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! (Or at least one happier than last year). 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:
1. Pre-work for class
2. Class Details/Logistics
Normally, we would meet in Paulson Auditorium, a cavernous amphitheater with all of the charm of Madison Square Garden on a bad day (which would be any day that the Knicks actually play there) every Monday and Wednesday, starting on February 1, going through May 10. With the world still off balance , this year’s class will be entirely virtual but we will still meet at the scheduled class time (Mondays and Wednesdays, 12.30 pm - 1.50 pm) on Zoom. I will not take attendance, but I would really, really, really like to see you live during those times, preferably with your cameras turned on. As a teacher, I will miss being in a classroom with you, but I will try my best to make these Zoom sessions as close to that experience as possible. I know that some of you are in time zones, where this will the middle of the night. So, don’t worry! The sessions will be recorded and available in three places:
1. My website at: http://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr21.htm
2. On YouTube as a playlist: https://www.youtube.com/playlist?list=PLUkh9m2Borql2njENzmUX2DoZr5E2-YXs
3. On NYU Classes: As Zoom recordings
You can find out all you need to know about the class (for the moment) by going to the web page for the class:
This page has everything connected to the class, including webcast links, lecture notes and project links. The syllabus has been updated:
If you click on the calendar link, you will be taken to a Google calendar of everything related to this class.
You will note references to a project which will be consuming your lives for the next four months. This project will essentially require you to do a full corporate financial analysis of a company. While there is nothing you need to do at the moment for the project, you can start thinking about a company you would like to analyze and a group that you want to be part of.
3. Class Material
Now for the material for the class. The lecture notes for the class are available as a pdf file that you can download and print. I have both a standard version (one slide per page) and an environmentally friendly version (two slides per page) to download. You can also save paper entirely and download the file to your iPad or Kindle. Make your choice.
There is a book for the class, Applied Corporate Finance, but please make sure that you get the fourth edition. It is exorbitantly over priced but you can buy, rent or download it at Amazon.com or the NYU bookstore
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.
4. Final Thoughts
I know that the last few years have led you to question the reach of finance (and your own career paths) and COVID’s disparate effects on individuals and businesses has probably made you doubt yourself even more. 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 1st, in class. Until next time!
I hope that you are in some place warm and sunny, albeit distanced and safe. I also hope that you are ready to get started on classes and that you got my really long email a weeks ago. If you did not, you can find it here:
This one, hopefully, will not be as long and has only a few items
1. Website: In case you completely missed this part of the last email, all of the material for the class (as well as the class calendar) is on the website for the class:
Please do try to download the first lecture note packet soon. The direct link to the lecture note packet is below:
Lecture note packet 1: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/cfpacket1spr21.pdf (as pdf file) or http://www.stern.nyu.edu/~adamodar/pptfiles/acf4E/cfpacket1spr21.pptx (powerpoint file)
You can print it off or just keep it on your tablet (as long you can make notes on the pages).
2. Pre-class prep: What kind of twisted mind comes up with a pre-class prep for the very first class? That said, I know that some of you are worrying about whether you are ready, especially if your accounting and finance foundations are shaky. If so, you can take my speedy quick accounting-for-people-who-think-accounting-is-mostly-pointless class (it should not take more than a few hours) or foundations-in-a-hurry finance class.
3. YouTube links: I had sent these out in my previous email but no harm repeating. The YouTube Playlist for this class is: https://www.youtube.com/playlist?list=PLUkh9m2Borql2njENzmUX2DoZr5E2-YXs. You can find the webcasts for this class at: http://www.stern.nyu.edu/~adamodar/New_Home_Page/webcastcfspr21.htm. For those of you who have not got around to checking, class is scheduled from 12.30-1.50 pm on February 1, and I will see you on Zoom. See you there! Until next time!
I hope that you have had a good week since my last email, and if your response is what last email, you may want to check this link:
Next week, at the first class, I will spend time laying out what the class is about, what I hope that we will accomplish during the semester, as well as establish the key themes that underlie corporate finance. You can download the syllabus ahead of time:
As you read the syllabus, you will notice mention of a project and in case you are curious, here is the link to the project resources:
Once we are through the syllabus in the first session, we will turn our attention to the lecture note packets, and every slide you see in class after this will be in that packet. The lecture notes are in two parts, and the first part can be obtained at this link (which I sent you last week as well):
It is also available in powerpoint form (though the file size is bloated), if you go to the lecture note page or webcast page of the class..
Now that I have drowned you in stuff, just a little aside. I don’t much care for academic research and almost everything that I write is for practitioners, and my blog (sounds new age, doesn’t it?) has become the first repository for my writing. I spend the first few weeks of each year, talking about the data that I update on my website:
The first two updates are on my blog. Please browse through them, because they are relevant for class:
I will see you in class next week (Monday. February 1, at 12.30 pm, NY time on Zoom). The zoom link for all of the sessions is below:
Until next time!
As we head into the last weekend before class, I am sending this as a collective email to all of my classes (Corporate Finance, MBA Valuation and Undergraduate Valuation). So, please be careful before you replay all, since roughly a thousand people are in the three classes put together. When I start class on Monday, it will be my 37th year teaching and I am thankful that I still look forward to the day. There is no other profession where you can start with a fresh slate every few months, even though you may screw it up in the subsequent days and weeks. The class times on Monday (February 1), just in case you need a reminder, are:
As you can see, there is only a sliver of time between the classes (ten minutes), and if I seem like I am in a rush to get out, once class ends, that is the reason. Please come to the zoom class, unless the time zones work too much against you or you have life and death commitments.
I last emailed you just four days ago, and for those of you are wondering how much can happen in four days, the evidence is in front of you. We have had three big market movement days (two negative, one positive) in the last three days, and if you are thinking about places to hide from risk, you may want to start by reading my third data post for 2021:
If you did not get a chance to look at the first two, they are linked at the bottom, and one of them gives you my market view (I would not pay for it, but its free…). The even bigger story is the frenzy around GameStop, with Reddit traders taking hedge funds to the woodshed. The story has legs because it has shades of David versus Goliath, and it feeds into many of the populist and political themes that have surrounded us for the last decade. I normally don’t write reactive posts, but this one was big enough that I did it anyway:
As you read this post, you will see that I am not a fan of hedge funds, most of which are run by people who bring nothing to the table, while charging obscene fees and delivering sub-standard returns. That said, I am not sure what the end game for Reddit investors is, either. I have offered four choices, and given my opinion, but you be the judge! Until next time!
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. Until next time!
In the first puzzle for this semester, I am going to focus on the objective in corporate finance, In class, I said that the end game is to maximize the value of the business and that in practice, this gets narrowed to maximizing stock prices. That objective has given corporate finance its focus, but has also given rise to criticism that it comes at the expense of other claimholders. That is a legitimate point, and even the Business Roundtable seemed to come around to a stakeholder point of view in this missive:
In a post shortly thereafter, I took issue with the Business Roundtable, and argued that it was the wrong message and that the messenger, Jamie Dimon, was singularly ill equipped to talk about shareholder interests, given how cavalierly he has ignored them over his tenure.
I know that many of you will disagree with me on my conclusions, but I think that this will be a great start for tomorrow’s class. So, please read both and try to answer these questions:
No pressure and completely optional, but I think it is worth your time. Until next time!
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. 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).
2. 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)
3. 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…
4. 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. To get access to Capital IQ, you need to ask for it, and the attached document leads you through the process. As with all things IT related, I am sure that there are glitches and if you find them, let me know. Until next time!
Attachment: CapIQ Access
I know that it is still early in the class and office hours are not on your mind, but they will be soon. Let me start with my office hours, which are scheduled as you know, from 11 am - 12 pm, NY time, every Monday and Wednesday for all three classes. Since NYU classes is finicky about how zoom sessions show up in classes, I had to create the session in my corporate finance class (and will show up to those who are enrolled in the class on their Zoom stream) but not in the valuation classes. Consequently, I am sharing the details of the zoom session just for my office hours (since the meeting ID is the same for all of the sessions, all you have to do is incorporate this into your calendar and it should show up every Monday and Wednesday):
Join Zoom Meeting
Meeting ID: 937 2783 3493
TA Office hours and review sessions
In addition, your TAs will have both office hours each week, and a review session, where they will cover problems from past quizzes and exams, related to the material of the week. I have scheduled the Zoom sessions for those, and they should show up on NYU classes, when you log on. Sorry for this convoluted and messy email, but there are some things that are more complicated online than in physical locations. Until next time!
As promised, here is the first of the weekly in-practice webcasts. These are 10-15 minute webcasts designed to work on practical issues in corporate finance. This week’s issue is a timely one, if you are working on picking companies for your project (as you should be..). It is about the process of collecting data for companies, the first step in understanding and analyzing them. The webcast link is below:
It is a little dated (but I have been too lazy to update it), but I don’t think it is too painful to watch, and you may even find it useful. I have also put the link up on the webcast page for the class:
The webcasts for the first two classes should be on there, if you missed (physically, metaphysically or mentally) and the links to the project and syllabus that I handed out in the class. You can stream or YouTube the sessions, or download videos/audios. Also, if you joined the class late, you can get all emails sent up till today here:
Finally, have you had a chance to look at the weekly puzzle? If not, give it a shot by going here:
At the risk of nagging, please do get the lecture note packet 1 downloaded before Monday’s class. It is now available (or was at least yesterday) in the bookstore. Until next time!
Before I start on the newsletter part, a quick note about the TAs for this class, Sam Greene (firstname.lastname@example.org) and Siddharth Kejriwal (email@example.com). The times and zoom links are available on NYU classes. They will be holding office hours every week, and having a zoom session to go through applications of the material from the week, using past quizzes. As you start the weekend, I decided to butt in with the first of my newsletters. As you browse through it (and I hope you do), you will realize that this is not really news or even fake news. It is more akin to a GPS for the class telling you where we’ve been and where we plan to go. It is a good way to get a sense of whether you are falling behind on either the class or the project, especially as we get deeper into the class. So, enjoy your weekend and I will see you on Monday! Until next time!Attachment: Issue 1 (February 6)
|2/7/21||I hope that you are enjoying Super Bowl Sunday. If nothing else, it brings home the importance of focus and the difference between objectives and constraints. The objective for any well fun NFL team (and no, the Jets don’t belong) is to win the Super Bowl, and everything else (keeping team spirit up, fans happy etc.) is a constraint. This week, we will complete our discussion of the objective function in corporate finance, continuing with stock price maximization tomorrow and alternatives to that objective thereafter. Along the way, we will look at shareholder wealth maximization and corporate sustainability and I may kill a few sacred cows along the way. I would strongly recommend that if you have not tried the weekly puzzle for this week, you should. It is not only relevant to the classes to come but is at the foundation of the big debates we are having in business, politics and society. If you have no idea what I am talking about, here is the link to the weekly puzzle:
If you are wondering why I am not posting a solution, take a look at the puzzle again, and the answer should be fairly obvious. In the meantime, please do pick a company, and if you have picked a company, take a look at the board of directors and corporate governance. Until next time!
Today's class extended the discussion of everything that can wrong in the real world. Lenders, left unprotected, will be exploited. Information can be noisy and markets can be irrational. Social costs can be large. Relating back to class, I have a couple of items on the agenda and neither requires extensive reading or research. I would like you to think about market efficiency without any preconceptions. You may believe that markets are short term, volatile and over react, but I would like you to consider the basis of these beliefs. Is it because you have anecdotal evidence or because you have been told it is so or is it based upon something more concrete? We will start the next class by talking about social costs and benefits and how difficult it is to incorporate them into decision making and we will continue on that theme in the next class. Again, plenty to think about while you are sitting in your CSR class! We have spent a couple of sessions being negative - managers are craven, markets are noisy and bondholders get ripped off. In the next class, we will take a more prescriptive look at what we should be doing in this very imperfect world. As always, reading ahead in chapter 2, if you have the book, will be helpful.
I hope that your search for a group has ended well and that you are thinking about the companies that you would like to analyze. Better still, perhaps you have a company picked out already. If you do, try to find a Bloomberg terminal (there is one in the MBA lounge and there used to be one in the basement)... If you do find one vacant, jump on it and try the following:
1. Press the EQUITY button
2. Choose FIND YOUR SECURITY
3. Type the name of your company
4. You might get multiple listings for your company, especially if it is a large company with multiple listings and securities. Try to find your local listing. For a US company, this will usually be the one with your stock symbol followed by US. For a non-US company, it will have the exchange symbol for your country (GR: Germany, FP: France, LN: UK etc...) It may take some trial and error to find the listing....
5. Type in HDS
6. Print off the first page of the HDS (it should have the top 17 investors in your company).
If you cannot find a Bloomberg terminal or don't have access to one, try going on Yahoo! Finance and type in the name or symbol for your company. Once you find your company, find the tab that says Holders and click on it. You should get a listing of the top stockholders in your company. In fact, while you are on that page, take note of the percent of your company's stock held by insiders and by institutions. I have also attached the post class test and solution for today's class. Until next time!
In this week’s puzzle, I want to take a look at activist investing, warts and all. To get a perspective on activist investing, start with this old (but still relevant) post on activist investing:
Then, follow up with this more recent post on Softbank’s problem, after the WeWork disaster
Top it all off with this news story about Elliott Management, a leading activist investor, targeting Softbank:
Finally, consider these questions:
1. Why did Softbank get targeted by Elliott Management now?
2. What do you think of Elliott’s proposals for Softbank?
3. Assuming Softbank decides to fight Elliott Management, what would you advise Softbank to do?
4. More generally, what are the pluses and minuses of having activist investors in a market?
Just to be clear, you don’t have to show me your answers. These puzzles are more about you getting comfortable with your assessment of different aspects of corporate finance. Until next time!
The objective function matters, and there are no perfect objectives. That is the message of the last two classes. Once you have absorbed that, I am willing to accept the fact that you still don't quite buy into the "maximize value" objective. That is fine and I would like you to keep thinking about a better alternative with three caveats. First, you cannot cop out and give me multiple objectives - I too would like to maximize stockholder wealth, maximize customer satisfaction, maximize social welfare and employee benefits at the same time but it is just not doable. Second, your objective function has to be measurable. In other words, if you define your objective as maximizing the social good, how would you measure social good? Third, take your objective (and the measurement device you have developed) and ask yourself a cynical question: How might managers game this system for maximum benefit, while hurting you as an owner? In the long term, you may almost guarantee that this will happen.
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: https://www.calvert.com
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 research 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. I also hope that you have had a chance to register for Capital IQ and if you have not, I am reattaching the directions on how to do so. Until next time!
Attachment: CapIQ Access
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
I hope that you get a chance to not only watch these webcasts but also try them out on your company. Until next time!
1. First things, first. Your newsletter is attached for the week.
Attachment: Issue 2 (February 13)
2. Company choice & groups: I was checking the corporate finance master sheet:
3. Orphans up for adoption: It looks like all the orphans have been adopted. Sally Struthers would be proud of you (if you have no idea who she is, type in her name and Ethiopia, and you will see what I mean. There is one group of three people that would like add ons. So, if you are in a large group and would like to split off, I can put you in touch with that group. Thank you!
I hope that you had an enjoyable and productive long weekend, and since we have no class tomorrow, you will get at least one day without email. On Wednesday, we will complete our discussion of corporate governance and start with a discussion of risk and how it plays out in hurdle rates. In the process, we will talk about the model that started the ball rolling, the capital asset pricing model (CAPM, how it is mystified by some and vilified for others, often in advancement of their agendas, and about alternatives to i5. We will move through this discussion in hyper speed for two reasons. One is that I have zero interest in reinventing modern portfolio theory and showing the mechanics of correlation and covariance. The second is that while I use the CAPM as a tool to estimate hurdle rates, I am not wedded to it and accept all kinds of alternatives (some of which we will talk about in class).
If you are still shaky about even the assumptions that underlie the model, my suggestion is that you read chapter 3 from the applied corporate finance book before the class. We will then start on the fun stuff of applying the model, starting with what should be a slam dunk (risk free rates) which is increasingly not and then turning to the equity risk premium, a number that analysts often turn towards services to look up but really has deep implications for both valuation and corporate finance. So, much to do and I hope that you come along for the ride.
Finally, since we will be talking about hurdle rates, you may find my most recent blog post on the topic useful:
In fact, if you find yourself with nothing else to do, try the second in this data update series as well:
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:
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):
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). Until next time!
I am sorry to hit you with a second email on the same day, but this one is about getting data for your company, In the next week or two, we will delve into estimating betas for your company, and if you have access to a Bloomberg terminal, you can pull up the beta page for your company. If you have used a Bloomberg terminal before, you will easily find your way on it, but just in case you have not, I have put together a webcast to help you:
While I look at only a couple of commands (HDS, to get ownership lists, and BETA, to get the beta page) in this webcast, I have a document that lists out all of the Bloomberg commands I use:
If you are in New York, and you can go into school, you can find the Bloomberg terminals in the building:
If you are not in New York, and you don’t have access to a Bloomberg terminal, never fear. All of the data that you get from a Bloomberg, you can get from other sources, and I will send you those links on Thursday. That’s about it. Until next time!
We started the class by wrapping up the question of at the end game in business, and why I (and you don’t have have to) still trust markets, over managers and expert panels. Markets have no ego, and if allowed to play out, will devise corrections to almost every over reach in business, whether it be managers taking advantage of shareholders, borrowers ripping off lenders, companies lying to markets or creating large social costs. My view is that companies should run to maximize value, even if the market does not recognize it right away, and that managers need to consider the messages in stock prices.
We then moved on to risk and some of you may be regretting the shift from the soft stuff , but trust me that it is still fun.. If it is not, keep telling yourself that it will become fun. Anyway, here are a few thoughts about today's class.
1. The Essence of Risk: There has been risk in investments as long as there have been investments. If you have the time, pick up a copy of Against the Gods by Peter Bernstein, John Wiley and Sons. It is a great book and an easy read. If you want more, you should also pick up a copy of Capital Ideas by Peter as well... That traces out the development of the CAPM....
2. More on Models: If you want to read more about the CAPM, you can begin with chapter 3 in the book. It provides an extended discussion of what we talked about in class today....
3. Diversifiable versus non-diversifiable risk: The best way to understand diversifiable and non-diversifiable risk is to take your company and consider all of the risks that it is exposed to and then categorize these risks into whether they are likely to affect just your company, your company and a few competitors, the entire sector or the overall market.
If you can, try to make your assessment of whether the marginal investors in your companies are likely to be diversified. Look at both the percent of stock held in your company and the top 17 investors to make this judgment. If your assessment leads you to conclude that the marginal investor is an institution or a diversified investor, you are home free in the sense that you can now feel comfortable using traditional risk and return models in finance. If, on the other hand, you decide that the marginal investor is not diversified, we will come back in a few sessions and talk about some adjustments you may want to make to your beta calculations. Until next time!
If my nagging is paying off, you should have picked a company by now and if you have, you can move on to look at the marginal investors in you company, with the objective of assessing whether they are diversified, since it will let you know whether you are on safe ground using the CAPM or any other risk and return model. This will require a degree of judgment, but remember that you are not trying to identify a particular investor (Blackrock, Vanguard etc.) but a type of investor (institutional, insider, individual etc.). In making this assessment, having access to a Bloomberg terminal can speed the process, and if you get a chance, look at the YouTube video that I sent to you about using Bloomberg. If you don’t have access to a terminal, never fear, since much of the data is public. You can get both the breakdown of investors into insider and institutional, as well as the top holders of your stock. Here for instance is the page for PlugPower, a US company listed on the NASDAQ (under Holders): https://finance.yahoo.com/quote/PLUG/holders?p=PLUG
The assessment of who the marginal investor in PlugPower is easy to make. It is a large institutional investor, and very diversified. You can see that 53% of PlugPower’s shares are held by institutions, and if you are wondering whether that is high or low, I have data on insider and institutional holdings, by sector, for US, Global, European, Emerging (with China and India as separate date sets), Japan and Australia/NZ/Canada. You can find them here:
Scroll down to insider/institutional holdings and download the excel spreadsheets. Until next time!
In the only session we had this week, we covered some ground, moving well into our discussion of risk and return models. Next week, we will be starting on the first of the three inputs into your cost of equity, the risk free rate. If you want to get ahead of the curve, you can watch the webcast for this week, which looks at how to estimate risk free rates in different currencies, and how sovereign default spreads can be useful in getting there:
On a different note, I had sent you a YouTube video on how to use Bloomberg to get basic data on your company. For those of you wondering how I got a Bloomberg terminal installed in my home, I did not. What I used instead is a really neat interface called Bloomberg Anywhere that you can use to make your terminal mimic a Bloomberg. If you are in New York, and can access a terminal at Stern (I sent you the locations), you should, but I have learned (thank you to Houss El Marabti) that you too have access to Bloomberg Anywhere, as a Stern student. I have attached the instructions on how to use it in the document below, but keep in mind that there are only a handful of connections that Bloomberg allows at any one time. (Read the document to the end to see why). Given that constraint, you should plan your Bloomberg expedition with purpose, and be ready to get the stuff you need quickly. For the moment, I would like you to get on, if you can, and print off four Bloomberg pages for your company:
HDS: Just print page 1 (which will have the top 17 holders of stock in your company)
BETA: Just print the default page (which will be a 2-year weekly beta against the local index)
CRPR: which will give you the bond ratings for your company, if it is rated
DDIS: which will give you the maturity distribution for your company, if it has debt, with an average maturity
If you play this right, it will take only a few minutes, and if you don’t have a printer, just take pictures of each of these pages. Until next time!
Attachment: Student instructions for Bloomberg
Last week, we put the objective function to rest and turned our attention to risk models. Next week, we will start our discussion of risk free rates, and how best to estimate risk premiums and convert them into hurdle rates. If you have had a chance to pick a company for your project, this is a good week to catch up on the corporate governance part, and perhaps even get a risk free rate in the currency of your choice. This week’s newsletter is attached.Attachments: Issue 3 (February 20)
|2/21/21||This week, we will complete our discussion of risk and return models before moving on to riskfree rates, and answering the question of why riskfree rates vary across currencies. We will then look at estimating equity risk premiums & continue on our build up to hurdle rates. Since the material will get denser and the topics will build on each other, you may find it useful to read chapter 4 in the book ahead of class. In the meantime, if you have not picked a company, please do so, and if you don’t have a group still reach out.|
We started today’s class by tying up the last loose ends with risk and return models, talking about how assuming that there are no transactions costs and private information can lead us all to hold the market portfolio, and how risk can be then measured as risk added to that portfolio. We did damn the CAPM with faint praise, arguing that it does not do very well at explaining differences in returns across companies, but that it does at least as well as the alternatives. We then started on the mechanics of the model, taking about risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:
In fact, risk free rates turned negative in a few currencies, upending what we know about risk free rates in. Here is my post on negative risk free rates.
In the final few minutes of the session, we turned to equity risk premiums and how they are related to risk aversion. More on that in the next class
As we are reach the tail end of another market crisis, it is a good time to think about our views on risk and how it plays out in how we react to the crisis. Both economics and finance are built on risk aversion, i.e., that investors need to be paid extra (over and above an expected value) to take risks. That notion of risk aversion has been challenged and modified over time, but it still is at the heart of how we measure risk and come up with expected returns. Economists agree that not only does risk aversion vary across individuals but it also varies, for the same individual, across time. In this puzzle, which has no right answer, I would like you to wrestle with the question of how risk averse you, explanations that you can offer for that risk aversion and the consequences for your business and investment decision making. You can find the full details of the puzzle here:
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 is one that you can try at no cost (it will take only a few minutes):
Take the rest, 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 was spent talking mostly about equity risk premiums. The key theme to take away is that equity risk premiums don't come from models or history but from our guts. When we (as investors) feel scared or hopeful about everything that is going on around us, the equity risk premium is the receptacle for those fears and hopes. Thus, a good measure of equity risk premium should be dynamic and forward looking. We looked at three different ways of estimating the equity risk premium.
1. Survey Premiums: I had mentioned survey premiums in class and two in particular - one by Merrill of institutional investors and one of CFOs. You can find the Merrill survey on its research link (but you may be asked for a password). You can get the other surveys at the links below:
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 January 2020
The approach that I use for computing country risk premiums at the start of 2020 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 2020 update:
Play with the spreadsheet. In fact, try it with today’s index level and T.Bond rate and see what the ERP is right now.
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 or get on Bloomberg anywhere. 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.
The post class test and solution for today are attached.
As part of the weekly project nag, I am going to start by assuming that you have picked a company to analyze and that if you have not entered its name in the Google shared spreadsheet, it is an oversight that you will fix soon.
Here are some things to consider doing to catch up:
It is Friday and time for the in-Practice Webcasts. I have two for this week. The first is on estimating implied equity risk premiums:
The supporting materials are below:
Implied ERP spreadsheet (from February 2013): http://www.stern.nyu.edu/~adamodar/pc/implprem/ERPFeb13.xls
S&P on buybacks (from earlier this year): http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/webcasts/ERP/SP500buyback.pdf
S&P 500 Earnings: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/webcasts/ERP/SP500eps.xls
The webcast uses the February 2013 spreadsheet, but I have tweaked the spreadsheet a little bit and the cell numbers have changed in the updated version, but the process remain the same. More importantly, I talk about where to get the inputs for future earnings on the index and the data has become richer since. If you download the latest version of my ERP spreadsheet, and look under the growth worksheet, you can see where the raw data comes from.
The second webcast is on company equity risk premiums, using operating exposure:
Webcast on company ERP calculation: https://youtu.be/D3IGn6tH03c?list=PLUkh9m2BorqkNIdjpZY2kI0qzRbEv5F5L
Slides for webcast: http://people.stern.nyu.edu/adamodar/pdfiles/blog/ERPforCompany.pdf
Worksheet for webcast: http://www.stern.nyu.edu/~adamodar/pc/datasets/ERP&GDP.xlx
This spreadsheet is an old one. You can get the updated values for GDP and ERP by going to my website:
Updated ERP spreadsheet: http://www.stern.nyu.edu/~adamodar/pc/datasets/ctryprem.xlsx
First, it is the weekend and the newsletter is attached. Second, and perhaps more important, your quiz is a week from Monday (on March 9) and for those of you who have time on your hands this weekend, you may want to start the work on the quiz. We have not quite completed the material in class yet, but here is a preview:
|2/28/21||I hope that you have had a productive (and fun) weekend. Three 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). Third, the solution link that I sent you for the past quizzes had a typo in it. Here is the corrected link:|
In this class, 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:
This week’s challenge is on betas and I have used GameStop as my lab experiment. First, check out the description of the puzzle (with the beta pages for both companies):
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 8 (next Monday). The TAs, Sam and Siddharth, are both incredibly knowledgeable and helpful and I will add an office hour on Friday for questions that you may have
In today’s class, we looked past regression betas at how the choices companies make about the businesses they enter can determine their betas.. Summarizing the class, here is what we listed as the three determinants of betas:
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 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 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. More on that in a different email. Until next time!
|3/4/21||Today is usually the project update day. If you really have the time for it, this is a good week to get a bottom up beta for your company and estimates costs of equity for each business line it operates in. I will be putting up a blog post on this tomorrow, but you can get betas by business going to my website:
If you scroll down, you will set betas (levered and unlettered), by business and while the html file includes only US companies, you can download the averages for the rest of the world in the next column.
If you prefer to compute your bottom up betas yourself, you can use other databases, but the one that is easiest and most comprehensive is the S&P Capital IQ database. Early this semester, I had sent you instructions on how to get access that database, and if you have not, try to do so now. (See attached instructions). It provides you incredibly powerful screening tools with 45000+ publicly traded companies, and very simple ways of picking the data you need and downloading that data into a spreadsheet. Until next time!
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 get the updated version from 2020 here:
I will let you get back to the grind now, but just in case, you have not even started on the quiz preparation and don’t have the energy to check old emails, here are the key links:
Review session webcast: https://www.youtube.com/watch?v=jH8L7cW6Yns&feature=youtu.be
All past quiz 1s: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1.pdf
All past quiz 1 solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz1sol.xlsx
I know…. I know… Last thing you want to do right now, but this week’s newsletter is attached. Since the quiz is on your mind, here are a few thoughts:
Until next time!
Attachments: Issue 5 (March 6)
|3/7/21||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. Also, if you can convert revenues to value, for bottom up betas especially, it always makes sense to do so. Multiplying by an EV to Sales ratio accomplishes this.
6. Why do you use the average debt to equity ratio in the past to unlever a regression beta?
The regression beta is based upon returns over the regression time period. Hence, the debt to equity ratio that is built into the regression beta is the average debt to equity ratio over the period.
7. What is the link between Debt to capital and debt to equity ratios?
If you have one, you can always get the other. For instance, the Fall 2006 quiz gives you the average debt to capital ratio over the last 5 years of 20%. The easiest way to convert this into a debt to equity is to set capital to 100. That would give you debt of 20 and equity of 80, based upon the debt to capital ratio of 20%. Divide 20 by 80 and you will get the debt to equity ratio of 25%.
8. How do you annualize non-annual numbers?
The most accurate thing to do is to compound. Thus, if 1% is your monthly rate, the annual rate is (1.01)^12-1.... if 15% is your annual rate, the monthly rate is (1.15)^(1/12) -1... When the number is low, as is usually teh case with riskfree rates, you can use the approximation of dividing by 12 (to get monthly) or 52 (to get weekly). But try to always compound the Jensen's alpha numbers, since they can be much bigger.
9. What is the cash effect on beta? Why does it sometimes get taken out and sometimes get put back in?
I know that dealing with cash is on of the more confusing aspects of beta and cost of equity. Let's start with some basics. If a company has cash on its balance sheet, that cash is an asset with a zero beta (or at least a very low one) and it will affect the beta for the company and the beta that you observe for its equity (say, from a regression). What you do with cash will therefore depend upon what beta you are starting with and what beta you want to end up with.
For the pure play or unlevered beta by business: You start with the average (or median) regression beta across the comparable companies in the business. To get to a pure play beta for the business, here are the steps:
Step 1: Unlever the regression beta, using the gross debt to equity ratio for the sector
Unlevered beta for median company in sector = Regression beta/ (1+ (1- tax rate) (Debt/Equity Ratio for the sector))
Step 2: Clean up for the cash held by the typical company in the sector, using the median cash/ firm value for the sector (see below for firm value)
Unlevered beta for the business = Unlevered beta for median company/ (1 - Cash/Firm value for the sector)
Note that you use sector averages all the way through this process, for regression betas, debt to equity ratios and cash/firm value
Alternatively, you can use the net debt to equity ratio and cut it down to one step
Net Debt to Equity = (Debt - Cash)/ Market value of equity
Unlevered beta for the business = Levered Beta for median company /(1+ (1-tax rate) (Net Debt to Equity))
To get to the bottom up equity beta for a company: You start with the unlevered betas with the businesses and work up to the equity beta in the following steps:
Step 1: Compute a weighted average of the operating business betas, using the values of the operating businesses in the company:
Unlevered beta for operating assets of the company = Pure play betas weighted by values of the operating businesses
Step 2: Compute a weighted average of all of the assets of the company, with the company's cash included (since cash has a beta of zero)
Unlevered beta for entire company = Unlevered beta for operating assets (Value of operating assets/(Cash + Value of operating assets))
Step 3: Compute a levered beta for just the operating assets of the company, using the debt to equity ratio of the company
Levered beta for operating assets of the company = Unlevered beta for operating assets (1+ (1- tax rate) Company's D/E ratio)
Step 4: Compute a levered beta for all of the assets of the company, with cash included
Levered beta for all assets of the company = Unlevered beta for entire company (1+ (1- tax rate) Company's D/E ratio)
It is the beta in step 4 that is directly comparable to your regression beta. Note that all the numbers in this part are the company's numbers - for values for the businesses, cash holdings and debt/equity.
10. Why do you weight unlevered betas by enterprise value (as you did in the Disney/Cap Cities acquisition) and in computing Disney's bottom up beta?
The unlevered beta is a beta fo the asset side of the balance sheet, right? So, when weighting these unlevered betas, you want to weight them by how much the businesses are worth (and not how much the equity is worth). That is why I used enterprise value weights in the Disney bottom up beta computation. I cheated on the Cap Cities acquisition by ignoring cash for both Disney and Cap Cities, but if cash had been provided, I would have used enterprise value. In case you are a little confused about the different values, here they are:
Market cap or Value of equity: This is the value of just equity
Firm value = Market value of Debt + Market value of Equity
Enterprise value = Market value of Debt + Market value of Equity - Cash (This of this as the value of just the operating assets of the company)
Thus, if a company has 100 million in equity, 50 million in debt and 20 million in cash:
Market cap = 100
Firm value = 150
Enterprise value = 150-20 = 130
Finally, if you did watch the review session and were wondering about the answers to the last page, I have attached my answers. Your quiz will be accessible from 4 am tomorrow (Monday, March 8) morning, NY time, until 1.30 pm, NY time, and will take an hour. So, please start your quiz by 12.30 pm, NY time, if you push it later. There will be class tomorrow from 12.30 pm - 1.30 pm. So, if you are done with your quiz, please come to class. Until next time! Sorry about the long email…
I know that it is tough to sit in on a class, after you have taken a quiz and I appreciate it that so many of you did come to class. We started class today by looking at how divisional betas and costs of equity are critical for multi-business companies, in making investments and allocation capital. We also looked at the process of estimating betas for the remaining public companies in the mix, with financial service companies being treated a little differently, because debt is impossible to nail down, and levering and unlevering betas is tough to do. Finally, we examined how to estimate the cost of equity of a private company, and why it may be higher than an otherwise equivalent public company. I have attached the post class test & solution. You will notice a couple of questions about debt, which we have not covered in class, but I think that you will be able to handle those.
The quiz scores should be accessible in a little while (at 6 pm, NY time), with the full solutions to the problems, when you click on your quiz. I hope that you did well and I will send out a few notes on the quiz tomorrow, but right now may be too soon. One final note. If you have checked your Google calendar, you will notice that there is a group case due on March 31 just before class (at 10.30 am). That case should be available for download tomorrow or day after, and more about it, when it is accessible.Attachments: Post-class test and solution
|3/8/21||I know that some of you tried to check your quiz answers and ran into a brick wall. I would take the blame, but NYU classes seems to have trouble with setting times, especially if you are working from a different time zone. It should be working now, both in terms of checking your quiz score and the solutions. One problem that threw some of you for a loop was the riskfree rate in Peruvian Sul, where if you do it right, and net out the dollar default spread from the Peruvian Sul government bond rate, many of you ended with a negative risk free rate. (’The problem randomizes the numbers.. So, each of you got a different set of numbers.) That is entirely plausible in a world where currencies do have risk free rates, and the fact that Peru is not Aaa rated country is irrelevant, since the government bond rate is what is affected by default risk. I don’t think that you should even be looking at distributions right now, since this is the first quiz and it is only 10%, but I know that some of you will not rest easy until you know.|
I know that today is your puzzle day, but rather than give you a puzzle, I am posting the case with one of the exhibits as an excel spreadsheet:
It is a case built around an investment analysis and it is a group project. The project is due by March 31, 2020, before the start of class. I know that you have three weeks, but I would suggest reading it right aways and doing it in bit size pieces. For instance, one of the things you will need to estimate is a discount rate for the project, and much of what we have done in class in the last few sessions should help.
In today’s class, we started by looking at the three criteria that sets debt apart: a contractual commitment that is usually tax deductible and comes with consequence for control and survival, if missed. We argued that all interest bearing debt as well as lease commitments need to be considered. We then talked about estimating a cost of debt, specifying that it is the cost of borrowing money long term, today. Finally, w explained our preferences for market value weights on debt and equity in a cost of capital calculation, arguing that market value weights trump book value weights every single time. For the market value of debt, we argued for including both interest bearing debt converted to market value and the present value of lease commitments. To get a cost of debt, you need a bond rating (actual or synthetic) as well as default spreads that go with these ratings. The former should be available for your company, if it is rated. If not, use the following spreadsheet to rate your company:
It comes with a lease converted, if you want to use it. The default spreads used to be accessible online for free at bondsonline.com, but it seems to be defunct. You can get default spreads for key ratings classes (AAA, AA, A, BBB, BB, B and CCC & below) from the Federal Reserve website in St. Louis.
Look for the effective yield and then subtract out the risk free rate from it. While you may have to extrapolate from these numbers for intermediate ratings, it is eminently doable. Alternatively, you can get updated spreads for every ratings class from a Bloomberg terminal by typing in FWIW, and resetting a couple of inputs. (If I can get on Bloomberg, I will try to make a video of how to do it… Looks like I cannot get on right now.)
File this away under “There is no rest for the wicked”, as I bring you back to the your project. Assuming that you have been working along with me, by now, you should have a risk free rate in the currency of your choice, an unlettered beta reflecting the business or businesses that your company is in and the equity risk premium that you have for your company. To get the unlevered beta to a levered beta, you need market values for equity and debt. With a publicly traded company, the former should be easy (market capitalization of all classes of shares) but the debt can be tricky. You should at least be able to get a book value of debt from the balance sheet (remember to count both short term and long term interest bearing debt), and if your company has leases and is following either GAAP or IFRS, the lease debt should also be there. If you don’t trust accountants, and want to do this right, you can covert book debt to market debt and capitalize leases for your company, but you will need a cost of debt for your company to be able to do this, and you can get that using either an actual rating or a synthetic rating for your company. I have a ratings spreadsheet that will do both (compute a synthetic rating for a company and capitalize leases. This is the link that I sent out yesterday:
Once you have all these numbers, you can compute a cost of capital. I know that you may be several steps behind, but if you do get to this number, please remember to go to the Google shared spreadsheet and enter your numbers for your company:
|3/12/21||We are through the cost of capital in class, and if you can compute a cost of capital for your company (or multiple costs, if it is many businesses), you will be all caught up. You are welcome to use my data and spreadsheets and the in-practice webcasts as crutches in doing this. I have added a webcast on estimating cost of debt and debt ratios, using the Home Depot as an example.
There are two issues that I will nag you on:
1. Project: On your project, you have everything you need to compute the cost of capital for your company, and its divisions. Please do so, while the material is fresh.
2. Case: I sent you the link for the case earlier in the week. If your response is what case, or if you have not read it, please read it, and if you can, start working on the portions that you feel comfortable working with.
Attachment: Issue 6 (March 13)
In this week's classes, we will start on measuring investment returns, looking at four projects, including a hypothetical Rio Disney theme park. We will start with accounting earnings before making the transition from returns to cash flows to incremental cash flows. Since our discussion is particularly relevant for the case, it would help greatly if you read the case before tomorrow’s class.
I noticed that the due date on page 1 the case is wrong. It is March 31 (not April 1), before class.
In this session, we started on measuring investment returns, drawing on the theme from jerry Macguire (Show me the money). After making an argument for the primacy of cash flows, we looked at how a good measure of return is time weighted and incremental and how every investment is a project (small or large). We spent the bulk of the class describing the Rio Disney investment, and then computing the return on capital on that investment, based upon expected revenues and operating income. We also looked at what the hurdle rate for the investment should be, drawing on the notion that the discount rate for a project should reflect the risk of that project (business, geography etc.). We ended the class extending the return on capital concept to entire companies to judge the quality of existing investments.
|3/16/21||We will be talking about sunk costs in class nest week, 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).
In today's class, we started the move from earnings to cash flows, by making three standard adjustments: add back depreciation & amortization (which leaves the tax benefit of the depreciation in the cash flows), subtract out cap ex and subtract out changes in working capital. Finally, we introduced the key test for incremental cash flows by asking two questions: (1) What will happen if you take the project and (2) What will happen if you do not? If the answer is the same to both questions, the item is not incremental. That is why "sunk" costs, i.e., money already spent, should not affect investment decision making. It is also the reason that we add back the portion of allocated G&A that is fixed and thus has nothing to do with this project. Finally, we looked at two time-weighted, incremental cash flow approaches to calculating returns, NPV and IRR, and used them to analyze the Rio Disney theme part. I have attached the post class test for today, with the solution. In the final part of the class, we looked at time weighting cash flows, why and how we do it.
Today is also usually the day that I write to you about your project, but if you are budgeting your time to immediate priorities, you should be working on the case. In case your fascination with corporate finance leads you to work on the case, here are a few suggestions on dealing with the issues.
Until next time!
As you know (and your email box attests to this), I have been sending an email a day since school started, and I am facing a quandary. I have been told that this coming weekend is a long quiet weekend, in lieu of your mid-semester break. I am not sure what this means, but I guess that sending you emails over the weekend may disrupt whatever quiet thoughts you were planning to have. So, I am going to post the in practice webcasts that I would have posted tomorrow now, and it covers the question of whether your company's existing investments pass muster. Are they good investments? Do they generate or destroy value? To answer that question, we looked at estimating accounting returns - return on invested capital for the overall quality of an investment and the return on equity, for just the equity component. By comparing the first to the cost o capital and the second to the cost of equity, we argued that you can get a snapshot (at least for the year in question) of whether existing investments are value adding. The peril with accounting returns is that you are dependent upon accounting numbers: accounting earnings and accounting book value. In the webcast for this week, I look at estimating accounting returns for Walmart in March 2013. Along the way, I talk about what to do about goodwill, cash and minority interests when computing return on capital and how leases can alter your perspective on a company. Here are the links:
Walmart: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10K.pdf (10K for 2012) and http://people.stern.nyu.edu/adamodar/pdfiles/cfovhds/webcasts/ROIC/walmart10Klast%20year.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. Have a serene weekend and may the force be with you!
I have restrained myself from emailing you all weekend, to give you some alone time, but I am afraid that time has passed. So, with no further ado, here are three things to bring you back to the real world:
1. Newsletter: The newsletter for this week, which you would normally have got yesterday, is attached. As always, it is scintillating.
2. Case: Even though I was giving you three days of peace and quiet, it was obvious that some groups were working on the case. (I was answering emails, even though I was not sending them). Please keep doing so, and remember that the case is due a week from Wednesday, on March 31, before class that day.
3. Quiz 2: I screwed up and had scheduled the quiz for March 31 as well. Since that is overload, In a move of utmost compassion, I have moved the quiz to the following Monday (April 5). You are welcome!
4. This week: This week will continue the discussion of investment returns, with more project analyses tomorrow, followed by an examination of how we choose between projects.
In this class, we started by looking at the use of sensitivity analysis and simulators to enrich the discussion of uncertainty. I mentioned a book by Edward Tufte on visualizing information that I recommend strongly (not for this class, but for life in general:
It is a great book! I also talked about Crystal Ball in class. You have access to it as a student at Stern and 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).
We then moved on to how taking an equity perspective can alter how you measure returns and cash flows, and alter the hurdle rate you use, using an iron ore project for Vale as illustration. Finally, we started by looking at an acquisition as a really big project, and argued that the same rules should apply to acquisitions as to regular projects. The cash flows should include any side benefits and costs and the cost of capital you use should reflect the risk of the project (target company), not the entity looking at the project (acquiring firm). A reminder again that we have no class for a week, but the beat goes on. The case is due a week from Wednesday.
I know that you are busy working on the case (or should be) but here is the weekly puzzle for this week. We have been talking, in class, about investment decisions and how best to make them. While we laid out the framework of forecasting cash flows and computing NPV, the reality is that you make the best decisions that you can, with the information that you have at the time, and the real world then delivers its own surprises. In this week’s challenge, I confront this issue head on by looking at Chevron’s $54 billion investment in a natural gas plant in Australia. The decision was made in 2009, when oil and gas prices were much higher and rising, and the plant is just going to start production. Take a look at the challenge:
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. In fact, in the aftermath of this crisis, this will be the scenario that unfolds in almost every company that made a big investment decision last year, and particularly true for oil companies. Las year, with COVID, I am sure that there are many businesses, small and large, that faced questions about investment decisions that they locked themselves into pre-COVID.
I know that we have no class today, and I also know that many of you are using the day to work on the case. As you face uncertainty on the case, I thought it would be a good time to talk about healthy ways of dealing with uncertainty. Specifically, the best way to deal with uncertainty is to face up to it and embrace it, using statistical tools and common sense. I had talked about Monte Carlo simulations and the use of Crystal Ball, in conjunction with Excel, to incorporate uncertainty into valuation. If you get a chance, read this blog post, since it gives you a step by step approach to doing a Monte Carlo simulation:
There are two challenges you will face along the way. The first is one created by the inability of statistics classes to create either an intuitive feel for or a love of statistics. I cannot fill in that gap entirely, but if the only statistical distribution you remember from your statistics class is a normal distribution, read this quick and dirty summary of what the distributions mean and how to pick between them:
It will take about 20 minutes to read, but will help you when you get to choose between distributions. The second is coming up with parameters for the distribution, a data question, and the answer lies in looking at the data. For instance, if you are trying to get a distribution going on interest rates or exchange rates or commodity prices, you can use historical data, and the Federal Reserve has that data going back a hundred years in this amazing link (which I have sent to you before):
If it is cross sectional data (for instance, operating margins across software companies), there is no better place to look than on S&P Capital IQ (Remember the link I sent you to be able to get access… If not, I have attached it again).
Please do not take this as a suggestion that I want you to do a Monte Carlo simulation on the case. In fact, I don’t want you to do that, because to do it right, you will have to leave the confines of the case (and find data on electric car sales and costs). It is more as a tool that you can use in whatever area of business you go into. Even “strategy” people have to face uncertainty.
I know that the project is officially on the backburner for this week. I have nothing specific to say about the case, but here are some general thoughts:
1. Debt: I was trying to help you by giving you the book and market value of interest-bearing debt, to prevent you having to go to the balance sheet and working through the present value of debt on your own. You still have to compute the present value of lease commitments to get to total debt.
2. Cash flow timing: In discounted cash flow valuation, for convenience, we assume that cash flows occur at a point in time, rather than over time. It is easiest to assume that point in time to be the end of the year. While you can finesse this assumption, by using mid-year conventions, but it is really not worth it. And the start of a year, in time value terms, is the same as the end of the prior year.
3. Capital Maintenance: I know that many of you are struggling with this, and I am afraid that I have to give you an opaque answer. You can always look at what I did in the Disney theme park, but there is no fixed rule that works across investments, but you can draw on something that I did in that case. One is to use depreciation as your scalar for determining how much capital maintenance you need; depreciation reduces capital invested in a project and depreciation replenishes it.
4. What if questions: If you ask what if questions about the case, please follow my advice and keep it focused on the assumptions that you feel matter the most, and tie our analysis to your decision.
That’s about it. If you get done with the case analysis and want to submit it, please email it to me, with “Google Car” in the subject, and with all your group members ccd on this email.
At the moment, you are probably working on the case and will not get a chance to take a look at the in-practice webcast for this week, but I look at what comprises a typical project in a company and how to assess project characteristics. Here are the links:
As you will see, when you try this on your company, it is easier in some companies than others. A typical project at Costco is much easier to identify (probably another 100,000 square foot store) than at Disney (where it can be new theme park, a new movie, a television series for streaming or a licensing deal for a consumer products).
I know that you are busy working on the case, and I won’t take up too much of your time. Two quick reminders. The first is that the newsletter for the week is attached. The second is that we will be finishing up the first packet this coming week, and moving on to packet 2 of the lecture notes. Please download the packet. The links are available on the webcast and lecture note pages for the class:
The powerpoint version seems to have issues that I will try to fix in the next 24 hours.
Attached: Issue 8 (March 27)
This week, we will finish the last parts of investment analysis, with the discussion of the case (and you know which case I am talking about) on Wednesday, in class. Consequently, it is critical that you submit your case before the class begins at 12.30 pm, NY time, on Wednesday. Here are some specifics that will make my life easier:
1. Case write up: Please keep your write-up brief and convert the file into a pdf file. Please include your detailed cash flow table as an appendix, and do not include any figures or tables that you don’t refer to in your write up. On the cover page, please include the following information : (a) Group member names, (b) Cost of capital for the project, (c) ROIC on project, (d) NPV (10-year case), (e) NPV (longer life case) and (f) Accept/Reject the project.
2. Email: When you email your case write up (the pdf file) to me, please cc everyone in the group and put “Google Car” in the subject. That way, when I grade the project, I can return it to everyone in the group at the same time.
In today’s session, we started by looking at mutually exclusive investments, and contrasting NPV and IRR and why they might give you different decisions, and noted the differences in reinvestment assumptions. We then talked about the side costs that projects can create for companies, when they use its existing resources, and how to estimate the opportunity costs. Finally, we turned our attention to side benefits that can accrue to a company from a new project, and how that benefit can be captured analysis, extending from additional revenues on an existing business line to synergies in acquisitions.
A final note regarding the case. When you are done with the numbers on your case, could you submit your findings in the attached spreadsheet. (You don’t have to wait until your final submission to do this.) This will help me put the summary of your findings into the presentation on Wednesday.
|3/30/21||I know that this is not on top of your to-do list for today, but your second quiz is on Monday, April 5, and it will be online from 4 am - 1.30 pm, NY time, that day. You will be able to find the quiz by going to NYU classes and once you have found this class, by checking the menu items on the left. You should see tests and quizzes and if you click on that, you should see quiz 2 but only on Monday. The quiz is open book, open notes, you can use your laptops. I have put the review session for quiz 2 up online (on the webcast page for the class) with the presentation. The links are below:
You can also find all past quizzes with the solutions in the following links:
All past quiz 2s: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2.pdf
Quiz 2 solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2sol.xlsx
In keeping with the structure of this class, there will be class on Monday (April 5).
On a different note, I am looking forward to seeing your case analysis. The deadline for submission for the final report ( by email, as a pdf file) is 12.30 pm, NY time, tomorrow, but if you can send me your final numbers for the case in the attached spreadsheet, I would appreciate it.
The bulk of today's class was spent on the Google GCar case. While the case itself will soon be forgotten (as it should), I hope that some of the issues that we talked about today stay fresh. In particular, here were some of the central themes (most of which are not original):
Theme 1: The discount rate for a project should reflect the risk of the project, not the risk of the company looking at the project. Hence, it is the beta for fitness companies that drives the cost of capital for Google GCar, rather than the cost of capital for Google as a company. That principle gets revisited when we talk about acquisition valuation... or in any context, where risk is a consideration.
Theme 2: To get a measure of incremental cash flows, you cannot just ask the question, "What will happen if I take this investment?". You have to follow up and ask the next question: "What will happen if I don't take the investment? It is the incremental effect that you should count. That was the rationale we used for counting the savings from the distribution system not made in year 8.
Theme 3: If you decide to extend the life on an investment or to make earnings grow at a higher rate, you have to reinvest more to make this possible. In the context of the case, that is the rationale for investing more in capital maintenance in the longer life scenario than in the finite life scenario. Thus, I am not looking for you to make the same capital maintenance assumptions that I did but I am looking for you to differentiate between the two scenarios.
I have put the presentation and excel spreadsheet with my numbers online (with corrections made to the after-tax cost of debt and the finite life length):
Please download them. Not only will they be useful to do a comparison of why your numbers may be different from mine but also to get ready for the next quiz. The quiz will cover the cost of capital section (after bottom up betas) as well as investment analysis (NPV, IRR, cash flows, incremental cash flows). To be safe, you should start around slide 177 and go through slide 327.
In the last part of the class, we tied up some loose ends relating to investment analysis, starting with a big picture perspective of the options that are often embedded in project analysis that may lead us to take negative NPV investments. The post class test and solution for today are also attached.
I just began grading the cases and you should be getting yours back soon, with a FIFO method applying (I am grading the cases in the sequence that they were turned in and sending it to everyone in the group who is ccd). As you look at the case and my grading, I will make a confession that some of the grading is subjective, but I have tried my best to keep an even hand. I have put together a grading template with the ten issues that I am looking for in the case.
http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/GCarCaseGrading.pdf (Also attachment)
When you get your case, you will find your grade on the cover page. You will see a line item that says issues, with a code next to it. To see what the code stands for look at the grading template. In the last column, you will see an index number of possible errors (1a, 2b etc...) with a measure of how much that particular error/omission should have cost the group. I have tried to embed the comment relevant to your case into your final grade. So, if you made a mistake on sunk cost (4, costing 1/2 a point) and allocated G&A (5, costing 1/2 a point) in your analysis. On the front page of your case, you will see something like this in your grade for the class (Overall grade; 9/10; Issues: 3b,5) I hope that helps clarify matters. It is entirely possible that I may have missed something that you did or misunderstood it. You can always bring your case in and I will reassess it. I have also allowed leeway on the revenue forecasts (unless they are egregiously off), and I have not taken points off for minor math errors. Finally, on how to read the scores, the case is out of 10 and the scoring is done accordingly. I hate to give letter grades on small pieces of the class, but I know that I will be hounded by some until I do so. So, here is a rough breakdown:
<5.5: Hopefully no group will plumb these depths
Attachments: Grading Template
First, my thanks for the time and sweat that went into the case reports. I appreciate it and if you are disappointed with your grade, I am truly sorry. think all the cases are done and you should have got them already. It is entirely possible that a couple slipped through my fingers. If so, please email me with your case attachment again (with no changes of course), and make sure you put “Google Car” in the subject.. I will go back and find your original submission in mailbox and get it graded. I am attaching that grading code that I had sent you before, so that you can make some sense of your grade. If you feel that i have missed something in your analysis, please make your argument. I am always willing to listen. Here are some thoughts:
1. Beta and cost of equity: The only absolute I had on this part of the case was that you could not under any conditions justify using Google's beta to analyze a project in a different business. However, I was pretty flexible on different approaches to estimating betas from the list of auto companies. Also, if you used that cost of capital to discount the synergy benefits to Google. I did not make an issue of it in this case, since the differences were so small, but something to think about.
2. Cost of debt and debt ratio: If there was one number that most groups agreed on, it was that the cost of debt for Google was 2.1% (the riskfree rate + default spread). On the debt ratio, on leases, there were variations on how you dealt with the lump sum after year 5, but I think pretty much everyone discounted at the pre-tax cost of debt (the right thing to do).
3. Cash flows in the finite life case: I won't rehash the arguments about why we need to look at the difference between investing in year 3 and year 8 for computing the cost of the expansion of distribution. Some of you either ignored the savings in year 8 or attempted to allocate a portion of the investment in year 3, a practice that is fine for accounting returns but not for cash flows. But here were some other items that did throw off your operating cash flows:
4. Cash flows in the longer life case: The key in this scenario is that you need more capital maintenance, starting right now. (Here is a simple test: If your after tax cash flows from years 1-10 are identical for the 15-year life and longer life scenarios, you have a problem...) Though some groups did realize this, they often started the capital maintenance in year 11, by which point in time you are maintaining depleted assets. Those groups that did not include capital maintenance at all argued that they felt uncomfortable making estimates without information. But ignoring something is the equivalent of estimating a value of zero, which is an estimate in itself. A few of you used the defense that I had asked you not to go out of the case, but you don’t have to, since your depreciation is the key indicator of how much maintenance cap ex you need. Also, you cannot keep depreciation in your cash flows (in perpetuity) and not have capital maintenance that matches the depreciation, since you will run out of assets to depreciate, sooner rather than later. The basis for capital maintenance estimates should always be depreciation and your book capital; tying capital maintenance to revenues or earnings can be dangerous.
Finally, and this is a pet peeve of mine. So, just humor me. Please do not use the word "net income" when you really mean after-tax operating income. Not only is it not right, but it will create problems for you in valuation and corporate finance. Also, try to restrain your inner accountant when it comes to capital budgeting. As a general rule, projects don't have balance sheets, retained earnings or cash balances. Also, if a project loses money, don't create deferred tax assets or loss carryforwards but use the losses to offset against earnings right now and move on. Now that the case is behind us, time to get ready for a busy week coming up. Oh, and one more thing. I did put up an in-practice webcast about finding a typical project for a company on the webcast page for the class. It will come in handy, when you go back to working on you project for the class (remember).
Today is the day that I would send you a In practice webcast, but I will leave you alone to first recover from the case and then get ready for the quiz on Monday (April 6). Here are some details:
1. Quiz time and logistics: The quiz will be accessible from 4 am to 1.30 pm, NY time, on Monday, April 5. Since it is a one hour quiz, you will need to start by 12.30 pm to get done. We will have class from 12.30 pm - 1.50 pm, NY time, on April 5.
2. Content: It will cover the sections of cost of capital that we did not cover on quiz 1 and go all the way through investment analysis, including the parts that you covered on the case. (Slides 175-328).
3. Rules: it is open book, open notes and open laptops. You will have an hour and there will be five multiple choice and calculated answer questions. Unfortunately, no partial credit.
4. Review for the quiz: The links to the review for the quiz and the past quizzes are below:
Review session: https://youtu.be/wsSwIfvaIG4
Slides for review: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/reviewQuiz2.pdf (Fixed a link error from earlier email)You can also find all past quizzes with the solutions in the following links:
Past Quiz Solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz2sol.xlsx
Finally, the case is a more complicated version of almost anything you will run into on the quiz. So, please review both your analysis and mine, as review for the quiz.
I won’t take too much of your time, given how much of it I already have. The newsletter for the week is attached. If you have any questions about the quiz, please send them to me, and I will try to respond. I am on the road, visiting family in LA, and may not get back to you right away.
Attachment: Issue 9 (April 3)
As you know, it is quiz day, and it is tomorrow. I have been sloppy about sending you details about the timing and I am sorry. Here is the scheduled timing for tomorrow. The quiz will be accessible starting at 4 am, NY time, primarily for the few people who are in Asia and are taking the class remotely, and will be available until 1.30 pm, NY time. Since the quiz is scheduled for an hour, you need to start by 12.30 pm, NY time, at the latest. I am sorry if I have not been responsive to emails these last four days, since I was up in Los Angeles, visiting my son and his family for Easter.
This week, we will start on the financing question, and I want to remind you again to download the second packet. I know that some of you have had trouble with the PowerPoint version, and I am sorry. I have tried everything, but it is not a server or upload problem, but a PowerPoint problem. I have created a version using the old PowerPoint that I think works, if you still prefer PowerPoint to pdf.
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.
I know what you are thinking… Right? He wants me to do a case, follow up with a quiz and then ask me to do a corporate finance puzzle.! Not happening! I understand but nevertheless, just in case you feel the urge, this week’s puzzle is up and running. It revolves around the tax benefit of debt and in particular, how perverse the US tax code was prior to 2018. I know that there is a lot of heated debate about the tax reform act that happened at the end of 2017, and while there is much to dislike about the reform (especially if you live in a high tax state like New York or California), I believe that the corporate tax reform it included, especially on foreign income, was vastly overdue. To give you a sense of how bad things used to be, I pulled up a write up and puzzle from almost six years ago as the puzzle for this week.
While the facts are dated and Pfizer never went through with its tax inversion plan, put yourself back in time and try to address the questions. On an entirely different note, the final exam for this class is scheduled for May 17. It had originally been set for May 18, but I think that the school realized its mistake and moved it back a day. The last day of class is May 10, which is when your final project is also due.
I am truly sorry about the technical glitches during class today, but I have learned that what technology gives, it can take away, and I hope that the distractions did not impede the lessons from the class. I looked at the Miller Modigliani theorem through the prism of the debt tradeoff and followed up by using the financing hierarchy that companies seem to move down, when they think about raising fresh financing. I then moved on to looking at how the cost of capital can be used to optimize the right mix of debt and equity. In effect, you estimate the costs of debt and equity at different debt ratios, and try to find the mix of debt and equity that minimizes your cost of capital. If you want to try your hand at using the spreadsheet to optimize debt ratio, try the following:
We will continue with this discussion next week. looking at limits to the approach, and variants.
The clock is ticking down to the end of the semester, and since next weekend is supposed to be quiet one, I am going to go big on this weekend. Since we are in capital structure/financing this week, I will focus on that component. The first thing you can do (if you remember what company you are analyzing) is to take it through the qualitative analysis, i.e., the trade off items on capital structure:
Again, remember that this spreadsheet is designed to get around the circularity in the calculation of interest expenses, and you need to check the iteration box in excel preferences.
I know that I have been sending you serial emails on the project over the whole semester and that some of you are way behind. Since it may be overwhelming to go back and review every email that I have sent out over time, I thought it would make sense to pull all the resources that I have referenced for the project into one page, which you can use as a launching pad for starting (or continuing) your work on the project.
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. In my experience, the very best projects actually are in fewer pages than the page limit, not the most.
In this week’s classes, we talked about the trade off between debt and equity and today's in-practice webcast takes you through the process of assessing this trade off, with suggestions on variables/proxies you can use to measure each of the above factors. If you are interested, here are the links:
I am also attaching two sets of spreadsheets: one contains the updated marginal tax rates by country and the other has the 2021 version of average effective tax rates by sector for US as well as for Global companies.
Marginal tax rates by country: http://www.stern.nyu.edu/~adamodar/pc/datasets/countrytaxrates.xlsx
Effective tax rates by industry
I have attached the weekly newsletter. And while this may qualify as nagging, if you do get a chance to get caught up on your projects, please enter your company’s numbers into the Google shared spreadsheet:
In today’s class, we started by tying up loose ends on the cost of capital approach, starting with why moving to the optimal changes the value of a business (hint: it is all in the tax code) and then looking at how sensitive the optimal debt ratio is to changes in operating income or rating constraints. We also looked at enhancements to the approach, where we incorporated indirect bankruptcy costs in the analysis. Finally, we examined 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. Next session, we will wind up the analysis of the optimal debt ratio and then move on to whether to move to that optimal, and if yes, how quickly.
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:
We started this class with the adjusted present value approach, where we begin with the unlevered firm value, and then add the tax benefits of debt and net out expected bankruptcy costs. While you can download the APV spreadsheet that I have online, I don’t really see a need to do the APV analysis of your company’s capital structure, since the expected bankruptcy cost is a black box. We then looked at peer group analysis, where companies decide how much to borrow by looking at what other companies in the sector do. You can check out the debt ratios for other companies in your sector by going to my website:
US industry averages: http://www.stern.nyu.edu/~adamodar/pc/datasets/dbtfund.xls
Global industry averages: http://www.stern.nyu.edu/~adamodar/pc/datasets/dbtfundGlobal.xls
I know that you are approaching your quiet weekend and that you have no class until Monday, and I will stick with my resolution of not sending you any emails until Monday That said, though, if you want to get a last burst on the project in, before you take off for the weekend, I would suggest computing your optimal capital structure for your company. While we covered different approaches to computing the optimal, including the APV approach, I would recommend that you stick with two. The first is the cost of capital approach, with our without enhancement, and the spreadsheet is here:
The in-practice webcast for the week is on using the 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 under calculation options.
The second way you can assess your company’s debt ratio is by comparing it to the average debt ratio of the peer group, with some subjective judgment going into what comprises a peer company. You can find industry averages on my website and download individual company data from S&P Capital IQ. I have also updated the debt regression for the entire market for 2021, and you can find it online at this link:
Welcome back from a very short break, but now that you are, we are in for a sprint over the next three weeks. You have three to-do items left in the class, one more quiz on April 28, your final project is due on the last day of class (May 10) and your final exam (May 17). The quiz will cover all of the debt material we have covered in packet 2, including tomorrow’s session and I will put up the review session, material and past quizzes up tomorrow. On debt design itself, the objective is to design the perfect financing, one that gives you the tax benefits of debt with the flexibility of equity. That may seem like the impossible dream, companies and their investment bankers constantly try to create securities that can play different roles with different entities: behave like debt with the tax authorities while behaving like equity with you. In this week's puzzle, I look at one example: surplus notes. Surplus notes are issued primarily by insurance companies to raise funds. They have "fixed' interest payments, but these payments are made only if the insurance company has surplus capital (or extra earnings). Otherwise, they can be suspended without the company being pushed into default. The IRS treats it as debt and gives them a tax deduction for the interest payments, but the regulatory authorities treat it as equity and add it to their regulatory capital base. The ratings agencies used to split the difference and treat it as part debt, part equity. The accountants and equity research analysts treat it as debt. In effect, you have a complete mess, working to the insurance company's advantage.
What are surplus notes? http://en.wikipedia.org/wiki/Surplus_note">Surplus notes: What are they?
The IRS view of surplus notes: 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.
One final note. Many of you are struggling with tax rates right now, from trying to decipher the difference between marginal and effective tax rates to understanding they play out in value. I just put up a post on tax rates on my blog that examines these issues, using the current debate about whether corporate tax rates should be raised as a launching pad:
In today's class, we looked at the design principles for debt. We started by completing a five step process for designing the perfect debt before looking at both intuitive and quantitative ways of debt design. In particular, we looked at a macro economic regression of firm value/operating income against interest rates, GDP, inflation and exchange rates. Keeping in mind the objective of matching debt to assets, think about the typical investments that your firm makes and try to design the right debt for the project. If your firm has multiple businesses, design the right kind of debt for each business. In making these judgments, you should try to think about
- whether you would use short term or long term debt
- what currency your debt should be in
- whether the debt should be fixed or floating rate debt
- whether you should use straight or convertible debt
- what special features you would add to your debt to insulate the company from default
Your objective is to get the tax advantages without exposing yourself to default risk. If you want to carry this forward and do a quantitative analysis of your debt, I will send you a spreadsheet tomorrow that will help in the macro economic regressions. I also mentioned that the individual company regressions against the macro variables are so noisy that it is probably not worth the effort. If you are just curious and want to try this out on your company, I do have the macro data collected in a spreadsheet that you can use to run this regression for your company:
It has annual and quarterly data through 2020. Just a warning that it is extremely noisy and may spit out output that does not make sense. The post class test & solution for today is attached.
|4/21/21||The third and final quiz is a week from today, on April 28. The review session for the quiz is available at the link below
Webcast link: https://www.youtube.com/watch?v=5UNYKC8rYiU
You can check out past quizzes and solutions at the links below:
Past quiz 3 solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xlsx
Just remember the quiz is multiple choice/ calculated questions, just like the first two quizzes. Until next time!
On the project, the place to start your debt design is with intuition. In fact, if you have done a prior step in the project (where I asked you to describe a typical project for your company), you are well in place to complete your intuitive analysis. In my view, this is the more critical part of debt design (more important that the quantitative analysis that I will describe in the rest of this email). If you plan to do a quantitative analysis of your debt. I have attached the spreadsheet that has the macroeconomic data on interest rates, inflation, GDP growth and the weighted dollar from 1986 to the present (I updated it to include 2020 data. The best place to find the macro economic data, if you want to do it yourself, is to go to the Federal Reserve site in St. Louis:
Give it a shot and download the FRED app on your iPad and iPhone. You can dazzle (or bore) your acquaintances with financial trivia. You can enter the data for your firm and the spreadsheet will compute the regression coefficients against each. You can use annual data (if your firm has been around 5 years or more). If it has been listed a shorter period, you may need to use quarterly data on your firm. The data you will need on your firm are:
- Operating income each period (this is the EBIT)
- Firm value each period (Market value of equity + Total Debt); you can use book value of debt because it will be difficult to estimate market value of debt for each period. You can also enterprise value (which is market value of equity + net debt), if you are so inclined. I know that you should be including the present value of lease commitments each period, but that would require doing it each year for the last ten. The easiest way to get this data is to use the FA function in Bloomberg or from S&P Capital IQ.
I have to warn you in advance that these regressions are exceedingly noisy and the spreadsheet also includes bottom-up estimates by industry. There is one catch. When I constructed this spreadsheet, I was able to get the data broken down by SIC codes. SIC codes are four digit numbers, which correspond to different industries. The spreadsheet lists the industries that go with the SIC code, but it is a grind finding your business or businesses. I am sorry but I will try to create a bridge that makes it easier, but I have not figured it out yet. My suggestion on this spreadsheet. I think it should come in low on your priority list. In fact, focus on the intuitive analysis primarily and use this spreadsheet only if you have to the time and the inclination. My webcast for tomorrow will go through how best to use the spreadsheet.
I know that you are busy but I have put up the webcast up on debt design, using Walmart as my example, online (on the webcast page as well as on the project resource page). Here are the details on the webcast:
WMT financial summary: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTFAsummary.pdf
WMT macrodur.xls spreadsheet: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/debtdesign/WMTmacrodur.xls
The updated macroduration spreadsheet with data through 2020 was attached to yesterday’s email! Hope you find it useful. One final point. If you find this in-practice webcast useful and want to review the whole series, the playlist is on YouTube and you can find it at this link:
Also, I am sorry to harp on the Google shared spreadsheet but please enter your numbers there for your company, as you have them.
You can use my Disney numbers as guidance, and the page numbers on the lecture notes will tell you where the numbers come from. I don’t know whether it will make you feel more in control, but it will make me feel better. Until next time!
Bad news: Another weekly newsletter for you. Good news: It is the second to last one, which is my not-so-subtle way of telling you that the end of the semester is fast approaching. On a different note, the third quiz is on Wednesday and if you want to try your hand at prior year’s quizzes, you can find them here:
Past Quiz 3s solutions: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/prqz3sol.xls
If you want to watch the review session for the quiz, it is here:
Webcast link: https://www.youtube.com/watch?v=5UNYKC8rYiU
As you can see, it will be focused on the capital structure section (which is lecture note packet 2, until page 148). The quiz will be accessible from 4 am until 1.30 pm, NY time, , and as with the previous quiz, you will have an hour to take it.
Speaking of the quiz, I know that some of you have had trouble with the all-or-nothing quality of the multiple choice quizzes and I understand. That said, a multiple choice question does provide advantages, insofar as the right answer is one of the choices, and while the other answers may work with conceptual errors, they should not with math errors. There is thus a trade off here between a open-ended answer quiz and a multiple choice, and the average scores on the two multiple choice question quizzes have actually been slightly higher than the scores on the more traditional quizzes that I gave in 2019. For those of you who feel truly handicapped by the multiple-choice form, I will offer the option of taking an open-answer quiz. It will still be open-book, open-notes and an hour, but you will have to show your work (which takes more time), but you can get partial credit. If you want to avail yourself of that option, please go to the Google shared spreadsheet below and sign up before Tuesday at noon, NY time. I need the day to make sure that I get the two quizzes running and to the right people:
Attachment: Issue 12 (April 24)
We spent today's session first talking about the characteristics of dividends, i.e., that they are sticky and follow earnings as well as reasons for the shift towards buybacks in recent decades, We ended the class by looking at two bad reasons for paying dividends (that they are more certain, that you had a good year). As you wrap your head around buybacks and what they can and cannot do to companies, you may find the following post that I have on the topic useful (or not):
As you work through the past quizzes, here are a few things you may want to keep in mind:
A reminder again that your quiz will be available starting at 4 am, NY time and be accessible until 1.30 pm, NY time, and that you have an hour to finish the quiz. I wish you the best of luck! Until next time!
For those of you who were in class today, thank you. I know that having a full class following a quiz is tough and I appreciate your being there. In today’s session, we started by looking at one good reason for paying dividends, including having an investor base that likes dividends, one iffy reason (dividends as a signal) and one borderline reason (that you can rip of lenders). We then looked at three questions that need to be asked in assessing dividend policy, starting with how much a company can afford to return to stockholders (FCFE), then looking at how much is actually returned in dividends and buybacks and finally assessing whether you trust management enough to give them the freedom to set dividend policy. Next session, we will put this framework into practice by asking and answering these questions with the companies that we are examining in this class: Vale, Tata Motors and Baidu.
|4/29/21||In this email, I would like to focus on the project. As you look at the calendar, there is some bad news and some good news. The bad news is that you have three class sessions and two weekends left in the class. I know that you may be in a bit of a panic, but here is what needs to get done on the project. (I am going to start off from the end of section 5, since I have nagged you sufficiently about the steps through that one).
1. Optimal capital structure: You need to compute the optimal debt ratio for your company
1.1: Estimate the cost of capital at different debt ratios.
1.2: If you want to augment the analysis by using the APV approach (apv.xls), do so. Clearly, these approaches will add value only if you have a sense of how operating income will change as the ratings change for your company or the bankruptcy cost as a percent of firm value.
1.3: Assess how your firm's debt ratio compares to the sector. You can just compare the debt ratio for your firm to the average for the sector. If you feel up to it, you can try running a regression of debt ratios of firms in your sector against the fundamentals that drive debt ratio (Look at the entertainment sector regression I ran for Disney in the notes).
2. Debt design: As you work your way through or towards the debt design part, here are a few sundry thoughts to take away for the analysis:
2.1. The heart of debt design should be the intuitive analysis, where you look at what a typical project/investment is for your firm (perhaps in each business it is in) and design the most flexible debt you can, given the risk exposure.
2.2. The quantitative tools (the regression of firm value/ operating income versus macro variables) may or may not yield useful data. The bottom-up approach (using sector averages) offer more promise. If you have a non-US company, a US company with little history or get strange results, stick with just the intuitive approach. Use the spreadsheet at this link to do both:
Try it, but if your numbers look weird, just stick with the intuitive analysis and move on.
2.3: Compare the actual debt to your perfect debt (either from the intuitive approach or from the quantitative approach) and make a judgment on what your company should do.
3. Dividend analysis: We developed a framework for analyzing whether your company pays out too much or too little in dividends in class yesterday. You can read ahead to chapter 11, if you want, and use the spreadsheet at the link below to examine your company.
3.1: Examine whether your company has returned cash to its stockholders over the last few years (5-10 or whatever time your firm has been in existence) and if yes, in what form (dividends or stock buybacks). The information should be in your statement of cash flows.
You can watch the webcast I will be posting tomorrow, if you run into questions.
3.3: Make a judgment on whether your company should return more or less cash to its stockholders.
The next section has not been covered yet in class, but you can get a jump on it now, if you want.
4. Valuation: This is a corporate finance class, with valuation at the tail end. We will look at the basics of valuation next week and you will be valuing your company. Since we will not have done much on valuation, I will cut you some slack on the valuation. It provides a capstone to your project but I promise not to look to deeply into it. Knowing how nervous some of you are about doing a valuation, I have a process to ease the valuation: Download the fspreadsheet on my website. It is a one-spreadsheet-does-all and does everything but your laundry.
You will notice that the spreadsheet has some default assumptions built in (to prevent you from creating inconsistent assumptions). I let you change the defaults and feel free to do so, if you feel comfortable with the valuation process. If not, my suggestion is that you leave the inputs alone. You will notice that I ask you for a cost of capital in the input page. Since you already should have this number (see the output in the optimal capital structure on section 1), you can enter it. If you want to start from scratch, there is a cost of capital worksheet embedded in the valuation spreadsheet. There is a diagnostic section that points to some inputs that may be getting you into trouble. I also ask you for information on options outstanding to employees/managers. That information is usually available for US companies in the 10K. If you cannot find it, your company may not have an option issue. Move on. Finally, this version of the spreadsheet was built to allow for the fact that 2020 (most recent year of the analysis) was an extraordinary year for many companies, and that 2021 will also reflect that event (with bounce back growth for most firms). In the spreadsheet, you will notice inputs reflecting a very bad year, which should come as no surprise, since I am valuing Boeing. You can then revert back in 2022 to whatever optimistic story you might have about your company. Second, the equity risk premiums have all been updated to 2021 numbers (for the US and other countries). If you find yourself stuck or just want to watch a bad homemade movie, try this YouTube guide that I have to using the spreadsheet:
5. Google shared spreadsheet: As you get the numbers for your company, please enter them into the shared spreadsheet. In fact, to provide some inducement to do this, I will assign 5 points out of the 30 points on the final project to getting your numbers into the spreadsheet.
Please, please do this by Sunday, May 9, since I will need the numbers for the final session.
6. Project write-up and formatting: If you are thinking of the write-up for the project and formatting choices, you can look at some past group reports on my site (under the website for the class and project). Repeating a link that I gave you a couple of weeks ago:
I prefer brevity and I want to emphasize the page limit of 20 pages on the report (plus 2 pages for each additional company over 5), if you are doing it as a group. If you are doing this individually, you should be able to do your write up in 5 pages or less. As a general rule, steer away from explaining mechanics - how you unlevered or levered betas -and spend more time analyzing your output (why should your company have a high beta? And what do you make of their really high or low return on capital?).
Ah, where is the good news? You will be done with the project exactly 11 days from today. It is due by 5 pm on May 10.
By now, I hope that you have had a chance to check out the third quiz solutions, and there are two common mistakes that I noted:
As we work through the analysis of dividend policy, you have to look at the trade off on traditional dividends (and whether your company is a good candidate for paying dividends or increasing them). You have to follow up by assessing potential dividends and whether your company is returning more, less or just about the same amount as that potential dividends.
The first webcast looks at the trade off on dividends
The second webcast looks at the question, again using Intel:
Annual Report: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/IntelAnnualReport.pdf
Historical data: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/webcasts/dividends/IntelBloomberg.pdf
The spreadsheet that goes with these webcasts is an old one. So, use the updated version that I sent you yesterday which has data through 2020:
I hope you get a chance to take a look at the webcast.
The good news is that this is the last newsletter. The bad news is that this means the end is near. If you are working on your project this weekend, I hope that it is a productive one and at the risk of reminding you one times too many, please enter your numbers in the Google shared spreadsheet, when you have a chance.
Looking to the final exam, I know it is early, but here are a few reminders. The final exam will be on May 17 and as with the quizzes, it will be accessible for 12 hours. Since it is a 2-hour final, you will need to get started about two hours before the accessibility ends. It will be open book, open notes. If you are ready to reviewing past finals:
You can try past final exams and check the solutions here:
I will have more Zoom sessions next week, as we get closer to the final, I promise!
Attachment: Issue 13 (May 1)
I won’t risk asking you what you are doing this weekend because I may hit a nerve. This week, we will approach closure on the class, finishing the dividend section tomorrow and starting valuation right after. In parallel, I hope that you will be tying up loose ends on your project. I will have my regular office hours on Monday and Wednesday (11 am - 12 pm, NY time), and I will add two more office hours:
Wednesday, 7 pm - 8 pm, NY time: https://nyu.zoom.us/j/94870538854
Friday: 7 pm - 8 pm, NY time: https://nyu.zoom.us/j/99755679472
See you in class!
In today's class, we started by using the dividend assessment process of looking at FCFE/cash return and then gauging trust in management, using the companies that we have used as lab experiments in the class (Vale in 2013, Tata Motors in 2013) and peer group analysis. In the process, we looked at why it is so difficult to get out of a dysfunctional dividend policy, as control trumps sanity and worries about the short term and peer group comparable delay action.
We then started on valuation as the place where all of the pieces of corporate finance come together - the end game for your investment, financing and dividend decisions. We then looked at how these numbers can be different depending on whether you take an equity or firm perspective to valuation and what causes these numbers to change. Ultimately, though, the best way to learn valuation is by playing with the numbers and seeing how value changes. I did talk about the presence of uncertainty and how it affects how you approach the numbers and if you are interested, you may find my blog post relevant for that discussion:
Finally, I have a spreadsheet that is versatile enough to cover every company in this class. Please use it for your valuation:
If you need some guidance on using this spreadsheet, try this YouTube video that I put together last year:
This YouTube video was made last March for Boeing, when much of the debate for the near term (next year) was about how badly COVID would damage revenues and earnings. In May 2021, the debate has shifted to how much companies will benefit in the near term (next year) from the improvement in revenues and earnings that are going to come from recovery. But the structure of the spreadsheet is mostly intact. Many of the inputs that you need for this spreadsheet should have already have been estimated or looked up for other parts of the project. Also, as you enter the key numbers for revenue growth, target operating margin and sales/invested capital, think of the story that drives these numbers. I know that you may find this to be a bit of a black box at the moment, but given that time is of the essence, I thought it would not make sense for you to be building up your excel skills at the moment.
As your project winds down (or up), I am sure that there are loose ends from earlier sections that may bother you, I have listed a few of the questions that seem to be showing up repeatedly in emails:
1. Do I need to update my accounting numbers to reflect first quarter earnings reports?
The answer is complicated. I would like them to be, and it is easy to do, if you have kept your input numbers in a separate sheet. If you have hard coded numbers into spreadsheet, it will be really messy, and my advice is don’t do it. Pick a date for your macro numbers (risk free rate, equity risk premium etc.) and do your analysis as of that date. Move on!
1a. My company had a very odd (bad or good) year in 2020, because of COVID. Can I go back to 2019 or earlier to get my numbers?
If 2020 was an outlier for your company, as will almost certainly be the case if you are an airline, hotel or toilet paper company, you can look at 2019 numbers, but before you use those numbers as your base year numbers to compute ROIC or optimal debt ratios, you should ask yourself whether the company will go back to what it used to be, even if COVID fades tomorrow. In short, consumer behavior may have changed making it possible that your future looks much worse than your pre-COVID numbers (think Carnival Cruise Lines) or much better (Zoom).
1b. I just discovered that my company lists revenues from "other businesses". How should I treat these in bottom-up beta computations?
If your company tells you what the other businesses are, you can try to incorporate their betas into your bottom up beta. If all you have is a nebulous 'other businesses', I would ignore it in beta computations.
1c. I just discovered that my US company has revenues from other countries (including emerging markets) and in other currencies. How does this affect my cost of equity/debt/capital?
First, if you have chosen to do your analysis in a currency (say US dollars), your riskfree rate will be the riskfree rate in that currency (US treasury bond rate), even if the company has revenues in multiple currencies. Second, your cost of debt will still be that of a domestic company. Coca Cola will not have to pay an Indian country default spread when it borrows money in rupees. If it had to, it would just borrow in the US and use currency derivatives to manage risk. Third, and this is the only place it may make a difference, it may change the equity risk premium you use. Instead of using the mature market premium, you may decide to incorporate the additional risk of some of the countries that you operate in. Note that this is likely only if you know your revenue exposure in some detail and you get significant revenues from emerging market countries (with less than AAA ratings).
1d. What should I be doing with the cash balance that my company has when computing the unlevered beta?
Adjusting betas for cash creates more headaches and confusion than perhaps any other aspect of discount rates. Back up, though. To get the unlevered betas of the businesses that your company is in, you should always start with the average regression beta for the companies in the sector, unlever the betas using the average gross D/E ratio and then adjust for the average cash balance at these companies. (That will yield the unlevered betas corrected for cash for each of the businesses that your company is in).
Now, comes the tricky part. You can compute an unlevered beta for just the operating businesses that your company is in, by taking the weighted average of the unlevered betas of the businesses. You can also compute an unlevered beta for the entire company, with cash treated as an asset/business with a beta of zero. The latter will always be lower than the former. My suggestion is that you compute both.
If you are now computing a cost of equity as an input into the cost of capital, you want to use the unlevered beta of just the operating assets of the business as your starting point for levered beta and cost of equity. That is because the cost of capital is a discount rate that we apply to operating cash flows (and to value the operating assets). In fact, we add the current cash balance to this value, because cash has been kept separated from operating assets. (If you use the lower unlevered beta that you get with cash incorporated into the calculations to get to a cost of capital, you will end up at least partially double counting cash, once by lowering the beta and the cost of capital, and again when you add cash at the end).
When would you use the beta for the company (with the cash beta of zero incorporated into your calculation)? Rarely. Here is one scenario. Let's assume that you are looking at a discounting the dividends of a company or an overall cash flow that is estimated from net income. These cash flows reflect cash flows from all of the company's assets (not just its operating assets) and it is appropriate to use the lower company beta with the cash effect built in.
(If you find this too abstract, go back to lecture note packet 1 and check out pages 177 & 178, where I estimated Disney's beta and cost of capital)
2. My company already reports leases as debt. Should I capitalize leases?
No. You don’t have to, if you generally trust accountants. If you don’t, you can use the capitalization spreadsheet (assuming you have commitments for the future) and do it yourself, but don’t double count.
3. I have a negative book value of equity. How do I compute ROE and ROC?
First the book equity you should use for ROE and ROC should be the total shareholders equity, which can be a negative number. With a negative book value of equity, you cannot compute ROE. You should still be able to compute return on capital, since adding the book value of debt to negative book equity should still lead to a positive book capital. If book capital is negative, though, you cannot estimate return on capital either.
4. My ROE > Cost of equity and my ROC < Cost of capital (or vice versa). How is this possible and how do I explain it?
There are two reasons why the two measures may yield different conclusions:
1. The net income includes income/losses from non-operating assets including cross holdings in other companies. If you have cross holdings that are making you a lot of money, you can end up with a high ROE, even though ROC looks anemic. If you have cross holdings that are losing you money, the reverse can happen. Net income is also affected by other charges (restructuring, impairment etc.) and other income... I trust the ROC measure more when it comes to answering the question of whether the company takes good investments.
2. The ROE reflects the actual interest expense on debt. To the extent that you are borrowing money at rates lower than what you should be paying (given your default risk and pre-tax cost of debt), you are exploiting lenders and making equity investors better off. Thus, you can take bad projects with "cheap" debt and emerge successful as an equity investor. (Think of the LBOs done earlier this year.)
5. My Jensen's alpha is positive (negative) and my excess return is negative (positive). How do I reconcile these findings?
Market prices are based on expectations of how well or badly you will do in the future. To the extent that you beat or fail to meet these expectations, stock prices will rise or fall. Thus, if you are a company that is expected to earn a 30% ROC and you earn a 25% ROC, you will see your stock price go down (negative Jensen's alpha) even though you have a healthy positive EVA. Conversely, if you are a company that is expected to make only a 2% ROC and you make a 3% ROC, you will see your stock price go up (positive Jensen's alpha) while your EVA will be negative.
6. How do I come up with the cash flows and characteristics of a typical project?
I really do not expect you to come up with cash flows. Just describe in very general, intuitive terms what a typical project will look like for your company. For Boeing, for instance, you would describe a typical project in the aerospace business as being very long term, with a long initial period of negative cash flows (when you do R&D and set up manufacturing facilities) followed by an extended period of positive cash flows in multiple currencies.
7a. My optimal debt ratio is coming out to be zero. What am I doing wrong? The most common input error that can lead to an optimal debt ratio of zero is that you mismatched units (it is usually the share count that is in different units than the rest of your numbers). If there are no input errors, it is entirely possible that your optimal debt ratio is really zero. That can happen in three scenarios. The first is if your operating income is a low percentage of your enterprise value; for high growth firms, the market cap can be high relative to operating income, because of growth potential being priced in. Zoom, for instance, is a vibrant, fast growing company but its optimal debt ratio is zero percent. The second is if you have a very low unlevered beta, which can happen either because you are in a very safe business or because you are using a regression beta that does not reflect your current debt to equity ratio.
7b. The cost of capital is higher at my optimal debt ratio than at my current debt ratio. Why does that happen and what do I do?
Try the "FAQ" worksheet in the capital structure spreadsheet.
8. If my firm is already at its optimal debt ratio, do I still need to go through the debt design part?
Yes. You still have to determine whether the debt the company already has on it's books is of the right type. The only scenario where you can skip this is if both your actual and optimal debt ratios are zero percent.
9. I cannot do the macro regression (because my company has been listed only a short period or is non-US company). What do I do about debt design?
Skip the macro regression. You can still use the bottom up estimates for the sector in which your firm operates. To do this, you need an SIC code which your non-US company will not have. Look up a US competitor to your company and look up its SIC code. You can also still do the intuitive debt design. (I would do the same if you are getting absurd or meaningless results from your macro regression...)
10. My macro regression is giving me strange look output. What should I do?
Take a deep breath. The macro regression is run with 10 or 11 observations and you can get "weird" output because of outliers. That is why you should look at the bottom up estimates and bring in your views on what a typical project for a company looks like.
11. My company pays no dividends. Should I bother with dividend analysis section?
Yes. Paying no dividends is a dividend policy. You will have to estimate the FCFE to check to see if this policy makes sense. (If the FCFE <0, it does...)
12. I have a non-US company. How do I get market returns and riskfree rates for the dividend analysis section?
On this one, I am afraid that the fault is mine for not giving you a way to pull up the data on other markets. To compensate, I will be okay with you using the US data for non-US companies.
13. I am getting strange looking FCFE for my company... What's going on?
Check the signs of the numbers you are inputting into the spreadsheet. If you are entering cap ex as a negative number, for instance, I will flip the sign around and add cap ex instead of subtracting it out...
14. My value is very different from the price. What's wrong?
First, very different is in the eye of the beholder. i have valued companies and obtained values that are less than one fifth of the price and five times more than the price. The reason is sometimes in my inputs but it can also be a massively under or over priced stock. So. check your numbers and if you feel comfortable with them, let it go.
15. What do I have to do, when I feel comfortable with the numbers that I have?
Please enter the numbers you have for your company in the Google shared spreadsheet:
When you are entering the numbers, please follow the number format that I have used for Disney. For instance, for R squared, I list 73%, not 0.73 or 73, and if you can also enter your R squared the way I did, it would make my work on Sunday a lot easier, if you follow my formatting, since this Google shared spreadsheet becomes the raw data with which I work.
16. What should the final project report look like?
Please turn in one report for the whole group and save it as a pdf file (less chance of bad things happening to formatting than with Word or Powerpoint files). On the front page, please list all group members in alphabetical order (last name). Please do not attach or include any excel spreadsheets. In addition, make sure that you list all the group members alphabetically on the first page and use “The Torture Ends” in the subject line.
17. When will this torture end?
Six days from today (5 pm on May 10)... but the memories will last forever…
In today’s session, we continued on the question of how best to value a company by first looking at the four key components of value - cash flows from existing investments, growth in the future, discount rates and the terminal value. With cash flows, we noted the contrast between cash flows to equity and cash flows to the firm, with the former being after debt payments and the latter before. With discount rates, we argued that the same discount rates that we computed for investment hurdle rates can be used in valuation, with the caveat that these discount rates will change over time, as a company changes. While you can adjust betas, costs of debt and debt ratios, a simpler way to target a cost of capital in stable growth is to look at the median cost of capital for companies, in this graph.
These numbers are from January 2021 and collectively have increased by about 0.50% since, as the riskfree rate has risen and the equity risk premium has gone down. The median cost of capital for a global company now is about 6%, in US dollar terms. With growth, the key is recognition that growth comes from what companies do in terms on how much they reinvest and how well, rather than from outside sources. Finally, for terminal value, I argued that the growth rate in perpetuity has to be less than or equal to the risk free rate.
Since you will be valuing companies in different stages in the life cycle, with the COVID crisis throwing a wrench in the works, I would like you to use the spreadsheet linked below:
For assistance along the way, try this YouTube video:
I hope that your project numbers are getting nailed down. From the looks of the Google shared spreadsheet, we are taxiing towards takeoff and I thank you. I don’t plan to download the numbers (to prepare for the last class until Sunday. Please enter your numbers, if you have not already, by then. If you have entered the numbers and change your mind, you can go in and change your numbers before then.
As you work on the final pieces of the project (dividends and valuation), cut yourself some slack. This is a process that requires both sides of your brain (left and right) stay engaged, and it can be exhausting as well as stressful. One constant question that you may have, as you do your analysis, is “how do I know this is right?”. While there is an answer, when the question is purely mechanical (like computing last year’s FCFE), there is none, when you are making you are analyzing your company’s capacity to carry debt, pay dividends and be valued right. All you can do is use the information you have, make your best judgments about the company, develop your story for your company and then let the chips fall where they might. While I will contest you, when I think your story has internal inconsistencies, I am very accepting of stories that diverge from my own. None of us has a monopoly on the truth... Until next time!
I will keep this short.
1. Please give the valuation of your company a try, if you are done with the capital structure and dividend sections. As I mentioned in my email earlier this week, I understand that we have not spent much time on valuation and the spreadsheet that I sent you may seem like a black box, but if you look past the complexities, it is simply an attempt to convert what you know about your company into growth, profitability and reinvestment assumptions. The rest is just mechanics.
2. When you have the numbers, please enter them in the Google shared spreadsheet. I would like those numbers by Sunday, even though your project is not due until Monday at 5 pm, NY time. And I will keep my promise and add 5 points to your overall score, when you do submit.
I will check in on you tomorrow and day after, but your slides for the last class will not be available until next Monday (since it needs the data from the shared spreadsheet).
3. I was scheduled to have office hours today on Zoom from 7 pm- 8 pm, NY time. Unfortunately, Spectrum, my internet provider, has decided to do maintenance work in the neighborhood and had cut off service for the rest of the day. I am truly sorry to leave you stranded, but if you were planning to come to office hours to ask a question, could you send it by email instead?
I will not waste your time with a long email or another newsletter. You have enough on your plate already. The Google spreadsheet is starting to get populated and I thank you, but if you still have numbers to enter, here you go:
By now, the time for nagging is done. Three final notes:
1. If you have not entered the numbers into the Google shared spreadsheet, please do so.
2. If your project is ready for submission, please submit it as a group (with all the group members ccd) and make sure that you put “The Torture Ends” in the subject.
3. Once I have all the spreadsheet numbers, I will put together the closing presentation to you tomorrow morning and get it to you before class. If you can make it to class live, I would really appreciate seeing you there. It will be our last class and I will try to make it memorable.
I am sorry that I cut it this close, but your slides for today are available at
See you in a few minutes.
Again, thank you for sending me your summaries and helping me put together the presentation for today's class. If you were not able to make it to class, here is the link to the presentation:
In class today, we looked at the big picture of the class, using the project findings to illuminate each part from corporate governance to risk to investment analysis to capital structure, dividend policy and valuation. If you want to see the summary numbers for the entire class online, try this link:
As for the final, I will send you a detailed email tomorrow. For the moment, I will let you enjoy a few minutes of respite.
As you get ready for the final exam, here are some thoughts.
1. Preparation: Since the final exam covers the entire class, preparing for it can be intimidating, but here is the saving grace. The material is interlinked. Thus, preparing for the valuation part, requires you to review how you compute cash flows and cost of capital, which is from an earlier part of the class. I have a review we
You can try past final exams and check the solutions here:
2. Format: There will be ten multiple choice questions on the final, patterned on the questions you saw on the quiz. Each question is worth 3 points. If you are uncomfortable with the all or nothing feature of the multiple choice format, you can sign up for the open ended version by going to this Google shared spreadsheet:
3. CFEs: I don’t mean to be a nag, but please do complete your CFEs when you get a chance. The reason is purely selfish. If you don’t, you will not be able to check your grade, and if you cannot check your grade, I know exactly who you will be contacting. If you don’t know how to do them, here are the instructions:
Student Instructions for Completing Online Course Evaluations
|5/16/21||It must feel blessedly free not to be getting emails from me, but here is one of the last few. Your final exam will be accessible from 4 am - 8 pm, NY time, tomorrow (May 17). Please allow for two hours to finish the exam. I hope that the review and the past exams helped you get prepared.|
|5/17/21||I am sorry to disturb you on your final exam day, but starting in a few minutes, I will start grading and returning your projects. I will do so in the order that I received them, and will cc everyone on the reply. I am sorry that I could not get them back to you last week, but since my valuation exams (for the MBA and the undergraduate classes) were last Wednesday, I graded those first. The project grade will be out of 25, and the remaining 5 points will be credited to you for having entered your numbers into the Google shared spreadsheet.|
The grades are officially in and you should be able to check them online soon. On a more general note, I want to thank you for the incredible amount of work you put into this class. I know how difficult this semester was for many of you, and that you did not sign up for an online class, when you enrolled at Stern. I too would have vastly preferred to teaching you in person, and I never thought I would stay this, but I do miss Paulson Auditorium. I appreciate how many of you managed to join me live on my Zoom sessions, and wifi shakiness notwithstanding, you made it easier for me to teach.
I know that I buried you under emails (this is the 129th of the class), assignments, projects and weekly puzzles and I also know that most of you were unable to keep up. However, the material for the class will stay online and on iTunes U for the foreseeable future. If you want to review parts of the class, please do go back and review the lecture, look through the notes and even try that week's puzzle. If you really, really want to master corporate finance, don't waste too much time reading books & papers or listening to lectures. Pick another company (preferably as different as you can get from your project company) and take it through the project analysis. Each time you repeat this process, it will not only get easier and more intuitive, but you will always learn something new. I still do!
Finally, in return for reading all (many, most, some) of my emails this semester, I have something to offer in return. If you have a question in corporate finance, valuation or investments, where you think I can be of use, you are welcome to always reach out to me. Perhaps, you will come back to be tortured again next year in valuation! For the last time (at least for this class)!