustration that has these numbers worked out. To save you the trouble of multiple clicks, I am listing the final link below:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/ACF3E/appldCF3E.htm
Go to chapter 4 and click on 4.7.
2. Underling questions: Even after you work through the numbers, you may be unclear about why we go through this torture. I have put together a list of the top ten questions on bottom up betas that I hope answer every conceivable question you may have about the process.

After you have gone through both, you may still be unconvinced about the utility of this process. I completely understand. However, do not throw the baby out with the bathwater. In other words, just because you think this bottom up beta process is cumbersome does not mean that you should not be adjusting your hurdle rates within a company for businesses of different risk. So, hold on to that principle and come up with your own (perhaps simpler) ways of computing those hurdle rates. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: Reminder again: The review session is from 11-12 tomorrow (Thursday, March 3) in KMEC 2-60.
P.S2: I have put the handout from class today online on the webcast page for the class, in case you did not get it.

Attachment: Ten questions on bottom up betas

Subject: Today's webcasts

Hi!
As some of you (who have been looking) have noticed, today's webcasts are not up and running. I don't like to pass the buck (Actually, I do.. I did blame Moody's for Lebanon's country risk premium... but this sounds so much more upstanding) but this delay is not my fault. The tech people tell me that there is a problem with the server (I think tech people have a list of top ten problems that they pass on to the rest of us... hoping we have no idea what the problem really is.. and server issues are at the top of the list) and that they are having trouble with the webcasts. They promise me that it will be resolved sooner rather than later. I will keep you posted.
On a completely different note, did you get a chance to estimate what Disney's beta would have been, if they had borrowed the entire $18.5 billion to buy Cap Cities? I have the solution but I will hold off until later tonight. Give it your best shot...

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Webcasts are up

Hi!
The webcasts are finally up and running, just as American Idol was ending. I think that this was a preconceived diabolical plan by Fox to inflate ratings for the show... So, enjoy!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Disney beta... and a few other pre-review session loose ends

Hi!
If you remember, we looked at the beta for Disney after its acquisition of Cap Cities. The first step was assessing the beta for Disney after the merger. That value is obtained by taking a weighted average of the unlevered betas of the two firms using firm values (not equity) as the weights. The resulting number was 1.026. The second step is looking at how the acquisition is funded. We looked at an all equity and a $10 billion debt option in class and I left you with the question of what would happen if the acquisition were entirely funded with debt. (If you have not tried it yet, you should perhaps hold off on reading the rest of this email right now)
Debt after the merger = 615+3186 + 18500 = $22,301 million ( Disney has to borrow $18.5 billion to buy Cap Cities Equity 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 - that is where the 0.64 on the slide comes from

2. As you start working through past quizzes, you will find that the last question - about betas and what happens after firms restructure - is always the toughest one. A couple of suggestions that may ease your passage. First, separate the effects of changes in business mix from changes in financial leveral. For the former, you work with unlevered betas and firm values. For the latter, you look at debt to equity ratios. For instance, divesting a business changes your business mix because it replaces an operating asset with cash. Paying that cash out as a dividend will affect both your business mix (by taking cash out of the business) and reducing your equity. We will spend a lot of time in the review session today on this issue.

3. Finally, here are two other questions about past quizzes that seem to keep coming up:
a. Why is 5.5% the risk premium in past quizzes and problems?: As you work through a lot of the past exams, you have probably noticed that a 5.5% risk premium magically pops up when you look at the solutions. This is why. If you are not given a risk premium for equity in a problem, you should look it up in your notes and use the historical premium or the implied equity premium and specify what you did. If you were doing that today, you would be using 4.31% (which is the geometric premium for stocks over T.Bonds) or 4.94% (implied equity premium); check your lecture notes to see where these numbers come from. At the time that these quizzes were worked out, that historical premium was closer to 5.5%.
b. Is it possible that some of the problems lend themselves to multiple interpretations? If you read a problem and are not sure about something, make an assumption and state it. When grading the quiz, I will consider your assumption.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Review session webcast up..

Hi!
The review session went off smoothly today. The webcast for the session can be found here:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfquizreview.htm
I hope you find it useful. I also have attached the completed last slide, with consequences of actions for unlevered and levered beta.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: This is not fun...

Hi!
I know what you have planned for this weekend, and you will test the proposition that corporate finance is fun!! Anyway, I want to keep this short and sweet. The newsletter is attached.

Until next time (which will be really, really soon)!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Newsletter # 5

Subject: Top ten list

I did get a few questions repeatedly yesterday and I think it makes sense to answer them publicly:
1. Why do we use past T.Bill rates for Jensen's alpha and the current treasury bond rate for the expected return/cost of equity calculation?
The Jensen's alpha is the excess return you made on a monthly basis over a past time period (2 years or 5 years, depending on the regression). Since you are looking backwards and computing short-term (monthly or weekly) returns, you need to use a past, short-term rate; hence, the use of past T.Bill rates. The cost of equity is your expected return on an annual basis for the long term future. Hence, we use today's treasury bond or long term government bond rate as the riskfree rate.
2. When do you use the arithmetic average risk premium over T.Bills as your risk premium?
Only when you are asked to compute the expected return over the next year (a one-year number). You will never use it to compute a long term cost of equity.
3. Why do you use the US historical risk premium for European stocks?
The US historical risk premium is used as the premium for any mature market, because the US has the longest uninterrupted historical data on stock and treasury bond returns. Most European markets are categorized as mature markets. Hence, it makes sense to use the US premium.
4. How do you adjust for the additional country risk in emerging market stocks?
If the country you are analyzing is not AAA, you should adjust for the risk by adding an "extra" premium to your cost of equity. The simplest way to do this is to add the default spread for the country bond to the US risk premium. This will increase your equity risk premium and when multiplied by your beta will increase the cost of equity. A slightly more sophisticated approach is to adjust the default spread for the relative risk of equities versus bonds (look at the Brazil example in the notes) and adding this amount to the US premium. This will give you a higher cost of equity. (See the Mexico example in the review session). If you are given enough information to do the latter, do it (rather than use just the default spread).
5. 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. In the local currency, you should start with the government bond rate in the local currency and take out of that number any default spread that the market may be charging (see the Mexico example in the review packet)
6. Why do you use the average debt to equity ratio in the past to unlever betas?
The regression beta is based upon returns over the regression time period. Hence, the debt to equity ratio that is built into the regression beta is the average debt to equity ratio over the period.
7. What is the link between Debt to capital and debt to equity ratios?
If you have one, you can always get the other. For instance, the Fall 2006 quiz gives you the average debt to capital ratio over the last 5 years of 20%. The easiest way to convert this into a debt to equity is to set capital to 100. That would give you debt of 20 and equity of 80, based upon the debt to capital ratio of 20%. Divide 20 by 80 and you will get the debt to equity ratio of 25%.
8. How do you annualize non-annual numbers?
The most accurate thing to do is to compound. Thus, if 1% is your monthly rate, the annual rate is (1.01)^12-1.... if 15% is your annual rate, the monthly rate is (1.15)^(1/12) -1... If you have trouble or get stuck, just go with the simpler computation; multiply or divide by 12.
9. Why do you not annualize betas?
As some of you have noted when asked for a cost of equity, I almost always compute it in annual terms. To obtain that number, I take an annualized riskfree rate, an annualized risk premium and the beta from a regression which may be a weekly or monthly regression. This struck some of you as inconsistent (after I harangued you about being consistent on the Jensen's alpha computation). There is a simple reason, Unlike the intercept, the beta has neither a currency nor a time interval attached to it. Thus, a beta of 1.2 is 1.2 in dollar terms or peso terms and 1.2 in weekly, monthly or annual terms. Here is a simple analogy to illustrate why. Beta is a relative number. Thus, if I walk twice as fast as you, that statement would apply whether I computed your speed in miles or kilometers per hour (the currency analog) and whether I was talking about the distance you walked in an hour or a day (the time analog).
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 = Debt + Equity
Enterprise value = Debt + 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 is about it... Hope I have not added to your confusion. Relax.. and I will see you soon. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Illuminations

Well, I guess I have pretty much ruined your weekend and I am sorry. I had a great time in North Carolina. My 18-year old son tried his best to act like he was not related to me (and being a kind father, I obliged). We went to the North Carolina-Duke game in Chapel Hill.. And as a UCLA fan, I was tempted to yell a rejoinder when they made a big deal about their 6 national championships... but I held back. And I think I managed to get all of your emails answered... (If I missed any of you, it was not intentional).

Two more very quick points and I will leave you to your own devices:
1. The bane of technology: I have had several emails about my proposed ban of technological devices and whether these cover Kindles and Nooks, since many of you have done the environmentally friendly act of downloading the slides to those devices and not printing them off. This is a thicket into which I have little desire to go, but I have no choice. So, here is my midway compromise: devices without full connectivity (such as Kindles and Nooks) are okay but device with (iPads) are not... This may seem arbitrary but I cannot think of a way of securing the classroom with connected devices. I know that you have signed the honor code, but I have to be ready for the least honorable amongst you (I know.. I know.. I am a cynic).
2. The age of Enlightenment or Aquarius or something: Anyway, I hope that the quizzes a re getting a little easier as you keep at them and that the skies are starting to open up. In fact, the theme for this song should be emerging:
http://www.youtube.com/watch?v=gIqLsGT2wbQ
I am just hoping that it is not this one:
http://www.youtube.com/watch?v=ZeZm7KQJT1o
Do hold out one exam and take it in real time (without the solutions next to you). Relax and don't stress out too much! Until tomorrow!

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: In case you still need a reminder, the quiz is in the first 30
minutes of class and your room assignments are as follows:
If your last name begins with Go to
A - G KMEC 2-60
H-K KMEC 2-70
L-Z Schimmel Auditorium

P.S,2: There will be class after the quiz... Please do come to it.... we will start class at 11.05.

P.S. 3: If you are going to be missing the quiz, you need to let me know before 10.30 am tomorrow (by emailing me...)

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Quizzes not done yet but other stuff

Hi!
Still grading.. but a couple of quick notes. First, someone left a calculator behind in KMEC 2-60. It is a Kenko KK-82TL and Michele Prencipe has the calculator. His email address is <michele.prencipe@stern.nyu.edu>. Second, I know you are in no mood to think about bottom up betas and total betas right now but please do review what we did with Bookscape in class today to estimate a cost of equity for a private business. You will get more mileage out of that concept with friends and relatives who come to you for help than you will with any other concept in class. Third, I put both quizzes online (on the webcast page) today. (I have not put the solutions up because they will just freak you out... imagining the worst possible scenarios) If you missed the quiz or completely blanked out, try taking in at home (while you are watching House or Pretty Little Liars - I do have a 16-year old daughter) and see if you do better. I know it is small consolation but it will make you feel much better about yourself..

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Cattle call

Hi!
The quizzes are done. Before you jump out of your seat and head for the exits, please read the rest of the email:
1. Where are they?
They are on the 9th floor of KMEC. As you come out of the elevators, walk towards the front door of the finance department. Before you enter the door, look to your left. You will behold the piles.
2. How are they organized?
They are organized in alphabetical order, face down. Please take your quiz. Do not browse and please, please do not get them out of alphabetical order. (It is amazing how long it takes to get the quizzes into order).
3. What if I cannot find my quiz?
Check with your friends first. If not, shoot me an email. I can at least tell you whether I have a grade recorded for you.
4. What if I cannot pick up the quiz today?
I will leave the piles out there until the end of the week.
5. What if I do not want my quiz outside?
I understand. Send me an email and I will remove your quiz and put it in my office. You can collect it from me. Please send me this email quickly.
6. How do I check the grading?
I have attached the solutions to both quizzes. Quiz a is the one with Goldman Sachs and Quiz b is the one with Bank of America. Check the solutions and you will see the grading guidelines that I used. I reserve some subjective judgment along the way.
7. What if I do not agree with the grading?
Come and see me. I do make mistakes, when I grade, and I may have overlooked something or been unfair. I will fix my mistakes.
8. How do I check how I stand relative to others?
I have attached the distribution of the scores. While I hate to do this on a 10% quiz, I have also attached tentative grades (because experience has shown me that this is a hopeless fight to wage: some of you will not rest easy until you have a grade). The key with the grade, whether really good or bad, is that it is for one quiz and it is a very small part of the class. If you did badly, remember that you get one quiz on which you get a freebie. If you did well, congratulations and keep at it.

That is about it for the moment. See you in class tomorrow! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: I will also post these online on the webcast page for the class.

Attachments: Quiz (a and b), Solution (a and b) and Distribution

Subject: I'm baaaack...

Hi!
I know that I have outlived my welcome but I wanted to test the limits again. If you do feel inclined to take a look at corporate finance today, here are a few notes:

1. Private businesses: Last session, I noted that private firms operate at a disadvantage, relative to publicly traded companies in the same business, because the owners of private businesses are over invested in their own companies. Investors in public companies can afford to be much more cavalier about risk (and charge a lower discount rate) because they are more diversified. I did get quite a few emails from people who were upset by the message: that private businesses would be driven out by publicly traded companies. For those of you who are horrified by the vision of a completely corporatized economy, let me hasten to add that I don't foresee doomsday for entrepreneurship/ private business but I do see limits.
a. Small, private businesses will continue to exist and prosper and they will see the most success in
- niche businesses, which are too small for public companies to enter an exploit (Mystery Bookstore)
- personal businesses, where customers want to know the person(s) that they are working with (think doctors, dentists, plumbers, electricians)
- new businesses, where you are creating a new product/service that corporations are unable to provide (because they are too separated from their customers0
b. For the most successful private businesses, the most lucrative exit strategy will be to either go public or sell to a public company.
c. Some successful private business owners may choose not to go public and settle for lower value because they get emotional dividends from running their own businesses
d. Finally, some private business owners try to mitigate the "lack of diversification" by either diversifying their companies into multiple businesses or selling portions of their businesses to private equity investors (and then investing the funds into diversified portfolios)
I remain convinced that entrepreneurs are the engine for a vibrant economy but I also believe that having lucrative exit strategies (IPOs and public sales) increases entrepreneurship in the economy. So, rather than view the market as an enemy, entrepreneurs should view it as an ally.

2. Debt and the cost of debt: We will be addressing what to count as debt and how to come up with a cost of debt for a company. I know it is a long shot but if you can look up the following, it will make life easier (for me and you). I will use Disney to illustrate the process, but it will pack a lot more oomph if you can look up the following for your company:
a. A Bond rating for your company: Not all companies are rated, but if your company is, try to find the rating for your company from S&P or Moody's
b. Book value of interest bearing debt: This should be on the balance sheet of the company (and also on Yahoo! Finance and other sites)
c. Interest expenses on debt: This should be in the income statement for the company
d. Maturity schedule for debt: This should be in the footnotes, and should tell you how much debt is coming due each year.
e. Lease or rental commitments: There should be another footnote that gives you these commitments for the next 5 years and a lump sum for beyond year 5

That's about it (for the moment). See you in class tomorrow! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Bottom up Betas...

Hi!
Now that you have had a chance to pick up your quiz (you have, haven't you?) and gone through the requisit celebration/ mourning period, it is time to think about the project (before or after the break). So, lets talk about bottom-up betas. Here are the basis steps involved in estimating them:
Step1: You have to get a breakdown of the businesses that your firm is in. You can get this by downloading your firm's 10K from the SEC web site or checking its annual report. Don't try to break the company down into too much detail, because you will have trouble finding comparable firms. Thus, if you have an oil company, breaking it down into drilling, refining and exploration is a recipe for frustration.
Once you have it, browse through it (I would say read it but that would be a painful exercise) to find the breakdown of your firm's business. Usually, the company will give you at least revenue and operating income by business. If you have a non-US company, you should be able to find this information in their annual report.

Step 2: Estimate bottom-up unlevered betas for each business. There are four routes you can follow, depending on how much time you are willing to spend on the process-

a. The Easy Route (5 minutes): You can use the unlevered betas that I have computed by business on my web site.
http://www.damodaran.com
You can get to it by going to updated data and looking for levered and unlevered betas by business- I have them as separate datasets for the US, Europe, Emerging Markets and Japan. The advantage is that it is easy to do... The disadvantage is that you will not get the wonderful experience of doing it yourself and the breakdown may not be detailed enough for you.

b. The Slightly more involved route (20-30 minutes): At the top of the updated data page, you will find the complete excel datasets of the 30000+ companies that I used to construct the industry average tables. You can download the datasets (Do it on a high-speed line because it is a very large dataset) and then create your own group of comparable firms. All of the raw data on the company is provided - betas, debt, equity and cash - and you have to construct your own unlevered beta. Try it if you have a chance.

c. The Bloomberg Way (30 minutes - 2 hours, depending): After all, real finance mavens use Bloomberg. You can get the information to estimate unlevered betas by getting on a Bloomberg terminal and typing ESRC. You can then screen across markets and industries to pick firms in particular markets. Once you have your sample ready, you can modify the output page to contain the information you need - betas, debt, equity, cash and tax rates, for example. The advantage is that you can do this for non-US stocks. The disadvantages is that Bloombergs are notoriously user unfriendly and you can get only a paper printout. (We don't pay enough for a download function)

d. Capital IQ: Capital IQ is an awesome database of global companies. You have free access to it, while you are at Stern and you should take full advantage. You do have to jump through a few procedural hoops to get your login and password, but once you do, you can screen in lots of different ways. I put together an absolutely spellbinding video of my screen as I used Cap IQ to show you how easy it is to use. Click on the link below (and be ready for a long wait. The file is big...)
http://pages.stern.nyu.edu/~adamodar/podcasts/CapIQforbeta.m4v

Step 3: Compute the values of each of the businesses that your firm is in. I would recommend using revenues as the starting point. If you are not comfortable using pricing ratios, weight the businesses based on revenues. If you would like a more precise estimate, go back to the comparable firms you pulled up in step 2 and compute the value to sales ratio for the industry
Enterprise Value to Sales = (Market value of Equity + Debt - Cash) / Revenues
Multiply the revenues from each of the businesses by these value to sales ratios to get estimated values, and use them to compute weights.

Step 4: Compute a bottom-up unlevered beta for your company by taking a weighted average of the betas in step 2 with the weights in step 3..

I have more to say about the cost of debt, but this email has reached critical mass... So, have fun.. Until next time!

Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Purple scarf

Hi!
Oops. Sorry, but I found a purple scarf as I walking out of class today. it is quite stunning but I am afraid it does not go with my complexion. If any of you did leave this purple scarf, I have it in my office and you can pick it up....

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Cost of debt

Hi!
Now that you have the bottom up beta (you cannot blame me for hopeful thinking), I want to review some of what you will need to do to come up with a cost of debt and perhaps come up with market values of debt and equity to compute the cost of capital. (This could be something you do on the long plane trip to wherever you are going.... Just get the raw data before you get on...)
1. Get the raw data on interest bearing debt: In particular, take a look at the balance sheet and identify the interest bearing debt. It is not always easy to do since you will see ambiguous items such as long term liabilities. Include both bank loans and corporate bonds, short term and long term debt. (It is possible that your firm has no debt. Don't ruin your eyes looking for something that does not exist. A clue that your firm has no debt will be in your income statement if your interest expenses are zero).
2. Collect lease commitment data: For US companies, the lease commitments (if any) should be in a footnote. The current year's lease payment will be in close proximity. These lease commitments are also called rental commitments....Again, note that not all companies have lease commitments.... and you may not be able to find this table for non-US companies. (European companies break down lease commitments but give you ranges: the lease commitment for years 1-3, 4-5, and beyond. Compute an annual average, if this is the case.
3. Check to see if your company is rated by S&P or Moody's: If you have access to a Bloomberg terminal, you can do this by clicking on CORP and then typing in the name of your company. If nothing shows up, you don't have a rating. If something does, you can click on any of the bonds and look up the actual rating. Another less focused approach is to just type in the name of the company and rating in your Google search and see what comes up.
4. Get a synthetic rating: For firms without a rating, this will be your primary basis for estimating the cost of debt. For firms with an actual rating, it will give you a basis for comparison. You can continue to use the actual rating, but be aware of the synthetic rating as well. I have attached a spreadsheet that will do dual duty - estimate the synthetic rating and convert lease commitments into debt for you... It also gives you the default spread to use with the rating and thus the pre-tax cost of debt for your firm. Just make sure that the riskfree rate you are using is the same 10-year default free rate you used earlier on your cost of equity (Thank you...thank you... I aim to please) (I updated the default spreads at the start of 2010. If you want even more updated numbers, you can try bondsonline.com but you have to pay $35 for an updated table)
5. Get a marginal tax rate to use on your cost of debt: I have attached a link to the page on my website that has the marginal tax rates by country
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/countrytaxrate.htm
That's about it. Have a great spring break! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Synthetic ratings spreadsheet

Subject: Have a great break!

Hi!
I know that many of you are away, in the far reaches of the world and that the last thing you want to think about is Corporate Finance. Understood! No newsletter for this week and you will not hear from me for the rest of the week. Have a great trip and see you when you get back!

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: For those of you who have been left behind, the case for the class (which is due on April 4) is online as a pdf file on the website for the class.
https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/AppleiTVcase.pdf
You can read it, if you are bored... or not..

Subject: The fun is over... or is it just beginning?

Hi!
You have to give me credit for restraining myself for as long as I did, but it is time to get back to work. I know that some of you are still on your way home and will be jet lagged and exhausted when you read this email... So, my apologies:
1. Newsletter: I have attached the newsletter for the week to this email. Since it has been a while since our last class, you may just want to glance at it to see where we are in the lecture notes and where we will be going next.

2. Case: Just in case you did not get the email that I sent out on Monday, the case is available online and can be downloaded as a pdf file.
https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfcase.html
It is due two weeks from tomorrow (on April 4) and it is a group case....

3. Project: I did send out two long emails about bottom up betas and the cost of debt in the week before the break but I know that you probably did not get around to doing either. To those who are so far behind that you have given up hope on ever catching up, I have created one link where I summarize everything I have sent out about the project so far and I hope it helps...
https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfprojectsummmmidway.htm
Please do try to get to it sometime this week and input the numbers into the Google spreadsheet when you get a chance.

4. Investment returns: We will be starting on measuring investment returns this week. This will require at least a minimalist acquaintance with accounting statements.. If you need a quick primer, try this:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/accstate.htm
If you also need to brush up on present value, here is a primer on that topic:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/PVPrimer/pvprimer.htm

5. Email apology: For those of you who were marooned in New York and sent me emails over the week, I apologize if I was tardy or terse on my replies. It was not because I was grumpy but because I was on my iPhone and my texting and typing skills on the small keyboard are woeful (as my daughter points out with great glee..) As to where I was, here is a clue:

In fact, two questions that will have relevance for tomorrow's lecture: Where am I? Whose castle is in the background? (The answer to the first question is obvious.. the second not so much..)

See you tomorrow in class! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Newsletter # 6

Subject: Capital invested and ROC

Glad to have you back.. I plan to make this email a general one about computing capital invested, the meaning of return on capital and the use of pre-debt versus after-debt cashflows. I am sure you will read the sub-text for implications for the case... (If your response is "What case?, you have not been reading your emails...) We looked at return on capital in two contexts today. One was to compute the return on capital for an entire firm and the other was in computing return on capital for a prospective project. The way we compute return on capital and how we use it is different under the two scenarios:
a. Return on capital for an individual project:
How it is computed: The return on capital for an individual project is computed using the projected operating income after taxes in the numerator and the projected capital invested in the project in the denominator. To compute the former, you subtract out operating expenses, including depreciation and allocated expenses, but not financial expenses (such as interest expenses on debt or lease expenses) from revenues; you multiply this number by (1- Marginal tax rate), since the project adds operating income at the margin to estimate the after tax operating income. To compute the latter, you want to stay focused on only the capital investments made in the project. In general, the capital invested in any year can be computed by taking the capital invested at the beginning of the year and adding to it any new capital expenditures made during the year and subtracting out the depreciation expense for the year. If there are working capital investments made, I would that to capital invested as well. For instance, take the Disney theme part example from yesterday (look at slides 207 & 209). There are three components to the book capital for the theme park:
1. Pre-project investment: Since the $500 million that has been spent already has been capitalized, you start the project with this as part of your book capital
2. New investments in theme parks: Any new capital expenditures will increase the book capital invested in these assets and any depreciation will reduce it.
3. Working capital investments: The 5% of revenues that comprise working capital will become part of capital invested.
Book capital at time 0 = 500 (Pre-project investment) + 2000 (Investment in Magic Kingdom) + 0 (no working capital yet) = 2500
Book capital at time 1 = 450 (Pre-project investment net of depreciation of 50) + 3000 (Investment in Magic Kingdom) + 0 (no working capital) = 3450
Book capital at time 2 = 400 (Pre-project investment net of 2 years of depreciation + 3813 (Investment in Magic Kingdom) + 63 (Working capital) = 4,275
(The 3813 in new assets = 3000 (Investment at the start of year 2) + 1000 (New Investment in year 2) - 375 (Depreciation in year 2) + 188 (Capital Maintenance in year 2))
Note that there is no retained earnings or traditional double entry stuff. Projects don't have balance sheets. Any excess cash from the project goes to the company and does not build up within the project.
You have a choice of computing return on capital based on just the capital invested at the beginning of the year or the average for the year. To compute the average in year 1, here is what you do: (2500 + 3450)/2 = 2,975
(As an exercise, see if you can get to book capital at time 3)
How it is used: The return on capital is a return on the overall investment in a project and is compared to the cost of capital for the project. If the return is greater, the project looks good (at least on an accounting basis)
If you want to see all of the gory details of how the numbers get estimated, you can get them online by going to the website for the book and clicking on illustration 5.5. If you want to save time, you can just click the link below:
https://www.stern.nyu.edu/~adamodar/pc/acf3E/ch5RioDisney.xls

b. Return on capital for the entire firm
How it is computed: The return on capital for an entire firm is computed using the after-tax operating income of the firm and the capital invested in all of its existing assets. To measure the former, we usually start with the operating income in the most recent year and apply a tax rate to it. Since this is the entire operating income for the business (rather than income added at the margin), using an effective tax rate is defensible albeit dangerous if the effective tax rate is volatile; I prefer to use the marginal tax rate here as well to compute the after-tax operating income. To measure capital invested in existing assets, I go to the balance sheet and look up the book value of debt and equity in the firm, making the assumption that this must be the capital invested in the assets that generate the operating income. (We cannot use market value of equity and debt, since market value reflects growth potential and does not reflect what was originally invested in existing assets) If the company had a substantial cash balance, it makes sense to net this number out of the book value, because cash does not generate operating income.
Return on capital for a firm = EBIT (1-t)/ (Book value of debt + Book value of equity - Cash)
Here again, you have a choice of using the number from the beginning of the year or an average. Since both the numerator (operating income) and denominator (book values of debt and equity) are accounting numbers, we are risking a great deal; accounting changes can alter returns on capital and equity. However, it has become one of the most widely used numbers in corporate finance and valuation. If you are interested in delving into the details of what can go wrong with the estimate and how to fix it, I have a paper on the topic:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1105499
It is scintillating (not), deeply satisfying (yeah,,, right...) and will change your life (for the worse..)
How it is used: You can compare a company's return on capital to its overall cost of capital. If it is higher, the company, on average, has taken good investments. If lower, it has destroyed value. The caveat, though, is that you are trusting accounting estimates of earnings and capital invested.

One final point. I used the term "capital maintenance" today and the use of the word maintenance may have confused some of you. In accounting, maintenance expenses are operating expenses, not capital expenses. However, maintenance in accounting refers to a person polishing brass knobs or replacing screws on an a machine. I use capital maintenance much more broadly to cover investments you have to make to replace depleting assets and to preserve the earning power of your assets. Let me give you an example. Disneyworld used to have a ride called 20,000 leagues submarine ride that they constructed in 1971. About 5 years ago, they shut the ride down and spent megabucks to replace it with a ride called "Little Nemo's world". That investment is a capital investment that will depreciated and falls under my measure of capital maintenance.... In fact, this is a standard feature of every Disney theme park (where existing rides are shut down and replaced with new rides at substantial cost).

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Case and class tomorrow!

Hi!
I hope that you gradually getting out of vacation mode and into school mode. To help you in the transition, here are a couple of notes:
a. Project: The link I sent you in the Sunday email for project-related emails was not working (sorry about that). It is fixed now. Glance at it quickly:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfprojectsummmmidway.htm

b. Case: In the next two sessions, we will be exploring both the mechanics of estimating cash flows and some nuances. Much of the discussion will be very, very relevant to both the case and the next quiz. It would help (you and me) immensely if you can read the case and start thinking about it before tomorrow's class. So, take a look:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfcase.html

Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu

Subject: The case... and Edward Tufte

I know that you have lots of other stuff on your plate right now and are not really thinking about corporate finance (I find that hard to believe but then again, I am biased..) In case your fascination with corporate finance leads you to crack open the case, here are a few suggestions on dealing with the issues.
a. Do the finite life analysis first. It is more contained and easier to work with. Then, try the longer life analysis. It is trickier...
b. If you find yourself lacking information, make reasonable assumptions. Ignoring something because you don't have enough information is not a good choice.
c. I think the case is self contained. For your protection, I think you should stay with what is in the case. You are of course not restricted from wandering off the reservation and reading whatever you want on furniture retailing and manufacturing, but you run the risk of opening up new fronts in a war (with other Type A personalities in other groups who may be tempted to one up by bringing in even more outside facts to the case) that you do not want to fight. And please do not override any information that I have given you in the case. (I have given you a treasury bond rate and a risk premium, for instance.)
d. There are accounting and tax rules that you violate at your own risk. For instance, investing in production capacity is always a capital expenditure. At the same time, make your life easy when it comes to issues like depreciation. If nothing is specified about deprecation, use the simplest method (straight line) over a reasonable life.
e. There is no one right answer to the case. In all my years of providing variations of this case, I have never had two groups get the same NPV for a case. There will be variations that reflect the assumptions you make at the margin. At the same time, there are some wrong turns you can make (and i hope you do not) along the way.
f. Much of the material for the estimation of cash flows was covered today and in the next 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.
g. 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...

Finally, I mentioned a book by Edward Tufte on the visual display of information. Here is the Amazon link.
http://www.amazon.com/Visual-Display-Quantitative-Information-2nd/dp/0961392142
It is well worth the money.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Newsletter...

Hi!
Hope that you have had a chance to read the case and perhaps even meet as a group to start thinking about division of labor.... Anyway, if you have questions, you can ask me, though I may not give you a direct answer... I have the newsletter for the week attached. Hope you get a chance to look at it.

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Newsletter #7

Subject: Correction on newsletter...

Hi!
Here is a puzzle. If you write a newsletter and no one really reads it, should you be making corrections to errors you may have made in it? As you ponder this life-changing question, I am going to issue a correction to yesterday's email. The second quiz is on Monday, April 11, not Monday, April 4. Sorry about the typo and thank you to the two people who did notice.. I will assume that more people read it but did not catch the error. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Today's class

Hi!
I know that you are probably busy on the case, but a few notes on today's class. You can read the subtext for implications for the case, but do so at your own risk.

1. 2. Simulations: For those of you who have not tried Crystal Ball, try it in the lab downstairs. The biggest plus is that it is very intuitive and easy to use. In fact, the more significant problem you may face is that you are not familiar with the listed statistical distributions. In case you are interested, try this paper I have on statistical distributions and when to use which one:
https://www.stern.nyu.edu/~adamodar/pdfiles/papers/probabilistic.pdf
Incidentally, if you like Crystal Ball, buy it while you are still a student. The price goes up exponentially once you graduate.

2. Equity versus Firm analysis: In today's class, I contrasted the equity analysis at Aracruz with the firm analysis in Disney. Since this is a recurring them in corporate finance and valuation. I have a summary of the key differences/ measures with each approach:
Firm Equity
Earnings After-tax operating income Net Income
Investment BV of capital invested BV of Equity
(Debt + Equity - Cash)
Return ROC = After-tax OI/ ROE = Net Income/
BV of capital BV of equity
Discount rate Cost of capital Cost of equity
Cash flow Cash flow to firm Cash flow to equity
= After-tax Operating inc = Net Income
+ Depreciation + Depreciation
- Cap Ex - Cap ex
- Chg in WC - Chg in WC
- Debt repayments
NPV Discount CF to firm at Discount CF to equity at
cost of capital and subtract cost of equity and subtract
out total investment out equity portion of total
investment

The key is to stay consistent.

3. Should you hedge? With Aracruz, I noted that it made no sense to hedge against paper prices (since the reasons investors buy commodity companies is to be exposed to commodity price risk but that it might make sense to hedge against exchange rate risk. If you are interested in the topic of risk management, you may want to read chapter 10 of my book on strategic risk taking (hint! it is under books on my website... ) Here is the link that will download just chapter 10:
https://www.stern.nyu.edu/~adamodar/pdfiles/papers/hedging.pdf

4. Acquisition valuation: While we have not looked at company valuation yet in the class, I wanted the acquisition analysis of Sentient Technologies to illustrate a key point. When valuing a target firm for an acquisition, it is the risk characteristics of the target firm that should determine the cost of equity and capital, not those of the acquiring firm. That is why we used the beta of food processing firms, the debt ratio for Sentient and the tax rate and risk premium for the US in valuing Sentient, even though the acquiring firm is a chemical company from India.

5. NPV versus IRR: There are three scenarios where NPV and IRR can yield divergent rankings for mutually exclusive projects. The first is the case where projects have multiple changes in signs (negative to positive and back to negative), where you can get multiple IRRS. the solution is to stick with NPV. The second is when you have differences in scale. NPV will bias you towards larger projects and IRR to smaller projects. If you have a capital rationing constraint, go with IRR. The third is the reinvestment rate assumption, with NPV assuming you can reinvest at the cost of capital and IRR at the IRR.. the former is a more reasonable assumption. I have an extended discussion in chapter 6 of the book.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Case formatting

I know that I am jumping the gun here, but I wanted to make sure that you get this email in time. Here are some general issues for the case:
1. Case due date: April 4, by 10.30 am

2. How should it be turned in?:
After some consideration, I think it makes sense to switch to an Electronic format. However, I am a little wary of multiple attachments (since I could very easily miss one). So, here is my compromise. Put together the report, as if you were going to print it off (with the excel spreadsheets as attachments). Then create one pdf file and send that file to me by 10,30 am on Monday. Very important: For the subject, enter "Apple rules" (I have created a special mailbox for the case submissions and using this subject will put your submission directly into the box. Using "PC rules" will result in an immediate trashing of your submission.

3. What should be in the report?
Here is a list of what I would like to see in the final report:
As you work through the numbers, here are some suggestions for formatting the case report.
1. Cover page: Please include the following
- Names of group members (in alphabetical order: it makes my job of entering grades easier)
- Cost of capital used for project analysis
- NPV, IRR and ROC (for 10-year lifecase)
- NPV (for infinite or longer life case)
- Recommendation: Invest in this business or Don't invest in this business
2. Written analysis: Please keep brief, summarizing your numerical findings, key assumptions and backing for your recommendation.
3. Base Case analysis: Full print out of your forecasted earnings and cashflows by year, including details on individual items (G&A, Capacity etc....)
4. Any what-if analysis, scenarios and graphs you want to add on....
As a general rule, if you do not reference an item in the appendix in your written analysis, please have mercy and do not include it.

Finally, when you feel comfortable with your final numbers, please go into the attached spreadsheet, enter your summary numbers and email them to me before Monday.

I can pull the numbers together for the class presentation ....
... Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Newsletter

Hi!
I won't even ask you how the case is coming because I may open up some wounds... but I hope that the bleeding is limited and that you survive. I have attached the newsletter for this week. If you get a chance, take a look at it.

Aswath Damodaran
adamodar@stern.nyu.edu

Attached: Newsletter # 8

Subject: Case submissions

Hi!
I won't take too much of your time. Two quick notes. First, remember to get your summary data (cost of capital, ROC, NPV (finite), NPV (infinite), Accept/Reject) to me, when you get a chance.

Second, when you do submit your final case report, please put "Apple rules" in the subject and cc your team mates. That way, once I am done, I can reply to all of you with the graded case.

Thanks! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: The Apple iTV Case

Hi!
Thank you for getting your project reports and summaries in... I appreciate your help. A few notes to add to today's discussion:
1. Presentation: If you were not able to get the presentation for the case, I have attached it to this email. Hope you get a chance to browse through it.
2. Excel spreadsheet: If you did want to, I have also attached the excel spreadsheet with the finite and the perpetual life assumptions.
3. Revenue forecast: I was not as clear and unambiguous as I should have been on the overall market and market share. Since the case made it sound like the market of 30 million sets was just for the US and Apple does expect to get only 70% of its revenues in the US, I think it is reasonable to scale your revenues up to reflect the additional sales. (So, while I estimated revenues of $780 million in year 1, your revenues would be 780/(0.7) = $1110 million in year 1.
Since the case touches on almost every aspect of investment analysis, which is also the topic for next week's quiz, please try to get familiar with the numbers that you crunched for the case (and in my solutions).
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Next quiz

Hi!
Now that packet 1 has been put to rest and the case has been handed in, it is time for the next torture to begin. The next quiz will be a week from today (on April 11). In advance, a few notes:
1. Material to be covered: We will cover everything since the first quiz, through the end of packet 1. In the lecture note packet, this works out to from slide 140-End. In terms of content, we will cover the cost of debt and capital and capital budgeting in all its facets. Think of everything you did on the case and you have a good perspective on what will be covered. In the book, it is the last part of chapter 4, chapter 5 and chapter 6.
2. Review session: The review session is tomorrow (April 5) from 12-1 in KMEC 2-60. If you cannot make it, the webcast should be up later tomorrow. I have attached the presentation for the review.
3. Quiz seating: As with quiz 1, we have two extra rooms: KMEC 2-60 and 2-70. Since I don't want to play favorites (though I am not sure which room is better), I have juggled the seating chart:
If your last name begins with Go to
A - M Schimmel
N - R KMEC 2-70
S - Z KMEC 2-60
One final point. On this quiz, it is important that you are comfortable with the PV functions in your calculator - moving from annuities to PV or from PV to annuities. So, please get that nailed down.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Grading template for the case

Hi!
In about 20-30 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. 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 into your cash flow sheet. So, you will see something like this in the comment on your case (1a. You should be using the beta of the business, not the beta of the company) 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. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Delay on webcast

Folks,
I am sorry but there was a problem with the server today at Stern that is also causing delays in the webcasts being posted. I will post them as soon as I get the link.

Subject: Newsletter

Hi!
I am sure that you are busy working through past quizzes. Just in case you get bored, I have attached the newsletter for the week...
Until next time!

Aswath Damodaran

Attached: Newsletter # 9

Subject: Reminders on the next quiz

Hi!
First, I have returned all of the cases that I had received. So, if you have not received your case back, please let me know. Second, I have reattached the seating arrangement for tomorrow's class (in case you lost the last one...):
If your last name begins with Go to
A - M Schimmel
N - R KMEC 2-70
S - Z KMEC 2-60
So, hope to see you, rested and ready... Until next time...

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Quizzes are done

Hi!
The good news: the quizzes are done. The bad news: the quizzes have to be picked up. As before, here are the details"
1. Where do I pick up the quizzes? On the 9th floor of KMEC, as you get off the elevators and walk towards the front reception doors, look to your left. You will see the quizzes, alphabetically sorted, in four boxes. Please take your quiz and leave the rest in order.
2. How do I check the grading? Download the attached solution sheets (with grading guidelines). If you spot any oversight or errors (in either direction.. who am I kidding?), please bring your quiz and I will fix my errors.
3. Where is the scoring distribution? I have attached the distribution for this quiz...
4. What were the issues in this quiz? This quiz, more than the first, tested your capacity to work with present values/ annuities/cash flows. While I did give you ample warning about being able to do annuities and present values, it does seem to still pose a problem for some. In fact, here are the key points on each question that I was checking on:
Question 1: Basic principle underlying problem: Cash flows in a currency have to be discounted back in a discount rate estimated in the same currency
Basic tool needed: Converting a discount rate in one currency to a discount rate in a different currency
Question 2: Basic principle underlying problem: All you care about in assessing a new investment are its incremental effects. The existing revenues at the laundromat are irrelevant. All you care about is the incremental revenues and the incremental depreciation from the investment.
Basic tools needed: Compute an annuity from a PV and working backwards through an income statement
Question 3 Basic principles underlying problem: (1) When discounting cash flows, use a discount rate that reflects the risk in the cash flows. (2) When comparing choices with different lives, you have to find a way to make up for the time difference
Basic tools needed: Discounting and converting into an equivalent annuity
Question 4 Basic principle underlying problem: The only effect of depreciation is a tax effect
Basic tools needed: Computing the present value tax benefits versus expensing
If you blanked out on one or more of the problems, please make sure that you get the basic principle and understand the tools.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attached: Quiz solution (a or b) and compare your score to the distribution

Subject: Optimal Capital Structure

Hi!
If you feel up to it, you can compute the optimal capital structure for your firm. Gather up your financial statements, cozy up to your computer and then do the following.
1. Go online to
https://www.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.html
Download the excel spreadsheet called capstru.xls and save it. For those of you are who have trouble, I am attaching the file, just in case...
2. Before you input any numbers, go into preferences in excel, open the calculation option and make sure that there is a check in the iteration box.
3. Read the Read me worksheet in the spreadsheet
4. Go to the input page and input the numbers for your firm. Each input box has a comment in it. Read the comment before you input the value. You can start off using the most recent year's numbers but may want to come back and normalize some of the numbers (EBITDA) later.
5. For the moment, leave the answers to the last two questions on the input page at their default levels. (Yes and Yes)
6. Go to the output page. You should see the current and optimal debt ratio for the firm as well as the current cost of capital and the optimal cost of capital.Ê You will also see the entire schedule of ratings and costs of equity for every debt ratio. I also calculate the change in value per share for your firm and do your laundry while I am it.... (Hey... What can I say? I am a full service operation)
7. If you find DIV/0 or VALUE! errors all over your sheet, go back to step 1... Sorry... but it is easier to download a fresh version of the spreadsheet than to fix the error.
8. If you find yourself needing more help along the way, you can also try the webcast that is a companion to the spreadsheet. (It is on the spreadsheet page....)

Here is the good news for those of you who are lagging on the project. This spreadsheet will get you caught up with your hard working teammates.. I know this violates the "little red hen" principle but better caught up than not. For those of you who have no idea what management book, the "little red hen principle" is in, here is a link:
http://www.amazon.com/Little-Red-Hen-Paul-Galdone/dp/0899193498/sr=8-1/qid=1163118866/ref=pd_bbs_1/104-7801449-2061545?ie=UTF8&s=books

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: Someone left their watch (a Rado) in Schimmel. If it is yours, you will find it listed on Ebay for $ 50... Just kidding.. I have it...

If the spreadsheet opens with a warning that the program cannot calculate something, don't freak out... the iteration box (see 2 above) has not been checked off yet. Make sure you put a check on it and it will all be fine..

Attached: capstru.xls

Subject: Post mortem on case

Hi!
By now, you should have got your case back. (If you have not, let me know!) As always, there seems to be a great deal of angst (and I understand why) about average scores and grades. While I am loath to assign grades to scores, since this is only 10% of your overall score, I guess I have no choice but to attach the distribution (see attachment). I know you do not want to even think about the case any more, but I would like to list out the five most common issues; think of it as a Letterman top 5 list for the case). Here is the list (from smallest to largest misdemeanors; the last two may count as felonies):
5. Equity or the Firm?: While I understand the impulse to compute interest expenses on the debt in the case, doing so puts you on the pathway to computing cash flows after debt payments (or to equity). The discount rate that you then have to use is the cost of equity and the rest of your cash flows will also have to be after debt payment. (Your initial investment will no longer be $2.2 billion; it will be net of the debt you take). Needless to say, no one who embarked on this path carried it to its logical conclusion.. So, my advice. Steer away from cash flows to equity, unless you want to estimate all cash flows to debt (not just interest expenses).
4. Working capital: There were three issues with working capital. In its most diabolical form, total working capital was subtracted out from cash flows each year, rather than the change. Needless to say, this added a couple of billion in negative cash flows to your analysis and pushed the project over the edge. A much smaller problem was ignoring the change in the initial year, when your working capital increased from zero and counting only changes thereafter. The third issue and a very minor one (which I did not take off any points for) was putting the change in working capital in the same year as your revenues, rather than in the previous year (since working capital investments happen at the beginning of each year).
3: Project ends, now what?: In the finite life case, the project ends and all assets need to be dealt with. In other words, you need to make explicit assumptions about what will happen to working capital and fixed assets (the billion that does not get depreciated) at the end. While the easiest assumption to make is that you get book value back, you can make alternate assumptions as long as you follow through and compute the tax effect. In other words, if you assume that the fixed assets will fetch nothing, you have to show your tax savings from the capital losses. In other words, ignoring something will not make it go away.
2. Incremental all the way: The notion of incremental cash flow includes both cash you will have to spend and cash you will save yourself from spending. That is why the expansion investment generates a negative cash flow in year 6 (since it has to be spent) and a positive cash flow in year 11 (since you save money that year). While allocation is fine for accounting purposes, it has nothing to do with cash flows (even if yields a very similar answer with some allocations).
1. Forever is not free: The infinite life case does not just mean adding a perpetual growth rate on your last year's cash flow and computing an immense terminal value. If you decide that you want your project to last forever, you have to manage it to achieve this end right from the very start (not year 12). In practice, you will have to maintain your assets earning power, by replacing and constantly replenishing them. This translates into capital maintenance. Can the NPV with the infinite life scenario be lower than the NPV with the finite life? Absolutely. It is a trade off. You get lower cash flows each year for the next 10 years, but a higher terminal value. For some projects, the trade off will be negative.
I know how much work you put into this project and I really, really appreciate it. I hope it was a worthwhile exercise, and it should provide a solid foundation for any finance related work you do during the summer. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Capital structure spreadsheet and newsletter

Hi!
The newsletter for the week is attached. More important, though, how is the capital structure spreadsheet coming along? Please try to get working on that. Trust me. It is really not a long process. For those of you who have completed the capstru.xls spreadsheet, I have more fun planned, I introduced the enhanced cost of capital approach in class yesterday. If you want to see how your firm looks with indirect bankruptcy costs built in, try the attached spreadsheet.

This spreadsheet is very similar to the capstru.xls spreadsheet in terms of inputs. In fact, you should be able to cut and past right into the input page.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attached: capstruenhanced.xls, Newsletter # 10

Subject: What is current?

Hi!
A recurrent theme in the emails I have been getting this weekend (and I am glad to see them mostly about the project) is a question of what "current" data to us. I know that this confusion arises from the fact that market data can be as of right now but accounting data is always dated - December 31, 2010 for some of you and December 31, 2000 for others... with quarterly data and different year-ends thrown in for good measure.
I have a simple rule when it comes to data. With each input, I look for the most updated data that I can find. With market data, this would imply that you should be using the data as of the day of the analysis: thus, interest rates and stock prices should always be updated (I know that this will mean that these inputs can change over the course of the weeks that you do the analysis, but try to pick a date during that period as your base date) For accounting data, this would imply going with the most recent financial statements that you can find. I would prefer that you use the 2010 statements, but I recognize that some of your companies may not have released their 2010 numbers. In those cases, you may have to fall back on 2009 data for your company (or use the most recent quarterly statements). If you can, try to maintain a master data sheet with the accounting data that you are using - we use only about a dozen items from the financial statements. Thus, you can update them when the 2010 statements are available. Different people in the same group may have different accounting data year ends, but that is okay.
While this may seem inconsistent, it is reality, You have to analyze and value companies over the course of the year and accounting data is not constantly updated while market data is... Not much that we can do about it... Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Tomorrow's class

Hi!
From the flurry of emails this weekend, my guess is that quite a few of you gave the capital structure spreadsheets a shot. If you did not, there is still time and I have attached both the original capital structure spreadsheet and the enhanced version to this email. (I know that you don't believe me but it really only 30 minutes of work to get caught up). Assuming that you do get caught up before tomorrow's class, please bring the following to class:
1. The "Results from Analysis" box from your base capital structure spreadsheet (capstru.xls). This should be in the worksheet titled "Optimal Capital Structure" in the spreadsheet.
2. Take note of the following inputs into the worksheet:
- Tax rate (B8 on the input page)
- EBITDA (I3 on Optimal capital structure worksheet)
- Value of firm (C3 and C4 on capital structure worksheet)
3. If you have time, check out the following:
a. EBITDA/ Firm value = EBITDA/ (Market value of equity (C3) + Market value of interest bearing debt (C4))
b. Estimated rating for your firm at the optimal debt ratio
One final point. The spreadsheet is designed to be helpful (perhaps too much so). So, enter your actual operating income and interest expense numbers as well as your lease commitments. I will make all the adjustments to operating income for you... I have to run to my youngest son's baseball game.. But I will keep checking if you have any issues.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachments; capstru.xls, capstruenhanced.xls

Subject: Capital Structure spreadsheets

Hi!
Hope you had a great weekend (getting caught up on corporate finance). I also hope you have had a chance to enter the numbers for your company into the capital structure spreadsheet (capstru.xls). Just a reminder of a couple of rough spots you may run into:
1. Make sure that you go into Excel preferences and check off the iteration box under calculation options.
2. The spreadsheet is very unforgiving of errors (because of the iteration function). If you make a typo, the spreadsheet can very quickly implode on you and give you DIV/0 or REF errors. If this happens, do not try to fix the spreadsheet (it is not worth the trouble). Instead, download a fresh version of the spreadsheet (from my website or the email) and copy your input page into that spreadsheet (don't forget to copy the lease numbers as well if you have any).
3. Since the spreadsheet will capitalize leases and adjust operating income and interest expenses, do not do this on your own and enter the adjusted numbers. (if you want to do this, just say no to leases... otherwise the spreadsheet will double count leases).

On a different note, I had sent a spreadsheet to allow you to compute the enhanced capital structure (with operating income a function of your rating). There were a couple of inconsistencies between the spreadsheets (which you may not have noticed for your company). To make things easier, I have modified the enhanced capital structure spreadsheet to make it completely compatible with the capstru spreadsheet. You can copy and paste the input page (and lease page) from your capital structure spreadsheet directly into the enhanced capital structure spreadsheet.

Until next time!

Aswath Damodaran

Attachment: capstruenhanced.xls

Subject: Madonna, Donald Trump and capital structure

Hi!
You never thought that two of the biggest celebrities on the face of the earth were associated with capital structure, right? More proof that it is all corporate finance... A few notes on this morning's class:
1. APV: I conveyed my skepticism with using APV as a capital structure tool, without a good assessment of bankruptcy costs. However, if you really want to just give it a shot with your company's numbers, here is a spreadsheet that will help you do it.

2. Relative analysis: I have the industry averages for debt to capital ratios (book and market) on my website for companies in the US, Europe, Japan and emerging markets under updated data. You will find the data here
http://www.damodaran.com
Click on updated data and scroll down to debt ratios. I have attached the industry averages for the US

3. Assessing whether your firm is potentially a target for a takeover/bankruptcy. This is as much a subjective exercise as it is an objective one, but look at the following:
a. For takeover probability
- Market cap of the company
- Insider holdings as % of overall stock (should be part of your corporate governance section)
- Jensen's alpha (from your risk assessment section)
b. For bankruptcy probability
- Rating (from your cost of capital section)
- Interest coverage ratio (also from your cost of capital section)
- News stories

And I was not kidding about the Don (as his ex-wife, Ivana, used to call him)
http://www.ibtimes.com/articles/133317/20110412/donald-trump-bankruptcy.htm
And this guy wants an apprentice... to learn what?

Or about Madonna
http://www.youtube.com/watch?v=VgkOCJ9PGkk

Though for most CEOs, this is a better theme song..
http://www.youtube.com/watch?v=mvtDHH_IfP8

Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: apv.xls, dbtfund.xls

Subject: Debt design

Hi!
I If you are pondering about how to design the perfect bond for your firm (let's preserve illusions and assume that you do have the optimal worked out for your firm), you may want to move to the next step in the process. Here are the steps:
1. 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.

2. You should also try to do a quantitative analysis of your debt. You can download 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 this morning to include 2006 data, in case you have the updated numbers) by going to
https://www.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm
The spreadsheet is called macrodur.xls.

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 + Debt); you can use book value of debt because it will be difficult to estimate market value for each period.
The easiest way to get this data is to use the FA function in Bloomberg and choose the income statement items for operating income and the enterprise value breakdown. You can print off either annual or quarterly data.
I have to warn you in advance that these regressions are exceedingly noisy and the spreadsheet also includes bottom-up estimates by industry. The industries are listed by SIC code and you can find your company's SIC code by going to compfirm.xls, the spreadsheet with individual firms on my web site. If you cannot find your SIC code, pick the nearest one with the same first 2 digits. Thus, if you cannot find 131, use 130 or 132.

P.S: The macro economic data is from the Federal Reserve Bank website
http://research.stlouisfed.org/fred/

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: macrodur.xls

Subject: Newsletter

Hi,
Two quick notes. First, from the flurry of emails related to the project, it looks like a lot of you are working on it. Glad to see that. Second, I am attaching the newsletter for the week. I know we speeded through the debt design part. While it may have looked like I was in a hurry, it is partly because there is not much of substance after you have established the basic theme: you want to issue securities that give you the flexibility of equity and the tax advantages of debt. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Newsletter # 11

Subject: Review session and seating arrangements

Hi!
The third quiz is on Wednesday in the first 30 minutes of class. If you will not be at the quiz, please let me know before 10.30 on Wednesday. The review session is scheduled for Tuesday. I will get back to you with the time and , since there seems to be some flux in rooms and times. I have attached the presentation for the review session to this email. As for the seating, I was unable to get 2-60 for this quiz. So, we are spread out over three rooms.
If your last name starts with Go to
E -H 2-70
I - L 3-110
M-O 3-120
A-D, P-Z Schimmel
I am sorry about the disjointed seating, but I was trying to be fair.. probably will not work.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Review for quiz 3

Subject: To (1+g) or not to (1+g)

Hi!
I know you are busy but there are three questions that seem to have come up from reviewing the past quizzes that I want to address:
1. In computing the change in firm value from changing the cost of capital, should you multiply the savings by (1+g)?
I know that the last thing you want to deal with right now is a deep philosophical question but this is one that you will confront again and again as you go through finance. To provide some context, the present value of a growing perpetuity is
PV = Expected cash flow next year/ (r -g)
The key is that the numerator should be the expected cash flow next year. Thus, if you are told that a firm expects to generate $ 100 million in cash flows next year, the present value is
PV = 100/ (r -g)... No need for (1+g) since you already have next year's number
If you are given the cash flow in the current or most recent year, though, you have to grow this number out
PV = 100 (1+g)/(r-g)
In the context of cost of capital changes and computing firm value, it is a little hazy as to what you are estimating when you multiply firm value by the change in the cost of capital.
a. If you are multiplying today's firm value (market value of equity + debt) by the change in the cost of capital, you are getting the savings over the next year. Consequently, you don't need to multiply by (1+g). This is what I assumed in computing the increase in firm value for Disney and there is no (1+g) in the equaitonl
b. If you are multiplying the firm value from the end of the last financial year (which may be 4,6 or even 9 months ago), you are getting a saving from the last year and you should multiply by (1+g)
When nothing is stated in a problem (and nothing is in most of the quizzes), I would accept either answer but please specify what you are assuming. Hope that this does not confuse you further...
2. What does rational mean?
In many of the problems, I ask you to assume that investors are rational. Basically, what I am asking you to assume that the the investors who sell their shares back get the same share of the increase in firm value as those who do not. Thus, you can divide the change in the firm value by the total number of shares outstanding.
3. How do you adjust ROC for leases?
The PV of leases should be added to the book value of debt, when computing capital invested. The operating income can be adjusted in one of two ways:
Adjusted Operating income = Operating Income + current year's lease - depreciation on leased asset
Operating income = Operating Income + pre-tax cost of debt * PV of leases
They will not give you the same answer but they accomplish the same objective (and you will get full credit either way).

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Spring 2010 quiz

Hi!
You must be way ahead of where I expected you to be. You are noticing that I did not put quiz 3 from Spring 2010 into the practice quizzes. I have attached the quiz to this email. The solution is already online.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Review session webcast

Hi,
If you were not able to make it to the review, the webcast is up and running. You can get to it by going to the website for the class and checking towards the bottom of the page. The review presentation can also be downloaded...

Subject: Review session follow-up

Hi!
The webcast from the review session is up and running at:
http:///www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr11.htm
Three quick points about the quiz:
1. Approaches for computing optimal: Look at all four approaches for computing the optimal debt ratio but make sure that you understand the cost of capital approach...
2. Debt design: I will not expect you to be able to run regressions on macro variables, but I hope you can read and use the regressions.
3. Duration: Duration shares some features with betas: Assets and liabilities individually have durations, and the duration of assets is a value-weighted average. Work through a few of the problems with duration to get more comfortable with the concept.

Finally, during the review session, I raised the question of how the price at which you buy back stock will affect the value of the remaining shares. I have included a spreadsheet that will allow you to assess the effect in any buyback (I did not incorporate the (1+g) in the numerator). Play with the buyback price and see if you can get a sense of what is happening. I worked out the price for the buyback to be $62.50 to make the remaining shareholders get none of the value increase (I took out the (1+g) in the computation...)

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: firmvaluecomputation.xls

Subject: Project to-do list

Hi,
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 4, 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 enhanced cost of capital approach (capstruenhanced.xls) or 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, stick with just the intuitive approach. Use the attached spreadsheet to do both of these:

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 will be developing a framework for analyzing whether your company pays out too much or too little in dividends. You can read ahead to chapter 11, if you want, and use the attached spreadsheet to examine your company. The session on Monday will be a lot easier, if you do one or the other.
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.

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 Wednesday 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 prepared a three step process to ease the valuation:
4.1: Download the fcffginzu.xls spreadsheet on my website. It is a one-spreadsheet-does-all and does everything but your laundry. It is available at http:///www.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm

4.2: There is a webcast that goes with the spreadsheet (on the spreadsheet page) that will take you through what I am trying to do.
4.3. If you go to the valuation output page, there is a diagnostic section that points to some inputs that may be getting you into trouble.

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. 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?). I will send an email just on this part of the process soon.

Ah, where is the good news? You will be done exactly t2 days from today. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: dividends.xls, fcffginzu.xls

Subject: Cattle call

Folks,
The quizzes are done and can be picked up at the usual spot. The standard rules apply: no browsing and no messing with the alphabetical order. I have attached the distribution and the solutions... The quiz with Loman Enterprises is quiz a and the one with Lagerfiled is quiz b. Have fun! Until next time! (And by now, I know you view that as a threat more than a promise...)

Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: Solutions to quiz a and quiz b, distribution.

Subject: Newsletter

Hi!
A sign of impending something (doom, happiness, relief) but the last newsletter for the class is attached. Just as a head's up, this is what the next two weeks looks like:
May 2: Class (Dividend Policy)
May 4: Class (Valuation)
May 8: Summaries of your corporate finance project numbers due (I will send a spreadsheet that you will fill out with your key numbers).
May 9: Class (Mopping up and big picture) - Don't miss it...
May 9: Final project due by 5 pm
May 12: Review session (TBA)
May 13: Final Exam 9 am-11am in Schimmel and other rooms (TBA)

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Newsletter # 12

Subject: To 10 or 14 questions on the project

Hi!
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).
2. If I have no or little conventional debt and significant operating lease commitments with no rating, how do I compute a synthetic rating?
This may be a rehash of an email from a few weeks ago but it bears repeating. 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 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 EVA 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 "Read me first" 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?
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 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...)
11. 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....
12. 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...
13. 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.
14. When will this torture end?
Next week on Monday... but the memories will last forever...

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Formatting for final report

Hi!
I know that many of you are still working on the numbers for the project but I wanted to lay down some details for the final project submission.
1. When is the project due?
The final project report is due on May 9 by 5 pm.
2. How does it have to be delivered?
Please turn it in electronically, preferably in pdf format (rather than word, though I can live with word, if you have trouble). When you email your report, make sure you put "Grand Finale" in the subject and cc all of your team members on the email.
3. How should it be formatted?
The first page should include your names (in alphabetical order) with your company names as well. While there is no specific format for the report, you can see examples of reports from prior semesters online (Click on the website for the class and then on the project...). Please try to keep the written part of the report to less than 25 pages (if you have 5 companies or less) or 30 pages (if you have more than 5 companies). (This is a suggestion, more than a constraint. If you do run over, I will keep reading, but try to be profound....)You can have as many appendices and add ons as you want but only if they are referenced in the text. If you really want your report to pack some oomph, try to integrate your company findings and talk about how the differences or similarities in your companies manifest themselves in your results. Focus more on explaining what the numbers tell you about the company than on how you derived them.
4. What else needs to get done?
When you have the numbers worked out for your companies, please send me the attached summary spreadsheet with the numbers. I can wait until late evening Sunday, but if I can get them sooner, it will be better (for me). Please do not add columns or change the spreadsheet format.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: The project... what else?

Hi!
Hope things are moving right along (at this stage in the process, moving along is the most critical part of the process). Here are a few loose ends that seem to keep popping up:
1. Capital structure
1a. When analyzing capital structure, let the capstru.xls spreadsheet be your base spreadsheet for the analysis. Use the enhanced version (capstruenhanced.xls) to stress test your recommendations and modify your analysis.
1b. When you run the debt design regressions (macrodur.xls), do not be surprised if you get weird over-the-top results. That is what happens when you have small samples and a few outliers. Make your intuitive analysis the base of your recommendation and use the regression results/sector averages judiciously to modify your recommendations.
1c. If you cannot find your SIC code in the sector averages, use the nearest one starting with the same first 2 digits.

2. Dividend policy
2a. When inputting numbers into the dividend spreadsheet from the statement of cash flows, be careful with the signs. A negative number for change in working capital in the statement of cash flows is an increase in working capital. (Just as a check, take one year's numbers and see if you get the same FCFE, working through the numbers by hand)
2b. If you have stock buybacks (and not all companies do), the amount of the buybacks should be in the statement of cash flows.
2c. This is a close call, but do not net out new stock issues from stock buybacks, and here is why. A company that consistently issues stock to buy back stock and pay dividends is not behaving very sensibly and you want to be able to isolate these companies.

3. Valuation
I think things will be a little clearer after tomorrow's class. In fact, what would help is if you started inputting the numbers into the fcffginzu spreadsheet and printed off the input page and brought it to class with you tomorrow. Here are some general suggestions:
3a. Options: The options that affect your value are management options. If your company has granted these options (and many don't), you should find the details of all options outstanding in a table in the annual report or 10K. That table should also have a weighted average exercise price and maturity for your firm's options. (Use the total options outstanding, not just the vested ones...). As a related input, you are probably wondering how to get the standard deviation to use in the option pricing model. There are three choices: (1) use the industry average standard deviation in equity on my website under updated data (2) the option table in your company's 10K might also include an estimate of the standard deviation (3) if you can get on a Bloomberg and find your company, type in HVT and you will get the annualized standard deviation.
3b. Growth: This is a tough one. When you are asked how long your company will grow and what growth rate to use, your first reaction will be panic and your second will be: who really knows? I cannot give you a simple way around this, but we will talk about ways to estimate growth in class tomorrow. Make your best judgment for the moment and move on.
3c. Stable growth: The inputs here are critical. Before you enter strange and unsustainable numbers that will blow up your valuation, you may want to read chapter 12 of the book. For the moment, set your stable growth rate ≤ riskfree rate and let your reinvestment rate be computed from your stable period return on capital. This may sound like Greek to you, but it won't be after tomorrow.

4. General
4a. The rogue 10K: Some of you have just opened your company's 10K and discovered that it has a loss. Before you panic, here are some options. Consider replacing last year's operating loss with an average over many years (say, the last 5 years). You do not have to normalize any of the other numbers.
4b. Valuation spreadsheet: The valuation spreadsheet can be a little moody. First, make sure the iteration box is checked under calculation options. Second, if your spreadsheet seems to have problems (especially with the option part), send it to me and I can fix it pretty quickly.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Valuation Blues?

Hi!
Good day! Given the "vampire hours" many of you seem to keep (I did get about 30 emails between 2 am and 4 am last night; of course, I was sleeping through this barrage and woke up to it this morning), I would not be surprised if you are not awake when this email gets to you. Anyway, I know that valuation seems like a black box now. You put in numbers and a value pops out... As you work through the numbers, here are some things to keep in mind:
1. My value is " very" different from the price. What should I do?
Depends on what you mean by "very" different. Stock prices are volatile and values change. Getting a value that is 30-40% off the price is not uncommon. In fact, you would expect this to happen for most companies. Hence, if the stock price is 25 and you get 35 or 40 (or 10 and 15), don't freak out. It can happen and often does.
2. I am getting errors for the equity option valuation and for the final value/share. What do I do?
This is a tricky problem. You can try turning the options input to compute the value from the price (P) instead of the value (V) in the inputs page and see if it makes a difference. If it continues, send me the spreadsheet and I will fix it.
3. I am getting a negative value for equity. Is that possible?
The stock price cannot be negative but the value of equity can become negative, if the value of your firm is less than the outstanding debt. For firms with huge debt loads, this can happen. If it does, your conclusion is that the equity is worth nothing.
4. My value of equity is way off (too low or too high). What should I check?
See the attached framework for diagnosing potential errors.
5. My value is still way off...
That is why we do valuation, right? Sometimes, the market makes mistakes....
Hope you have a productive day!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: valchklist.doc

Subject: The weekend begins...

Hi!
I won't ask you what you are doing, since I can pretty much guess the answer. Four very quick notes:
1. EVA comparisons: If you are trying to compare your firm's excess returns to the industry average, don't compare the EVAs directly (since they are absolute values and the industry numbers are in millions). Instead, compare the return spreads (ROC - cost of capital, ROE - cost of equity).
2. ROC computations: I know that I may have been guilty of some sloppiness but the ROC = EBIT (1-t)/ (BV of equity + BV of debt - Cash). The EBIT should be adjusted for leases and the BV of debt should include the PV of leases.
3. Valuation: I know that this is a leap, but remind yourself that the model does not estimate expected growth. It just uses your inputs to make that estimate. Thus, if your inputs yield a low ROC and reinvestment rate for last year and you assume that these will continue for the future, you will get a low growth rate. Reentering the numbers will not change that result. If you believe that your company will have higher growth than that estimated by fundamentals, you have to do one of three things:
a. Change your reinvestment rate and return on capital for the future. You can look at industry averages or historical data to make your best judgment, but it is still a judgment.
b. Override the fundamental growth rate and input a growth rate. While this does make growth exogenous, it may be the only choice for firms where margins and ROC are changing over time.
c. Don't keep iterating and changing your inputs until the value is close to the price. That is not the point of the exercise.
4. Non-cash working capital can be negative for some (in fact many) companies. If so, it becomes a source of cash rather than a use of cash.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: The fat lady is gargling...

Updates received: 300
Updates to come: 90+
Here is the plan for tomorrow. I will put the presentation together tomorrow morning and email it to you by 9 am. (Sorry...) I will try to make a few copies but no promises... Please do come to class tomorrow, even if you have work left to do on the project. I promise you that it will be memorable.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Final presentation and final project

Hi!
Thank you for being in class.... I hope it was mildly memorable... I have attached the presentation to this email. When you send your final project report, please make sure that you put "Grand Finale" in the subject and cc everyone in your group.
Aswath Damodaran
adamodar@stern.nyu.edu

Subject: CFE, review session and final exam details

Hi!
I am sure that turning in the project lifted a huge weight off your shoulders. I know how much work is involved and I truly, truly appreciate the effort you put into it. Now, that it is a sunk cost, time to move on:
1. CFE: As I mentioned yesterday, you can check your grades online only if you fill out the CFEs. Please, please do follow the instructions below and finish your CFE. (In fact, do it right now.. it will take you only a couple of minutes and it is one less thing to think about for the rest of the semester:
Student Instructions for Completing Online CFEs

1. Login to https://ais.stern.nyu.edu and provide your password. Use the same login and password that you use for accessing email. If you have not activated your Stern account yet, please visit http://start.stern.nyu.edu to activate your Stern account and password.
2. Select the "Submit CFEs" link (select correct term) under "Course Evaluation".
3. In the dialog box, highlight the course you wish to evaluate and follow the instructions.

2. Review session: The review session is scheduled for 12-1 on Thursday in KMEC 2-60. The review presentation is attached. If you cannot make it, it will be webcast.

3. Final exam: The final exam is scheduled for 9-11 on Friday. We will also have KMEC 2-60 and KMEC 2-70. I know that each of you has had at least one quiz away from Schimmel (which everyone seems to hate) and I really cannot make this even, since some of you will get two turns away. So, at the risk of pissing you off, here is my seating plan for Friday:
If your last name begins with Go to
A- C KMEC 2-70
D- Q Schimmel
R - Z KMEC 2-60

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Final review presentation

Hi!
I am in the process of grading the projects and returning them - about 20% of the projects have gone out and there are more to do... When you get your graded projects, you will notice that the project is graded out of 30 and wonder how I, in my infinite wisdom or stupidity, saw enough daylight between projects to be able to assign grades ranging from 23 (the low so far) to 30 (the high). I could tell you that the grading was entirely objective, but that would be a lie. While I did not bring personal biases or favoritism into play, I did make some subjective judgments. However here is the checklist I used to make my assessment:

1. The numbers: Clearly, the first thing that I wanted to make sure that every report included were the computed numbers - the Jensen's alpha, the cost of capital, the EVA, the optimal capital structure and the assessment of dividends. The good news on this one was that most of you seem to be complying, with two minor exceptions. First, some of you did not compute the Jensen's alpha (or at least you never talked about it). While I understand abandoning regression betas (and encourage it), the Jensen's alpha is still a useful measure of stock price performance. In fact, you can bundle it with your EVA assessment to make a judgment on the company. Second, some of you did not compute the FCFE for your company, if your company was not paying dividends. In fact, the assessment made was that the company did not have dividends and hence an assessment of dividend policy was unnecessary. Note that a policy of paying no dividends is still a dividend policy and looking at the FCFE for the firm can allow you to assess whether that policy makes sense. Thus, a firm that has negative FCFE and pays no dividends is on solid ground but one that has positive FCFE and pays no dividends has to be analyzed.

2. The "Why: In my view, the easy part of corporate finance is the what... which is what the numbers provide: What is the Jensen's alpha? What is the optimal debt ratio? What is the EVA? I was looking for the why, i.e., the background story. With Apple, for instance, the Jensen's alpha is a huge positive number. But why did Apple's stock do so well? Was it the quality of their management, sheer luck or competitive incompetence? Similarly, with the EVA, two thirds of your companies generated returns on capital that exceeded the cost of capital... That is a number.. It would have been interesting at that point to assess what the company's competitive advantages are (In fact, I noticed that some of you did a SWOT analysis of your company, perhaps a carry over from your strategy class but you did it at the end of the report. This would have been a perfect spot for it.

3. The links: While the project is broken up into sections, the sections are not independent. Take, for instance, the capital structure and the dividend sections. Assume that you find (as most of you seem to be so far) that your company has too little debt relative to its optimal. Then assume that in the dividend section, you find that your company is returning more than its FCFE as dividends/buybacks. Rather than look at the latter in isolation and argue for cutting dividends/buybacks, you can view it as perfectly reasonable, given that you want to increase your debt ratio. The more linkages you have across the sections, the richer your analysis will become.

4. The tools: You used lots of tools (many of which were on my website) to make your number judgments and I could tell that some of you were skeptical about the tools. That is perfectly appropriate and is healthy. However, recognize that when you do get a number from a tool that does not make sense to you, it has to be one of the inputs that generate the output, not the tool itself. Thus, if you get an optimal debt ratio of 80 or 90%, you may view it as absurd, but it can occur only because the operating income you entered was a very high percent of your firm value. You can, of course, decide that the 2009 operating income for your company was abnormal but that would then explain the output. Put differently, look past the output (valuation, optimal capital structure) and look at your inputs as drivers and compare them across companies.

5. The Narrative: This is the toughest one to get. With every company, there is a narrative that is waiting to be found and once you find it, it runs through your entire analysis. With Under Armour, for instance, the narrative is of a young, growth company with a charismatic and controlling CEO, that has been exceptionally successful, but is now facing grown-up challenges. That narrative explains the company's investment, financing and dividend policy but can be also used to point to potential dangers in the future. With Sanofi, the narrative is of a mature pharmaceutical firm, whose internal growth opportunities are drying up, going for a big acquisition and betting that it will pay off... I know that this is tough to do, but the pieces of corporate finance all tie together in a bigger picture and it is the same top management that determines all of the pieces...

If you feel that I have been unfair in my overall assessment, I am sorry. I know the immense amount of work that you put into your projects and I appreciate every minute of time you spent. I hope that you will get a payoff, if not immediately or even on your job, somewhere along the way.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Review session follow up

Hi!
The review session webcasts are up and running. You can get them by going to the webcast page for the class.

I did throw out several unanswered questions that I said I would answer later today and here I go:
1. Spring 1999 exam: Pepsico: In the problem on Pepsi, I raised the question of what the answer would have been if the firm had chosen to hold on to the $10 billion in cash, instead of buying back stock or borrowing debt..
Unlevered beta = 1.075 (40/50) + 0 (10/50) = 0.86
Levered beta = 0.86 (1+ (1-.4) (10/40)) = 0.989 ; the existing debt to equity ratio remains unchanged
If they had borrowed the $ 2 billion and kept that in cash as well, you could adapt this answer.

2. Spring 1997 exam: Why are the firm and equity NPVs different and how can we make them converge?
The reason is a little complicated. The debt ratios of 60% Equity and 40% debt are based on market value, not book value.
The book value of the project is $40 million (what you invest)
The market value of the project is $51.95 million (the present value of cash flows to the firm at the cost of capital, before you subtract the initial investment)
If you borrow 40% of $51.95 million and compute the FCFE based on this debt, you will end up with the same NPV

3. Spring 1999; Campbell Soup Capital structure: We worked out the change in firm value to be $2,093 million. What if you paid $ 35 per share on the stock buyback?
Number of shares bought back = 3000/35 = 84.714
Value increase paid to those who sold back = 84.714 (35-30) = 428.57
Remaining value increaes = 2093 -429 = 1664 million
Remaining shares = 300 - 84.71 = 215.19
Value increase for remaining shares = 1664/215.19 = $7.33
Try this with different buyback prices...

4. Valuation question: The key component in valuation is preserving consistency between growth, reinvestment and return on capital assumptions
g = ROC * Reinvestment rate
In the problem, we worked through the growth was given (15%) and the reinvestment rate can be computed as (net cap ex + chg in WC)/ EBIT (1-t) = 75%
Thus, the ROC = g/ Reinvestment rate = 15%/75% = 20%
If the ROC stays the same and growth drops to 4%,
New reinvestment rate in stable growth = 4/ 20 = 20%
Hope this helps. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Final exams are done...

Hi!
The final exams are ready to be picked up in front of the finance department. Look to your left as you get off the elevator and walk towards the front door. As always, please leave the exams in alphabetical order. I have attached the solutions to the exams, with the distribution for just the final (no grades on this one... the final grades should be out soon).... I am working on the grades right now and will let you know as soon as they are ready... Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: Solutions to finals a and b

Subject: Final email for class

Hi!
I just turned the grades in and they should be online. I know that each and every one of you spent an incredible amount of time in this class and I really, really appreciate it. I also know that some of you will be disappointed in your grades and I feel as badly as you do about not being able to help you master the mechanics. I hope that a bad grade does not sour you on finance and that you will take tools away from this class that you can use elsewhere.
One of the best things about teaching is that you get closure at the end of every semester and it is time to wrap up and move on. When we started in January, I said that I would try to make this a class that would stay with you for the rest of your life. I may not have succeeded but I really did try! I I hope that you find ways to use what we have talked about in this class in whatever you choose to do in your future. Just as an aside.. If you really want to master Corporate Finance, the best way to do it is by getting your hands dirty... I know that this will sound masochistic, but pick another company and do the entire corporate finance analysis on it. You will find two things. First, it will take a lot less time the second time around. Second, you will learn something new with every company you examine.
You will notice that this email does not end with the three words that every other email that I sent this semester ended with: until next time. For better or worse, this is my last email to you in this class. However, you do have my email address for life. No matter what you decide to do or where you go to work, I am only an email away.. If you have questions, doubts or just thoughts you want to share, I will be always glad to be the recipient. While I will not promise an instantaneous turn-around, i will get back to you. If you do choose to take my valuation class, you can look forward to a whole new set of emails and I look forward to seeing you in the Fall or the Spring. As a final thought , I want to wish you a wonderful summer. God speed!

Aswath Damodaran
adamodar@stern.nyu.edu