Capital Structure (updated for January 2018)

In this session, we continued our discussion of cash flows, by first putting to rest some final issues on earnings, including the tax rate to use in computing after-tax cash flows and dealing with money losing companies. In the process, we did look at what to do about accounting fraud, and while the answer is not much, there may be a role for forensic accounting. To be honest, most forensic accounting books are designed for valuation morticians, but here are a couple that you may find useful:http://www.amazon.com/Financial-Shenanigans-Accounting-Gimmicks-Reports/dp/0071703071/ref=pd_sim_b_8http://www.amazon.com/Creative-Cash-Flow-Reporting-Sustainable/dp/0471469181/ref=pd_sim_b_2We then moved on to examine broad questions about what to include in capital expenditures and working capital, before putting the cash flow topic to rest by working out debt cash flows and cash flows to equity.Start of the class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/cftests2.pdfSlides: http://www.stern.nyu.edu/~adamodar/podcasts/valspr21/session8slides.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session8test.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session8soln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

In this session, we continue with our discussion of corporate governance by examining how lenders get exploited, markets have frictions and there are social costs. Learn more about your ad choices. Visit megaphone.fm/adchoices

In today’s class, we looked past regression betas at how the choices companies make about the businesses they enter can determine their betas.. Summarizing the class, here is what we listed as the three determinants of betas:1. Betas are determined in large part by the nature of your business. While I am not an expert on strategy, marketing or productions, decisions that you make in those disciplines can affect your beta. Thus, your decision to go for a price leader as opposed to a cost leader (I hope I am getting my erminology right) or build up a brand name has implications for your beta. As some of you probably realized today, the discussion about whether your product or service is discretionary is tied to the elasticity of its demand (an Econ 101 concept that turns out to have value)... Products and services with elastic demand should have higher betas than products with inelastic demand. And if you do get a chance, try to make that walk down Fifth Avenue...2. Your cost structure matters. The more fixed costs you have as a firm, the more sensitive your operating income becomes to changes in your revenues. To see why, consider two firms with very different cost structures Firm A Firm BRevenues 100 100- Fixed costs 90 0- Variable costs 0 90Operating income 10 10Consider what will happen if revenues rise 10%. The first firm will see its operating income increase to 20 (an increase of 100%) whereas the second firm will see its operating income go up to 11 (an increase of 10%)... that is why looking at percentage change in operating income/percentage change in revenues is a measure of operating leverage.3. Financial leverage: When you borrow money, you create a fixed cost (interest expenses) that makes your equity earnings more volatile. Thus, the equity beta in a safe business can be outlandishly high if has lots of debt. The levered beta equation we went through is a staple for this class and we will revisit it again and again. So, start getting comfortable with it. I know that this 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 and A on bottom up betas which highlights the estimation process and some of its pitfalls:http://www.stern.nyu.edu/~adamodar/New_Home_Page/TenQs/TenQsBottomupBetas.htmSlides: http://www.stern.nyu.edu/~adamodar/podcasts/cfspr21/session9slides.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session9test.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session9soln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

Having laid out all that can go wrong with stock price maximization, we looked at alternative corporate governance models and objectives. We then moved on to defining risk. (The slide version of this session is not working yet. So, I have uploaded the video version.. Tough to read the slides but you can get them by going to:Blog post on Petrobras (to start class): http://aswathdamodaran.blogspot.com/2015/02/how-low-can-you-go-doing-petrobras-limbo.htmlSlides: http://www.stern.nyu.edu/~adamodar/podcasts/cfspr15/cfsession4.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session4test.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session4soln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

n 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:http://www.stern.nyu.edu/~adamodar/pc/ratings.xlsxIt 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 and below) from the Federal Reserve website in St. Louis. https://fred.stlouisfed.org/categories/32348?t=corporate%3Byield&ob=pv&od=descLook 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.Slides: http://www.stern.nyu.edu/~adamodar/podcasts/cfspr21/session11slides.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session11test.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session11soln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

We continued our discussion of earnings and cash flows, starting with an examination of why accountants treat capital expenses as operating expenses (R and D is a prime example), and how to counter that effect We then dealt with some final issues on earnings, including the tax rate to use in computing after-tax cash flows and dealing with money losing companies. In the process, we did look at what to do about accounting fraud, and while the answer is not much, there may be a role for forensic accounting. We then moved on to examine broad questions about what to include in capital expenditures and working capital.Start of the class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/cftests2.pdfSlides: https://nyu.box.com/s/78d95svdz3v0rbkvm2457sxdex2j1viwPost class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session9Btest.pdfPost class solution: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session9Bsoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

In this class, we continued our discussion of stories, and how critical it is to keep the feedback loop open, so that you can make your stories better. We also talked about how story breaks, shifts and changes. Since I talked about dealing with new earnings reports, I thought you may find these two posts of interest in how narratives shift, and with them, values:Reacting to Earnings Reports: http://aswathdamodaran.blogspot.com/2014/08/reacting-to-earnings-reports-lets-get.htmlNarrative Resets: http://aswathdamodaran.blogspot.com/2015/08/narrative-resets-revisiting-tech-trio.html We started with two conventional valuations, one of Con Ed, another of 3M.Start of the class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/storytest.pdfSlides: http://www.stern.nyu.edu/~adamodar/podcasts/valspr21/session13slides.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session13aXtest.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session13aXsoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

In this session, we look at the standard approach to estimating betas, i.e., regressing returns on a stock against returns on market, and how that regression yields information about your company beyond just a risk measure.Slides: http://www.stern.nyu.edu/~adamodar/podcasts/cfspr15/cfsession7.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session7test.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session7soln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

In today’s class, we looked at how best to adapt valuation models to value companies on the dark side. Specifically, we examined how best to value young companies with limited information. If you are interested, try this paper on valuing young companies:https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1418687 I also mentioned a blog post that you may find relevant for today’s discussion on how dilution in future years is already incorporated into value:http://aswathdamodaran.blogspot.com/2018/07/share-count-confusion-dilution-employee.htmlStart of the class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/dcfvaltests.pdfSlides: http://www.stern.nyu.edu/~adamodar/podcasts/valspr21/session14slides.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session14Ctest.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session14Csoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

During today's session we finished the last loose ends in valuation and started on connecting stories to numbers. The way in which companies and equity research analysts treat stock based compensation is criminally negligent and I hope that you found this session useful in clarifying your thinking on the topic. We then started on how story telling is at the heart of valuation, and a five step process for connecting stories to numbers. If you want a longer version of my stories to numbers session, you may prefer this Google talk version that I did a few years ago on the same topic:https://www.youtube.com/watch?v=uH-ffKIgb38It is longer and in a little more detail.Start of the class test: https://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/looseends2.pdf Slides: https://pages.stern.nyu.edu/~adamodar/podcasts/valUGspr24/session14slides.pdfPost-class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session14aXtest.pdfPost-class test solution: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session14aXsoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices