As you get ready for Super Bowl Sunday parties, it is my solemn duty to inform you that your winter vacation is finally over and that classes start tomorrow. If you have ignored the last two emails that I sent you, you may want to check them out now. Quickly, here a few things to check for class tomorrow:

1. Location: The class is in Paulson Auditorium, which is the lower level of 40 West 4th Street. You have already had events there as part of that first week of brainwashing or orientation or whatever it is called. 
2. Time: Class will start at 10.30. When you come in, you will see two stacks of handouts for the class up in front. Please take one of each. If you prefer a digital copy, they are also online on the webcast page for the class: https://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr20.htm
3. Lecture Notes: The first lecture note packet for the class is on the webpage listed above, and you can download either the pdf or powerpoint version. You can keep it in digital form on your iPad, but if you choose to print it, please don’t use the Stern printers. The packet is more than 300 pages, and it creates a printing problem downstairs.

In the first puzzle for this semester, I am going to focus on the objective in corporate finance, In class, I said that the end game is to maximize the value of the business and that in practice, this gets narrowed to maximizing stock prices. That objective has given corporate finance its focus, but has also given rise to criticism that it comes at the expense of other claimholders. That is a legitimate point, and even the Business Roundtable seemed to come around to a stakeholder point of view in this missive:

In a post shortly thereafter, I took issue with the Business Roundtable, and argued that it was the wrong message and that the messenger, Jamie Dimon, was singularly ill equipped to talk about shareholder interests, given how cavalierly he has ignored them over his tenure. 

I know that many of you will disagree with me on my conclusions, but I think that this will be a great start for tomorrow’s class. So, please read both and try to answer these questions:

No pressure and completely optional, but I think it is worth your 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:

1. Project hub: To find out pretty much anything you need to about the project, get questions answered or look at past project reports, here is where you should go: https://people.stern.nyu.edu/adamodar/New_Home_Page/cfproj.html 
2. Find a group: If you have trouble finding one, try the orphan spreadsheet for the class (https://docs.google.com/spreadsheets/d/1GinmcjwRiOTSOHpJmGJinJLZy8B5wF4MFSv50OCjXKw/edit?usp=sharing  ). If you have a group and need an orphan to adopt, try the spreadsheet as well. 
3. Pick a company/theme: This will require some coordination across the group but pick a company and find a theme that works for the group. Each person in the group picks a company and the companies form the theme.
4. Annual Report: Find the most recent annual report for your company. If it is a US company, also download the 10K from the SEC website.
5. Updated information: If your company has quarterly reports or filings pull them up as well.
6. Board of Directors: Get a listing of the board of directors for your company & start your preliminary assessment.

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:

https://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr20.htm 

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. You can stream or YouTube the sessions, or download videos/audios. Also, if you joined the class late, you can get all emails sent up till today here:

https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfemail.html 

Finally, have you had a chance to look at the weekly puzzle? If not, give it a shot by going here:

https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfpuzzles/cfspr20puzzle1.html 

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.

Before I start on the newsletter part, a quick note about the TAs for this class. They are:

They will be holding office hours from on Mondays and Wednesdays, from 09:30-10:30 and on Tuesdays from 12pm-2pm. In case you missed it, they will also be holding review sessions every Monday, starting February 10, from 4.30-5.30. The room is KMEC 2-65 and you can sign up on this Google shared spreadsheet:

https://docs.google.com/spreadsheets/d/1LX-HzMfo7dRIxmtEVpoZyqhQCn1lWAzHI_rZhqZb6CY/edit?usp=sharing 

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!

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. I would strongly recommend that if you have not tried the weekly puzzle for this week, you should. It is not only relevant to the classes to come but is at the foundation of the big debates we are having in business, politics and society. If you have no idea what I am talking about, here is the link to the weekly puzzle:

If you are wondering why I am not posting a solution, take a look at the puzzle again, and the answer should be fairly obvious.  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.

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. 

Attachments: Post-class test and solution

In this week’s puzzle, I want to take a look at activist investing, warts and all. To get a perspective on activist investing, start with this old (but still relevant) post on activist investing:

http://aswathdamodaran.blogspot.com/2012/06/activist-value-investing-be-your-own.html 

Then, follow up with this more recent post on Softbank’s problem, after the WeWork disaster

http://aswathdamodaran.blogspot.com/2019/11/the-softbank-wework-end-game-savior.html 

Top it all off with this news story about Elliott Management, a leading activist investor, targeting Softbank:

Finally, consider these questions:

1. Why did Softbank get targeted by Elliott Management now?

2. What do you think of Elliott’s proposals for Softbank?

3. Assuming Softbank decides to fight Elliott Management, what would you advise Softbank to do?

4. More generally, what are the pluses and minuses of having activist investors in a market?

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. 

As for the project & class, time sure does fly, when you are having fun... We are exactly 15.38% (4 sessions out of 26) through the class (in terms of class time) and we will kick into high gear in the next two weeks. I am going to assume for the moment that my nagging has worked and that you have picked a company to analyze. Here is what you can be doing (or better still, have done already):

1. Download the latest financials for the company: You don't have to print them off. In fact, I find it convenient to keep them in a folder in pdf format, since my computer can search the document far more quickly than I can. For all companies, this will include the latest annual report and with US companies, try to find the latest 10K and 10Q on the SEC website. If you are analyzing a private business, you will need to get the most recent financial data from the owner (who hopefully is related to you and still likes you…)
2. Put the board of directors under a microscope: The first step in understanding your company is to start at the top. Take a look at who sits on the board and how long they have been sitting there. In particular, the question that you are trying to answer is how effective this board will be in keeping any eye on the top management of the company. Start with the cosmetic measures, which is what most corporate governance services and laws focus on, but look for something more tangible. Has the board shown any backbone in stopping or slowing down management? I had mentioned the DEF-14 as the place to get information about the board. You can find it on the SEC website (https://www.sec.gov/edgar/searchedgar/companysearch.html). For instance, here is what I found for Amazon. (https://ir.aboutamazon.com/sec-filings/sec-filing/def-14a/0001193125-18-121077) If you have a non-US company, you will not find this filing, but remember Sherlock Holmes and the "dog that did not bark”. Sometimes, the absence of information is more powerful than its presence.
3. Assess the "power" structure: As Machiavelli pointed out, power abhors a vacuum (he said no such thing, but you can pretty much attribute anything to him or Confucius and sound literate). Specifically, try to find who the largest stockholders in your company are. You can get this from the Bloomberg terminals (HDS page), Capital IQ (holders) or online for free (Yahoo! Finance or Morningstar). Once you have this list, here are the questions that you should try to answer: 
• If you are a small stockholder in this company, do you see any likelihood that any of these stockholders will stand up for stockholder rights or are they more likely to sell and run?
• Are there any stockholders on the list whose interests may lie in something other than maximizing stockholder wealth? (For instance, we talked about the government as a stockholder and how its interests may be different from that of the rest of the stockholders.. Think of an employee pension fund being on that list... Or another company being the largest stockholder…)
4. Activist Investors: One of the things that tilt the game a little bit more in favor of shareholders in their tussle with managers is the presence of activist investors. The problem with identifying whether your company has activist investors is that these investors (Carl Icahn, Bill Ackman) often operate through entities that don’t obviously contain their names. If you are interested, here is a list of some of the biggest activists. Check to see if they are on your company’s top stockholder list. https://www.carriedin.com/activist-investors/ 

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. 

Webcast: https://www.youtube.com/watch?v=3yCJeFpgt-Y 

Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/corpgov.ppt

HP Annual Report: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf 

HP 14DEF:  https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPDEF14A.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).

Very quick note before you get back to your weekend festivities. Your newsletter is attached for the week.

And in case you have not picked a company yet, please do. If any of you are in groups that would like an extra person, please let me know as well. I have a couple of lost souls that need salvation. Thank you!

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: https://www.nobelprize.org/prizes/economic-sciences/1990/markowitz/lecture/(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 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%20Must%20Read%20This/Barber-Odean%202011.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 2020): https://www.stern.nyu.edu/~adamodar/pc/datasets/sovrrating2020.xlsx  

Sovereign CDS spreads (Jan 2020): https://www.stern.nyu.edu/~adamodar/pc/datasets/sovrCDS2020.xlsx 

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…

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. One final note. The second packet for the class is available to download online. You can find it on the webcast page for the class:

In the only session we had this week, we covered some ground, completing our discussion of risk and return models in financing and starting on the first of the three inputs into your cost of equity, the risk free rate. 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:

CFO survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2422008 

Analyst survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2450452 

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html

On the same page, you can pull up my estimates of country risk premiums for about 150 countries from January 2020

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

The approach that I use for computing country risk premiums at the start of 2020 is described more fully in this post:

https://aswathdamodaran.blogspot.com/2020/02/data-update-4-country-risk-and-currency.html 

I know that I have used up my quota of emails for today, but this has nothing to do with this week’s class, but has to do with the final. As you well know, your final exam is scheduled for May 15, and I know that some of you have other commitments to family and friends and would like to take the exam early. I will be offering an early exam on May 13, TBA, for you, if you are interested. I have started a Google sheet for you to sign up, if you want to take the early exam. Don’t worry! If you sign up and change your mind, I am okay with that too.

As we are in the midst of another market crisis, it is a good time to think about our views on risk and how it plays out in how we react to the crisis. Both economics and finance are built on 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:

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 (which I have attached to this email) that looked at how betas for companies change over time and concluded based upon a small sample and data from 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 has been locked up for a while. Tomorrow’s second In-Practice webcast will cover how to read a regression beta. 

t is Friday and time for the in-Practice Webcasts. I have two for this week. The first is on estimating company equity risk premiums, using operating exposure:

Webcast on company ERP calculation: https://youtu.be/D3IGn6tH03c?list=PLUkh9m2BorqkNIdjpZY2kI0qzRbEv5F5L 

Slides for webcast: https://people.stern.nyu.edu/adamodar/pdfiles/blog/ERPforCompany.pdf 

Worksheet for webcast: https://www.stern.nyu.edu/~adamodar/pc/datasets/ERP&GDP.xlx

This spreadsheet is an old one. You can get the updated values for GDP and ERP by going to my website:

Updated ERP spreadsheet: https://www.stern.nyu.edu/~adamodar/pc/datasets/ctryprem.xlsx

I also 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:

First, it is the weekend and the newsletter is attached. Second, and perhaps more important, your quiz is a week from Monday (on March 9) 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:

As you are probably aware of by now, the first quiz is a week from today and you may be a little nervous. As your dentist would say, just relax, but as with the dentist, that is easier said than done. So, here is some information that may calm your nerves. Think of it as Corporate Finance Novocaine:

1. When? The quiz is scheduled for a week from today, on March 9, in the first 30 minutes of class (from 10.30-11.00). Please don’t be late and please remember that there is class after the quiz.

2. Where? There are two rooms for the quiz and the seating arrangements are below:

3. What will it cover? The quiz will cover corporate governance and everything that we have done on hurdle rates, through betas. In terms of pages in the lecture note packet, it will be through page 176 in the lecture note packet 1. 

4. What can I use during the exam? I could be snarky and say your brain, but that would not be nice! Seriously, you can use any notes you have, books and your iPad or tablet (if that is where you have stored your notes). You can even use your laptop as long as you use it just to review notes that you have on it. You cannot use Excel or any tools on either your tablet or your PC.

5. How do I prepare? Review the notes and rewatch the sessions, if they are not clear, but ultimately, you need to practice your hand at actually solving problems (and not be quick in checking the solutions).  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:

I have also put together a review session for the quiz, shot in my dark apartment (sorry about the video quality) last spring, but the topics are timeless and the links are below:

6. What if I have to miss the quiz? If you  have to miss the quiz, have a good reason or at least make up a really good one, and let me know before the quiz starts at 10.30 am on March 9. If you do miss the quiz, the 10% will be reallocated to your remaining quizzes (which will be worth 12% apiece) and your final exam (which will be worth 36%, instead of 30%). The cost of missing the quiz is that you have used up your freebie and your remaining quizzes will count for more, but that is small enough that you should definitely miss the quiz if you are feeling sick. I don’t need doctor’s notes. I think that we are all adults here, and I will trust you. 

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):

First, I had promised to be around today and I will be from 2-3 but I was unable to get a room. So, you will have to come to my office (KMEC 9-69), if you have questions. Second, today is usually the project update day. If you really have the time for it, this is a good week to get a bottom up beta for your company and estimates costs of equity for each business line it operates in. I will be putting up a blog post on this tomorrow, but you can get betas by business going to my website:

If you scroll down, you will set betas (levered and unlettered), by business and while the html file includes only US companies, you can download the averages for the rest of the world in the next column.

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:

Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/BottomupBeta.mp4 

United Technologies 10K: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/UT10K.pdf

Spreadsheet to help compute bottom up beta:  https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/bottomupbeta.xls

The last spreadsheet has built into it the industry averages that I have computed for different sectors in the US in 2015. You can get the updated version from 2020 here:

I will let you get back to the grind now, but just in case, you have not even started on the quiz preparation and don’t have the energy to check old emails, here are the key links:

Review session webcast: https://www.youtube.com/watch?v=jH8L7cW6Yns&feature=youtu.be 

All past quiz 1s:  https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1.pdf

All past quiz 1 solutions:  https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1sol.xlsx

The seating for the quiz again is:

It is true that technology is a mixed blessing, but it does provide us with platforms to do things that we could have only dreamed about twenty years ago. I know that you are preparing for the first quiz, and that some of you are pretty nervous. I have set up a Zoom session on NYU classes for tomorrow from 12 pm - 1 pm, and you are welcome to join in, if you have questions. The link to the session is here:

 https://nyu.zoom.us/j/109563205

If you have never used Zoom, don’t worry, it is a very simple platform to get on. You can either just join with audio (a good idea if you are still in your pajamas or worse) or with audio and video. You can also join using your computer, a tablet or even your phone,. I will set up the session in the first 5 minutes and the rest of the hour is yours to ask any questions that you might have about the quiz. (You can raise your hand online and I can call on you… ) 

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. Also, if you can convert revenues to value, for bottom up betas especially, it always makes sense to do so. Multiplying by an EV to Sales ratio accomplishes this.

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

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

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

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

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

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

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

I 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 of 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 1 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. 

Case: https://people.stern.nyu.edu/adamodar/pdfiles/cfexams/NetflixFit.pdf

Add on to case: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/FitnessCompanies.xls 

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:

1. Where? The quizzes can be picked up on the ninth floor of KMEC. As you come off the elevator, walk straight towards the entry door to the department, but before you get there, stop and look to your right. There should be a set of metal shelves and your quizzes should be on the top shelf in alphabetical order.
2. How? The quizzes are face down and alphabetical order. Please take your quiz, leave the rest of the stack intact and do not mess with the alphabetical order.
3. What next? I have attached the solution to the quiz.  The grading template is in the solution and you can make sure that I have not been unfair to you. (Please don’t go to the TAs. They bear no responsibility.
4. Then what? You can check your score against the distribution, also attached, to see how you did relative to everyone else in class.
5. Final thoughts: This is just the first installment of the class, and it is this worth only 10%. Therefore, if you did badly, remember that you can make it go away by doing well on the remaining exams. If you did well, congratulations, but there is plenty left in the class.

Today’s first online class went reasonably well and I hope that you were able to join in. If you did, we talked first about the weights on debt and equity in a cost of capital calculation, arguing that market value weights trump book value weights every single time. For the market value of debt, we argued for including both interest bearing debt converted to market value and the present value of lease commitments. Once we had the cost of capital nailed down, we moved on to returns, and started with an argument for cash flows as opposed to earnings and why those cash flows should be time weighted. We started on project analysis, defining project broadly to include everything from a large acquisition to replacing the water fountain in your office building, and set up four projects to assess. In this session, we started with the Rio Disney project and how accounting earnings and book value can be estimated, and used to derive a return on capital, and argued that the right discount rate for this project should be the cost of capital (because it is being compared to return on capital0 for Disney Theme parks, adjusted for Brazil country risk.

If you were unable to attend the Zoom session, it was recorded and you can find it on NYU classes under Zoom.  I also recorded it and will put up an audio, video and YouTube version of the same. Finally, as we take a break, here are a few things to think about.

1. Case: This may have passed you by, but the case is now ready for download(https://people.stern.nyu.edu/adamodar/pdfiles/cfexams/NetflixFit.pdf). If you end up with time on your hands during the break , you can start by reading the case, and if you are so inclined, continue by working on some of the analysis. You can interact with your group members virtually, if you don’t want to expose yourself to viral risk.
2. Project: I know. I know. I cannot help it, but nag you again on the project. We are through the cost of capital in class, and if you can compute a cost of capital for your company (or multiple costs, if it is many businesses), you will be all caught up. You are welcome to use my data and spreadsheets and the in-practice webcasts as crutches in doing this. I have added a webcast on estimating cost of debt and debt ratios, using the Home Depot as an example. 

It’s only been a week, but it does seem a lifetime ago, since I talked to you last, and I hope that you and your loved ones are safe and in good health. Now that the class has been moved entirely online, I decided that it would be good to make sure that we had the logistics lined up, given that my end game is that you receive the same experience (or as close to it) as we can get, as you would have at Stern. Here is what I thought made the most sense, and I am willing to listen to suggestions:

1. Location and time differences: I know that you are scattered around the world, and I would like you to start by going to the link below and telling me where you are, what your time zone (- or +, relative to New York) and the name of the company that you have picked for your project. (Yes. I am still nagging you about that): https://docs.google.com/spreadsheets/d/1MKzjv0uYwscMTd-NczsUM2SVg44JrPVzJbrGw5NkThs/edit?usp=sharing
2. Classes: We will meet on Zoom for our regular classes every Monday and Wednesday, from 10.30 am-11.50 am, NY time. The Zoom links are under NYU classes and Zoom is an easy platform to learn to work with. I would really, really like you to be online live for the classes. I know that some of you are in time zones, where being in class will be difficult, and a few of you might have broadband issues. I will record the Zoom session on my computer and create YouTube videos and downloadable audio files, if you miss a class. The advantage of the YouTube videos is that they adjust to your bandwidth, and you can even watch them on a smartphone, with cell service.
3. Office hours: I will hold an hour of office hours, on Zoom, where I will be at least on Zoom every Tuesday from 1 pm - 2 pm, NY time, if you have questions. (Except for next week (March 26), when office hours will be from 3 pm- 4 pm.  If you have questions that you think can be resolved by email, please reach out to me. I will set aside an hour each day to answer emails. So, it is not an imposition.
4. Quizzes and Final exam: The quizzes will be on the scheduled dates (April 6 and April 29), and they will be online. They will still be open book, open notes, but you can use your laptop as well, and the only change that I will make (and I do it with a heavy heart) is that it will be multiple choice. The quiz will be accessible for 6 hours that day (to allow for different time zones) and will take one hour to do (once started). If you are qualified to get extra time, please let me know and I will set the time differently for you. The final exam will be on May 15 and will be available for 24 hours (NY time) and take 2 hours to do.
5. Case: I have wrestled with what to do about the case. I do think it is a significant part of putting the learning from this class into practice. I will leave the case due date on April 1, before the Zoom session that day. It is a group project, but if you find yourself unable to connect with your group, because of time and logistical issues, you can do it individually (just let your group know). I will let you know specifics about how to submit the case to me before then.
6. Project: The project is going to require some lifting and I will help you as best as I can. I would prefer that you stay a group for the project and interact, but I will be adding a nagging version of a Google spreadsheet, where I will ask you to enter numbers as you get them. I will obviously be available for questions on your company, which may be going through convulsions as you do your analysis. The final project report is still due on May 11, before the Zoom class that day.
7. TA review sessions: Flavia Sounis and Mauricio Mitidieri, the TAs for this class, will continue to have office hours (Flavia from  12 pm -1 pm, NY time, on Tuesday and Mauricio from 4.30 pm - 5.30 pm on Wednesdays). The review session will be from 4.30 pm  - 5.30 pm every Monday).

I know that these are unsettling, scary times, but we will get through them, and perhaps even come out stronger, smarter and kinder on the other side. I have been posting weekly about how this is playing out in markets, and you can all find the first three below:

There will another one coming on 3/20.

I know that you are far away (hopefully at least 6 feet) from me, and that you have lots of things on your mind. That said, I will stick with routine, for my own sanity, and hopefully for yours. So, it will be back to an email-a-day starting today, endless nagging, online classes and the rest of the class. With no further ado, here is today’s installment. 

We will pick up where we left off on Monday, at 10.30 am, NY time, for a Zoom class. The Zoom link is available on NYU classes, but just in case, here it is:  https://nyu.zoom.us/j/304350657.  

I will be on Zoom tomorrow for our first class after the break at 10.30 am NY time. 

https://nyu.zoom.us/j/304350657.

Looking at the Google calendar, I know that this may be tough for some of you, given the time difference, but please attend if you can.If you cannot the recordings will be on Zoom and I will also make a YouTube video for low bandwidth devices and settings.Those recordings and additional material will be on the webcast page for the class:

In tomorrow’s class, we will continue with our discussion of the Rio Disney project, making the transition from returns to cash flows to incremental cash flows. Since our discussion is particularly relevant for the case, it would help greatly if you read the case before tomorrow’s class.

I know that watching online classes was not what you signed up and teaching to a computer screen was not what I signed up for, but let’s make the best of it.

For those of you who were able to join the Zoom session today, thank you, and for those of you who did not, I am truly sorry, but I forgot to hit the Zoom record button. That said, I did record the whole session on my computer and will download the whole class on YouTube. The link should be on the webcast page for the class by later today. 

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.  Finally, we looked at two time-weighted, incremental cash flow approaches to calculating returns, NPV and IRR, and used them to analyze the Rio Disney theme part.  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 Netflix 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 Netflix should enter the fitness 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. 

If you missed yesterday’s class on Zoom, I apologize for the screw up on recording it on NYU classes, but I did record it on my computer and you can watch the YouTube version here.

I hope that you get a chance to watch and work on the Netflix case.

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:
http://youarenotsosmart.com/2011/03/25/the-sunk-cost-fallacy/
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. 
http://aswathdamodaran.blogspot.com/2012/10/the-yankees-rod-problem-sunk-costs-and.html

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:
https://people.stern.nyu.edu/adamodar/New_Home_Page/cfpuzzles/cfspr20puzzle6.htm 
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).

and the good news if you did not is that I did hit the record button on Zoom, and the recording should be up later today. I will also make the audio and YouTube versions. In today's session, we started by looking at how to deal with uncertainty, and cautioned against two practices:

1. Doing what if analysis as a defensive mechanism to cover your rear-end, rather than as the basis for better investment decisions and management.

2. Double counting risk, by rejecting positive NPV projects because the what if or simulation gives you negative NPVs some of the time.

In the context of what if analysis. I also mentioned Edward Tufte's book on the visual display of information. If you are interested, you can find a copy here:

First, a reminder that I will be available for office hours today from 3 pm - 4pm, NY time. Today is also 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. 

1. Do the finite life (15-year) analysis first. It is more contained and easier to work with. Then, try the longer life analysis. It is trickier…
2. On the Netflix studio investment, there seems be some confusion and I blame myself for loose wording. If you have no idea what I am talking about, here is the relevant section. Netflix Fit will use 30% of the studio for its content and that percentage will remain fixed over the next 10 years. The Asian content will continue to require 20% more each year, starting at the 40% that it will use next year: 
3. If you find yourself lacking information, make reasonable assumptions. Ignoring something because you don't have enough information is making an assumption too, just a bad one. 
4. When you run into an estimation question, ask yourself whether you need the answer to get accounting earnings or to get to incremental cash flows. If it is to get to earnings, and if your final decision is not going to be based on earnings, don’t waste too much time on it.
5. I think the case is self contained. For your protection, I think that you should stay with what is in the case. You are of course not restricted from wandering off the reservation and reading whatever you want on the fitness business and Netflix’s future, but you run the risk of opening up new fronts in a war (with other Type A personalities in other groups who may be tempted to one up by bringing in even more outside facts to the case) that you do not want to fight. And please do not override any information that I have given you in the case. (I have given you a treasury bond rate and equity risk premiums, for instance. Don’t bring in Corona Virus effects into your analysis. )
6. There are tax rules that you violate at your own risk. For instance, investing in physical facilities is always a capital expenditure. At the same time, make your life easy when it comes to issues like depreciation. If nothing is specified about deprecation, use the simplest method (straight line) over a reasonable life.
7. There is no one right answer to the case. In all my years of making up these cases, I have never had two groups get the same NPV for a case. There will be variations that reflect the assumptions you make at the margin. At the same time, there are some wrong turns you can make (and i hope you do not) along the way.
8. Much of the material for the estimation of cash flows was covered yesterday and in the last two sessions. You can get a jump on the material by reviewing chapters 5 and 6 in the book. The material for the discount rate estimation is already behind us and you should be able to apply what we did with Disney to this case to arrive at the relevant numbers.
9. Do not ask what-if questions until you have your base case nailed down. In fact, shoot down anyone in the group who brings up questions like "What will happen if the margins are different or the market share changes?" while you are doing your initial run…
10. Do not lose sight of the end game, which is that you have to decide based on all your number crunching whether Netflix should invest in the fitness business or not. Do not hedge, prevaricate, pass the buck or hide behind buzz words.
11. The case report itself should be short and to the point (if you are running past 4 or 5 pages, you either have discovered something truly profound or are talking in circles). You can always have exhibits with numbers, but make sure that you reference them in the report.

I know that you are working on the case right now and that the project is on the back burner. When you get back to it, though, one of the questions that you will be addressing is whether your company's existing investments pass muster. Are they good investments? Do they generate or destroy value? To answer that question, we looked at estimating accounting returns - return on invested capital for the overall quality of an investment and the return on equity, for just the equity component. By comparing the first to the cost o capital and the second to the cost of equity, we argued that you can get a snapshot (at least for the year in question) of whether existing investments are value adding. The peril with accounting returns is that you are dependent upon accounting numbers: accounting earnings and accounting book value. In the webcast for this week, I look at estimating accounting returns for Walmart in March 2013. Along the way, I talk about what to do about goodwill, cash and minority interests when computing return on capital and how leases can alter your perspective on a company. Here are the links:

Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/ROIC.mp4
Walmart: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10K.pdf (10K for 2012) and https://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10Klast%20year.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 Monday, April 6. It will be online and while the quiz will be accessible for 9 hours on that day (more details to follow), once you open the quiz online, you will have an hour. It is open book, open notes and you can use your laptops. The one concession that I have had to make is that the quiz, while it will resemble past quizzes, will be multiple choice (I am sorry but open ended online quizzes for a class this big are not viable). 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:

https://people.stern.nyu.edu/adamodar/New_Home_Page/cfprob0.html 

If you want to wait, I will send you more detailed instructions next week,

I hope that you are doing well and just in case you are stuck at home with nothing to read, I have attached the latest newsletter. It is, as usual, filled with scintillating tidbits (not) and amazing news (even more not), but it will get you caught up, in case you are falling behind. Leading into the weekend, I hope that the case is not giving you headaches. I won’t give you unsolicited advice, but I do have one. When you look at the case, focus on what changes, not what does not. On that mysterious note, I will leave you to your own devices. Until next time and please stay safe!

Attachment: Issue 7 (March 28)

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 beyond redemption...) By the end of Wednesday's class, we will be close to 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:

You can download either the pdf file or the powerpoint version. 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.)

Names of the group members in alphabetical order (or individual, if you are turning it in individually)

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 “Netflix Fit Endgame”. You don’t have to wait until Wednesday 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.

Presentation: https://www.stern.nyu.edu/~adamodar/pptfiles/acf3E/reviewQuiz2.ppt
Webcast: https://youtu.be/wsSwIfvaIG4 
You can also find all past quizzes with the solutions in the following links:
All past quiz 2s: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2.pdf
Quiz 2 solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2sol.xlsx

In keeping with the structure of this class, there will be a Zoom class on Monday (April 6), but it will be only 50 minutes, from 11 am - 11.50 am, NY time.  I will be having Zoom office hours tomorrow, from 1 pm - 2 pm, NY time, if you have any questions about the quiz or the case. Until next time!

The bulk of today's class was spent on the Netflix Fit case. While the case itself will soon be forgotten (as it should), I hope that some of the issues that we talked about today stay fresh. In particular, here were some of the central themes (most of which are not original):

Theme 1: The discount rate for a project should reflect the risk of the project, not the risk of the company looking at the project. Hence, it is the beta for fitness companies that drives the cost of capital for Netflix Fit, rather than the cost of capital for Netflix 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 studio investment not made in year 8.

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 (with corrections made to the after-tax cost of debt and the finite life length):

1. Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/NetflixFitPresentation.pdf 
2. Excel spreadsheet with analysis: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/NetflixFitAnalysis.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.  The quiz will cover the cost of capital section (after bottom up betas) as well as investment analysis (NPV, IRR, cash flows, incremental cash flows). To be safe, you should start around slide 177 and go through slide 314.

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 soon. 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.   (See link)

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.  I have also allowed leeway on the revenue forecasts (unless they are egregiously off), because different assumptions about retention ratios can lead you to very different conclusions. (I promise you that I will not be nitpicking.)

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:

9.5-10:  A
9: A-
8.5:  B+
7.5-8:  B
6.5-7:  B-
5.5-6:  C

<5.5:  Hopefully no group will plumb these depths

I have also updated the excel spreadsheet to reflect the fact that my case analysis that I presented in class had used a 5% working capital requirement, instead of 10% (I had meant to change it in the case, but never got around to it). For those of you who noticed, thank you. For those of you who did not, that’s okay.

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), and make sure you put “Netflix Fit Endgame” in the subject.. 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. ( fixed a couple of typos on the studio investment years and it should make more sense now). If you feel that i have missed something in your analysis, please come by and make your argument. I am always willing to listen. 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 Netflix's beta to analyze a project in a different business. However, I was pretty flexible on different approaches to estimating betas from the list of fitness companies.  Also, if you consolidated use that cost of capital to discount the synergy benefits to Netflix. 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 Netflix Fit was 3.5% (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 4 and year 6 for computing the studio investment. Some of you either ignored the savings in year 6 or attempted to allocate a portion of the investment in year 4,  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 1-10 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 11, by which point in time you are maintaining depleted assets. Those groups that did not include capital maintenance at all argued that they felt uncomfortable making estimates without information. But ignoring something is the equivalent of estimating a value of zero, which is an estimate in itself. 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. 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). 

Today is the day that I would send you a In practice webcast, but I will leave you alone to first recover from the case and then get ready for the quiz on Monday (April 6). Here are some details:

If you are ready to get started on that, here are some lead ins:

Past Quizzes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2.pdf

Past Quiz Solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2sol.xlsx

I won’t take too much of your time, given how much of it I already have. The newsletter for the week is attached. I will also be having Zoom office hours today (Saturday, April 4) from 5 pm - 6 pm, NY time. The Zoom link is below:

If you have any questions about the quiz, you can reach me then.

I know what you are thinking… Right? He wants me to do a case, follow up with a quiz and then ask me to do a corporate finance puzzle.! 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 that happened at the end of 2017, 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 six 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 doing well. I am sorry to be late on the project update email, but life got in the way. Anyway, a few quick updates:

1. Updated equity risk premiums: If you get a chance, please read my latest viral update post: https://aswathdamodaran.blogspot.com/2020/04/a-viral-market-meltdown-vi-price-of-risk.html

In addition to breaking down the market action by market, and within equity, by region, sector and other classifications, I updated the price of risk. Put simply, I computed the equity risk premium every day from February 14, 2020 to April 3, 2020. On April 1, 2020, the ERP for the S&P 500 stood at 6.01% (adjusted for lower earnings/cash flows). I used this update to also revisit my equity risk premiums by country and the updated ERPs by country are at the link below:

2. Google shared spreadsheet: One of the perils of taking a class online is that you can get lost in the maze, especially on things like projects. I know that I am a nag about this, but to provide both a prod and an assist, I have added all of the key numbers that you will need to have for this project into the Google shared spreadsheet, showing the numbers that I got for Disney and the page in the lecture note packet where I got them, and leaving cells where you can enter the numbers for your company. You may find it intimidating when you first open in, but trust me on this one. You will find that using it will give you structure on the numbers for your company.

Please do visit the shared spreadsheet and enter the numbers you have, at least so far for your company.

In Wednesday’s class, we talked about the trade off between debt and equity and today's in-practice webcast takes you through the process of assessing this trade off, with suggestions on variables/proxies you can use to measure each of the above factors. If you are interested, here are the links:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/tradeoffdebt.mp4 

Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/tradeoffdebt/debttradeoff.ppt
Spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/tradeoffdebt/tradeoffHP.xls
I am also attaching two spreadsheets: one contains the updated marginal tax rates by country and the other has the 2020 version of average effective tax rates by sector for US as well as for Global companies.

Marginal tax rates by country: https://www.stern.nyu.edu/~adamodar/pc/datasets/countrytaxrates.xlsx

Effective tax rates by industry

US: https://www.stern.nyu.edu/~adamodar/pc/datasets/taxrate.xls

Global: https://www.stern.nyu.edu/~adamodar/pc/datasets/taxrateGlobal.xls

I am also wrestling with what to do about the Zoom classes next week. To get you up to speed, my son and daughter-in-law were expecting a girl on May 4, 2020, but she decided to come early and arrived yesterday. (Here is a picture of her, age 12 hours old, this morning.) The good news is that she is healthy and doing well (though it has been only 24 hours) but they will all be in the hospital at least for a few days. The bottom line is that my grandson, Noah, who is two with us, and I have my hands full keeping him from getting himself and me into trouble, since my wife is teaching her second grade class on Zoom. I don’t think Noah will sit through a Zoom session, and I may have to offer a recorded alternative session and extra office hours to let you ask questions. I am sorry for the last minute twist, but… 

As I mentioned in yesterday’s email, I may have to do recorded sessions for Monday and Wednesday but I will let you know by tomorrow. I have attached the week’s newsletter (in case you are still keeping tabs). And please, please, please do visit the Google shared spreadsheet and enter the numbers that you have for your company:

I am sorry for missing the live session with you today but I hope that you had a chance to watch the recorded sessions. They are accessible on the webcast page the class and I am sorry about some glitches earlier today in that access. 

Zoom: https://nyu.zoom.us/rec/play/ucAvIeug-zM3GtKdtASDB6QsW9W6KKisg3Id-vdbnRmxUHlVZFunMLYXYLSadrz5Vn0I3nKORdVhV3-2

YouTube: https://youtu.be/5nSZLVbpG44

During the class, we started with the trade off between debt and equity and argued that in a world with no taxes, default risk and agency costs, it would not matter how much you borrowed. But in the real world, where all of those are in existence, there is an optimal debt ratio and we started on the first tool for assessing this optimal, which is the cost of capital, arguing that the debt ratio that minimized this was the optimal debt ratio. That requires estimating the cost of equity and debt at each debt ratio, and while I went through this for Disney, I said I would send a spreadsheet that would do this for you:

Please try this spreadsheet when you get a chance. It requires only about a dozen inputs for your company, and most to them are simple, to compute the optimal debt ratio for your company, and in the process, you will also compute the cost of capital for your company. 

I am sorry to be so difficult to get in touch with this week, but I would like you to keep things moving. To begin with, I hope that you had a chance to watch yesterday’s recorded session. Tomorrow’s session will also be recorded and should be available to watch at the regular class time (10.30 am - 11.50 am), if you are so inclined. I also sent you the link to the spreadsheet to compute the optimal capital structure. Please try it out, if you get a chance and if you need 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.

I hope that you had a chance to watch the recorded session for today. In case, you have not, it is available on Zoom and YouTube:

Zoom: https://nyu.zoom.us/rec/play/v5Arcuipqzo3T4GdtwSDB_8rW47pLKOs2nQc86ZbxUizUSQFYFXzYboWNLH_at_tGQitml2jmRsIBmNE

YouTube: https://youtu.be/v8Tih7nxt_o

The relevant pages in your lecture note packet 2 are pages 62-101. In this session, I start by looking at stress testing the optimal debt ratio and follow up by adding three other approaches for arriving at an optimal mix of debt and equity: the enhanced cost of capital approach, the adjusted present value approach, and relative analysis (where you set your debt ratio based upon the rest of the sector). I know that I threw a lot into the session, and I will be around for office hours today in about 10 minutes at the link below:

I don’t really see a need to do the APV analysis of your company’s capital structure, since the expected bankruptcy cost is a black box, but you can check out the debt ratios for other companies in your sector by going to my website:

US industry averages: https://www.stern.nyu.edu/~adamodar/pc/datasets/dbtfund.xls

Global industry averages: https://www.stern.nyu.edu/~adamodar/pc/datasets/dbtfundGlobal.xls

If you go to the data page on my website, you will see more data on debt, by sector.

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:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfprojectresources.html

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:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfproj.html

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:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/project/projform.htm

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 attached webcast on using the cost of capital spreadsheet, using Dell as my example. You can find the webcast and the related information below:

Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/optdebt.mp4 

Dell 10K: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/optdebt/dell10K2013.pdf

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 under calculation options. 

Also, I am sorry to harp on the Google shared spreadsheet but please enter your numbers there for your company, as you have them. 

You can use my Disney numbers as guidance, and the page numbers on the lecture notes will tell you where the numbers come from. I don’t know whether it will make you feel more in control, but it will make me feel better.

newsletter for this week to this email. I also wanted to thank the people who have already started entering numbers into the shared google spreadsheet:

And if you have not, I look forward to seeing your numbers as well. Finally, I know that your quiz is not for a week from Monday (April 27), but I have attached the links to the quiz reviews 

Just remember the quiz is multiple choice.

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: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3.pdf

Past Quiz 3s solutions: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xlsx

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. I also mentioned that the individual company regressions against the macro variables are so noisy that it is probably not worth the effort. If you are just curious and want to try this out on your company, I do have the macro data collected in a spreadsheet that you can use to run this regression for your company:

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

It has annual and quarterly data through 2019. The post class test & solution for today is attached. 

Attachment: Post-class test and solution

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. 

There are two other notes. One relates to the optimal capital structure spreadsheet that you may have tried on your company. Some of you have directed my attention to what seems like a mistake on my computation of the interest coverage ratio, where it looks like I am dividing taxable income by interest expenses to get to the interest coverage ratio. In truth, I am doing the right thing, but in a convoluted way.

EBIT/ Interest expenses = (EBIT - Interest Expenses)/ Interest Expenses + Interest Expenses/ Interest Expenses = Taxable Income/Interest Expenses + 1

The last part is what I am using. The other relates to the fact that some of you did not print off the Bloomberg regression page for your company before you were forced to leave campus. Don’t let this paralyze you. The only numbers that you get from the spreadsheet are your raw beta, intercept and R-squared. You can get the beta and the R-squared for your company from S&P Capital IQ. You can also get a rough measure of Jensen’s alpha by doing the following:

Jensen’s alpha = Average return on your stock - Raw Beta * Average return on the market, over the rergression period. Thus, if you are using the 2-year beta from S&P Capital IQ, you would compute the annual average return on your stock in the last two years (using the price change over the period and any dividends) and the annual average return on the S&P 500 over the same two years (you can use just the change in the index and ignore dividends).

I know that you are busy but I have put the webcast up on debt design, using Walmart as my example, online (on the webcast page as well as on the project resource page).  Here are the details on the webcast:
Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/debtdesign.mp4

Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/debtdesign.ppt
WMT financial summary: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTFAsummary.pdf
WMT macrodur.xls spreadsheet: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTmacrodur.xls

The updated macroduration spreadsheet with data through 2019 was attached to yesterday’s email but I am attaching it again, just in case! Hope you find it useful. 

I am also tracking the numbers on the Google shared spreadsheet (I am sending you the link again, though you are probably tired of it), but I am glad to see the page start to fill up. If you have not entered the numbers yet, please do:

Until next time!

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

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 will get over the finish line. This week, we will start on and mostly complete our discussion of dividend policy, the last of the three big corporate finance pieces. We will have class after the quiz on Wednesday, though it will start 30 minutes later than usual at 11 am, NY time and go through 11.50 am. I have office hours today, though I would prefer to use that hour for my two valuation classes, where the quiz is tomorrow, and again on Tuesday (6 pm - 7 pm, NY time), where you will be the center of attention. The zoom links are below:

Today’s session, 5 pm - 6 pm, NY time: https://nyu.zoom.us/j/91501927508 

Tuesday’s session: 6 pm - 7 pm, NY time: https://nyu.zoom.us/j/571950569

I first want to apologize for the glitches in today’s zoom session. The broadband was an issue and I thank you for suggesting that I turn off the video and leave the slides, since it improved somewhat. If you had trouble, the session as recorded on my computer will be available on YouTube later today. We spent today's session first talking about the characteristics of dividends, i.e., that they are sticky and follow earnings as well as reasons for the shift towards buybacks in recent decades, We ended the class by looking at two bad reasons for paying dividends (that they are more certain, that you had a good year). In the next class, we will talk about three good reasons for paying dividends as well as a way of measuring how much cash can be returned (FCFE).  That class, though, will be on Wednesday, which is also the day of the third quiz and it will be a full session from 10.30- 11.50 am, NY time (not a shortened session). At the risk of repeating what I have emailed out multiple times already, here are the links that matter

2. Content: The quiz will cover capital structure; Lecture note packet 2: 1-148; Chapters 7-9 in the book

3. Timing: The quiz will be open from 3 am - 2 pm on Wednesday, April 29. It will be an hour long and be multiple choice. So, please get started before 1 pm. Also, I know that the quiz times overlap the class, but if you can make it to the class, I would enjoy seeing you there.

As you work through the past quizzes, here are a few things you may want to keep in mind:

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. 

https://www.stern.nyu.edu/~adamodar/pc/capstru.xlsx  

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). 

You can watch the webcast I will be posting tomorrow, if you run into questions.

I know that this has been an unsettling semester for many of you, both in terms of classes and life, and the last thing I want to do is to make your life more difficult. I know that I have been demanding of your time and that I nag you without stop, but I really, really want to make sure that you are able to get as much out of this class online, as you would have in person. That may not be doable, but I will be damned if I stop trying. That said, we are on the cusp of the last part of the class and I decided that it is time to talk about that which will not be mentioned, which is grades. With no further ado, here we go.

1. Sunk Costs:  We are collectively done with three quizzes and a case, and you should be able to check your score on NYU Classes in the grade book. As you look at your quiz grades, remember that your worst quiz score will be replaced by the average score on the remaining quizzes (already done) and the final (still to come). Thus, if you have 6,8 and 10 on your three quizzes, your worst quiz (6) will get replaced by your average score on the other two quizzes and the final. Since you have not done the final yet, I cannot give you the answer, but if you get 27/30 on the final, your percentage score across the two best quizzes and the final will be 90% (8+10+27/50). Your worst quiz will get marked up to a 9/10.
2. Quiz distributions: I usually give out distributions on the quiz scores, and I am going to stay true to that practice. I am attaching the distributions for quizzes 2 & 3 to this email. Be very careful what you read into these scores.
3. Pass option? I know that this semester, you have the option of taking this class pass/fail instead of for a grade. Some of you have emailed me about whether you should take this option and I cannot make that judgment for you. That said, I also am cutting some slack into the grading distribution to allow for the fact that it is more difficult, especially if you are not a finance person, to take this class online and that even if you are not doing well on the quizzes, it may not be reflective of the work you are putting into the class. Consequently, I will look at both the case and the final project to make a judgment on your final grade. Put simply, if you turn in a solid effort on both and I believe that you are getting comfortable with corporate finance, I will put a floor on your grade. Whether that floor is a C, a B- or a B will rest on how you do on the final exam. You may still prefer a P to that grade, but to get the pass, you still need to do the final project. 
4. Multiple choice: I have wrestled with the multiple choice versus open ended question in writing the quizzes and exams. I don’t like multiple choice questions, because they don’t allow for nuance or partial credit. To compensate, though, you have more time, you can use your laptop and I have made each question a stand alone question, so that you don’t have carry over mistakes. With all that said, I know that some of you feel that the multiple choice format is putting you at a disadvantage. Talk to me in the next few days, if that is the case. If your concern is more at the margin, that a silly mistake on one question will cost you an A, leave that in my hands and trust me. I will figure out an equitable solution.

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

Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/dividendtradeoff.mp4

Presentation: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/dividendtradeoff.pdf 

The second webcast looks at the question, again using Intel:

Webcast: https://www.stern.nyu.edu/~adamodar/podcasts/Webcasts/dividendassessment.mp4 

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 and at the risk of reminding you one times too many, please enter your numbers in the Google shared spreadsheet, when you have a chance. 

Looking to the final exam, I know it is early, but here are a few reminders. The final exam will be on May 15 and as with the quizzes, it will be accessible for 12 hours. Since it is a 2-hour final, you will need to get started about two hours before the accessibility ends. It will be open book, open notes. I know that in the pre-COVID days, there was talk of an early final exam, as some of you had other plans. Since it looks like this shut down has put all o

In today's class, we started by using the dividend assessment process of looking at FCFE/cash return and then gauging trust in management, using the companies that we have used as lab experiments in the class (Disney in 2003, 2009 and 2013, Vale in 2013, Tata Motors in 2013) and peer group analysis. In the process, we looked at why it is so difficult to get out of a dysfunctional dividend policy, as control trumps sanity and worries about the short term and peer group comparables delay action.  We then started on valuation as the place where all of the pieces of corporate finance come together - the end game for your investment, financing and dividend decisions. 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. 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:

http://aswathdamodaran.blogspot.com/2016/05/dcf-myth-3-you-cannot-do-valuation-when.html 

Finally, I have 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. I know that you may find  this to be a bit of a black box at the moment, but given that time is of the essence, I thought it would not make sense for you to be building up your excel skills at the moment. 

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

The answer is complicated. I would like them to be, and it is easy to do, if you have kept your input numbers in a separate sheet. If you have hard coded numbers into spreadsheet, it will be really messy, and my advice is don’t do it. Pick a date for your macro numbers (risk free rate, equity risk premium etc.) and do your analysis as of that date. Move on!

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. 

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). 

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)

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.

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.

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.)

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.

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.

7a. My optimal debt ratio is coming out to be zero. What am I doing wrong? The most common input error that can lead to an optimal debt ratio of zero is that you mismatched units (it is usually the share count that is in different units than the rest of your numbers). If there are no input errors, it is entirely possible that your optimal debt ratio is really zero. That can happen in three scenarios. The first is if your operating income is a low percentage of your enterprise value; for high growth firms, the market cap can be high relative to operating income, because of growth potential being priced in. Zoom, for instance, is a vibrant, fast growing company but its optimal debt ratio is zero percent.  The second is if you have a very low unlevered beta, which can happen either because you are in a very safe business or because you are using a regression beta that does not reflect your current debt to equity ratio. 

Try the "FAQ" worksheet in the capital structure spreadsheet. 

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.

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...)

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.

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...)

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.

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... 

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.

Please enter the numbers you have for your company in the Google shared spreadsheet:

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). On the front page, please list all group members in alphabetical order (last name). 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.

Six days from today (5 pm on May 11)... but the memories will last forever…

In today’s session, we continued on the question of how best to value a company by first looking at the four key components of value - cash flows from existing investments, growth in the future, discount rates and the terminal value. With cash flows, we noted the contrast between cash flows to equity and cash flows to the firm, with the former being after debt payments and the latter before. With discount rates, we argued that the same discount rates that we computed for investment hurdle rates can be used in valuation, with the caveat that these discount rates will change over time, as a company changes. While you can adjust betas, costs of debt and debt ratios, a simpler way to target a cost of capital in stable growth is to look at the median cost of capital for  companies, in this graph.

These numbers are from January 2020 and collectively have increased by about 0.50% since. The median cost of capital for a global company now is about 8%, in US dollar terms. With growth, the key is recognition that growth comes from what companies do in terms on how much they reinvest and how well, rather than from outside sources. Finally, for terminal value, I argued that the growth rate in perpetuity has to be less than or equal to the risk free rate. Since you will be valuing companies in different stages in the life cycle, with the crisis throwing a wrench in the works, I would like you to use the spreadsheet linked below:

For assistance along the way, try this YouTube video:

I know that you feel uncomfortable with the valuation part, as it is towards the end of this class and requires story telling, but do the best you can. And if you feel you like this process or are curious, come back next spring for the valuation class.

In today’s session, we continued on the question of how best to value a company by first looking at the four key components of value - cash flows from existing investments, growth in the future, discount rates and the terminal value. With cash flows, we noted the contrast between cash flows to equity and cash flows to the firm, with the former being after debt payments and the latter before. With discount rates, we argued that the same discount rates that we computed for investment hurdle rates can be used in valuation, with the caveat that these discount rates will change over time, as a company changes. While you can adjust betas, costs of debt and debt ratios, a simpler way to target a cost of capital in stable growth is to look at the median cost of capital for  companies, in this graph.

These numbers are from January 2020 and collectively have increased by about 0.50% since. The median cost of capital for a global company now is about 8%, in US dollar terms. With growth, the key is recognition that growth comes from what companies do in terms on how much they reinvest and how well, rather than from outside sources. Finally, for terminal value, I argued that the growth rate in perpetuity has to be less than or equal to the risk free rate. Since you will be valuing companies in different stages in the life cycle, with the crisis throwing a wrench in the works, I would like you to use the spreadsheet linked below:

For assistance along the way, try this YouTube video:

I know that you feel uncomfortable with the valuation part, as it is towards the end of this class and requires story telling, but do the best you can. And if you feel you like this process or are curious, come back next spring for the valuation class.

Attachments: Post-class test and solution

I hope that your project numbers are getting nailed down. From the looks of the Google shared spreadsheet, we are taxiing towards takeoff and I thank you. I don’t plan to download the numbers (to prepare for the last class until Sunday. Please enter your numbers, if you have not already, by then. If you have entered the numbers and change your mind, you can go in and change your numbers before then.

'

One quick side note. I noticed that many of you had SKIP as the answer to the R-squared. Since it is not a key number in your analysis, I don’t mind, but the R-squared for your company should be accessible on S&P Capital IQ. To get the number, though, you need to go through the screening tab on top (don’t ask me why you cannot easily get to it on the company page), screen for your company and its peer group, and then in the display columns, look under market data/ stock price/volume.

I will keep this short. 

1. Please give the valuation of your company a try, if you are done with the capital structure and dividend sections. As I mentioned in my email earlier this week, I understand that we have not spent much time on valuation and the spreadsheet that I sent you may seem like a black box, but if you look past the complexities, it is simply an attempt to convert what you know about your company into growth, profitability and reinvestment assumptions. The rest is just mechanics. 

2. When you have the numbers, please enter them in the Google shared spreadsheet. I would like those numbers by Sunday, even though your project is not due until Monday at 5 pm, NY time. And I will keep my promise and add 5 points to your overall score, when you do submit.

3. I will be having office hours today at 1 pm, NY time. I know that office hours are getting crowded, but I have about 800 people in the three classes put together. I know office hours are scheduled to be until 2 pm, but I will stay on today as long as there are people waiting.

It is the final weekend of the class, and I wanted to remind you again to enter the numbers for your company, when you have them, into the Google shared spreadsheet:

https://docs.google.com/spreadsheets/d/1MKzjv0uYwscMTd-NczsUM2SVg44JrPVzJbrGw5NkThs/edit?usp=sharing 

In addition, please remember to fill out the course evaluations. The instructions are below. To be honest, I don’t know what the consequences are for forgetting, but why risk it? Just get it done!

• To access your CE, sign into Albert and scroll down to the Enrolled Courses section. Click the Eval icon for the course you would like to evaluate.
• The evaluation will open in a new tab. Please ensure your pop-up blocker is disabled, otherwise you will not be able to access your evaluation. Instructions on how to disable your pop-up blocker can be found here.
• When you have completed the evaluation be sure to click the submit button.
  
  

I would say the end is near, but in these apocalyptic times, that may create a panic, but the fat lady is clearing her throat. Here are a few last to-dos on the class:

Thank you! I know how much time you are investing in this class and I appreciate it.

For those of you who were able to enter your numbers into the Google shared spreadsheet, thank you. The presentation for tomorrow’s class is at the link below. Please download when you get a chance:

https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/ProjSumm20.pdf 

And as I mentioned in earlier email today, I would love to see you live in class (really). 

Again, thank you for sending me your summaries and helping me put together the presentation for today's class. If you were not able to make it to class, I have attached the presentation to this email.  

In class today, we looked at the big picture of the class, using the project findings to illuminate each part from corporate governance to risk to investment analysis to capital structure, dividend policy and valuation. On the valuation part, I made a mistake on both the graph and the undervalued stocks that you found. The correct graph (which now shows consistency with the valuation class, since 60% of  you found your stocks to be overhauled) is attached.  I will post the summary numbers for the entire class online.  As for the final, I will send you a detailed email tomorrow. For the moment, I will let you enjoy a few minutes of respite.

Attachments: Closing presentation, Project summaries

I decided to give you a break and some breathing room today, but I know that the final exam is coming up on Friday (April 15). The final exam review webcast, slides, exam and solution links are below:

I hope they help.

As you prepare for your final exam, here are some loose ends.

1.  Logistics: The final exam will be on Friday, May 15. It will be accessible from 3 am - 9 pm, NY time and will take 2 hours to do.
2. Questions: The questions will be multiple choice. There are 8 questions on the final with points ranging from 3 for some questions to 5 for others.
3. Coverage: The exam is comprehensive. It will cover the whole course. However, four of the questions (out of the eight) will relate to dividends and valuation, i.e., what we have done since the third quiz.

Until next time!