I hope that you are in some place warm and sunny, albeit distanced and safe. I also hope that you are ready to get started on classes and that you got my really long email a weeks ago. If you did not, you can find it here:

This one, hopefully, will not be as long and has only a few items

1. Website: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/corpfin.html
Please do try to download the first lecture note packet soon. The direct link to the lecture note packet is below:

Lecture note packet 1: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfpacket1spr21.pdf (as pdf file) or https://www.stern.nyu.edu/~adamodar/pptfiles/acf4E/cfpacket1spr21.pptx (powerpoint file)

You can print it off or just keep it on your tablet (as long you can make notes on the pages).

2. Pre-class prep: What kind of twisted mind comes up with a pre-class prep for the very first class? That said, I know that some of you are worrying about whether you are ready, especially if your accounting and finance foundations are shaky. If so, you can take my speedy quick accounting-for-people-who-think-accounting-is-mostly-pointless class (it should not take more than a few hours) or foundations-in-a-hurry finance class.

a. Accounting class: https://people.stern.nyu.edu/adamodar/New_Home_Page/webcastacctg.htm 

b. Basics of finance (present value, a dash of this and that….): https://people.stern.nyu.edu/adamodar/New_Home_Page/webcastfoundationsonline.htm 

3. YouTube links: I had sent these out in my previous email but no harm repeating. The YouTube Playlist for this class is: https://www.youtube.com/playlist?list=PLUkh9m2Borql2njENzmUX2DoZr5E2-YXs.  You can find the webcasts for this class at: https://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr21.htm. For those of you who have not got around to checking, class is scheduled from 12.30-1.50 pm on February 1, and I will see you on Zoom. See you there! Until next time!

As we head into the last weekend before class, I am sending this as a collective email to all of my classes (Corporate Finance, MBA Valuation and Undergraduate Valuation). So, please be careful before you replay all, since roughly a thousand people are in the three classes put together. When I start class on Monday, it will be my 37th year teaching and I am thankful that I still look forward to the day. There is no other profession where you can start with a fresh slate every few months, even though you may screw it up in the subsequent days and weeks. The class times on Monday (February 1), just in case you need a reminder, are:

• Corporate Finance, from 12.30 pm -1.50 pm, NY time
• Valuation (MBA), from 2 pm - 3.20 pm, NY time
• Valuation (Undergraduate) from 3.30 - 4.45 pm, NY time

As you can see, there is only a sliver of time between the classes (ten minutes), and if I seem like I am in a rush to get out, once class ends, that is the reason. Please come to the zoom class, unless the time zones work too much against you or you have life and death commitments. 

I last emailed you just four days ago, and for those of you are wondering how much can happen in four days, the evidence is in front of you. We have had three big market movement days (two negative, one positive) in the last three days, and if you are thinking about places to hide from risk, you may want to start by reading my third data post for 2021:

http://aswathdamodaran.blogspot.com/2021/01/data-update-3-for-2021-currencies.html 

If you did not get a chance to look at the first two, they are linked at the bottom, and one of them gives you my market view (I would not pay for it, but its free…). The even bigger story is the frenzy around GameStop, with Reddit traders taking hedge funds to the woodshed. The story has legs because it has shades of David versus Goliath, and it feeds into many of the populist and political themes that have surrounded us for the last decade. I normally don’t write reactive posts, but this one was big enough that I did it anyway:

http://aswathdamodaran.blogspot.com/2021/01/the-storming-of-bastille-reddit-crowd.html 

As you read this post, you will see that I am not a fan of hedge funds, most of which are run by people who bring nothing to the table, while charging obscene fees and delivering sub-standard returns. That said,  I am not sure what the end game for Reddit investors is, either. I have offered four choices, and given my opinion, but you be the judge! Until next time!

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. Until next time!

It is never too early to start nagging you about the project. So, let me get started with a checklist (which is short for this week but will get longer each week. Here is the list of things that would be nice to get behind you:

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/1bWDy_H3VOsv8xU92c8HNarPiJJQKMLThlaDvb7IySyA/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. Once you have picked the company, please enter the company’s name into this spreadsheet (recognizing that you can come back and change it, if you change your mind): https://docs.google.com/spreadsheets/d/1F327sLVgKJCaHKEz-pDmMREI-yPcspW7Lnmy6GDNrj8/edit?usp=sharing 
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.

In addition, your TAs will have both office hours each week, and a review session, where they will cover problems from past quizzes and exams, related to the material of the week. I have scheduled the Zoom sessions for those, and they should show up on NYU classes, when you log on. Sorry for this convoluted and messy email, but there are some things that are more complicated online than in physical locations. Until next time!

As promised, here is the first of the weekly in-practice webcasts. These are 10-15 minute webcasts designed to work on practical issues in corporate finance. This week’s issue is a timely one, if you are working on picking companies for your project (as you should be..). It is about the process of collecting data for companies, the first step in understanding and analyzing them. The webcast link is below:

It is a little dated (but I have been too lazy to update it), but 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/webcastcfspr21.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/cfspr21puzzle1.html 

At the risk of nagging, please do get the lecture note packet 1 downloaded before Monday’s class. It is now available (or was at least yesterday) in the bookstore. Until next time!

Before I start on the newsletter part, a quick note about the TAs for this class, Sam Greene (sg3097@stern.nyu.edu) and Siddharth Kejriwal (sg3097@stern.nyu.edu). The times and zoom links are available on NYU classes. They will be holding office hours every week, and having a zoom session to go through applications of the material from the week, using past quizzes.  As you start the weekend, I decided to butt in with the first of my newsletters. As you browse through it (and I hope you do), you will realize that this is not really news or even fake news. It is more akin to a GPS for the class telling you where we’ve been and where we plan to go. It is a good way to get a sense of whether you are falling behind on either the class or the project, especially as we get deeper into the class. So, enjoy your weekend and I will see you on Monday! Until next time!

Attachment: Issue 1 (February 6)

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. Until next time!

Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large.  Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? We will start the next class by talking about social costs and benefits and how difficult it is to incorporate them into decision making and we will continue on that theme in the next class. Again, plenty to think about while you are sitting in your CSR class!  We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. In the next class, we will take a more prescriptive look at what we should be doing in this very imperfect world. As always, reading ahead in chapter 2, if you have the book, will be helpful.

I hope that your search for a group has ended well and that you are thinking about the companies that you would like to analyze. Better still, perhaps you have a company picked out already. If you do, try to find a Bloomberg terminal  (there is one in the MBA lounge and there used to be one in the basement)... If you do find one vacant, jump on it and try the following:

1. Press the EQUITY button

2. Choose FIND YOUR SECURITY

3. Type the name of your company

4. You might get multiple listings for your company, especially if it is a large company with multiple listings and securities. Try to find your local listing. For a US company, this will usually be the one with your stock symbol followed by US. For a non-US company, it will have the exchange symbol for your country (GR: Germany, FP: France, LN: UK etc...) It may take some trial and error to find the listing....

5. Type in HDS

6. Print off the first page of the HDS (it should have the top 17 investors in your company).

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

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?

Just to be clear, you don’t have to show me your answers. These puzzles are more about you getting comfortable with your assessment of different aspects of corporate finance. Until next time!

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://www.sec.gov/Archives/edgar/data/1018724/000119312520108422/d897711ddef14a.htm) 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 my good friend, 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).

Attachment: Issue 2 (February 13)

I hope that you had an enjoyable and productive long weekend, and since we have no class tomorrow, you will get at least one day without email. On Wednesday, we will complete our discussion of corporate governance and start with a discussion of risk and how it plays out in hurdle rates. In the process, we will talk about the model that started the ball rolling, the capital asset pricing model (CAPM, how it is mystified by some and vilified for others, often in advancement of their agendas, and about alternatives to i5. We will move through this discussion in hyper speed for two reasons. One is that I have zero interest in reinventing modern portfolio theory and showing the mechanics of correlation and covariance. The second is that while I use the CAPM as a tool to estimate hurdle rates, I am not wedded to it and accept all kinds of alternatives (some of which we will talk about in class). 

If you are still shaky about even the assumptions that underlie the model, my suggestion is that you read chapter 3 from the applied corporate finance book before the class. We will then start on the fun stuff of applying the model, starting with what should be a slam dunk (risk free rates) which is increasingly not and then turning to the equity risk premium, a number that analysts often turn towards services to look up but really has deep implications for both valuation and corporate finance. So, much to do and I hope that you come along for the ride. 

Finally, since we will be talking about hurdle rates, you may find my most recent blog post on the topic useful:

In fact, if you find yourself with nothing else to do, try the second in this data update series as well:

I am sorry to hit you with a second email on the same day, but this one is about getting data for your company, In the next week or two, we will delve into estimating betas for your company, and if you have access to a Bloomberg terminal, you can pull up the beta page for your company. If you have used a Bloomberg terminal before, you will easily find your way on it, but just in case you have not, I have put together a webcast to help you:

While I look at only a couple of commands (HDS, to get ownership lists, and BETA, to get the beta page) in this webcast, I have a document that lists out all of the Bloomberg commands I use:

If you are in New York, and you can go into school, you can find the Bloomberg terminals in the building:

If you are not in New York, and you don’t have access to a Bloomberg terminal, never fear. All of the data that you get from a Bloomberg, you can get from other sources, and I will send you those links on Thursday. That’s about it. Until next time!

We started the class by wrapping up the question of at the end game in business, and why I (and you don’t have have to) still trust markets, over managers and expert panels. Markets have no ego, and if allowed to play out, will devise corrections to almost every over reach in business, whether it be managers taking advantage of shareholders, borrowers ripping off lenders, companies lying to markets or creating large social costs. My view is that companies should run to maximize value, even if the market does not recognize it right away, and that managers need to consider the messages in stock prices.

We then moved on to risk and some of you may be regretting the shift from the soft 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.  Until next time!

If my nagging is paying off, you should have picked a company by now and if you have, you can move on to 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. This will require a degree of judgment, but remember that you are not trying to identify a particular investor (Blackrock, Vanguard etc.) but a type of investor (institutional, insider, individual etc.). In making this assessment, having access to a Bloomberg terminal can speed the process, and if you get a chance, look at the YouTube video that I sent to you about using Bloomberg. If you don’t have access to a terminal, never fear, since much of the data is public. You can get both the breakdown of investors into insider and institutional, as well as the top holders of your stock. Here for instance is the page for PlugPower, a US company listed on the NASDAQ (under Holders): https://finance.yahoo.com/quote/PLUG/holders?p=PLUG

The assessment of who the marginal investor in PlugPower is easy to make. It is a large institutional investor, and very diversified.  You can see that 53% of PlugPower’s shares are held by institutions, and if you are wondering whether that is high or low, I have data on insider and institutional holdings, by sector, for US, Global, European, Emerging (with China and India as separate date sets), Japan and Australia/NZ/Canada. You can find them here:

Scroll down to insider/institutional holdings and download the excel spreadsheets. Until next time!

In the only session we had this week, we covered some ground, moving well into our discussion of risk and return models. Next week, we will be starting on the first of the three inputs into your cost of equity, the risk free rate. If you want to get ahead of the curve, you can watch the webcast for this week, which looks at how to estimate risk free rates in different currencies, and how sovereign default spreads can be useful in getting there:

Last week, we put the objective function to rest and turned our attention to risk models. Next week, we will start our discussion of risk free rates, and how best to estimate risk premiums and convert them into hurdle rates. If you have had a chance to pick a company for your project, this is a good week to catch up on the corporate governance part, and perhaps even get a risk free rate in the currency of your choice. This week’s newsletter is attached.

Attachments: Issue 3 (February 20)

We started today’s class by tying up the last loose ends with risk and return models, talking about how assuming that there are no transactions costs and private information can lead us all to hold the market portfolio, and how risk can be then measured as risk added to that portfolio. We did damn the CAPM with faint praise, arguing that it does not do very well at explaining differences in returns across companies, but that it does at least as well as the alternatives. We then started on the mechanics of the model, taking about risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:

http://aswathdamodaran.blogspot.com/2015/04/dealing-with-low-interest-rates.html 

In fact, risk free rates turned negative in a few currencies, upending what we know about risk free rates in. Here is my post on negative risk free rates.

http://aswathdamodaran.blogspot.com/2016/03/negative-interest-rates-unreal.html 

In the final few minutes of the session, we turned to equity risk premiums and how they are related to risk aversion. More on that in the next class

As we are reach the tail end 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:

Today's class was spent talking mostly about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at three different ways of estimating the equity risk premium. 

1. Survey Premiums:   I had mentioned survey premiums in class and two in particular - one by Merrill of institutional investors and one of CFOs. You can find the Merrill survey on its research link (but you may be asked for a password). You can get the other surveys at the links below:

As part of the weekly project nag, I am going to start by assuming that you have picked a company to analyze and that if you have not entered its name in the Google shared spreadsheet, it is an oversight that you will fix soon. 

https://docs.google.com/spreadsheets/d/1F327sLVgKJCaHKEz-pDmMREI-yPcspW7Lnmy6GDNrj8/edit?usp=sharing 

Here are some things to consider doing to catch up:

1. Corporate governance: If you have not started on your corporate governance section, please do so, focusing on the question of how much power you feel you have as a shareholder in your company. To make that assessment,  you should start with whether your company has two classes of shares to see if you have already lost the game. You should then look at share holdings in the company, to see whether an individual or family has a controlling interest (which does not have to be 51%… 25% or even 15% may be enough) and to examine whether you may be able to ride the backs of activist investors in the company. Once you are done, please go to the Google shared spreadsheet and enter your subjective assessment of how much power you think shareholders have in the company, on a scale of zero (no power) to two (strong power).
2. Marginal investor: Staying on the sheet of top stockholders in your company, in conjunction with what percent of your company’s stock is held by institutions and individuals, make a judgment on what type of investor (institutional, insider, individual) is the marginal investor in your company. Please input that too into the Google shared spreadsheet.
3. Riskfree Rate & ERP: Now, that we have the risk free rate nailed down (it depends on your currency) and a way of computing ERPs for companies, try to find the geographical breakdown of revenues for your company, so that you can compute a company ERP. I will be posting in-practice guides tomorrow on both.
4. Beta page: If you can get on Bloomberg (either a physical terminal or on the virtual terminal - see email from last week), please print off the BETA page for your company and bring it to class with you.

It is Friday and time for the in-Practice Webcasts. I have two for this week. The first is on estimating implied equity risk premiums:

The second webcast is on 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

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:

This week’s challenge is on betas and I have used GameStop as my lab experiment. First, check out the description of the puzzle (with the beta pages for both companies):

In today’s class, we looked past regression betas at how the choices companies make about the businesses they enter can determine their betas.. Summarizing the class, here is what we listed as the three determinants of betas:

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

2. Your cost structure matters. The more fixed costs you have as a firm, the more sensitive your operating income becomes to changes in your revenues. To see why, consider two firms with very different cost structures

Firm A Firm B

Revenues 100 100

- Fixed costs 90 0

- Variable costs    0  90

Operating income  10   10

Consider what will happen if revenues rise 10%. The first firm will see its operating income increase to 20 (an increase of 100%) whereas the second firm will see its operating income go up to 11 (an increase of 10%)... that is why looking at percentage change in operating income/percentage change in revenues is a measure of operating leverage.

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

I know that today's class was a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash).  If you got lost at some stage in the class, here are some of the ways you can get unlost:

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

I know…. I know… Last thing you want to do right now, but this week’s newsletter is attached. Since the quiz is on your mind, here are a few thoughts:

1. You should have the links to past quizzes and solutions. Try to work through at least some of the problems, starting with the latest quizzes and working back, not just browse them. You learn corporate finance by doing.
2. If you have never taken an online class and you are worried about what form this test since will take (since it will not be open ended like prior quizzes), I have created a demo quiz and it should be accessible through today and tomorrow on NYU classes. It will contain three questions, one qualitative multiple choice, one quantitative multiple choice and one calculated answer question; if you have no idea what I am talking about, take the demo quiz and find out. It is short (only twenty minutes) and it is meant to get you comfortable with accessing the quiz and answering the actual quiz. 
3. I will have office hours tomorrow (Sunday, from 6 pm - 7 pm, NY time). By then, you should have your reviews done and you are welcome to come in with your questions. The zoom link for the office hoursIs: https://nyu.zoom.us/j/92059720232 

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

Finally, if you did watch the review session and were wondering about the answers to the last page, I have attached my answers. Your quiz will be accessible from 4 am tomorrow (Monday, March 8) morning, NY time, until 1.30 pm, NY time, and will take an hour. So, please start your quiz by 12.30 pm, NY time, if you push it later. There will be class tomorrow from 12.30 pm - 1.30 pm. So, if you are done with your quiz, please come to class. Until next time! Sorry about the long email… 

I know that it is tough to sit in on a class, after you have taken a quiz and I appreciate it that so many of you did come to class. We started class today by looking at how divisional betas and costs of equity are critical for multi-business companies, in making investments and allocation capital. We also looked at the process of estimating betas for the remaining public companies in the mix, with financial service companies being treated a little differently, because debt is impossible to nail down, and levering and unlevering betas is tough to do. Finally, we examined how to estimate the cost of equity of a private company, and why it may be higher than an otherwise equivalent public company. I have attached the post class test & solution. You will notice a couple of questions about debt, which we have not covered in class, but I think that you will be able to handle those.  

The quiz scores should be accessible in a little while (at 6 pm, NY time), with the full solutions to the problems, when you click on your quiz. I hope that you did well and I will send out a few notes on the quiz tomorrow, but right now may be too soon. One final note. If you have checked your Google calendar, you will notice that there is a group case due on March 31 just before class (at 10.30 am). That case should be available for download tomorrow or day after, and more about it, when it is accessible.

Attachments: Post-class test and solution

I know that today is your puzzle day, but rather than give you a puzzle, I am posting the case with one of the exhibits as an excel spreadsheet:

1. The Case: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/GCar.pdf
2. Fitness company data (Excel): https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/AutoComps.xlsx

In today’s class, we started by looking at the three criteria that sets debt apart: a contractual commitment that is usually tax deductible and comes with consequence for control and survival, if missed. We argued that all interest bearing debt as well as lease commitments need to be considered. We then talked about estimating a cost of debt, specifying that it is the cost of borrowing money long term, today. Finally, w explained our preferences for market value 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.  To get a cost of debt, you need a bond rating (actual or synthetic) as well as default spreads that go with these ratings. The former should be available for your company, if it is rated. If not, use the following spreadsheet to rate your company:

It comes with a lease converted, if you want to use it. The default spreads used to be accessible online for free at bondsonline.com, but it seems to be defunct. You can get default spreads for key ratings classes (AAA, AA, A, BBB, BB, B and CCC & below) from the Federal Reserve website in St. Louis. 

Look for the effective yield and then subtract out the risk free rate from it. While you may have to extrapolate from these numbers for intermediate ratings, it is eminently doable. Alternatively, you can get updated spreads for every ratings class from a Bloomberg terminal by typing in FWIW, and resetting a couple of inputs. (If I can get on Bloomberg, I will try to make a video of how to do it… Looks like I cannot get on right now.) 

File this away under “There is no rest for the wicked”, as I bring you back to the your project. Assuming that you have been working along with me, by now, you should have a risk free rate in the currency of your choice, an unlettered beta reflecting the business or businesses that your company is in and the equity risk premium that you have for your company. To get the unlevered beta to a levered beta, you need market values for equity and debt. With a publicly traded company, the former should be easy (market capitalization of all classes of shares) but the debt can be tricky. You should at least be able to get a book value of debt from the balance sheet (remember to count both short term and long term interest bearing debt), and if your company has leases and is following either GAAP or IFRS, the lease debt should also be there. If you don’t trust accountants, and want to do this right, you can covert book debt to market debt and capitalize leases for your company, but you will need a cost of debt for your company to be able to do this, and you can get that using either an actual rating or a synthetic rating for your company. I have a ratings spreadsheet that will do both (compute a synthetic rating for a company and capitalize leases. This is the link that I sent out yesterday:

Once you have all these numbers, you can compute a cost of capital. I know that you may be several steps behind, but if you do get to this number, please remember to go to the Google shared spreadsheet and enter your numbers for your company:

There are two issues that I will nag you on:

1. Project: On your project, you have everything you need to compute the cost of capital for your company, and its divisions. Please do so, while the material is fresh.

2. Case: I sent you the link for the case earlier in the week. If your response is what case, or if you have not read it, please read it, and if you can, start working on the portions that you feel comfortable working with.

In this week's classes, we will start on measuring investment returns, looking at four projects, including a hypothetical Rio Disney theme park.  We will start with accounting earnings before 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.

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

I noticed that the due date on  page 1 the case is wrong. It is March 31 (not April 1), before class. 

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 (10-year) analysis first. It is more contained and easier to work with. Then, try the longer life analysis. It is trickier…
2. 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. 
3. 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.
4. 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 electric car business and Google’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. So, n need to make up your own )
5. 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.
6. 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.
7. 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.
8. 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…
9. Do not lose sight of the end game, which is that you have to decide based on all your number crunching whether Google should invest in the electric car business or not. Do not hedge, prevaricate, pass the buck or hide behind buzz words.
10. 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.

Until next time!

As you know (and your email box attests to this), I have been sending an email a day since school started, and I am facing a quandary. I have been told that this coming weekend is a long quiet weekend, in lieu of your mid-semester break. I am not sure what this means, but I guess that sending you emails over the weekend may disrupt whatever quiet thoughts you were planning to have. So, I am going to post the in practice webcasts that I would have posted tomorrow now, and it covers the question of 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. Have a serene weekend and may the force be with you! 

I have restrained myself from emailing you all weekend, to give you some alone time, but I am afraid that time has passed. So, with no further ado, here are three things to bring you back to the real world:

1. Newsletter: The newsletter for this week, which you would normally have got yesterday, is attached. As always, it is scintillating.

Issue 7 (March 20)

2. Case: Even though I was giving you three days of peace and quiet, it was obvious that some groups were working on the case. (I was answering emails, even though I was not sending them). Please keep doing so, and remember that the case is due a week from Wednesday, on March 31, before class that day.

3. Quiz 2: I screwed up and had scheduled the quiz for March 31 as well. Since that is overload, In a move of utmost compassion, I have moved the quiz to the following Monday (April 5). You are welcome!

4. This week: This week will continue the discussion of investment returns, with more project analyses tomorrow, followed by an examination of how we choose between projects.

In this class, we started by looking at the use of sensitivity analysis and simulators to enrich the discussion of uncertainty. I mentioned a book by Edward Tufte on visualizing information that I recommend strongly (not for this class, but for life in general:

We then moved on to how taking an equity perspective can alter how you measure returns and cash flows, and alter the hurdle rate you use, using an iron ore project for Vale as illustration. Finally, we started by looking at an acquisition as a really big project, and argued that the same rules should apply to acquisitions as to regular projects. The cash flows should include any side benefits and costs and the cost of capital you use should reflect the risk of the project (target company), not the entity looking at the project (acquiring firm). A reminder again that we have no class for a week, but the beat goes on. The case is due a week from Wednesday. 

I know that you are busy working on the case (or should be) but here is the weekly puzzle for this week. We have been talking, in class, about investment decisions and how best to make them. While we laid out the framework of forecasting cash flows and computing NPV, the reality is that you make the best decisions that you can, with the information that you have at the time, and the real world then delivers its own surprises. In this week’s challenge, I confront this issue head on by looking at Chevron’s $54 billion investment in a natural gas plant in Australia. The decision was made in 2009, when oil and gas prices were much higher and rising, and the plant is just going to start production. Take a look at the challenge:

https://people.stern.nyu.edu/adamodar/New_Home_Page/cfpuzzles/cfspr21puzzle7.htm  

Once you have read the puzzle, try to answer the following questions:

1. Should the analysts who looked at the plant in 2009 foreseen the oil price rout when making the investment decision? 
2. Asssume that at today's oil prices, the present value of expected cash flows on the plant is well below the $54 billion that it cost to build the plant? Should Chevron shut the plant down today? If yes, why? If not, why not?
3. Assume that you are offered $25 billion by Exxon Mobil for the plant? Would you accept it? What would determine your decision?
4. Now that you have seen the cost of this deal, what would you do differently, if anything, on any new investments that you make as an oil company?

These are fundamental questions that get asked almost every time a big investment goes bad. In fact, in the aftermath of this crisis, this will be the scenario that unfolds in almost every company that made a big investment decision last year, and particularly true for oil companies. Las year, with COVID, I am sure that there are many businesses, small and large, that faced questions about investment decisions that they locked themselves into pre-COVID.

I know that we have no class today, and I also know that many of you are using the day to work on the case. As you face uncertainty on the case, I thought it would be a good time to talk about healthy ways of dealing with uncertainty. Specifically, the best way to deal with uncertainty is to face up to it and embrace it, using statistical tools and common sense. I had talked about Monte Carlo simulations and the use of Crystal Ball, in conjunction with Excel, to incorporate uncertainty into valuation. If you get a chance, read this blog post, since it gives you a step by step approach to doing a Monte Carlo simulation:

There are two challenges you will face along the way. The first is one created by the inability of statistics classes to create either an intuitive feel for or a love of statistics. I cannot fill in that gap entirely, but if the only statistical distribution you remember from your statistics class is a normal distribution, read this quick and dirty summary of what the distributions mean and how to pick between them:

It will take about 20 minutes to read, but will help you when you get to choose between distributions. The second is coming up with parameters for the distribution, a data question, and the answer lies in looking at the data. For instance, if you are trying to get a distribution going on interest rates or exchange rates or commodity prices, you can use historical data, and the Federal Reserve has that data going back a hundred years in this amazing link (which I have sent to you before):

If it is cross sectional data (for instance, operating margins across software companies), there is no better place to look than on S&P Capital IQ (Remember the link I sent you to be able to get access… If not, I have attached it again). 

Please do not take this as a suggestion that I want you to do a Monte Carlo simulation on the case. In fact, I don’t want you to do that, because to do it right, you will have to leave the confines of the case (and find data on electric car sales and costs). It is more as a tool that you can use in whatever area of business you go into. Even “strategy” people have to face uncertainty.

I know that the project is officially on the backburner for this week. I have nothing specific to say about the case, but here are some general thoughts:

1. Debt: I was trying to help you by giving you the book and market value of interest-bearing debt, to prevent you having to go to the balance sheet and working through the present value of debt on your own. You still have to compute the present value of lease commitments to get to total debt.

2. Cash flow timing: In discounted cash flow valuation, for convenience, we assume that cash flows occur at a point in time, rather than over time. It is easiest to assume that point in time to be the end of the year. While you can finesse this assumption, by using mid-year conventions, but it is really not worth it. And the start of a year, in time value terms, is the same as the end of the prior year.

3. Capital Maintenance: I know that many of you are struggling with this, and I am afraid that I have to give you an opaque answer. You can always look at what I did in the Disney theme park, but there is no fixed rule that works across investments, but you can draw on something that I did in that case. One is to use depreciation as your scalar for determining how much capital maintenance you need; depreciation reduces capital invested in a project and depreciation replenishes it. 

4. What if questions: If you ask what if questions about the case, please follow my advice and keep it focused on the assumptions that you feel matter the most, and tie our analysis to your decision.

That’s about it. If you get done with the case analysis and want to submit it, please email it to me, with “Google Car” in the subject, and with all your group members ccd on this email.

At the moment, you are probably working on the case and will not get a chance to take a look at the in-practice webcast for this week, but I look at what comprises a typical project in a company and how to assess project characteristics. Here are the links:

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

Slides: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/typicalproject.pptx 

As you will see, when you try this on your company, it is easier in some companies than others. A typical project at Costco is much easier to identify (probably another 100,000 square foot store) than at Disney (where it can be new theme park, a new movie, a television series for streaming or a licensing deal for a consumer products). 

I know that you are busy working on the case, and I won’t take up too much of your time. Two quick reminders. The first is that the newsletter for the week is attached. The second is that we will be finishing up the first packet this coming week, and moving on to packet 2 of the lecture notes. Please download the packet. The links are available on the webcast and lecture note pages for the class:

https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfpacket2spr21.pdf 

The powerpoint version seems to have issues that I will try to fix in the next 24 hours.

This week, we will finish the last parts of investment analysis, with the discussion of the case (and you know which case I am talking about) on Wednesday, in class. Consequently, it is critical that you submit your case before the class begins at 12.30 pm, NY time, on Wednesday. Here are some specifics that will make my life easier:

1. Case write up: Please keep your write-up brief and convert the file into a pdf file. Please include your detailed cash flow table as an appendix, and do not include any figures or tables that you don’t refer to in your write up. On the cover page, please include the following information : (a) Group member names, (b) Cost of capital for the project, (c) ROIC on project, (d) NPV (10-year case), (e) NPV (longer life case) and (f) Accept/Reject the project.

2. Email: When you email your case write up (the pdf file) to me, please cc everyone in the group and put “Google Car” in the subject. That way, when I grade the project, I can return it to everyone in the group at the same time.

In today’s session, we started by looking at mutually exclusive investments, and contrasting NPV and IRR and why they might give you different decisions, and noted the differences in reinvestment assumptions. We then talked about the side costs that projects can create for companies, when they use its existing resources, and how to estimate the opportunity costs. Finally, we turned our attention to side benefits that can accrue to a company from a new project, and how that benefit can be captured analysis, extending from additional revenues on an existing business line to synergies in acquisitions. 

A final note regarding the case. When you are done with the numbers on your case, could you submit your findings in the attached spreadsheet. (You don’t have to wait until your final submission to do this.) This will help me put the summary of your findings into the presentation on Wednesday.

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 class on Monday (April 5).  

On a different note, I am looking forward to seeing your case analysis. The deadline for submission for the final report ( by email, as a pdf file) is 12.30 pm, NY time, tomorrow, but if you can send me your final numbers for the case in the attached spreadsheet, I would appreciate it.

The bulk of today's class was spent on the Google GCar 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 Google GCar, rather than the cost of capital for Google 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 distribution system 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/GoogleGCar.pdf 
2. Excel spreadsheet with analysis: https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/GCarsoln.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 327.

In the last part of the class, we tied up some loose ends relating to investment analysis, starting with  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, with a FIFO method applying (I am grading the cases in the sequence that they were turned in and sending it to everyone in the group who is ccd). 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.  

 https://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/GCarCaseGrading.pdf (Also attachment)

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 grading template. 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,5) I hope that helps clarify matters. It is entirely possible that I may have missed something that you did or misunderstood it. You can always bring your case in and I will reassess it.  I have also allowed leeway on the revenue forecasts (unless they are egregiously off), and I have not taken points off for minor math errors. 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

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 “Google Car” 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. If you feel that i have missed something in your analysis, please 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 Google'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 auto companies.  Also, if you used that cost of capital to discount the synergy benefits to Google. 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 Google was 2.1% (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 3 and year 8 for computing the cost of the expansion of distribution. Some of you either ignored the savings in year 8 or attempted to allocate a portion of the investment in year 3,  a practice that is fine for accounting returns but not for cash flows. But here were some other items that did throw off your operating cash flows:

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:

Finally, the case is a more complicated version of almost anything you will run into on the quiz. So, please review both your analysis and mine, as review for the quiz.

As you know, it is quiz day, and it is tomorrow. I have been sloppy about sending you details about the timing and I am sorry. Here is the scheduled timing for tomorrow. The quiz will be accessible starting at 4 am, NY time, primarily for the few people who are in Asia and are taking the class remotely, and will be available until 1.30 pm, NY time. Since the quiz is scheduled for an hour, you need to start by 12.30 pm, NY time, at the latest. I am sorry if I have not been responsive to emails these last four days, since I was up in Los Angeles, visiting my son and his family for Easter. 

This week, we will start on the financing question, and I want to remind you again to download the second packet. I know that some of you have had trouble with the PowerPoint version, and I am sorry. I have tried everything, but it is not a server or upload problem, but a PowerPoint problem. I have created a version using the old PowerPoint that I think works, if you still prefer PowerPoint to pdf.

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. On an entirely different note, the final exam for this class is scheduled for May 17. It had originally been set for May 18, but I think that the school realized its mistake and moved it back a day. The last day of class is May 10, which is when your final project is also due. 

I am truly sorry about the technical glitches during class today, but I have learned that what technology gives, it can take away, and I hope that the distractions did not impede the lessons from the class. I looked at the Miller Modigliani theorem through the prism of the debt tradeoff and followed up by using the financing hierarchy that companies seem to move down, when they think about raising fresh financing. I then moved on to looking at how the cost of capital can be used to optimize the right mix of debt and equity. In effect, you estimate the costs of debt and equity at different debt ratios, and try to find the mix of debt and equity that minimizes your cost of capital. If you want to try your hand at using the spreadsheet to optimize debt ratio, try the following:

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

We will continue with this discussion next week. looking at limits to the approach, and variants.

The clock is ticking down to the end of the semester, and since next weekend is supposed to be quiet one, I am going to go big on this weekend. Since we are in capital structure/financing this week, I will focus on that component. The first thing you can do (if you remember what company you are analyzing) is to take it through the qualitative analysis, i.e., the trade off items on capital structure:

1. Tax benefits: Check out your company's marginal tax rates, relative to those of others in your group. If you have the only Irish company in your group, you have the lowest marginal tax rate in your group and other things remaining equal, should have the least debt.
2. Added discipline: Go back and check the HDS page (with the top 17 stockholders in your company). If you don't see anyone from your management team in that list and no activist investors (Carl Icahn or Bill Ackman), your company could benefit from having more debt (to discipline management).
3. Bankruptcy cost: To assess your company's expected bankruptcy cost, look at two variables. The first is whether they are in a stable or risky business. If you are in a risky business, you have a much higher risk of bankruptcy than if you are in a nice safe business. The second is indirect bankruptcy cost. As I noted in class, these are the negative consequences of being viewed as being in financial trouble: customers stop buying, suppliers demand cash and customers leave. If those costs can be high at your company, you should borrow less money.
4. Agency costs: The more trouble lenders have in monitoring and keeping track of the money that they lend, the more borrowers will have to pay to borrow. Thus, if your company has intangible assets and difficult-to-monitor investments (R&D, for example), it should borrow less money.
5. Financial flexibility: If the investment needs in your company tend to be stable and predictable (a regulated utility, for instance), you should not value flexibility very much. If you grow through acquisitions and/or are in an unstable business, you will value it more and borrow less.

At the end of the qualitative assessment, you are just trying to decide whether you would expect your company to borrow no money, only some money or a lot of money. Since we have also covered the cost of capital approach in class, you can also try to find the optimal debt ratio for your company using the spreadsheet where I have mechanized the process:

Again, remember that this spreadsheet is designed to get around the circularity in the calculation of interest expenses, and you need to check the iteration box in excel preferences. 

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. 

In this week’s classes, 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 sets of spreadsheets: one contains the updated marginal tax rates by country and the other has the 2021 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 have attached the weekly newsletter. And while this may qualify as nagging, if you do get a chance to get caught up on your projects, please enter your company’s numbers into the Google shared spreadsheet:

https://docs.google.com/spreadsheets/d/1F327sLVgKJCaHKEz-pDmMREI-yPcspW7Lnmy6GDNrj8/edit?usp=sharing

Attachment: Issue 10 (April 10)

In this week’s puzzle I decided to use Valeant in 2015 to illustrate both the good side and the bad side of debt. Valeant was an obscure Canadian pharmaceutical company in 2009 but grew explosively between 2009 and 2015 to get to a market capitalization of $100 billion, primarily using debt-fueled acquisitions to deliver that growth. You can read the weekly puzzle here:

https://www.stern.nyu.edu/~adamodar/New_Home_Page/cfpuzzles/cfspr17puzzle10.htm 

In 2015, Valeant’s fortunes took a turn for the worse. Not only has its business model crumbled, but it had had both managerial problems and information disclosure issues that have added to the troubles. It’s biggest booster and investor, Bill Ackman,took his losses on the stock and apologized to investors in his fund for the “mistake” he made investing in the company. In November 2015, the stock price, which was close to $200 IN 2014, dropped below $10 and the company was clearly seeing the dark side of debt. Here are my questions:

We started this class with the adjusted present value approach, where we begin with the unlevered firm value, and then add the tax benefits of debt and net out expected bankruptcy costs. While you can download the APV spreadsheet that I have online, 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. We then looked at peer group analysis, where companies decide how much to borrow by looking at what other companies in the sector do.  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

I know that you are approaching your quiet weekend and that you have no class until Monday, and I will stick with my resolution of not sending you any emails until Monday That said, though, if you want to get a last burst on the project in, before you take off for the weekend, I would suggest computing your optimal capital structure for your company. While we covered different approaches to computing the optimal, including the APV approach, I would recommend that you stick with two. The first is the cost of capital approach, with our without enhancement, and the spreadsheet is here:

Welcome back from a very short break, but now that you are, we are in for a sprint over the next three weeks. You have three to-do items left in the class, one more quiz on April 28, your final project is due on the last day of class (May 10) and your final exam (May 17). The quiz will cover all of the debt material we have covered in packet 2, including tomorrow’s session and I will put up the review session, material and past quizzes up tomorrow. On debt design itself, the objective is to design the perfect financing, one that gives you the tax benefits of debt with the flexibility of equity. That may seem like the impossible dream, companies and their investment bankers constantly try to create securities that can play different roles with different entities: behave like debt with the tax authorities while behaving like equity with you. In this week's puzzle, I look at one example: surplus notes. Surplus notes are issued primarily by insurance companies to raise funds. They have "fixed' interest payments, but these payments are made only if the insurance company has surplus capital (or extra earnings). Otherwise, they can be suspended without the company being pushed into default. The IRS treats it as debt and gives them a tax deduction for the interest payments, but the regulatory authorities treat it as equity and add it to their regulatory capital base. The ratings agencies used to split the difference and treat it as part debt, part equity. The accountants and equity research analysts treat it as debt. In effect, you have a complete mess, working to the insurance company's advantage. 

What are surplus notes? http://en.wikipedia.org/wiki/Surplus_note">Surplus notes: What are they?

The IRS view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/taxview.pdf

The legal view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/courtview.pdf

The ratings agency view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/ratingsviewnew.pdf

The regulator's view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/regulatorview.pdf

The accountant's view of surplus notes: https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/GAAPview.pdf

After you have read all of these different views of the same security, try addressing some of the questions in the weekly challenge.

If this strikes you as too esoteric, there is a whole host of these shape shifting securities that try to be different things to different entities that you can find out there to explore.  

One final note. Many of you are struggling with tax rates right now, from trying to decipher the difference between marginal and effective tax rates to understanding they play out in value. I just put up a post on tax rates on my blog that examines these issues, using the current debate about whether corporate tax rates should be raised as a launching pad:

https://aswathdamodaran.blogspot.com/2021/04/the-corporate-tax-burden-facts-and.html 

In today's class, we looked at the design principles for debt. We started by completing a five step process for designing the perfect debt before looking at both intuitive and quantitative ways of debt design. In particular, we looked at 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 2020. Just a warning that it is extremely noisy and may spit out output that does not make sense. The post class test & solution for today is attached.

Just remember the quiz is multiple choice/ calculated questions, just like the first two quizzes. Until next time!

On the project, the place to start your debt design is with intuition. In fact, if you have done a prior step in the project (where I asked you to describe a typical project for your company), you are well in place to complete your intuitive analysis. In my view, this is the more critical part of debt design (more important that the quantitative analysis that I will describe in the rest of this email).  If you plan to do a quantitative analysis of your debt. I have attached the spreadsheet that has the macroeconomic data on interest rates, inflation, GDP growth and the weighted dollar from 1986 to the present (I updated it to include 2020 data. The best place to find the macro economic data, if you want to do it yourself, is to go to the Federal Reserve site in St. Louis:

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

https://docs.google.com/spreadsheets/d/1F327sLVgKJCaHKEz-pDmMREI-yPcspW7Lnmy6GDNrj8/edit?usp=sharing 

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. 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:

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). As you wrap your head around buybacks and what they can and cannot do to companies, you may find the following post that I have on the topic useful (or not):

http://aswathdamodaran.blogspot.com/2019/02/january-2019-data-update-8-dividends.html 

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). Of course, quiz 3 is also scheduled for Wednesday, and I wish you the best on that front. 

Attachments: Post-class test and solution

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.

By now, I hope that you have had a chance to check out the third quiz solutions, and there are two common mistakes that I noted:

1. Recapitalizations and Buybacks: When you do a buyback (in problem 1) or a recapitalization (in problem 2), as one source of capital (debt or equity) increases, the other source of capital has to decrease. In problem 1, for instance, borrowing $200 million and buying back stock will reduce equity by $200 million. If you don’t do this, it becomes almost impossible to isolate the effects of capital structure changes, since the company size will change as well. I know that this was a recurring theme in many of the past quizzes, and should thus not have been a surprise, but if you felt blindsided by this in either problem, I am sorry.
2. Tax rate when interest expenses > EBIT: When your interest expenses exceed your EBIT, you don’t lose all of your tax benefits but you do lose some of them. In the problem in question, the EBIT was $180 and the interest expense was $240; the marginal tax rate was 20%. You will get to deduct only up to $180 of your interest expenses, leading to a tax benefit of $36 ($180*.2). That tax benefit as a percent of interest expenses is 15%. You can also arrive at the answer by multiplying the marginal tax rate by (EBIT/Interest expense). This was an issue we ran into in all of the companies that we computed optimal cost of capital for, with the tax rates dropping at very high debt levels.
3. Share count when investors are rational: The key world in problem 4 is rational and it led to the only tricky part of this problem. The value change is $250 million ($20 / .08) but the key question becomes the share count you divide by, to get to change in the value per share. In a rational market, all investors (those who sell back and those that do not) will all demand a share of this increase in value, leading to my using the 40 million shares in the computation of change in value ($250/40 = $46.25). This is the rational solution, because shareholders who sell back will get $6.25/share, as will investors who do not. Some of you bought the shares back at the old price, leading to a lower share count (25 million) and a bigger jump in value per share ($10). The problem with this solution is that the people selling their shares back are behaving irrationally in accepting the old share price and denying themselves a share of what is rightfully theirs.

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 

I won’t risk asking you what you are doing this weekend because I may hit a nerve. This week, we will approach closure on the class, finishing the dividend section tomorrow and starting valuation right after. In parallel, I hope that you will be tying up loose ends on your project. I will have my regular office hours on Monday and Wednesday (11 am - 12 pm, NY time), and I will add two more office hours:

Wednesday, 7 pm - 8 pm, NY time: https://nyu.zoom.us/j/94870538854 

Friday: 7 pm - 8 pm, NY time: https://nyu.zoom.us/j/99755679472 

See you in class!

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 (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 comparable 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:

If you need some guidance on using this spreadsheet, try this YouTube video that I put together last year:

https://www.youtube.com/watch?v=F9GfXJ-IrSA&list=PLUkh9m2Borqnk6tJUpGzN4RcDUBAjovqN&index=6&t=3s 

This YouTube video was made last March for Boeing, when much of the debate for the near term (next year) was about how badly COVID would damage revenues and earnings. In May 2021, the debate has shifted to how much companies will benefit in the near term (next year) from the improvement in revenues and earnings that are going to come from recovery. But the structure of the spreadsheet is mostly intact. 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 177 & 178, where I estimated Disney's beta and cost of capital)

No. You don’t have to, if you generally trust accountants. If you don’t, you can use the capitalization spreadsheet (assuming you have commitments for the future) and do it yourself, but don’t double count.

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:

https://docs.google.com/spreadsheets/d/1F327sLVgKJCaHKEz-pDmMREI-yPcspW7Lnmy6GDNrj8/edit?usp=sharing 

When you are entering the numbers, please follow the number format that I have used for Disney. For instance, for R squared, I list 73%, not 0.73 or 73, and if you can also enter your R squared the way I did, it would make my work on Sunday a lot easier, if you follow my formatting, since this Google shared spreadsheet becomes the raw data with which I work.

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 10)... but the memories will last forever…

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.

I will check in on you tomorrow and day after, but your slides for the last class will not be available until next Monday (since it needs the data from the shared spreadsheet). 

3. I was scheduled to have office hours today on Zoom from 7 pm- 8 pm, NY time. Unfortunately, Spectrum, my internet provider, has decided to do maintenance work in the neighborhood and had cut off service for the rest of the day. I am truly sorry to leave you stranded, but if you were planning to come to office hours to ask a question, could you send it by email instead?  

I will not waste your time with a long email or another newsletter. You have enough on your plate already. The Google spreadsheet is starting to get populated and I thank you, but if you still have numbers to enter, here you go:

By now, the time for nagging is done. Three final notes:

1. If you have not entered the numbers into the Google shared spreadsheet, please do so.

2. If your project is ready for submission, please submit it as a group (with all the group members ccd) and make sure that you put “The Torture Ends” in the subject.

3. Once I have all the spreadsheet numbers, I will put together the closing presentation to you tomorrow morning and get it to you before class. If you can make it to class live, I would really appreciate seeing you there. It will be our last class and I will try to make it memorable.

I am sorry that I cut it this close, but your slides for today are available at

See you in a few minutes.

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, here is the link to the presentation:

https://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/ProjSumm21.pdf 

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. If you want to see the summary numbers for the entire class online, try this link:

https://www.stern.nyu.edu/~adamodar/pc/cfanalysis/cfspr21.xlsx 

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.

As you get ready for the final exam, here are some thoughts. 

1. Preparation: Since the final exam covers the entire class, preparing for it can be intimidating, but here is the saving grace. The material is interlinked. Thus, preparing for the valuation part, requires you to review how you compute cash flows and cost of capital, which is from an earlier part of the class. I have a review we

2. Format: There will be ten multiple choice questions on the final, patterned on the questions you saw on the quiz. Each question is worth 3 points. If you are uncomfortable with the all or nothing feature of the multiple choice format, you can sign up for the open ended version by going to this Google shared spreadsheet:

3. CFEs: I don’t mean to be a nag, but please do complete your CFEs when you get a chance. The reason is purely selfish. If you don’t, you will not be able to check your grade, and if you cannot check your grade, I know exactly who you will be contacting. If you don’t know how to do them, here are the instructions:

• 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.

The grades are officially in and you should be able to check them online soon. On a more general note, I want to thank you for the incredible amount of work you put into this class. I know how difficult this semester was for many of you, and that you did not sign up for an online class, when you enrolled at Stern. I too would have vastly preferred to teaching you in person, and I never thought I would stay this, but I do miss Paulson Auditorium. I appreciate how many of you managed to join me live on my Zoom sessions, and wifi shakiness notwithstanding,  you made it easier for me to teach.  

I know that I buried you under emails (this is the 129th of the class), assignments, projects and weekly puzzles and I also know that most of you were unable to keep up. However, the material for the class will stay online and on iTunes U for the foreseeable future. If you want to review parts of the class, please do go back and review the lecture, look through the notes and even try that week's puzzle. If you really, really want to master corporate finance, don't waste too much time reading books & papers or listening to lectures. Pick another company (preferably as different as you can get from your project company) and take it through the project analysis. Each time you repeat this process, it will not only get easier and more intuitive, but you will always learn something new. I still do! 

Finally, in return for reading all (many, most, some) of my emails this semester, I have something to offer in return. If you have a question in corporate finance, valuation or investments, where you think I can be of use, you are welcome to always reach out to me. Perhaps, you will come back to be tortured again next year in valuation! For the last time (at least for this class)!