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AswathDamodaran
Aswath Damodaran
First Principles
Investinprojectsthatyieldareturngreaterthantheminimumacceptable
hurdlerate.
Thehurdlerateshouldbehigherforriskierprojectsandreflectthefinancingmix
usedownersfunds(equity)orborrowedmoney(debt)
Returnsonprojectsshouldbemeasuredbasedoncashflowsgeneratedandthe
timingofthesecashflows;theyshouldalsoconsiderbothpositiveandnegative
sideeffectsoftheseprojects.
Chooseafinancingmixthatminimizesthehurdlerateandmatchestheassets
beingfinanced.
Iftherearenotenoughinvestmentsthatearnthehurdlerate,returnthecashto
stockholders.
Theformofreturnsdividendsandstockbuybackswilldependuponthe
stockholderscharacteristics.
Objective:MaximizetheValueoftheFirm
Aswath Damodaran
where,
n=Lifeoftheasset
CFt=Cashflowinperiodt
r=Discountratereflectingtheriskinessoftheestimatedcashflows
Aswath Damodaran
Equity Valuation
Thevalueofequityisobtainedbydiscountingexpectedcashflowsto
equity,i.e.,theresidualcashflowsaftermeetingallexpenses,tax
obligationsandinterestandprincipalpayments,atthecostofequity,
i.e.,therateofreturnrequiredbyequityinvestorsinthefirm.
t=n
CFtoEquity t
(1+ k e )t
t=1
ValueofEquity =
where,
CFtoEquityt=ExpectedCashflowtoEquityinperiodt
ke=CostofEquity
Thedividenddiscountmodelisaspecializedcaseofequityvaluation,
andthevalueofastockisthepresentvalueofexpectedfuturedividends.
Aswath Damodaran
Firm Valuation
Thevalueofthefirmisobtainedbydiscountingexpectedcashflows
tothefirm,i.e.,theresidualcashflowsaftermeetingalloperating
expensesandtaxes,butpriortodebtpayments,attheweighted
averagecostofcapital,whichisthecostofthedifferentcomponents
offinancingusedbythefirm,weightedbytheirmarketvalue
proportions.
t=n
CFtoFirm t
t
t=1 (1+ WACC)
ValueofFirm =
where,
CFtoFirmt=ExpectedCashflowtoFirminperiodt
WACC=WeightedAverageCostofCapital
Aswath Damodaran
Aswath Damodaran
VALUATION
Estimating Inputs:
I. Discount Rates
Criticalingredientindiscountedcashflowvaluation.Errorsin
estimatingthediscountrateormismatchingcashflowsanddiscount
ratescanleadtoseriouserrorsinvaluation.
Atanintutivelevel,thediscountrateusedshouldbeconsistentwith
boththeriskinessandthetypeofcashflowbeingdiscounted.
Thecostofequityistherateatwhichwediscountcashflowsto
equity(dividendsorfreecashflowstoequity).Thecostofcapitalis
therateatwhichwediscountfreecashflowstothefirm.
Aswath Damodaran
or to
Cost
Has
Preferably,
Historical
ImpliedPremium
ofbe
Equity
Premium
ina the
bottom-up
= same
Riskfree
beta, Rate
+
Beta *
currency
based
1.
Basedonhowequity
Mature
upon
as
Equity
cash
otherMarket
flows,
firms inPremium:
the
and defined
business,
Average
marketispricedtoday
premium
and
in firms
same
earned
own
terms
financial
by
(real orover
leverage
stocks
andasimplevaluation
nominal)
T.Bonds
as the
in U.S.
cash
2.
model
Country
flows risk premium =
Country Default Spread* ( Equity/ Countrybond)
Aswath Damodaran
(Risk Premium)
Aswath Damodaran
Cost of Borrowing
(1-t)
(Debt/(Debt + Equity))
Beta(Bottomup)
CostofEquity
Equity/(Debt+Equity)
Rating
AftertaxCostofDebt
Debt/(Debt+Equity)
CostofCapital
Aswath Damodaran
Boeing
1.01
10.58%
79.91%
AA
3.58%
20.09%
9.17%
TheHomeDepot
0.87
9.78%
95.45%
A+
3.77%
4.55%
9.51%
InfoSoft
1.49
13.19%
93.38%
A
3.48%
6.62%
12.55%
10
Aswath Damodaran
11
Thefirstadjustmentisforfinancingexpensesthataccountantstreatas
operatingexpenses.Themostsignificantexampleisoperatingleases.
The second adjustment is the treatment of some capital expenditures
as operating expenses. Here, the most dramatic example is the
treatmentofresearchanddevelopmentexpenses.
The third adjustment is to correct for the incidence of onetime or
irregularincomeandexpenses.Anyexpense(orincome)thatistrulya
onetimeexpense(orincome)shouldberemovedfromtheoperating
incomeandshouldnotbeusedinforecastingfutureoperatingincome.
Aswath Damodaran
12
Aswath Damodaran
Home
Depot
$2,661
$0
$0
$0
$154
$2,815
InfoSoft
$2,000
$0
$4,000
$2,367
$
$3,633
13
Thechoiceisbetweentheeffectiveandthemarginaltaxrate.Indoing
projections,itisfarsafertousethemarginaltaxratesincethe
effectivetaxrateisreallyareflectionofthedifferencebetweenthe
accountingandthetaxbooks.
Byusingthemarginaltaxrate,wetendtounderstatetheaftertax
operatingincomeintheearlieryears,buttheaftertaxtaxoperating
incomeismoreaccurateinlateryears
Ifyouchoosetousetheeffectivetaxrate,adjustthetaxratetowards
themarginaltaxrateovertime.
Aswath Damodaran
14
HomeDepot
2654
1040
39.19%
38.78%
35%
InfoSoft
1685
707.7
42.00%
42%
42%
Wewillusethe35%taxratetovalueBoeingandtheHomeDepotand
42%forInfoSoft.
Aswath Damodaran
15
Researchanddevelopmentexpenses,oncetheyhavebeenre
categorizedascapitalexpenses.Theadjustedcapexwillbe
AdjustedNetCapitalExpenditures=NetCapitalExpenditures+Current
yearsR&DexpensesAmortizationofResearchAsset
Acquisitionsofotherfirms,sincethesearelikecapitalexpenditures.
Theadjustedcapexwillbe
AdjustedNetCapEx=NetCapitalExpenditures+Acquisitionsofother
firmsAmortizationofsuchacquisitions
Twocaveats:
1.Mostfirmsdonotdoacquisitionseveryyear.Hence,anormalized
measureofacquisitions(lookingatanaverageovertime)shouldbeused
2.Thebestplacetofindacquisitionsisinthestatementofcashflows,
usuallycategorizedunderotherinvestmentactivities
Aswath Damodaran
16
CapitalExpenditures
R&D
Boeing
$1,584
$1,895
TheHomeDepot
$2,059
$0
InfoSoft
$2,000
$4,000
Depreciation
AmortizationofR&D
$1,517
$1,382
$373
$0
$1,000
$2,367
NetCapExw/oR&D
NetCapExwithR&D
$67
$580
$1,686
$1,686
$1,000
$2,633
Aswath Damodaran
17
Inaccountingterms,theworkingcapitalisthedifferencebetweencurrent
assets(inventory,cashandaccountsreceivable)andcurrentliabilities
(accountspayables,shorttermdebtanddebtduewithinthenextyear)
Acleanerdefinitionofworkingcapitalfromacashflowperspectiveisthe
differencebetweennoncashcurrentassets(inventoryandaccounts
receivable)andnondebtcurrentliabilities(accountspayable)
Anyinvestmentinthismeasureofworkingcapitaltiesupcash.
Therefore,anyincreases(decreases)inworkingcapitalwillreduce
(increase)cashflowsinthatperiod.
Whenforecastingfuturegrowth,itisimportanttoforecasttheeffectsof
suchgrowthonworkingcapitalneeds,andbuildingtheseeffectsintothe
cashflows.
Aswath Damodaran
18
Aswath Damodaran
TheHomeDepot
$56,154 30219
$1,360 2028
$667
$190
2.42% 6.71%
4.12% 7.08%
18.95% 12.30%
InfoSoft
20000
2000
$500
10.00%
NA
18.00%
19
Aswath Damodaran
20
Whenyoucannotestimatethefreecashfllowstoequityorthefirm,
theonlycashflowthatyoucandiscountisdividends.Forfinancial
servicefirms,itisdifficulttoestimatefreecashflows.ForDeutsche
Bank,wewillbediscountingdividends.
Ifafirmsdebtratioisnotexpectedtochangeovertime,thefreecash
flowstoequitycanbediscountedtoyieldthevalueofequity.For
Aracruz,wewilldiscountfreecashflowstoequity.
Ifafirmsdebtratiomightchangeovertime,freecashflowstoequity
becomecumbersometoestimate.Here,wewoulddiscountfreecash
flowstothefirm.ForDisney,wewilldiscountthefreecashflowto
thefirm.
Aswath Damodaran
21
Aswath Damodaran
22
gEPS =RetainedEarningst1/NIt1*ROE
=RetentionRatio*ROE
=b*ROE
Proposition 1: The expected growth rate in earnings for a company
cannotexceeditsreturnonequityinthelongterm.
Aswath Damodaran
23
ReinvestmentRateandReturnonCapital
gEBIT =(NetCapitalExpenditures+ChangeinWC)/EBIT(1t)*
ROC
=ReinvestmentRate*ROC
Proposition2:Nofirmcanexpectitsoperatingincometogrowover
timewithoutreinvestingsomeoftheoperatingincomeinnetcapital
expendituresand/orworkingcapital.
Proposition3:Thenetcapitalexpenditureneedsofafirm,foragiven
growthrate,shouldbeinverselyproportionaltothequalityofits
investments.
Aswath Damodaran
24
NetCapEx
ChangeinNonCashWC
TotalReinvestment
Boeing
$580
$667
$1,247
TheHomeDepot
$1,686
$190
$1,876
InfoSoft
$2,633
$500
$3,133
EBIT(1t)
ReinvestmentRate
$1,651
75.52%
$1,830
102.53%
$2,793
112.17%
Average:199498
IndustryAverage
65.98%
55.48%
131.85%
88.62%
NA
73.12%
Aswath Damodaran
25
AdjustedEBIT(1t)
AdjustedBVofcapital
ROC
Boeing
$1,651
$28,957
5.70%
AverageROC:19941998 6.59%
IndustryaverageROC
15.07%
Aswath Damodaran
TheHomeDepot
$1,830
$11,173
16.38%
InfoSoft
$2,793
$11800
23.67%
15.12%
14.10%
NA
17.20%
26
ReturnonCapital
ReinvestmentRate
ExpectedGrowthRate
Boeing
6.59%
65.98%
4.35%
TheHomeDepot
16.38%
88.62%
14.51%
InfoSoft
23.67%
112.17%
26.55%
Boeing:Usedaveragereturnoncapitalandreinvestmentrateoverlast5
years
TheHomeDepot:UsedcurrentreturnoncapitalandIndustryaverage
reinvestmentrate
InfoSoft:Usedcurrentreturnoncapitalandreinvestmentrate
Aswath Damodaran
27
Estimatethefollowing:
Thereinvestmentrateforyourfirm
Theaftertaxreturnoncapital
Theexpectedgrowthinoperatingincome,basedupontheseinputs
Aswath Damodaran
28
Apubliclytradedfirmpotentiallyhasaninfinitelife.Thevalueis
thereforethepresentvalueofcashflowsforever.
t = CFt
Value =
t
t = 1 (1+ r)
Sincewecannotestimatecashflowsforever,weestimatecashflows
foragrowthperiodandthenestimateaterminalvalue,tocapture
thevalueattheendoftheperiod:
CF
t
Value =
t
(1 + r)
Aswath Damodaran
29
Whenafirmscashflowsgrowataconstantrateforever,thepresent
valueofthosecashflowscanbewrittenas:
Value=ExpectedCashFlowNextPeriod/(rg)
where,
r=Discountrate(CostofEquityorCostofCapital)
g=Expectedgrowthrate
Thisconstantgrowthrateiscalledastablegrowthrateandcannotbe
higherthanthegrowthrateoftheeconomyinwhichthefirmoperates.
Whilecompaniescanmaintainhighgrowthratesforextendedperiods,
theywillallapproachstablegrowthatsomepointintime.
Whentheydoapproachstablegrowth,thevaluationformulaabovecan
beusedtoestimatetheterminalvalueofallcashflowsbeyond.
Aswath Damodaran
30
Growth Patterns
Akeyassumptioninalldiscountedcashflowmodelsistheperiodof
highgrowth,andthepatternofgrowthduringthatperiod.Ingeneral,
wecanmakeoneofthreeassumptions:
thereisnohighgrowth,inwhichcasethefirmisalreadyinstablegrowth
therewillbehighgrowthforaperiod,attheendofwhichthegrowthrate
willdroptothestablegrowthrate(2stage)
therewillbehighgrowthforaperiod,attheendofwhichthegrowthrate
willdeclinegraduallytoastablegrowthrate(3stage)
Aswath Damodaran
31
Sizeofthefirm
Successusuallymakesafirmlarger.Asfirmsbecomelarger,itbecomes
muchmoredifficultforthemtomaintainhighgrowthrates
Currentgrowthrate
Whilepastgrowthisnotalwaysareliableindicatoroffuturegrowth,thereis
acorrelationbetweencurrentgrowthandfuturegrowth.Thus,afirmgrowing
at30%currentlyprobablyhashighergrowthandalongerexpectedgrowth
periodthanonegrowing10%ayearnow.
Barrierstoentryanddifferentialadvantages
Ultimately,highgrowthcomesfromhighprojectreturns,which,inturn,
comesfrombarrierstoentryanddifferentialadvantages.
Thequestionofhowlonggrowthwilllastandhowhighitwillbecan
thereforebeframedasaquestionaboutwhatthebarrierstoentryare,how
longtheywillstayupandhowstrongtheywillremain.
Aswath Damodaran
32
Boeing
TheHomeDepot
InfoSoft
Firmhasthedominantmarket
Firmhasdominantmarketshare
Firmisasmallfirminamarket
shareofaslowgrowingmarket
ofdomesticmarket,butis
thatisexperiencingsignificant
enteringnewbusinessesandnew
growth.
markets(overseas)
CurrentExcessReturns
Firmisearninglessthanitscost
Firmisearningsubstantially
Firmisearningsignificant
ofcapital,andhasdonesofor
morethanitscostofcapital.
excessreturns.
Hugecapitalrequirementsand
Significanteconomiesofscale
Hasbothagoodproductand
technologicalbarrierstonew
areusedtoestablishcost
goodsoftwareengineers.
entrants.Managementrecord
advantagesoverrivals.Hasa
Competitiveadvantageislikely
overthelastfewyearshasbeen
managementteamthatisfocused tobelimited,sinceemployees
poor.
ongrowthandefficiency.
last5years
CompetitiveAdvantages
canbehiredaway,and
competitorsareextremely
aggressive.
LengthofHighGrowth
10years,entirelybecauseof
period
competitiveadvantagesand
barrierstoentry.
economiesofscale.
ofthismarketandthelackof
barrierstocompetitionmakeus
conservativeonourestimate.
Aswath Damodaran
33
Aswath Damodaran
HighGrowthFirmstendto
beaboveaveragerisk
paylittleornodividends
havehighnetcapex
earnhighROC(excessreturn)
havelittleornodebt
StableGrowthFirmstendto
beaveragerisk
payhighdividends
havelownetcapex
earnROCclosertoWACC
higherleverage
34
Startwiththefundamentals:
Profitabilitymeasuressuchasreturnonequityandcapital,instable
growth,canbeestimatedbylookingat
industryaveragesforthesemeasure,inwhichcaseweassumethatthisfirmin
stablegrowthwilllookliketheaveragefirmintheindustry
costofequityandcapital,inwhichcaseweassumethatthefirmwillstop
earningexcessreturnsonitsprojectsasaresultofcompetition.
Leverageisatoughercall.Whileindustryaveragescanbeusedhereas
well,itdependsuponhowentrenchedcurrentmanagementisandwhether
theyarestubbornabouttheirpolicyonleverage(Iftheyare,usecurrent
leverage;iftheyarenot;useindustryaverages)
Usetherelationshipbetweengrowthandfundamentalstoestimate
payoutandnetcapitalexpenditures.
Aswath Damodaran
35
Beta
Cost of Equity
After-tax Cost of Debt
Debt Ratio
Cost of Capital
Aswath Damodaran
Boeing
The Home Depot
InfoSoft
High Growth Stable Growth High Growth Stable Growth High Growth Stable Growth
1.014
1
0.869
0.869
1.489
1.2
10.58%
10.50%
9.78%
9.78%
13.19%
11.60%
3.58%
3.58%
3.77%
3.58%
3.48%
3.48%
20.09%
30.00%
4.55%
30.00%
6.62%
6.62%
9.17%
8.42%
9.51%
7.92%
12.55%
11.06%
36
ReinvestmentRateforBoeinginStableGrowth=5/8.42=59.36%
Inotherwords,
thenetcapitalexpendituresandworkingcapitalinvestmenteachyear
duringthestablegrowthperiodwillbe59.36%ofaftertaxoperating
income.
Aswath Damodaran
37
Return on Capital
Reinvestment Rate
Expected Growth Rate
Aswath Damodaran
Boeing
The Home Depot
InfoSoft
High Growth Stable Growth High Growth Stable Growth High Growth Stable Growth
6.59%
8.42%
16.38%
14.10%
23.67%
17.20%
65.98%
59.35%
88.62%
35.46%
112.17%
29.07%
4.35%
5.00%
14.51%
5.00%
26.55%
5.00%
38
Thesimplestandmostdirectwayofdealingwithcashandmarketable
securitiesistokeepitoutofthevaluationthecashflowsshouldbe
beforeinterestincomefromcashandsecurities,andthediscountrate
shouldnotbecontaminatedbytheinclusionofcash.(Usebetasofthe
operatingassetsalonetoestimatethecostofequity).
Oncethefirmhasbeenvalued,addbackthevalueofcashand
marketablesecurities.
Ifyouhaveaparticularlyincompetentmanagement,withahistoryof
overpayingonacquisitions,marketsmaydiscountthevalueofthiscash.
Aswath Damodaran
39
TheHomeDepot
$62
$0
$0
$0
$62
InfoSoft
$100
$400
$0
$0
$500
Boeinghasanoverfundedpensionplan.Weconsideredonly50%ofthe
overfunding,sincethefirmwillhavetopayataxof50%ifitdecides
towithdrawthefunds.
Aswath Damodaran
40
Implicitly,weareassumingherethatthemarketwillvaluecashat
facevalue.Assumenowthatyouarebuyingafirmwhoseonlyasset
ismarketablesecuritiesworth$100million.Canyoueverconsidera
scenariowhereyouwouldnotbewillingtopay$100millionforthis
firm?
Yes
No
Whatisorarethescenario(s)?
Aswath Damodaran
41
Holdingsinotherfirmscanbecategorizedinto
Minoritypassiveholdings,inwhichcaseonlythedividendfromthe
holdingsisshowninthebalancesheet
Minorityactiveholdings,inwhichcasetheshareofequityincomeis
shownintheincomestatements
Majorityactiveholdings,inwhichcasethefinancialstatementsare
consolidated.
Aswath Damodaran
42
Valuing
Equity
Notconsolidated
Firm
Consolidated
Firm
Aswath Damodaran
Whattodo
Valueequityinsubsidiaryandtake
shareofholding.
Valuesubsidiaryasafirmandadd
portionoffirmvalue.Addportionof
debtin subsidiarytothedebtin
estimatingequityvalue.
Stripoperatingincomeofsubsidiary
andvaluesubsidiaryseparately.Add
portionofthisvaluetovalueof
parentfirm.
43
Whenfinancialstatementsareconsolidated,someanalystsvaluethe
firmwiththeconsolidatedoperatingincomeandthensubtract
minorityinterestsfromthefirmvaluetoarriveatthevalueofthe
equityinthefirm.Whatiswrongwiththisapproach?
Aswath Damodaran
44
AssumethatyouhavedoneanequityvaluationofMicrosoft.Thetotal
valueforequityisestimatedtobe$400billionandthereare5billion
sharesoutstanding.Whatisthevaluepershare?
Aswath Damodaran
45
An added fact
In1999,Microsofthad500millionoptionsoutstanding,grantedto
employeesovertime.Theseoptionshadanaverageexercisepriceof$
20(thecurrentstockpriceis$80).Estimatethevaluepershare.
Aswath Damodaran
46
Theconventionalwayofgettingfromequityvaluetopersharevalueis
todividetheequityvaluebythenumberofsharesoutstanding.This
approachassumes,however,thatcommonstockistheonlyequity
claimonthefirm.
Inmanyfirms,thereareotherequityclaimsaswellincluding:
warrants,thatarepubliclytraded
managementandemployeeoptions,thathavebeengranted,butdonot
trade
conversionoptionsinconvertiblebonds
contingentvaluerights,thatarealsopubliclytraded.
Thevalueofthesenonstockequityclaimshastobesubtractedfrom
thevalueofequitybeforedividingbythenumberofsharesoutstanding.
Aswath Damodaran
47
Optionpricingmodelscanbeusedtovaluetheconversionoptionwith
threecaveats
conversionoptionsarelongterm,makingtheassumptionsaboutconstant
varianceandconstantdividendyieldsmuchshakier,
conversionoptionsresultinstockdilution,and
conversionoptionsareoftenexercisedbeforeexpiration,makingit
dangeroustouseEuropeanoptionpricingmodels.
Theseproblemscanbepartiallyalleviatedbyusingabinomialoption
pricingmodel,allowingforshiftsinvarianceandearlyexercise,and
factoringinthedilutioneffect
Aswath Damodaran
48
Number Life
(in000s)
BlackScholes
Value/option
$16.35
4315
4.5
$17.71
$23.32
8480
5
$14.23
$38.44
1779
7.1
$10.75
$41.25
4598
7.4
$10.34
$53.37
9481
8.7
$9.12
TotalValueofOptionsOutstandingatBoeing=
Aswath Damodaran
TotalValue(in
000s)
$76,418.65
$120,670.40
$19,124.25
$47,543.32
$86,466.72
$350,223.34
49
AverageExercisePriceofOptionsOutstanding=$20.17
StockPriceattimeofanalysis=$37.00
AverageMaturityofOptionsOutstanding=7.6years
NumberofOptionsOutstanding=47.728million
StandardDeviationofTheHomeDepotstock=30%
ValueofOptionsOutstanding=$2,021million
Aswath Damodaran
50
Step1:Valuethefirm,usingdiscountedcashfloworothervaluation
models.
Step2:Subtractoutthevalueoftheoutstandingdebttoarriveatthe
valueofequity.Alternatively,skipstep1andestimatetheofequity
directly.
Step3:Subtractoutthemarketvalue(orestimatedmarketvalue)of
otherequityclaims:
ValueofWarrants=MarketPriceperWarrant*NumberofWarrants :
AlternativelyestimatethevalueusingOPM
ValueofConversionOption=MarketValueofConvertibleBondsValue
ofStraightDebtPortionofConvertibleBonds
Step4:Dividetheremainingvalueofequitybythenumberofshares
outstandingtogetvaluepershare.
Aswath Damodaran
51
Aswath Damodaran
HighGrowthPhase
10years
StableGrowthPhase
Foreverafteryear10
65.98%
6.59%%
4.35%
59.36%
8.42%
5.00%
1.01
5.50%
19.92%
9.17%
1.00
5.50%
30.00%
8.42%
35%
35%
52
+
Boeing:
A Valuation
Terminal
EBIT(1-t)
$1,723
year
$1,798
$1,876
$1,958
$2,043
$2,132 (0.80)
$2,225
$2,321
$2,528
Current
Expected
Stable
Terminal
Cost
Weights
Discount
Firm
Riskfree
Beta
R
X
Unlevered
Firms
Historical
Country
Reinvestment
Return
isk Value:
Premium
ofD/E
Growth
on
Equity
Debt
Risk
Cashflow
Value
at
Rate
US
Capital
Growth
Beta
Cost
17,500
Rate
:for
of=to
Capital
1078/(.0842-.05)
Firm
(WACC)
==10.58%
31,496
+ 3.58%
(0.20)$2,422
= 9.17%
10
- Reinv
$1,137
$1,186
$1,238
$1,292
$1,348 $1,407 $1,468
$1,532
$1,598 $1,668
EBIT(1-t)
in
g
10.58%
(5%+
E
+
Government
1.01
5.5%
Sectors:
Ratio:
Premium
65.98%
6.59%
=
Cash:
=EBIT
5%;
80.08%
0.50%)(1-.35)
25.14%
(1-t)
0.88
Beta
: DBond
==
1,651
4,323
1.00;
19.92%
FCFF
$586
$612
$638
$695 $725
$757
$790
$824 $860
.6598*
D/(D+E)
-=
Rate
5.5%
0%
Nt
Debt:
3.58%
CpX
= .0659
5%
= 30%;ROC=8.42%
=8,194
.0435
568 $666
$2,654
$1,576
$1,078
-=Equity
4.35
Reinvestment
Chg%WC
13,630
Rate=59.36%
667
= FCFF
-Options
350
417
Reinvestment$13.14
Value/Share
Rate = 74.77%
Aswath Damodaran
53
Aswath Damodaran
HighGrowthPhase
10years
StableGrowthPhase
Foreverafteryear10
88.62%
16.37%
14.51%
35.46%
14.10%
5.00%
0.87
5.80%
4.55%
9.52%
0.87
5.50%
30.00%
7.92%
35%
35%
54
EBIT(1-t)
2095
2399
2747
3146
3602
4125
4723
5409
6194
7092
Current
Expected
Stable
Terminal
Cost
Weights
Discount
Firm
Riskfree
Beta
R
X
Unlevered
Firms
Historical
Country
Reinvestment
Return
Premium
ofD/E
Growth
on
Equity
Debt
Risk
Cashflow
Value
at
Rate
US
Capital
Growth
Beta
Cost
68,949
Rate
:for
of=to
Capital
4806/(.0792-.05)
Firm A
(WACC)
==9.79%
164,486
(0.9555) + 3.77% (0.0445) = 9.52%
10
+isk Value:
The
Home
Depot:
Valuation
1857
2126
2434
2788
3192
3655
4186
4793
5489
6285
EBIT(1-t)
in
g
9.79%
(5%+
E
+
Government
0.87
5.5%
Sectors:
Ratio:
Premium
88.62%
-16.37%
Reinv
=
Cash:
=EBIT
5%;
95.55%
0.80%)(1-.35)
4.76%
(1-t)
0.86
Beta
: DBond
==
1,829
0.87;
4.45%
62
.8862*.1637=
D/(D+E)
-=
Rate
5.5%
0%
FCFF
238
273
313
358
410
469
538
616
705
807
Nt
Debt:
3.77%
CpX
= 5%
= 30%;ROC=14.1%
.1451
4,081
1,799
- Chg WC
14.51
Reinvestment
=Equity
%
64,930
Rate=35.46%
190
= FCFF
-Options
2,021
<160>
Reinvestment$42.55
Value/Share
Rate =108.75%
Aswath Damodaran
55
Aswath Damodaran
HighGrowthPhase
5years
StableGrowthPhase
Foreverafteryear5
112.17%
23.67%
26.55%
29.07%
17.2%
5.00%
1.49
6.00%
6.62%
12.54%
1.20
6.00%
6.62%
11.05%
42%
42%
56
9520
Current
Expected
Stable
Terminal
Cost
Weights
Discount
Firm
Riskfree
Beta
R
X
Unlevered
Firms
Historical
Country
Reinvestment
Return
EBIT(1-t)
3535
4474
5661
7165
isk Value:
Premium
ofD/E
Growth
on
Equity
Debt
Risk
Cashflow
Value
at
Rate
US
Capital
Growth
Beta
Cost
59,218
Rate
:for
of=in
to
Capital
6753/(.1106-.05)
Firm (WACC) ==13.2%
111,384
(0.9338) + 3.36% (0.0662) = 12.55%
10
+9067
InfoSoft:
A
Valuation
EBIT(1-t)
EBIT
g
13.20%
(5%+
E
+
Government
1.49
5.5%
Sectors:
Ratio:
Premium
112.17%
-23.67%
3965
5029
6350
7937
10071
2773
Reinv
=
Cash:
= 5%;
93.38%
(1-t)
1.00%)(1-.42)
7.09%
1.43
Beta
: DBond
==
2,793
1.20;
6.62%
500
1.1217*.2367
D/(D+E)
-=
Rate
5.5%
0%
FCFF
6753
-430
-545
-689
-872
-1104
Nt
Debt:
3.36%
CpX
= 5%
= 6.62%;ROC=17.2%
=4,583
2,633
.2655
- Chg WC
26.55
Reinvestment
=Equity
%
55,135
Rate=29.07%
500
= FCFF
<340>
Reinvestment Rate = 112.17%
Aswath Damodaran
57
Relative Valuation
Inrelativevaluation,thevalueofanassetisderivedfromthepricing
of'comparable'assets,standardizedusingacommonvariablesuchas
earnings,cashflows,bookvalueorrevenues.Examplesinclude
Price/Earnings(P/E)ratios
andvariants(EBITmultiples,EBITDAmultiples,CashFlowmultiples)
Price/Book(P/BV)ratios
andvariants(Tobin'sQ)
Price/Salesratios
Aswath Damodaran
58
P0
GordonGrowthModel:
Dividingbothsidesbytheearnings,
P0
EPS 0
Dividingbothsidesbythebookvalueofequity,
P0
BV 0
Ifthereturnonequityiswrittenintermsoftheretentionratioandthe
expectedgrowthrate P
0
BV 0
DividingbytheSalespershare,
P0
Sales 0
Aswath Damodaran
59
Thevalueofafirminstablegrowthcanbewrittenas:
V
ValueofFirm=
0
Dividingbothsidesbytheexpectedfreecashflowtothefirmyields
theValue/FCFFmultipleforastablegrowthfirm:
V0
FCFF1
Thevalue/EBITDAmultiple,forinstance,canbewrittenasfollows:
Value
(1- t)
Depr (t)/EBITDA CEx/EBITDA
Working Capital/EBITDA
=
+
EBITDA
kc - g
kc - g
kc - g
kc - g
Aswath Damodaran
60
Determinants of Multiples
Multiple
Price/EarningsRatio
Price/BookValueRatio
Price/SalesRatio
Value/EBITDA
DeterminingVariables
Growth,Payout,Risk
Growth,Payout,Risk,ROE
Growth,Payout,Risk,NetMargin
Growth,NetCapitalExpenditureneeds,
Leverage,Risk
Value/Sales
Growth,NetCapitalExpenditureneeds,
Leverage,Risk,OperatingMargin
Value/BookCapital
Growth,Leverage,RiskandROC
Companionvariableisinitalics.
Aswath Damodaran
61
SimpleAverages:Theaveragemultipleofcomparablefirmsisusedto
valueanyfirm.Thisworksonlyifthefirmissimilartotheaverage
firminthesector.
AdjustedAverages:Here,theaveragemultipleisadjustedusingone
variable.Forinstance,thePEratiomaybedividedbygrowthtoarrive
ataPEGratio.
RegressionEstimates:Here,themultipleisregressedagainstoneor
morevariables,andtheregressionisusedtoestimatethevalueany
firm.
Aswath Damodaran
62
Aswath Damodaran
PE
ExpectedGrowth
PEG
51.00
11.18
10.74
9.73
14.14
6.06
46.57
12.56
16.04
12.14
46.55
16.86
39.53
13.54
23.96
23.15
9.83
8.33
9.05
122.17
18.14
153.00
15.71
10.87
9.53
28.41
50%
15%
20%
25%
30%
10%
5%
20%
40%
15%
30%
25%
38%
22%
19%
15%
23%
30%
17%
35%
16%
30%
11%
20%
18%
23%
1.02
0.75
0.54
0.39
0.47
0.61
9.31
0.63
0.40
0.81
1.55
0.67
1.04
0.62
1.26
1.54
0.43
0.28
0.53
3.49
1.13
5.10
1.43
0.54
0.53
1.40
63
Valuing InfoSoft
UsingSimpleAverage
ValueofEquity
=InfoSoftNetEarningsin1998*AveragePEratioforsector
=$977,300*28.41=$27.765million
UsingAverageAdjustedforGrowth
PEGRatio=1.40
ExpectedGrowthRateforInfoSoft=27.03%
ValueofEquity=$977,300million*1.40*27.03=$37.056million
Aswath Damodaran
64
PBV
1.83
2.32
3.66
3.93
1.77
6.00
3.33
2.49
7.17
1.59
0.65
4.22
4.46
2.83
3.50
ROE
11.85%
3.28%
25.41%
25.57%
14.46%
27.10%
13.95%
15.38%
33.03%
11.02%
10.51%
16.40%
16.23%
19.29%
9.09%
StandaradDeviationinStockPrices
61.19%
32.46%
36.63%
26.07%
47.02%
27.62%
27.15%
35.62%
18.15%
37.59%
36.12%
19.48%
22.16%
39.07%
34.32%
Average
3.32
16.84%
33.38%
Aswath Damodaran
65
PBV Regression
Regressingpricetobookratiosagainstreturnsonequityandrisk
(standarddeviation),weget
PBV=3.54+ 12.69ROE6.97StandardDeviationR2=76.15%
(2.97) (3.35)
(2.41)
Usingthisregression,wegetapredictedpricetobookvalueratiofor
Boeing, based upon its return on equity of 9.09% and a standard
deviationof34.32%:
PredictedPBVBoeing=3.54+ 12.69(.0909)6.97(.3432)=2.27
Boeing,whichistradingat3.50timesbookvalue,looksovervalued.
Aswath Damodaran
66
BaseduponthePBVratio,isBoeingunder,overorcorrectlyvalued?
UnderValued
OverValued
CorrectlyValued
Willthisvaluationgiveyouahigherorlowervaluationthanthe
discountedcashflowvaluation?
Higher
Lower
Aswath Damodaran
67
Assumethatyouarereadinganequityresearchreportwhereabuy
recommendationforacompanyisbeingbaseduponthefactthatits
PEratioislowerthantheaveragefortheindustry.Implicitly,whatis
theunderlyingassumptionorassumptionsbeingmadebythisanalyst?
Thesectoritselfis,onaverage,fairlypriced
Theearningsofthefirmsinthegrouparebeingmeasuredconsistently
Thefirmsinthegroupareallofequivalentrisk
Thefirmsinthegroupareallatthesamestageinthegrowthcycle
Thefirmsinthegroupareofequivalentriskandhavesimilarcash
flowpatterns
Alloftheabove
Aswath Damodaran
68
Aswath Damodaran
69
Aswath Damodaran
70
UsingtheDCFframework,therearefourbasicwaysinwhichthevalue
ofafirmcanbeenhanced:
Thecashflowsfromexistingassetstothefirmcanbeincreased,byeither
increasingaftertaxearningsfromassetsinplaceor
reducingreinvestmentneeds(netcapitalexpendituresorworkingcapital)
Theexpectedgrowthrateinthesecashflowscanbeincreasedbyeither
Increasingtherateofreinvestmentinthefirm
Improvingthereturnoncapitalonthosereinvestments
Thelengthofthehighgrowthperiodcanbeextendedtoallowformoreyears
ofhighgrowth.
Thecostofcapitalcanbereducedby
Reducingtheoperatingriskininvestments/assets
Changingthefinancialmix
Changingthefinancingcomposition
Aswath Damodaran
71
A Basic Proposition
Foranactiontoaffectthevalueofthefirm,ithasto
Affectcurrentcashflows(or)
Affectfuturegrowth(or)
Affectthelengthofthehighgrowthperiod(or)
Affectthediscountrate(costofcapital)
Proposition1:Actionsthatdonotaffectcurrentcashflows,future
growth,thelengthofthehighgrowthperiodorthediscountrate
cannotaffectvalue.
Aswath Damodaran
72
Value-Neutral Actions
Stocksplitsandstockdividendschangethenumberofunitsofequityinafirm,
butcannotaffectfirmvaluesincetheydonotaffectcashflows,growthorrisk.
Accountingdecisionsthataffectreportedearningsbutnotcashflowsshouldhave
noeffectonvalue.
ChanginginventoryvaluationmethodsfromFIFOtoLIFOorviceversainfinancial
reportsbutnotfortaxpurposes
Changingthedepreciationmethodusedinfinancialreports(butnotthetaxbooks)
fromacceleratedtostraightlinedepreciation
Majornoncashrestructuringchargesthatreducereportedearningsbutarenottax
deductible
Usingpoolinginsteadofpurchaseinacquisitionscannotchangethevalueofatarget
firm.
Decisionsthatcreatenewsecuritiesontheexistingassetsofthefirm(without
alteringthefinancialmix)suchastrackingstockcannotcreatevalue,thoughthey
mightaffectperceptionsandhencetheprice.
Aswath Damodaran
73
Theassetsinplaceforafirmreflectinvestmentsthathavebeenmade
historicallybythefirm.Totheextentthattheseinvestmentswere
poorlymadeand/orpoorlymanaged,itispossiblethatvaluecanbe
increasedbyincreasingtheaftertaxcashflowsgeneratedbythese
assets.
Thecashflowsdiscountedinvaluationareaftertaxesand
reinvestmentneedshavebeenmet:
EBIT(1t)
(CapitalExpendituresDepreciation)
ChangeinNoncashWorkingCapital
=FreeCashFlowtoFirm
Proposition2:Afirmthatcanincreaseitscurrentcashflows,without
significantlyimpactingfuturegrowthorrisk,willincreaseitsvalue.
Aswath Damodaran
74
Aswath Damodaran
75
$140.00
$120.00
$100.00
$80.00
$60.00
$40.00
$20.00
$0.00
3%
Aswath Damodaran
5%
7%
9%
11%
13%
15%
76
$60,000
$59,000
$58,000
$57,000
$56,000
$55,000
$54,000
$53,000
$52,000
0%
Aswath Damodaran
10%
20%
30%
40%
50%
77
$50.00
$45.00
$40.00
$35.00
$30.00
$25.00
$20.00
$15.00
$10.00
$5.00
$0.00
0%
Aswath Damodaran
5%
10%
15%
20%
78
Keepingallelseconstant,increasingtheexpectedgrowthinearnings
willincreasethevalueofafirm.
Theexpectedgrowthinearningsofanyfirmisafunctionoftwo
variables:
Theamountthatthefirmreinvestsinassetsandprojects
Thequalityoftheseinvestments
Aswath Damodaran
79
Reinvestment
Reinvest
Do
Increase
acquisitions
operating
capital
moreRate
inturnover ratio
projects
margins
* Return on Capital
= Expected Growth Rate
Aswath Damodaran
80
CostofCapital
ReturnonCapital
ReinvestmentRate
ExpectedGrowthRate
ValuePerShare
Aswath Damodaran
Boeing
9.17%
6.59%
65.98%
5.72%
$13.14
TheHomeDepot
9.51%
16.38%
88.62%
14.51%
$42.55
InfoSoft
12.55%
23.67%
112.17%
27.03%
$55.15
81
30.00%
20.00%
10.00%
0.00%
20%
10%
10%
20%
10.00%
20.00%
30.00%
Boeing
Aswath Damodaran
TheHomeDepot
InfoSoft
82
IncreasingthereinvestmentrateincreasesvaluepershareatThe
HomeDepotandInfoSoft,butreducesitatBoeing.Why?
Aswath Damodaran
83
Everyfirm,atsomepointinthefuture,willbecomeastablegrowth
firm,growingatarateequaltoorlessthantheeconomyinwhichit
operates.
Thehighgrowthperiodreferstotheperiodoverwhichafirmisable
tosustainagrowthrategreaterthanthisstablegrowthrate.
Ifafirmisabletoincreasethelengthofitshighgrowthperiod,other
thingsremainingequal,itwillincreasevalue.
Thelengthofthehighgrowthperiodisadirectfunctionofthe
competitiveadvantagesthatafirmbringsintotheprocess.Creating
newcompetitiveadvantageoraugmentingexistingonescancreate
value.
Aswath Damodaran
84
Somefirmsareabletosustainabovenormalreturnsandgrowth
becausetheyhavewellrecognizedbrandnamesthatallowthemto
chargehigherpricesthantheircompetitorsand/orsellmorethantheir
competitors.
Firmsthatareabletoimprovetheirbrandnamevalueovertimecan
increaseboththeirgrowthrateandtheperiodoverwhichtheycan
expecttogrowatratesabovethestablegrowthrate,thusincreasing
value.
Aswath Damodaran
85
GenericColaCompany
18.56%
7.50%
1.67
1.67
31.02%
12.53%
65.00%(19.35%)
65.00%(47.90%)
20.16%
8.15%
10years
10yea
12.33%
12.33%
97.65%
97.65%
4.16%
4.16%
2.35%
2.35%
12.13%
12.13%
$115
$13
86
Themostcompleteprotectionthatafirmcanhavefromcompetitive
pressureistoownapatent,copyrightorsomeotherkindoflegal
protectionallowingittobethesoleproducerforanextendedperiod.
Notethatpatentsonlyprovidepartialprotection,sincetheycannot
protectafirmagainstacompetitiveproductthatmeetsthesameneed
butisnotcoveredbythepatentprotection.
Licensesandgovernmentsanctionedmonopoliesalsoprovide
protectionagainstcompetition.Theymay,however,comewith
restrictionsonexcessreturns;utilitiesintheUnitedStates,for
instance,aremonopoliesbutareregulatedwhenitcomestoprice
increasesandreturns.
Aswath Damodaran
87
Anotherpotentialbarriertoentryisthecostassociatedwithswitching
fromonefirmsproductstoanother.
Thegreatertheswitchingcosts,themoredifficultitisforcompetitors
tocomeinandcompeteawayexcessreturns.
Firmsthatdevisewaystoincreasethecostofswitchingfromtheir
productstocompetitorsproducts,whilereducingthecostsof
switchingfromcompetitorproductstotheirownwillbeableto
increasetheirexpectedlengthofgrowth.
Aswath Damodaran
88
Thereareanumberofwaysinwhichfirmscanestablishacostadvantage
overtheircompetitors,andusethiscostadvantageasabarriertoentry:
Inbusinesses,wherescalecanbeusedtoreducecosts,economiesofscalecan
givebiggerfirmsadvantagesoversmallerfirms
Owningorhavingexclusiverightstoadistributionsystemcanprovidefirms
withacostadvantageoveritscompetitors.
Owningorhavingtherightstoextractanaturalresourcewhichisinrestricted
supply(Theundevelopedreservesofanoilorminingcompany,forinstance)
Thesecostadvantageswillshowupinvaluationinoneoftwoways:
Thefirmmaychargethesamepriceasitscompetitors,buthaveamuchhigher
operatingmargin.
Thefirmmaychargelowerpricesthanitscompetitorsandhaveamuchhigher
capitalturnoverratio.
Aswath Damodaran
89
120
100
80
60
40
20
0
1
Aswath Damodaran
10
90
Whichofthefollowingbarrierstoentryaremostlikelytoworkfor
thefirmthatyouareanalyzing?
BrandName
PatentsandLegalProtection
SwitchingCosts
CostAdvantages
Aswath Damodaran
91
Thecostofcapitalforafirmcanbewrittenas:
CostofCapital=ke(E/(D+E))+kd(D/(D+E))
Where,
ke=CostofEquityforthefirm
kd=Borrowingrate(1taxrate)
Thecostofequityreflectstherateofreturnthatequityinvestorsinthe
firmwoulddemandtocompensateforrisk,whiletheborrowingrate
reflectsthecurrentlongtermrateatwhichthefirmcanborrow,given
currentinterestratesanditsowndefaultrisk.
Thecashflowsgeneratedovertimearediscountedbacktothepresent
atthecostofcapital.Holdingthecashflowsconstant,reducingthe
costofcapitalwillincreasethevalueofthefirm.
Aswath Damodaran
92
Aswath Damodaran
93
Boeing
TheHomeDepot
InfoSoft
Aswath Damodaran
Current
Optimal
CostofCapital DebtRatio CostofCapital
DebtRatio
20.09%
9.17%
30%
9.16%
4.55%
9.51%
20%
9.23%
6.55%
12.55%
20%
12.28%
94
Thefundamentalprincipleindesigningthefinancingofafirmisto
ensurethatthecashflowsonthedebtshouldmatchascloselyaspossible
thecashflowsontheasset.
Bymatchingcashflowsondebttocashflowsontheasset,afirm
reducesitsriskofdefaultandincreasesitscapacitytocarrydebt,which,
inturn,reducesitscostofcapital,andincreasesvalue.
Firmswhichmismatchcashflowsondebtandcashflowsonassetsby
using
Shorttermdebttofinancelongtermassets
Dollardebttofinancenondollarassets
Floatingratedebttofinanceassetswhosecashflowsarenegativelyornot
affectedbyinflation
willendupwithhigherdefaultrisk,highercostsofcapitalandlowerfirmvalue.
Aswath Damodaran
95
TheValueEnhancementChain
AssetsinPlace
Expected Growth
Cost of Financing
Aswath Damodaran
Gimme
1. Divest assets/projects with
Divestiture Value >
Continuing Value
2. Terminate projects with
Liquidation Value >
Continuing Value
3. Eliminate operating
expensesthat generate no
current revenues and no
growth.
Eliminate new capital
expenditures that are expected
to earn less than the cost of
capital
If any of the fi rms products or
services canbe patented and
protected, do so
Oddson.
Couldworkif..
1. Reducenet working capital 1. Changepricing strategy to
requirements, by reducing
maximize the product of
inventory andaccounts
profit margins andturnover
receivable, or by increasing
ratio.
accounts payable.
2. Reducecapital maintenance
expenditureson assets in
place.
96
3830
Current
Expected
Stable
Terminal
Cost
Weights
Discount
Firm
Riskfree
Beta
R
X
Unlevered
Firms
Historical
Country
Reinvestment
Return
EBIT(1-t)
1788
1935
2095
2267
2454
2657
2876
3113
3370
3648
Premium
ofD/E
Growth
on
Equity
Debt
Risk
Cashflow
Value
at
Rate
US
Capital
Growth
Beta
Cost
Rate
:for
of=to
Capital
2,298(.0842-.05)
Firm (WACC) Valuation
==10.56%
67,148 (0.80) + 3.58% (0.20) = 9.16%
10
+isk Value:
Boeing:
A33,254
Restructured
EBIT(1-t)
in
g
13.85%
(5%+
E
+
Government
1.01
5.5%
Sectors:
Ratio:
Premium
65.98%
-12.50%
1179
1277
1382
1496
1619
1753
1898
2054
2223
2407
1532
Reinv
=
Cash:
=EBIT
5%;
80.08%
0.50%)(1-.35)
25.14%
(1-t)
0.88
Beta
: DBond
==
2,123
4,323
1.00;
19.92%
.6598*.125
D/(D+E)
-=
Rate
5.5%
0%
FCFF
608
658
713
1059
1146
1241
2298
771
835
904
978
Nt
Debt:
3.58%
CpX
= 5%
= 30%;ROC=12.5%
= .08
8,194
1,039
- Chg%WC
8.25
Reinvestment
=Equity
40,776
Rate=40%
667
= FCFF
-Options
350
417
Reinvestment$28.73
Value/Share
Rate = 80.38%
Aswath Damodaran
97
5950
7036
8320
9837
Current
Expected
Stable
Terminal
Cost
Weights
Discount
Firm
Riskfree
Beta
R
X
Unlevered
Firms
Historical
Country
Reinvestment
Return
EBIT(1-t)
2177
2574
3044
3599
4256
5032
Premium
ofD/E
Growth
on
Equity
Debt
Risk
Cashflow
Value
at
Rate
US
Capital
Growth
Beta
Cost
89,850
Rate
:for
of=to
Capital
6666/(.0792-.05)
Firm A
(WACC)
==10.39%
228,146(0.80)
+ 4.55% (0.20) = 9.23%
10
+isk Value:
The
Home
Depot:
Restructured
Valuation
8122
9604
11356
EBIT(1-t)
in
g
10.39%
(5%+
E
+
Government
0.98
5.5%
Sectors:
Ratio:
Premium
108.76%
-16.77%
2513
2972
3514
4155
4913
5809
6869
Reinv
=
Cash:
=EBIT
5%;
80%
2.00%)(1-.35)
25%
(1-t)
0.86
Beta
D: = Bond
20%
=1,841
0.87;
62
-1086
-1284
1.0876*.1677=
D/(D+E)
-=
Rate
5.5%
0%
FCFF
-1519
-336
-397
-470
-556
-657
-777
-919
Nt
Debt:
4.55%
CpX
= 5%
= 30%;ROC=14.1%
3,885
1,813
.1824
- Chg WC
18.24
Reinvestment
=Equity
%
86,027
Rate=35.46%
190
= FCFF
-Options
2,021
<161>
Reinvestment$56.81
Value/Share
Rate =108.76%
Aswath Damodaran
98
7165
11474
14521
18376
23255
29429
Current
Expected
Stable
Terminal
Cost
Weights
Discount
Firm
Riskfree
Beta
R
X
Unlevered
Firms
Historical
Country
Reinvestment
Return
EBIT(1-t)
3535
4474
5661
isk Value:
Premium
ofD/E
Growth
on
Equity
Debt
Risk
Cashflow
Value
at
Rate
US
Capital
Growth
Beta
121522
Cost
for
: Restructured
of=in
to
Capital
21918/(.1035-.05)
Firm (WACC) =Valuation
14.02%
= 409453
(0.80) + 5.37% (0.20) = 12.29%
10
+9067
InfoSoft:
ARate
12871
16288
20613
26086
33011
EBIT(1-t)
EBIT
g
14.02%
(5%+
E
+
Government
1.64
5.5%
Sectors:
Ratio:
Premium
112.17%
-23.67%
3965
5018
6350
8047
10170
Reinv
=
Cash:
= 5%;
80%
(1-t)
4.00%)(1-.42)
7.09%
1.43
Beta
D: = Bond
20%
=2,793
1.20;
500
-1397
-1767
-2237
-2831
-3582
1.1217*.2367=
D/(D+E)
-=
Rate
5.5%
0%
FCFF
-430
-544
-689
-872
-1103
Nt
Debt:
5.37%
CpX
= 5%
=20%;ROC=17.2%
4,583
2,633
.2655
- Chg WC
26.55
Reinvestment
=Equity
%
117439
Rate=29.07%
500
= FCFF
<340>
Reinvestment Rate = 112.17%
Aswath Damodaran
99
First Principles
Investinprojectsthatyieldareturngreaterthantheminimumacceptable
hurdlerate.
Thehurdlerateshouldbehigherforriskierprojectsandreflectthefinancingmix
usedownersfunds(equity)orborrowedmoney(debt)
Returnsonprojectsshouldbemeasuredbasedoncashflowsgeneratedandthe
timingofthesecashflows;theyshouldalsoconsiderbothpositiveandnegative
sideeffectsoftheseprojects.
Chooseafinancingmixthatminimizesthehurdlerateandmatchestheassets
beingfinanced.
Iftherearenotenoughinvestmentsthatearnthehurdlerate,returnthecashto
stockholders.
Theformofreturnsdividendsandstockbuybackswilldependuponthe
stockholderscharacteristics.
Objective:MaximizetheValueoftheFirm
Aswath Damodaran
100