Subject: Welcome back!

Hi,
I am sure that you are finding that summer is passing by way too fast, but the semester is almost upon us and I want to welcome you to the Valuation class. One of the best things about teaching a valuation class is that valuation is always timely. Anyway, I know that some of you are worried about the class but relax! If you can add, subtract, divide and multiply, you are pretty much home free... If you want to get a jump on the class, you can go to the class web site
https://www.stern.nyu.edu/~adamodar/New_Home_Page/equity.html
The syllabus for the class is available and there is a google calendar for the class that you can get to by clicking on
http://www.google.com/calendar/embed?src=51oitp7noia846earue645hlqc@group.calendar.google.com&ctz=America/New_York
For those of you already setting up your calendars, it lists when the quizzes will be held and when projects come due.
The first set of lecture notes for the class should be available in the bookstore by mid-week. If you want to save some money, they can also be printed off online (if you want to save some paper, you can print two slides per page and double sided). To get to the lecture notes, you can try
https://www.stern.nyu.edu/~adamodar/New_Home_Page/eqlect.htm
Please download and print only the first packet on discounted cashflow valuation. I will be updating the other two packets (yes, there are three...) to make them more timely.....
The best book for the class is the Investment Valuation book - the second edition. (The first edition won't be as useful... Sorry!) You can get it at Amazon or wait and get it at the book store... Alternatively, you can use "Damodaran on Valuation" or the "The Dark Side of Valuation" - again, make sure that you are getting the second edition.
https://www.stern.nyu.edu/~adamodar/New_Home_Page/public.htm
I am looking forward to seeing you on Sept 8 - Wednesday at 10.30 at KMEC 2-60 to be precise.. I think we are going to have a lot of fun. Until next time...

Subject: The end is night... repent, repent...

Hi,
Thought I would get your attention with some apocalyptic language... Just wanted to make sure of last minute details:

1. The first class is scheduled for Wednesday, September 8. I hope you can make it. If not, not the end of the world. The class will be webcast... and you can catch up.. but it will not be as exciting.

2. All of the sessions will be in KMEC 2-60. The room is warmer and more intimate than Schimmel Auditiorium... but that may be damning with faint praise.. As we will see in valuation, everything is relative.

3. The classes will be Monday/Wednesday from 10.30-12. I hope that the start time is not too early for you. If you are keeping vampire hours, it is time to switch.

4. In case you junked my last email, here are a few things that I hope you read in this one:
a. Text book: The preferred text book for this class is Investment Valuation, the second edition. Here is the Amazon link, if you want to deny the NYU bookstore the petty profits from this book...
http://www.amazon.com/gp/product/0471414905/ref=pd_lpo_k2_dp_sr_3?pf_rd_p=486539851&pf_rd_s=lpo-top-stripe-1&pf_rd_t=201&pf_rd_i=0471414883&pf_rd_m=ATVPDKIKX0DER&pf_rd_r=0ZYNXV2MS8DGTE8XJZGY
(Yikes... What the heck is that html address all about?0

b. Web site for class: There is a website for the class that you can access by going here. As many of you probably already know, I don't update the Blackboard stuff for the class...
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/equity.html

c. Lecture notes: The first of three lecture note packets for this class are available online. You can either download them and print them or buy them from the bookstore.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/eqlect.htm

d. Google calendar: There is a Google calendar available for the class. Please take a look at it and especially at the quiz dates. These are etched in stone and cannot be changed.
http://www.google.com/calendar/embed?src=51oitp7noia846earue645hlqc%40group.calendar.google.com&ctz=America/New_York

You may not believe this but I am looking forward to the first class.. I hope you are too... Until next time!

Subject: Lemmings, anyone?

Hi!
So, have you classified yourself yet? Are you a proud lemming, a "Yogi bear" lemming or a lemming with a life-vest? While you are pondering that life-changing question, I do have some points to make:
1. Please do find a group to nurture your valuation creativity, and a company to value soon. If you are ostracized, please let me know...
2. Once you pick a company, collect information on the company. I would start off on the company's own website and download the annual report for the most recent year (probably 2006) and then visit the SEC website (http:www.sec.gov) (for US listings) and download 10Q filings... If you can, also try to get to a Bloomberg before the Corporate Finance people start monopolizing it and see if you can print off the following pages for your company- BETA, DES (first 10 pages) and FA (income statement, cash flow and balance sheet numbers). If you have never used a Bloomberg, try the write-up I have on my site on using a Bloomberg:
http://pages.stern.nyu.edu/~adamodar/pdfiles/Bloombergfull.pdf
3. The web cast for the first class is up. You can get to it by going to
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/webcasteqfall10.htm
Take a peek. I think it is of superior quality... When you open the link, you can watch either the video or the slides. Give me your feedback. (The link to the audio podcast is not working yet. I am working on it)
If you did not get the syllabus, project description and the valuation intro in class this morning, they are all available to print off from this site.
Just to restate what I said in class this morning, you can pick any publicly traded company anywhere in the world to value. The non-US company that you value can have ADRs listed in the US but you still have to value it in the local currency and local market. You can even analyze a private company, if you can take responsibility for collecting the information.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Bias test

Hi!
In Wednesday's class, I made the claim that the biggest enemy of good valuation was bias, induced both the preconceptions we bring to our valuations and the biases added by the process. You may have dismissed my statements as hyperbole, but I would like you to think about how bias impedes the process by considering the following hypothetical scenarios, where you are the valuation analyst. In each case, i would like you to consider the direction of the bias (High value, low value, None) and the reason:
1. You are valuing your own business for sale to a third person.
2. You are a venture capitalist valuing this same business with the intent of taking an equity stake in it.
2. You are valuing your own business for divorce court; half of your estimated value will go to your spouse (soon to be ex-spouse).
3. You are an appraiser, working for the owner, valuing a business for tax purposes. (Your estimated value will be used to assess estate taxes)
4. You are an appraiser, working for the IRS, valuing the same business for tax purposes. (Your estimated value will be used to assess estate taxes)
5. You are a sell side equity research analyst, valuing a company with the intent of putting a buy or sell recommendation on it.
6. You are an M&A analyst, working for the investment banker for the acquirer in a friendly takeover, valuing the target company.
7. You are an M&A analyst, working for the investment banker for the target in a friendly takeover, valuing the target company.
8. You are an M&A analyst, working for the investment banker for the acquirer in a hostile takeover, valuing the target company.
9. You are an M&A analyst, working for the investment banker for the acquirer in a hostile takeover, valuing the target company.
10. You are buy-side analyst, valuing a company for your portfolio manager, who already happens to own a million shares of its stock.
11. You are buy-side analyst, valuing a company for your portfolio manager, who already happens to have shorted a million shares of its stock.
My answers in class on Monday, and we can check..
I I do have a few articles that you may find interesting reading about bias in valuation on the web site for the class under equity readings:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/eqread.htm
Do think about a company that you would like to value for the class. Remember that you have the option of changing companies any time over the next few weeks, if you have trouble... Finally, I thought you might like this lemming cartoon! Until next time!

Subject: Don't forget....

Hi!
Hope the wet weekend is going well for you. In case you have not done so yet, please print off lecture note packet 1 or buy it from the bookstore. You can get to them by going to:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/eqlect.htm
On a different note, I was emailed a link to a valuation blog that I think contains some interesting insights on investing and valuation. Take a look at it when you get a chance.
http://researchpuzzle.com/
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Firm versus Equity Valuation

Hi!
The webcast for the class is up. (I did add the downloadable version of the video file, which was missing for the first session). Building on the last theme of matching cash flows to discount rates, please take a look at the attached cash flows exhibit, if you get a chance, before class. These are the forecasted cash flows for a target company called Carborandum, made for the acquiring company (Kennecott) by its enterprising and skilled investment bankers (First Boston). Here is what I would like you to answer. Given the cash flows estimated in this table, which of the following six discount rates is the right one to use in computing the present value:
1. The cost of capital of Carborandum (13%)
2. The cost of capital of Kennecott (10.5%)
3. The weighted average of the costs of capital of the two firms (12%)
4. The cost of equity of Carborandum (16%)
5. The cost of equity of Kennecott (13.5)
6. The weighted average of the costs of equity of the two firms (14.5%)
Hint: Examine whether the cash flows are to equity or to the firm.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Carborandum cash flows

Subject: Weekly Challenge 1

Hi!
We ended the class today with the question of whether equity valued directly (by discounting cash flows to equity at the cost of equity) will yield the same value as equity valued indirectly (by valuing the firm and subtracting out debt). i know that we really have not delved into valuation in depth, but if you are up to it, try the first weekly challenge

Since this is your first weekly challenge, I want to make sure that I don't freak you out:
1. There will be no grade attached to this weekly challenge. Thus, there is no payoff to doing this (other than developing a depth of understanding about valuation and perhaps a small benefit on the quizzes) and no cost to not doing it.
2. If you decide to try it out, give it your best shot.
3. Once you have completed it, log into the Blackboard site for the class and submit your answer.
4. On Sunday, I will put up the solution to the weekly challenge.
5. If the answer matches yours, give yourself a pat on the back and move on. If it does not, try to understand why the answers vary.
6. If you still don't get it, email me.
I know that you are busy, but I think this will cement your valuation principles. Good luck!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: wkch1.htm

Subject: Risk free rates

Hi!
I hope that the discussion of riskfree rates a left you fairly clear about what to do next. In case, you are still confused, this is the next step in the process:

1. Pick a company (in case you have not already)

2. Determine a currency that you will value the company in. Once you have decided on the currency, find a riskfree rate in that currency. If your company is a US or European company, you just got lucky. Use the 10-year T.Bond rate as your riskfree rate for the US company and the 10-year Euro bond rate (pick the lowest one -probably Germany or France) for the European company. (If you have a non-Euro company, you should still be able to get a 10-year bond rate from the Financial Times). If you are valuing a company in an emerging market in the local currency (be brave), your job is a little more complicated.
2a. Get the longest term government bond rate you can get in the local currency. Try the Bloomberg terminals. If that does not work, get online and search... If that does not work, switch to a different currency.
2b. Get the local currency rating for the country by going to the moody's web site: http://www.moodys.com (Look under sovereign ratings)
2c. Estimate the default spread given the rating by downloading the country premium spreadsheet that I have attached to this email.
2d. Riskless Rate = Government bond rate - Default Spread given rating
I have a paper on riskfree rates that elaborates on the discussion in class today. It is really not a painful read, if you can spare the time. You can get to it by going to:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1317436
I also have a follow-up paper that I mentioned in class yesterday on the "What if" series.. what if nothing is riskfree
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1648164

Just a note to remind you that the email chronicles have now been updated online and you can find all old emails at:
https://www.stern.nyu.edu/~adamodar/New_Home_Page/eqemail.html
The fist three webcasts are up...

One final note. I have a request from someone who wants to get his young, growth company valued. Not only will it be a learning experience, but you can negotiate a reasonable compensation. I will be willing to serve as your unpaid advisor. If you are interested, let me know and I will put you in touch with him. Have fun! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: countrydefspreadsfall10.xls

Subject: Book that looks interesting this weekend

Hi!
For those of you who have been submitting your solutions to the weekly challenge on Blackboard (I see 5 submissions so far... Plenty more to come), thank you! For those of you still working on it, keep at it. You have until Sunday. For those of you who ask "What weekly challenge?", time to wake up. The weekly challenge is up online, if you want to download it. (Look under the website for the class or on Blackboard!!) I will post the solution on Sunday!! On a different note, I have attached the first newsletter for the class. Browse through it when you get a chance. There will be one at the end of each week for the rest of the semester. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

First newsletter

Subject: Last chance to try weekly challenge

Hi!
Solution coming in about 5 hours. Last chance to try the weekly challenge. Here it is, in case you cannot find it. Please submit your solution on Blackboard. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Solution to weekly challenge

Hi!
I guess time is up for the weekly challenge. I have attached the solution to this email. There were 55 submissions (about 33%), not bad for a first week. For those of you who did give the challenge a shot, thank you for doing so. For those who did not, I hope you get a chance to try the next weekly challenge.
On a different note, I have a blog that you can read (as if you don't get to hear enough from me already).. but just in case:
http://aswathdamodaran.blogspot.com/
If you get a chance, check it out! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: wkch1.xls

Hi!
Building on what is going on in markets right now and today's session, here are a few thoughts:
1. Country risk: The last few months should be a reminder of why country risk is not diversifiable. As you see markets are volatile around the world, I think you have a rationale for a country risk premium. You can get default spreads for country bonds on my site under updated data. If you are interested in assessing and measuring country risk, to get from default spreads to equity risk premiums, you need two more numbers. The first is the standard deviation for the equity market in the country that you are trying to estimate the premium for. Try the Bloomberg terminal. Find the equity index for the country in question (Bovespa for Brazil, Merval for Argentina etc.) and type in HVT. This should give you the annualized standard deviation in the index - change the default to weekly and use the 100-week standard deviation. Do the same for the country bond in question. The two standard deviations should yield the relative volatility. If you have trouble finding either number, just multiply the default spread by 1.5 to get a rough measure of the country risk premium. As for other sites that look at country risk, here is one that you may want to look at. It is the site maintained by Professor Campbell Harvey at Duke who does very good work on country risk:
http://www.duke.edu/~charvey/Country_risk/couindex.htm
If you want my estimates of country risk premiums, check under updated data on my website.
2. Company risk exposure to country risk: My concept of lambdas for countries is a work in progress. I have a paper on the topic that you can read, if you are so inclined:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=889388
3. Implied equity risk premiums: I am attaching the excel spreadsheet that will allow you to compute implied equity risk premiums. I am using the numbers that I used in class today to arrive at an equity risk premium of 6.43% at the start of 2009 and 4.36% at the start of 2010. This spreadsheet actually is from the start of this month (September 2010) and has the updated premium of 5.10%.

Please try to update the implied premium, using today's numbers for the S&P 500 (easy), 10-year T.Bond rate (easy), growth rate in earnings for next five years (Use 7% ) and just use the updated dividends and buybacks from the spreadsheet (since these were updated a few days ago).
4. Equity Risk Premium paper: Now that you have read and digested the riskfree rate paper (just kidding), you should try this paper that I have on ERP...
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1556382
It is a long paper but I think it is a fairly easy read. Let me know what you think!

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: ERPAug10.xls

Subject: An orphan

Hi!
If your group would like an additional member, I have one unattached - Athanasios Platis <athanasios.platis@stern.nyu.edu>. Please email him, if you are interested. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: This is what really drives M&A?

Hi!
I was browsing through articles about M&A. I have seen every possible rationale for why CEOs overpay, but this one takes the cake. It should at least make for some interesting cocktail party conversation:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364870
Have fun with it! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Weekly challenge # 2

Hi!
Another week bites the dust... For those of you keeping track, we are roughly 20% of the way through the class (seriously - 5 out of 26 sessions...) Anyway, two quick notes. The first is that the webcast is up and running. I know that the downloadable video file is having some issues (the streaming video works fine) and I am working on a solution. The second is that it is time for the second weekly challenge. It relates to the question I raised in class today about the relationship between equity risk premiums and riskfree rates. I am attaching the weekly challenge and the data you will need to address the question. Give it your best shot and submit your finding on Blackboard - let's see if we can get the number of responses past 55 (which is what we had last time). Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: I will be in Holland on Friday and Saturday but will try to keep ahead of my email.. In other words, don't expect me to let up in sending you emails.

Attachments: wkch2a.htm, wkch2data.xls

Subject: Bottom up Betas

Hi!
I know I am a little fixated on bottom up betas versus regression betas (and I should see a psychiatrist about this sickness). However, I did put together this list of 10 questions on bottom up betas that may enlighten you on my obsession and perhaps give you some ammunition when you have to argue with your colleagues about which beta to use in the future... I hope it helps... if you can think of any questions that I have missed, please do let me know.

As we move from discount rates to cash flows in the next session, here are some ways to keep the discount rate estimation in control:
1. Assuming that you have picked a currency to do the valuation, estimate a riskfree rate in that currency.
2. Estimate an equity risk premium for a mature market - the US historical risk premium (3.9%) or the implied premium today (6.5% or whatever you compute it to be) or the average implied equity risk premium for the US over time (4%) are all contenders. As I noted in class today, this may be a point in time where the current implied premium should be weighted more in your analysis, even if you believe will revert back to historical norms over the long term. Use this mature market premium for any country that has a AAA rating (most of Western Europe, for instance).
3. Estimate the additional risk premium for the country or countries that your firm has operations in that are not mature (less than AAA)... If your company is in too many countries to do this, classify revenues by region of the world and estimate an average regional risk premium (Asia is close to 3.5%, Latin America is closer to 7%...)
4. Estimate a bottom-up beta for your firm, using comparable companies. You can use the averages on my web site for different industries (https://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html) or you can do it on your own. The best resource, if you can get to it, is the Bloomberg terminal. Type in ESRC and try screening for stocks, starting with a narrow definition of comparable (same business, same region) first and then expanding your sample. If your firm is in multiple businesses, estimate the values of each of the businesses (try the revenue and EV/Sales route that I used for SAP).
5. If you can estimate a lambda. This will require that you estimate what a typical company in the risky country that your firm operates in. You can get rough estimates of these numbers from the paper I have on measuring company risk exposure.
6. Bring it all together in a cost of equity computation.
7. Pat yourself vigorously on the back for a job well done.

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Ten questions of bottom betas

Subject: A segue into relative valuation and a manual on risk management

Hi!
Was browsing through a financial website and came across this article on whether Google or Apple is cheaper:
http://seekingalpha.com/article/226594-apple-vs-google-which-stock-is-cheaper?source=email
Without going into the merits of the article (To be honest, I don't think it has any... it is a sloppy exercise in comparing multiples), I think it points to the Achilles heel of relative valuation. Even if you agree with the conclusion of the article which is that Apple is cheaper than Google, I am not sure what it tells me as an investor. Should I buy Apple? Just because it is cheaper than Google does not make it cheap. Why not follow up with articles on "Beavis vs Butthead: Who is smarter?" or "Lindsey Lohan vs Britney Spears: Who is the better role model?"....
On a completely different note, I have a book on strategic risk taking which I am sure most of you have not read and will be fine without reading. I did, however, create a compressed version of the book as a manual on risk management from a corporate governance perspective. If any of you are interested in the topic, you can get the manual by clicking below:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1681017
If you do read the manual, let me know what you think. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Newsletter for the week... and a prod on the weekly challenge

Hi!
Just because I am on another continent does not mean that I cannot harass you with emails. The newsletter for the week is attached... And please try to submit your weekly challenge solution, if you have not already.

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter

Subject: Solution to weekly challenge

Hi!
If you did try the challenge, good work! If not, try next week!

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: wkch2sol.xls

Subject: Cost of debt and capital

Hi!
:We spent a big chunk of today's class talking about default spreads and costs of debt.
1. Default spread website: First, I referenced a website that you can access to get updated default spreads:
http://www.bondsonline.com
Click on Today's market and on "Corporate Bond Spreads". Be forewarned. It will show you and old table of spreads (from2006) and you have to pay $35 to get an updated page. You can use your credit card or just go with the spreads on my site, which were updated a few weeks ago.
2, Synthetic rating: If you are ready to compute the synthetic rating for your firm, you can use the ratings spreadsheet on my site:

The default spreads in this sheet have been updated to reflect the January 2010 numbers.
3. Upcoming class: In the next class, we will talk about adjusting earnings for operating leases and R&D. Since these adjustments are inherently messy, I would recommend reading chapter 9 of the investment valuation book, especially if your accounting skills are a little rusty. If you do not have the book, read the papers I have on adjusting for operating leases and R&D online (under research/papers)

One final point. In the cost of capital test today, I had a bank loan with a face value of $ 1 billion and a coupon rate of 4%. With a cost of debt of 7%, here is what the market value of the loan will be:
Value of loan = Interest payment each year (PV of annuity for 8 years @7%) + Face value of loan (PV of single CF in 8 years at 7%)
= 40 (PMT = 40, n = 8, i =7%, PV = ?) + 1000 (FV = 1000, n =8, i =7%, PV =?)
= 238.85 + 582.01 = 820.86
I think I mistakenly said it was about 920 in today's class. I really meant to say 820. I am sorry! Here is how you would use it. In computing the debt ratio:
Debt ratio = 820/ (1000 +820) = 45%
In the convertible bond problem, here is how it would be used.
Market value of the bond = $1.2 billion
Value of debt portion = $ 820 million
Value of conversion option = $ 380 million
Debt ratio = 820/ (1000 + 380+ 820) = ! The conversion option gets added to equity to get an equity value of 1380)

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: ratings.xls

Subject: Third weekly challenge, forensic accounting and other matters

Hi!
Three separate notes related to today's class. The first is that the weekly challenge for this week is attached. I know that many of you did not have the time to try out last week's challenge, but trying this week's challenge is an excellent preparation for next week's quiz (hint... hint...) Give it your best shot and submit your solutions on Blackboard.

The second relates to forensic accounting. I have a few suggestions for books, if you are interested. The first is by Howard Schilit who just sold his forensic accounting practice for $ 50 million. It is called Financial Shenanigans and the Amazon url is
http://www.amazon.com/exec/obidos/tg/detail/-/0071386262/qid=1076606632/sr=2-1/002-2407243-0189656?v=glance&s=books
The other is by Terry Smith, who used to work for an accounting firm in the UK, until he decided to expose the seedy underbelly of accounting...
http://www.amazon.com/exec/obidos/ASIN/0712675949/qid=1076606899/sr=2-1/ref=sr_2_1/002-2407243-0189656
Needless to say, you need to have a firm grasp of basic accounting before you get into creative accounting... Did you sell your accounting text book back to the bookstore?

The third issue is on leases. Last year, as the accounting debate about capitalizing leases got going, I decided to take a look ahead at what would happen if we did decide to capitalize leases to the accounting numbers we all love to use - operating margins, returns on capital - and to valuation numbers (levered and unlevered betas, value etc.) My thoughts are in the paper below:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1390280

The quiz will cover everything we do through Monday (where we will finish the discussion of cash flows and get a good way through the estimation of growth. It will be in the first 30 minutes of class next Wednesday and there will be class after the quiz... .
Aswath Damodaran
adamodar@stern.nyu.edu

Weekly challenge # 3

Subject: R&D and Quiz 1

Hi,
First things first. Pursuant to our discussion of leases and R&D in class, here are my thoughts:
1. Operating Leases: If you can get your hands on the annual report or 10K for your company, see if you can find the lease commitments. If you cannot find it, and it is a US company, don't panic. Not all companies have lease commitments.
On a related note, some of you may be aware of a rule of thumb that analysts use, where they multiply the current year's lease payment by 7 (or 8) to get to the debt value of leases. If you are wondering where this rule of thumb comes from, here are its origins. In the early 1970s, the pre-tax cost of debt for a typical mature retail firm was about 7% and the typical lease lasted 12 years. The present value of an annuity for 12 years, with a 7% discount rate, is about 8 (7.94 to be exact). Hence, the rule of thumb. I have no problems with the rationale, but why use a rule of thumb, when you have the actual lease commitments and the current pre-tax cost of debt? It is not exactly rocket science.

2. R&D: Again, let me start with the rationale. A company invests in R&D expecting to get benefits over future years, rather than the current one. That again, meets the criteria for cap ex (rather than operating expenses, which is where we find it now). I could send you another paper to read, but you are probably sick of reading. Instead, I am attaching the excel spreadsheet that you can use to convert R&D into a capital expense.

Finally, to the important stuff on the quiz. Note below the key details:
1. Timing: 10.30-11, Wednesday, October 6 (Don't be late). There will be class after the quiz. So, please do stay. There will be coffee and donuts (not really... but you cannot blame me for trying..)
2. Format: You can look at the past quizzes (check online on the website for the class) to get a sense of the format. The quiz is open books, open notes. However, you cannot use laptops or maintain connectivity (cell phones, iPods etc...) during the quiz.
3. Weight: The quiz is worth 10%.
4. Protocol for missing a quiz: You have to let me know, by email, that you will be missing the quiz before 10.30 am on Tuesday.
5. Consequences of missing a quiz: The 10% will be moved to your remaining exams. In effect, your second and third quiz will be worth 12.5 points and your final will be 35 points. However, you will lose the option of having the score on your worst quiz moved up to your average score.
6. Getting ready for the quiz: Review the lecture notes (and the lecture webcasts, if necessary). Work through the problems in the book, if you have the time. The solutions are online on my website, under the website for the book. The key is to work through as many practice quizzes as you can in real time (30 minute limit) and without peeking at the solutions. Get a good night of sleep but make sure that your alarm is on.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: R&DConv.xls

Subject: Updated ERP for October 2010

Hi!
For those of you who are on my Twitter follower list, this will be old news (I tweeted it about 10 minutes ago.. You can still join the list and help me catch up with Lady Gaga at http://twitter.com/AswathDamodaran )... but I just updated the equity risk premium for the S&P. The equity risk premium based on closing prices on September 30, 2010, was 5.31%, up from 5.10% at the start of the month. The S&P 500 closed at 1141, up about 9% from the start of last month. Normally, an increase in the index would have pushed the premium down. More than offsetting this, though, was a report from S&P (attached to this email) that shows that buybacks bounced back in the second quarter and this pushed up the base year cash flow (dividends + stock buybacks) up almost 15%. Net effect is an increase in the equity risk premium.
I have attached both the implied premium spreadsheet and the S&P report... Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: ERPSep10.xls, sept10S&P.pdf

Subject: Newsletter

Hi!
Hope you are enjoying this weekend, preparing for the quiz (Could not resist the dig...) I am attaching this week's newsletter. In addition, please do give the weekly challenge a shot, when you get a chance. I have attached it too, just in case you have no idea what I am talking about.

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Newsletter

Subject: L2 Innovation Forum

As a general rule, I steer away from any forum that has the words "innovation" or "strategic" in their description, but this one is an exception. I don't know how this happened but I think I am actually part of this forum and I fully intend to shock the audience. Come, if you are interested:
http://bit.ly/InnovationForum

Subject: Nagging time

Hi!
Two quick notes. The first is that the culprit for the flash crash that occurred a few months ago has now been identified as one large computer-driven trade that fed on itself... Read all about it:
http://online.wsj.com/article/SB10001424052748704029304575526390131916792.html?mod=WSJ_hps_LEFTWhatsNews
Also, last chance to try this week's challenge. I know that you are busy preparing for the quiz, but this weekly challenge will help. Solution will be out later today.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Solution to weekly challenge

Hi!
Held off as long as I could on this weekly challenge. Solution is attached...

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: wkch3.xls

Subject: Loose Ends for this quiz... and a practice quiz...if you want to see if you are ready

Hi!
A few loose ends on topics that we will be covering for this quiz.
1. Currency: One theme that we have covered in this class is that currencies should have a neutral effect on value and that it is important that we preserve consistency on currency, by making sure that the discount rates and cash flows are in the same currency.
Key concepts to get nailed down: Estimating discount rates in different currencies and converting discount rates from one currency to another
2. Equity risk premiums: There are two components to the equity risk discussion. The first is estimating an equity risk premium for a mature market, such as the US. We presented two approaches - a historical risk premium and an implied equity risk premium, and I pushed for the latter. The second is estimating the add on country risk premium for a riskier emerging market. I presented three approaches for estimating the country risk premium - the default spread on the country bond, the relative equity market volatility and a melded approach that uses both the default spread and adjusts for relative volatility - and three approaches for estimating company risk exposure - the bludgeon approach (every company in a risky country gets the country risk premium added on), the refined bludgeon approach (multiply the country risk premium) and the lambda approach. If you have the information in the problem, I would like you to use the melded approach for country risk premium and the lambda approach. If you don't, you can use one of the approximations.
Key concepts to get nailed down: Historical versus Implied equity risk premiums, country risk premiums, lambdas
3. Betas: My prejudices on regression betas should have come through in class. I argued strongly for using bottom up betas, where betas are estimated by looking at how much value a company derives from each business and estimating a weighted average of betas of operating in that business.
Key concepts to get nailed down: Levered and unlevered betas, Estimating values of businesses
4. Cash flow adjustments: The last two sessions were focused on estimating cash flows - FCFF and FCFE. In the process, though, we considered several elements:
a. Treating lease commitments as debt: We argued that lease commitments should be treated as debt. To make this conversion, take the present value of lease commitments at the pre-tax cost of debt. This will also require you to adjust operating income by adding back the lease expense for the current year and subtracting out the depreciation on the leased asset.
b. Treating R&D (or similar items that are designed for future growth) as cap ex: To make this conversion, estimate a life for R&D, collect the R&D expenses going back in time for this life and then estimate the value of the research asset and amortization this year. The operating income then has to be adjusted as well, by adding back the R&D expense for the current year and subtracting out the amortization.
(I know that many of you were bemused by the tax adjustment that I talked about in this context. If you are still confused, let me try to explain what I am doing. Take a firm with stated operating income of $ 2 million, conventional net cap ex of $ 1 million, a tax rate of 40% and no working capital requirements. Assume that you have a 3-year life for R&D and that your current year's R&D expense is $ 4 million and that your R&D expenses in the last 3 years were $ 3 million, $ 2 million and $ 1 million respectively. If you capitalize R&D, here is what your schedule will look like:
Year R&D Unamortized Amortized
Current 4 4 0
-1 3 2 1
-2 2 0.667 0.667
-3 1 0 0.333
Total 6.667 2
If you capitalize R&D, your adjusted operating income = Stated OI + R&D in current year - Amortization of R&D = $2 million + $ 4 million - $ 2 million = $ 4 million
Your restated net cap ex = $ 1 million + 4 - 2 = $ 3 million
If I use the adjusted operating income of $ 4 million to compute the after-tax cash flows
FCFF = 4 (1-,4) - 3 = -$ 0.6 million
If I do this, though, I am missing one key fact. The tax code allows this company to deduct the entire R&D of $ 4 million to get to taxable income, whereas I am allowing only the amortization of $ 2 million. I am in effect missing the tax benefit that I am getting on the difference between the R&D expense and the amortization:
Missed tax benefit = (R&D expense in the current year - Amortization of research asset) (Tax rate) = (4 -2) (.4) = $0.8 million
My correct FCFF = - $0.6 million + 0.8 million = $ 0.2 million
Summarizing the effect of R&D, here is what my final computation looks like:
Adjusted after-tax operating income = (Stated operating income + R&D - Amortization of R&D)(1-t) = (2 + 4-2) (1-.4) = 2.4
+ Missed tax benefit on R&D = (R&D - Amortization of R&D) (t) = (4 -2) (.4) = 0.8
- Adjusted Net Cap ex = (Stated cap ex + R&D - Amortization of R&D) = (1 + 4 -2) = 3.0
- Change in non-cash WC = 0
= FCFF = 0.2

If you feel ready for the quiz, I have attached the quiz from last semester. As you try the quiz, I should note that those who did take the quiz felt it was a very tough quiz. I will leave it to you to judge that. (I have attached the solution.. Grade yourself and be lenient!)
Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Practice quiz and solution

Subject: Quizzes are done!!

Hi!
I am on my way to the airport to catch a flight to Munich but the quizzes are done. I have attached the solution and the distribution of points. Do go over the former and compare it to your solutions. If you have any questions, I am afraid that they will have to wait until Monday (unless you want to fly out to Germany and find me... I am staying at the Westin in Munich) but do bring them in. I mess up sometimes, while grading, and will gladly fix my mistakes. On the distribution, remember the serenity prayer:
http://www.aahistory.com/prayer.html
If you did well, congratulations but don't let your guard down. If you did badly, remember also that this is only 10% of your grade and that you can make it go away (by doing well on your other quizzes). Anyway, until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: I have one exam with "Benny" on it. If you are Benny, you may want to come in on Monday and tell me your last name...

Attachment: EqQuiz1Fall10sol.xls

Subject: Question of FCFF, Weekly challenge and some readings..

Hi!
I know that you are in no mood for valuation, right after your quiz. So, feel free to trash this email and not read it. In case you do read it, there are three points I would like to make:
1. Estimating growth: We have talked about estimating growth for the last two sessions. If you are interested in reading more on this topic, try this:
http://papers.ssrn.com/abstract=1162883.

2. What FCF is this guy talking about? One of my pet peeves about free cash flow is that people use it to mean whatever they want it to mean. If you get a chance, take a look at this article on free cash flows at Google. See if you can figure out what FCF he is talking about (equity or firm) and whether you agree with his computation.

3. Weekly challenge: If you are still up for it, the weekly challenge for this week is up and running. Give it a shot and submit your solutions to Blackboard before Sunday..

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: FCFFgoogle.pdf, Weekly challenge

Subject: I am baaackk!!

Hi!
I hope you have had a chance to pick up your quizzes. I did try to send a couple of emails from Munich but the email server at the hotel seemed to eat the emaisl. I am sure that they are in cyberspace now and will be delivered to you at an inopportune future date.
The newsletter for the week is up and running. Please browse through it when you get a chance.

Until next time!

Attachment: Newsletter

Subject: Google FCF and Terminal Value calculation

Hi!
I don't mean to sound hyperbolic but today's session was a key one in understanding why DCF works or more often fails. Here are a few issues to chew on:
1. Google FCF: In my last email, I sent you an article on Google FCF. I am convinced that the author of this article does not have a clear sense of what he means, but here is a generous interpretation:
The authors definition of FCFF = Buffett's owners' earnings = Net Income + Depreciation - Cap ex
To those of you who are wondering what this actually measures, compare this to the definition of FCFE
FCFE = Net Income - (Cap ex - Depreciation) - Change in Working capital - (Debt Repayments - new debt)
If you ignore working capital and assume that all net cap ex is covered by equity, Buffett's owners' earnings = FCFE
The author's premise, though, is absurd. His argument is that Google has very high FCFE because it has low net cap ex. What he is missing is that Google has spent billions in acquisitions in the last few years (that is the their primary cap ex)
2. Terminal value: While it is early, I am attaching this week's weekly challenge to this email because it relates so closely to the terminal value discussion today. Please try this challenge out sometime during this week and put your answer up on Blackboard. I think it will be worth your time.

3. The value of cash: We talked extensively about the value of cash in class today. I have a paper (I sound like a broken record) on the value of cash that you may find interesting (or not). If you want to dig in, here is the link:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=841485
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Weekly challenge

Subject: DCF valuation details

Hi!
I know that some of you are just turning your attention to the DCF valuation. I fully understand, because you do have other things to take care of. Anyway, I thought I would lend a helping hand:
1. Model building versus Model borrowing: This is not a modeling class and I am fine with you borrowing and adapting my models. If you decide to build your own model, keep it simple. Please do not use investment banking valuation models that you may have borrowed from a prior, current or summer job. Not only do they add detail, where you need none, but they often have fundamental mistakes built into them.
2. Which model should I use? First, go through the slides from a couple of sessions ago where we developed a roadmap for picking the right model. Once you have decided whether you want to use dividends, FCFE or FCFF, here is my suggestion. For companies where operating margins are not likely to change dramatically, use one of the ginzu models on my website. They are versatile and will do a lot a great deal of your dirty work (capitalizing R&D, converting leases to debt, taking care of management options) for you. For companies where margins are likely to change over time or companies with negative earnings, use the higrowth.xls spreadsheet (even if you do not expect high growth). In particular, stick with the following choices:
a. fcffginzu.xls: if you are doing a FCFF valuation of a firm that has positive operating income and you do not expect dramatic shifts in margins over time
b. fcfeginzu.xls: if you are doing a FCFE valuation of a firm that has positive net income and you do not expect dramatic shifts in margins over time
c. divginzu.xls: for financial service firms
d. higrowth.xls: for any firm that is losing money or has shifting margins over time, even if it is not in high growth
You can find all four of these spreadsheets under spreadsheets on my website. There is also a video that goes with the fcffginzu.xls spreadsheet explaining how to use it. It also includes spreadsheets that will convert leases and R&D and value options (I am a full service operation).

Let me clarify, though, what I would like to get from you when you turn it in:
1. Each of you can turn in your valuation individually. You do not have to submit as a group.
2. All I want is a base case valuation of your firm. It will be easiest if you submit the excel spreadsheet containing your valuation and include your assumptions page in the same spreadsheet.
3. There is no hard copy required and you can submit your DCF valuation spreadsheet electronically. But please do the following:
In the subject enter: "My perfect DCF Valuation". Do not deviate from the script or my filtering program will dump your email into my general email pile.
In the email text, specify the name of the company that you are valuing (yes, there are people who have submitted valuations of unnamed companies), the price per share that the stock is trading at today and your estimate of value per share.
4. Your DCF valuation will not be graded. I will review the valuation and send you back your own spreadsheet with my comments embedded in the spreadsheet. Some of the comments will be suggestions (which you are free to ignore) and some will be stronger than suggestions (and these should probablyy not be ignored).
5. If you don't get back your valuation within 48 hours of submitting it, please send me another email to let me know. My filtering program sometimes works in mysterious ways.
6. If you get done before October 29, go ahead and send your valuation in early.
So, don't freak out about this deadline. It is more feedback on your valuation than judgment day...

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Packet 2 ready to print

Hi!
A couple of quick notes. First, I sent the weekly challenge for this week early (on Monday). I am attaching it again to this email. Please, please give it a shot. It won't take you much time and it will be worth the effort. Submit your answers on Blackboard, when you get a chance. Second, the second lecture note packet is ready to print off. You can get to it online, either on the webcast page for the class or the lecture note page (from the website for the class). It should also be available in the bookstore by now. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Weekly challenge

Subject: Newsletter and a note about employee options

Hi!
The newsletter for this week is attached to this email. I also have papers on transpareny employee options that you are welcome to read, browse through or completely ignore:
On transparency: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=886836
On employee options: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=841504
But try to get the weekly challenge done before tomorrow (I won't harass you by attaching it again).

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 5

Subject: Solution to weekly challenge

Hi!
Hope you had a chance to give the weekly challenge a shot. If so, thank you! If not, next week!!!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: wkch4asol.xls

Subject: Second quiz date... and a late upload...

Hi!
Sorry about the delay in uploading the lecture video but it should be up now. (For some reason, I did not get the links until a short time ago). One more thing. I think I have two conflicting dates floating around for quiz 2. The quiz is scheduled for November 1.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Apple's earnings and Spreadsheets for Valuation

Hi!
It may be fortuitous that Apple reported its earnings yesterday, because it ties in so well with what we talking about yesterday on the value from existing assets versus the value of growth. For those of you who are not tracking prosaic stuff like this, here is the article on Apple's fourth quarter earnings report;
http://finance.yahoo.com/news/Apples-4th-Quarter-Beat-In-zacks-1126739033.html?x=0&.v=1
Apple beat expectations on earnings estimates by a lot, which is good news for the value of existing assets, but reported lower gross margins and declining growth in iPods, which is not good news for growth assets. The net effect is needless to say murky but the stock is down about 4% today.
On a different note, we went through several valuations in class yesterday. The point in these valuations is to not push my view of value down your throats but to emphasize consistency in estimates when doing valuation. If you want to download the excel spreadsheets that contain these valuations, you can get to them by going to:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/covals.htm
One final point. I am sorry about messing up on the quiz 2 dates. I understand that a few of you have made other plans for November 1, assuming that the quiz was October 27. Since the fault is mine, I am willing to give a make-up quiz on October 27, right after class. If you want to take the quiz on that date, let me know. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: A primer on valuing young start-ups and weekly challenge..

Hi!
I think that there is no more difficult task than valuing a young firm, and even more so, when it is private. I have a paper on the topic (surprise, surprise...) that you may find useful (even if you are not valuing a young company for your project).
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1418687
I also have the weekly challenge for this week. I had told you in class that it would be about circular reasoning in a disounted cash flow valuation model. I have saved that for next week. Instead, this week's challenge is on management options. Hope you get a chance to give it a shot (It will be good preparation for your next quiz.
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: Weekly challenge # 5

Subject: Dilution adjusted option value

Hi!
This week's challenge on management options does require you to value the options. The conventional Black Scholes will not work, since there is a dilution effect. I have a modified version of the model (which is what is built into the ginzu spreadsheets). Try it when you get a chance.

Aswath Damodaran
adamodar@stern.nyu.edu

Attachment: warrants.xls

Subject: Newsletter for the week

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 6

Subject: Solution to weekly challenge

Hi!
In case you did try the weekly challenge, here is the solution.. Until next time

Aswath Damodaran
adamodar@stern.nyu.edu

Weekly challenge # 5 solution & option valuation

Subject: Distress

Hi!
A couple of quick notes. First, we looked at how best to deal with distress in Monday's class, using Las Vegas Sands to illustrate the issues with DCF valuation. I have a paper on valuing distressed companies that you may find useful (if you are so inclined):
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1428022
I also have a spreadsheet that you can use to compute the probability of distress in a publicly traded company with bonds outstanding. Take it for a spin when you get a chance.

Finally, there is a weekly challenge for this week, even though we have a quiz next Monday. However, this is a very simple weekly challenge that should take only a few minutes. Try it if you can:

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

Attachments: distress.xls, wkch6.htm, daimler.xls

Subject: Newsletter, DCF valuation update and quiz notes

Hi!
Two days without emails from me. That must be some kind of record, but I have to disturb your weekend with three notes. First, the latest newsletter is attached. As you well know, we are into packet 2 and if you have not bought it or printed it yet, please do. Second, as expected, I received a flood of valuations yesterday and through today. As a consequence, I have about 100 valuations to get through. I will try to get yours to you before Monday.... Third, the quiz is in the first 30 minutes of class on Monday. Reiterating what I said in class, it will cover only DCF valuations. Some of the old quiz 2s have relative valuation problems in them. Ignore them for this quiz. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 7

Subject: DCF: My final thoughts

By now, you should have received back your DCF valuation back. (If you did If you have not, please send it again to me. Rather than make myself into an all-knowing oracle (which I am not), t thought I would take you through the process I used to diagnose your DCF valuations.
Input page checks
Step 1: Currency check: What currency is this company being valued in and is the riskfree rate consistent with that currency?
Right now, if you are valuing a company in US dollars, I would expect to see a riskfree rate of about 3.5% here.. though some of you used 30-year bonds rates which would give you a slightly higher value). if you are valuing your company in pesos or rubles, I would expect to see a higher riskfree rate, (Watch out for the tricky ones.. a Mexican company being valued in US dollars or a Russian company in Euros.. Your riskfree rates should revert back to 3.5%, if this is the case)
Step 2: ERP check: Is the equity risk premium being used consistent with where the market is right now and where this company has its operations?
If you are analyzing a company with operations only in developed markets, I would expect to see a number of about 4.5-5% here... That is because the current implied premium in the US (or any mature market) is about 5.31% (Oct 1, 2010). If you are using a much higher premium, you will under value your company whereas if you are using a much lower premium, you will over value your company. If your company is exposed to emerging market risk, I would expect to see something added to the mature market premium. While I begin with the presumption that where your company is incorporated is a significant factor in this decision, it should not be the only one in this decision. Coca Cola and Nestle should have some emerging market risk built into them.
Step 3: Units check: Are the inputs in consistent units?
Scan the input page. All inputs should be in the same units - thousands, millions, billions whatever... What you are looking are units with far too many digits to make sense. (Check the number of shares. It is the input that is most often at variance with the rest, usually because you use a different source for it than the financial statements)
Step 4: Normalization check: If earnings are being normalized, what is the normalized value relative to the current value? If reinvestment numbers are off, should they have been normalized as well?
In some cases, we normalize earnings by looking at historical average earnings or industry average margins. While this is perfectly defensible, you want to make sure that the normalization is working properly. Thus, if earnings of $ 3 million are being replaced with earnings of $ 3 billion, you want to make sure that this company has generated earnings like these in the past. You may also want to consider an alternative which is to allow margins to change gradually over time rather than replace current with normalized earnings.
As a follow up, check the reinvestment rate for the firm. If it a weird number (900%, -100% etc.), it may be because something strange happened in the base year (a huge acquisition, a dramatic drop in working capital). A better choice may be to average over time.
Output page checks:
a. High Growth Period.
Start by checking the length of the growth period and the cash flows during the growth period. In particular,
- Compare the FCFF (or FCFE) to the EBIT (1-t) (or Net Income). Especially if you are forecasting cap ex, working capital and depreciation independently, compute an implied reinvestment rate
Implied Reinvestment Rate = 1 - FCFF/ (EBIT (1-t) or 1 - FCFE/ Net Income
Thus, if you have after-tax operating income of 100 and FCFF of 95, your implied reinvestment rate is 5%
- Look at the expected growth rate over the period. Does it jive with your reinvestment rate? (If you see a high growth rate with a low reinvestment rate, the only way you can justify it is by calling on efficiency growth. For that argument to make sense, your current return on capital has to be a low number... See the attached excel spreadsheet that computes efficiency growth.

- If you are forecasting operating income, cap ex, depreciation and working capital as individual line items, back out your imputed return on capital:
Imputed Return on Capital = Expected EBIT (1-t)/ (Base Year Capital Invested + Sum of all reinvestment through year t-1)
If you see this number taking off through the roof or dropping towards zero, your reinvestment assumptions are unreasonable.
b. Terminal value
Start by checking to make sure your growth rate forever does not exceed your riskfree rate. Then follow up by
- Examining your reinvestment rate in your terminal year, using the same formula we used in high growth
- Backing out your implied return on capital (ROC = g/ Reinvestment Rate)
- Checking against your cost of capital in stable growth (you don't want to get more than 5% higher and you do not want to set it lower forever)
I have a spreadsheet that can help in this diagnostic:

One common error to watch out for is estimates of terminal value that use the cash flow in the final year, grow it out at the stable growth rate. That locks in your reinvestment rate from your last high growth year forever.
c. Cost of capital
As a general rule, your cost of capital should be consistent with your growth assumptions. Thus, you should expect to see betas move towards the stable range (0.8-1.2) and your debt ratios to rise towards industry average. Thus, your cost of capital in stable growth should be different from the cost of capital in high growth.
d. Final value of equity
Check for danger sign, including
- Cash and cross holdings becoming a huge percentage of value
- Options either being ignored or being a huge number
Market Price
As a final sanity check, look at the current market price. If your value is not even in the ballpark, go back and repeat all of the earlier steps...

Try it out with your own DCF valuation and then offer to do it for a friend... Then, take your toolkit on the road. Pick up a valuation done by an investment bank or equity research analyst and see if you can diagnose any problems in them. You are well on your way to being a valuation guru.
I have also attached a full set of diagnostic questions that you can consider in the context of valuation to this email.
Aswath Damodaran
adamodar@stern.nyu.edu

Attachments: chgrowth.xls, ImpliedROCROE.xls, postmortem.doc

Subject: Quizzes are done

Hi!
The quizzes are done and can be picked up outside the front door to the finance department. I have left copies of the solution and the distribution next to the quiz and included them as attachments....

Aswath Damodaran

Attachments: Quiz, Quiz solution, distribution

Subject: Weekly challenge on PEGY ratios

Hi!
I mentioned PEGY ratios in class today and the weekly challenge associated with the ratio. After much thought (really only about 10 minutes worth of it), I think it might be useful for you to try estimating the determinants of PEGY ratios.. Give it your best shot and don't let the algebra get you down:

Aswath Damodaran
adamodar@stern.nyu.edu

Weekly challenge # 7

Subject: Newsletter

Hi!
Three quick notes. The first is that the third and final lecture note packet is ready to download online (on the webcast page for the class) and should be available in the bookstore by next week. Please get a copy sometime next week. The second is that the Mystery project (You forgot all about that, right?) will no longer be a mystery after Wednesday. You will be able to get the description of the project and start working on it. It is not due until December 1, but you can actually finish it before Thanksgiving, if you so desire. Finally, the latest newsletter is attached.

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 8

Subject: Brand name and weekly challenge solutions

Hi!
I just realized that I never emailed you the solution to the weekly challenge for last week. For those of you who are waiting with bated breath, here is the solution:

We also started the discussion of brand names in class today. I know that I bring the cramped and restricted view of value to brand names and don't see the nuances and fine differences that brand name people do, but so be it. If you are interested in a more extended version of the discussion, you can try this paper on valuation brand names and intangible assets:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1374562
And one more reminder to print off packet 3 for next week. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Weekly challenge #7 solution

Subject: Mystery Project

Hi!
I know that this is probably putting salt on the raw wounds left by the quiz, but the mystery project is available to download.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/MystProject.htm
The bad news is that it is due on December 1 . The good news is that it is really not very involved: my estimate is that a few hours should get you to the analysis (and it is a group project with one analysis per group). I have attached both the description for the project and the dataset to go with it. You can also get it online on the course website (under mystery project). It is pretty much self-explanatory... Three notes of caution:
1. Don't read secret meaning into words: For instance, when I ask you to "control for differences in risk, growth and cashflow potential", I am stating the obvious. Picking the 5 stocks with the lowest PE ratios as your cheap stocks may not be appropriate since these stocks may be bedeviled with high risk, low growth or abysmal returns on equity. When you run a multiple regression, you are in fact controlling for differences in the variables that you use as your independent variables. However, using a PEG ratio is also controlling for differences in growth. That is why I have given you some leeway in deciding how you will do this.
2. Don't let the perfect be the enemy of the good: I know that in a perfect world, you would like the market value of debt (but you have only book value) and that it would nice to have expected growth rates in revenues (you only have it for EPS). Make do with what you have.
3. Do a relative valuation: Don't try to plug in values in the intrinsic equations that we derived for each multiple. All this will yield you is a two-stage dividend discount model value for each company, which is an intrinsic value (and a pretty crude one) for the company. So, steer away from that path and focus on what looks cheap on a relative (to other stocks in the sample) basis.
4. Don't try to use all of the information: There are more than a 100 items of information on every company. If you try to use it all, you will go crazy. If the trick in valuation is using what you should be and abandoning the rest, you should decide what is useful and what is not. (Hint: Let the data lead you..)

Please take a look at it when you get a chance.

Aswath Damodaran
adamodar@stern.nyu.edu

MystProject.htm, dataNov10.xls

Subject: Weekly challenge

Hi!
I know you have a lot on your plate this week, but this weekly challenge may help get you ready for next week's quiz.

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

Weekly challenge # 8

Subject: Newsletter, weekly challenge and quiz 3

Hi!
The weather was so good that I decided that it would not be right for me to pester you with weekends. But that peace has now come to an end. Three pieces of news:
1. Quiz 3: Quiz 3 will cover packet 2. It includes multiples and private company valuation. Chapters 17-20 cover multiples and chapter 24 covers private company valuations. Please do let me know if you are not going to take the quiz before 10.30 am on Wednesday.
2. Weekly challenge: The solution to the weekly challenge is attached. I know that most of you did not get a chance to even try it. But do look at both the challenge and the solution...
3. Newsletter: The newsletter for last week is also attached.. No big news...

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter, Weekly challenge soluton

Subject: Quizzes are done

Hi!
The quizzes are done. As I anticipated, most of you blew through problems 1 and 3 and had issues with problem 2. I have included the solution but am putting together a little more detailed explanation of how to deal with cross holdings. I will send it later.

Aswath Damodaran
adamodar@stern.nyu.edu

Quiz 3 solution, Quiz 3 distribution

Subject: Dealing with cross holdings

Nice work on the quiz but I have clearly left many doubts unresolved on the cross holdings Issue. I put together a little write up on cross holdings and how to deal with them in both DCF valuation and relative valuation. With DCF valuation, the objective is to make sure that you are counting into your value of equity what you own and not counting what you do not. With relative valuation, it is ensuring that what you have in your numerator (equity or enterprise value) matches up to what you have in your denominator. Thus, if you are trying to compute the EV/EBITDA of just the parent company, you have the EBITDA of just the parent company in the denominator and you want to make sure that you are counting only the value of the operating assets of the parent company in the numerator. When you compute the EV to EBITDA multiple for the consolidated company, you have the consolidated EBITDA in the denominator Since this includes 100% of the EBITDA of both the parent and the consolidated sub in it, your numerator should include 100% of the value of the operating assets in both the parent and the consolidated sub...
Two more side notes. I do know that the solution to the quiz has a typo in problem 3. While the set up claims to use the incorrect price to book ratio of 1.5, the actual solution uses the correct price to book ratio of 1.6. My mistake, and I apologize. The other is that the problem is vague about what risk is when it says 40% of the risk in a typical company comes from the market. Most of you read that to mean 40% of the standard deviation, and computed a total beta based on a correlation of 40%. That yields a total beta of 2.5 and a price to book ratio of 1.28. However, if you read that to mean 40% of the variance, the correlation will be the square root of 0.40, the beta will be 1.58 and the price to book ratio of 2.02. While I think I gave full credit to anyone who did this, let me know if you are one of the exceptions and I will fix the error.

Aswath Damodaran
adamodar@stern.nyu.edu

crossholdings.pdf

Subject: Just one note over the break, I promise!

Hi!
I know! I know! You are on break and you don't want to hear from me. Just one note and I will leave you alone for the rest of the week. First, most of you did pick up quiz 3. Thank you! I have the remaining quizzes in my office, in case you did not. Second, I will defer sending the newsletter until the end of this week. It will allow me to remind you of where we are in the class and to get ready for Monday's class. Third, there are only five sessions left after this week. In fact, there are two big deliverables coming due: the mystery project on December 1 and your final project on December 13. I will send an email on what's left to do on the big project when we get back, but just in case you are working on your mystery project, here are a few things to consider:
a. Don't lose sight of the ultimate objective: The ultimate objective is to find the five cheapest and most expensive stocks in the group, using relative valuation. Thus, whatever you use along the view (multiples, regressions, scatter plots, 3D stuff) is a tool and is not an end in itself.
b. Regression diagnostics: When you run a regression of a multiple against fundamentals, you may very well be disappointed by your output (low R-squared, wrong signs on the fundamentals etc.). You can try all of the standard statistical twists but don't fight the data. If your best efforts don't improve the regression, move on. Try a different multiple.
c. Outliers: If one or two outliers are skewing the data, and they are obviously outliers (a PE of 1000 or a PBV of 0.01), you can throw them out. Just be careful not to start pruning the data too much. You may be eliminating your most under and over valued companies.
d. Don't read secret meaning into words: For instance, when I ask you to "control for differences in risk, growth and cashflow potential", I am stating the obvious. Picking the 5 stocks with the lowest PE ratios as your cheap stocks may not be appropriate since these stocks may be bedeviled with high risk, low growth or abysmal returns on equity. When you run a multiple regression, you are in fact controlling for differences in the variables that you use as your independent variables. However, using a PEG ratio is also controlling for differences in growth. That is why I have given you some leeway in deciding how you will do this.
That's it. I hope you have a wonderful Thanksgiving with family and friends, and don't even think about valuation! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Welcome back

Hi!
I hope you are having a wonderful Thanksgiving weekend! Just to start the transition back to school, I am attaching the newsletter for the week (I skipped last week). We are at the beginnings of the real option section in the lecture note (packet 3, in case you are keeping count). Please give the first 29 pages a quick look before tomorrow's class. The mystery project is due on December 1, at 5 pm. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 9

Subject: Mystery project formatting and details

Hi!
Since we are approaching the dreaded due dat, I decided to put down specifics on submission.
1. When is the project due? By 5 pm, Wednesday, December 1, 2010

2. How should it be submitted?
Please submit your mystery project as an electronic document, with one submission per group. You can use either a pdf or a word format for the text and attach only those excel spreadsheets that you feel are absolutely necessary. (Please do not send me the original data file or the gory inside details of your number crunching)
When you email me the file, please put "Mystery project submission" in the subject...

3. What should be on the cover page?
The names of everyone in your group, in alphabetical order as well as the following:
a. The multiple of multiples you used to make your selections (PE, PBV, EV/EBITDA etc...)
b. Your five most under and over valued companies
c. The company you would invest in as an activist investor.
(If you can also put your information into the attached excel spreadsheet, I will be eternally grateful)

4. What should be in the report?
a. How you chose the multiple that you did...
b. How you used that multiple to assess companies... (If you used a regression, this would be the place you show it)
c. How you arrived at your most under and over valued companies
d. How you picked the one company that you would invest in as an activist investor
I am not a stickler for formatting... Be creative and bold...

Please keep it brief and to the point.

Aswath Damodaran
adamodar@stern.nyu.edu

Mystery project summary sheet

Subject: Equity in a troubled firm

Hi!
I hope that the discussion of using option pricing to explain the value of financial flexibility and equity value in troubled firms at least got you thinking... Anyway, I am not sure that I got across the rationale for thinking about equity as an option... So, let me try again. Assume that you and i both have $ 250,000 and go to Atlantic City. You gamble on your own wealth but the casino decides to lend me $750,000 with no backing. We both have 24 hours to gamble with the money we have and will keep gambling until our money runs out. We both start at the high stakes tables (think Casino Royale....) You gamble until you lose your $250,000 and then you are done. I start at the same tables, but I don't have to stop when I lose $ 250,000.... Since I have a million dollars to play with, I can lose $ 500,000 in the first 2 hours and still keep playing. In fact, once I lose $250,000, I have little incentive to play it safe. I am technically bankrupt (and you cannot come after my personal assets). I might as well keep taking bigger and bigger bets, hoping that one of them bails me out. That, in effect, is where the option value comes form - the fact that a firm value can drop below the outstanding debt and the equity investors still get to play the game.
If you are one of those unlucky people who has been saddled with the money-losing company, here is one more cross to bear. If your firm owes a lot (my rule of thumb is a market debt to capital ratio that exceeds 50%), you can value the equity in your firm as an option... Before you jump out of the window, let me hasten to add that it is not as bad as it sounds. Here are the inputs you need to the option pricing model:
1. S = Value that you attached to your firm (not equity) in your DCF valuation. I would make this a conservative estimate (use low or no growth) to reflect the fact this is liquidation value.
2. K = Face value of all of the outstanding interest- bearing debt in your firm. If you can, add the expected coupon or interest payments to this number. Thus, if you have a 10 year, 8% loan for $ 100 million, your face value would be 100 + 10 * (.08*100) = 180 million
3. t = Weighted average duration of the debt ( I know... I know.. Duration is a pain in the neck to estimate... You can use maturity) There should be a table in your financial statements telling you how much debt comes due by year (there will be a thereafter... just make that a year beyond your last year) Take a face-value weighted average of when the debt comes due.
4. Standard deviation in firm value = Use the bottom up estimate for the sector that you can download off my site. Go to updated data and look towards the bottom of the page.
5. Riskfree rate - Find the treasury bond rate that corresponds to your option life
If you want to download a spreadsheet that does the calculation for you, you can find one under spreadsheets on my site.... I am also attaching it to this email.
If you do not have a money losing, indebted firm, you do not have to do option pricing....

Aswath Damodaran
adamodar@stern.nyu.edu

Spreadsheet to value equity in troubled firm

Subject: Mystery project wrap-up

Hi!
I think that I have returned all of the mystery projects back. If you have not received yours, first please check with your teammates ( I tried to Reply All to get everyone on the list but a few did not have all of the group members ccd and I did forget on a few). There should be an attachment to the email, with your file and my comments on it. The grade is on the first page.
Looking over the mystery project, here are some of the overall impressions I have:
1. Multiple used: The two most widely used multiples were PE and EV/EBITDA. Here was the breakdown:
PE 9
EV/EBITDA 8
PBV 4
There were 32 groups overall. In making your choices, the following factors seemed to come into play: (a) the regression R-squared (higher R-squared) (b) differences in accounting standards across markets (led people to choose Revenue or EBITDA over EPS) (c) Number of firms that you would lose in the sample (steered away from multiples that cost you too many firms). I think that these are all legitimate factors. A few groups mentioned that they were using equity multiples because they were equity investors. I don't think that is necessarily the case. Equity investors can use EV multiples and back into a value for equity... There were five groups that used combinations of multiples and that too is okay.

2. Regressions: Almost everyone followed the script and ran the regressions... One thing I did notice is that some of you chose to stick with all of the variables in the regression, even when there was no statistical significance. Sometimes, taking a variable out rather than leave it is the better choice. About 20% of the groups reported regressions with dummy variables for emerging markets, but the statistical significance of that variable was marginal. The reason may lie in the types of firms that are in this sample. These are the largest market cap firms and most of them are multinationals. The fact that they are incorporated in emerging markets may therefore not matter very much. Five groups ran the regressions by sector or used sector dummies. While this makes sense, you have to be careful to make sure that you have enough data within each sector to sustain the regression.

3. Recommendations: When picking under and over valued companies, what matters is the percentage and not the absolute difference. In other words, a company that trades at a PE of 10 with a predicted PE of 15, is more undervalued that a company that trades at a PE of 40 with a predicted PE of 50. Here is the list of companies that came through as most under valued:
Company Number of groups
Arcelor Mittal 7
AstraZenaca 5
Bristol-Myers Squibb 7
E.ON AG 6
Eli Lilly 6
Honda 6
Gazprom 18
Lukoil 11
Samsung 14
United Healthcare 6
Note the two Russian companies on the list. Perhaps, a Putin dummy would have made sense. For most overvalued, here is the list of the top few:
Amazon 15
GE 7
Hutchison Whampoa 6
Tencent Holdings 12
Walmart de Mexico 11

4. LBO candidate: Almost all of you focused on finding an under valued company (which is good), an under levered company (makes sense) but the search on the third dimension was all over the place. Some of you were looking for companies with high margins and others with stable cash flows. As a general rule, control requires inputs that you can change and that indicates a firm with below-average margins. There was almost no overlap between the groups with no company being picked more that twice. I have a paper on LBOs that fleshes out what you may want to look for in a LBO candidate. f you get a chance, please browse through it.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1162862
Thank you for the effort you put into this project. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: To do list for the big project

Hi!
As promised, here is your to-do list on the rest of the project. It is a long email but I hope it helps.

1. DCF Valuation
1.1. Consider feedback you got on your original DCF valuation and respond, but only if you want to.
1.2. Update macro numbers - riskfree rate to today's rate and equity risk premium (if you are using 6.43% still, check out the front page of my website for an updated premium from Nov 2009)
1.3. Update company financials. If a new quarterly report has come out, compute new trailing 12-month numbers
1.4. Review your final valuation for consistency

2. Relative valuation
2.1. Collect a list of comparable firms (stick with the sector and don't be too selective. You will get a chance to control for differences later) and raw data on firms (market cap, EV, earnings, revenues, risk measures, expected growth)
(You can this data from Bloomberg or Cap IQ. The latter is a little more user friendly)
2.2. Pick a multiple to use. There may be an interative process, where you use the regression results from 2.4 to make a better choice here)
2.3. Compare your company's pricing (based on a multiple) to the average and median for the sector. Make a relative valuation judgment based upon entirely subjective analysis.
2.4. Run a regression across the sector companies. (Be careful with how many independent variables you use. As a rule of thumb, you can add one more independent variable for every 10 observations. Thus, if you have only 22 firms in your list, stick with only two.)
2.5. Use the regression to make a judgment on your company and whether it is under or over valued. (If you are using an EV multiple, estimate the relative value per share. This will require adding cash and subtracting out debt from EV to get to equity value and then dividing by the number of shares)
2.6. Use the market regression on my website to estimate the value per share for your firm.

3. Option valuation
3.1. Check to see if your company qualifies for an option pricing model. It will have to be a money losing company with significant debt obligations (a market debt to capital ratio that exceeds 50%).
3.2. If yes, do the following:
3.2.1: Use your DCF value for the operating assets of the firm (not the equity value) as the S in the option pricing model
3.2.2: Use the book value of debt (not the market value) as the K in the option pricing model
3.2.3: Check your 10K for a footnote that specifies when your debt comes due. Use a weighted-maturity, with the weights reflecting the debt due each year. (You don't have to worry about duration)
3.2.4: Go to updated data on my website and check towards the bottom of the page for the industry average standard deviations, Use the standard deviation in firm value (not equity value) as the standard deviation in the option pricing model.
3.2.5: The value of equity that you get from this model is your option pricing estimate of value for equity.
I have attached an excel spreadsheet that should help in this effort.
Spreadsheet to value equity in troubled firm

4. Bringing it all together
4.1: Line up your intrinsic value per share (from the DCF model), the relative value per share (from the sector), the relative value per share (from the market regression) and the option based value per share (if it applies)
4.2: Compare to the market price now (not in January 2010 or September 2010)
4.3: Make your recommendation (buy, sell or hold)

5. Numbers to me!!!!
Fill in the attached excel spreadsheet when you have all the numbers for all of the people in your group and please get it to me by Sunday morning. (If you have someone who is holding up the group, just send me the rest of the numbers). Please do not modify the spreadsheet in any way.
Mystery project summary sheet

6. Final Project write up
Write up your findings in a group report. The report should be brief and need not include the gory details of your DCF valuation. Just provide the basic conclusions, perhaps the key assumptions that you used in each phase of valuation. (There should be relatively little group work. So, you may not really need to get together for much more than basic organization of the report) The group report is due electronically by Monday, May 3, at 5 pm. A pdf or word format works best. You do not need to attach the raw data and excel spreadsheets). I am not a stickler for format but here are good examples of reports from previous semesters online.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/eqass2.htm

And no.. you don't have to do everything that these groups did (So, don't spend the next five days converting your DCF valuations into pictures). I just like the fact that the valuations were organized, presented in much the same format and were to the point. Of course, content matters.

7. Celebrate, but remember that your final exam is a few days later.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Acquisiton tests and newsletter

Hi!
Two quick notes. The first is that the weekly newsletter is attached to this email. Needless to say, it reminds you that next week is your last full week of classes - you have class the following Monday. The second is a a follow-up to something I mentioned at the end of the last class. I said that I would be sending out a pre-class test for next session's class on acquisition valuation. I have attached that as well. Please give it a shot. I don't think it will take more than 15-20 minutes to do.

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 11, Acquisiton test

Subject: Reminder

Hi!
Two quick notes. The first is that the weekly newsletter is attached to this email. Needless to say, it reminds you that next week is your last full week of classes - you have class the following Monday. The second is a a follow-up to something I mentioned at the end of the last class. I said that I would be sending out a pre-class test for next session's class on acquisition valuation. I have attached that as well. Please give it a shot. I don't think it will take more than 15-20 minutes to do.

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Sorry about this morning

Hi!
I am truly sorry about being late for class this morning. Anyway, thank you for waiting for me and I hope the session on acquisitions was worth it. In case you want to carry this forward, here are a few links:
a. Track record of acquisitions: I mentioned the KPMG study on acquisitions in class. I have a link on my site to it but I have attached the entire file, in case you are interested:
Link to KPMG study

b. Synergy: I also mentioned Mark Sirower's book on synergy... If you are interested, try this link:
http://www.amazon.com/Synergy-Trap-Mark-L-Sirower/dp/0684832550
On a different note, I also found some interesting work extending relative valuation into arenas where it has not been used before. I am attaching a paper written by a Princeton economist called Orley Ashenfelter on the value of wine. For years, Orley (who is an interesting character) has used regressions of wine prices against the temperature and rainfall in the Bordeaux area to predict prices and publishes the results in a newsletter called Liquid Talk. He has done better at predicting wine prices than so-called wine experts (you know the type - sniff the wine with supercilious expression, make these comments about how the wine carries the whiff of this (fruit of various kind, shoe leather, whatever) and the touch of that - and make you look ignorant).... It is a fun paper to read, especially if you are interested in wine... Just as a counter-point, in case you are too enamored with regressions, I have included one of my favorite papers on econometrics by my stat professor (from my MBA days at UCLA).. I think it is well worth reading.
Leamer: Taking the Con out of Econometrics
Ashenfelter on wine

Aswath Damodaran
adamodar@stern.nyu.edu

Hi!
As you work through the relative valuation section, a few questions that seem to be recurring:
1. Sample size: There is a trade off between sample size and finding companies that look more like yours. If you are doing a subjective comparison - comparing your company's PE with the PE ratio of comparables, controlling for differences with a story, you want a small sample of companies that look like yours. If you are doing a regression, you should try to get a larger sample, even if it means bringing in firms that may not look like yours. You can control for differences in the regression.
2. Market regressions: The updated market regressions from the start of 2010 are on my website under updated data. Look to the bottom of the page. Unfortunately, I don't have an update from right now (which is what you would want). So,take the market predictions with a grain of salt, since they are 11 months old and markets have gone up.
See you in class tomorrow! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Summary Sheet

Hi!
Just a couple of quick reminders. The first is to fill out the summary sheet that I sent a few days ago, when you have the numbers. While I would prefer to get the summary for the entire group, I will take what I can get. I would like to get all of the summaries in by Sunday, so that I can pull the presentation together for Monday.. but earlier is even better. The second is a reiteration: the final project report can be turned in electronically by 5 pm, either as a pdf file or a doc file. Good luck! Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Mystery project summary sheet

Subject: Last newsletter

Hi!
The final newsletter is attached. I will also keep a running tab of the summaries as I get them. Here is the latest update:
Company summaries received = 0
Company summaries yet to come = 172
Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Newsletter # 12

Subject: Moving on up...

Summaries received = 80
Waiting on = 92
To give you a heads up on what I plan to do, I will wait as long as I can tonight for the summaries. I will then go through all of the summaries to put together my presentation by early tomorrow morning and get it to you by 8.30 am. Please check your email for it, print it off and bring it to class with you. Since this is the last class, I would like to see as many of you in class as I can, even if you prefer me on webcast. I promise that it won't be too painful a session and would like to use it to bring everything we have done in the class together. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

I will make copies for class. Potential for chaos too high. See you soon!

Sent from my iPhone

Subject: Final exam

Hi!
By now, you should have your final projects back. I am sorry, if my comments were a little cryptic and if any of them don't make sense, they were written in the immediate aftermath of the disastrous news that Cliff Lee signed with the Phillies... (C'mon... What person in his right mind picks Philadelphia over NY? San Francisco, I can understand... but Philadelphia?) If you did not get your final project back, let me know.
The final exam is on Friday from 10-12 and I have two rooms for test takers: 2-60 and 2-65.
If your last name begins with Go to
A - M 2-60
N-Z 2-65
Please be there at 10 am.
I also know that the solutions to the 2009 final have some problems with them. I think I have fixed them now. Please download another version of the solutions (and try not to print it, if you don't have to).
One final point. I have been asked whether you need to know how to use the option pricing model. The answer is yes, though I will supply you with the normal distribution. You will still need to compute d1 and d2, for both the conventional BS and the dividend adjusted BS (If you have no idea what I am talking about, look at the first 20 pages of packet 3). Please try a few problems in the practice exams and make sure that you are comfortable doing the problems. (The normal distribution is in your lecture notes as well - I think page 16 or 17 or packet 3).

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: CFE reminder

Folks,
I got my reminder and am passing on the message to you. Please fill out the evaluations, when you get a chance (do it now, before you forget). If you do not, the school (not me) cuts off your access to the grades... Then you will have to email me over Christmas break..

Begin forwarded message:

From: Records and Registration <mbacfe@stern.nyu.edu>
Date: December 16, 2010 5:00:14 AM EST
To: adamodar@stern.nyu.edu
Subject: CFE Reminder

Dear Professor Damodaran:

As you know, the Online Course Faculty Evaluation for your course, B40.3331.01 began 14-dec-2010 and will end at midnight on 20-dec-2010.

Students enrolled in the course have already received an email reminder to submit their evaluation prior to the end date. The evaluation process is valuable for both faculty and students, and to ensure the maximum response rate, we ask that you remind students to complete this important task. Please assure them that their responses are completely confidential and anonymous. We will be communicating with the students who have not completed the evaluation at this point directly via email until the end date of the online evaluation.

Thank you for your help. If you have any questions do not hesitate to contact Gia Pangilinan at gpangili@stern.nyu.edu or x80182.

Regards,

Office of Records and Registration

Student Instructions for Completing Online CFEs

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

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Last minute questions on option pricing

Hi!
There are two questions seems to be coming up on the real options problems and m afraid I have contributed to the confusion. So, here is some clarification:

1. What is the probability that S>K?
As stated in class, it is N(d2) which is the risk neutral probability that S>K. In some of the problems, though, I have used a range from N(d1) and N(d2) as the range of probabilities. Let me explain why. N(d1), in addition to being an option delta, is also a probability that the option will be in the money. In fact, the only reason d1 is different from d2 is because you are uncertain about S
d2 = d1 - square root of the standard deviation
If you had a standard deviation of zero, N(d1) = N(d2). As the uncertainty increases, the gap between these two numbers will widen. Thus, you go from being certain about the probability to having a range. Having said all of this, N(d2) should be the point estimate on the probability that S>K. You can use the range to indicate that there is uncertainty about this probability.

2, What is the cost of delay?
This is a tough one. Sometimes, I use 1/n and sometimes I use the cashflow next year/ S and sometimes I use no cost of delay at all. Lets look at the conceptual basis. The cost of delay is a measure of how much you will lose in the next period if you don't exercise the option now as a fraction of the current value of the underlying asset (It parallels the dividend yield. On a listed option on a stock, if you exercise, you will have the stock and get the dividends in the next period) . Thus, if you have a viable oil reserve, the cost of delay is the cashflow you would have made on the developed reserve next period divided by the value of the reserve today.
Here is the overall rule you should adopt. If you have a decent estimate of the cashflows you will receive each period from exercising the option, it is better to use that cashflow/ PV of the asset as the dividend yield. If your cashflows are uneven or if you do not know what the cashflow will be each period, you should use 1/n as your cost of delay. If you will lose nothing in terms of cashflows by waiting, you should have no cost of delay.
Let me take three examples. The first is the bidding for rights to televise the Olympics in an earlier quiz. There were two years left to the Olympics and you were trying to price the option. In this case, there is no cost of delay since you really cannot exercise the option early even if it is deep in the money. (You cannot televise the Olympics a year before they happen...) The second is the oil reserve option. Since the cashflows from the reserve tend to be fairly uniform over time (based upon the barrels of oil you would produce and the current price per barrel, it is easy to estimate the cashflows you would generate each year on the reserve. In most of the oil reserve problems, therefore, you would go with the cashflow/ PV of oil in the reserve as your cost of delay. The third is the patent examples. While you may be able to estimate the expected cashflow each year from commercialising the patent, these cashflows are more difficult to obtain and are less likely to be uniform over time. That is why many of the patent problems use the less preferred option of 1/n as the cost of delay, where n is the number of years left in the patent.

Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Subject: Final exams are graded..

Hi!
The final exams are graded but won't be ready for pick up until Monday. I am sorry, but I don't feel up to making the trip into the city. I am attaching the solution to the final exam. Please don't freak out until you have your final exam picked up. I have the final grades for the class ready to go as well and should input them by this weekend. Until next time!

Aswath Damodaran
adamodar@stern.nyu.edu

Final exam solution, Distribution

Subject: Final grades are in!

Hi!

I hope you are done and are out celebrating. However, just in case you still care about grades, yours just went online. Since most of you have been with me for the better part (or worse part, depending on your pespective) of a year, through two classes, this will be my last official email to you as Stern MBAs. Note that this email does not end with the same three words with which I have ended every other email, "Until next time".

I want to to wish you the very best with whatever you plan to do with your lives. I hope your life's choices brings you as much joy as mine have. Here are my three pieces of advice (if you feel in the mood for it). First, have fun at whatever you choose as a career. If you enjoy what you are doing, you will never have to work a day in your life... Second, diversify. Get your joy from many places - friends, family, work... Third, preserve your options - your option to expand (and do something new and different), to abandon (things you don't have to do) and to delay... Life is a high variance sport... Get the most out of it.

You have my email address for life and can bounce off any questions, queries or issues that you have with corporate finance, valuation or the most valuable sports franchises in the world (the answer, unfortunately, is always the Yankees!!!) . It has been a pleasure teaching you for the last semester or two. Thank you and have a wonderful new year?

Aswath Damodaran
adamodar@stern.nyu.edu

P.S: I will put the final exams out at about 10 am on Monday, when I get into my office. I will take back whatever exams that are not picked up by Tuesday evening into my office and hold them for the break.