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The Corporate Finance Email Chronicles: Spring 2016


I confess. I send out a lot of emails and I am sure that you don't read some of them. Since they sometimes contain important information as well as clues to my thinking (deranged though it might be), I will try to put all of the emails into this file. They are in chronological order, starting with the earliest one. SThey are in chronological order, starting with the earliest one. So, scroll down to your desired email and read on, or if the scrolling will take you too long, click on the link below to go the emails, by month:

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

Happy new year! I hope you have a wonderful break (good news: it is still break..) and that you will come back tanned, rested and ready to go. This is the first of many, many emails that you will get for me. You can view that either as a promise or a threat. I am delighted that you have decided to take the corporate finance class this spring with me and especially so if you are not a finance major and have never worked in finance. I am an evangelist when it comes to the centrality of corporate finance and I will try very hard to convert you to my faith. I also know that some of you may be worried about the class and the tool set that you will bring to it. I cannot alleviate all your fears now, but here are a few things that you can do to get an early jump:
a. Get a financial calculator and do not throw away the manual. I know that you feel more comfortable using Excel, but you will need a calculator for your quizzes/exams.
b. The only prior knowledge that I will draw on will be in basic accounting, statistics and present value. If you feel insecure about any of these areas, I have short primers on my web site that you can download by going to
Having got these thoughts out of the way, let me get down to business. You can find out all you need to know about the class (for the moment) by going to the web page for the class:
This page has everything connected to the class, including webcast links, lecture notes and project links. The syllabus has been updated:
You will be getting a hard copy of it on the first day of class but the the quiz dates are specified online. If you click on the calendar link, you will be taken to a Google calendar of everything related to this class.
You will note references to a project which will be consuming your lives for the next four months. This project will essentially require you to do a full corporate financial analysis of a company. While there is nothing you need to do at the moment for the project, you can start thinking about a company you would like to analyze and a group that you want to be part of.

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

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

One final point. I know that the last few years have led you to question the reach of finance (and your own career paths). I must confess that I have gone through my own share of soul searching, trying to make sense of what is going on. I will try to incorporate what I think the lessons learned, unlearned and relearned over this period are for corporate finance. There are assumptions that we have made for decades that need to be challenged and foundations that have to be reinforced. In other words, the time for cookbook and me-too finance (which is what too many firms, investment banks and consultants have indulged in) is over. To close, I will leave you with a YouTube video that introduces you (in about 3 minutes) to the class.
I hope you enjoy it. That is about it. I am looking forward to this class. It has always been my favorite class to teach (though I love teaching valuation) and I have a singular objective. I would like to make it the best class you have ever taken, period. I know that this is going to be tough to pull off but I will really try. I hope to see you on February 1st, in class.


As the long winter break winds down, I first hope that you are far away from the snow and slush in New York, some place warm. I also hope that you are ready to get started on classes and that you got my really long email a weeks ago. If you did not, you can find it here:
This one, hopefully, will not be as long and has only a few items

1. Website: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
Please do try to download the first lecture note packet by Monday. The direct link to the lecture note packet is below:
Lecture note packet 1: https://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/cfpacket1spr16.pdf

2. Pre-class prep: Are you kidding me? What kind of twisted mind comes up with a pre-class prep for the very first class. Just relax, have fun this weekend and try to be in class. If you cannot make it, never fear! The webcast for the class will be up a little while after the class, but it just won't be the same as being there in person.

For those of you who have not got around to checking, class is scheduled from 10.30-11.50 in Paulson Auditorium on February 1. See you there!


I don’t know whether you signed up for this, but class has not even started and this is the third email that you are getting from me (if you missed the last two, check this link: https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfemail.html). However, since class is just around the corner, I decided to send you both a final reminder and to perhaps give you some advance warning about what’s coming in these next few weeks.

  1. The details: The class details are simple. We will meet every Monday and Wednesday from 10.30-11.50 in Paulson Auditorium, starting February 1st and going through May 9. If you have been to Paulson Auditorium already, it was probably as part of Stern Launch, those two weeks of fun, frolic and intellectual stimulation (I am trying so hard to bite my tongue here that I think I bit it off)!. This is about as bad a setting as Madison Square Garden, but unlike the New York Knicks, we will make even this setting work. My advice to you is to try to avoid the back rows on the side of the room (front and center is always best), since they come with both limited view seats and bad acoustics. As for what you need to bring to the first class, the only essential is that you be there, awake and curious, but if not, I will take alive and caffeinated. If you can check the webpage for the class (https://www.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html), it would be great, and it would be awesome if you can print off the lecture note packet 1 for the class (available at this link, https://www.stern.nyu.edu/~adamodar/New_Home_Page/cflect.htm ) or buy it at the bookstore.
  2. “The only class that matters”: I know that you have other classes on your schedule but I will apologize in advance for acting as if this is the only class that you will be taking this semester. I will give you stuff to do in this class that will eat into your time in other classes, and in the process, I may be laying waste to your marketing, strategy and management classes, but since there is not much to lay waste too, I won’t be losing any sleep over these transgressions and I hope that you don’t either.
  3. Micro aggressions aplenty and a few macro aggressions too: If you are easily troubled by micro aggressions, you will either be mortally wounded by this class or will develop a thicker skin. I plan to commit multiple micro aggressions every class and will find fault with entire professional groups, starting with accountants, moving on to strategists and then turning on finance professors. In fact, I expect to be committing macro aggressions against other groups, especially bankers and consultants. Since many of you fall or fell into one of these groups, it is only a matter of time before you get really pissed off about something I say. Sorry, in advance, but I cannot stop myself. I have a version of Tourette’s that leads me to blurt out these things!
  4. Dish it back: I also follow the adage that if you dish it out, you should be willing to have it dished back to you. Nothing would make me happier than to have you disagree with me, as long as you marshal your facts and back it up with arguments. This class is not about making you think like me (the world would be such a boring place) but to help you think for yourselves, on the big corporate finance and investing questions of the day.
  5. You cannot wait? You want to get started now? If you are in this much of a hurry to get started, you may need some psychological counseling, but if you really want to get a jump on this class, you can play some Moneyball with me. At the start of every year, I collected and analyze data on every publicly traded company in the world. This year, that sample included 41,889 companies and my findings are on my blog as seven posts, structured very much like the class. You can find them at http://aswathdamodaran.blogspot.com and they are the seven posts in January. Just browse through them all when you get a chance..

See you on Monday! I hope that this class will excite you, but if that fails, I will settle for provoke, even anger or incite you, but I hope never to bore you. That, too me, is the one unforgivable teaching sin.


I promised you with a ton of emails and I always deliver on my promises... Here is the first of many, many missives that you will receive for me….. First, a quick review of what we did in today's class. I laid out the structure for the class and an agenda of what I hope to accomplish during the next 15 weeks. In addition to describing the logistical details, I presented my view that corporate finance is the ultimate big picture class because everything falls under its purview. The “big picture” of corporate finance covers the three basic decisions that every business has to make: how to allocate scarce funds across competing uses (the investment decision), how to raise funds to finance these investments (the financing decision) and how much cash to take out of the business (the dividend decision). The singular objective in corporate finance is to maximize the value of the business to its owners. This big picture was then used to emphasize five themes: that corporate finance is common sense, that it is focused, that the focus shifts over the life cycle and that you cannot break first principles with immunity.

On to housekeeping details.
1. Project Group: I have not described the project yet, but you don’t have until Wednesday to get started. For the moment, try to at least find a group that you can work with for the rest of the semester. Find people you like/trust/can get along with/ will not kill before the end of the semester. The group should be at least 4 and can be up to 8 (if you can handle the logistics). Each person will be picking a company and having a larger group will not mean less work. This group will do both a case and the project, both of which I will talk about next class.
2. Webcasts: The webcasts should be up a few hours after the class ends. Please use the webcasts as a back-up, in case you cannot make it to class or have to review something that you did not get during class, rather than as replacement for coming to class. I would really, really like to see you in class. The web cast for the first class is up now and you can get it at
Try it out and let me know what you think. I have been told that it come through best if you have a 50 inch flat panel TV and surround sound. You will also find the syllabus and project description in pdf format to download and print on this page. The lecture note packet is also on this page. If you were not able to come to class today, because of weather issues (or anything else), here are the links to the syllabus and project that were handed out:
Syllabus: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfsyllspr16.pdf
Project: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfproj.pdf
3. Drop by: I know this is a large class but I would really like to meet you at some point in time personally. So, drop by when you get chance... I don't bite....
4. Lecture note packet 1: Please bring the first lecture note packet to class on Wednesday. If you want to buy it at the bookstore and the bookstore does not have it, just print off the first 15 pages for Wednesday’s class. Here is the link to lecture note packet 1.
Lecture note packet 1: https://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/cfpacket1spr16.pdf
5. Past emails: If you have registered late for this class and did not get the previous emails, you can see all past emails under email chronicles
on my web site
6. Post class test & solution: Each class, I will be sending out a post class test and solution for each class. This is just meant to reinforce what we did in class that day and there are no grades or prizes involved. I am attaching the ones for today's class.
That is about it, for this email.


I know that it is the first week of this class but it is never too early to start thinking creatively. This week’s puzzle is built around the corporate life cycle structure that I introduced in class yesterday, and particularly around what to do with Microsoft. Start by reading the description of the puzzle:

If you have the time, do read the two blog posts referenced in the puzzle:
As I thought about companies to offer to you to examine, i wanted to stay away from the obvious ones: Snapchat is obviously a very young company, Facebook and Google are growing mature companies and Apple is probably a mature company. I picked Microsoft, a company where there can be debate about where they are in the life cycle and what to do next. So, put yourself in the shoes of Microsoft’s CEO and think about what you would do, if you ran the company. In particular, I want you to think about what would make the most sense for Microsoft’s stockholders and then think about what would advance your personal capital the most and decide. Have fun with it. There is no right answer but I opened a discussion board on YellowDig (for which I sent out an invitation earlier today). So, please go back and accept that invitation and post your thoughts.


In today's class, we started on what the objective in running a business should be. While corporate finance states it to be maximizing firm value, it is often practiced as maximizing stock price. To make the world safe for stock price maximization, we do have to make key assumptions: that managers act in the best interests of stockholders, that lenders are fully protected, that information flows to rational investors and that there are no social costs. We started on why one of these assumptions, that stockholders have power over managers, fails and we will continue ripping the Utopian world apart next class.

1. Administrative Stuff: I went through the structure for the class and mentioned the quiz dates. As noted in class, if you are going to miss a quiz, the 10% from that quiz will be moved to the rest of the exam grade for the class and if you take all three, your worst quiz will get marked up to the average on your remaining exams. Here are a few other details:
Class announcements: I will allow one announcement at the beginning of each class, limited to two minutes. If you are interested in making an announcement, please use this Google shared spreadsheet to sign up. (Link: https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1SbapcKe2AwgZ63v9FaVSux_nK4pQDEK3viHxXH_LXnc/edit?usp=sharing )
Orphan list: If you have trouble finding a group, I have started the orphan list at this link. (https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1ZQhI4GzHT4DJSN4RGBUvy7r_I3QLl545nqm6VG5Z-ts/edit?usp=sharing ) Please go sign up. I filled in the first row with my information but I am not really interested in being part of a group or being adopted.
Yellowdig: For those of you who have already accepted my invitation to be part of Yellowdig (https://www.yellowdig.com), thank you. If you have not, please do go back to yesterday’s emails and check for the invite. If you cannot find it, I will send it to you again.

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

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

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

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


It is never too early to start nagging you about the project. So, let me get started with a checklist (which is short for this week but will get longer each week. Here is the list of things that would be nice to get behind you:
Find a group: If you have trouble finding one, try the orphan spreadsheet for the class. If you have a group and need an orphan to adopt, try the spreadsheet as well. Orphan Spreadsheet: https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1ZQhI4GzHT4DJSN4RGBUvy7r_I3QLl545nqm6VG5Z-ts/edit?usp=sharing
Pick a company/theme: This will require some coordination across the group but pick a company and find a theme that works for the group. Each person in the group picks a company and the companies form the theme.
Find the most recent annual report for your company.
If your company has quarterly reports or filings pull them up as well.
Get a listing of the board of directors for your company & start your preliminary assessment.
In doing all of this, you will need data and Stern subscribes to one of the two industry standards: S&P Capital IQ (the other is Factset). It is truly a remarkable dataset with hundreds of items on tens of thousands of public companies listed globally, including corporate governance measures. I believe that you have automatic access to Capital IQ. Just make sure you do. You will not regret it and it will not only save you lots of time in the future but will give you another weapon you can use in analysis.

On a different note, I want to update you on three TAs for the class, their office hours and the review sessions that they are planning to hold.
Tyler Albright, tyler.albright@stern.nyu.edu, Office hours: Tuesday 11-12
Charlotte Baranne, cb3271@stern.nyu.edu, Office hours: Tuesday: 5-6
Ramandeep Singh, rs5058@stern.nyu.edu, Office hours: Tuesday 4.30-5.30
They plan to have a review session every week on Wednesday from 4.45- 5.45 in KMEC 3-55. Since the room fits only about 60 people, I have set up a Google sign up spreadsheet for the classes, if you are interested in attending. The sessions will take problems from past quizzes and work through them in sync with what is going in class.
Google sign up sheet: https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1Gcs0Dp5vm4M2IaNK-94oZLPGZL2I2ghn_Wq6Vk9VMqY/edit?usp=sharing

2/5/16 As promised, here is the first of the weekly in-practice webcasts. These are 10-15 minute webcasts designed to work on practical issues in corporate finance. This week’s issue is a timely one, if you are working on picking companies for your project (as you should be..). It is about the process of collecting data for companies, the first step in understanding and analyzing them. The webcast link is below:
I don’t think it is too painful to watch and you may even find it useful. I have also put the link up on the webcast page for the class:
The webcasts for the first two classes should be on there, if you missed (physically, metaphysically or mentally) and the links to the project and syllabus that I handed out in the class. At the risk of nagging, please do get the lecture note packet 1 printed off or bought before Monday’s class. It is now available (or was at least yesterday) in the bookstore.

The sun is out and I hope that you are enjoying your weekend. I won’t ruin it with a long email but the first newsletter is attached. Not much news but it provides some perspective on where we are (not far) and where we are going.

Attachment: Issue 1 (February 6)

2/7/16 As you get ready for the Super Bowl party, a quick preview of the week to come. This week, we will continue with our discussion of corporate governance, focusing first on where power in a company rests (stockholders, managers, labor, the government) and the consequences for corporate finance. We will then move on to lenders/bondholders and how left unprotected, they can be exploited, and on to financial markets, examining both the predilection of firms to delay/manage bad news and investor reactions to it. Having laid bare the limitations of the assumptions that underlie traditional corporate finance, we will examine alternatives to stock price maximization. In Wednesday’s class, we will start on the big question of what comprises risk, how to measure it and convert it into a hurdle rate. Have fun and I hope that you enjoy watching the game as much as you do assessing the quality of the advertising.

Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? i also want to think about how managers in publicly traded companies can position themselves best to consider the public good, without being charitable with other people's money, as a precursor to the next class. We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. 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.

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 (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
3. Type the name of your company
4. You might get multiple listings for your company, especially if it is a large company with multiple listings and securities. Try to find your local listing. For a US company, this will usually be the one with your stock symbol followed by US. For a non-US company, it will have the exchange symbol for your country (GR: Germany, FP: France, LN: UK etc...) It may take some trial and error to find the listing....
5. Type in HDS
6. Print off the first page of the HDS (it should have the top 17 investors in your company).

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

Attachments: Post-class test and solution


It is Tuesday and time for the second weekly challenge. In the utopian world, maximizing a company's stock price is equivalent to maximizing it's value, since markets are efficient. But what if they are not? What if markets are driven by short term considerations and investors? In that case, maximizing prices is not the same as maximizing value. This puzzle is built around a letter than Laurence Fink, head of Blackrock, sent to the S&P 500 companies advising them to play the long game. The details of the puzzle are at the link below:
After you have read the puzzle, here are the five questions that I would like you to start thinking about, since it is a perfect preview for tomorrow’s class:

  1. Do you think that investors are collectively guilty of being short term in their thinking? What evidence can you offer to back this up?
  2. If yes, who do you think is more short term? Instiutitional investors or individual investors? Any evidence?
  3. Are managers at companies more long term or more short term than investors? Why?
  4. Mr. Fink is suggesting that if companies don't tell compelling stories about where they are going, investors will step in and fill in the details. Do you agree with this statement? If yes, what is the solution?
  5. If your end game is a more efficient market (where value and price converge), and you were a top public policy official or a politicians running for high office, what changes would you propose to market regulations, tax laws and investor rights to make this happen?
    There is a YouTube video that goes with this puzzle (https://youtu.be/TCPrxsx5DMQ) and I have put it up on YellowDig (Did you accept my invitation yet? You can still do it). Please go in and tell me what you think about these issues on the YellowDig discussion board.

The objective function matters, and there are no perfect objectives. That is the message of the last two classes. Once you have absorbed that, I am willing to accept the fact that you still don't quite buy into the "maximize value" objective. That is fine and I would like you to keep thinking about a better alternative with three caveats. First, you cannot cop out and give me multiple objectives - I too would like to maximize stockholder wealth, maximize customer satisfaction, maximize social welfare and employee benefits at the same time but it is just not doable. Second, your objective function has to be measurable. In other words, if you define your objective as maximizing the social good, how would you measure social good? Third, take your objective (and the measurement device you have developed) and ask yourself a cynical question: How might managers game this system for maximum benefit, while hurting you as an owner? In the long term, you may almost guarantee that this will happen. On the theme of investor time horizon and stockholder composition, here is an interesting read: http://bit.ly/YrNIMX
Building on the theme of social good and stockholder wealth a little more, there are a number of fascinating moral and ethical issues that arise when you are the manager in a publicly traded firm. Is your first duty to society (to which we all belong) or to the stockholders (who are your ultimate employers)? If you have to pick between the two and you choose the former, do you have an obligation to be honest and let the latter know? What if you believed that the market was overvaluing your stock? Should you sit back and let it happen, since it is good for your stockholders, or should you try to talk the stock price down? On the question of socially responsibility, there are groups out there that rank companies based upon social responsibility. I have listed a few below, but they are a few of many:
Ethisphere (never heard of them): http://ethisphere.com/worlds-most-ethical/wme-honorees/
Calvert Social Index: http://www.calvert.com/sri-index.html
Domini: http://www.kld.com/indexes/ds400index/index.htm
Dow Jones Sustainability Index: http://www.sustainability-indices.com
And this is just the tip of the iceberg. Environmental organizations, labor unions and other groups all have their own corporate rankings. In other words, whatever your key social issue is, there is a way to stay true (as a consumer and investor).

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

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

This email has gone on way too long already, but one final note. A little more than a year ago, I took a look at Petrobras, just as a cautionary note on what happens to a company when its objective function becomes muddled (with national interest constraints). You can read it here.

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


As for the project & class, time sure does fly, when you are having fun... We are exactly 15.38% (4 sessions out of 26) through the class (in terms of class time) and we will kick into high gear in the next two weeks. I am going to assume for the moment that my nagging has worked and that you have picked a company to analyze. Here is what you can be doing (or better still, have done already):
1. Download the latest financials for the company: You don't have to print them off. In fact, I find it convenient to keep them in a folder in pdf format, since my computer can search the document far more quickly than I can. For all companies, this will include the latest annual report and with US companies, try to find the latest 10K and 10Q on the SEC website. If you are analyzing a private business, you will need to get the most recent financial data from the owner (who hopefully is related to you and still likes you...)
2. Put the board of directors under a microscope: The first step in understanding your company is to start at the top. Take a look at who sits on the board and how long they have been sitting there. In particular, the question that you are trying to answer is how effective this board will be in keeping any eye on the top management of the company. Start with the cosmetic measures, which is what most corporate governance services and laws focus on, but look for something more tangible. Has the board shown any backbone in stopping or slowing down management?
3. Assess the "power" structure: As Machiavelli pointed out, power abhors a vacuum (he said no such thing, but you can pretty much attribute anything to him or Confucius and sound literate). Specifically, try to find who the largest stockholders in your company are. You can get this from the Bloomberg terminals (HDS page), Capital IQ (holders) or online for free (Yahoo! Finance or Morningstar). Once you have this list, here are the questions that you should try to answer:
If you are a small stockholder in this company, do you see any likelihood that any of these stockholders will stand up for stockholder rights or are they more likely to sell and run?
Are there any stockholders on the list whose interests may lie in something other than maximizing stockholder wealth? (For instance, we talked about the government as a stockholder and how its interests may be different from that of the rest of the stockholders.. Think of an employee pension fund being on that list... Or another company being the largest stockholder...)
As I mentioned yesterday, I will be putting up a webcast tomorrow on how to analyze the "top shareholder" list, using a range of companies. Hope you to get a chance to watch it. Since we have no class on Monday, you should have plenty of time. For those of you have tried to get on Capital IQ and have been unable to, I have good news. I heard back from the powers-to-be that the class has been added to the Capital IQ list and you should be able to logon and download data. Let me know if you have any trouble.

On a related note, I will not keep tabs on your company choices officially, since I leave the choice up to you and will let you live with the consequences. It would be interesting though (to me and to everyone else in the class), if we could see the choices. So, I am opening a shared Google spreadsheet for you to use to enter the names of the people in your group and the company choices that you have made.
Remember that nothing is set in stone and that you can always change your company at any time (even as late as May 8, if you so desire). I also have a couple of lost souls who have no groups. So, if you need or would like an extra person for your group, please let me know.


Since you have a long weekend ahead of you, with nothing to do but binge watch The Walking Dead (ahead of the season opener on Sunday), I thought I would get in two in-practice webcasts this week and nag you about your project (yet again). Since these webcasts are directly connected to what you will or should be doing on the project, the best way to use them is to pick a company and use the webcasts to get the relevant parts of the project done.

1. Assessing Corporate Governance: This webcast looks at ways to assess the corporate governance at your company, using HP from 2013 as an example. I use HP's annual report, its filings with the SEC and other public information to make my assessment of the company.
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/corpgovHP.mp4
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/corpgov.ppt
HP Annual Report: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf
HP 14DEF: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf
You can find these links in all three forums (my webcast page, Yellowdig, iTunes U) and it looks at what information to use and how to use it to assess the corporate governance structure of a company. (Sorry about the striped sweater… Should have known better).

2. Stockholder Holding Assessment: This webcast is on assessing who the top stockholders in your company are and thinking through the potential conflicts of interest you will face as a result. The webcast went a little longer than I wanted it to (it is about 24 minutes) but if you do have the list of the top stockholders in your company (the HDS page from Bloomberg, Capital IQ, Morningstar or some other source), I think you will find it useful.
Webcast link: http://youtu.be/x_H_4KTeOkc
Presentation link: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/holders.ppt
Finally, one hopeful sign for investors is the presence of activist investors (like Carl Icahn) in your midst, not because they always do the right thing but because they put managers on notice. To help you determine whether you have an activist investor in your listing, I have a link (dated, but it is the best I could do) that lists the activist investors in the US (with phone numbers, if you ever want to call them):

Finally, if you do get a chance, please reflect and comment on the weekly challenge (on YellowDig) and enter your group details in the shared Google spreadsheet (https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/17uwl0LZutgAs2KtCf1N2qnGEnSve2iPGX-XydjIWoBg/edit?usp=sharing). I do have a couple of people who have had trouble finding groups. So, if you have room for one more person in your group, please let me know.


As you get ready for the long weekend (or are already deep into it), I will keep this short. Weekly newsletter is attached. Read it, if you can. Find a group. Pick a company. Start collecting data. Make your bed. Clean your room. Brush your teeth. (Sorry… Got carried away with the task list..)

Attachment: Issue 2 (February 13)


I hope that you had a great weekend, though the snow and the ice yesterday probably put a damper on it. Time for this week’s puzzle: Tomorrow, we start on our discussion of risk and return models in finance, and they are all built on the presumption that marginal investors are diversified. While the argument for diversification is always a slam dunk in class rooms, with statistical evidence at its base, it is surprisingly contested. Thus, there is a significant subset of investors who believe that diversification hurts investors rather than helps them, and while it is easy to dismiss them as uninformed, I think we make a mistake by doing so. In fact, I can see why some investors may be better off with more concentrated portfolios and I captured the essence of the trade off in a blog post that I did a while back:
In this week’s challenge, I would like you to think about diversification intuitively and personally. In particular, read the full challenge here:
Then, please try to answer the following questions:
1. Both sides of this debate use overwrought claims to make their case.
- Some proponents of diversification claim that diversifying across assets and asset classes eliminates all risk from your portfolio. Explain why this is not true.
- Some proponents of concentrated portfolios claim that if you diversify, all you can ever do is keep up with the market. Explain why this is not true.
2. How many stocks/assets would you hold in your portfolio?
a. One to two stocks/assets
b. Three to five
c. Five to ten
d. Ten to Twenty
e. Twenty to Fifty
f. More than Fifty
3. Explain why you chose the number that you did in the last question and how it may change over time (as you age, gain more investing knowledge, get wealthier).
4. If you have an entrepreneurial streak and want to start your own business, you will end up undiversified, investing all your human and financial capital in that start up, at least to begin with. How do you reconcile this action with the argument for diversification?
As before the puzzle is posted on Yellowdig (which has an iPhone app now, if you are interested). Please post your thoughts.


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.

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. Finally, if you are up for the challenge, try to estimate the risk free rate in the currency of your choice. Of course, if this is US dollars, not much of a challenge... It is a good exercise to try a more difficult currency. I will be posting a webcast on Friday on doing this. So, stay tuned. I have also attached the post class test & solution for today...

A couple of reading suggestions, if you get a chance. One relates to the puzzle that I mailed out for this week on risk and in particular, on whether diversification is good or not. The link is here:
If you want to, please go into the Yellowdig page and post your comments. I won’t hold it against you, if you disagree with me.

Attachments: Post-class test and solution

2/18/16 This week, we started on what I like to call the “meat and potatoes” part of corporate finance, not very appetizing if you are a vegan, but essential nevertheless. I am going to assume, at this stage, that my nagging has worked and that you have picked a company. This week, your tasks are simple ones:
Pick a currency that you would like to do the analysis in. For most of you, the choice will be easy, and the currency that you will do the analysis in will be the currency in which the financials are reported, which, in turn, will be the currency of the country in which your company is incorporated. For some of you the choice will be a little more complicated, since the currency in which the financials are reported may not match the currency of the country in which the company is incorporated. This is the case, for instance, with commodity companies which often report their financials in US dollars, even though they may located in the UK or Latin America. Finally, there will be companies where the reporting may be in the local currency (Rubles, Nigerian Naira) where you decide that discretion is the better part of valor and you decide to do your analysis in an alternate currency (say US dollars or Euro) because getting inputs (on risk free rates and inflation) is easier.
Get a risk free rate in that currency: Remember that, at least for corporate finance purposes, a risk free rate is a long term (10-year), default-free rate. If you have a government that is Aaa rated that issues bonds in that currency, your task is very simple. Find a 10-year bond issued by that government and look up the rate on that bond. Thus, in US dollars, the US Ten-year T.Bond rate today, and in Euros, the German 10-year Euro bond rate, can be used as risk free rates. If there is no Aaa rated government bond in your currency, your task just got messier. You will have to back out the default spread for that government out of the government bond rate. We will be getting to this at the start of class next Monday, but you can get a jump if you watch the in-Practice webcast tomorrow. For the moment, here are some resources you can use to get started:
Local Currency Government bond rates: http://www.tradingeconomics.com/bonds
Moody’s Sovereign Ratings, by country: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/sovrCDSFeb16.pdf
Sovereign CDS spreads, by country: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/MoodysFeb16.xls
My lookup table on ratings and default spreads: https://www.stern.nyu.edu/~adamodar/pc/datasets/sovratingspreads.xlsx
2/19/16 If you have picked a company, you should be able to pick a currency to do your analysis. Most of the time, the most pragmatic choice is to stick with the local currency, in which the financials are reported. Note, though, that if you have a commodity company, the conventional practice is often to report everything in US dollars, even for non-US companies. Once you pick the currency, you should try to get a risk free rate. As I promised, I do have a webcast on estimating the risk free rate that you may or may not find useful.
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/riskfree.mp4
Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/riskfree/riskfree.ppt
While the spreadsheet uses (and links) to the sovereign ratings and CDS spreads from March 2013, I sent you the updated sovereign CDS spreads, Moody’s ratings and updated lookup table yesterday but I listing them again, just in case.
Local Currency Government bond rates: http://www.tradingeconomics.com/bonds
Moody’s Sovereign Ratings, by country: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/sovrCDSFeb16.pdf
Sovereign CDS spreads, by country: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/MoodysFeb16.xls
My lookup table on ratings and default spreads: https://www.stern.nyu.edu/~adamodar/pc/datasets/sovratingspreads.xlsx
I know that this webcast is a little ahead of where we are in the class, but watching it will help you in the first part of class tomorrow.


Not much to add to my emails from this week, but the latest newsletter is attached. If you are interested, I did three posts on my blog this week, pairing of companies: Apple vs Alphabet on Monday, Amazon and Netflix on Wednesday and Facebook and Twitter on Friday, looking at them as businesses, investments and trades.
Apple vs Alphabet: http://aswathdamodaran.blogspot.com/2016/02/race-to-top-duel-between-alphabet-and.html
Amazon vs Netflix: http://aswathdamodaran.blogspot.com/2016/02/the-disruptive-duo-amazon-and-netflix.html
Facebook vs Twitter: http://aswathdamodaran.blogspot.com/2016/02/management-matters-facebook-and-twitter.html
I hope that you enjoy them
2/21/16 This will be a big week, as we start with risk free rate tomorrow, move on to estimating equity risk premiums and then measure the relative risk of an investment. By the end of the week, you should be able to compute a cost of equity for any publicly traded company, no matter how complicated and where it is located in the world, I promise. For the moment, though, relax and tell yourself it is not that complicated (because it is not). If that does not work, start reading chapter 4, not because you will get revelations but because you will fall asleep and then you will not be stressed out any more.

We started today’s class by tying up the las loose ends with risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The rest of today's class was spent talking about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at three different ways of estimating the equity risk premium.
1. Survey Premiums: I had mentioned survey premiums in class and two in particular - one by Merrill of institutional investors and one of CFOs. You can find the Merrill survey on its research link (but you may be asked for a password). You can get the other surveys at the links below:
CFO survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2422008
Analyst survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2450452

2. Historical Premiums: We also talked about historical risk premiums. To see the raw data on historical premiums on my site (and save yourself the price you would pay for Ibbotson's data...) go to updated data on my website:
On the same page, you can pull up my estimates of country risk premiums for about 130 countries from February 2016

3. Implied equity premium: Finally, we computed an implied equity risk premium for the S&P 500, using the level of the index. If you want to try your hand at it, here is my February 2016 update:
Play with the spreadsheet. Try changing the index level, for instance, and see what it does to the premium.

4. Company revenue exposure: As a final step, see if you can find the geographic revenue distribution for your company. You can then use my latest ERP update to get the ERP for your company

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

The post class test and solution for today are attached.

Attached: Post-class test and solution


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

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

On a different note, there is an article about JP Morgan’s trading fiasco in London, titled the Big Whale. The trader who was “flagged” as responsible is speaking up and naming names, and guess what? I agree with him that this was not a solo operation. In fact, adding to my suggestion yesterday about hiring the mothers of traders to sit behind them when they trade, perhaps we should do this up and down the management ranks. Here is my original post, if you are interested.
Until next time!


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

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

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

Attachments: Post-class test and solution


If my nagging is paying off, you should have picked a company by now and if you have, you can move on to the equity risk premium part of your project. The first step is to review the material from yesterday’s class first, so that you understand the basics of equity risk premium estimation. Once you have done that, you should print off or download (I prefer the latter) the annual report or 10K for your company. As you browse through the document, look for any information that the company gives you on where it does business. Most companies will give you a breakdown of revenues geographically, though not always at the level of detail that you like, and some may even go further and give you EBITDA or assets geographically. Take what you can get and stick with revenues as your measure of geographic exposure. Your final task is to create a weighted average of the equity risk premiums and while you can use the equity risk premium spreadsheet below and your task can range from simple to slightly messy, depending upon your regional breakdowns:
1. If you have your company’s exposure to individual countries: Your task is simple. You can use the equity risk premiums that I have for those countries and take a weighted average.
2. If you have your company’s regional exposure and it matches my regional breakdown: I computed weighted averages for Asia, North America, South America, Western Europe, Eastern Europe/Russia, Asia and Australia/NZ. If your company breakdown is similar or close, you can use my weighted averages.
3. If you have your company’s regional exposure but it does not match mine: You will have to be ingenious, but it is not too difficult to do. Start with this spreadsheet, which has GDP and ERP for each country:
Set the GDPs of any country/ region you don’t want to count in your average to zero and the spreadsheet will compute the ERP for your designated region. Thus, if you has a US company that breaks down revenues into the US and the rest of the world, all you need to do is set the GDP for the US to zero and the global weighted average that you get will now be for the rest of the world. If you have no idea what I am talking about, watch the in-Practice webcast which will be put up tomorrow.

On the second front, I hope that you have had a chance to print off the Bloomberg beta page for your company. Once you have it, do check the adjusted beta and confirm for yourself that it is in fact equal to
Adjusted Beta = Raw Beta (.67) + 1.00 (.33)
I mentioned in class that I initially was curious about where these weights were coming from but I think I have found the original source. It was a paper written more than 30 years ago (which I have attached to this email) that looked at how betas for companies change over time and concluded based upon a small sample and data from 1926-1940 (I am not kidding!) that they converged towards one, with roughly the magnitudes used by Bloomberg. Why has it not been updated with larger samples and better data? Well, that is what happens when "here when I got here" becomes the response to questions about numbers we use all the time. I have also forwarded this email to the beta calculation guy at Bloomberg. I hope that they have let him out of that basement room, where he was locked up. Tomorrow’s second In-Practice webcast will cover how to read a regression beta.


In yesterday’s email, I suggested to you that you estimate the equity risk premium for your company. Since you are so good about following my directions, I know that you have already done what you need to, but in case you run into trouble, the first webcast might be helpful. It looks at both how I estimate equity risk premiums for countries and how to estimate the equity risk premium for an individual company, even one that uses an eclectic geographic breakdown of revenues:
Webcast: https://youtu.be/D3IGn6tH03c?list=PLUkh9m2BorqkNIdjpZY2kI0qzRbEv5F5L
Slides: https://people.stern.nyu.edu/adamodar/pdfiles/blog/ERPforCompany.pdf
ERP&GDP spreadsheet: https://www.stern.nyu.edu/~adamodar/pc/datasets/ERP&GDP.xls

In the second webcast, I take a look at Disney's 2-year weekly regression (from February 2011- February 2013). I have the Bloomberg page attached. I am also attaching the spreadsheet that I used to analyze this regression, which you are welcome to use on your company. The webcast is available at the link below:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/Regression.mp4
Disney’s Regression Bloomberg beta page: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Regression/Disneyregression.pdf


Two quick notes. First, the newsletter for the week is attached. Second, I know that Capital IQ has been spotty and downright unreliable. In fact, I have lost my Capital IQ connection, at least for the weekend. I have reached out to the IT people in charge of this and hope to get it resolved by next week. Have a great weekend!

Attachment: Issue 4 (February 27)

2/28/16 I apologize again for scaring you about the first quiz earlier today. Nevertheless, the first quiz is coming a week from tomorrow, but this week, we will continue with our discussion of regression betas. Tomorrow, we will look at alternatives to regression betas starting and that discussion will spill into Wednesday. Along the way, we will look at how to estimate the beta of a company after a merger and the betas for different parts of a multi-business company. If you want to read ahead in chapter 4 of the book, please do so. It is one of the most critical parts of the class, especially since it will feed into almost everything else we do later in the class. Until next time!

We started class today by connecting the three pieces that we have talked about so far in class, the risk free rate, the equity risk premium and beta to an expected return and how that expected return becomes a cost of equity. We spent the rest of the class talking about the determinants of betas. Before we do that, though, there is one point worth emphasizing. Betas measure only non-diversifiable or market risk and not total risk (explaining why Harmony can have a negative beta and Philip Morris a very low beta).

1. Betas are determined in large part by the nature of your business. While I am not an expert on strategy, marketing or productions, decisions that you make in those disciplines can affect your beta. Thus, your decision to go for a price leader as opposed to a cost leader (I hope I am getting my erminology right) or build up a brand name has implications for your beta. As some of you probably realized today, the discussion about whether your product or service is discretionary is tied to the elasticity of its demand (an Econ 101 concept that turns out to have value)... Products and services with elastic demand should have higher betas than products with inelastic demand. And if you do get a chance, try to make that walk down Fifth Avenue...

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

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

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

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

Attachments: Post-class test and solution


First, a few administrative details. There was a problem with yesterday’s webcasts, but it got fixed this morning. I put the streaming link and the audio link up and will add the video download and YouTube links later. Second, the first quiz is coming up and I will be doing a review session on Friday from 12-1 in KMEC 2-60. As you may know, that room fits only 170 and if everyone shows up, we are in trouble. I do know that some of you will not be able to show up and that review session will be recorded and the webcasts will be available shortly thereafter.

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


Moving right along, I know that today's class was a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash). If you got lost at some stage in the class, here are some of the ways you can get unlost:
1. Review the slides that we covered today.
2. Try the post-class test and solution. I think it will really help bring together some of the mechanical issues involved in estimating betas.
3. Read this short Q&A on bottom up betas which highlights the estimation process and some of its pitfalls:
Finally, watch your emails tomorrow, since I will be sending the seating chart for quiz 1 as well as the presentation that I plan to use in the review session on Friday. That session is scheduled from 12-1 in KMEC 2-60. I know that many of you will not be able to make it. (In fact, I have to hope that you don't all show up since there are 330 people in this class and that room fits only 160). The class will be recorded and webcasts will be accessible by Friday evening.

Finally, if you remember, we looked at the beta for Disney after its acquisition of Cap Cities in the last class. The first step was assessing the beta for Disney after the merger. That value is obtained by taking a weighted average of the unlevered betas of the two firms using firm values (not equity) as the weights. The resulting number was 1.026. The second step is looking at how the acquisition is funded. We looked at an all equity and a $10 billion debt issue in class and I left you with the question of what would happen if the acquisition were entirely funded with debt. (If you have not tried it yet, you should perhaps hold off on reading the rest of this email right now)
Debt after the merger = 615+3186 + 18500 = $22,301 million ( Disney has to borrow $18.5 billion to buy Cap Cities Equity and it assumes the debt that Cap Cities used to have before the acquisition)
Equity after the merger = $31,100 (Disney's equity pre-merger does not change)
D/E Ratio = 22,301/31,100= 0.7171
Levered beta = 1.026 (1+ (1-.36) (0.7171)) = 1.497
Note that I used a marginal tax rate of 36% for both companies, which was the case in 1996.

One final point. I mentioned that there the class will be spilt on Monday for the 10.30-11 quiz slot. I was lucky enough to get KMEC 1-70, which is a bigger room and here is the seating arrangement for the quiz:
If your last name begins with Go to
A -G KMEC 1-70
H - Z Paulson
That is about it for now. The post class test and solution are attached. I will send you the review presentation in a different email.

Attachment: Post-class test and solution


A few different items to bring to your attention today.
1. The Quiz
The review session is tomorrow from 12-1 in KMEC 2-60. I know that many of you will not be able to make it, but the session will be recorded and the webcast should be up and running by tomorrow night. I have attached the slides that I will be using for the review. I sent out the class seating in yesterday’s email, but in case you missed it:
If your last name begins with Go to
A -G KMEC 1-70
H - Z Paulson

2. Class yesterday:
In class yesterday, I went through how I computed the beta for the move business in Disney. Since there were a lot of numbers and a fair amount of calculation, I don’t blame you if you lost track of what I was doing. I did a YouTube video that takes you through the process a little more slowly and in steps. So, if you have any questions, try this link:

3. The Case
I know that this is a little early, but the case for the class is ready to download at this link:
The last table can be also be downloaded as a spreadsheet (to save you the trouble of entering numbers by hand)
The case is a group project and it is due on March 30 by 10.30 am. It is an exercise in a number of skills, basic accounting, financial forecasting, model building in Excel and corporate finance. So, please read it soon (how about today) and start thinking about it. Some of the stuff that you need to do, you can do right now. Some, you may have to wait until next week and perhaps beyond.

Attachment: Quiz Review Slides


The quiz review is up and ready to access online on the webcast page for the class. The direct link to the webcasts are below:
Streaming: http://nyustern.mediasite.com/Mediasite/Play/87fb240b60524c17b25f0ff4c8789afc1d
Download video: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/87fb240b60524c17b25f0ff4c8789afc1d/videopodcast.mp4
Download audio: https://www.stern.nyu.edu/~adamodar/podcasts/cfspr16/ReviewQuiz1.mp3
The YouTube version will be up later tonight.

I know that you are in no mood for in practice webcasts or working on your project, but I have a webcast on the mechanics of estimating bottom up betas. I use United Technologies to illustrate the process and I go through how to pull up companies from Capital IQ. Even if you don't get a chance to watch it after the quiz, it may perhaps be useful later on. Here are the links:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/BottomupBeta.mp4
United Technologies 10K: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/UT10K.pdf
Spreadsheet to help compute bottom up beta: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/bottomupbeta.xls
The last spreadsheet has built into it the industry averages that I have computed for different sectors in the US in 2015. You can easily replace it with the global averages from 2016 that I also have on my site and tweak the spreadsheet. Give it a shot!

Attachment: Presentation


Remember last week, when I sent you the top ten questions on the quiz, by accident. Since most of you probably deleted that email right away, I am sending it again, and I hope it makes more sense now, since you may have one of these questions:

1. Why do we use past T.Bill rates for Jensen's alpha and the current treasury bond rate for the expected return/cost of equity calculation?
The Jensen's alpha is the excess return you made on a weekly/monthly basis over a past time period (2 years or 5 years, depending on the regression). Since you are looking backwards and computing short-term (monthly or weekly) returns, you need to use a past, short-term rate; hence, the use of past T.Bill rates. The cost of equity is your expected return on an annual basis for the long term future. Hence, we use today's treasury bond or long term government bond rate as the riskfree rate.

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

3. How do you estimate a riskfree rate for a currency in an emerging market?
If you are doing your analysis in US dollars or Euros, you would use the riskfree rates in those currencies: the US treasury bond rate for US dollars and the German Euro bond for the Euro. In the local currency, you should start with the government bond rate in the local currency and take out of that number any default spread that the market may be charging (see the Mexico example in the review packet). The default spread can be obtained in one of three ways: (a) The difference between the rate on a dollar (Euro) denominated bond issued by the country and the US treasury bond rate (German Euro bond rate), (b) CDS spread for the country or (c) typical default spread given the local currency rating for the country.

4. How do you adjust for the additional country risk in companies that have operations in emerging markets?
If the country you are analyzing is not AAA, you should adjust for the risk by adding an "extra" premium to your cost of equity. The simplest way to do this is to add the default spread for the country bond to the US risk premium. This will increase your equity risk premium and when multiplied by your beta will increase the cost of equity. A slightly more sophisticated approach is to adjust the default spread for the relative risk of equities versus bonds (look at the Mexico example in the review) and adding this amount to the US premium. This will give you a higher cost of equity. If you are given enough information to do the latter, do it (rather than use just the default spread). When assessing the equity risk premium for a company, look past where the company is incorporated at where it does business. The equity risk premium that you use should be a weighted average of the equity risk premiums of the countries in which the company operates.

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

6. Why do you use the average debt to equity ratio in the past to unlever a regression beta?
The regression beta is based upon returns over the regression time period. Hence, the debt to equity ratio that is built into the regression beta is the average debt to equity ratio over the period.

7. What is the link between Debt to capital and debt to equity ratios?
If you have one, you can always get the other. For instance, the Fall 2006 quiz gives you the average debt to capital ratio over the last 5 years of 20%. The easiest way to convert this into a debt to equity is to set capital to 100. That would give you debt of 20 and equity of 80, based upon the debt to capital ratio of 20%. Divide 20 by 80 and you will get the debt to equity ratio of 25%.

8. How do you annualize non-annual numbers?
The most accurate thing to do is to compound. Thus, if 1% is your monthly rate, the annual rate is (1.01)^12-1.... if 15% is your annual rate, the monthly rate is (1.15)^(1/12) -1... When the number is low, as is usually teh case with riskfree rates, you can use the approximation of dividing by 12 (to get monthly) or 52 (to get weekly). But try to always compound the Jensen's alpha numbers, since they can be much bigger.

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

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

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

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

I have also attached the newsletter for this week. That is about it... Hope I have not added to your confusion. Relax.. and I will see you soon.

Attachment: Issue 5 (March 5)


I know that it is tough to sit in on a class, after you have taken a quiz and I appreciate it that so many of you did come to class. We started class today by looking at how betas and costs of equity have to be adjusted for private companies, where the owners and potential buyers may not be diversified. We then moved on to what makes debt different from equity, and using that definition to decide what to include in debt, when computing cost of capital. Debt should include any item that gives rise to contractual commitments that are usually tax deductible (with failure to meet the commitments leading to consequences). Using this definition, all interest bearing debt and lease commitment meet the debt test but accounts payable/supplier credit/ underfunded pension obligations do not. We followed up by arguing that the cost of debt is the rate at which you can borrow money, long term, today and then looked at ways of coming up with that number from the easy scenarios (where a company has a bond rating) to the more difficult ones (where you have only non-traded debt and bank loans and no rating). I have attached the post class test & solution. You will notice a few questions relate back to something we talked about in the prior class, total betas, since I did not get a chance to include those in my last post class test.

One final note. If you have checked your Google calendar, you will notice that there is a group case due on March 30 just before class (at 10.30 am). I know that this is way in advance of that date, but that case is also now available to download. I am attaching the case to this email but I will send you another one specifically about the case and what you might be able to get started on in the near term. Back to grading quizzes.

Attachment: Post-class test and solution


The quizzes are done and ready to pick up. To get them, here is what you need to do.
Step 1: Take the elevator to the ninth floor of KMEC.
Step 2: When you get off the elevator, start walking towards the front glass doors that lead into the reception area (BUT DON’T GO IN).
Step 3: Just before you get to the door, look to your right and you should see a pick-up area for stuff.
Step 4: On the top shelf, you will find your quizzes, face down and in two stacks, in alphabetical order.
Step 5: Take your quiz (and your quiz alone). Please don’t browse.
Step 6: Check your quiz against the solutions attached. If your quiz had Galaxy in the last problem, your solution in to Quiz a and if your quiz had Jardin in problem 3, you want the Quiz b solution.
Step 7: If you think something in the grading does not match up to the template, please bring it in and I will fix it.
Step 8: Check your score against the attached distribution.

As you review the quizzes, a few notes on the solutions.
Problem 1: On problem 1b, I did accept two different answers as right answers. The first is that the voting shares are held by activist investors. As small stockholders, you now have someone to fight management on your behalf. That way my choice, but I can also understand why you may choose the voting shares that are widely dispersed, because it may make acquisitions easier. On 1d, you need only the assumption that the marginal investor is diversified for only market risk to get priced. It is only if you want to go further and use beta as a measure of this risk that you need the other assumptions.
Problem 2: The company ERP is a weighted average of the ERPs by country. In part b, the fact that you are estimating the cost of equity in one currency does not mean that you can use just that currency’s country ERP in your calculation. You still have to use the weighted average ERP.
Problem 3: The weights in part a should be value weights (not revenue weights) and you have to deal with the cash balance that the company has. It is true that the debt is not given to you explicitly, but it is implicitly given, since you have the values of the assets and you can back out the debt (which is one more reason to use a financial balance sheet). The presence of cash makes the unlevered beta lower and affects the levered beta for the company. If you did use a net debt ratio correctly, you should get full credit.
If you did use revenues as weights for the businesses, you did lose a point, but that is it. In other words, as long as you stayed with those numbers all the way through parts 3a and 3b, you should not lose more points in part b. I have listed out what your answers should be to parts 3a and 3b, with revenue weights. If I have unfairly penalized you in part b, bring your quiz in or even just take a picture of the last page and send it to me and I will fix your score.

One final note. Before you take your quiz score too far in either direction, remember that it is not only just 10% of your grade. Thus, if you did really well, there is lots left to do. If you did badly, this could become your freebie quiz that will be replaced by your average score on the remaining exams.

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

3/8/16 I know that you are getting ready for Spring break and I hope that you have lots of fun. Just in case, you are missing your weekly puzzle (I would suggest seeing a psychiatrist), here is this week’s puzzle.
While risk and return models try to measure risk using regressions of stock returns against market indices, it is only during crisis periods that you really see the differential risk across sectors or businesses. One simple way to back out a measure of market risk exposure (an implied beta) is to take a periodwhere markets were in crisis (say January-February 2016) and look at differences in returns across sectors. It is dangerous to base everything on a month but it is an interesting technique. Here are the questions worth exploring;
Based upon just the YTD returns, what was the riskiest sector in the market and which one was the safest?
Why might you want to be cautious about generalizing this finding?
If you had this data for the worst 50 months in the market, would you be able to use it to get a measure of the relative risk of each sector and convert it into a number that looks like a beta?

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

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

Attached: Post-class test and solution


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

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

Attachments: Issue 6 (March 19)

3/20/16 I hope that you are back, rested and ready to go. I know that it has been ten days since our last class, a long enough period for you to have forgotten where we are. Well, we were just starting on the Rio Disney theme park analysis and had set the table. Tomorrow, we will start with projections of future earnings and returns on capital and then move on to cash flows, incremental cash flows and time weighted incremental cash flows. Since the case is all about a project (Netflix investing in a studio), I would suggest at least reading it before tomorrow’s class, since there might be parts of the class that you will find useful. Looking forward to tomorrow (and I hope that I am not the only one..)

I know that it is probably tough to get back into school mode, but I hope that you are making the transition. In today's class, we started by stating our ideal measure of return: it should be based upon cash flows, focus on just the incremental and be time weighted. After defining project broadly as including any type of investment, small or large, revenue generating or cost cutting, we started on the Rio Disney theme park analysis. We laid out the initial costs for the theme park and the assumptions about expenses, both direct and allocated. We began the class today by extending the return on capital concept to entire companies and argued that notwithstanding its accounting limitations, comparing the return on capital to the cost of capital provides us with a basis for measuring whether a company’s existing investments are good (or not).
We then returned to the Rio Disney analysis and moved from earnings to cash flows, by making three standard adjustments: add back depreciation & amortization (which leaves the tax benefit of the depreciation in the cash flows), subtract out cap ex and subtract out changes in working capital. Finally, we introduced the key test for incremental cash flows by asking two questions: (1) What will happen if you take the project and (2) What will happen if you do not? If the answer is the same to both questions, the item is not incremental. That is why "sunk" costs, i.e., money already spent, should not affect investment decision making. It is also the reason that we add back the portion of allocated G&A that is fixed and thus has nothing to do with this project. I have attached the post class test for today, with the solution.

Attachments: Post-class test and solution


First things first. I know that many of you have asked about this and I am sorry that I have not responded with specifics, but I was trying to nail down the exact times. The regularly scheduled final for this class is May 13 from 9 am -11 am. There will be an early final for those who want to use that option on May 11, though the time and the room have not been nailed down yet.

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


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

Attachments: Post-class test and solution

3/24/16 I know that you have lots of other stuff on your plate right now and are not really thinking about corporate finance (I find that hard to believe but then again, I am biased..) In case your fascination with corporate finance leads you to work on the case, here are a few suggestions on dealing with the issues.
Do the finite life (10-year) analysis first. It is more contained and easier to work with. Then, try the longer life analysis. It is trickier...
If you find yourself lacking information, make reasonable assumptions. Ignoring something because you don't have enough information is making an assumption too, just a bad one.
When you run into an estimation question, ask yourself whether you need the answer to get accounting earnings or to get to incremental cash flows. If it is to get to earnings, and if your final decision is not going to be based on earnings, don’t waste too much time on it.
I think the case is self contained. For your protection, I think that you should stay with what is in the case. You are of course not restricted from wandering off the reservation and reading whatever you want on the movie business and Netflix’s future, but you run the risk of opening up new fronts in a war (with other Type A personalities in other groups who may be tempted to one up by bringing in even more outside facts to the case) that you do not want to fight. And please do not override any information that I have given you in the case. (I have given you a treasury bond rate and equity risk premiums, for instance.)
There are tax rules that you violate at your own risk. For instance, investing in physical facilities is always a capital expenditure. At the same time, make your life easy when it comes to issues like depreciation. If nothing is specified about deprecation, use the simplest method (straight line) over a reasonable life.
There is no one right answer to the case. In all my years of providing these cases, I have never had two groups get the same NPV for a case. There will be variations that reflect the assumptions you make at the margin. At the same time, there are some wrong turns you can make (and i hope you do not) along the way.
Much of the material for the estimation of cash flows was covered yesterday and in the last session. You can get a jump on the material by reviewing chapters 5 and 6 in the book. The material for the discount rate estimation is already behind us and you should be able to apply what we did with Disney to this case to arrive at the relevant numbers.
Do not ask what-if questions until you have your base case nailed down. In fact, shoot down anyone in the group who brings up questions like "What will happen if the margins are different or the market share changes?" while you are doing your initial run…
Do not lose sight of the end game, which is that you have to decide based on all your number crunching whether Netflix should invest in this studio or not. Do not hedge, prevaricate, pass the buck or hide behind buzz words.
The case report itself should be short and to the point (if you are running past 4 or 5 pages, you either have discovered something truly profound or are talking in circles). You can always have exhibits with numbers, but make sure that you reference them in the report.
3/25/16 I know that you are working on the case right now and that the project is on the back burner. When you get back to it, though, one of the questions that you will be addressing is whether your company's existing investments pass muster. Are they good investments? Do they generate or destroy value? To answer that question, we looked at estimating accounting returns - return on invested capital for the overall quality of an investment and the return on equity, for just the equity component. By comparing the first to the cost o capital and the second to the cost of equity, we argued that you can get a snapshot (at least for the year in question) of whether existing investments are value adding. The peril with accounting returns is that you are dependent upon accounting numbers: accounting earnings and accounting book value. In the webcast for this week, I look at estimating accounting returns for Walmart in March 2013. Along the way, I talk about what to do about goodwill, cash and minority interests when computing return on capital and how leases can alter your perspective on a company. Here are the links:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/ROIC.mp4
Walmart: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10K.pdf (10K for 2012) and https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10Klast year.pdf (10K for 2011)
Spreadsheet for ROIC: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmartreturncalculator.xls
I hope you get a chance to watch the webcast. It is about 20 minutes long…

I will keep this brief. The weekly newsletter is attached, the case is due on Wednesday before the class (at 10.30 am) and spring is here. Until next time!

Attachment: Issue 7 (March 26)


In the week to come, we will continue and complete our discussion of investment returns, starting tomorrow with a comparison of NPV versus IRR and then moving on to look at side costs and side benefits. A big chunk of Wednesday's class will be dedicated to discussing the case (If you ask, "What case?", you are asking for retribution...) By the end of Wednesday's class, we will be done with packet 1. Packet 2 is ready to be either downloaded online or can be bought at the bookstore. To download it, go to the webcast page for the class and check towards the top of the page:

Anyway, speaking about the case, here are some closing instructions:
1. As you write your case analysis, keep it brief. There is no need for story telling, strategic discussions or second guessing yourself. Crunch through the numbers, pick your investment decision rule and make your decision.
2. Once you are done with the case analysis, put together a report. In the report, make sure you include a table that shows how you the details of your operating income and cash flow calculations, by year and a computation of your discount rate or rates. (Please don’t attach Excel spreadsheets to your report..)
3. On the cover page, please include the following:
Names of the group members in alphabetical order
Cost of capital for Netflix Studio
Accounting Return on Project
NPV for Studio (10-year life)
NPV for Studio (Longer life)
Decision: Accept or Reject
4. Convert your case report into a pdf file and email me the file, ccing everyone in your group. In the subject of the email, please enter “To studio or not to studio”. You don’t have to wait until Wednesday at 10.30 and can submit any time before.
5. If you can take the key numbers that you get, put them in the Excel spreadsheet which is attached and email them to me by Tuesday night (or earlier if you have them), I will be everlastingly grateful. I would like to show you (as a class) the distribution of findings across groups.


We started today's class by looking at mutually exclusive investments and why NPV and IRR may give you different answers: a project can have more than one IRR, IRR is biased towards smaller projects and the intermediate cash flows are assumed to be reinvested at the IRR. As to which rule is better, while NPV makes more reasonable assumptions about reinvestment (at the hurdle rate), companies that face capital rationing constraints may choose to use IRR. We then compared projects with different lives and considered how best to incorporate side costs and side benefits into investment analysis. In the meantime, you have all of the tools you need to address the Netflix Studio project. Please send your group project report as a pdf file with “To studio or not to studio" as the subject before 10.30 am on Wednesday. Please put the decision you made on the investment (Accept or Reject), the cost of capital that you used and the NPV of the project on the cover page. Also, please fill out the attached spreadsheet with your numbers and send them back to me when you have them (or as early as you can).

Attachment: Post-class test and solution


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

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

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

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

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

In the last part of the class, we tied up some loose ends relating to investment analysis, starting with valuing side benefits and synergies and then taking a big picture perspective of the options that are often embedded in project analysis that may lead us to take negative NPV investments. The post class test and solution for today are also attached.

Attachments: Post-class test and solution


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


First, my thanks for the time and sweat that went into the case reports. I appreciate it and if you are disappointed with your grade, I am truly sorry. think all the cases are done and you should have got them already. It is entirely possible that a couple slipped through my fingers. If so, please email me with your case attachment again (with no changes of course.. I will go back and find your original submission in mailbox and get it graded. I am attaching that grading code that I had sent you before, so that you can make some sense of your grade. If you feel that i have missed something in your analysis, please come by and make your argument. I am always willing to listen. After 70+ cases, I am a so sick of Netflix, I might cancel my subscription... and I am sure you are too, but I thought that it would be a good time to talk about some key aspects of the case:

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

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

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

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

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

Now that the case is behind us, time to get ready for a busy week coming up. On Monday, we will start on financing choices tomorrow and continue with the trade off between debt and equity after the quiz on Wednesday. So, please do bring packet 2 to class with you. Oh, and one more thing. I did put up an in-practice webcast about finding a typical project for a company on the webcast page for the class.


As the second quiz approaches and you get a chance to digest your case feedback, a few quick notes:
1. I have attached the newsletter for the week.
2. Just a reminder that we will start packet 2 on Monday. So, please either buy it, download it to your device or print it before then.
3. If you feel the urge to try your hand at past quiz 2s, here are the links:
Past Quizzes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2.pdf
Past Quiz Solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2sol.xls .
There will be a review session for the quiz on Tuesday in KMEC 2-60 from 12-1. It will be recorded and webcast later that day. I will send out the seating arrangements for the quiz tomorrow.



In today's class, we started our discussion of the financing question by drawing the line between debt and equity: fixed versus residual claims, no control versus control, and then used a life cycle view of a company to talk about how much it should borrow. We then started on the discussion of debt versus equity by looking at the pluses of debt (tax benefits, added discipline) and its minuses (expected bankruptcy costs, agency cost and loss of financial flexibility). Even with the general discussion, we were able to look at why firms in some countries borrow more than others, why having more stable earnings can make a difference in how much you can borrow and why having intangible assets can affect your borrowing capacity. After the quiz on Wednesday, we will continue with this discussion. The post class test relates mostly to session 15 (last session on synergy and side benefits), but it is worth doing just to get that part under your belt. I am also attaching the slides for tomorrow’s review session, scheduled for 12-1 in KMEC 2-60.

Attachments: Post-class test and solution


First, before I forget, here is the seating for tomorrow’s quiz:
If your last name begins with Go to
H -N KMEC 1-70
A- G, O-Z Paulson

Second, the quiz review webcast is up and running. Here are the links:
Streaming: http://nyustern.mediasite.com/Mediasite/Play/68874715ce524cc7b94f2f2b3d924f8f1d
Downloadable: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/68874715ce524cc7b94f2f2b3d924f8f1d/videopodcast.mp4
I have attached the presentation. I will see you tomorrow at the quiz (and I am sorry if that sounds like a threat.. It was not meant to be..).

Attachments: Review Presentation

4/5/16 I know what you are thinking… Right? He wants me to prepare for a quiz after a week of working on the case and he expects me to do a puzzle on top of that! Not happening! I understand but nevertheless, just in case you feel the urge, this week’s puzzle is up and running. It revolves around the tax benefit of debt and in particular, the perversity of the US tax code. You can find the puzzle here:
As you can see the puzzle is structured around the recent attempt by the US Treasury to stop the inversion phenomenon, where US companies try to merge with foreign companies and move their domiciles to more friendly tax climates. If you get a chance, please take a look at it.

I want to start off by apologizing for being unfair to those of you who spent lots of time preparing for the quiz and still ran into a time constraint. It was uncharitable and unfair to say that it was only a matter of finding the right way to answer questions and that you would not have a time constraint. As I grade through your quizzes, I recognize how many different ways (and I am constantly surprised by this) that small tangents can end up sucking up large amounts of time and with 30 minutes, you don’t have much time. It is also particularly difficult, if your background is not in numbers and you have to work through them. So again, I am sorry. When I grade the quizzes, I am cognizant of this constraint and try to bring it into the grading. In the session that followed the quiz, I look at the Miller Modigliani theorem through the prism of the debt tradeoff. I then move on to looking at how the cost of capital can be used to optimize the right mix of debt and equity. We will continue with this discussion next week.

Attachments: Post-class test and solution


The quizzes are done and are ready to be picked up. They are in the usual space (the entry to the finance department, just before you get to the door) and are in three neat alphabetical stacks. Please leave them in the same order. I have attached the solutions and the grading distribution below.

As you look at the distribution, you will notice that the average and median scores are about a point and a half lower than on the last quiz and that is where my mea culpa comes in. (It sounds so much better to say that it was my mistake in latin). I do think that I put too many moving parts in this quiz, and while each of them was not a big deal, the sum total proved to be overwhelming for some of you. Some of the problems can be attributed to the time constraint and that taking a couple of wrong turns can very quickly eat into 30 minutes, but some are conceptual and I will take responsibility for not delivering the message clearly enough. Here are some of the key issues:
1. Risk adjusted discount rates: If there is a theme that I have tried to bring home through the last three weeks, it is that the discount rate for a project should reflect the risk of the project and your currency of choice. About 50% of this quiz was directed at the concept.
- In problem 1, you were asked to estimate the cost of capital to use on an Indian retail expansion, with the proviso that it would be all equity funded. To get to the cost of capital, you will therefore need to compute the cost of equity for investing in all-equity funded Indian project. The fact that it is all equity funded requires you to use an unlevered beta (which is why you were given the lease commitments and the market value of equity of the firm, in conjunction with the levered beta). The ERP you should use should be the Indian ERP. To convert this number to an Indian rupee cost of capital, you just have to add on the differential inflation.
- In problem 3, it was all about the discount rate. In part a, the cash flows are guaranteed by the company and the only risk that you face is that the guarantor will default. Hence, you use the cost of debt. In part b, you get a share of operating income, which is a pre-debt earnings and the appropriate discount rate is the cost of capital. Here is a simple template to put this into practice:
Cash flow guaranteed by government with no default risk: Discount rate should be risk free rate
Cash flow guaranteed by corporation or default-exposed government: Cost of debt for that corporation or government
Cash flow tied to operating income of the company (or operating cash flows): Cost of capital
Cash flow tied to net income for the company: Cost of equity
2. Incremental cash flows: In project analysis, it is the incremental cash flows that matter. This was problem 2 in a nutshell. You were given revenues and EBITDA margins with and without the renovation. Since you are assessing whether to do the renovation, you should be using the incremental EBITDA (EBITDA with renovation minus EBITDA without). The same incremental concept is what you would use to answer part c. Depreciating an asset creates a tax benefit (equal to the tax rate times the depreciation) and the PV of that tax benefit is what you see in the NPV. Expensing it gives you the tax benefit (on the entire amount) immediately. Hence, your NPV will increase by the difference.

If you did well on this quiz, I commend you, since it suggests that both these concepts have taken root. If you did not, please take a look at why. If it is purely a time issue and having an extra ten minutes would have made the difference, let’s talk since there are ways in which you can reclaim some of that time. If it is deeper, the solution is (unfortunately) working through the concept with more examples. I will do my part to reduce the number of moving parts in the next quiz, to stop the numbers overload that some of you felt on this one.

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


I know that you just got back your quiz and you are in no mood for corporate finance but this is a great weekend to get caught up with your big project. We are in the capital structure section and the first thing you can do (if you remember what company you are analyzing) is to take it through the qualitative analysis, i.e., the trade off items on capital structure:
Tax benefits: Check out your company's marginal tax rates, relative to those of others in your group. If you have the only Irish company in your group, you have the lowest marginal tax rate in your group and other things remaining equal, should have the least debt.
Added discipline: Go back and check the HDS page (with the top 17 stockholders in your company). If you don't see anyone from your management team in that list and no activist investors (Carl Icahn or Bill Ackman), your company could benefit from having more debt (to discipline management).
Bankruptcy cost: To assess your company's expected bankruptcy cost, look at two variables. The first is whether they are in a stable or risky business. If you are in a risky business, you have a much higher risk of bankruptcy than if you are in a nice safe business. The second is indirect bankruptcy cost. As I noted in class, these are the negative consequences of being viewed as being in financial trouble: customers stop buying, suppliers demand cash and customers leave. If those costs can be high at your company, you should borrow less money.
Agency costs: The more trouble lenders have in monitoring and keeping track of the money that they lend, the more borrowers will have to pay to borrow. Thus, if your company has intangible assets and difficult-to-monitor investments (R&D, for example), it should borrow less money.
Financial flexibility: If the investment needs in your company tend to be stable and predictable (a regulated utility, for instance), you should not value flexibility very much. If you grow through acquisitions and/or are in an unstable business, you will value it more and borrow less.
At the end of the qualitative assessment, you are just trying to decide whether you would expect your company to borrow no money, only some money or a lot of money.

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

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


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

Attachment: Issue 9 (April 9)


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

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

Attachments: Post-class test and solution

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

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

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

Attachments: Post-class test and solution


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

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

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

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

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


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

In a sign that the end game is getting closer, I also have been thinking about the final exam. As you well know, the final is scheduled for May 13 from 9 am -11 am and there will be an early final offered on May 11 from 1.30 to 3.30 pm. Since there are only 120 seats in the room that I have for the early final, I am going to ask for sign ups for the early final in this Google shared spreadsheet.
Please enter your name, your email address and that you are in the 10.30-11.50 (MBA) class.

4/16/16 I hope that I have not ruined your entire weekend with the project, because it is way too nice a day to be stuck inside. The weekly newsletter is attached.
Attachments: Issue 10 (April 16)

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

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

See you in class tomorrow.


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

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

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

Attachments: Post-class test and solution


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

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

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

One final note. The TA review session for next week has been moved by popular demand to Tuesday, April 26, from 4.30-6.

Attachments: Post-class test and solution


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

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


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

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

Attachment: https://www.stern.nyu.edu/~adamodar/pc/macrodur.xls


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

Attachment: Issue 11 (April 23)


We spent all of the session setting up the trade off on dividends, starting with the argument that Miller/Modigliani made that dividends don't matter (in a world where investors are taxed at the same rate on dividends & capital gains & stock issuance is costless) to the dividends are bad school (built on the almost century long higher tax on dividends) to the dividends are good school. We closed by looking at two bad reasons for paying dividends (that they are more certain, that you had a good year) and three potentially good reasons (to signal to market, to make your clientele happy and to take advantage of debt holders). However, most of you are are probably focused on the third quiz and a few quick notes:
1. Seating arrangement: The seating for Wednesday's quiz is as follows:
If your last name starts with Go to
A-P Paulson Auditorium
Q-Z KMEC 1-70
I know that this will result in those with the last name, starting with P ending up in Paulson for all three quizzes, but i could not find a way to get everyone into KMEC 1-70 at least once this semester.

2. Review session: The review session will be in Paulson from 12-1 tomorrow. The review presentation is attached. So, please print it off when you get a chance, since I will not be able to make copies for tomorrow.

3. Content: The quiz will cover capital structure; Lecture note packet 2: 1-142; Chapters 7-9 in the book

Attachments: Post-class test and solution


The review session for the quiz is up and running. You can get to it by going to one of the links below:
Streaming: http://nyustern.mediasite.com/Mediasite/Play/c49d3bfd8c344cddbd0ede9ad19f2e381d
Download: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/c49d3bfd8c344cddbd0ede9ad19f2e381d/videopodcast.mp4
I have also posted it on iTunes U and will shortly have a version on YouTube. Slides attached.

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


Today, in class, we moved on to look at how much a company can afford to pay out as dividend. This measure, that I titled FCFE, is the cash left over after taxes, reinvestment needs and net debt payments. When a company pays out less than its FCFE, it is accumulating cash, and we laid the foundations for analyzing dividend policy by asking the key question: do you trust managers with your cash? During the session, we applies this framework to the Disney and Vale. Post class test and solution attached.

Attachments: Post-class test and solution


The quizzes are done and can be picked up in the usual spot. As you review the grading, there are a couple of points that I want to make that may explain the grading, especially on problem 1. Don’t just check the answer, since your answer may match mine, but for the wrong reasons. The key to this problem is recognizing what a special dividend will do to equity. Let me back up. Depending on the quiz that you took, your firm was an all equity funded firm with $150 million in market value of equity (or 500 million if you got quiz b). The financial balance sheet looks as follows:
With quiz a
Assets Liabilities
Assets 150 Equity 150
With quiz b
Assets Liabilities
Assets 500 Equity 500
Now the firm goes out and borrows $50 million (or $250 million in quiz b) and pays a special dividend. After the transaction, here is what your balance sheet looks like:
With quiz a
Assets Liabilities
Assets 150 Equity 100
Debt 50
D/E = 0.50, D/Capital = 0.3333
With quiz b
Assets Liabilities
Assets 500 Equity 250
Debt 250
D/E = 1.00 D/Capital = 0.50
If you left the equity at $200, you have a $50 million magical gap to explain away, since you now will have increased the value of the business by $50 million without doing a thing. (If you were working with quiz b, you would have left equity at $500 million, increasing the value of your business by $250 million without lifting a finger) Special dividends reduce the value of your equity (by causing the stock price to go down by the amount of the dividends). This my seem like nit picking but if it were not true, you would have the ultimate money machine, a company that can keep paying dividends without affecting its market capitalization. I have attached the solutions and the grading distribution.

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


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

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

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

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

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

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

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

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

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

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

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


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

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

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

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


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

Attachment: Issue 12 (April 30)


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

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

Attachments: Post-class test and solution


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

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

Attachments: Valuation Spreadsheet


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

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

Attachments: Post-class test and solution


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

5/7/16 I will keep you updated through the weekend on the number of summaries that I have receive and the number yet to come. It is not intended to panic you or evoke guilt but to just keep you in the loop. And if you do have last minute questions or just need some handholding and therapy (It is going to be okay! This too shall pass! You are a good person, Just having a bad moment!... Just practicing my lines..), you can email me and I will try to respond as soon as I can. I have a couple of tasks to get done over the weekend but I should be able to check email. My iPhone typing skills are abysmal. So, please forgive me if my replies seem abrupt or nonsensical (that spell check on the iPhone is deadly)!
Updates received so far: 6
Updates to come: 300+
If your response is what summary, I am attaching the summary sheet, just in case. When you do send your summary, please include “The Fat Lady is waiting” in the subject line. If you are sending in your final project, please list “ The Torture ends” in the subject.

The summaries continue to roll in.
Summaries received: 178
Still to come: 157

A quick head's up about tomorrow. I will continue to pull the numbers from any summaries I receive through 7 am tomorrow. So, please keep them coming. I am planning on getting the presentation ready, using your summaries as the basis, on my train ride into work tomorrow. While it is unlikely that I will be able to make copies before class, I will email you the presentation. On a different note, I know that you are probably exhausted after pulling this together, but please do try to come to class tomorrow. Not only will it provide an overview of the class and a preview of the final exam, but I will try to make it memorable. There will be fireworks, pearls of wisdom and small hints about the final exam (which will not be webcast).


I am sorry but it took me a little longer than I had hoped but the presentation is attached. If you can, download it before class. If not, after should work. See you in class!

Attachments: Closing presentation


Again, thank you for sending me your summaries and helping me put together the presentation for today's class. If you were not able to make it to class (and I don't blame you for sleeping in, especially if you were the person sending your summary in at 6.40 am), I have attached the presentation to this email as well as the summary numbers for every company in the class. In class today, we looked at the big picture of the class, using the project findings to illuminate each part from corporate governance to risk to investment analysis to capital structure, dividend policy and valuation. I have posted the summary numbers for the entire class online and attached it to this email as well. The review session for the final exam will be on tomorrow (May 10) from 3-4 in KMEC 2-60 and it will be webcast, if you cannot make it. I have attached the slides for the review session. The final exam is on Friday from 9-11 and I will send the seating chart out shortly. The early final, by invitation or permission only, is on Wednesday from 1.30-3.30 in KMEC 1-70.

One final reminder. The CFEs have to be completed for you to be able to access your grades and you have between May 12 and May 14 to get this done. Please, please do it tomorrow and get it out of the way. To show you how seriously I take the suggestions in these evaluations, I will wear more earth tones, if that is what you suggest.

Student Instructions for Completing Online CFEs

Login to https://www.stern.nyu.edu/cfe. 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.
Select the CFE that you wish to complete.

Attachment: Closing presentation, Project summaries


Review session: I am sorry but I know that some of you are waiting for the webcast. It took a long time but it is now ready.
Streaming: http://nyustern.mediasite.com/Mediasite/Play/f116088f3e2c433bbe4fa53cfa914be51d
Downloadable: https://nyustern.mediasite.com/Mediasite/FileServer/2fa71667-5d89-4131-b70d-d2cac9fa99c1/Presentation/f116088f3e2c433bbe4fa53cfa914be51d/videopodcast.mp4
The review slides are attached.
In the review, I did an example with Campbell Soup and I suggested that you try different prices for the buyback, just to see if you get it. I have attached an excel spreadsheet that you can use to check your answers. (I have worked out the solution with a $38 buyback price but you can change the price around).

Early final exam: The early final is tomorrow in KMEC 1-70 from 1.30-3.30. Usual rules to apply.

Seating for regular final exam: The regular final exam is on Friday from 9-11. The seating arrangement is as follows:
If your last name starts with Go to
A-G or P KMEC 1-70
H-O, Q-Z Paulson


The final exams are done and can be picked up in the usual spot. If you are not around, I will keep the exams for the summer. As for the exam itself, it was “challenging” and the scores reflect the challenge, with only one perfect score (the distribution is attached). I have attached the solution with the grading template. No grades attached to the scores, since the final grades will be available by tomorrow morning. Back to work!

Attachments: Final exam & solution


The grades are officially in and you should be able to check them online soon. In the interests of transparency, I have attached a spreadsheet where you can enter your scores on the quizzes, the final exam, the case and the final project and see your final grade computation. (Note that the spreadsheet does not contain your scores and that you have to enter them to update the spreadsheet). On a more general note, I want to thank you for the incredible amount of work you put into this class. You made it easier for me to teach and I really appreciate it. I know that I buried you under emails (this is the 124th of the class), assignments, projects and weekly puzzles and I also know that most of you were unable to keep up. However, the material for the class will stay online and on iTunes U for the foreseeable future. If you want to review parts of the class, please do go back and review the lecture, look through the notes and even try that week's puzzle. If you really, really want to master corporate finance, don't waste too much time reading books & papers or listening to lectures. Pick another company (preferably as different as you can get from your project company) and take it through the project analysis. Each time you repeat this process, it will not only get easier and more intuitive, but you will always learn something new. I still do!

I hope that you have a wonderful summer planned out and that those plans come through. If you choose to continue to be tortured, I hope to see you in valuation in the fall. Unfortunately, due to an undergrad Valuation class that I will be teaching in the spring, there will be no spring version of the class). If you decide that you have had enough, I don't blame you and I hope that you are taking something away from this class which will be useful in whatever you choose to do. That's about it for my last email. Until next time or perhaps for the last time!

Attachment: Grade Checker