Corporate Finance: Spring 2014

Aswath Damodaran

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Ponderous Thoughts, or maybe not

1. There are few facts and lots of opinions.a. Even the givens (cash & risk free rate) are notb. With accounting and market numbers, all bets are off.

2. The real world is a messy place.a. Money making firms can become money losersb. Companies can be restructured/ given facelifts

3. Models don’t compute values and optimal paths. You do.

4. Change is the only constant.

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The Breakdown in the Classical Objective Function

STOCKHOLDERS

Managers puttheir interestsabove stockholders

Have little controlover managers

BONDHOLDERSLend Money

Bondholders canget ripped off

FINANCIAL MARKETS

SOCIETYManagers

Delay badnews or provide misleadinginformation

Markets makemistakes andcan over react

Significant Social Costs

Some costs cannot betraced to firm

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I. Where does the power lie?

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II. Who is your marginal investor?From Spring 2013

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III. Risk Profiles and Costs of Equity

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Beta: The Standard Approach

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Regression Estimation Approaches

Typical reasons1. My company is unique. I cannot find comparable firms.2. My company is in only one line of business3. My bottom-up beta is too different from my regression beta

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Beta Distribution

  BetaAverage 1.09Median 1.07High 2.9Low 0.28

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Jensen’s Alpha Distribution

  AlphaAverage 16%Median 5%High 1310% Keurig Green MountainLow -379% AMD

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R Squared

  R squaredAverage 33%Median 20%High 69% Intuitive SurgicalLow 0% Many

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Cost of Capital

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Distribution of Current Market Value Debt Ratios

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IV. The Quality of Investments: The Firm View

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Return Spreads

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VI. The Optimal Financing Mix

 Optimal debt ratio

Average 31.26%Median 30.00%High 90.00% Samsung, HP, Darden, ConocoLow 0.00% 17 firms

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Under versus Over Levered Firms

  Under or over levered  Average -10.49%  Median -7.33%  Low -67.86% SamsungHigh 27.00% Shutterfly

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VIII. The Right Kind of Financing

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IX. Measuring Potential Dividends

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Dividends versus FCFE

  FCFE/Dividends

Average 66.65%

Median 12.49%

Low 0.E+0

High 2164.00%

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X. Valuation: Match up cashflows and discount rates…

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Getting to equity value per share

Approach used To get to equity value per share

Discount dividends per share at the cost of equity

Present value is value of equity per share

Discount aggregate FCFE at the cost of equity

Present value is value of aggregate equity. Subtract the value of equity options given to managers and divide by number of shares.

Discount aggregate FCFF at the cost of capital

PV = Value of operating assets+ Cash & Near Cash investments+ Value of minority cross holdings-Debt outstanding= Value of equity-Value of equity options =Value of equity in common stock/ Number of shares

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Value versus Price

 Under or over valuation

Average 56.88%Median 21.44%Low 0.000High 1578.26%

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Ways of changing value…

Aswath Damodaran25

Aswath Damodaran26

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So, how do you explain the price? Its all relative..

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Most undervalued stocks!!

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The Triple Whammy: Underlevered, Cash Build-up and Under valued?

Company PowerJensen's Alpha

ROC - WACC

Current Debt ratio

Optimal Debt Ratio Dividends FCFE Value/share Price/Share

AGCO 1 -8.58% 5.85% 22.36% 50.00% 57.5 241.6 $166.41 $55.15 AMCX 1 6.08% 15.42% 31.10% 80% 0 $29,584.00 $(7.34) $58.00 Apple 1 77.00% 54.23% 3.79% 80.00% 35912 120184 $720.97 $585.54 Apple 1 26.20% 22.61% 3.35% 70.00% 27172 48729 $1,293.71 $592.58 Chevron 0 -0.50% 6.51% 7.63% 60.00% 9532 9537.14 $148.94 $118.91 CISCO 1 -0.80% 2.27% 11.81% 50.00% 3310.00 5458.00 26.73 23.03Coca-Cola 0 -5.25% 0.58% 16.60% 30.00% 21732 54026 $40.91 $31.80 eBay 0 5.10% 1.41% 6.18% 40.00% 0 2036 $61.11 $50.54 Express 0 -9.77% 7.78% 49.43% 80.00% 0 70.98 $17.68 $14.62 Express, Inc. 1 -9.77% 7.78% 49.43% 80.00% 32.97 111.02 $17.68 $14.62 Francesca's 1 2.10% 16.86% 22.29% 40.00% $18,291 $73,592 $27.69 $16.27 FujiFilm Holdings Corporation 0 -0.04% -1.27% 24.13% 50.00% 40 2,681,154 $4,956.22 $2,570.00 Google 0 0.06% 20.13% 2.29% 20.00% 801 30809 $589.56 $518.73 Gran Tierra Energy 1 3.44% -1.00% 7.80% 30.00% 0 136.7 $9.28 $7.25 HP 1 -0.19% 5.74% 27.40% 50.00% $900.20 $9,644.40 $35.88 $32.23 Intel 0 -6.40% 6.26% 9.73% 50.00% 3913 5744 $37.51 $26.30 Intuitive Surgical 1 -10.21% 15.31% 0.14% 20.00% 2027.9 2152 $487.66 $363.50 LVMH 0 1.16% 4.94% 15.97% 50.00% 1242 € 6,143.60 € 176.46 € 140.10 Michael Kors 0 33.02% 98.12% 3.06% 40.00% 0 $397.60 116.25 91.82Michael Kors 0 33.02% 98.12% 3.06% 40.00% 0 $397.60 116.25 91.82Newmont Mining 1 -7.80% 5.11% 35.70% 50.00% $448 1999 $51.73 $24.02 NOV 0 17.00% 1.63% 16.60% 50.00% 203 249.29 $91.77 $77.87 Qualcomm 1 -2.98% 54.62% 0.25% 40.00% 1450.8 5790.2 $88.81 $79.50 Samsung 0 1.43% 9.73% 5.38% 90.00% $1,226.14 $11,231.18 $2,475,433.50 $1,350,000.00 Schlumberger 0 -0.10% 2.85% 9.80% 50% $15,169.00 $29,784.00 $99.91 $69.10 Tyson Foods, Inc 1 22.84% 8.81% 18.43% 70.00% 304 3708 $49.89 $38.44 Tyson Foods, Inc 1 22.84% 8.81% 18.43% 70.00% 304 3708 $49.89 $38.44 Verizon 1 -0.2517 8.30% 34.08% 60.00% 5936 18918 $55.08 $47.60 Verizon 1   11.46% 39.74% 60.00% 51031 71987 $78.27 $48.49 Viacom 0 1.11% 10.25% 26.01% 50.00% 509 3703 $101.64 $83.64 World Fuel Services 2 32.30% 2.60% 16.76% 50% 17.32 87.12 $49.96 $43.17 ZuoAn 0 -31.14% 20.92% 12.14% 80.00% 0 $90 $6.82 $1.70 ZuoAn 0 -31.14% 20.92% 12.14% 80.00% 0 $90 $6.82 $1.70

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First Principles

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Objectives of this class

If you get the big picture, the details will come (sooner or later)

Tools are useful but only in the larger context of answering bigger questions.

Corporate finance is not so bad !!!

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And don’t forget your CFEs…

1. This course was mentally challenging/intellectually stimulating.1 2 3 4 5 6 7

No-brainer! Brilliant insights!

2. This course was demanding of my time.1 2 3 4 5 6 7

What work? Haven’t slept all semester.

3. This course provided me with tools and information that I will find useful in the future .

1 2 3 4 5 6 7

Only in prison Completely relevant

4. Overall evaluation of the course1 2 3 4 5 6 7

Horrible! ( I want my money back) Stupendous!

5. The instructor was organized and well prepared for class.1 2 3 4 5 6 7

Had trouble finding classroom Scarily efficient!

6. The instructor communicated his/her ideas and material well.1 2 3 4 5 6 7

Garbled gobbledygook! Should have own TV show

7. The instructor was enthusiastic about his/her subject matter.1 2 3 4 5 6 7

Dead man talking! I am a convert

8. Overall evaluation of the instructor 2 3 4 5 6 7

Dog! Star!