Beruflich Dokumente
Kultur Dokumente
THREE PRINCIPLES
Investment Principle
Only invest in projects which can give returns beyond hurdle rate
Hurdle rate should be higher for high risk investments
hurdle rate will also depend on type of capital
ROI should be based on cash flows and not on earnings - better if earlier
Financing Principle
Find a mix of debt and equity that maximizes value and minimizes hurdle rate
Match debt to type of asset and currency of investment
Dividend Principle
If no appropriate investments are available, return cash to owners
Riskfree rate
Riskfree rate should be in the same currency as the cashflows
Use 10 year treasury bond rates of AAA rated countries directly
For countries where governments are not AAA rated, check their rating and estimate the associated default spread from Mood
For example, in Nov 2013, the Indian government's rupee bond rate was 8.82%. The local surrency rating at Moody's was BAA3
Getting a default spread
1. If the local govt. has a Dollar bond, then subtract the US rate from the local govt; rate
2. CDS market spread for a country
3. If 1 and 2 not available, use sovereign rating of a country to estimate what would be the typical spread for that rating
If local currency riskfree rate is not available, do the entire analysis is another currency. Will require an expected exchange rate
TIBS rate - Real riskfree rate (adjusted for inflation)
Risk Premium
Premium that investors demand on an average risk investment
Beta
Betas are weighted averages
Beta company = Beta cash x % cash of firm value + Beta business (1-%cash of firm value). Beta cash is 0
Beta business is the Beta of operating assets
Regression Beta
Regression of stock and market gives beta. It is the slope of the line
Time interval - Don't go too far back as companies change with time - usually 2 to 5 years
Interval of return (daily, weekly monthly) - use weekly or monthly
Return - (Price end - Preice beginning + Divident period)/ Price beginning
Index should be wide eg. S&P 500
Calculate returns on index in similar way
The regression standard error gives the range of Beta
Also, Betas can be different based on the index that is used. Hence, this estimate is noisy and hence cannot completely trusted
Bottom up Betas
Average regression betas of all publicly traded companies in the industry. Use median if there are outliers.
Unlever the beta to get the average company Beta and remove the effect of cash to get the Beta for the business. Eg. Beta busi
Find weighted beta for all the businesses of the firm
Unlever the beta and lever up with the firm's D/E ratio
Weights can be by revenue. Better if by value. Eg. Use comparable companies' sales by EV and own company's sales to get EV
For a firm in multiple businesses, instead of assuming D/E to be the same for all businesses, allocate the debt based on the we
Calculate separate Betas and cost of equity for each business. Use the Beta for the business to evaluate investments and not th
Else, the safer businesses will subsidise the riskier ones. Hence, multi-business companies should always use different Betas fo
Betas can be across countries
Sample size should be large
Cost of Equity in Brazil = (1+ Cost of Equity in US) x [(1+Inflation estimate in Brazil)/(1+ Inflation estimate in US)] - 1
For private businesses, use average D/E ratios of comparable companies
The beta is calculated for marginal investor. The investor is diversified and hence is only exposed to market risk and not to firm
For private businesses, the cost of equity underestimates the risk as the owner is not diversified
Divide Beta by root of average R squared of the comparable companies to get the Total Beta and use it t o calculate rate of equ
Debt
Commitment to make payments in the future - contractual obligation
Failure to make payments leads to loss of control
Interest is non-deductible
All interest bearing liabilities - loans and bonds - come under debt. Lease commitments are also commitments and hence can b
Cost of debt is the rate at which the firm can borrow money long term today
Cost of debt = Risk free rate + default spread. Use the bond ratings to estimate default spread. Both should be in same currenc
For emerging market companies, also add the country risk unless the risk free rate incorporates that
Cost of Debt in INR = (1+ Cost of debt in USD) x (1+Expected inflation in INR)/(1+Expected inflation in USD) - 1
If bond rating is not available, use interest coverage ratio to estimate rating.
This gives the pre tax cost of debt.
Use the marginal tax rate to get the after tax cost of debt = pre-tax cost of debt (1-marginal tax rate)
Market value of debt
Treat all the debt as a bond with face value equal to total debt and interest payments based on last year's interest and maturity
Hurdle Rate
Use Cost of capital or cost of equity based on whether the cash flows are to firm or equity holders
Currency Adjustment
To do analysis in another currency, convert Dollar cashflows to local currency
Use current exchange rate for Year 0. For subsequent years use the multiply by (1+Inflation in local)/(1+ inflation in USD) to adj
At the same time, discount rate will change.
NPV in local currency will be same as product of current exchange rate and NPV in USD
venue share.
rate of dividends)
rate to get the risk premium.
sh flows for for few years and then terminal value to find the rate of return
are outliers.
ta for the business. Eg. Beta business = Beta company/(1-median cash % of Firm value of comparables)
own company's sales to get EV of business. Do this for each business and use the EVs to weight the Betas)
ocate the debt based on the weight of identifiable assets
evaluate investments and not the Beta for the company.
uld always use different Betas for different businesses.
n estimate in US)] - 1
ed to market risk and not to firm specific risks. However, this is not true for private businesses.
tion in USD) - 1
n last year's interest and maturity at weighted average maturity of the debt
Companies in early stage should have low debt as almost all earnings need to be reinvested and the growth lies in the future.
Matured companies with steady earnings with low re-investment needs take debt
If there is no tax, no bankruptcy cost and no agency cost, then debt or equity is irrelevant - Miller Modiglani
Financing Mix
t like risky projects and prefer companies which have tangible assets.
ler Modiglani