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. They are in chronological order, starting with the earliest one. So, scroll down to your desired email and read on, or if the scrolling will take you too long, click on the link below to go the emails, by month.
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:
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 use this enroll code: EZZ-PFA-KHF . Alternatively, try this link:
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.
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 2 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 4th, in class. Until next time!
As the long winter break winds down, I first hope that you are far away from the gray weather in New York, some place warm and sunny. 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://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfpacket1spr19.pdf (as pdf file) or https://www.stern.nyu.edu/~adamodar/pptfiles/acf4E/cfpacket1spr19.pptx (powerpoint file)
You can print it off or just keep it on your tablet (as long you can make notes on the pages). You can also buy the packet at the bookstore, at their usual nosebleed prices, if you prefer a bound packet.
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.
3. iTunes U and YouTube links: I had sent these out in my previous email but no harm repeating:
For those of you who have not got around to checking, class is scheduled from 10.30-11.50 in Paulson Auditorium on February 4. See you there! Until next time!
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.
That is about it, for this email.
It is me again, but then again I promised you a deluge and it has to start sometime. Yesterday, in class, I said that Tuesdays would be our “weekly puzzle” days, where I would post a topic, with questions, for discussion. I had originally planned to reuse a puzzle on the Tata Family Group from a prior year, but an op ed from yesterday’s New York Times on buybacks is too good to pass by, because it cuts to heart of everything that we will be talking about in the next few weeks. You can find the details of the puzzle on the webcast page for the class, but I have also reproduced it in this email.
Buybacks have been at the center of a heated debate in the United States, with some arguing that they are the reason for companies not reinvesting in new factories, widening income inequalities and a variety of other social ills. In an op-ed in the New York Times on February 4, 2019, Senators Schumer and Sanders make their case for why buybacks should be restricted. You can find the link below:
Implicit in the opinion piece are three assumptions, and without any prejudgment, here they are:
I know that we live in political times, and that our red or blue predispositions can affect how we react, but please try to set your political priors to the side and think through each of these assumptions as objectively as you can.
I know that I run the risk of creating biases, but here are two blog posts of mine (one old and one from this year) that you are welcome to read, rip apart or use:
I considered opening a Facebook page for the forum, but social media may be a little too open for this process. Instead, I have used NYU Classes to create a forum with this topic. You will finds it on the NYU class page for this class. So, I hope that you will go on to the forum and present your views and show, in the process, that we can disagree without being disagreeable.
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:
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:
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. It is what it is. Finally, I am attaching the post class test and solution for today’s session. Until next time!
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:
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 and you should find it in your Stern Life Dashboard. 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. That’s about it, for now. Until next time!
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. One final note. I had mentioned that you had access to S&P Cap IQ yesterday but It turns out that you have to go to self-register to be able to access it.Until next time!
I know that this is the weekly puzzle and I really want you to come to your own conclusions. That is why I am sending this link reluctantly:
It is my blog post on buybacks. Read it, if you get a chance. You don’t have to agree with all or even any of it. Just hope it gets you thinking! Until next time!
As you start the weekend, I decided to butt in with the first of my newsletters. As you browse through it (and I hope you do), you will realize that this is not really news or even fake news. It is more akin to a GPS for the class telling you where we’ve been and where we plan to go. It is a good way to get a sense of whether you are falling behind on either the class or the project, especially as we get deeper into the class. So, enjoy your weekend and I will see you on Monday! Until next time!
Attachment: Issue 1 (February 9)
I’ll keep this short. This week, we will complete our discussion of the objective function in corporate finance, continuing with stock price maximization tomorrow and alternatives to that objective thereafter. Along the way, we will look at shareholder wealth maximization and corporate sustainability and I may kill a few sacred cows along the way. In the meantime, please do pick a company, and if you have picked a company, take a look at the board of directors and corporate governance. Until next time!
Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? We closed the class by talking about social costs and benefits and how difficult it is to incorporate them into decision making and we will continue on that theme in the next class. Again, plenty to think about while you are sitting in your CSR 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, if you have the book, 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
2. Choose FIND YOUR SECURITY
3. Type the name of your company
4. You might get multiple listings for your company, especially if it is a large company with multiple listings and securities. Try to find your local listing. For a US company, this will usually be the one with your stock symbol followed by US. For a non-US company, it will have the exchange symbol for your country (GR: Germany, FP: France, LN: UK etc...) It may take some trial and error to find the listing....
5. Type in HDS
6. Print off the first page of the HDS (it should have the top 17 investors in your company).
If you 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. Until next time!
For the second weekly challenge, I decided on a throw back to a challenge I used two years ago, because it brings home issues of corporate governance at founder and family controlled publicly traded companies that are still relevant . It is about corporate governance at one of India’s oldest and best regarded family groups, the Tatas. The group which has been around since 1868, has more than a hundred companies under it, and has had only seven heads over its 150-year life, most of whom came from the Tata family. In 2012, Ratan Tata stepped down and Cyrus Mistry was named the new head. While not an immediate Tata family member, he is related by marriage to the family and he himself comes from a family with deep connections to the group going back in time. It is perhaps because of the group’s history that people were shocked when Cyrus was fired on October 24, 2016, and Ratan Tata reinstated as the head. You can start with the blog post that I had on the group in November:
That lays out my views not just on the Tata group but on family groups in general. Once you have that read, you can then look at the specifics of this week’s puzzle, where I bring the story up to date.
Once you have read these pieces (and other links), there are four questions that I would like you to answer:
As you can see, these are open ended questions where there is no right answer. To be clear, there is no grade attached to answering these weekly puzzles but I believe that there is a payoff in understanding. I have created a forum on NYU classes (this may be one of the few things that I use NYU classes for) where, if you feel the urge to share, you should.
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.
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:
JUST Capital: https://justcapital.com/rankings/
Calvert Social Index: http://www.calvert.com/perspective/social-impact
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). Notice how the rankings vary even across the ethics sphere. No surprise that no one has a monopoly on virtue.
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 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 few years 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. Until next time!
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):
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 you have a long weekend ahead of you, with nothing to do but binge watch You on Netflix and old episodes of Game of Thrones, 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.
HP Annual Report: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf
You can find these links in all three forums (my webcast page, 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 that lists the activist investors in the US:
I hope that you get a chance to not only watch these webcasts but also try them out on your company
Very quick note before you get back to your weekend festivities. Your newsletter is attached for the week.
Attachment: Issue 2 (February 16)
I hope that you had an enjoyable and productive long weekend, and I did give you a day off without emails yesterday. Tomorrow, we will complete our derivation of the CAPM and talk about alternatives to it, in hyper speed for two reasons. One is that I have zero interest in reinventing modern portfolio theory and showing the mechanics of correlation and covariance. The second is that while I use the CAPM as a tool to estimate hurdle rates, I am not wedded to it and accept all kinds of alternatives (some of which we will talk about tomorrow). If you are still shaky about even the assumptions that underlie the model, my suggestion is that you read chapter 3 from the applied corporate finance book before tomorrow’s class. On Wednesday, we start on the fun stuff of applying the model, starting with what should be a slam dunk (risk free rates) which is increasingly not and then turning to the equity risk premium, a number that analysts often turn towards services to look up but really has deep implications for both valuation and corporate finance. So, much to do and I hope that you come along for the ride. And a final nag: if you have not picked a company, please do so soon! Until next time!
I should start with an apology for any confusion created by the email I sent yesterday. I was operating on Sunday-mode (since I send the week-ahead emails every Sunday) and the references to classes “tomorrow” and “Wednesday” must have been puzzling. We have only one class this week and the discussion of risk will be in that class, as will be the intuitive derivation of the CAPM. I thought that this week’s puzzle should be built around the central themes of portfolio theory, which is that diversification is the best weapon against risk, since it eliminates firm specific risk. That view, though, gets push back from some big name investors, including some value investing legends and Mark Cuban (who is also a legend, at least in his own mind). You can start the puzzle by reading the arguments for and against diversification:
For Diversification: http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1990/markowitz-lecture.pdf (Harry Markowitz’s Nobel Prize talk)
For Concentration: http://www.fool.com/investing/general/2014/07/20/why-warren-buffett-doesnt-diversify-too-much.aspx (He who should not be named is named… )
The evidence, from looking at investor behavior, is that most individual investors side with the latter than the former (though that does not mean that it is right):
Evidence on investors: http://www.umass.edu/preferen/You Must Read This/Barber-Odean 2011.pdf
I am going to surprise you with my view. While I am more inclined to diversify than not, I can also see scenarios where not diversifying makes sense. In fact, I have a blog post on the question of how much diversification is good for you (and the answer will vary across individuals):
This is a topic that is important not just for your finance class, but for your personal portfolios, as you accumulate wealth (I am assuming that this Stern MBA, which you are paying a hefty price for will pay off).
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. You may want to look at the in-practice webcast I sent on the topic last Friday (and is also posted on the webcast page for the class), if you get stuck.
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… If it is in an emerging market currency, more so since you need default spreads (either from a sovereign rating or a sovereign CDS spread). Here are links to the latest versions of both:
Moody’s ratings (Jan 2019): https://www.stern.nyu.edu/~adamodar/pc/datasets/sovrrating2019.xls
Sovereign CDS spreads (Jan 2019): https://www.stern.nyu.edu/~adamodar/pc/datasets/sovrCDS2019.xls
And please do think about the parting question from class: why do risk free rates vary across currencies?I have also attached the post class test & solution for today… Until next time!
If my nagging is paying off, you should have picked a company by now and if you have, you can move on to two questions. The first is to take a look at the marginal investors in you company, with the objective of assessing whether they are diversified, since it will let you know whether you are on safe ground using the CAPM or any other risk and return model. The second is the risk free rate part of the project, where you have to pick a currency at analyze your company in, and then go through the process of estimating risk free rates in that currency.
I will be putting up webcasts tomorrow on both topics. On an entirely different note, the class is moving into high gear, which also means that your anxiety level about tests and quizzes is probably also going up. Miguel Echavarria and Luis Gonzalez, the TAs for the class, have kindly agreed to do review sessions each week for people who may have questions about mechanics and material. The review sessions are scheduled for each Monday from 4.45-5.45 pm, right after class, in KMEC 3-70. Since that room fits only 70, I have set up a Google shared spreadsheet for you to sign up, if you want to go to the sessions:
Every aspect of life is grist for the corporate finance mill. To illustrate, remember the discussion that we had in class about company-specific risk, which affects one or a few companies, and market risk, which affects many or all companies. I got a reminder of that, a couple of days ago, when I was watching the UNC-Duke basketball game. I am not a fan of either team, but as a depressed UCLA Bruins fan, I have had to resort to desperate measures to distract myself. During the game, as many of you might have heard, Duke’s superstar freshman, Zion Williamson, sprained his knee:
You are probably wondering what this has to do with risk, right? Turns out that the reason that Zion fell was because he blew out his Nike PG 2.5 shoes, and Nike’s stock price took a hit the next day:
That is a perfect example of company-specific risk, a risk that clearly has an effect on value and price, but a risk that a diversified investor should not be building into the discount rate.
On a different note, the webcast for this week looks at how to estimate risk free rates in different currencies, and how sovereign default spreads can be useful in getting there:
If you want the updated values for both country default risk measures try these links:
Please watch it, when you get a chance.
Last week, we put the objective function to rest and turned our attention to risk models. Having started our discussion of risk free rates, we will continue this week to talk about how best to estimate risk premiums and convert them into hurdle rates.
Attachments: Issue 3 (February 23)
This week, we will complete our discussion of riskfree rates, by answering the question of why riskfree rates vary across currencies. We will then move on to estimating equity risk premiums & continue on our build up to hurdle rates. Until next time!
We started today’s class by tying up the last 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 key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:
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:
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 150 countries from February 2017
The approach that I use for computing country risk premiums at the start of 2019 is described more fully in this post:
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 2017 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 next Wednesday. Let's get the project done in real time, in class.
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, though the links to free risk assessment services are no longer free. There are, however, plenty of risk aversion tests online. Here are a couple that you can try at no cost:
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:
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:
In keeping with project Thursday, 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, that looked at how betas for companies change over time and concluded based upon a small sample and data from way back in time, 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
I went through the Bloomberg regression beta page in class and suggested that you try doing the same with your company. In this week’s webcast, I take a look at Disney's 2-year weekly regression (from February 2011- February 2013). I have the Bloomberg page attached. I am also attaching the spreadsheet that I used to analyze this regression, which you are welcome to use on your company. The webcast is available at the link below:
Disney’s Regression Bloomberg beta page: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Regression/Disneyregression.pdf
The best way to make this stick is to try this on your company quickly (like right now).
First, it is the weekend and the newsletter is attached. Second, and perhaps more important, your quiz is a week from Monday (on March 11) and for those of you who have time on your hands this weekend, you may want to start the work on the quiz. We have not quite completed the material in class yet, but here is a preview:
Attachment: Issue 4 (March 2)
|3/3/19||I hope that you have had a productive (and fun) weekend. Two quick notes. First, this week, we will first look at where betas really come from (not from a regression) and devise a way of estimating betas for companies that will free us from the tyranny of regression betas. Second, as the quiz is a week from tomorrow, I will check in on you, to make sure that you have access to everything you need to get prepared for the quiz (both in terms of material and logistics).|
|3/3/19||NYU, in typical wimpy fashion, has canceled class tomorrow. I am almost tempted to override them and have class tomorrow, but I don’t think that the building will be operational. At the same time, I do not want to miss a class, since we have places to go and things to cover. Here is the compromise solution. I will record an online lecture that covers the material that I was planning to cover in class tomorrow, and you can watch it before class on Wednesday. That way, you get your money’s worth for your tuition, I get to stay on course with the class and the earth will continue to rotate around the sun.|
I thought that the call against the Saints in the NFL Playoffs was the pits, but the decision to cancel school runs close. To work out how much it cost you, I took your annual tuition ($71,000+) and divided by ten classes and then by 26 session to arrive at about $275 per session. I would suggest that you invoice NYU for that amount, though I don’t think you will get a response. To reduce your cost somewhat (and to serve my own interests of telling my corporate finance story), I recorded a class for today and the YouTube link is below;
The slides and the post-class test are below:
It is 52 minutes long (I did cut you a break on time) and I don’t think it is that excruciating to watch. Please try to watch this class sometime today, or at least before class on Wednesday, since I will assume you have and move forward. Summarizing the class, here is what we listed as the three determinants of betas:
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.
This week’s challenge is on betas and I have used two companies, Valeant and GoPro as my lab experiments. First, check out the description of the puzzle (with the beta pages for both companies):
Once you have browsed through it, here are the questions that I would like you to consider:
Just a reminder again that the first quiz is on March 11 (next Monday), from 10.30-11 am. Please check your email on Saturday for seating arrangements and past quizzes/solutions. The TAs, Luis and Miguel, are both incredibly knowledgeable and helpful. As you know, they had to move their review session from yesterday to today, because of the snow day. The time is still 4.45-5.45 and the room is still being negotiated for.
|3/6/19||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:
Since the class built on Monday’s online session, please watch it when you get a chance. In fact, the post class test and solution I am attaching relate to that class.
Catching up with past promises, if you remember, we looked at the beta for Disney after its acquisition of Cap Cities in the online class (you will remember only if you actually watch the 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.
That’s about it for now, but your quiz is on Monday. So, you will be hearing from me over the weekend.
If you want to take time away from preparing for the quiz, 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:
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 2019 that I also have on my site and tweak the spreadsheet.
Give it a shot!
I also thought that since Disney has been under the microscope in class and we talked about how Bob Iger has affected the company with his decision stay on as CEO, you might be interested in this article:
Take a look at the vote. It sounds like the natives are getting restless.
I know that Luis has done two review sessions for the quiz already, and I hope that some of you were able to go to those sessions. That said, if you did not make it, I thought that it might help if I did a review session, to bring together concepts. You can find the review session here (it is about 30 minutes long):
The slides that I used are attached. If you do want to practice, you can find the past quiz 1s that I have given for this class, with solutions, at the links below:
Past quiz solutions: https://www.stern.nyu.edu/~adamodar/pdfilers/cfexams/prqz1sol.xlsx
Finally, the quiz will be in the first 30 minutes of class on Monday, March 11, from 10.30-11. You will be in two rooms, KMEC 2-60 and Paulson. Please go to the right room, based upon your last name:
If your last name begins with Go to
A -J KMEC 2-60
K - Z Paulson
Finally, the newsletter for the week is attached.
Attachment: Issue 5 (March 9)
|3/10/19||First things first. I noticed an error in my solution to the Spring 2014 quiz, problem 2, where I computed default spreads for countries. The excel equation did not carry through when I was copying from the master file and the default spreads have now been corrected. (If you never noticed it, just let it go. If you struggled with it, I am sorry). As I get emails about the quiz, I thought it would be a good idea to pull together a list of the top emailed questions that I have received so far.
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
Sorry about the long email…
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 to estimate the beta for a bank and then why you may want to adjust the beta for a private company. We also looked at 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. 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 April 3 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 will send you another one specifically about the case and what you might be able to do to get started on in the near term. Back to grading quizzes!
Your quizzes are done and can be picked you. I am sorry for sending you the notification so late in the evening, but I was in Boston all day with your graded quizzes and with no easy way to get them back until I returned a few minutes ago. Here are the quiz pick up details:
I know that today is your puzzle day, but since we are leading into the spring break, I decided to skip it. See you in class tomorrow,
I know that you are probably heading off on break and I had promised you that I would not bug you over the break. I will keep my promise, but as a parting gift, here are a few thoughts to take with you into the break:
Having said all of that, life’s too short for it to be all about corporate finance. So, have fun and you will hear from me again a week from Saturday.
You must admit that I showed immense restraint, not emailing you for the week, but your respite is over and I am back!!! Three separate notes to just get you caught up.
1. The Class: I know that it seems like a century ago but when I last met a week and a half ago, we had just started our analysis of investment returns. Just in case you need to get an exact fix on which slide we let off on, the newsletter is attached.
2. The Project: I know that you have been working hard on your project during the spring break. (I know.. I know.. but we are playing make believe here). In case you feel the urge to get caught up and estimate the cost of debt, I have posted an in-practice webcast on the webcast page. The webcast is from a few years ago 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…)
3. The Case: As you might remember (or preferred to forget), the case is due on April 3, nine days from today. If you have not started, start. If you have, keep at it. If you are done, I am in awe.
It is a group project.
Attachment: Issue 6 (March 23)
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 estimating returns and revisiting the hurdle rate for the Rio Disney theme park, separating those risks that we should be bringing into it from those that we should not. We then started the move 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. In the final part of the class, we looked at time weighting cash flows, why and how we do it.
On a separate note, I would strongly encourage you to read the Whole Foods case, if you have not already, and start building your analysis. The reason that I use the word “building” is that your mission is to decide whether Whole Foods should enter the restaurant business and you should marshal the many “facts” in the case to reach that conclusion. This is not just a modeling exercise (though it will require you to build a financial model), an accounting exercise (though you have to forecast accounting numbers) but a decision-making exercise. It can be fun to flex your judgment skills, but only if you don’t get mired in small details.
|3/26/19||We talked about sunk costs in class in the last session, and how difficult it is to ignore them, when making decisions. You can start your exploration of the sunk cost fallacy with this well-done, non-technical discourse on it:
You can then follow up by reading a tortured Yankee fan's (my) blog post on the Yankee's A Rod problem and the broader lessons for organizations that have made bad decisions in the past and feel the need to stick with them.
Finally, I know that you are probably busy working on your case (spare me my illusions) but in case you have some time, I would like to pose a hypothetical, just to see how you deal with sunk costs. Before you read the hypothetical, please recognize that I am sure that the facts in this particular puzzle do not apply to you, but act like they do, at least for purposes of this exercise:
I hope you get a chance to give it a shot. It will take only a few minutes of your time (though it may take a few years off your life).
This week, we will pick up on investment returns, starting with the theme of looking at cash flows, rather than earnings. We will use hypothetical projects, a new Disney theme park in Rio, an iron ore mine for Vale in Canada and an acquisition by Tata Motors, to illustrate both how to measure cash flows and to convert them into returns. It will help you immensely if you can at least read the case before you come into class. If your response is “what case”, here is the link:
All in all, much to do this week. But welcome back!
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. WUltimately, 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. You can also download a free, full-featured trial version from Oracle:
The only bad news is that it is available only for the PC. As a Mac user, I have to open my Mac as a PC (which kills me) and use Office for Windows (which kills me even more, since I don’t know any of the neat short cuts or where things are in the tool bar).
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.
Today is usually the day that I write to you about your project, but if you are budgeting your time to immediate priorities, you should be working on the case. In case your fascination with corporate finance leads you to work on the case, here are a few suggestions on dealing with the issues.
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:
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.
On a different note, and looking at week after next, you have a quiz on Wednesday, April 10. It is a little early to be doing much about it, but if you are raring to go, the past quiz 2s are already online at the link below:
If you want to wait, I will send you more detailed instructions next week,
I won’t distract you from working on the case this weekend. However, the latest newsletter is attached, just in case you want a break.
Attachment: Issue 7 (March 30)
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:
As a powerpoint file, you can then choose to print off two slides per page (or even four, if you have really good eyes).
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 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 email.)
3. On the cover page, please include the following:
Names of the group members in alphabetical order
Cost of capital for WF Dining Investment:
Accounting Return on Project
NPV for WF Dining (15-year life)
NPV for WF Dining (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 “The Dining Case”. 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.
Finally, I have attached the post class test and solution for today’s class.
I know that you are probably busy working on the case (or should be) but here is the weekly puzzle for this week. We have been talking, in class, about investment decisions and how best to make them. While we laid out the framework of forecasting cash flows and computing NPv, 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:
These are fundamental questions that get asked almost every time a big investment goes bad.
|4/2/19||The cases are starting to come in. Please remember two things. The first is to use “The Dining Case” as the subject. I know it sounds picky but it makes my job of organizing emails much easier. The second is to fill out the case results. I should have added the units on the NPV in my original sheet, but I overlooked it. Could you please send me the NPVs in millions (not thousands or dollars). It will make it easier to create group stats. (If you have already sent it in, don’t worry. I made your numbers into millions.|
The bulk of today's class was spent on the WF Diningcase. 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 restaurants that drives the cost of capital for the dining business, rather than the cost of capital for Whole Foods (or Amazon) as a company. That principle gets 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 parking investment not made in year 12.
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:
Excel spreadsheet with analysis: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/WFDiningAnalysis.xlsx
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.
I just began grading the cases and you should be getting yours back soony. 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 I will be hounded by some until I do so. So, here is a rough breakdown:
<5.5: Hopefully no group will plumb these depths
By now, I think I am done with the cases and you should have received them back. If you did not, it is possible that they are in my email pile (I am behind by 633 emails and falling further behind, even as I try to catch up) because the words “The Dining Case” was not on the subject line. As you look at the case grade, you will notice coded messages about mistakes. Before you go on Google search and try to find out what 3a or 9b might mean, you may want to check the grading template that I sent you yesterday. Incidentally, today is the day that I would normally nag you about the project, but I will leave you alone to first recover from the case and then get ready for the quiz next Wednesday. If you are ready to get started on that, here are some lead ins:
If you feel the urge to try your hand at past quiz 2s, here are the links:
I will be doing a review session for this quiz, just as I did for the first quiz, but this quiz is very much an extension of what you did on the case. So, if you are a little shaky about what we did in the case and why, you may want to shore up your weaknesses.
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 Whole Food, that I don’t think I will ever shop there again. Here are some thoughts:
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 Whole Food or Amazon'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 Whole Foods Dining and Prepared Foods and are using the same cost of capital on both. I did not make an issue of it in this case, since the differences 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 Whole Foods Dining was 4.75% (the riskfree rate + default spread). On the debt ratio, on leases, there were variations on how you dealt with the lump sum after year 5, but I think pretty much everyone discounted at the pre-tax cost of debt (the right thing to do).
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 6 and year 12 for computing the parking investment. Some of you either ignored the savings in year 12 or attempted to allocate a portion of the investment in year 5, 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:
4. Cash flows in the longer 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 1-15 are identical for the 15-year life and longer life scenarios, you have a problem...) Though some groups did realize this, they often started the capital maintenance in year 16, 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. A few of you used the defense that I had asked you not to go out of the case, but you don’t have to, since your depreciation is the key indicator of how much maintenance cap ex you need. 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. It will come in handy, when you go back to working on you project for the class (remember). Until next time!
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:
4. The seating arrangements for quiz 2 are below:
If your last name begins with Go to
A -P Paulson
Q -Z KMEC 2-60
Until next time!
Attachments: Issue 8 (April 6)
|4/7/19||In the week to come, we will turn to the second part of corporate finance, the financing principle, and look at what the right mix of debt and equity for a firm should be. We will explore the trade off on debt versus equity, and perhaps start on quantitative tools for assessing this trade off. There is your quiz on Wednesday, but it will be entirely on the investment principle, with an emphasis on how we compute cash flows and returns on projects. It will also cover cost of capital mechanics.|
I know that you are in quiz prep mode. So, first thing first. I created a review session for the quiz that you can watch here:
Review session: https://youtu.be/wsSwIfvaIG4
Slides for review: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/reviewQuiz2.pdf
I hope that it helps. 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.
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, how perverse the US tax code was prior to 2018. I know that there is a lot of heated debate about the tax reform act, and while there is much to dislike about the reform (especially if you live in a high tax state like New York or California), I believe that the corporate tax reform it included, especially on foreign income, was vastly overdue. To give you a sense of how bad things used to be, I pulled up a write up and puzzle from almost four years ago as the puzzle for this week.
While the facts are dated and Pfizer never went through with its tax inversion plan, put yourself back in time and try to address the questions.
I hope that you are recovering or recovered from the quiz. I will grade the quiz and I apologize in advance for the fact that you will not get them back until Saturday afternoon, since I have to leave for London this evening. I am planning on taking the quizzes and grading them on the flight. In effect, they will ready to pick up tomorrow, but you will have to fly out to London for the pick up. In the session that followed the quiz, I look at the Miller Modigliani theorem through the prism of the debt tradeoff and followed up by using the financing hierarchy that companies seem to move down, when they think about raising fresh financing. 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.
|4/11/19||I have finished grading your quizzes but am still across the Atlantic. I should be back by Saturday afternoon and will let you know when I put them out. I know that 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:
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:
I am also attaching two spreadsheets: one contains the updated marginal tax rates by country and the other has the 2019 version of average effective tax rates by sector for US as well as for Global companies. Hope you find them useful!
I just got into my office from the airport and I cannot wait to unload the 300 quizzes I have been carrying in my backpack. You can pick them up in the usual place (ninth floor of KME just before you get to the front door, on your right, on the top shelf). If you cannot wait, you should be able to get them even on a Saturday. They are in impeccable alphabetical order. Please leave them that way. I have attached the solutions to the quizzes as well as the distribution. Finally, it is Saturday and the weekly newsletter is also attached.
This week, we will continue our analysis of the optimal financing mix by looking at tools that you can use to assess optimal capital structure. If you want to get a jump on the class and get caught up on your project at the same time, I have a suggestion. I have attached the spreadsheet that I will be using to optimize cost of capital for Disney. If you enter your company’s numbers into this spreadsheet, you will not only get an optimal debt ratio for your class but also get caught up on almost 75% of what you should have done already on the project. How can you beat a deal like that? (It will take you about 20 minutes to input the numbers into spreadsheet and if you want help, I have a YouTube video that may help:
It is a slightly older version which does not include the bells and whistles I added after the tax reform of last year.
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). Disney was underlevered and Tata Motors was over levered.
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 Little 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).
In this week’s puzzle I decided to use Valeant in 2015 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 2015, Valeant’s fortunes took a turn for the worse. Not only has its business model crumbled, but it had had both managerial problems and information disclosure issues that have added to the troubles. It’s biggest booster and investor, Bill Ackman,took his losses on the stock and apologized to investors in his fund for the “mistake” he made investing in the company. In November 2015, the stock price, which was close to $200 IN 2014, dropped below $10 and the company was clearly seeing the dark side of debt. Here are my questions:
In today’s class, we continued our discussion of the cost of capital approach to optimizing debt ratios by first looking at enhancements to the approach and then 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..
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. If you look at the projects, you will see that the formats vary. Some use Word and one is in Powerpoint. They all emphasize comparative analysis and go beyond the numbers. So, be creative, put it in the format that best fits how you want to deliver your narrative and have fun with it. Note, in particular, to put muscle behind my plea for brevity. I have put a page limit of 20 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 every additional company.
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:
Dell optimal capital structure spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/optdebt/dellcapstru.xls
You will notice that the Dell capital structure spreadsheet which is from a few 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.
I hope that you are enjoying the start of the weekend and I will not spoil it by telling that this is a great time to get caught up on the project. I am attaching the newsletter for this week.
Attachment: Issue 10 (April 20)
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. The best way to reinforce the concept is to try and apply it to your own company (that you are following for the project). Trust me! This is not rocket science.
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 solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls
As with he prior quizzes, I will send you a quiz review webcast soon. I have also attached today's post class test & solution.
|4/23/19||In yesterday’s class, we talked about the perfect security as one that preserves the flexibility of equity while giving you the tax benefits of debt. 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.
If this strikes you as too esoteric, there is a whole host of these shape shifting securities that try to be different things to different entities that you can find out there to explore.
In today's class, we looked at the design principles for debt. In particular, we looked a6 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. In the meantime, if you are interested in what dividend policy around the world looks like, try this post of mine from earlier this year:
The post class test & solution for today is attached.
Sorry about sending you two emails on the same day, but I wanted to make sure that this did not get lost in the shuffle. Your third and final quiz is a week from tomorrow and I thought it would be good to offer you a brief preview;
Quiz 3 will be on May 1, from 10.30-11. There will be class afterwards.
The seating for the quiz will be in two rooms:
If your last name begins with Go to
A -J KMEC 2-60
K -Z Paulson
2. What will it cover?
It will cover all of capital structure. In terms of slides this would be packet 2, from pages 1-145. In terms of chapters in the book, it would chapters 7-9. We will cover everything from the intuitive trade off on debt versus equity to debt design.
3. Review Session
The review session for the quiz is available at the link below
4. Past quizzes
You can check out past quizzes and solutions at the links below:
Past quiz 3 solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls
Hope this helps!
|4/25/19||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.
Attachment: Macro Duration 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:
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 2018 was attached to yesterday’s email but I am attaching it again, just in case! Hope you find it useful.
Attachment: Macro Duration Spreadsheet
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. On a different note, the third quiz is on Wednesday and if you want to try your hand at prior year’s quizzes, you can find them here:
Past Quiz 3s solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls
If you want to watch the review session for the quiz, it is here:
As you can see, it will be focused on the capital structure section (which is lecture note packet 2, until just after page 145).
Attachment: Issue 11 (April 27)
|4/28/19||Tomorrow’s class will be session 22, leaving us with four sessions of class after. That, of course, is my cue to nag you to work on your project. One way or the other, even if it means that I have to drag you, we are getting over the finish line. This week, we will complete our discussion of dividend policy, the last of the three big corporate finance pieces, and we may even start on valuation after the quiz on Wednesday. As you prepare for the quiz, some of you have noticed that the solution to the spring 2015 quiz does not seem to match the quiz. That is because I got the quizzes for spring 2014 and spring 2015 mixed up. I am sorry, but it is fixed now.|
We spent today's session setting up the trade off on dividends, 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). In the final part of the session, we looked at both how much cash a company would afford to return to shareholders (by computing a FCFE) and comparing that to actual cash returned (in dividends and buybacks), but looked at how trust in management and excess debt capacity can alter your final judgment on whether a company should return more or less cash to shareholders. 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 begins with Go to
A -J KMEC 2-60
K -Z Paulson
2. Review session: At the risk of repeating what I have tweeted out multiple times already, here are the links that matter
The review session for the quiz is available at the link below
The quizzes from past years are available at the links below:
Old quiz solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls
I have attached the review session slides to this email.
3. Content: The quiz will cover capital structure; Lecture note packet 2: 1-145; Chapters 7-9 in the book
The quizzes are done and you can pick them up in the usual spot. I know that it is late and I hope that you don’t make the trek to school just to pick it up tonight. It’s not worth it. The only reason I decided to bring it over tonight is because I have an early morning flight and did not want to rush to get it in before I left in the morning. I also hope that you get a chance to work on dividend policy, now that we are done with that topic. It is on to valuation next week.
|5/2/19||In this email, I would like to focus on the project. 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.
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.
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 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). Repeating a link that I gave you a couple of weeks ago:
I prefer brevity and I want to emphasize the page limit of 20 pages on the report (plus 2 pages for each additional company over 5). 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 13.
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). 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 first webcast looks at the trade off on dividends
The second webcast looks at the question, again using Intel:
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 2018:
I hope you get a chance to take a look at the webcast.
On the final exam, here are a couple of clarifying details. The exam is scheduled from 10 am -12 pm on May 17 and as with the quizzes, I will get an extra room (in addition to Paulson) and let you know about the seating. There are some of you that will not be able to make it to the official exam. There will be an early version on May 17 from 1 pm - 3 pm in KMEC 3-55. I have set up a Google shared spreadsheet for early exam takers.
Since this is the day after your project is due and the last session, you will not get much time for preparation and if you can avoid it, I would encourage you to stay with the official date, but you now have a choice. I will send you more information on the final exam sometime next week.
The good news is that this is the last newsletter. The bad news is that this means the end is near. If you are working on your project this weekend, I hope that it is a productive one. If you are not, I hope that you are having fun at whatever else you may be doing.
Attachment: Issue 12 (May 4)
I hope that you had a productive weekend and that you still managed to get some time outside. That said, the last full week of classes is approaching and I thought I should give you heads up of what’s coming. Tomorrow, we will complete our assessment of dividend policy and start on the last part of the class, valuation. As we will see, you have already done the bulk of the heavy lifting for this part of the class, without even realizing it. That said, some of you are probably thinking ahead to the final exam next week. Here are some details:
1. When? The official final exam for this class will be on Friday, May 17, from 10-12. As with the quizzes, the exam will be held in Paulson and one the room (TBA). There will be an early version of the exam on May 14, from 1-3 pm in KMEC 3-55. Please sign up on the Google shared spreadsheet, if you are taking the early exam.
2. What? The final exam will cover the whole class. It is cumulative.
3. To get ready: You can start with the review that I put together for the final exam, using the Spring 2017 final as my springboard:
Review session: https://youtu.be/XOCfyjEdg-k
Review session slides: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/reviewFinalNew.pdf
You can try past final exams and check the solutions here:
Past final solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/cffinals.xlsx
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, 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 blog post relevant for that discussion:
I also mentioned a valuation of Deutsche Bank. On the off chance that you want to dig deeper, here is my take on Deutsche in October 2016:
Finally, I did mention a spreadsheet that is versatile enough to cover every company in this class. Please use it for your valuation:
Many of the inputs that you need for this spreadsheet should have already have been estimated or looked up for other parts of the project. Also, as you enter the key numbers for revenue growth, target operating margin and sales/invested capital, think of the story that drives these numbers.
Finally, for those of you who missed it, the review session, presentation and past finals are linked below:
Review session: https://youtu.be/XOCfyjEdg-k
Review session slides: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/reviewFinalNew.pdf
You can try past final exams and check the solutions here:
Past final solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/cffinals.xlsx
Post class test and solution are attached.
Since the project is due in less than a week and you may still have not done the valuation part, I decided to provide a helping hand on it. The spreadsheet that I used to illustrate the process is the fcffsimpleginzu.xls ( https://www.stern.nyu.edu/~adamodar/pc/fcffsimpleginzu.xlsx) that I had sent in an email last week and the company. 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.If you are working on the project and are at the valuation part and struggling, I have a webcast on using this spreadsheet that turned out to be longer than I hoped it would be (about 30 minutes) but it could help you understand both the craft and practice of valuation. The link is below:
Note that I have added a couple of bells and whistles to the spreadsheet since I created this, but it remains fundamentally the same.
Finally, if you do get the numbers together for your companies, please put them into the attached spreadsheet and get them back to me by Sunday, at the latest, and earlier will be better. I would prefer to get one spreadsheet for the whole group, but if you have someone holding you up, please send me the numbers for as many people as you have the numbers for.
It will be raw material for my Monday class.
Today, we completed the last pieces of the valuation puzzle, first looking at why we need a terminal value and then at the rest of the assumptions that go with being a mature firm. We used Vale as an example of a mature company and a cautionary note about what happens when you normalize by just averaging over time. I did mention that Vale was one of my biggest losers, and if you are interested, here is my “No Mas, No Mas” post on the company:
The bad news is that I lost a lot of money on that bet, but the good news is that the stock kept going down further, and I was able to buy it again at a much lower price. We also completed the terminal value for Disney and brought it into a final valuation. The bottom line is that corporate financial decisions ultimately drive the inputs to valuation. On a different note, I hate to be a nag (not really… but I have to say that), but if you get your project numbers, please send them to me as soon as you feel comfortable with them by filling in this spreadsheet.
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 as well as several criminal codes.
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. What should the final project report look like?
Please turn in one report for the whole group and save it as a pdf file (less chance of bad things happening to formatting than with Word or Powerpoint files). Please do not attach or include any excel spreadsheets. In addition, make sure that you list all the group members alphabetically on the first page and use “The Torture Ends” in the subject line.
17. When will this torture end?
Four days from today (5 pm on May 13)... but the memories will last forever…
The first submissions have come in and I will keep a running tab of the numbers, partly to keep myself sane and partly to nag those of you who have not returned it yet.
Companies in: 10
Companies yet to come in: 290
Just to make my life simpler and please put “Thanos” as the subject, when you send your summary sheets in. I will make sure that he does not close his hand.
Summaries received: 64
Still to come: 236
Thank you for all the summaries (I got 275 out of 293…) and I have the presentation done. I will try make some copies for class but the pdf version is attached. See you in class (in person, not virtually, I hope..) And the fat lady is singing:
know that it must be a relief to have completed the projects. I am just starting the grading and the projects are being returned in the order in which I received them. You should receive a pdf file with the comments embedded in them, with the grade on the first page and it is out of 30. Now, on to the final exam. It is scheduled for Friday, May 17 from 10 am -12 pm. As with the quizzes, I have KMEC 2-60 for the final, and here is the seating set up:
If your last name begins with Go to
A -P Paulson
Q -Z KMEC 2-60
The exam, like the quizzes, will be open book and open notes.
I know that the course evaluations are the last thing that you are thinking about right now, but for your sake (to get your grades) and mine, could you please take a few minutes and complete them. The instructions are below:
Student Instructions for Completing Online Course Evaluations
I have no idea what that pop up blocker thing is all about, but I am sure that you will figure it out.
The final exams are done and can be picked up in the usual spot. While I have attached the solution and distribution, you will notice the there are no grades attached to the scores. That is because your final grades are only a few days away, as soon as I get your final projects graded (I am only about a third of the way through and will try to work through the rest in the next couple of days). There is one specific problem on the final that I want to draw your attention to, not so much because of the point it may have cost you but because it is (to me) one of the most misunderstood parts of finance, i.e., picking a discount rate for cash flows. The fixation on computing corporate costs of equity and capital can sometimes lead us down the pathway of thinking that those numbers can be used to discount any cash flows coming into the company, but that logic is trumped by a more powerful one. The discount rate for a project should reflect its risk. Thus, the licensing fee from Biogen has no operating risk associated with it, since it is guaranteed, and the only risk is that Biogen may default. Thus, the right discount rate is the cost of debt for Biogen. Similarly, the other offer is 15% of net income, and that is key since net income is equity income, and the discount rate is the cost of equity for Merck. Finally, you cannot compare a 5-year offer with a 10-year one. You have two choices. You can make assumptions about cash flows after year 5 or convert into an annuity.
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 125th of the class), assignments, projects and weekly puzzles and I also know that most of you were unable to keep up. However, the material for the class will stay online and on iTunes U for the foreseeable future. If you want to review parts of the class, please do go back and review the lecture, look through the notes and even try that week's puzzle. If you really, really want to master corporate finance, don't waste too much time reading books & papers or listening to lectures. Pick another company (preferably as different as you can get from your project company) and take it through the project analysis. Each time you repeat this process, it will not only get easier and more intuitive, but you will always learn something new. I still do! I truly wish you the best. And finally, remember to work on your weak side! If you are a story teller, build up your number crunching skills, and if you are a number crunching, let your imagination run loose!
Finally, in return for reading all (many, most, some) of my emails this semester, I have something to offer in return. If you have a question in corporate finance, valuation or investments, where you think I can be of use, you are welcome to always reach out to me. I hope that you have a wonderful summer planned out and that those plans come through. I wish you the best and I hope that you are able to find joy in whatever you choose to do! For the last time (at least for this class)! Perhaps, you will come back to be tortured again next year in valuation!
Attachment: Grade Checker spreadsheet.