I confess. I send out a lot of emails and I am sure that you don't read some of them. Since they sometimes contain important information as well as clues to my thinking (deranged though it might be), I will try to put all of the emails into this file. They are in chronological order, starting with the earliest one. So, scroll down to your desired email and read on...
Happy new year! I hope you have have a wonderful break and that you will come back tanned, rested and ready to go. This is the first of many, many emails that you will get for me. You can view that either as a promise or a threat.
I am delighted that you have decided to take the corporate finance class this spring with me and especially so if you are not a finance major and have never worked in finance. I am an evangelist when it comes to the centrality of corporate finance and I will try very hard to convert you to my faith. I also know that some of you may be worried about the class and the tool set that you will bring to it. I cannot alleviate all your fears now, but here are a few things that you can do to get an early jump:
Having got these thoughts out of the way, let me get down to business. You can find out all you need to know about the class (for the moment) by going to the web page for the class:
The syllabus has been updated and you will be getting a hard copy of it on the first day of class but the the quiz dates are specified online. If you click on the calendar link, you will be taken to a Google calendar of everything related to this class.
I am a minimal user of NYU Classes (I hate closed systems) but am planning to use a young upstart site that allows content, social media and commentary to co-exist called Yellowdig. The site is listed below:
I will also be posting the contents of the site (webcasts, lectures, posts) on iTunes U. If you have never used it, here is what you need: an Apple device (iPhone or iPad), the iTunes U app on the device and you need to link to the link below:
I know that you are feeling overwhelmed by now, but for those of you with devices and slower broadband, I also have a YouTube Playlist for the class:
Now for the material for the class. The lecture notes for the class are available as a pdf file that you can download and print. I have both a standard version (one slide per page) and an environmentally friendly version (two slides per page) to download. You can also save paper entirely and download the file to your iPad or Kindle. Make your choice.
There is a book for the class, Applied Corporate Finance, but please make sure that you get the fourth edition. It is exorbitantly over priced but you can buy, rent or download it at Amazon.com or the NYU bookstore
One final point. I know that the last few years have led you to question the reach of finance (and your own career paths). I must confess that I have gone through my own share of soul searching, trying to make sense of what is going on. I will try to incorporate what I think the lessons learned, unlearned and relearned over this period are for corporate finance. There are assumptions that we have made for decades that need to be challenged and foundations that have to be reinforced. In other words, the time for cookbook and me-too finance (which is what too many firms, investment banks and consultants have indulged in) is over.
That is about it. I am looking forward to this class. It has always been my favorite class to teach (though I love teaching valuation) and I have two objectives. I would like to make it the best class you have ever taken, period. I know that this is going to be tough to pull off but I will really try. I hope to see you on February 2nd in class.
As the long winter break winds down, I hope you are ready to get started on classes. I also hope you got my really long email last weekend. If you did not, you can find it here:
1. Website: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
2. Online classes: I sent out an invitation for you to join the class on Yellowdig (https://www.yellowdig.com/board/Corporate+Finance+Spring+2015 ) Many of you have accepted the invitation and I thank you. You can choose to also follow the class on iTunes U or on YouTube (see last email for details).
3. Pre-class prep: Are you kidding me? What kind of twisted mind comes up with a pre-class prep for the very first class. Just relax, have fun this weekend and try to be in class. If you cannot make it, never fear! The webcast for the class will be up a little while after the class, but it just won't be the same as being there in person.
For those of you who have not got around to checking, class is scheduled from 10.30-11.50 in Paulson Auditorium on February 2. See you there!
I am sorry for hitting with you a third email before class has even started, but it never hurts to be prepared. Just to prevent any shock that you might feel when you walk into the class on Monday, here is what you can expect to see:
See you on Monday! Until next time!
I promised you with a ton of emails and I always deliver on my promises... Here is the first of many, many missives that you will receive for me.....
First, a quick review of what we did in today's class. I laid out the structure for the class and an agenda of what I hope to accomplish during the next 15 weeks. In addition to describing the logistical details, I presented my view that corporate finance is the ultimate big picture class because everything falls under its purview. The “big picture” of corporate finance covers the three basic decisions that every business has to make: how to allocate scarce funds across competing uses (the investment decision), how to raise funds to finance these investments (the financing decision) and how much cash to take out of the business (the dividend decision). The singular objective in corporate finance is to maximize the value of the business to its owners. This big picture was then used to emphasize five themes: that corporate finance is common sense, that it is focused, that the focus shifts over the life cycle, that it is universal and that violating first principles will exact a cost, no matter who does it.
On to housekeeping details:
2. Get started on picking companies: Avoid money losing companies, financial service firms and firms with capital arms like GE and GM. Once you have your group nailed down, let me know the names of the people in your group and, if possible, the companies you have picked. In picking a company, pick a theme that is fairly broad and pick companies that match this. Thus, if your theme is entertainment, you can analyze Sony, Time Warner, Netflix and even Apple. I would encourage getting diverse companies in your group - large and small, focused and diversified, and non-US companies. (In other words, you don't want five companies that are carbon copies of each other. There is little that you will find interesting to say about differences across companies, if there are none)
3. Once you pick your company, you can start collecting the data. You should begin by accessing basic data on your company. I would begin with the old standard, the company's annual report, which you should be able to get off the company's website. If you have a non-US company, you should be able to find an English version of the annual report on most company sites. If not, you better be able to read Portuguese or Spanish. You can also get the latest filings (10K and 10Q) for US companies off the SEC website:
4. Board of Directors: If you do pick a company by Wednesday, use the annual report or 10K can get a listing of the board of directors for your company. It will dovetail nicely into our discussion for Wednesday. If you can find a mission statement for the company (on its website, from the annual report), that would be even better.
5. Webcasts for the class: The webcasts should be up a few hours after the clas ends. Please use the webcasts as a back-up, in case you cannot make it to class or have to review something that you did not get during class, rather than as replacement for coming to class. I would really, really like to see you in class. The web cast for the first class is not up yet, but it should be soon. When it is, you should be able to find it at
6. Drop by: I know this is a large class but I would really like to meet you at some point in time personally. So, drop by when you get chance... I don't bite....
7. Lecture note packet 1: Please bring the first lecture note packet to class on Wednesday. You can buy it at the bookstore, if you have money to spare, or download it online.
8. Past emails: If you have registered late for this class and did not get the previous emails, you can see all past emails under email chronicles
9. Yellowdig stragglers: If you have not registered on Yellowdig and would like to and have not got an invitation, please let me know. You can get to the site by typing in:
10. Announcements: If you plan to make announcements in this class (and it may be way too early for this), there is a shared Google spreadsheet for sign-ups, since there will be only one announcement at the start of every class.
11. Post class test & solution: Each class, I will be sending out a post class test and solution for each class. This is just meant to reinforce what we did in class that day and there are no grades or prizes involved. I am attaching the ones for today's class.
I am glad to see the sun out today, though I wish it were 40 degrees warmer (fahrenheit, not celsius). Anyway, three quick notes for today. The first is that the corporate finance puzzle #1 is up and running. In class yesterday, we talked about the perils of ignoring first principles in finance generally and about mismatching currencies specifically. In this week's puzzle, I look at the turmoil created by the Swiss Central Bank's decision to unpeg the Swiss Franc. I highlight six stories of entities/groups affected by the decision. They range the spectrum from homeowners in Poland to hedge fund honchos. After you read about their plight and empathize with them, please do think about what they share in common, why they are in trouble and how (if at all) they could have avoided their problems.
Second, it took me a while but all of the streams of yesterday’s class are up and running. I know that most of you were in class yesterday but check out the links anyway. You never know when you might need them.
Third, I hope that you are well on your way to finding a group. In case you are not attached yet, the orphan list that I put up last Friday seems to have quite a few people on it. Please add your name to the list or better still, contact other people on the list. And as you find groups, please take your names of the list:
One final reminder. Please get lecture note packet 1 before class tomorrow and bring it to class. We will be starting on the packet.
In today's class, we started on what the objective in running a business should be. While corporate finance states it to be maximizing firm value, it is often practiced as maximizing stock price. To make the world safe for stock price maximization, we do have to make key assumptions: that managers act in the best interests of stockholders, that lenders are fully protected, that information flows to rational investors and that there are no social costs. We then looked at what can go wrong, by starting on the manager-stockholder linkage. The two mechanisms that stockholders can use to keep control of managers, the annual meeting and board of directors, are flawed and often ineffective.
1. Other People's Money: Just a few added notes relating to the class that I want to bring to your attention. The first is the movie Other People's Money, which is one of my favorites for illustrating the straw men that people like to set up and knock down. You can find out more about the movie here:
2. DisneyWar: I mentioned the dysfunctional actions taken by Disney during the 1990s. If you want to review these on your own, try this book written by James Stewart. It is in paperback, on Amazon:
3. Company Choice: On the question of picking companies for your group, some (unsolicited) advice:
4. Once you have picked your company, start by assessing the board of directors (and making judgments on how effective or ineffective it is likely to be). To help in this process, I have posted the original article in 1997 that covered the best and the worst boards as well as a more recent article detailing what Business Week looks at in assessing boards under corporate finance readings:
You can find out more about your company by going to the SEC site (http://www.sec.gov) and looking up the 14-DEF for your US-based company.. You may not be able to find a 14-DEF (or its equivalent) for a foreign company, but the difficulty of finding this information may be more revealing than any information that you may have unearthed. On that mysterious note, until next time…
P.S: Post class test and solution for today’s class attached
|2/5/15||It is never too early to start nagging you about the project. So, let me get started with a checklist (which is short for this week but will get longer each week. Here is the list of things that would be nice to get behind you:
Find a group: If you have trouble finding one, try the orphan spreadsheet for the class. (https://docs.google.com/a/stern.nyu.edu/spreadsheets/d/1m1Ij9t0JEFEoxAyKHyFJ6QxRgFHOaN-972frKG7NLeI/edit?usp=sharing )
Pick a company/theme: This will require some coordination across the group but pick a company and find a theme that works for the group.
Find the most recent annual report for your company.
If your company has quarterly reports or filings pull them up as well.
Get a listing of the board of directors for your company & start your preliminary assessment.
In doing all of this, you will need data and Stern subscribes to one of the two industry standards: S&P Capital IQ (the other is Factset). It is truly a remarkable dataset with hundreds of items on tens of thousands of public companies listed globally, including corporate governance measures. However, to use Capital IQ, you have to enroll and this is an email I got earlier this week about enrolling. Please, please register now. You will not regret it and it will not only save you lots of time in the future but will give you another weapon you can use in analysis.
|2/6/15||As you get ready to enjoy your weekend, a few notes for today:
1. Lecture note packets: The bookstore has lecture note packet 1 back in stock, if you are interested in buying it. The download for free on to your iPad or print if off some sucker's printer options are always available. You can get the packet by clicking on the link below:
2. Post-class tests: I posted post-class tests for both of this week's sessions and will continue to do so for all of the coming ones. If you have already worked through them, thank you. If not, just browse through them quickly to make sure that there are no loose ends. You will find them on the webcast page for the class (http://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr15.htm ), the Yellowdig page for the class, on iTunes U or on the Youtube channel for the class. Take your pick.
3. Orphans: I am getting straggling emails from some of you about your sad plight as orphans. The orphan page can be found here for both listing and adoption:
4. Webcast of the week: I mentioned that I would do short in-practice webcasts each week. This week's webcast is up and ready to watch. It looks at ways to assess the corporate governance at your company, using HP from 2013 as an example. I use HP's annual report, its filings with the SEC and other public information to make my assessment of the company. You can find it in all three forums (webcast page, Lore, iTunes U) and it looks at what information to use and how to use it to assess the corporate governance structure of a company. Let me know if there are "production quality" issues and I know.. I know.. That striped sweater is not camera-ready, but I forgot... Sorry!
5. Corporate finance email chronicles: I have updated the email chronicles page to reflect all the emails sent out in this class:
If you joined the class late, have short term memory loss or are nostalgic for emails from days gone by, click on the link.
6. Weekly puzzle posting: I posted the first weekly puzzle of the week (the after effects of the surge in the Swiss Franc). If you did or do get a chance to look at it, and have your answers to the questions that I posed, you can go to the discussion board on Yellowdig and post your views (with links, if you so desire). You have to be registered on Yelllowdig to do this. Most of you are, but if you are not, go to https://www.yellowdig.com.
Until next time!
The first newsletter is attached. It is filled with gripping details of Kim Kardashian’s balance sheet (assets and liabilities detailed), an expose of what exactly is bedeviling the New York Knicks this season and it also contains the true reasons why Russell Wilson threw that pass in the waning minutes of the Super Bowl. (Not really, but a little hype does not hurt). Think of it as the National Enquirer on steroids. Seriously, do whatever you need to do this weekend first, then what you want to do and if you have time left over, take a look at the newsletter. It should not take more than a couple of minutes to browse through.
Attachment: Newsletter #1
This week, we will continue with our discussion of corporate governance, focusing first on where power in a company rests (stockholders, managers, labor, the government) and the consequences for corporate finance. We will then move on to lenders/bondholders and how left unprotected, they can be exploited, and on to financial markets, examining both the predilection of firms to delay/manage bad news and investor reactions to it. Having laid bare the limitations of the assumptions that underlie traditional corporate finance, we will examine alternatives to stock price maximization.
On a different note, the TAs have lined up tutorial sessions starting on February 17th. These are optional and for anyone who feels that they can use extra help. Since the room for the TA sessions fits only 65, I have a Google shared spreadsheet created for the TA sessions and you can see the first two sessions. Please sign up if you are interested. If you lose interest after you sign up, please take your name off the list.
One final reminder. The lecture note packets are back in stock at the bookstore. So, please bring lecture note packet 1 with you to class tomorrow (either in the bookstore version, your downloaded version or a printout). See you in class tomorrow!
Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? i also want to think about how managers in publicly traded companies can position themselves best to consider the public good, without being charitable with other people's money. We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. In the next class, we will take a more prescriptive look at what we should be doing in this very imperfect world. As always, reading ahead in chapter 2 will be helpful.
I hope that your search for a group has ended well and that you are thinking about the companies that you would like to analyze. Better still, perhaps you have a company picked out already. If you do, try to find a Bloomberg terminal (there is one in the MBA lounge and there used to be one in the basement)... If you do find one vacant, jump on it and try the following:
If you cannot find a Bloomberg terminal or don't have access to one, try going on Yahoo! Finance and type in the name or symbol for your company. Once you find your company, scroll down the left hand column until you get to Major Holders and click on it. You should get a listing of the top stockholders in your company. In fact, while you are on that page, take note of the percent of your company's stock held by insiders and by institutions. I have also attached the post class test and solution for today's class.
|2/10/15||Ever been to the Shake Shack in Madison Square Park? I remember seeing it when it first opened, being tempted to try it out and giving up on it because of the long lines. Anyway, Shake Shack went public to rapturous response a few weeks ago, with the stock doubling on the opening day. As traders and portfolio managers fell over each other trying to buy the stock and the founder, restauranteur Danny Meyer, was feted, there were a few discordant notes, especially about the way corporate governance is structured at the company. The company not only has high-voting and low-voting shares that are tilted to give Mr. Meyer full control of the company, with well below 50% of the overall holding, but it also has some strange clauses that come close to self dealing. Of course, Shake Shack is not the first company to play this game but it is the latest in a series of companies that have copied the Google model of governance. I would suggest that you start with this Bloomberg article specifically on the corporate governance issue:
Follow up with this document from Shake Shack about their corporate governance practices:
If you really have the time and the inclination, start reading through the prospectus and see if you can catch all the little tricks being used to preserve control in the hands of existing managment:
Finally, take a look at the questions that I have on the issue both from the perspective of the founders/insiders and investors:
And if you can get a conversation going on Yellowdig, all the more power to you!
As we take baby steps towards measuring risk, I want to review where we stand. The objective function matters, and there are no perfect objectives. That is the message of the last two classes. Once you have absorbed that, I am willing to accept the fact that you still don't quite buy into the "maximize value" objective. That is fine and I would like you to keep thinking about a better alternative with three caveats. First, you cannot cop out and give me multiple objectives - I too would like to maximize stockholder wealth, maximize customer satisfaction, maximize social welfare and employee benefits at the same time but it is just not doable. Second, your objective function has to be measurable. In other words, if you define your objective as maximizing the social good, how would you measure social good? Third, take your objective (and the measurement device you have developed) and ask yourself a cynical question: How might managers game this system for maximum benefit, while hurting you as an owner? In the long term, you may almost guarantee that this will happen. On the theme of investor time horizon and stockholder composition, here is an interesting read: http://bit.ly/YrNIMX
Finally, I mentioned a paper that related stock prices to corporate governance scores in class today. You can find the link to the paper below:
I am also attaching the post-class test & solution for this session.
As for the project & class, time sure does fly, when you are having fun... We are exactly 15.38% (4 sessions out of 26) through the class (in terms of class time) and we will kick into high gear in the next two weeks. I am going to assume for the moment that my nagging has worked and that you have picked a company to analyze. Here is what you can be doing (or better still, have done already):
One final note. If you are trying to watch the webcast of yesterday’s class, you are probably getting a blank screen. I am working on a fix and hopefully should have it up and running soon. Until next time!
I hope you have fun plans for the long weekend, but perhaps you can slip in some corporate finance in there. A few loose ends:
2. Holdings webcast: The webcast for this week is up and it is on assessing who the top stockholders in your company are and thinking through the potential conflicts of interest you will face as a result. The webcast went a little longer than I wanted it to (it is about 24 minutes) but if you do have the list of the top stockholders in your company (the HDS page from Bloomberg, Capital IQ, Morningstar or some other source), I think you will find it useful.
3. Google Shared Spreadsheet: I have posted these links online on the webcast page, Yellowdig and on iTunes U. Finally, the TAs will be starting their weekly sessions next week. In case you are interested in attending these sessions, the Google shared spreadsheet to sign up is open.
Another week passes and the newsletter chronicles its passing. Last week, we completed our discussion of the firm's objective function by looking at the flaws in the market and how market price maximization can go wrong. However, we also noted that the alternatives to it also can go wrong and it becomes a question of choosing between flawed objectives. Next week, we will start our discussion of risk by looking at risk and return models in finance and how they look at/measure risk. I know that this is a long weekend and I hope that you can get your groups in place and companies picked, perhaps even get the corporate governance section done. In fact, if you do get a chance to get into school, please find a Bloomberg terminal and print off the pages that we will be using for the next week: HDS, BETA and DES (4-5 pages). If you are unsure about how to read this output, I have prepared a packet on how to use your Bloomberg printouts for the rest of this class:
Attachments: Newsletter #2
A quick note, previewing the week to come. Since we have no class tomorrow, it will be a short week. On Wednesday, we will look at risk and return models in finance. If you took Foundations last semester, or waived out of it, you may have seen these models already. If you are taking it right now, you may be seeing it in class now or very soon. Never fear! My focus in this class is very different. I will not be going through the statistical proofs and the mind-numbing portfolio theory. I am interested in something simpler: how do these models help me come up with hurdle rates in corporate finance?
We have been dancing around the question of activist investors and whether they are good or bad for markets. The Economist has a cover article on the topic this week that you may find useful:
You may also find this blog post I put up a couple of years ago interesting (or not):
|2/17/15||I hope that you had a great weekend, but it is over (as if you did not know). I did give you a break yesterday with no emails but that respite is over. In this week's puzzle, I focus on risk and how we set ourself up for scams by forgetting that opportunity comes with danger. There are three news articles that I have linked up in this puzzle: the first one is to a Wikipedia description of Ponzi schemes (I have no intellectual pretensions and use Wikipedia all the time). The second is the obituary of Robert Citron,the treasurer of Orange County at the time of the pension disaster in the 1990s. The third (and this is the focus of the puzzle) is a news story about the arrest of an MIT Professor and his HBS-educated son for a hedge fund scam. While it is not the biggest scam of all time, I think it crystallizes why these investment schemes are born, why they work and why they inevitably fail:
Ponzi Scheme: The Original: http://en.wikipedia.org/wiki/Ponzi_scheme
Robert Citron, RIP: http://www.nytimes.com/2013/01/18/business/robert-citron-culprit-in-california-fraud-dies-at-87.html?_r=0
MIT Professor/son arrested: http://www.bloomberg.com/news/articles/2014-08-12/ex-mit-professor-son-to-plead-guilty-in-hedge-fund-scam
If you get a chance, here is what I would like you to think about. Put yourself in the shoes of the victims in these scams and think about why you may have been tempted to join in. Then, put yourself in the shoes of the scammer and determine how you would structure these scams to draw in gullible and greedy investors. A con game requires that the con man and the victim both cooperate and it is worth looking at why it happens. The puzzle can be found at this link:
You can use Yellowdig to post your thoughts (and I have started a discussion topic around risk). Until next time (from Dartmouth College at Hanover, NH, where it is even colder than New York)!
Some of you may be regretting the shift from the soft stuff (objectives, social welfare etc.) to the hard stuff, but trust me that it is still fun.. If it is not, keep telling yourself that it will become fun. Anyway, here are a few thoughts about today's class.
A couple of reading suggestions, if you get a chance. One relates to the puzzle that I mailed out for this week on risk and in particular, to Bernie Madoff. If you are fascinated by Madoff, the following article is relevant/readable and I strongly recommend it: http://nakedshorts.typepad.com/files/madoff.pdf
Second, in case you want to get started preparing for quiz 1 (Don't freak out. It is not until March 9), you can find all past quizzes that I have given in this class below (with solutions);
I hope you get to enjoy what looks like the first good weekend in a long, long time! If you get bored and run out of stuff to do, here are a couple of reading suggestions. I have also attached the always-awesome, amazing-read newsletter (not and not) of the week!
Attachment: Newsletter #3
|2/22/15||I hope that you had a great weekend! In tomorrow's class, we will begin our discussion of equity risk premiums and in Wednesday's class, we will take a closer look at how to estimate betas or relative risk measures. They are crucial building blocks to coming up with hurdle rates but there are lots of estimation issues and questions. If you have not had a chance to watch the webcast on risk free rates, please try to do so. It is only 14 minutes long and I don't think it is too painful. I am attaching the links again, in case you have nothing to do tonight or early tomorrow morning.
A final point. I have put lecture note packet 2 online, if you want to get a jump on downloading it, though we will not use it until after the break.
The bulk of today's class was spent talking about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at three different ways of estimating the equity risk premium.
2. Historical Premiums: We also talked about historical risk premiums. To see the raw data on historical premiums on my site (and save yourself the price you would pay for Ibbotson's data...) go to updated data on my website:
3. Implied equity premium: Finally, we computed an implied equity risk premium for the S&P 500, using the level of the index. If you want to try your hand at it, here is my February 2015 update:
4. Company revenue exposure: As a final step, see if you can find the geographic revenue distribution for your company. You can then use my January 2015 ERP update to get the ERP for your company
Beta reminder: Pease do try to find a Bloomberg terminal. Click on Equities, find your stock (pinpoint the local listing; there can be dozens of listings....) and once you are on your stock's page of choices, type in BETA. A beta page should magically appear, with a two-year regression beta for your company. Print if off. If no one is waiting for the terminal, try these variations:
The post class test and solution for today are attached.
|2/24/15||This week’s puzzle is a really simple one but it is very useful to go from the abstract to real on the notion of firm specific and market risk. You can start with the puzzle description here:
In effect, here is what I do. I take today’s Wall Street Journal and break down the stories under What’s News into firm specific and market risk as well as good/bad/neutral news. If you can do the same with the journal for the rest of this week, you will be surprised at how quickly it becomes second nature. Try it. It’s not that bad.
Today's class covered the conventional approach to estimating betas, which is to run a regression of returns on a stock against returns on the market index. We first covered the estimation choices: how far back in time to go (depends on how much your company has changed), what return interval to use (weekly or monthly are better than daily), what to include in returns (dividends and price appreciation) and the market index to use (broader and wider is better). We also looked at the three key pieces of output from the regression:
If you can get your hands on the beta page for your company, you should be able to make these assessments for your company. You can also get a guide to reading the Bloomberg pages for your company by clicking below:
Finally, I have also attached the post-class test and solution for today.
I hope that you have had a chance to print off the Bloomberg beta page for your company. Once you have it, do check the adjusted beta and confirm for yourself that it is in fact equal to
The bottom line is this. Do I believe that the betas of companies tend to move towards one over time, if they survive? Yes, partly because they get larger over time and partly because they get more diversified. When we get to valuation, in this class and the elective (if you choose to extend your torture at my hands), you will see that I move betas towards one in almost every valuation that I do. But I don't do it right away and I reserve the discretion to do it faster for some firms than for others. Bloomberg clearly does not trust you to know which direction one is… You and I do...
It is Friday and time for the weekly in practice webcast. In the webcast, I take a look at Disney's 2-year weekly regression (from February 2011- February 2013). I have the Bloomberg page attached. I am also attaching the spreadsheet that I used to analyze this regression, which you are welcome to use on your company. The webcast is available at the link below:
The weekly newsletter is attached and as you can see, we are moving along at a reasonable clip. If you have not been keeping up, this is a good weekend to catch up since the first quiz is a week from Monday.
Attachment: Weekly Newsletter #4
|3/1/15||I hope that you had a good weekend. In tomorrow’s class, we will continue with our discussion of betas by looking at the determinants of betas and then a way to get around the limitations of a single regression beta. We will continue that discussion on Wednesday and use the approach to estimate a cost of equity for private firms. While we may start on debt and its cost on Wednesday, the first quiz, which is a week from tomorrow, will end with the beta discussion.|
I want to spend this email talking about the determinants of betas. Before we do that, though, there is one point worth emphasizing. Betas measure only non-diversifiable or market risk and not total risk (explaining why Harmony can have a negative beta and Philip Morris a very low beta).
1. Betas are determined in large part by the nature of your business. While I am not an expert on strategy, marketing or productions, decisions that you make in those disciplines can affect your beta. Thus, your decision to go for a price leader as opposed to a cost leader (I hope I am getting my erminology right) or build up a brand name has implications for your beta. As some of you probably realized today, the discussion about whether your product or service is discretionary is tied to the elasticity of its demand (an Econ 101 concept that turns out to have value)... Products and services with elastic demand should have higher betas than products with inelastic demand. And if you do get a chance, try to make that walk down Fifth Avenue...
2. Your cost structure matters. The more fixed costs you have as a firm, the more sensitive your operating income becomes to changes in your revenues. To see why, consider two firms with very different cost structures
3. Financial leverage: When you borrow money, you create a fixed cost (interest expenses) that makes your equity earnings more volatile. Thus, the equity beta in a safe business can be outlandishly high if has lots of debt. The levered beta equation we went through is a staple for this class and we will revisit it again and again. So, start getting comfortable with it. (The equation for the levered beta was supposed to be on page 146, but went missing. I have attached it to this email. Please print it off)
I also introduced the notion of betas being weighted averages with the Disney - Cap Cities example. I worked out the beta for Disney under two scenarios: an all-equity funded acquisition of Cap Cities and their $10 billion debt/ $8.5 billion equity acquisition. As an exercise, please try to work out the levered beta for Disney on the assumption that they funded the entire acquisition with debt (all $18.5 billion). The answer will be in tomorrow's email.
If you are ready to get started on preparing for the first quiz, here are the links that you need:
Last week, Warren Buffett came out with his much anticipated letter to Berkshire Hathawaystockholders. What made it even more special was that it was his 50th annual letter and he used it to summarize how he built the company up and his investment philosophy. The letter can be found at this link:
Moving right along, I know that today's class was a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash). If you got lost at some stage in the class, here are some of the ways you can get unlost:
Finally, if you remember, we looked at the beta for Disney after its acquisition of Cap Cities in the last class. The first step was assessing the beta for Disney after the merger. That value is obtained by taking a weighted average of the unlevered betas of the two firms using firm values (not equity) as the weights. The resulting number was 1.026. The second step is looking at how the acquisition is funded. We looked at an all equity and a $10 billion debt issue in class and I left you with the question of what would happen if the acquisition were entirely funded with debt. (If you have not tried it yet, you should perhaps hold off on reading the rest of this email right now)
On days like these, I think of moving to San Diego and I am sure that you are tired of winter as well. But the wheels keep grinding and your quiz is still on Monday. Good news is that the break is a few days later and you may be able to get to someplace warmer. For the review session, scheduled from 12-1 in KMEC 2-60 tomorrow (Friday, March 6), I have attached the slides that I will be using. Please download or make copies of these slides:
The quiz is on Monday from 10.30-11 and to alleviate the crowding in Paulson, I have also reserved KMEC 1-70 for that time. The seating for the quiz is as follows:
I won’t even mention the project, since I am a realist.
I know that most of you were not able to make it to the quiz, but the webcast is now up online. You can get it by going to the link below:
I know that you are in no mood for in practice webcasts or working on your project, but I have a webcast on the mechanics of estimating bottom up betas. I use United Technologies to illustrate the process and I go through how to pull up companies from Capital IQ. Even if you don't get a chance to watch it today or this weekend, it may perhaps be useful later on. Here are the links:
I won't ask you how the weekend is going, because I may be hitting a sore spot. I did put together a list of the top ten questions that I am getting in my emails. Perhaps, you have one of these questions:
1. Why do we use past T.Bill rates for Jensen's alpha and the current treasury bond rate for the expected return/cost of equity calculation?
2. How do you decide whether to use a historical or an implied equity risk premium?
3. How do you estimate a riskfree rate for a currency in an emerging market?
4. How do you adjust for the additional country risk in companies that have operations in emerging markets?
5. Why do you use revenues (rather than EBIT or EBITDA) as the basis for your weighting?
6. Why do you use the average debt to equity ratio in the past to unlever a regression beta?
7. What is the link between Debt to capital and debt to equity ratios?
8. How do you annualize non-annual numbers?
9. What is the cash effect on beta? Why does it sometimes get taken out and sometimes get put back in?
Alternatively, you can use the net debt to equity ratio and cut it down to one step
To get to the bottom up equity beta for a company: You start with the unlevered betas with the businesses and work up to the equity beta in the following steps:
10. Why do you weight unlevered betas by enterprise value (as you did in the Disney/Cap Cities acquisition) and in computing Disney's bottom up beta?
I have also attached the newsletter for this week. That is about it... Hope I have not added to your confusion. Relax.. and I will see you soon.
Attachment: Newsletter #5
A few very quick points and I will leave you to your own devices:
1. The bane of technology: I must have not been clear about what I was allowing/not allowing during the quiz. Just to clarify. You can use your iPads, Kindles or Nooks, as long as you don't use connectivity. No laptops, though!
2. Levered betas, unlevered beta for company and unlevered beta for the business: There still seem to be some loose ends associated with betas. Just in case you are still confused, I put together a simple example to bring it home. See attachment.
4. Seating reminder: In case you have forgotten your room assignment for tomorrow:
Finally, please do remember that there is class after the quiz and that we will also have class on Wednesday. I hope the complete the discussion of hurdle rates tomorrow by first defining debt, then laying out the first principles for computing the cost of debt and then coming up with weights for the cost of capital. On Wednesday, we will look at the first steps in measuring investments returns, before everyone leaves for spring break.
Attachment: Beta Addendum
I know that it is tough to sit in on a class, after you have taken a quiz and I appreciate it that so many of you did come to class. We started class today by looking at what makes debt different from equity, and using that definition to decide what to include in debt, when computing cost of capital. Debt should include any item that gives rise to contractual commitments that are usually tax deductible (with failure to meet the commitments leading to consequences). Using this definition, all interest bearing debt and lease commitment meet the debt test but accounts payable/supplier credit/ underfunded pension obligations do not. We followed up by arguing that the cost of debt is the rate at which you can borrow money, long term, today and then looked at ways of coming up with that number from the easy scenarios (where a company has a bond rating) to the more difficult ones (where you have only non-traded debt and bank loans and no rating). I have attached the post class test & solution. You will notice a few questions relate back to something we talked about in the prior class, total betas, since I did not get a chance to include those in my last post class test.
One final note. If you have checked your Google calendar, you will notice that there is a group case due on April 1 in class (at 10.30 am). I know that this is way in advance of that date, but that case is also now available to download. I am attaching the case to this email but I will send you another one specifically about the case and what you might be able to get started on in the near term. Back to grading quizzes...
Your quizzes are ready to pick up. To get them, please come up to the 9th floor of KMEC. When you get off the elevators, walk towards the main doors to the finance department but before you go in, look to your right. You should see the quizzes in three neat piles on top of the table, sorted alphabetically and face down. Please leave these piles in the same order that you found them, after you have found your quiz.
I have attached the solutions with the grading templates to both quizzes (if you had the risk free rate in 2a in Zlotys, you had Quiz a and in Forints, you had Quiz b). I have also attached the distribution for the first quiz. As I mentioned in class, please don’t overreact to your score on the first quiz. There is plenty more to come. And if you have any issues with the quiz grading, please drop by and let me know your concerns. If you feel strongly that your multiple choice answer was right (and I have found it to be wrong), I am willing to listen to your rationale, though I may not accept it. Do not approach the TAs since they are blameless in this process. I grade the quizzes and any mistakes are mine.
|3/10/15||I hope you have had a chance to pick up your quiz. I do know that some of you have questions about the grading, and if you do, please do come by. I don’t bite. On a different note, if you are still in the mood for corporate finance, this week’s puzzle is built around bond ratings (since we just finished talking about it in class). The place to start, if you are unfamiliar with the process, is with this very old document from Moody’s which still describes the process well:
Follow it up by reading the news story on Petrobras being downgraded:
Next, take a look at the financials of Petrobras to get a measure of why they are in this much trouble:
Once you have the lay of the land, try answering the questions in this document:
See you in class tomorrow!
I know that some of you were in Spring break mode already, but today's class represented a transition from hurdle rates to measuring returns. We started by completing the last pieces of the cost of capital puzzle: coming up with market values for equity (easy for a publicly traded company) and debt (more difficult). We then began our discussion of returns by emphasizing that the bottom line in corporate finance is cash flows, not earnings, that we care about when those cash flows occur and that we try to bring in all side costs and benefits into those cash flows. Defining investments broadly to include everything from acquisitions to big infrastructure investments to changing inventory policy, we set the table for investment analysis by setting up the Rio Disney investment. We will return to flesh out the details in the next session (after the break). The post class test and solution are attached.
I also emailed you the case on Monday. Just in case you did not get it (or skipped over that email), you can get the case by going to the link below:
|3/12/15||No nagging about the project today. Just enjoy your spring break and come back rested and ready. I will not send you an email (and that is a promise) until late next week. So, if you have serious withdrawal issues, check the email chronicles. Be safe and be good!|
I know that spring break is not officially over but my hiatus from sending your emails is over and I do have a couple of notes on the case and the project, First, on the case. I know that most of you have not had a chance to read the case, let alone analyze it, but if you did read it, I hope that you will get started on it soon. (If your reaction is what case?, you may want to click on this link:
While it has the Home Depot's numbers, you can use it for any company. I hope it is useful. I have also attached the newsletter for the week, in case you have completely forgotten where we were in class.
Attachments: Newsletter #6
|3/22/15||I hope that you are back from spring break and I know that some of you are fighting jet lag and sheer exhaustion. In case you are actually reading your emails tonight, here is a preview of what's coming this week. Tomorrow and Wednesday, we will start on a hypothetical project, a new theme park for Disney in Rio, and you will play the role of decision maker. We will start by projecting the expected earnings on the theme park, and convert those earnings into measures of accounting return. After taking a short detour into using accounting returns to judge entire companies, we will return to the theme park investment and talk about getting from earnings to cash flows first, and then from cash flows to incremental cash flows. We will close by working out ways to time weight the cash flows and come up with time weighted, cash flow measures of return. We will then look at how the analysis would be different, if it were done in a different currency, and dealing with uncertainty in project analysis. This week's sessions will also provide a great deal of background on what you will have to do on the Apple iCar case. So, if you can read the case before the classes, I think you will be able to make the connections (if and when they occur).|
I know that it is probably tough to get back into school mode, but I hope that you are making the transition. In today's class, we started by stating our ideal measure of return: it should be based upon cash flows, focus on just the incremental and be time weighted. After defining project broadly as including any type of investment, small or large, revenue generating or cost cutting, we started on the Rio Disney theme park analysis. We laid out the initial costs for the theme park and the assumptions about expenses, both direct and allocated. We began the class today by extending the return on capital concept to entire companies and argued that notwithstanding its accounting limitations, comparing the return on capital to the cost of capital provides us with a basis for measuring whether a company’s existing investments are good (or not).
We talked about sunk costs in class yesterday and how difficult it is to ignore them, when making decisions. You can start your exploration of the sunk cost fallacy with this well-done, non-technical discourse on it:
Finally, I know that you are probably busy working on your case (spare me my illusions) but in case you have some time, I would like to pose a hypothetical, just to see how you deal with sunk costs. Before you read the hypothetical, please recognize that I am sure that the facts in this particular puzzle do not apply to you, but act like they do, at least for purposes of this exercise:
In today's session, we looked at three tools for dealing with uncertainty: payback, where you try to get your initial investment back as quickly as possible, what if analysis, where the key is to keep it focused on key variables, and simulations, where you input distributions for key variables rather than single inputs. Ultimately, though, you have to be willing to live with making mistakes, if you are faced with uncertainty. I also mentioned Edward Tufte's book on the visual display of information. If you are interested, you can find a copy here:
I know that you have lots of other stuff on your plate right now and are not really thinking about corporate finance (I find that hard to believe but then again, I am biased..) In case your fascination with corporate finance leads you to work on the case, here are a few suggestions on dealing with the issues.
As I mentioned in class, Crystal Ball is probably not going be very useful to you on this case, but you should be able to play with it on the school computers. If you want to look at the product, you can download a trial version (you can use it for 15 days) at the Oracle site:
I know that you are working on the case right now and that the project is on the back burner. When you get back to it, though, one of the questions that you will be addressing is whether your company's existing investments pass muster. Are they good investments? Do they generate or destroy value? To answer that question, we looked at estimating accounting returns - return on invested capital for the overall quality of an investment and the return on equity, for just the equity component. By comparing the first to the cost o capital and the second to the cost of equity, we argued that you can get a snapshot (at least for the year in question) of whether existing investments are value adding.
The peril with accounting returns is that you are dependent upon accounting numbers: accounting earnings and accounting book value. In the webcast for this week, I look at estimating accounting returns for Walmart in March 2013. Along the way, I talk about what to do about goodwill, cash and minority interests when computing return on capital and how leases can alter your perspective on a company. Here are the links:
I know that you have a lot of work to do on the case. So, I won't make this long. The newsletter is attached.
In the week to come, we will continue and complete our discussion of investment returns, starting tomorrow with a comparison of NPV versus IRR and then moving on to look at side costs and side benefits. A big chunk of Wednesday's class will be dedicated to discussing the case (If you ask, "What case?", you are asking for retribution...) By the end of Wednesday's class, we will be close to done with packet 1. Packet 2 is ready to be either downloaded online or can be bought at the bookstore. To download it, go to the webcast page for the class and check towards the top of the page:
Anyway, speaking about the case, here are some closing instructions:
We started today's class by looking at mutually exclusive investments and why NPV and IRR may give you different answers: a project can have more than one IRR, IRR is biased towards smaller projects and the intermediate cash flows are assumed to be reinvested at the IRR. As to which rule is better, while NPV makes more reasonable assumptions about reinvestment (at the hurdle rate), companies that face capital rationing constraints may choose to use IRR.
|3/31/15||I know that you are busy with the case and probably have neither the time nor the patience for weekly puzzles and I don’t blame you. However, if you are up for it, I do have a challenge related to something we talked about in class yesterday: side benefits, synergies and franchise values. The franchise in question is Frozen and the puzzle revolves around it. Please read the description of the puzzle here:
If you just have a little time, think about how you would build in these side benefits at the time that you consider a new animated movie project at Disney. If you have more time, take a look at my Star Wars franchise valuation and see if you can extend it to Frozen. It is fun to do and may stand you in good stead if you are entering the entertainment business.
This valuation was done when Disney bought Lucas Arts a few years and is dated, but the structure should still work.
The bulk of today's class was spent on the Apple iCar case. While the case itself will soon be forgotten (as it should), I hope that some of the issues that we talked about today stay fresh. In particular, here were some of the central themes (most of which are not original):
I have put the presentation and excel spreadsheet with my numbers online:
|4/1/15||In a little while, the first graded cases will go out. (If you submitted early, you should get it first. If not, you may have to wait longer). As you look at the case and my grading, I will make a confession that some of the grading is subjective but I have tried my best to keep an even hand. I have put together a grading template with the ten issues that I am looking for in the case.
When you get your case, you will find your grade on the cover page. You will see a line item that says issues, with a code next to it. To see what the code stands for look at the attached document. In the last column, you will see an index number of possible errors (1a, 2b etc...) with a measure of how much that particular error/omission should have cost the group. I have tried to embed the comment relevant to your case into your final grade. So, if you made a mistake on sunk cost (4, costing 1/2 a point) and allocated G&A (5, costing 1/2 a point) in your analysis. On the front page of your case, you will see something like this in your grade for the class (Overall grade; 9/10; Issues: 4,5) I hope that helps clarify matters. It is entirely possible that I may have missed something that you did or misunderstood it. You can always bring your case in and I will reassess it.
Finally, on how to read the scores, the case is out of 10 and the scoring is done accordingly. I hate to give letter grades on small pieces of the class, but I know that will be hounded by some until I do. So, here is a rough breakdown:
I think all the cases are done and you should have got them already. It is entirely possible that a couple slipped through my fingers. If so, please email me with your case attachment again (with no changes of course.. I will go back and find your original submission in mailbox and get it graded. I am attaching that grading code that I had sent you before, so that you can make some sense of your grade. If you feel that i have missed something in your analysis, please come by and make your argument. I am always willing to listen. After 70+ cases, I am a little sick of Apple’s iCar... and I am sure you are too, but I thought that it would be a good time to talk about some key aspects of the case:
1. Beta and cost of equity: The only absolute I had on this part of the case was that you could not under any conditions justify using Apple's beta to analyze a project in a different business. However, I was pretty flexible on different approaches to estimating betas from the list of auto firms. Also, if you consolidated your cash flows from auto and iDevice sales, it is perfectly appropriate (and in fact correct) to take a weighted average of the auto and device betas. The catch, though, is that the weights change over time. It is avoid that re-weighting problem that I used my approach of discounting each of the cash flows using its own cost of capital.
2. Cost of debt and debt ratio: If there was one number that most groups agreed on, it was that the cost of debt for Apple was 2.5% (the riskfree rate + default spread). On the debt ratio, on leases, there were variations in what you assumed would happen with the lump sum in year 6. I spread it over 5 years but I am fine with groups that used 3 or 10 years instead. It has only a small impact on the value. Finally, I did notice a disquieting practice where some groups were adjusting the auto beta for the cash held by Apple. Apple’s large cash holdings cannot be used to push
3. Cash flows in the finite life case: I won't rehash the arguments about why we need to look at the difference between investing in year 3 and year 8 for computing the battery factory investment. Many of you either ignored the savings in year 8 or attempted to allocate a portion of the investment in year 3, a practice that is fine for accounting returns but not for cash flows. But here were some other items that did throw off your operating cash flows:
4. Cash flows in the infinite life case: The key in this scenario is that you need more capital maintenance, starting right now. (Here is a simple test: If your after tax cash flows from years 1-10 are identical for the 10-year life and longer life scenarios, you have a problem...) Though some groups did realize this, they often started the capital maintenance in year 11, by which point in time you are maintaining depleted assets. Those groups that did not include capital maintenance at all argued that they felt uncomfortable making estimates without information. But ignoring something is the equivalent of estimating a value of zero, which is an estimate in itself. Also, you cannot keep depreciation in your cash flows (in perpetuity) and not have capital maintenance that matches the depreciation, since you will run out of assets to depreciate, sooner rather than later. The basis for capital maintenance estimates should always be depreciation and your book capital; tying capital maintenance to revenues or earnings can be dangerous.
Finally, and this is a pet peeve of mine. So, just humor me. Please do not use the word "net income" when you really mean after-tax operating income. Not only is it not right but it will create problems for you in valuation and corporate finance. Also, try to restrain your inner accountant when it comes to capital budgeting. As a general rule, projects don't have balance sheets, retained earnings or cash balances. Also, if a project loses money, don't create deferred tax assets or loss carryforwards but use the losses to offset against earnings right now and move on.
Now that the case is behind us, time to get ready for a busy week coming up. On Monday, we will start on financing choices tomorrow and continue with the trade off between debt and equity after the quiz on Wednesday. So, please do bring packet 2 to class with you.
The first note for the day is that there is an in-practice webcast up and running, just in case you feel the urge to do part 5 of the project. It involves identifying a "typical" project for your company, and unlike the other webcasts, it is not grounded in 10Ks or annual reports. It is short and not particularly intense. The links to the webcast and the slides that accompany it are below:
The second quiz, though, is coming up. If you feel ready to get started, here are the details:
I hope you get a chance to get out there and enjoy the spring weather. In case you get bored and want something to read, I have attached the newsletter for the week. Just a reminder that we will start packet 2 on Monday. So, please either buy it, download it to your device or print it before then. I have also been asked whether you can use Excel (on the computer or your device) for the quiz and the answer is no. The quiz will not require elaborate calculations and a calculator should suffice.
|4/5/15||In the week to come we will turn to the financing principle and start the discussion of the trade off between debt and equity. While tomorrow’s material will not be on the quiz on Wednesday, I hope to see you there, with packet 2 in hand.|
In today's class, we started our discussion of the financing question by drawing the line between debt and equity: fixed versus residual claims, no control versus control, and then used a life cycle view of a company to talk about how much it should borrow. We then started on the discussion of debt versus equity by looking at the pluses of debt (tax benefits, added discipline) and its minuses (expected bankruptcy costs, agency cost and loss of financial flexibility). Even with the general discussion, we were able to look at why firms in some countries borrow more than others, why having more stable earnings can make a difference in how much you can borrow and why having intangible assets can affect your borrowing capacity. After the quiz on Wednesday, we will continue with this discussion. The post class test relates mostly to session 15 (last session on synergy and side benefits), but it is worth doing just to get that part under your belt. I am also attaching the slides for tomorrow’s review session. (All of the copiers in the finance department are down. I won’t be able to make copies. I am sorry!
The review session video is not quite ready to download yet, but you can watch the stream of the session by going to:
|4/7/15||I know! I know! I am piling on, but just in case you feel the urge to look at corporate finance after your quiz, the puzzle for the week is up and it centers around distress at oil companies, triggered by large debt burdens, taken on in better times. The puzzle is available at this link:
Included with the puzzle is a spreadsheet containing all publicly traded oil companies with the total debt they owe and the numbers you can use to scale that debt, including market & book equity, EBITDA and bond ratings, if available. I have attached that spreadsheet. Hope you enjoy solving the puzzle.
I know that you probably had a tough time keeping focus after the quiz, but enough about the quiz. In today's class, we looked at the cost of capital approach as a way of optimizing your financing mix. Put briefly, you look for the debt ratio that minimizes your cost of capital. That does require that we estimate the cost of equity and debt at different debt ratios and we started the process using Disney as an example.
The quizzes are done and are in the usual spot (ninth floor of Finance department, KMEC, should be right ahead of you when you come out of the elevator, on your right). Please just take your quiz and leave the pile in alphabetical order. I have attached the solution and the distribution. As always, if there is a problem, please bring it to my attention and I will fix it. (The TAs have nothing to do with the grading. So, please do not harass them.) I will be out for a meeting from 12.30 -1.30 but should be back soon after.
I know that you just got back your quiz and you are in no mood for corporate finance but this is a great weekend to get caught up with your big project. We are in the capital structure section and the first thing you can do (if you remember what company you are analyzing) is to take it through the qualitative analysis, i.e., the trade off items on capital structure:
Today's in practice webcast takes you through the process of assessing this trade off, with suggestions on variables/proxies you can use to measure each of the above factors. If you are interested, here are the links:
I will keep this really short, since I am sure that you are sick of me. Last week, we began our discussion of capital structure by laying out the trade off between debt and equity for all businesses. That trade off, with tax benefit and added discipline as pluses and expected bankruptcy and agency costs as minuses, sets up the framework that we will build on in the coming week to find the right mix of debt and equity for any business. The newsletter is attached. Until next time!
Attachment: Newsletter #9
|4/12/15||This week, we continue with our discussion of finding the right financing mix. Tomorrow, we will complete our discussion of using the cost of capital approach to find the optimal debt ratio for Disney, Tata Motors, Baidu and Vale. On Wednesday, we will talk about finding the right financing mix for financial service firms and talk about the adjusted present value approach. By the end of the week, you should be able to compute the optimal debt ratio for your firm (in the big project). By the way, if you have not picked up your quiz yet, they are still outside the front door to the Finance department. Until next time!|
In today's class, we continued our discussion of the cost of capital approach to deriving an optimal financing mix: the optimal one is the debt ratio that minimizes the cost of capital. To estimate the cost of capital at different debt ratios, we estimated the levered beta/ cost of equity at each debt ratio first and then the interest coverage ratio/synthetic rating/cost of debt at each debt ratio, taking care to ensure that if the interest expenses exceeded the operating income, tax benefits would be lost. The optimal debt ratio is the point at which your cost of capital is minimized. Using this approach, we estimated optimal debt ratios for Disney (40%), Tata Motors (20%), Vale (30% with actual earnings, 50% with normalized earnings), Baidu (10%) and Bookscape (30%). Disney was underlevered, Tata Motors was over levered and Bookscape was at its optimal. We closed the class by looking at an extension of the cost of capital approach, which allowed us to bring in expected bankrutpcy costs into the discussion.
Now, to the project, which I know has been on the back burner for a while. I know that some of you are way behind on the project, and as I mentioned in class today, I will offer you a way to catch up. If you get a chance, please try the optimal capital structure spreadsheet (attached) for your firm and bring your output to class on Wednesday. It will help if you have a bottom up beta (based on the businesses that your company operates in) and an ERP (given the countries it gets its revenues from) but if you don’t, use a regression beta and the ERP of the country in which your company operates (for the moment). Until next time!
|4/14/15||In class yesterday, we talked about how a firm can borrow money to buy back shares and, in the process, make its shareholders better off, primarily due to the tilt in the tax code due to debt. However, it is a trade off and only firms that have debt capacity (are under levered) will gain from leveraged recapitalizations. If you are struggling with that concept, this week’s puzzle will come in handy. I focus on Walgreens, a company that has been targeted by activist investors as a good candidate for a leveraged recap. You can read the background here, with both the investor and company viewpoints on the wisdom of a recapitalization:
However, both sides have weak links in their arguments. To make your own judgment, try doing the assessment on your own. Everything you need is at the link below:
If you have some time, try it out. It will help you (I think) on multiple fronts. Until next time!
We started today's class, using the optimal capital structure spreadsheet to compute the optimal debt ratios for Walgreens. We then looked at extending the approach to financial service companies, where the focus shifts to regulatory capital and equity and the determinants of optimal debt ratios. We noted that higher tax rates, higher cash flow capacity (EBITDA/EV) and lower risk all translate into higher optimal debt ratios and explain differences in optimals across companies. Across time, the optimal debt ratios for all firms will become higher if the bond market demands less of a premium for risk (default spreads) than the equity market (with equity risk premiums). In the final part of the class, we looked at coming with optimal debt ratios by looking at the rest of the sector and the rest of the market. Next session, we will move on to the other half of the financing principle: whether and when to move to the optimal and designing the perfect debt. The post class test and solution are attached. Until next time!
I know that I have been nagging you to get the optimal debt ratio for your firm done. To bring the nagging to a crescendo, I have done the webcast on using the cost of capital spreadsheet, using Dell as my example. You can find the webcast and the related information below:
I know that I have been sending you serial emails on the project over the whole semester and that some of you are way behind. Since it may be overwhelming to go back and review every email that I have sent out over time, I thought it would make sense to pull all the resources that I have referenced for the project into one page, which you can use as a launching pad for starting (or continuing) your work on the project.
2. Main project page: I had mentioned the main page for the project at the very start of the class, but I am sure that it got lost in the mix. So, just to remind you, there is an entry page for the project which describes the project tasks and provides other links for the project:
3. Project formatting: I guess some of you must be starting on writing the project report or some sections thereof. While there is no specific formatting template that I will push you towards, I do have some general advice on formatting and what I would like to see in the reports:
I hope you are enjoying this great weekend! I will keep this short. The newsletter for the week is attached. If you do get a chance, watch the webcast on using the optimal capital structure spreadsheet that I put up on the webcast page yesterday. Better still, if you can plug the numbers in for your own company and get the optimal, I would be ecstatic. Until next time!
Attachment: Issue 10 (April 18)
As we approach the closing weeks for the class, we will build on the optimal debt ratio that we estimated last week and look at the next step: whether to move to the optimal and if so, how quickly and what the right type of debt for a firm should look like. We will them move on to the basics of designing the perfect debt for a firm, both in intuitive terms and by using a quantitative approach. So, if you have the optimal debt ratio for your firm worked out, bring it to class with you tomorrow.
Also, in case it got lost in the email I sent on Friday, I have created a hub for all of the materials related to the project. Visit it, when you get a chance.
Finally, I do know that a few of you who are second year MBAs have a senior trip that overlaps with the final exam and had asked about an early final. I was able to get a room and a time for this early final. It will be in KMEC 2-90 from 9.30-11.30. If you are not going on the senior trip, please do not take advantage of this option.
In today's session,we looked at applying closure to the optimal debt ratio analysis by looking at how quickly you should move to the optimal and what actions to take (recap versus taking projects), drawing largely on numbers that we have estimated already for the company (Jensen's alpha, ROC - Cost of capital). We then followed up by examining the process of finding the right debt for your firm, with a single overriding principle: that the cash flows on your debt should be matched up, as best as you can, to the cash flows on your assets. The perfect security will combine the tax benefits of debt with the flexibility of equity.
At this stage in the class, we are close to done with capital structure (chapters 7,8 &9) and with all of the material that you will need for quiz 3 (which is not until a week from Wednesday). Thus, you can not only finish this section for your project but start preparing for the quiz at the same time. Quiz 3 and the solution to it are also up online, under exams & quizzes on the website for the class:
I have also attached today's post class test & solution.
This week's puzzle lays the foundation for the perfect financing vehicle. Specifically, the perfect financing for a firm will combine the best of equity (the flexibility it offers you to pay dividends only when you can afford them) with the best of debt (the tax advantages of borrowing). While this may seem like the impossible dream, companies and their investment bankers constantly try to create securities that can play different roles with different entities: behave like debt with the tax authorities while behaving like equity with you. In this week's puzzle, I look at one example: surplus notes. Surplus notes are issued primarily by insurance companies to raise funds. They have "fixed' interest payments, but these payments are made only if the insurance company has surplus capital (or extra earnings). Otherwise, they can be suspended without the company being pushed into default. The IRS treats it as debt and gives them a tax deduction for the interest payments, but the regulatory authorities treat it as equity and add it to their regulatory capital base. The ratings agencies used to split the difference and treat it as part debt, part equity. The accountants and equity research analysts treat it as debt. In effect, you have a complete mis mash, working to the insurance company's advantage.
Attachments: The questions
In today's class, we looked at the design principles for debt. In particular, we noted the allure of matching up debt cash flows to asset cash flows: it reduces default risk and increases debt capacity. We then looked at the process of designing the perfect debt for your company, starting with the assets you have, checking to see if you still get your tax deduction, keeping different interest groups happy and sugarcoating the bond enough to make it palatable to bond holders. We then went through three basic approaches to debt design: an intuitive assessment of a company's products and pricing power, an analysis of expected cash flows on a single project and a macro economic regression of firm value/operating income against interest rates, GDP, inflation and exchange rates.
In the second half of the class, we started on our discussion of dividend policy. We began by looking at some facts about dividends: they are sticky, follow earnings, are affected by tax laws, vary across countries and are increasingly being supplanted by buybacks at least in the United States. We will continue the discussion of how much companies should return to investors in the next session. The post class test & solution for today is attached.
If you have done the intuitive analysis of what debt is right for your firm, you can try to do a quantitative analysis of your debt. I have attached the spreadsheet that has the macroeconomic data on interest rates, inflation, GDP growth and the weighted dollar from 1986 to the present (I updated it to include 2013 data. The best place to find the macro economic data, if you want to do it yourself, is to go to the Federal Reserve site in St. Louis:
You can enter the data for your firm and the spreadsheet will compute the regression coefficients against each. You can use annual data (if your firm has been around 5 years or more). If it has been listed a shorter period, you may need to use quarterly data on your firm. The data you will need on your firm are:
The easiest way to get this data is to use the FA function in Bloomberg and choose the income statement items for operating income and the enterprise value breakdown. You can print off either annual or quarterly data.
I have to warn you in advance that these regressions are exceedingly noisy and the spreadsheet also includes bottom-up estimates by industry. There is one catch. When I constructed this spreadsheet, I was able to get the data broken down by SIC codes. SIC codes are four digit numbers, which correspond to different industries. The spreadsheet lists the industries that go with the SIC code, but it is a grind finding your business or businesses. I am sorry but I will try to create a bridge that makes it easier, but I have not figured it out yet. My suggestion on this spreadsheet. I think it should come in low on your priority list. In fact, focus on the intuitive analysis primarily and use this spreadsheet only if you have to the time and the inclination. My webcast for tomorrow will go through how best to use the spreadsheet.
Attachments: Duration Spreadsheet
|4/24/15||I know that you are busy but I have put the webcast up on debt design, using Walmart as my example, online (on the webcast page as well as on the project resource page). Here are the details on the webcast:
WMT financial summary: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTFAsummary.pdf
WMT macrodur.xls spreadsheet: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTmacrodur.xls
I hope you get a chance to watch the webcast and design the perfect debt for your firm. Until next time!
Bad news: Another weekly newsletter for you. Good news: It is the second to last one, which is my not-so-subtle way of telling you that the end of the semester is fast approaching. Until next time!
Attachment: Issue 11 (April 25)