I confess. I send out a lot of emails and I am sure that you don't read some of them. Since they sometimes contain important information as well as clues to my thinking (deranged though it might be), I will try to put all of the emails into this file. They are in chronological order, starting with the earliest one. They are in chronological order, starting with the earliest one. So, scroll down to your desired email and read on, or if the scrolling will take you too long, click on the link below to go the emails, by month.
Happy new year! I hope you have a wonderful break (good news: it is still break..) and that you will come back tanned, rested and ready to go. This is the first of many, many emails that you will get for me. You can view that either as a promise or a threat. I am delighted that you have decided to take the corporate finance class this spring with me and especially so if you are not a finance major and have never worked in finance. I am an evangelist when it comes to the centrality of corporate finance and I will try very hard to convert you to my faith. I also know that some of you may be worried about the class and the tool set that you will bring to it. I cannot alleviate all your fears now, but here are a few things that you can do to get an early jump:
I will also be posting the contents of the site (webcasts, lectures, posts) on iTunes U. If you have never used it, here is what you need: an Apple device (iPhone or iPad), the iTunes U app on the device and you need to use this enroll code: EZZ-PFA-KHF . Alternatively, try this link:
Like all things Apple, the set up iis very well done and it is neat, being able to catch up on a lecture you missed on your iPad, while browsing through the lecture notes on it too. I know that you are feeling overwhelmed by now, but for those of you with devices and slower broadband, I also have a YouTube Playlist for the class:
Please check it out.
Now for the material for the class. The lecture notes for the class are available as a pdf file that you can download and print. I have both a standard version (one slide per page) and an environmentally friendly version (two slides per page) to download. You can also save paper entirely and download the file to your iPad or Kindle. Make your choice.
If you prefer a copied package, the first part (of two) should be in the bookstore next week. There is a book for the class, Applied Corporate Finance, but please make sure that you get the fourth edition. It is exorbitantly over priced but you can buy, rent or download it at Amazon.com or the NYU bookstore
While I have no qualms about wasting your money, I know that some of you are budget constrained (a nice way of saying "poor") . If you really, really cannot afford the book, you should be able to live without it.
One final point. I know that the last few years have led you to question the reach of finance (and your own career paths). I must confess that I have gone through my own share of soul searching, trying to make sense of what is going on. I will try to incorporate what I think the lessons learned, unlearned and relearned over this period are for corporate finance. There are assumptions that we have made for decades that need to be challenged and foundations that have to be reinforced. In other words, the time for cookbook and me-too finance (which is what too many firms, investment banks and consultants have indulged in) is over. To close, I will leave you with a YouTube video that introduces you (in about 2 minutes) to the class.
I hope you enjoy it. That is about it. I am looking forward to this class. It has always been my favorite class to teach (though I love teaching valuation) and I have a singular objective. I would like to make it the best class you have ever taken, period. I know that this is going to be tough to pull off but I will really try. I hope to see you on February 4th, in class. Until next time!
As the long winter break winds down, I first hope that you are far away from the gray weather in New York, some place warm and sunny. I also hope that you are ready to get started on classes and that you got my really long email a weeks ago. If you did not, you can find it here:
This one, hopefully, will not be as long and has only a few items
1. Website: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
Please do try to download the first lecture note packet by Monday. The direct link to the lecture note packet is below:
Lecture note packet 1: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfpacket1spr19.pdf (as pdf file) or http://www.stern.nyu.edu/~adamodar/pptfiles/acf4E/cfpacket1spr19.pptx (powerpoint file)
You can print it off or just keep it on your tablet (as long you can make notes on the pages). You can also buy the packet at the bookstore, at their usual nosebleed prices, if you prefer a bound packet.
2. Pre-class prep: Are you kidding me? What kind of twisted mind comes up with a pre-class prep for the very first class? Just relax, have fun this weekend and try to be in class. If you cannot make it, never fear! The webcast for the class will be up a little while after the class, but it just won't be the same as being there in person.
3. iTunes U and YouTube links: I had sent these out in my previous email but no harm repeating:
For those of you who have not got around to checking, class is scheduled from 10.30-11.50 in Paulson Auditorium on February 4. See you there! Until next time!
I promised you with a ton of emails and I always deliver on my promises... Here is the first of many, many missives that you will receive for me….. First, a quick review of what we did in today's class. I laid out the structure for the class and an agenda of what I hope to accomplish during the next 15 weeks. In addition to describing the logistical details, I presented my view that corporate finance is the ultimate big picture class because everything falls under its purview. The “big picture” of corporate finance covers the three basic decisions that every business has to make: how to allocate scarce funds across competing uses (the investment decision), how to raise funds to finance these investments (the financing decision) and how much cash to take out of the business (the dividend decision). The singular objective in corporate finance is to maximize the value of the business to its owners. This big picture was then used to emphasize five themes: that corporate finance is common sense, that it is focused, that the focus shifts over the life cycle and that you cannot break first principles with immunity.
On to housekeeping details.
That is about it, for this email.
It is me again, but then again I promised you a deluge and it has to start sometime. Yesterday, in class, I said that Tuesdays would be our “weekly puzzle” days, where I would post a topic, with questions, for discussion. I had originally planned to reuse a puzzle on the Tata Family Group from a prior year, but an op ed from yesterday’s New York Times on buybacks is too good to pass by, because it cuts to heart of everything that we will be talking about in the next few weeks. You can find the details of the puzzle on the webcast page for the class, but I have also reproduced it in this email.
Buybacks have been at the center of a heated debate in the United States, with some arguing that they are the reason for companies not reinvesting in new factories, widening income inequalities and a variety of other social ills. In an op-ed in the New York Times on February 4, 2019, Senators Schumer and Sanders make their case for why buybacks should be restricted. You can find the link below:
Implicit in the opinion piece are three assumptions, and without any prejudgment, here they are:
I know that we live in political times, and that our red or blue predispositions can affect how we react, but please try to set your political priors to the side and think through each of these assumptions as objectively as you can.
I know that I run the risk of creating biases, but here are two blog posts of mine (one old and one from this year) that you are welcome to read, rip apart or use:
I considered opening a Facebook page for the forum, but social media may be a little too open for this process. Instead, I have used NYU Classes to create a forum with this topic. You will finds it on the NYU class page for this class. So, I hope that you will go on to the forum and present your views and show, in the process, that we can disagree without being disagreeable.
In today's class, we started on what the objective in running a business should be. While corporate finance states it to be maximizing firm value, it is often practiced as maximizing stock price. To make the world safe for stock price maximization, we do have to make key assumptions: that managers act in the best interests of stockholders, that lenders are fully protected, that information flows to rational investors and that there are no social costs. We started on why one of these assumptions, that stockholders have power over managers, fails and we will continue ripping the Utopian world apart next class.
1. Administrative Stuff: I went through the structure for the class and mentioned the quiz dates. As noted in class, if you are going to miss a quiz, the 10% from that quiz will be moved to the rest of the exam grade for the class and if you take all three, your worst quiz will get marked up to the average on your remaining exams. Here are a few other details:
2. Other People's Money: Just a few added notes relating to the class that I want to bring to your attention. The first is the movie Other People's Money, which is one of my favorites for illustrating the straw men that people like to set up and knock down. You can find out more about the movie here:
But I found the best part on YouTube. It is Danny DeVito's "Larry the Liquidator" speech:
Watch it when you get a chance. Not only is it entertaining but it is a learning experience (though I am not sure what you learn). Incidentally, it is much, much better than Michael Douglas's "Greed is good" speech in the first "Wall Street " which was a blatant rip-off of Ivan Boesky's graduation address to the UC Berkeley MBAs in 1986 (which I happened to be at, since I was teaching there that year).
3. DisneyWar: In next week’s session, I will be talking about the dysfunctional state of Disney in the 1990s. If you want to review these on your own, try this book written by James Stewart. It is in paperback, on Amazon:
If you are budget-constrained, you can borrow my copy and return in when you are done. (I have only one copy. First come, first served)
4. Company Choice: On the question of picking companies for your group, some (unsolicited) advice:
As a final reminder. Please pick your company soon... As you can see from today's class, we are getting started on assessing your company…
If you want to print off the financial statements for your company, I would recommend that you start with the annual report for the most recent year. You should be able to pull it off the website for the company, under investor relations. If you want to keep going, and it is a US company, go to o the SEC site (http://www.sec.gov). If it is a non-US company, you will have to find the equivalent regulatory body in your country. For some of your companies, you will find less data than on others. Don’t fret. It is what it is. Finally, I am attaching the post class test and solution for today’s session. Until next time!
It is never too early to start nagging you about the project. So, let me get started with a checklist (which is short for this week but will get longer each week. Here is the list of things that would be nice to get behind you:
In doing all of this, you will need data and Stern subscribes to one of the two industry standards: S&P Capital IQ (the other is Factset). It is truly a remarkable dataset with hundreds of items on tens of thousands of public companies listed globally, including corporate governance measures. I believe that you have automatic access to Capital IQ and you should find it in your Stern Life Dashboard. You will not regret it and it will not only save you lots of time in the future but will give you another weapon you can use in analysis. That’s about it, for now. Until next time!
As promised, here is the first of the weekly in-practice webcasts. These are 10-15 minute webcasts designed to work on practical issues in corporate finance. This week’s issue is a timely one, if you are working on picking companies for your project (as you should be..). It is about the process of collecting data for companies, the first step in understanding and analyzing them. The webcast link is below:
I don’t think it is too painful to watch and you may even find it useful. I have also put the link up on the webcast page for the class:
The webcasts for the first two classes should be on there, if you missed (physically, metaphysically or mentally) and the links to the project and syllabus that I handed out in the class. At the risk of nagging, please do get the lecture note packet 1 printed off or bought before Monday’s class. It is now available (or was at least yesterday) in the bookstore. One final note. I had mentioned that you had access to S&P Cap IQ yesterday but It turns out that you have to go to self-register to be able to access it.Until next time!
I know that this is the weekly puzzle and I really want you to come to your own conclusions. That is why I am sending this link reluctantly:
It is my blog post on buybacks. Read it, if you get a chance. You don’t have to agree with all or even any of it. Just hope it gets you thinking! Until next time!
As you start the weekend, I decided to butt in with the first of my newsletters. As you browse through it (and I hope you do), you will realize that this is not really news or even fake news. It is more akin to a GPS for the class telling you where we’ve been and where we plan to go. It is a good way to get a sense of whether you are falling behind on either the class or the project, especially as we get deeper into the class. So, enjoy your weekend and I will see you on Monday! Until next time!
Attachment: Issue 1 (February 9)
I’ll keep this short. This week, we will complete our discussion of the objective function in corporate finance, continuing with stock price maximization tomorrow and alternatives to that objective thereafter. Along the way, we will look at shareholder wealth maximization and corporate sustainability and I may kill a few sacred cows along the way. In the meantime, please do pick a company, and if you have picked a company, take a look at the board of directors and corporate governance. Until next time!
Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? We closed the class by talking about social costs and benefits and how difficult it is to incorporate them into decision making and we will continue on that theme in the next class. Again, plenty to think about while you are sitting in your CSR class! We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. In the next class, we will take a more prescriptive look at what we should be doing in this very imperfect world. As always, reading ahead in chapter 2, if you have the book, will be helpful.
I hope that your search for a group has ended well and that you are thinking about the companies that you would like to analyze. Better still, perhaps you have a company picked out already. If you do, try to find a Bloomberg terminal (there is one in the MBA lounge and there used to be one in the basement)... If you do find one vacant, jump on it and try the following:
1. Press the EQUITY button
2. Choose FIND YOUR SECURITY
3. Type the name of your company
4. You might get multiple listings for your company, especially if it is a large company with multiple listings and securities. Try to find your local listing. For a US company, this will usually be the one with your stock symbol followed by US. For a non-US company, it will have the exchange symbol for your country (GR: Germany, FP: France, LN: UK etc...) It may take some trial and error to find the listing....
5. Type in HDS
6. Print off the first page of the HDS (it should have the top 17 investors in your company).
If you cannot find a Bloomberg terminal or don't have access to one, try going on Yahoo! Finance and type in the name or symbol for your company. Once you find your company, find the tab that says Holders and click on it. You should get a listing of the top stockholders in your company. In fact, while you are on that page, take note of the percent of your company's stock held by insiders and by institutions. I have also attached the post class test and solution for today's class. Until next time!
For the second weekly challenge, I decided on a throw back to a challenge I used two years ago, because it brings home issues of corporate governance at founder and family controlled publicly traded companies that are still relevant . It is about corporate governance at one of India’s oldest and best regarded family groups, the Tatas. The group which has been around since 1868, has more than a hundred companies under it, and has had only seven heads over its 150-year life, most of whom came from the Tata family. In 2012, Ratan Tata stepped down and Cyrus Mistry was named the new head. While not an immediate Tata family member, he is related by marriage to the family and he himself comes from a family with deep connections to the group going back in time. It is perhaps because of the group’s history that people were shocked when Cyrus was fired on October 24, 2016, and Ratan Tata reinstated as the head. You can start with the blog post that I had on the group in November:
That lays out my views not just on the Tata group but on family groups in general. Once you have that read, you can then look at the specifics of this week’s puzzle, where I bring the story up to date.
Once you have read these pieces (and other links), there are four questions that I would like you to answer:
As you can see, these are open ended questions where there is no right answer. To be clear, there is no grade attached to answering these weekly puzzles but I believe that there is a payoff in understanding. I have created a forum on NYU classes (this may be one of the few things that I use NYU classes for) where, if you feel the urge to share, you should.
The objective function matters, and there are no perfect objectives. That is the message of the last two classes. Once you have absorbed that, I am willing to accept the fact that you still don't quite buy into the "maximize value" objective. That is fine and I would like you to keep thinking about a better alternative with three caveats. First, you cannot cop out and give me multiple objectives - I too would like to maximize stockholder wealth, maximize customer satisfaction, maximize social welfare and employee benefits at the same time but it is just not doable. Second, your objective function has to be measurable. In other words, if you define your objective as maximizing the social good, how would you measure social good? Third, take your objective (and the measurement device you have developed) and ask yourself a cynical question: How might managers game this system for maximum benefit, while hurting you as an owner? In the long term, you may almost guarantee that this will happen.
Building on the theme of social good and stockholder wealth a little more, there are a number of fascinating moral and ethical issues that arise when you are the manager in a publicly traded firm. Is your first duty to society (to which we all belong) or to the stockholders (who are your ultimate employers)? If you have to pick between the two and you choose the former, do you have an obligation to be honest and let the latter know? What if you believed that the market was overvaluing your stock? Should you sit back and let it happen, since it is good for your stockholders, or should you try to talk the stock price down? On the question of socially responsibility, there are groups out there that rank companies based upon social responsibility. I have listed a few below, but they are a few of many:
JUST Capital: https://justcapital.com/rankings/
Calvert Social Index: http://www.calvert.com/perspective/social-impact
Dow Jones Sustainability Index: http://www.sustainability-indices.com
And this is just the tip of the iceberg. Environmental organizations, labor unions and other groups all have their own corporate rankings. In other words, whatever your key social issue is, there is a way to stay true (as a consumer and investor). Notice how the rankings vary even across the ethics sphere. No surprise that no one has a monopoly on virtue.
While it may seem like we are paying far too much attention to these minor issues, I think that understanding who has the power to make decisions in a company will have significant consequences for how the company approaches every aspect of corporate finance - which projects it takes, how it funds them and how much it pays in dividends. So, give it your best shot... On a different note, we will be continue with our discussion of risk on Wednesday (no class on Monday). As part of that discussion, we will confront the question of who the marginal investor in your company is. If you have already printed off the list of the top stockholders in your company (HDS page in Bloomberg or the Major Holders page from Yahoo! Finance), bring it with you again. If you have not, please do so before the next class. Also, watch for the in-practice webcast day after tomorrow, because I will go through how to break down the HDS page. Finally, I mentioned a paper that related stock prices to corporate governance scores in class today. You can find the link to the paper below:
In closing, though, I know that the sheer size of the class and the setting make it intimidating for participation. I understand but I hope that (a) you will feel comfortable enough to make your views heard, even if they are at odds with mine and (b) that you talk to me in person or by email about specific issues that we are covering in class that you may not understand or have a different perspective.
This email has gone on way too long already, but one final note. A few years ago, I took a look at Petrobras, just as a cautionary note on what happens to a company when its objective function becomes muddled (with national interest constraints). You can read it here.
I am also attaching the post-class test & solution for this session. Until next time!
As for the project & class, time sure does fly, when you are having fun... We are exactly 15.38% (4 sessions out of 26) through the class (in terms of class time) and we will kick into high gear in the next two weeks. I am going to assume for the moment that my nagging has worked and that you have picked a company to analyze. Here is what you can be doing (or better still, have done already):
I will be putting up a webcast tomorrow on how to analyze the "top shareholder" list, using a range of companies. Hope you to get a chance to watch it.
Since you have a long weekend ahead of you, with nothing to do but binge watch You on Netflix and old episodes of Game of Thrones, I thought I would get in two in-practice webcasts this week and nag you about your project (yet again). Since these webcasts are directly connected to what you will or should be doing on the project, the best way to use them is to pick a company and use the webcasts to get the relevant parts of the project done.
1. Assessing Corporate Governance: This webcast looks at ways to assess the corporate governance at your company, using HP from 2013 as an example. I use HP's annual report, its filings with the SEC and other public information to make my assessment of the company.
HP Annual Report: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/corpgovHP/HPAnnual.pdf
You can find these links in all three forums (my webcast page, iTunes U) and it looks at what information to use and how to use it to assess the corporate governance structure of a company. (Sorry about the striped sweater… Should have known better).
2. Stockholder Holding Assessment: This webcast is on assessing who the top stockholders in your company are and thinking through the potential conflicts of interest you will face as a result. The webcast went a little longer than I wanted it to (it is about 24 minutes) but if you do have the list of the top stockholders in your company (the HDS page from Bloomberg, Capital IQ, Morningstar or some other source), I think you will find it useful.
Webcast link: http://youtu.be/x_H_4KTeOkc
Presentation link: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/holders.ppt
Finally, one hopeful sign for investors is the presence of activist investors (like Carl Icahn) in your midst, not because they always do the right thing but because they put managers on notice. To help you determine whether you have an activist investor in your listing, I have a link that lists the activist investors in the US:
I hope that you get a chance to not only watch these webcasts but also try them out on your company
Very quick note before you get back to your weekend festivities. Your newsletter is attached for the week.
Attachment: Issue 2 (February 16)
I hope that you had an enjoyable and productive long weekend, and I did give you a day off without emails yesterday. Tomorrow, we will complete our derivation of the CAPM and talk about alternatives to it, in hyper speed for two reasons. One is that I have zero interest in reinventing modern portfolio theory and showing the mechanics of correlation and covariance. The second is that while I use the CAPM as a tool to estimate hurdle rates, I am not wedded to it and accept all kinds of alternatives (some of which we will talk about tomorrow). If you are still shaky about even the assumptions that underlie the model, my suggestion is that you read chapter 3 from the applied corporate finance book before tomorrow’s class. On Wednesday, we start on the fun stuff of applying the model, starting with what should be a slam dunk (risk free rates) which is increasingly not and then turning to the equity risk premium, a number that analysts often turn towards services to look up but really has deep implications for both valuation and corporate finance. So, much to do and I hope that you come along for the ride. And a final nag: if you have not picked a company, please do so soon! Until next time!
I should start with an apology for any confusion created by the email I sent yesterday. I was operating on Sunday-mode (since I send the week-ahead emails every Sunday) and the references to classes “tomorrow” and “Wednesday” must have been puzzling. We have only one class this week and the discussion of risk will be in that class, as will be the intuitive derivation of the CAPM. I thought that this week’s puzzle should be built around the central themes of portfolio theory, which is that diversification is the best weapon against risk, since it eliminates firm specific risk. That view, though, gets push back from some big name investors, including some value investing legends and Mark Cuban (who is also a legend, at least in his own mind). You can start the puzzle by reading the arguments for and against diversification:
For Diversification: http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1990/markowitz-lecture.pdf (Harry Markowitz’s Nobel Prize talk)
For Concentration: http://www.fool.com/investing/general/2014/07/20/why-warren-buffett-doesnt-diversify-too-much.aspx (He who should not be named is named… )
The evidence, from looking at investor behavior, is that most individual investors side with the latter than the former (though that does not mean that it is right):
Evidence on investors: http://www.umass.edu/preferen/You Must Read This/Barber-Odean 2011.pdf
I am going to surprise you with my view. While I am more inclined to diversify than not, I can also see scenarios where not diversifying makes sense. In fact, I have a blog post on the question of how much diversification is good for you (and the answer will vary across individuals):
This is a topic that is important not just for your finance class, but for your personal portfolios, as you accumulate wealth (I am assuming that this Stern MBA, which you are paying a hefty price for will pay off).
Some of you may be regretting the shift from the soft stuff (objectives, social welfare etc.) to the hard stuff, but trust me that it is still fun.. If it is not, keep telling yourself that it will become fun. Anyway, here are a few thoughts about today's class.
1. The Essence of Risk: There has been risk in investments as long as there have been investments. If you have the time, pick up a copy of Against the Gods by Peter Bernstein, John Wiley and Sons. It is a great book and an easy read. If you want more, you should also pick up a copy of Capital Ideas by Peter as well... That traces out the development of the CAPM....
2. More on Models: If you want to read more about the CAPM, you can begin with chapter 3 in the book. It provides an extended discussion of what we talked about in class today....
3. Diversifiable versus non-diversifiable risk: The best way to understand diversifiable and non-diversifiable risk is to take your company and consider all of the risks that it is exposed to and then categorize these risks into whether they are likely to affect just your company, your company and a few competitors, the entire sector or the overall market.
If you can, try to make your assessment of whether the marginal investors in your companies are likely to be diversified. Look at both the percent of stock held in your company and the top 17 investors to make this judgment. If your assessment leads you to conclude that the marginal investor is an institution or a diversified investor, you are home free in the sense that you can now feel comfortable using traditional risk and return models in finance. If, on the other hand, you decide that the marginal investor is not diversified, we will come back in a few sessions and talk about some adjustments you may want to make to your beta calculations. You may want to look at the in-practice webcast I sent on the topic last Friday (and is also posted on the webcast page for the class), if you get stuck.
Finally, if you are up for the challenge, try to estimate the risk free rate in the currency of your choice. Of course, if this is US dollars, not much of a challenge… If it is in an emerging market currency, more so since you need default spreads (either from a sovereign rating or a sovereign CDS spread). Here are links to the latest versions of both:
Moody’s ratings (Jan 2019): http://www.stern.nyu.edu/~adamodar/pc/datasets/sovrrating2019.xls
Sovereign CDS spreads (Jan 2019): http://www.stern.nyu.edu/~adamodar/pc/datasets/sovrCDS2019.xls
And please do think about the parting question from class: why do risk free rates vary across currencies?I have also attached the post class test & solution for today… Until next time!
If my nagging is paying off, you should have picked a company by now and if you have, you can move on to two questions. The first is to take a look at the marginal investors in you company, with the objective of assessing whether they are diversified, since it will let you know whether you are on safe ground using the CAPM or any other risk and return model. The second is the risk free rate part of the project, where you have to pick a currency at analyze your company in, and then go through the process of estimating risk free rates in that currency.
I will be putting up webcasts tomorrow on both topics. On an entirely different note, the class is moving into high gear, which also means that your anxiety level about tests and quizzes is probably also going up. Miguel Echavarria and Luis Gonzalez, the TAs for the class, have kindly agreed to do review sessions each week for people who may have questions about mechanics and material. The review sessions are scheduled for each Monday from 4.45-5.45 pm, right after class, in KMEC 3-70. Since that room fits only 70, I have set up a Google shared spreadsheet for you to sign up, if you want to go to the sessions:
Every aspect of life is grist for the corporate finance mill. To illustrate, remember the discussion that we had in class about company-specific risk, which affects one or a few companies, and market risk, which affects many or all companies. I got a reminder of that, a couple of days ago, when I was watching the UNC-Duke basketball game. I am not a fan of either team, but as a depressed UCLA Bruins fan, I have had to resort to desperate measures to distract myself. During the game, as many of you might have heard, Duke’s superstar freshman, Zion Williamson, sprained his knee:
You are probably wondering what this has to do with risk, right? Turns out that the reason that Zion fell was because he blew out his Nike PG 2.5 shoes, and Nike’s stock price took a hit the next day:
That is a perfect example of company-specific risk, a risk that clearly has an effect on value and price, but a risk that a diversified investor should not be building into the discount rate.
On a different note, the webcast for this week looks at how to estimate risk free rates in different currencies, and how sovereign default spreads can be useful in getting there:
If you want the updated values for both country default risk measures try these links:
Please watch it, when you get a chance.
Last week, we put the objective function to rest and turned our attention to risk models. Having started our discussion of risk free rates, we will continue this week to talk about how best to estimate risk premiums and convert them into hurdle rates.
Attachments: Issue 3 (February 23)
This week, we will complete our discussion of riskfree rates, by answering the question of why riskfree rates vary across currencies. We will then move on to estimating equity risk premiums & continue on our build up to hurdle rates. Until next time!
We started today’s class by tying up the last loose ends with risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:
The rest of today's class was spent talking about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at three different ways of estimating the equity risk premium.
1. Survey Premiums: I had mentioned survey premiums in class and two in particular - one by Merrill of institutional investors and one of CFOs. You can find the Merrill survey on its research link (but you may be asked for a password). You can get the other surveys at the links below:
2. Historical Premiums: We also talked about historical risk premiums. To see the raw data on historical premiums on my site (and save yourself the price you would pay for Ibbotson's data...) go to updated data on my website:
On the same page, you can pull up my estimates of country risk premiums for about 150 countries from February 2017
The approach that I use for computing country risk premiums at the start of 2019 is described more fully in this post:
3. Implied equity premium: Finally, we computed an implied equity risk premium for the S&P 500, using the level of the index. If you want to try your hand at it, here is my February 2017 update:
Play with the spreadsheet. Try changing the index level, for instance, and see what it does to the premium.
4. Company revenue exposure: As a final step, see if you can find the geographic revenue distribution for your company. You can then use my latest ERP update to get the ERP for your company.
Beta reminder: Pease do try to find a Bloomberg terminal. Click on Equities, find your stock (pinpoint the local listing; there can be dozens of listings....) and once you are on your stock's page of choices, type in BETA. A beta page should magically appear, with a two-year regression beta for your company. Print if off. If no one is waiting for the terminal, try these variations:
1. Time period: Change the default to make it about 5 years and the interval from weekly (W) to monthly (M). Print that page off
2. Index: The default index that Bloomberg uses is the local index (a topic for discussion next session). You can change the index. Type in NFT (Bloomberg's symbol for the MSCI Global Equity index) in the index box and rerun the regression.
Bring the beta page (s) with you to class next Wednesday. Let's get the project done in real time, in class.
Both economics and finance are built on the pillar of risk aversion, i.e., that investors need to be paid extra (over and above an expected value) to take risks. That notion of risk aversion has been challenged and modified over time, but it still is at the heart of how we measure risk and come up with expected returns. Economists agree that not only does risk aversion vary across individuals but it also varies, for the same individual, across time. In this puzzle, which has no right answer, I would like you to wrestle with the question of how risk averse you, explanations that you can offer for that risk aversion and the consequences for your business and investment decision making. You can find the full details of the puzzle here:
One of the side products of the growth of robo advisors is a proliferation of tools that investors can use to assess how risk averse they are. This article in the New York Times nicely sets the table. In the article, though the links to free risk assessment services are no longer free. There are, however, plenty of risk aversion tests online. Here are a couple that you can try at no cost:
Take one of the tests, both to get a measure of how risk aversion gets measured and how risk averse you are as an individual. Then, try to answer the following questions:
Today's class covered the conventional approach to estimating betas, which is to run a regression of returns on a stock against returns on the market index. We first covered the estimation choices: how far back in time to go (depends on how much your company has changed), what return interval to use (weekly or monthly are better than daily), what to include in returns (dividends and price appreciation) and the market index to use (broader and wider is better). We also looked at the three key pieces of output from the regression:
In keeping with project Thursday, I hope that you have had a chance to print off the Bloomberg beta page for your company. Once you have it, do check the adjusted beta and confirm for yourself that it is in fact equal to
Adjusted Beta = Raw Beta (.67) + 1.00 (.33)
I mentioned in class that I initially was curious about where these weights were coming from but I think I have found the original source. It was a paper written more than 30 years ago, that looked at how betas for companies change over time and concluded based upon a small sample and data from way back in time, that they converged towards one, with roughly the magnitudes used by Bloomberg. Why has it not been updated with larger samples and better data? Well, that is what happens when "here when I got here" becomes the response to questions about numbers we use all the time. I have also forwarded this email to the beta calculation guy at Bloomberg. I hope that they have let him out of that basement room, where he was locked up. Tomorrow’s second In-Practice webcast will cover how to read a regression beta
I went through the Bloomberg regression beta page in class and suggested that you try doing the same with your company. In this week’s webcast, I take a look at Disney's 2-year weekly regression (from February 2011- February 2013). I have the Bloomberg page attached. I am also attaching the spreadsheet that I used to analyze this regression, which you are welcome to use on your company. The webcast is available at the link below:
Disney’s Regression Bloomberg beta page: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Regression/Disneyregression.pdf
The best way to make this stick is to try this on your company quickly (like right now).
First, it is the weekend and the newsletter is attached. Second, and perhaps more important, your quiz is a week from Monday (on March 11) and for those of you who have time on your hands this weekend, you may want to start the work on the quiz. We have not quite completed the material in class yet, but here is a preview:
Attachment: Issue 4 (March 2)
|3/3/19||I hope that you have had a productive (and fun) weekend. Two quick notes. First, this week, we will first look at where betas really come from (not from a regression) and devise a way of estimating betas for companies that will free us from the tyranny of regression betas. Second, as the quiz is a week from tomorrow, I will check in on you, to make sure that you have access to everything you need to get prepared for the quiz (both in terms of material and logistics).|
|3/3/19||NYU, in typical wimpy fashion, has canceled class tomorrow. I am almost tempted to override them and have class tomorrow, but I don’t think that the building will be operational. At the same time, I do not want to miss a class, since we have places to go and things to cover. Here is the compromise solution. I will record an online lecture that covers the material that I was planning to cover in class tomorrow, and you can watch it before class on Wednesday. That way, you get your money’s worth for your tuition, I get to stay on course with the class and the earth will continue to rotate around the sun.|
I thought that the call against the Saints in the NFL Playoffs was the pits, but the decision to cancel school runs close. To work out how much it cost you, I took your annual tuition ($71,000+) and divided by ten classes and then by 26 session to arrive at about $275 per session. I would suggest that you invoice NYU for that amount, though I don’t think you will get a response. To reduce your cost somewhat (and to serve my own interests of telling my corporate finance story), I recorded a class for today and the YouTube link is below;
The slides and the post-class test are below:
It is 52 minutes long (I did cut you a break on time) and I don’t think it is that excruciating to watch. Please try to watch this class sometime today, or at least before class on Wednesday, since I will assume you have and move forward. Summarizing the class, here is what we listed as the three determinants of betas:
I also introduced the notion of betas being weighted averages with the Disney - Cap Cities example. I worked out the beta for Disney under two scenarios: an all-equity funded acquisition of Cap Cities and their $10 billion debt/ $8.5 billion equity acquisition. As an exercise, please try to work out the levered beta for Disney on the assumption that they funded the entire acquisition with debt (all $18.5 billion). The answer will be in tomorrow's email.
This week’s challenge is on betas and I have used two companies, Valeant and GoPro as my lab experiments. First, check out the description of the puzzle (with the beta pages for both companies):
Once you have browsed through it, here are the questions that I would like you to consider:
Just a reminder again that the first quiz is on March 11 (next Monday), from 10.30-11 am. Please check your email on Saturday for seating arrangements and past quizzes/solutions. The TAs, Luis and Miguel, are both incredibly knowledgeable and helpful. As you know, they had to move their review session from yesterday to today, because of the snow day. The time is still 4.45-5.45 and the room is still being negotiated for.
|3/6/19||I know that today's class was a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash). If you got lost at some stage in the class, here are some of the ways you can get unlost:
1. Review the slides that we covered today.
2. Try the post-class test and solution. I think it will really help bring together some of the mechanical issues involved in estimating betas.
3. Read this short Q&A on bottom up betas which highlights the estimation process and some of its pitfalls:
Since the class built on Monday’s online session, please watch it when you get a chance. In fact, the post class test and solution I am attaching relate to that class.
Catching up with past promises, if you remember, we looked at the beta for Disney after its acquisition of Cap Cities in the online class (you will remember only if you actually watch the class). The first step was assessing the beta for Disney after the merger. That value is obtained by taking a weighted average of the unlevered betas of the two firms using firm values (not equity) as the weights. The resulting number was 1.026. The second step is looking at how the acquisition is funded. We looked at an all equity and a $10 billion debt issue in class and I left you with the question of what would happen if the acquisition were entirely funded with debt. (If you have not tried it yet, you should perhaps hold off on reading the rest of this email right now)
Debt after the merger = 615+3186 + 18500 = $22,301 million ( Disney has to borrow $18.5 billion to buy Cap Cities Equity and it assumes the debt that Cap Cities used to have before the acquisition)
Equity after the merger = $31,100 (Disney's equity pre-merger does not change)
D/E Ratio = 22,301/31,100= 0.7171
Levered beta = 1.026 (1+ (1-.36) (0.7171)) = 1.497
Note that I used a marginal tax rate of 36% for both companies, which was the case in 1996.
That’s about it for now, but your quiz is on Monday. So, you will be hearing from me over the weekend.
If you want to take time away from preparing for the quiz, I have a webcast on the mechanics of estimating bottom up betas. I use United Technologies to illustrate the process and I go through how to pull up companies from Capital IQ. Even if you don't get a chance to watch it after the quiz, it may perhaps be useful later on. Here are the links:
United Technologies 10K: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/UT10K.pdf
Spreadsheet to help compute bottom up beta: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/Bottomupbeta/bottomupbeta.xls
The last spreadsheet has built into it the industry averages that I have computed for different sectors in the US in 2015. You can easily replace it with the global averages from 2019 that I also have on my site and tweak the spreadsheet.
Give it a shot!
I also thought that since Disney has been under the microscope in class and we talked about how Bob Iger has affected the company with his decision stay on as CEO, you might be interested in this article:
Take a look at the vote. It sounds like the natives are getting restless.
I know that Luis has done two review sessions for the quiz already, and I hope that some of you were able to go to those sessions. That said, if you did not make it, I thought that it might help if I did a review session, to bring together concepts. You can find the review session here (it is about 30 minutes long):
The slides that I used are attached. If you do want to practice, you can find the past quiz 1s that I have given for this class, with solutions, at the links below:
Past quiz solutions: http://www.stern.nyu.edu/~adamodar/pdfilers/cfexams/prqz1sol.xlsx
Finally, the quiz will be in the first 30 minutes of class on Monday, March 11, from 10.30-11. You will be in two rooms, KMEC 2-60 and Paulson. Please go to the right room, based upon your last name:
If your last name begins with Go to
A -J KMEC 2-60
K - Z Paulson
Finally, the newsletter for the week is attached.
Attachment: Issue 5 (March 9)
|3/10/19||First things first. I noticed an error in my solution to the Spring 2014 quiz, problem 2, where I computed default spreads for countries. The excel equation did not carry through when I was copying from the master file and the default spreads have now been corrected. (If you never noticed it, just let it go. If you struggled with it, I am sorry). As I get emails about the quiz, I thought it would be a good idea to pull together a list of the top emailed questions that I have received so far.
1. Why do we use past T.Bill rates for Jensen's alpha and the current treasury bond rate for the expected return/cost of equity calculation?
The Jensen's alpha is the excess return you made on a weekly/monthly basis over a past time period (2 years or 5 years, depending on the regression). Since you are looking backwards and computing short-term (monthly or weekly) returns, you need to use a past, short-term rate; hence, the use of past T.Bill rates. The cost of equity is your expected return on an annual basis for the long term future. Hence, we use today's treasury bond or long term government bond rate as the riskfree rate.
2. How do you decide whether to use a historical or an implied equity risk premium?
In a market like the US, with a long and uninterrupted history, the choice depends on whether you believe that things will revert back to the way they were (in which case you may decide to go with the historical premium) or that the world is a dynamic, ever-shifting place, in which case you should go with the implied premium. In most other markets, where you don't have a long history, it is not really a choice, since the historical premium is too noisy (big standard error) to even be in contention. Thus, I use a short cut. If it is a AAA rated country like Germany or Australia or Singapore, I use the US equity risk premium, arguing that mature markets need to share a common premium. If it is not a AAA rated country, see the answer to (4).
3. How do you estimate a riskfree rate for a currency in an emerging market?
If you are doing your analysis in US dollars or Euros, you would use the riskfree rates in those currencies: the US treasury bond rate for US dollars and the German Euro bond for the Euro. In the local currency, you should start with the government bond rate in the local currency and take out of that number any default spread that the market may be charging (see the Mexico example in the review packet). The default spread can be obtained in one of three ways: (a) The difference between the rate on a dollar (Euro) denominated bond issued by the country and the US treasury bond rate (German Euro bond rate), (b) CDS spread for the country or (c) typical default spread given the local currency rating for the country.
4. How do you adjust for the additional country risk in companies that have operations in emerging markets?
If the country you are analyzing is not AAA, you should adjust for the risk by adding an "extra" premium to your cost of equity. The simplest way to do this is to add the default spread for the country bond to the US risk premium. This will increase your equity risk premium and when multiplied by your beta will increase the cost of equity. A slightly more sophisticated approach is to adjust the default spread for the relative risk of equities versus bonds (look at the Mexico example in the review) and adding this amount to the US premium. This will give you a higher cost of equity. If you are given enough information to do the latter, do it (rather than use just the default spread). When assessing the equity risk premium for a company, look past where the company is incorporated at where it does business. The equity risk premium that you use should be a weighted average of the equity risk premiums of the countries in which the company operates.
5. Why do you use revenues (rather than EBIT or EBITDA) as the basis for your weighting?
Note that what you would really like to know is the value of a company's different businesses/geographies, but since you don't have value, you look for proxies. While you may have a choice of different measures (revenues, EBITDA, EBIT etc), I prefer revenues for three reasons. First, it is always a positive number, which is good since I want weights that are greater than zero. Second, it is less susceptible to accounting allocation judgments than numbers lower down on the accounting statement. Third, I can convert it into a value by using an EV/Sales multiple, which I can get from the sector.
6. Why do you use the average debt to equity ratio in the past to unlever a regression beta?
The regression beta is based upon returns over the regression time period. Hence, the debt to equity ratio that is built into the regression beta is the average debt to equity ratio over the period.
7. What is the link between Debt to capital and debt to equity ratios?
If you have one, you can always get the other. For instance, the Fall 2006 quiz gives you the average debt to capital ratio over the last 5 years of 20%. The easiest way to convert this into a debt to equity is to set capital to 100. That would give you debt of 20 and equity of 80, based upon the debt to capital ratio of 20%. Divide 20 by 80 and you will get the debt to equity ratio of 25%.
8. How do you annualize non-annual numbers?
The most accurate thing to do is to compound. Thus, if 1% is your monthly rate, the annual rate is (1.01)^12-1.... if 15% is your annual rate, the monthly rate is (1.15)^(1/12) -1... When the number is low, as is usually teh case with riskfree rates, you can use the approximation of dividing by 12 (to get monthly) or 52 (to get weekly). But try to always compound the Jensen's alpha numbers, since they can be much bigger.
9. What is the cash effect on beta? Why does it sometimes get taken out and sometimes get put back in?
I know that dealing with cash is on of the more confusing aspects of beta and cost of equity. Let's start with some basics. If a company has cash on its balance sheet, that cash is an asset with a zero beta (or at least a very low one) and it will affect the beta for the company and the beta that you observe for its equity (say, from a regression). What you do with cash will therefore depend upon what beta you are starting with and what beta you want to end up with.
For the pure play or unlevered beta by business: You start with the average (or median) regression beta across the comparable companies in the business. To get to a pure play beta for the business, here are the steps:
Step 1: Unlever the regression beta, using the gross debt to equity ratio for the sector
Unlevered beta for median company in sector = Regression beta/ (1+ (1- tax rate) (Debt/Equity Ratio for the sector))
Step 2: Clean up for the cash held by the typical company in the sector, using the median cash/ firm value for the sector (see below for firm value)
Unlevered beta for the business = Unlevered beta for median company/ (1 - Cash/Firm value for the sector)
Note that you use sector averages all the way through this process, for regression betas, debt to equity ratios and cash/firm value
Alternatively, you can use the net debt to equity ratio and cut it down to one step
Net Debt to Equity = (Debt - Cash)/ Market value of equity
Unlevered beta for the business = Levered Beta for median company /(1+ (1-tax rate) (Net Debt to Equity))
To get to the bottom up equity beta for a company: You start with the unlevered betas with the businesses and work up to the equity beta in the following steps:
Step 1: Compute a weighted average of the operating business betas, using the values of the operating businesses in the company:
Unlevered beta for operating assets of the company = Pure play betas weighted by values of the operating businesses
Step 2: Compute a weighted average of all of the assets of the company, with the company's cash included (since cash has a beta of zero)
Unlevered beta for entire company = Unlevered beta for operating assets (Value of operating assets/(Cash + Value of operating assets))
Step 3: Compute a levered beta for just the operating assets of the company, using the debt to equity ratio of the company
Levered beta for operating assets of the company = Unlevered beta for operating assets (1+ (1- tax rate) Company's D/E ratio)
Step 4: Compute a levered beta for all of the assets of the company, with cash included
Levered beta for all assets of the company = Unlevered beta for entire company (1+ (1- tax rate) Company's D/E ratio)
It is the beta in step 4 that is directly comparable to your regression beta. Note that all the numbers in this part are the company's numbers - for values for the businesses, cash holdings and debt/equity.
10. Why do you weight unlevered betas by enterprise value (as you did in the Disney/Cap Cities acquisition) and in computing Disney's bottom up beta?
The unlevered beta is a beta fo the asset side of the balance sheet, right? So, when weighting these unlevered betas, you want to weight them by how much the businesses are worth (and not how much the equity is worth). That is why I used enterprise value weights in the Disney bottom up beta computation. I cheated on the Cap Cities acquisition by ignoring cash for both Disney and Cap Cities, but if cash had been provided, I would have used enterprise value. In case you are a little confused about the different values, here they are:
Market cap or Value of equity: This is the value of just equity
Firm value = Market value of Debt + Market value of Equity
Enterprise value = Market value of Debt + Market value of Equity - Cash (This of this as the value of just the operating assets of the company)
Thus, if a company has 100 million in equity, 50 million in debt and 20 million in cash:
Market cap = 100
Firm value = 150
Enterprise value = 150-20 = 130
Sorry about the long email…
I know that it is tough to sit in on a class, after you have taken a quiz and I appreciate it that so many of you did come to class. We started class today by looking at how to estimate the beta for a bank and then why you may want to adjust the beta for a private company. We also looked at what makes debt different from equity, and using that definition to decide what to include in debt, when computing cost of capital. Debt should include any item that gives rise to contractual commitments that are usually tax deductible (with failure to meet the commitments leading to consequences). Using this definition, all interest bearing debt and lease commitment meet the debt test but accounts payable/supplier credit/ underfunded pension obligations do not. We followed up by arguing that the cost of debt is the rate at which you can borrow money, long term, today. I have attached the post class test & solution. You will notice a few questions relate back to something we talked about in the prior class, total betas, since I did not get a chance to include those in my last post class test.
One final note. If you have checked your Google calendar, you will notice that there is a group case due on April 3 just before class (at 10.30 am). I know that this is way in advance of that date, but that case is also now available to download.
I will send you another one specifically about the case and what you might be able to do to get started on in the near term. Back to grading quizzes!
Your quizzes are done and can be picked you. I am sorry for sending you the notification so late in the evening, but I was in Boston all day with your graded quizzes and with no easy way to get them back until I returned a few minutes ago. Here are the quiz pick up details:
I know that today is your puzzle day, but since we are leading into the spring break, I decided to skip it. See you in class tomorrow,
I know that you are probably heading off on break and I had promised you that I would not bug you over the break. I will keep my promise, but as a parting gift, here are a few thoughts to take with you into the break:
Having said all of that, life’s too short for it to be all about corporate finance. So, have fun and you will hear from me again a week from Saturday.
You must admit that I showed immense restraint, not emailing you for the week, but your respite is over and I am back!!! Three separate notes to just get you caught up.
1. The Class: I know that it seems like a century ago but when I last met a week and a half ago, we had just started our analysis of investment returns. Just in case you need to get an exact fix on which slide we let off on, the newsletter is attached.
2. The Project: I know that you have been working hard on your project during the spring break. (I know.. I know.. but we are playing make believe here). In case you feel the urge to get caught up and estimate the cost of debt, I have posted an in-practice webcast on the webcast page. The webcast is from a few years ago but I used Home Depot as my example for the analysis and it does providing an interesting test of getting updated information. The most recent 10K for the Home Depot at the time of the webcast was as of January 29, 2012. Since a new 10K was due a few weeks after the webcast, I used the 10Q from the most recent quarter (as of the time of the webcast) to update information. (Most of you will get lucky and your most recent 10K or annual report will be ready to use, but just in case it is not…)
3. The Case: As you might remember (or preferred to forget), the case is due on April 3, nine days from today. If you have not started, start. If you have, keep at it. If you are done, I am in awe.
It is a group project.
Attachment: Issue 6 (March 23)
I know that it is probably tough to get back into school mode, but I hope that you are making the transition. In today's class, we started by estimating returns and revisiting the hurdle rate for the Rio Disney theme park, separating those risks that we should be bringing into it from those that we should not. We then started the move from earnings to cash flows, by making three standard adjustments: add back depreciation & amortization (which leaves the tax benefit of the depreciation in the cash flows), subtract out cap ex and subtract out changes in working capital. Finally, we introduced the key test for incremental cash flows by asking two questions: (1) What will happen if you take the project and (2) What will happen if you do not? If the answer is the same to both questions, the item is not incremental. That is why "sunk" costs, i.e., money already spent, should not affect investment decision making. It is also the reason that we add back the portion of allocated G&A that is fixed and thus has nothing to do with this project. I have attached the post class test for today, with the solution. In the final part of the class, we looked at time weighting cash flows, why and how we do it.
On a separate note, I would strongly encourage you to read the Whole Foods case, if you have not already, and start building your analysis. The reason that I use the word “building” is that your mission is to decide whether Whole Foods should enter the restaurant business and you should marshal the many “facts” in the case to reach that conclusion. This is not just a modeling exercise (though it will require you to build a financial model), an accounting exercise (though you have to forecast accounting numbers) but a decision-making exercise. It can be fun to flex your judgment skills, but only if you don’t get mired in small details.
|3/26/19||We talked about sunk costs in class in the last session, and how difficult it is to ignore them, when making decisions. You can start your exploration of the sunk cost fallacy with this well-done, non-technical discourse on it:
You can then follow up by reading a tortured Yankee fan's (my) blog post on the Yankee's A Rod problem and the broader lessons for organizations that have made bad decisions in the past and feel the need to stick with them.
Finally, I know that you are probably busy working on your case (spare me my illusions) but in case you have some time, I would like to pose a hypothetical, just to see how you deal with sunk costs. Before you read the hypothetical, please recognize that I am sure that the facts in this particular puzzle do not apply to you, but act like they do, at least for purposes of this exercise:
I hope you get a chance to give it a shot. It will take only a few minutes of your time (though it may take a few years off your life).
This week, we will pick up on investment returns, starting with the theme of looking at cash flows, rather than earnings. We will use hypothetical projects, a new Disney theme park in Rio, an iron ore mine for Vale in Canada and an acquisition by Tata Motors, to illustrate both how to measure cash flows and to convert them into returns. It will help you immensely if you can at least read the case before you come into class. If your response is “what case”, here is the link:
All in all, much to do this week. But welcome back!
In today's session, we started by looking at two time-weighed cash flow returns, the NPV and IRR. We then looked at three tools for dealing with uncertainty: payback, where you try to get your initial investment back as quickly as possible, what if analysis, where the key is to keep it focused on key variables, and simulations, where you input distributions for key variables rather than single inputs. WUltimately, though, you have to be willing to live with making mistakes, if you are faced with uncertainty. I also mentioned Edward Tufte's book on the visual display of information. If you are interested, you can find a copy here:
It is a great book! I also talked about Crystal Ball in class. You have access to it as a student at Stern, at least on the school computers. You can also download a free, full-featured trial version from Oracle:
The only bad news is that it is available only for the PC. As a Mac user, I have to open my Mac as a PC (which kills me) and use Office for Windows (which kills me even more, since I don’t know any of the neat short cuts or where things are in the tool bar).
I also promised you a primer on statistical distributions for using Crystal Ball more sensibly and you can find them here:
We then turned our attention to analyzing a project in equity terms, using a Vale iron ore mine in Canada and in the process faced the question of whether we should hedge risk either at the output or input levels. If you found the risk hedging question we talked about in class this morning interesting or worth thinking about, here is a paper (actually a chapter in a book on risk that I have) that you may find useful:
That’s about it.
Today is usually the day that I write to you about your project, but if you are budgeting your time to immediate priorities, you should be working on the case. In case your fascination with corporate finance leads you to work on the case, here are a few suggestions on dealing with the issues.
I know that you are working on the case right now and that the project is on the back burner. When you get back to it, though, one of the questions that you will be addressing is whether your company's existing investments pass muster. Are they good investments? Do they generate or destroy value? To answer that question, we looked at estimating accounting returns - return on invested capital for the overall quality of an investment and the return on equity, for just the equity component. By comparing the first to the cost o capital and the second to the cost of equity, we argued that you can get a snapshot (at least for the year in question) of whether existing investments are value adding. The peril with accounting returns is that you are dependent upon accounting numbers: accounting earnings and accounting book value. In the webcast for this week, I look at estimating accounting returns for Walmart in March 2013. Along the way, I talk about what to do about goodwill, cash and minority interests when computing return on capital and how leases can alter your perspective on a company. Here are the links:
Walmart: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10K.pdf (10K for 2012) and http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10Klast year.pdf (10K for 2011)
Spreadsheet for ROIC: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmartreturncalculator.xls
I hope you get a chance to watch the webcast. It is about 20 minutes long.
On a different note, and looking at week after next, you have a quiz on Wednesday, April 10. It is a little early to be doing much about it, but if you are raring to go, the past quiz 2s are already online at the link below:
If you want to wait, I will send you more detailed instructions next week,
I won’t distract you from working on the case this weekend. However, the latest newsletter is attached, just in case you want a break.
Attachment: Issue 7 (March 30)
In the week to come, we will continue and complete our discussion of investment returns, starting tomorrow with a comparison of NPV versus IRR and then moving on to look at side costs and side benefits. A big chunk of Wednesday's class will be dedicated to discussing the case (If you ask, "What case?", you are asking for retribution...) By the end of Wednesday's class, we will be done with packet 1. Packet 2 is ready to be either downloaded online or can be bought at the bookstore. To download it, go to the webcast page for the class and check towards the top of the page:
As a powerpoint file, you can then choose to print off two slides per page (or even four, if you have really good eyes).
Anyway, speaking about the case, here are some closing instructions:
1. As you write your case analysis, keep it brief. There is no need for story telling, strategic discussions or second guessing yourself. Crunch through the numbers, pick your investment decision rule and make your decision.
2. Once you are done with the case analysis, put together a report. In the report, make sure you include a table that shows the details of your operating income and cash flow calculations, by year and a computation of your discount rate or rates. (Please don’t attach Excel spreadsheets to your email.)
3. On the cover page, please include the following:
Names of the group members in alphabetical order
Cost of capital for WF Dining Investment:
Accounting Return on Project
NPV for WF Dining (15-year life)
NPV for WF Dining (Longer life)
Decision: Accept or Reject
4. Convert your case report into a pdf file and email me the file, ccing everyone in your group. In the subject of the email, please enter “The Dining Case”. You don’t have to wait until Wednesday at 10.30 and can submit any time before.
5. If you can take the key numbers that you get, put them in the Excel spreadsheet which is attached and email them to me by Tuesday night (or earlier if you have them), I will be everlastingly grateful. I would like to show you (as a class) the distribution of findings across groups.
Finally, I have attached the post class test and solution for today’s class.
I know that you are probably busy working on the case (or should be) but here is the weekly puzzle for this week. We have been talking, in class, about investment decisions and how best to make them. While we laid out the framework of forecasting cash flows and computing NPv, the reality is that you make the best decisions that you can, with the information that you have at the time, and the real world then delivers its own surprises. In this week’s challenge, I confront this issue head on by looking at Chevron’s $54 billion investment in a natural gas plant in Australia. The decision was made in 2009, when oil and gas prices were much higher and rising, and the plant is just going to start production. Take a look at the challenge:
Once you have read the puzzle, try to answer the following questions:
These are fundamental questions that get asked almost every time a big investment goes bad.
|4/2/19||The cases are starting to come in. Please remember two things. The first is to use “The Dining Case” as the subject. I know it sounds picky but it makes my job of organizing emails much easier. The second is to fill out the case results. I should have added the units on the NPV in my original sheet, but I overlooked it. Could you please send me the NPVs in millions (not thousands or dollars). It will make it easier to create group stats. (If you have already sent it in, don’t worry. I made your numbers into millions.|
The bulk of today's class was spent on the WF Diningcase. While the case itself will soon be forgotten (as it should), I hope that some of the issues that we talked about today stay fresh. In particular, here were some of the central themes (most of which are not original):
Theme 1: The discount rate for a project should reflect the risk of the project, not the risk of the company looking at the project. Hence, it is the beta for restaurants that drives the cost of capital for the dining business, rather than the cost of capital for Whole Foods (or Amazon) as a company. That principle gets revisited when we talk about acquisition valuation... or in any context, where risk is a consideration.
Theme 2: To get a measure of incremental cash flows, you cannot just ask the question, "What will happen if I take this investment?". You have to follow up and ask the next question: "What will happen if I don't take the investment? It is the incremental effect that you should count. That was the rationale we used for counting the savings from the parking investment not made in year 12.
Theme 3: If you decide to extend the life on an investment or to make earnings grow at a higher rate, you have to reinvest more to make this possible. In the context of the case, that is the rationale for investing more in capital maintenance in the longer life scenario than in the finite life scenario. Thus, I am not looking for you to make the same capital maintenance assumptions that I did but I am looking for you to differentiate between the two scenarios.
I have put the presentation and excel spreadsheet with my numbers online:
Excel spreadsheet with analysis: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/WFDiningAnalysis.xlsx
Please download them. Not only will they be useful to do a comparison of why your numbers may be different from mine but also to get ready for the next quiz.
In the last part of the class, we tied up some loose ends relating to investment analysis, starting with valuing side benefits and synergies and then taking a big picture perspective of the options that are often embedded in project analysis that may lead us to take negative NPV investments. The post class test and solution for today are also attached.
I just began grading the cases and you should be getting yours back soony. As you look at the case and my grading, I will make a confession that some of the grading is subjective but I have tried my best to keep an even hand. I have put together a grading template with the ten issues that I am looking for in the case. When you get your case, you will find your grade on the cover page. You will see a line item that says issues, with a code next to it. To see what the code stands for look at the attached document. In the last column, you will see an index number of possible errors (1a, 2b etc...) with a measure of how much that particular error/omission should have cost the group. I have tried to embed the comment relevant to your case into your final grade. So, if you made a mistake on sunk cost (4, costing 1/2 a point) and allocated G&A (5, costing 1/2 a point) in your analysis. On the front page of your case, you will see something like this in your grade for the class (Overall grade; 9/10; Issues: 3b,9a) I hope that helps clarify matters. It is entirely possible that I may have missed something that you did or misunderstood it. You can always bring your case in and I will reassess it. Finally, on how to read the scores, the case is out of 10 and the scoring is done accordingly. I hate to give letter grades on small pieces of the class, but I know that I will be hounded by some until I do so. So, here is a rough breakdown:
<5.5: Hopefully no group will plumb these depths
By now, I think I am done with the cases and you should have received them back. If you did not, it is possible that they are in my email pile (I am behind by 633 emails and falling further behind, even as I try to catch up) because the words “The Dining Case” was not on the subject line. As you look at the case grade, you will notice coded messages about mistakes. Before you go on Google search and try to find out what 3a or 9b might mean, you may want to check the grading template that I sent you yesterday. Incidentally, today is the day that I would normally nag you about the project, but I will leave you alone to first recover from the case and then get ready for the quiz next Wednesday. If you are ready to get started on that, here are some lead ins:
If you feel the urge to try your hand at past quiz 2s, here are the links:
I will be doing a review session for this quiz, just as I did for the first quiz, but this quiz is very much an extension of what you did on the case. So, if you are a little shaky about what we did in the case and why, you may want to shore up your weaknesses.
First, my thanks for the time and sweat that went into the case reports. I appreciate it and if you are disappointed with your grade, I am truly sorry. think all the cases are done and you should have got them already. It is entirely possible that a couple slipped through my fingers. If so, please email me with your case attachment again (with no changes of course.. I will go back and find your original submission in mailbox and get it graded. I am attaching that grading code that I had sent you before, so that you can make some sense of your grade. If you feel that i have missed something in your analysis, please come by and make your argument. I am always willing to listen. After 70+ cases, I am a so sick of Whole Food, that I don’t think I will ever shop there again. Here are some thoughts:
1. Beta and cost of equity: The only absolute I had on this part of the case was that you could not under any conditions justify using Whole Food or Amazon's beta to analyze a project in a different business. However, I was pretty flexible on different approaches to estimating betas from the list of movie companies. Also, if you consolidated your cash flows from the Whole Foods Dining and Prepared Foods and are using the same cost of capital on both. I did not make an issue of it in this case, since the differences were so small, but something to think about.
2. Cost of debt and debt ratio: If there was one number that most groups agreed on, it was that the cost of debt for Whole Foods Dining was 4.75% (the riskfree rate + default spread). On the debt ratio, on leases, there were variations on how you dealt with the lump sum after year 5, but I think pretty much everyone discounted at the pre-tax cost of debt (the right thing to do).
3. Cash flows in the finite life case: I won't rehash the arguments about why we need to look at the difference between investing in year 6 and year 12 for computing the parking investment. Some of you either ignored the savings in year 12 or attempted to allocate a portion of the investment in year 5, a practice that is fine for accounting returns but not for cash flows. But here were some other items that did throw off your operating cash flows:
4. Cash flows in the longer life case: The key in this scenario is that you need more capital maintenance, starting right now. (Here is a simple test: If your after tax cash flows from years 1-15 are identical for the 15-year life and longer life scenarios, you have a problem...) Though some groups did realize this, they often started the capital maintenance in year 16, by which point in time you are maintaining depleted assets. Those groups that did not include capital maintenance at all argued that they felt uncomfortable making estimates without information. But ignoring something is the equivalent of estimating a value of zero, which is an estimate in itself. A few of you used the defense that I had asked you not to go out of the case, but you don’t have to, since your depreciation is the key indicator of how much maintenance cap ex you need. Also, you cannot keep depreciation in your cash flows (in perpetuity) and not have capital maintenance that matches the depreciation, since you will run out of assets to depreciate, sooner rather than later. The basis for capital maintenance estimates should always be depreciation and your book capital; tying capital maintenance to revenues or earnings can be dangerous.
Finally, and this is a pet peeve of mine. So, just humor me. Please do not use the word "net income" when you really mean after-tax operating income. Not only is it not right but it will create problems for you in valuation and corporate finance. Also, try to restrain your inner accountant when it comes to capital budgeting. As a general rule, projects don't have balance sheets, retained earnings or cash balances. Also, if a project loses money, don't create deferred tax assets or loss carryforwards but use the losses to offset against earnings right now and move on. Now that the case is behind us, time to get ready for a busy week coming up. On Monday, we will start on financing choices tomorrow and continue with the trade off between debt and equity after the quiz on Wednesday. So, please do bring packet 2 to class with you. Oh, and one more thing. I did put up an in-practice webcast about finding a typical project for a company on the webcast page for the class. It will come in handy, when you go back to working on you project for the class (remember). Until next time!
As the second quiz approaches and you get a chance to digest your case feedback, a few quick notes:
1. I have attached the newsletter for the week.
2. Just a reminder that we will start packet 2 on Monday. So, please either buy it, download it to your device or print it before then.
3. If you feel the urge to try your hand at past quiz 2s, here are the links:
4. The seating arrangements for quiz 2 are below:
If your last name begins with Go to
A -P Paulson
Q -Z KMEC 2-60
Until next time!
Attachments: Issue 8 (April 6)
|4/7/19||In the week to come, we will turn to the second part of corporate finance, the financing principle, and look at what the right mix of debt and equity for a firm should be. We will explore the trade off on debt versus equity, and perhaps start on quantitative tools for assessing this trade off. There is your quiz on Wednesday, but it will be entirely on the investment principle, with an emphasis on how we compute cash flows and returns on projects. It will also cover cost of capital mechanics.|
I know that you are in quiz prep mode. So, first thing first. I created a review session for the quiz that you can watch here:
Review session: https://youtu.be/wsSwIfvaIG4
Slides for review: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/reviewQuiz2.pdf
I hope that it helps. In today's class, we started our discussion of the financing question by drawing the line between debt and equity: fixed versus residual claims, no control versus control, and then used a life cycle view of a company to talk about how much it should borrow. We then started on the discussion of debt versus equity by looking at the pluses of debt (tax benefits, added discipline) and its minuses (expected bankruptcy costs, agency cost and loss of financial flexibility). Even with the general discussion, we were able to look at why firms in some countries borrow more than others, why having more stable earnings can make a difference in how much you can borrow and why having intangible assets can affect your borrowing capacity. After the quiz on Wednesday, we will continue with this discussion.
I know what you are thinking… Right? He wants me to prepare for a quiz after a week of working on the case and he expects me to do a puzzle on top of that! Not happening! I understand but nevertheless, just in case you feel the urge, this week’s puzzle is up and running. It revolves around the tax benefit of debt and in particular, how perverse the US tax code was prior to 2018. I know that there is a lot of heated debate about the tax reform act, and while there is much to dislike about the reform (especially if you live in a high tax state like New York or California), I believe that the corporate tax reform it included, especially on foreign income, was vastly overdue. To give you a sense of how bad things used to be, I pulled up a write up and puzzle from almost four years ago as the puzzle for this week.
While the facts are dated and Pfizer never went through with its tax inversion plan, put yourself back in time and try to address the questions.
I hope that you are recovering or recovered from the quiz. I will grade the quiz and I apologize in advance for the fact that you will not get them back until Saturday afternoon, since I have to leave for London this evening. I am planning on taking the quizzes and grading them on the flight. In effect, they will ready to pick up tomorrow, but you will have to fly out to London for the pick up. In the session that followed the quiz, I look at the Miller Modigliani theorem through the prism of the debt tradeoff and followed up by using the financing hierarchy that companies seem to move down, when they think about raising fresh financing. I then move on to looking at how the cost of capital can be used to optimize the right mix of debt and equity. We will continue with this discussion next week.
|4/11/19||I have finished grading your quizzes but am still across the Atlantic. I should be back by Saturday afternoon and will let you know when I put them out. I know that you are in no mood for corporate finance but this is a great weekend to get caught up with your big project. We are in the capital structure section and the first thing you can do (if you remember what company you are analyzing) is to take it through the qualitative analysis, i.e., the trade off items on capital structure:
Today's in practice webcast takes you through the process of assessing this trade off, with suggestions on variables/proxies you can use to measure each of the above factors. If you are interested, here are the links:
I am also attaching two spreadsheets: one contains the updated marginal tax rates by country and the other has the 2019 version of average effective tax rates by sector for US as well as for Global companies. Hope you find them useful!
I just got into my office from the airport and I cannot wait to unload the 300 quizzes I have been carrying in my backpack. You can pick them up in the usual place (ninth floor of KME just before you get to the front door, on your right, on the top shelf). If you cannot wait, you should be able to get them even on a Saturday. They are in impeccable alphabetical order. Please leave them that way. I have attached the solutions to the quizzes as well as the distribution. Finally, it is Saturday and the weekly newsletter is also attached.
This week, we will continue our analysis of the optimal financing mix by looking at tools that you can use to assess optimal capital structure. If you want to get a jump on the class and get caught up on your project at the same time, I have a suggestion. I have attached the spreadsheet that I will be using to optimize cost of capital for Disney. If you enter your company’s numbers into this spreadsheet, you will not only get an optimal debt ratio for your class but also get caught up on almost 75% of what you should have done already on the project. How can you beat a deal like that? (It will take you about 20 minutes to input the numbers into spreadsheet and if you want help, I have a YouTube video that may help:
It is a slightly older version which does not include the bells and whistles I added after the tax reform of last year.
In today's class, we continued our discussion of the cost of capital approach to deriving an optimal financing mix: the optimal one is the debt ratio that minimizes the cost of capital. To estimate the cost of capital at different debt ratios, we estimated the levered beta/ cost of equity at each debt ratio first and then the interest coverage ratio/synthetic rating/cost of debt at each debt ratio, taking care to ensure that if the interest expenses exceeded the operating income, tax benefits would be lost. The optimal debt ratio is the point at which your cost of capital is minimized. Using this approach, we estimated optimal debt ratios for Disney (40%), Tata Motors (20%), Vale (30% with actual earnings, 50% with normalized earnings). Disney was underlevered and Tata Motors was over levered.
Now, to the project, which I know has been on the back burner for a while. I know that some of you are way behind on the project, and as I mentioned in class today, I will offer you a way to catch up. In doing so, I will be violating “The Little Red Hen Principle”. If you have no idea what I am talking about, try this link: http://www.amazon.com/Little-Red-Hen-Golden-Book/dp/0307960307/ref=sr_1_1?s=books&ie=UTF8&qid=1460414914&sr=1-1&keywords=the+little+red+hen. If you get a chance, please try the optimal capital structure spreadsheet (attached) for your firm and bring your output to class on Wednesday. It will help if you have a bottom up beta (based on the businesses that your company operates in) and an ERP (given the countries it gets its revenues from) but if you don’t, use a regression beta and the ERP of the country in which your company operates (for the moment).
In this week’s puzzle I decided to use Valeant in 2015 to illustrate both the good side and the bad side of debt. Valeant was an obscure Canadian pharmaceutical company in 2009 but grew explosively between 2009 and 2015 to get to a market capitalization of $100 billion, primarily using debt-fueled acquisitions to deliver that growth. You can read the weekly puzzle here:
In 2015, Valeant’s fortunes took a turn for the worse. Not only has its business model crumbled, but it had had both managerial problems and information disclosure issues that have added to the troubles. It’s biggest booster and investor, Bill Ackman,took his losses on the stock and apologized to investors in his fund for the “mistake” he made investing in the company. In November 2015, the stock price, which was close to $200 IN 2014, dropped below $10 and the company was clearly seeing the dark side of debt. Here are my questions:
In today’s class, we continued our discussion of the cost of capital approach to optimizing debt ratios by first looking at enhancements to the approach and then at the determinants of the optimal. In particular, it was differences in tax rates, cash flows (as a percent of value) and risk that determined why some companies have high optimal debt ratios and why some have low or no debt capacity. We then looked at the Adjusted Present Value (APV) approach to analyzing the effect of debt. In particular, this approach looks at the primary benefit of debt (taxes) and the primary costs (expected bankruptcy) and netted out the difference from the unlevered firm value. If you are interested in trying this out, I have attached an APV spreadsheet which you can use on your company (with your own judgment call on what the indirect bankruptcy cost is as a percent of value). We closed the discussion of optimal by noting that many firms decide how much to borrow by looking their peer group and argued that if you decide to go this route, you should use more of the information than just the average. If you can plug in the numbers for the optimal debt ratio into the optimal capital structure, it would be a giant step forward on your project. More on the project tomorrow..
I know that I have been sending you serial emails on the project over the whole semester and that some of you are way behind. Since it may be overwhelming to go back and review every email that I have sent out over time, I thought it would make sense to pull all the resources that I have referenced for the project into one page, which you can use as a launching pad for starting (or continuing) your work on the project.
1. Resource page: I put the link up to the corporate finance resource page, where I will collect the data, spreadsheets and webcasts that go with each section of the project in one place to save you some trouble:
2. Main project page: I had mentioned the main page for the project at the very start of the class, but I am sure that it got lost in the mix. So, just to remind you, there is an entry page for the project which describes the project tasks and provides other links for the project:
3. Project formatting: I guess some of you must be starting on writing the project report or some sections thereof. While there is no specific formatting template that I will push you towards, I do have some general advice on formatting and what I would like to see in the reports:
It also has sample projects from prior years that you can browse through. If you look at the projects, you will see that the formats vary. Some use Word and one is in Powerpoint. They all emphasize comparative analysis and go beyond the numbers. So, be creative, put it in the format that best fits how you want to deliver your narrative and have fun with it. Note, in particular, to put muscle behind my plea for brevity. I have put a page limit of 20 pages on your entire written report (You can add appendices to this, but use discretion), if you have five companies or less. If you have more than five companies, you can add 2 pages for every additional company.
I know that I have been nagging you to get the optimal debt ratio for your firm done. To bring the nagging to a crescendo, I have done the webcast on using the cost of capital spreadsheet, using Dell as my example. You can find the webcast and the related information below:
Dell optimal capital structure spreadsheet: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/optdebt/dellcapstru.xls
You will notice that the Dell capital structure spreadsheet which is from a few years ago has a few minor tweaks that make it different from this year's version, but it is fundamentally similar. In particular, take note of the fact that the spreadsheet will not work unless you have the iteration box checked.
I hope that you are enjoying the start of the weekend and I will not spoil it by telling that this is a great time to get caught up on the project. I am attaching the newsletter for this week.
Attachment: Issue 10 (April 20)
In today's session,we looked at applying closure to the optimal debt ratio analysis by looking at how quickly you should move to the optimal and what actions to take (recap versus taking projects), drawing largely on numbers that we have estimated already for the company (Jensen's alpha, ROC - Cost of capital). We then followed up by examining the process of finding the right debt for your firm, with a single overriding principle: that the cash flows on your debt should be matched up, as best as you can, to the cash flows on your assets. The perfect security will combine the tax benefits of debt with the flexibility of equity. The best way to reinforce the concept is to try and apply it to your own company (that you are following for the project). Trust me! This is not rocket science.
At this stage in the class, we are close to done with capital structure (chapters 7,8 &9) and with all of the material that you will need for quiz 3 (which is not until a week from Wednesday). Thus, you can not only finish this section for your project but start preparing for the quiz at the same time. Quiz 3 and the solution to it are also up online, under exams & quizzes on the website for the class:
Past Quiz 3s solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls
As with he prior quizzes, I will send you a quiz review webcast soon. I have also attached today's post class test & solution.
|4/23/19||In yesterday’s class, we talked about the perfect security as one that preserves the flexibility of equity while giving you the tax benefits of debt. While this may seem like the impossible dream, companies and their investment bankers constantly try to create securities that can play different roles with different entities: behave like debt with the tax authorities while behaving like equity with you. In this week's puzzle, I look at one example: surplus notes. Surplus notes are issued primarily by insurance companies to raise funds. They have "fixed' interest payments, but these payments are made only if the insurance company has surplus capital (or extra earnings). Otherwise, they can be suspended without the company being pushed into default. The IRS treats it as debt and gives them a tax deduction for the interest payments, but the regulatory authorities treat it as equity and add it to their regulatory capital base. The ratings agencies used to split the difference and treat it as part debt, part equity. The accountants and equity research analysts treat it as debt. In effect, you have a complete mess, working to the insurance company's advantage.
What are surplus notes? http://en.wikipedia.org/wiki/Surplus_note">Surplus notes: What are they?
The IRS view of surplus notes: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/taxview.pdf
The legal view of surplus notes: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/courtview.pdf
The ratings agency view of surplus notes: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/ratingsviewnew.pdf
The regulator's view of surplus notes: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/regulatorview.pdf
The accountant's view of surplus notes: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/weeklypuzzles/surplusnotes/GAAPview.pdf
After you have read all of these different views of the same security, try addressing some of the questions in the weekly challenge.
If this strikes you as too esoteric, there is a whole host of these shape shifting securities that try to be different things to different entities that you can find out there to explore.