Porject 450 Guideline

4/25/2014 Project Emails/Information
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/cfprojectsumm.htm 1/20
EmailsontheProject
Over the course of the project, you will get many, many emails from me. Many of these will have to do
with the project. In this page, you can see all of the information related to the project that I will be
sending out, categorized by your project progress. Choose where you are in the project and check out
the information.
1. Choosing a company
2. Getting data on the company
3. Stockholder/ Manager Objectives
1. Assessing your board
2. Analyzing your firm's good citizen standing
4. Finding your firm's marginal investor
5. Risk Analysis
1. Riskfree Rates
2. Risk Premiums
3. Regression logistics
4. Evaluating your firm's risk regression
5. Estimating a bottom-up unlevered beta
6. Estimating debt and cost of debt
7. Estimating a bottom-up levered beta
8. Estimating a cost of capital
6. Investment Analysis
1. Estimating a Return on capital for your firm
2. Mechanical Issues with estimating return on capital
3. Estimating Economic Value Added
7. Capital Structure
1. Qualitative Analysis of capital structure
2. Cost of capital approach - Optimal Debt Ratio
3. Mechanics of computation: Cost of capital approach
4. Downside risk assessment
5. Analyzing your optimal debt ratio
6. Other Optimal debt ratio approaches
7. Getting to the optimal
8. Designing the perfect debt
8. Dividend Policy
1. A Qualitative Analysis of Dividend Policy
2. Analyzing whether your firm should be paying more or less
3. Fixing the dividend problem
9. Valuation
1. Which valuation model should I use?
2. How do I deal with the stable growth phase?
3. What are the key inputs in the FCFE and Dividend spreadsheets?
4. What are the key inputs in the fcffginzu.xls spreadsheet?
5. What do I do if I have a money losing company?
I. Picking a company
In picking a company, keep the following in mind:
a. Pick a company which has been around at least a year (preferably two), since it is nice
to have two annual reports to compare. If you want to pick a company that has been listed
less than that, make sure that you can get at least one year of financial statements.
b. It can be listed anywhere in the world
c. Make sure that the companies in your group are tied together by a common thread
same sector or industry.
d. Avoid money losing companies, financial service firms and firms with capital arms like
GE and GM). Once you have your group nailed down, let me know the names of the people
in your group and, if possible, the companies you have picked. I will set up a Google
Spreadsheet where you can enter your companies, once you have picked them. In picking a
company, pick a theme that is fairly broad and pick companies that match this. Thus, if your
theme is entertainment, you can analyze Sony, Time Warner, Netflix and even Apple. I
would encourage getting diverse companies in your group - large and small, focused and
diversified, and non-US companies. (In other words, you don't want five companies that are
carbon copies of each other. There is little that you will interesting to say about differences
across companies, if there are none).
e. Finally, some (unsolicited) advice:
1. Define your theme broadly: In other words, don't pick five money-losing
airlines as your group. Pick Continental Airlines, Southwest, Ryan Air,
Travelocity and Embraer.... Three very different airline firms, a travel service
and a company that supplies aircraft to the airlines.
2. Do not worry about making a mistake: If you pick a company that you regret
picking later, you can go back and change your pick.... If you do it in the first
5 weeks, it will not be the end of the world. (If you are leery about picking a
foreign company, pick one that has ADRs listed in the US. It will make your
life a little easier. You should still use the information related to the local listing
(rather than the ADR).
3. If you want to sound me out on your picks, go ahead. I have to tell you up
front that I think that there is some aspect that will be interesting no matter
what company you pick. So, do not avoid a company simply because it pays
no dividends or has no debt.
4. If you want to kill two birds with one stone, pick a company that you already
own stock in or plan to work for or with .....
As a final reminder. Please pick your company soon and don't forget to enter
in the google spreadsheet... As you can see from today's class, we are getting
started on assessing your company...

II. Getting data on the company
Much of the data comes from Bloomberg and if you have never
used a Bloomberg before, it can be daunting.... Let me know if you get stuck,.
You can get much of it from the Bloomberg terminals (there is one on the
second floor in the reading room and there should be one downstairs in the
computer room) and if you have never used a Bloomberg before, it can be
daunting.... Let me know if you get stuck (You can also get a manual on using
Bloomberg data written by yours truly u on my web site.)
http://pages.stern.nyu.edu/~adamodar/pdfiles/Bloombergfull.pdf
If you have a US company, visit the SEC website
http://www.sec.gov and print off the latest 14-DEF for your firm. If you are
wondering what an HDS page and how to get it, you need to get to a
Bloomberg terminal, click the equity button and find your company. Once you
have found the company, type in HDS and you will get a listing of the top
holders of equity in your company.... print off just the first page.
If you have a foreign company: Analyzing a non-US company can be
interesting but sometimes frustrating. Here are some suggestions on getting
information (which is the most frustrating part):
a. Bloomberg: When you type in your company's name into Bloomberg, the first thing that
will strike you is the number of listings that Bloomberg will pull up on your company. (Nokia
has more than a 100 listings under equity). To get the listing that will contain all the information
for your company, you need the primary listing in the local market. (The ADRs (which are the
listings traded in the US) will not provide you with adequate information.) Look for the country
code for the local market (In Western Europe, for example, FP: France, IM: Italy, GR: Germany,
GA: Greece; LN: UK; SW: Switzerland; Pl: Portugal: FH: Finland etc...You can get a more
complete list on Bloomberg). Once you have found the listings on the local market (and there
will often be more than one), it is a process of trial and error. Check a listing and type in DES. If
you get only 2 or 3 pages, you have the wrong listing... Keep trying and you will hit the
jackpot...) Once you have found the listing, print off everything you would for a US company
(HDS, Beta, DES (first 10 pages), FA (item 25))
b. Financial Filings: You will be able to get annual reports for almost any non US company. I
usually try the company's own web site first (companyname.com usually gets you there) and
print off the annual report. You can also try the following web site that lets you print off annual
reports once you have registered with them (a pain, but it is free).
http://www.carol.co.uk
The UK does have its own version of the SEC and you can get information on UK companies
by going to
http://www.companies-house.gov.uk/
c. Company's website: Try going on to the company's own website and looking for investor
relations. The last annual report is usually available to download
III. Stockholder/ Manager Objectives
a. Assessing a Board
Once you have picked your company, start by assessing the board of directors
(and making judgments on how effective or ineffective it is likely to be). To
help in this process, I am attaching the original article in 1997 that covered the
best and the worst boards as well as a more recent article detailing what
Business Week looks at in assessing boards.
There are a number of interesting sites that keep track of directors and their
workings. I have listed a few below:
http://corpgov.net/: This is a general site listing corporate governance issues
and links
http://www.ecgi.org/ : Covers corporate governance in Europe
Yahoo! finance reports corporate governance scores for individual
companies...
http://finance.yahoo.com/
Type in the symbol for the company that you want to look up and check under
profile.
Finally, if you have used Capital IQ (and you have access to it, you can
download all kinds of stuff on your company's corporate governance
structure).
You can find out more about your company by going to the SEC site
(http://www.sec.gov) and looking up the 14-DEF for your company.. You
may not be able to find a 14-DEF (or its equivalent) for a foreign company,
but the difficulty of finding this information may be more revealing than any
information that you may have unearthed.
Ultimately, there are to questions that you are trying to answer:
i. How much power do you as an individual stockholder have over the management
of this company?
To make this assessment, you want to start by looking at the board of directors and
examining it for independence and competence. I know that there are lots of
unknowns here, but work with at least what you know - the size of the board, the
appearance of independence, the (perceived) quality of these directors. With US
companies, you can get more information about the directors from the DEF14 (a
filing with the SEC that you can get from the SEC website). With non-US
companies, you may sometimes find yourself lacking information about potential
conflicts of interests, but what you cannot find is often more revealing than what you
can find out; it points to how little power stockholders have in these companies. Also
look at subtle ways in which power is shifted to managers at the expense of
stockholders including anti-takeover amendments (poison pills, golden parachutes), if
you can find reference to them.
ii. Are there other potential conflicts of interests between inside stockholders and
outside stockholders?
In some companies, you will find that there are large stockholders in the company
who also play a role in running the company. While this may make you feel a little
more at ease about managers being held in check (by these large stockholders),
consider who these large stockholders are and whether their interests may diverge
from yours. In particular, the largest stockholder in your company can be a
founder/CEO, a family holding, the government or even employees in the company.
What they might want managers to do may be very different from what you would
want managers to do... Look for ways in which these inside stockholders may
leverage their holdings to get even more power (voting and non-voting shares for
inside stockholders, veto powers for the government...)
Attachment: Business Week article on board of directors
b. Assessing a company's good citizen standing
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, I mentioned that there were groups out there that ranked companies
based upon social responsibility. I have listed a few below, but they are a few of
many:
Calvert Social Index: http://www.calvert.com/sri-index.html
Domini: http://www.kld.com/indexes/ds400index/index.ht
Dow Jones Sustainability Index:http://www.sustainability-index.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). I had also
mentioned CRO magazine in class and their top hundred. In case you are interested,
here is the link:
http://www.thecro.com/content/100-best-corporate-citizens
In general, assessing whether companies are socially responsible is difficult to do.
You can get the outliers in both directions by looking at rankings in financial
publications like the Wall Street Journal, Fortune and Business Week. For instance,
you can get the most admired companies by going to
http://www.fortune.com/fortune/mostadmired
For how organized labor views companies,
http://www.aflcio.org/corporateamerica/
If you interested in socially responsible investing, try this web site:
http://www.socialinvest.org/
It has links not only to mutual funds that invest in socially conscious companies but
also on resources that can be used to put pressure on companies that are not socially
responsible.
IV. Finding your firm's marginal investor
To find your firm's marginal investor, start off by looking at the top 15
investors in your firm. You can get this by printing off the first page of the
HDS function in Bloomberg by doing 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).
In addition, look up the percent of the stock held by institutions in your firm. In
general, if most of the top investors in your firm are institutions and a high
percent of the stock is held by institutions, your marginal investor is an
institution as well. In doing this, note the following:
For an investor to be a marginal investor, you need both a large holding and trading.
You can have firms like Oracle where the largest single investor is an individual
(Larry Ellison) but that investor will not be the marginal investor.
It is difficult to identify a specific institution as the marginal investor. You are more likely to
identify a class of investors (mutual funds) as marginal investors.
In some cases, another company can be the largest investor in your company. In this case,
you need to find the top investors in that company to find the marginal investor in your
company.
If a trust or the company's pension fund is the largest investor, it is unlikely to trade and
thus be the marginal investor.
If you want to compare your firm's insider and institutional holdings to typical values for
your sector, try this dataset.
V. Risk and Return
a. Risk free Rates
If you are now ready to dip your toes in the water, you can get started building towards a
minimum acceptable hurdle rate. If you are analyzing a company in US dollars (it could be a US
or non-US company), this will be easy. Go to
http://www.bloomberg.com/markets/C13.html?sidenav=front
Get the 10-year bond rate.
If you are analyzing a company in Europe, I mentioned in class that you would want to use the
lowest 10-year Euro bond rate that you can find:
http://www.bloomberg.com/markets/iyc.html
If you are analysing an emerging market company, things get really messy because the
government bond rates will have default risk embedded in them. If you are truly interested in
delving deeper on the topic (you must be sick), I have a paper (I know that I need some
psychological counseling) on risk free rates that you can read this weekend:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1317436
If you want to go from a sovereign rating for your country to a default spread, you may want to
look at this handout from class.
b. Risk Premiums
Survey Risk Premiums: I had mentioned survey premiums in class and two in particular - one by
Merrill of institutional investors and one of CFOs. I have attached the links to both:
Merrill survey: http://newsroom.bankofamerica.com/index.php?s=43&item=8619
CFO survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1654026
Analyst survey: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1609563 (My revenge on
Ibbotson is on page 7 of the downloaded paper... Petty, I know...)
Historical Risk Premium: If you are analyzing a US company, you can get the historical
premium out of my notes (4.53% for 1928 - Current). 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:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html
If you have a non-US company, don't even bother estimating a historical premium. Instead, do
the following.
Step 1: Get the sovereign rating for your country
http://www.moodys.com/moodys/cust/RatingAction/bl_rList.asp?busLineId=7
Step 2: Get a default spread for a bond issued by your country. If you want to go from a
sovereign rating for your country to a default spread, you may want to look at this handout from
class. If you cannot find dollar or Euro denominated bonds, you can use the typical spreads for
your rating by using the attached spreadsheet that I updated on my web site.
Step 3: Estimate the volatility of the equity market and the country bond. For this, you have to go
to the nearest Bloomberg terminal. Find the equity index (start with WEI) and click on the index.
Once you find it, type in HVT and change the default from daily (D) to weekly (W). Try the
same with the bond. If you run into a dead end, use a relative volatility of 1.5
Step 4: Add the premium you get in step 3 to the historical risk premium for the US.
I have the equity risk premiums for 90+ countries on my website at
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html
Implied Equity Premium: You can download the implied premium spreadsheet from my web site
(under spreadsheets) and play with it. In effect, we look at the level of equity prices today (S&P
500 Index) and expected cash flows from dividends & stock buybacks in the future to back out
an internal rate of return on stocks. Subtracting out the riskfree rate gives you the implied equity
risk premium. As you review your notes (and I hope you have been able to watch the webcast,
in case you missed the class), here are some questions that may come up:
1. How do get the expected cash flows from stocks?
Unlike a bond, stocks do not come with promised cash flows. All
you can do is look at the past and make your best estimates for the
future. he best source for the cash flows on the S&P 500 is S&P.
Every three months, they release an update on dividends and
buybacks on the S&P 500 stocks, which you should be able to
find on the S&P website.
I then looked up the growth rate that equity research analysts were
estimating for earnings for the next 5 years (5%) and used it to get
expected cash flows for the next 5 years. The best source for
expected growth on the S&P 500 is zacks.com, a service that
collects and reports on analyst estimates of growth for companies.
While the premium edition requires a paid subscription, there is
enough on the site which is free, for you to get this input. You can
also get the growth rate from Yahoo! Finance, by looking up any
company, and then clicking on estimates. The only problem with
the Yahoo estimates is that they average out the expected growth
rate from analysts following individual companies and are biased
upwards.
2. What happens after year 5?
Stocks, in theory, can generate cash flows forever. However,
since we are looking at the largest companies in the market, the
growth rate has to subside to the nominal growth rate of the
economy. I used the riskfree rate as a proxy for this growth rate.
Here is my reasoning:
Nominal growth rate in economy = Expected inflation + Expected
real growth rate in economy
Riskfree rate= Expected inflation + Expected real interest rate
In the long term, expected real interest rate = expected real growth
rate. To deliver a real interest rate of 2%, the economy has to
generate 2% more in goods and services or it will operate at a
deficit.
3. What next?
Once you have the expected cash flows and the current level of
the index, it is trial and error to arrive at the internal rate of return.
Alternatively, you can use the solver function in excel.
I know that the concept is complex but it is well worth
understanding. If you are up to it, try computing today's implied
equity risk premium in the attached spreadsheet (which has the
implied premium from January 1, 2013). Remember that this is an
implied premium for an entire market. It has nothing to do with
your company. You need to input a dividend yield and growth
rate for the entire market. Should you use this premium or the
historical premium? Depends upon your point of view. If you
want your valuation to be market neutral, use the current implied
equity risk premium. If you believe that numbers revert back to
historical averages, use the historical premium.

c. Regression Logistics
Betas are wondrous things, shifting and changing, as you change your index, your return
period (two years, three years, five years etc...) and your return interval (daily, weekly,
monthly). Just a quick review of the key issues on estimating betas:
1. All regression betas come with standard errors. While you can get a point estimate for a
beta, it is more honest to consider the range for betas. (The standard error itself is related to
the R-squared of the regression; high R-squared generally goes with low standard errors).
2. Because of the standard error (noise) in beta estimates, you should not be surprised to see
different services report different betas for the same company. You can, for instance,
compare your Bloomberg beta to the beta reported in Yahoo! Finance. The betas will be
different for any number of reasons - different return periods, different return intervals,
different indices - but if you consider the range on each beta (because of the standard errors
of the estimates), you would be hard pressed to reject the hypothesis that the betas in the
different services are the same
3. If you really want to see how betas change, capture a Bloomberg terminal (this may
require hand-to-hand combat), find your stock, type BETA and play with the defaults. You
can change the index (SPX to Dow to NYSE to NFT (MS Global Equity index), the return
interval (D, W, M, Q) and the return period and see how the beta shifts as you do this. Note
that the regression with the lowest standard error on the beta may not necessarily yield the
best beta estimate.
To navigate your way through a Bloombeg beta page, you may want to try this link.

d. Evaluating your firm's regression
You can check the numbers from your risk analysis by going through the
following steps:
a. Check out the obvious output:
a.1. The raw beta is your regression beta
a.2: The adjusted beta = 2/3 (Raw beta) + 1/3 (1). Thus, if your raw beta is
1.20, the adjusted beta will be (2/3) (1.20) + (1/3) (1.00) = 1.13
a.3. The R-squared should be listed in decimals. Thus a 0.30 R-squared tells
you that have an R-squared of 30%.
b. Compute your Jensen's alpha
b.1: Start with the intercept on the beta page. It is already in percent. Thus, an
intercept of 0.22 is 0.22% (Notice the inconsistency with how R-squared is
reported)
b.2: You need the average riskfree rate for last 2 (5) years if you have a 2-year
(5-year) regression. Since this a bit of a pain to look up,especially for non-US
$ analyses, I have made the estimates for you for a few currencies:
b.3: Convert the riskfree rate (which is always reported in annualized terms) to
a weekly or monthly riskfree rate by dividing by 52 or 12.
b.4: Jensen's alpha = Intercept - Riskfree rate (`1- Raw Beta). Keep your units
straight.
One of the inputs that you require for Jensen's alpha is the average T.Bill rate
from the last 5 years. If you want to do this precisely, you can visit the Federal
Reserve site at St. Louis:
http://research.stlouisfed.org/fred/data/irates/gs6m
You can get approximate answers using the annual averages I have included in
the attached spreadsheet. If you are wondering why you use current 10-year
T.Bond rates for expected returns and T.Bill rates for the Jensen's alpha, it is a
matter of perspective. When estimating expected returns, you are looking at a
long term return for the future and hence you use the 10-year T.Bond rate
today. When analyzing Jensen's alpha, you are looking at an investor who
buys and sells each month for the last 5 years and hence you use the average
T.Bill rate over the last 5 years....

e. Estimating a bottom-up beta
Step 1: You have to get a breakdown of the businesses that your firm is in.
You can get this by downloading your firm's 10K from the SEC web site or
checking its annual report. Don't try to break the company down into too much
detail, because you will have trouble finding comparable firms. Thus, if you
have an oil company, breaking it down into drilling, refining and exploration is
a recipe for frustration.
Once you have it, browse through it (I would say read it but that would be a
painful exercise) to find the breakdown of your firm's business. Usually, the
company will give you at least revenue and operating income by business. If
you have a non-US company, you should be able to find this information in
their annual report.
Step 2: Estimate bottom-up unlevered betas for each business. There are four
routes you can follow, depending on how much time you are willing to spend
on the process-
a. The Easy Route (5 minutes): You can use the unlevered betas that I have
computed by business on my web site.
http://www.damodaran.com
You can get to it by going to updated data and looking for levered and
unlevered betas by business- I have them as separate datasets for the US,
Europe, Emerging Markets and Japan. The advantage is that it is easy to do...
The disadvantage is that you will not get the wonderful experience of doing it
yourself and the breakdown may not be detailed enough for you.
b. The Slightly more involved route (20-30 minutes): At the top of the updated
data page, you will find the complete excel datasets of the 30000+ companies
that I used to construct the industry average tables. You can download the
datasets (Do it on a high-speed line because it is a very large dataset) and then
create your own group of comparable firms. All of the raw data on the
company is provided - betas, debt, equity and cash - and you have to construct
your own unlevered beta. Try it if you have a chance.
c. The Bloomberg Way (30 minutes - 2 hours, depending): After all, real
finance mavens use Bloomberg. You can get the information to estimate
unlevered betas by getting on a Bloomberg terminal and typing ESRC. You
can then screen across markets and industries to pick firms in particular
markets. Once you have your sample ready, you can modify the output page to
contain the information you need - betas, debt, equity, cash and tax rates, for
example. The advantage is that you can do this for non-US stocks. The
disadvantages is that Bloombergs are notoriously user unfriendly and you can
get only a paper printout. (We don't pay enough for a download function)
d. Capital IQ: Capital IQ is an awesome database of global companies. You
have free access to it, while you are at Stern and you should take full
advantage. You do have to jump through a few procedural hoops to get your
login and password, but once you do, you can screen in lots of different ways.
I put together an absolutely spellbinding video of my screen as I used Cap IQ
to show you how easy it is to use. Click on the link below (and be ready for a
long wait. The file is big...)
http://pages.stern.nyu.edu/~adamodar/podcasts/CapIQforbeta.m4v
Step 3: Compute the values of each of the businesses that your firm is in. I
would recommend using revenues as the starting point. If you are not
comfortable using pricing ratios, weight the businesses based on revenues. If
you would like a more precise estimate, go back to the comparable firms you
pulled up in step 2 and compute the value to sales ratio for the industry
Enterprise Value to Sales = (Market value of Equity + Debt - Cash) /
Revenues
Multiply the revenues from each of the businesses by these value to sales ratios
to get estimated values, and use them to compute weights.
Step 4: Compute a bottom-up unlevered beta for your company by taking a
weighted average of the betas in step 2 with the weights in step 3..

f. Estimating Dollar Debt and Cost of Debt
Step 1: Peruse your company's balance sheet to see how much interest bearing debt it has
outstanding. If you have the 10K, use it since it contains more information. (If there is conflict
between your 10K and Bloomberg, go with the 10K). To find interest bearing debt, start with
the current liabilities since short term debt and the short term portion of long term debt will be
listed there. Then move on to long term liabilities to look for long term interest bearing debt. I
have to warn you that there will be a bunch of other long term liabilities that are not interest
bearing debt - ignore them.
Step 2: If you are working with the 10K, look for two more pieces of information in there:
- Lease and rental commitments for the next 5 years and beyond (do not count capital leases). If
you cannot find this information anywhere in your 10K, don't panic. About a third of all US
companies have no operating lease commitments.
- A schedule of when the debt is owed. It will be listed by year. Take a weighted (by how much
debt is due in each year) average of when the debt comes due. (You may find that the table just
aggregates all debt due after year 5 into a lump sum. Just treat it as due in 10 years and move on)
Both pieces of information will be in the footnotes. European companies report this information
in their annual reports.
Step 3: Obtain the interest expenses for the most recent financial year. If you cannot find any
interest expenses, check to see if you have any debt. If you don't, there's your reason. If you do
find debt but no interest expenses, if may be because your firm is netting interest expenses
against the interest income from cash. (This will especially be the case when you have relatively
little debt.) If you have a net interest expense instead of a gross expense, try this: multiply your
cash balance by a riskless rate (say 3%) to get an estimate of interest income and add this to your
net interest expenses.
Step 4: Obtain a rating for your company.
a. If your company is rated: You can get the rating by going onto Bloomberg and looking under
corp bonds or into the bondsonline.com site:
https://www.bondpage.com/general/menu/index.cfm?
Method=top_side_main_frame&Active=corporate
Type your name under issuer and voila....
b. If your company is not rated:
You can use the attached ratings.xls spreadsheet to get a synthetic rating for your firm (As a
bonus, it will convert your operating leases into debt for you). You can use this spreadsheet for
non-US companies as well. If your company has a market cap of $ 5 billion and higher use 1
(for type of firm). If less than $5 billion, use 2....
If you have negative operating income and no rating, talk to me...
Step 5: Estimate a pre-tax cost of debt for your firm by first estimating the default spread, based
upon your rating, and then adding this default spread to the 10-year riskless rate. (Stick with the
same currency that you used for your cost of equity). While I have default spreads at the start of
the year in the ratings spreadsheet, you can pay $39 and get updated numbers at http:
www.bondsonline.com
Use the industrial spreads over 10-yr bonds.
Step 6: Estimate a marginal tax rate for your firm. Start with the effective tax rate which should
be reported in your 10K but remember that this rate may be lower than the marginal. To get the
marginal tax rate, you will usually have to go to the tax code but let me save you the trouble. In
the US, you can safely assume that the marginal tax rate (if you have an operating profit) is 35%
+, maybe close to 40%. For the marginal tax rates in other countries, try the following link:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/countrytaxrate.htm
Step 7: Compute the market value of your interest bearing debt. To do this, set the following
parameters:
Coupon payment (PMT)= Annual interest expense from last year (gross)
Maturity (n) = Weighted average maturity of your debt from step 2
Face Value (FV) = Book value of interest bearing debt from step 1
Interest rate (r or i) = Pre-tax cost of debt from step 5
Estimate the present value of the debt. You will have the market value.
Step 8: Compute the market value of equity (market price * Number of shares = Market cap),
taking into account all classes of shares outstanding (except for preferred stock) and compute the
weights of debt and equity:
Market value of debt = Market value of interest bearing debt (from step 8) + PV of operating
leases (from step 6)
Market value of equity = Market capitalization
g. Estimating bottom-up levered beta
Compute a levered beta for your company. In making this estimate, you will be using an
unlevered beta from the bottom-up estimate. Since the debt that you used for that unlevered
beta calculation was only interest bearing debt (no operating leases were considered), use
only the interest bearing debt and the market value of equity to compute a debt to equity
ratio.(This is inconsistent with how you define debt in step 9 but the only way to preserve
consistency is to convert the operating leases of all firms into debt and who has the patience
for that?) Using the marginal tax rate, estimate a levered beta:Levered Beta = Unlevered
Beta (1 + (1-t) (Debt/ Equity))

h. Estimating Cost of Capital
To compute a cost of capital for your firm, you need to use the levered beta from the last
step to get a cost of equity and the after-tax cost of debt from the earlier step. You will
weight each by the market value of equity and debt (including operating leases) to get a
cost of capital.
Cost of capital = Cost of equity (E/ (D+E)) + After-tax cost of debt (D/(D+E))
Preferred stock is a pain in the neck. You cannot include it with debt since preferred
dividends are not tax deductible. You cannot include it with equity, because it is not equity.
If you have preferred stock that is less than 5% of firm value, ignore it
If you have preferred stock that is greater than 5% of firm value, then create a third
component in your cost of capital and weight it based on the market value of preferred
stock. Attach the cost of preferred stock
Cost of preferred stock = Preferred dividend yield = Preferred dividend/ Preferred stock
price.
VI. Measuring Investment Returns
a. Estimating Return on Capital
To estimate the return on capital for your firm for the most recent year, you need two numbers -
an after-tax operating income for the year and the book value of debt and equity at the start of
the year. You should be able to get the pre-tax operating income from the most recent income
statement and the book values of debt and equity from last year's balance sheet (For 2002
operating income, use 2001 book value of debt and equity). The debt will include all interest
bearing debt and the shareholders equity should be the total (which will include paid-in capital
and retained earnings)
Return on capital = Operating income from most recent year (1 - Marginal tax rate)/ (Book value
of debt + Book value of equity from end of previous year- Cash from end of previous year)
b. Mechanical issues in computing return on capital
* In computing return on capital, you should be using the book value of debt and equity from the
end of the previous financial year. The book value of equity can be negative but the book value
of capital should always be positive.
* If you have a lot of operating leases, you will get a cleaner estimate of return on capital if you
adjust both the book value of capital and the operating income for the operating leases. Your
adjusted return on capital will be
Adjusted return on capital =( EBIT (1-t) + Pre-tax cost of debt * PV of Operating leases (1-t))/
(Book value of equity + Book value of debt + PV of Operating leases- Cash)
Technically, you should be using the present value of operating leases from the end of the
previous year (In other words, you will need the previous year's 10K. If you do not want to do
this, go ahead and use this year's operating lease commitment PV
* If my book value of equity is negative, how do I compute ROE?
You cannot. Just put in NA or NMF for the ROE. The book value of capital should not be
negative... Use it to compute the ROC.
* I am getting a really low ROC for my firm. Is this possible?
Firms screw up and take bad investments. It is all too common.
c. From Return on capital to EVA
* To go from return on capital to EVA, you will need your company's cost of capital. Some of
you noted the seeming inconsistency of using book value for return on capital and market value
for cost of capital. I think that you can live with it if you recognize that you are trying to measure
two different things - the return on capital measures how well you are doing on the projects you
have already invested in (hence book value matters) whereas the cost of capital measures what it
costs you to raise money (where market value matters)
EVA = (ROC - Cost of capital) (BV of Debt + BV of Equtiy)
* You should stick with the previous year's book value of debt and equity in this calculation as
well.
Comparing EVA across companies is problematic since it is a dollar value and will be larger for
larger companies. One way you can compare your firm's EVA to the industry average is to
compute what your company's EVA would have been if it had earned the same return spread
(ROC - Cost of capital) as the rest of the industry
Industry average EVA = (Industry average ROC - Industry average Cost of capital) * (Your
firm's book value of capital)
You can get the industry averages by going to this dataset that I have on EVA.
* As a final note, you are getting a snap shot of one year when you compute your firm's EVA
and ROC. To get some sense of trends, you may want to compute the EVA and ROC over four
or five years.
VII. Capital Structure
a. Qualitative Analysis of Optimal Capital Structure
In this section, you will take your firm through the five components that go into the trade off and
see where your firm will fall in terms of debt ratios based upon each:
a. Tax Rate: Take note of your company's effective tax rate and also check to see whether your
company operates in any high tax rate entities (Germany is a good example). You can compare
your company's tax rate with the average paid by other firms paid in the industry by going to my
web site and checking the data set that summarizes debt fundamentals by industry.
b. Added Discipline: Generally, the power of debt to act as a disciplinary mechanism will be
greater in larger firms with more dispersed stockholdings. You can look at both the size of the
firm (in terms of market cap) but it may be more useful to look at insider holdings. Firms with
less insider holdings should be more likely to use debt as a disciplinary mechanism than firms
with high insider holdings.
a. Bankruptcy costs: You have to look at two things. One is the probability of bankruptcy. This
should be a function of the volatility of earnings and cashflows in your business. A technology
firm should have a higher probability of bankruptcy for any given level of earnings than a food
processing firm. The other is the cost of bankruptcy - especially indirect costs. Firms that
produce assets with long lives and a need for service should have higher indirect costs because
the perception of default can be devastating for their sales.
b. Agency costs: Firms that have intangible assets should be faced with higher agency costs since
lenders will have a tougher time monitoring how the money is used. They should therefore
borrow less.
c. Future Financing Flexibility: If you are in an industry which is in transition or a business
where future investment needs are uncertain, you will value financing flexibility more and
borrow less.
When you do this part of the analysis, you have to recognize two things. One is that it is
subjective. The second is that it will give you a sense of direction rather than a numerical
answer. In other words, you may able to tell me that your firm should have a lot of debt but you
won't be able to tell me whether that is 50% or 70%.
b. Cost of Capital Approach to Optimal Capital Structure
1. Open the attached excel spreadsheet (you can also download the spreadsheet from my web
site under spreadsheets).
2. Before you input any numbers, go into preferences in excel, open the calculation option and
make sure that there is a check in the iteration box.
3. Read the Read me worksheet in the spreadsheet
4. Go to the input page and input the numbers for your firm. Each input box has a comment in it.
Read the comment before you input the value. You can start off using the most recent year's
numbers but may want to come back and normalize some of the numbers (EBITDA) later.
5. For the moment, leave the answers to the last two questions on the input page at their default
levels. (Yes and Yes)
6. Go to the output page. You should see the current and optimal debt ratio for the firm as well
as the current cost of capital and the optimal cost of capital. You will also see the entire schedule
of ratings and costs of equity for every debt ratio. I also calculate the change in value per share
for your firm and do your laundry while I am it.... (Hey... What can I say? I am a full service
operation)
Here is the good news for those of you who are lagging on the project. This spreadsheet will get
you caught up with your hard working teammates.. One final point about the synthetic ratings
worksheet embedded in this spreadsheet. It treats operating leases slightly differently from the
stand alone synthetic rating sheet. This sheet makes the more reasonable assumption that only
the imputed interest expense on the operating leases counts towards the interest coverage ratio.

c. Mechanics on computing optimal debt ratio
I do not want the optimal capital structure spreadsheet to become a black box... So, let me try to
explain some of the things that I am doing in the spreadsheet:
a. Refinancing old debt: As I mentioned in class yesterday, I assume that you have to refinance
all of your old debt at whatever new interest rate you will have at the new debt ratio. Thus, if
you have $ 1 billion in debt at 6% on your books and you increase your debt ratio (thus lowering
your rating) and your interest rate to 8%, I assume that you will be forced to refinance the debt at
8%. This is not that unrealistic. A bank will probably have covenants that allow them to
renegotiate the interest rate on old debt and many corporate bonds today have put clauses
allowing bondholders to reset interest rates in the event of a recapitalization.
b. Firm value calculation: In computing the change in firm value, I calculate the change using
both a perpetuity assumption and a growing perpetuity. In the latter case, I estimate the "implied
growth rate" in your cashflows from your market value but I then cap this growth rate at the
riskfree rate. (I am assuming that the riskfree rate is a good proxy for the long term nominal
growth rate of the economy)
c. Per share value change: To compute the change in value per share, I divide the firm value
change by the primary shares outstanding before the stock buyback. I am assuming that investors
are rational and will demand their share of the spoils when they sell their shares back to the firm.
d. Checking for downside risk
To check for downside risk, there are two paths you can take. One is to reduce your operating
income based upon either past standard deviation in operating income or what happened during
the last recession. Don't do this if your operating income is already depressed. The other is to
constrain your bond rating to be higher than investment grade and computing your optimal debt
ratio with this constraint.
Your final recommendation on debt ratio for your firm should reflect this downside assessment
and may very well be lower than the unconstrained optimal that you computed in the previous
step.
You can also assess what your optimal capital structure would be, if you allow the operating
income to change as the rating changes by using this spreadsheet.
e. Explaining your optimal debt ratio
Once you have your optimal debt ratio, you may want to explain why it is what it is. To do this,
compare your firm's optimal debt ratio to those of others in your group and compare them on
three dimensions:
1. Tax rate: Other things remaining equal, the higher your marginal tax rate, the higher your
optimal debt ratio. (In fact, experiment in your capital structure spreadsheet with a 0% tax rate
and and a 70% tax rate for your firm and see what happens to the optimal debt ratio)
2. Cashflow generating capacity (EBITDA/ (Market value of equity + Market value of debt)):
The higher this ratio, the higher your optimal debt ratio will be. Again, you can have firms that
you categorize as very successful - Microsoft, for example - which have low optimal debt ratios
because their market values are so high.
3. Volatility in Earnings/ Business: This will show up in a couple of places. One is in the cost of
equity (higher unlevered beta) and the cost of debt (lower ratings). The other is when you do the
what-if analysis on your operating income...

f. Other Capital Structure Approaches
If you just want to get a sense of how the APV approach works, you can download the apv.xls
spreadsheet on my web site (I have also attached it to this email). I don't think it will add much to
your analysis and you can skip it if you do not have the time. You can try to do a relative capital
structure analysis of your company by looking at companies in your sector - in fact, use the same
companies you used for your bottom-up levered beta calculation - and run a regression of debt
ratios against fundamentals. This is similar to what I did for Disney with entertainment
companies. You can get the raw data for this regression by going to my web site and
downloading the compfirm.xls spreadsheet which is at the top of the updated data page. Finally,
I have an updated market regression for debt ratio under updated data online (Cross sectional
regression of debt ratio)... You can plug in the numbers for your company to see what its optimal
debt ratio would be
http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html
g. Getting to the optimal debt ratio
Once you have the optimal debt ratio, you need to go through the framework for getting to the
optimal. Here are the steps:
Step 1: Evaluate whether you have the luxury of time. If you have an underlevered firm, you are
looking at the likelihood of being taken over in a hostile acquisition. Make a judgment based
upon
a. The market cap of the firm: The larger the market cap, the smaller the likelihood
b. Insider holdings: The greater the insider holdings, the lower the likelihood
c. Jensen's alpha: The more negative the alpha, the greater the likelihood
If you have an overlevered firm, you are looking at the likelihood of bankruptcy. Your best
assessment will come from the bond rating of the firm. If it is below investment grade, the
chance of bankruptcy is high.
Step 2: Examine whether your company has good investment opportunities. You can get a
partial picture by computing the EVA and ROC for the firm. If they are positive and you believe
that this will hold for future projects, you should invest in projects with your excess debt
capacity (if you are underlevered) or with equity (if you are overlevered)
Step 3: Make your recommendation of the best path to the optimal debt ratio for your firm.

Calculation details: The cost of capital at my optimal is higher than the cost of
capital at my current debt ratio. Why does that happen?
1. You are closer to your optimal at the existing debt ratio than at the optimal. Since
the optimal is computed at 10% intervals, a 20% optimal debt ratio indicates that the
true is optimal is between 15 and 25%. If you are at a 13% debt ratio, you may be
closer to the optimal than any 10% increment.
Fix: Do nothing. You are already at your optimal.
2. If you use an actual rating (rather than a synthetic rating) to compute your current
cost of capital, and your actual rating is much higher than your synthetic rating, you
may find that your fhat the current cost of capital is lower than your optimal.
Fix: Switch to a synthetic rating in the optimal capital structure spreadsheet.
3. If you use a synthetic rating, you may still have a mismatch between your actual
interest expenses and the estimated interest expenses. If you have a lot of your debt
at low rates on your books (either because you used short term debt or you were
able to borrow at lower rates in earlier periods), your interest coverage ratio will be
high when you use actual interest expenses. The spreadsheet computes the interest
expenses at each debt ratio by taking the dollar debt and multiplying by the updated
long-term interest rate (based upon the rating at each level of debt). For example, if
you have $ 4 billion in debt and your firm value is $ 10 billion, your current debt
ratio is 40%. If your current interest expense is $ 200 million, it is used to compute
your synthetic rating. Assume that you compute a pre-tax cost of debt of 10% at at
40% debt ratio. The spreadsheet will compute your interest expenses to be $ 400
million and compute an interest coverage ratio and rating using this expense.
Fix: Say no to the default question of whether you want existing debt to be
refinanced at the new rate. Be careful, though. This debt will eventually have to be
refinanced at the higher rates and the spreadsheet is giving you some advance
warning.
4. If you have only or primarily operating leases as debt, you may find that the
interest rate at your existing debt ratio is higher than the interest rate that you
compute at your optimal (even though the optimal interest rate is more debt). This
comes about because the interest expense on operating leases is computed first with
a conservative interest rate (estimated by treating operating leases as debt) and then
used to compute a synthetic rating. The spreadsheet itself uses a more reasonable
estimate of your rating.
Fix: You can go into your ratings worksheet in your capital structure spreadsheet
and change the EBIT and interest expenses to include only imputed interest
expenses on operating leaese PV rather than the entire expense. On second thought,
send your capital structure spreadsheet to me and I will make the fix for you.
h. Designing the perfect debt
1. 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.
2. You should also try to do a quantitative analysis of your debt. I have attached a spreadsheet
that has built into it the macro-economic data that you need - interest rates, inflation, GDP
growth and the weighted dollar. 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 + Debt); you can use book value of debt
because it will be difficult to estimate market value for each period.
I have to warn you in advance that these regressions are exceedingly noisy and the spreadsheet
also includes bottom-up estimates by industry. The industries are listed by SIC code and you can
find your company's SIC code by going to compfirm.xls, the spreadsheet with individual firms
on my web site.

VI. Dividend Policy
1. Qualitative Analysis of Dividend Policy
Step 1: Examine how much your company pays in dividends and how much it bought back in
stock over each of the last 5 years. The best place to get this information is the statement of
cashflows.
Step 2: Examine the following qualitative factors to make a judgment on what you would expect
your company to be paying in dividends:
a. Investment opportunities: Look at both your EVA calculation and how much your company
invested in capital spending and acquisitions. The better your investment opportunities, the less
you should return to stockholders.
b. Stability of Earnings: If your earnings are volatile, you should pay less in dividends (and
perhaps shift to stock buybacks). To make an assessment of earnings stability, use both common
sense (tech earnings are much more volatile than food processing earnings) and your firm's own
earnings history. (try computing a standard deviation in earnings)
c. Signalling needs: If you are smaller firm with no or very few analysts following you, you may
choose to use dividends as a signal and end up with more dividends.
d. Capital structure and bondholder constraints: If you are overlevered (from your capital
structure) analysis, you should not be paying dividends. If you are underlevered, you may want
to pay out more.
e. Stockholder characteristics: There will be an element of self-fulfilling prophecy here. If you
have historically paid dividends, you have probably accumulated an investor clientele who likes
dividends.
Based upon the qualitative factors, make a judgment on how much your company should be
paying in dividends.
Step 3: Compare the actual dividend policy to your expected dividend policy. At this stage,
remember that a policy of not paying dividends is also a dividend policy and has to be justified
or rejected.
2. A Framework for analyzing Dividend Policy
Step 1: Collect the information to compute the FCFE every year for your company for the last 5
years. This information should be in the statement of cashflows each year. In making this
assessment, consider the following:
a. Start with the net income each year and add back the non-cash charges (depreciation,
amortization and other non-cash charges)
b. Subtract out capital expenditures. If there were cash acquisitions done during the period, add
the value of these acquisitions to the cap ex. If you are using a statement of cashflows, the cap ex
number will already be a negative cashflow. (Don't take a negative of a negative and make cap
ex a positive cashflow)
c. Subtract out changes in non-cash working capital. You can get the individual items out of the
10K statement of cashflows or look at the Bloomberg summary of the statement of cashflows (in
the description) where you consolidate the non-cash working capital. Here again, the sign on the
cashflow should tell you whether non-cash working capital changes are creating positive or
negative cashflows.
d. You should end up with the FCFE each year
You can use the spreadsheet on my web site to do this.
Step 2: Compare the cash returned by your firm to its stockholders each year over the same
period. The dividends and the stock buybacks should both be reported in the statement of
cashflow. If your company has both stock buybacks and stock issues in the same year, it is
probably best not to net them out and to focus on the stock buybacks alone.
Step 3: Retrieve the EVA and Jensen's alpha you have already computed for your firm. There
are four possibilities:
Scenario 1: Positive EVA, Positive Jensen's alpha: Firms with good projects delivering higher
than expected returns
Scenario 2: Positive EVA, Negative Jensen's alpha: Firms with good projects but project returns
were not as high as expected
Scenario 3: Negative EVA, Positive Jensen's alpha: Bad projects but returns may be improving
and are better than expected
Scenario 4: Negative EVA. Negative Jensen's alpah: Bad projects delivering less than expected
returns

Calculation details:
1. Where can I get stock returns and information on interest rates for earlier years?
The data can be obtained by going to updated data on my web site and clicking on historical
returns. You need the stock returns and the T.Bill rates for each of the years for which you have
data.
2. If my company has both stock issues and buybacks, should I net out stock issues against
buybacks?
No. Stick with just the stock buybacks.
3. My FCFE jump around from year to year. Should I be worried?
This is normal. That is why you estimate the average FCFE over the period and compare it to
the average dividends +stock buybacks over the same period.
4. Where can I get returns on my stock each year for the dividends spreadsheet?
The FA print out from Bloomberg has returns on your stock each year for the last 10 years.
3. Making a recommendation on dividend policy
If your firm is not paying out as much as it can afford to but returns scenario 1 (from step 3 of
last part): let company accumulate cash and give it freedom to set dividend policy it wants
If your firm is not paying out as much as it can afford to but returns scenario 2 (from step 3 of
last part): Give it freedom to set dividend policy but watch trend in returns; if returns continue to
drop you may revisit the question
If your firm is not paying out as much as it can afford to but returns scenario 3 or 4 (from step 3
of last part): Company should return cash to stockholders
If your firm is paying more than it can afford to but returns scenario 1 (from step 3 of last part):
Company should stop returning cash to stockholders and invest in projects
If your firm is paying out more than it can afford to but returns scenario 2 (from step 3 of last
part): If downward trend in returns is long term, continue to pay out cash. It it can be reversed,
invest in projects
If your firm is paying out more than it can afford to but returns scenario 3 or 4 (from step 3 of
last part): Company should stock returning cash and fix its investment problem. Fixing the
investment problem (investing less in bad projects) may make its dividend problem go away.
.
VII. Valuation
1. Which valuation spreadsheet should I use to value my company?
Use the fcffsimpleginzu.xls model, It is a malleable model, that should work for most firms. You
can adapt it, if you want.
2. How do you deal with stable growth in each of the models?
In all of the spreadsheets
a. You can make the model a stable growth model by setting the high growth period to zero.
You can also make any of these models a 3-stage growth model by saying yes to the question of
whether you want your inputs to adjust gradually during the second half.
b. There is an industry average worksheet in each spreadsheet that provides industry average for
relevant variables for your industry
c. Even though your valuation may use accounting data which is old, the value is a current value
and should be compared to the market price today.
d. In stable growth, observe the limit on the stable growth rate. Set it less than or equal to the
riskfree rate.
e. When you put your company into stable growth, try to adjust the inputs for the model to stable
growth levels. In particular
- Move beta towards one. (The rule of thumb is that beta should be between 0.8 and 1.2)
- If your ROE (ROC) is higher than the industry average, move it towards the industry average
in stable growth. If your ROE (ROC) is less than cost of equity (cost of capital), move it to the
cost of equity (cost of capital) in stable growth
f. Make sure you input everything in the same units. If you enter your earnings in million, the
number of shares also have to be entered in millions.
3. If you are using the fcffsimpleginzu spreadsheet, what are the key inputs to the model?
If you are using the fcffginzu.xls spreadsheet:
* Make sure that you check the iteration box under calculation options before you start doing
anything.
* You can get the information on options outstanding from your latest 10K. Just enter the total
number of options outstanding, the average exercise price and the weighted average strike price
from that table into the spreadsheet. (I use all options, not just the vested ones.)
* As with the equity valuation model, it is best to let the model compute the reinvestment rate in
stable growth from your stable period ROC.
4. What do I do if I have a money losing company?
If you have a money losing company, you have probably had an easy ride so far. Your optimal
debt ratio was probably zero or close to zero and your firm certainly could not afford to pay
dividends, but I am afraid the good times are over when you get to the valuation stage. As you
have already probably realized, you cannot grow a money losing company out of trouble since
the losses et only bigger. The use of reinvestment rates and returns on capital to get expected
growth rates won't work because you have negative returns on capital and reinvestment rates. To
value your firm, you will have to do the following:
1. Start with revenue growth: It is the only number on your income statement that is guaranteed
to be positive. You can either forecast revenue growth based upon the company's history or you
can look for a forecast of growth. Alternatively, you can look at growth rates for the industry.
2. Estimate future operating margins: The key to valuing these companies is to make the
negative margin that they have now into a positive margin in the future. Rather than try to
forecast what the margin is year by year, I would try to forecast a target margin 5 or 10 years
out. I would adjust the margin from current levels to the target level. Again, industry average
operating margins make sense.
3. Estimate reinvestment: You will need to still reinvest money to get the revenue growth. If
current cap ex and depreciation numbers look strange or give weird results, you can use a sales
to capital ratio to estimate reinvestment in future years. A sales to capital ratio of 3, for instance,
would indicate that for every $3 in additional revenues, you will invest a $ 1 in new capital. The
industry average sales to capital ratios may be worth looking at.
4. Adjust the cost of capital inputs: Troubled firms can have high betas and sometimes high debt
ratios. You can adjust both to more reasonable levels over time.
The fcffsimpleginzu.xls spreadsheet allows you to do all of the above. You may still find your
equity to be worth little or even a negative amount. (The latter can happen if the value that you
get for the firm is less than the outstanding debt). Since a stock cannot trade for less than zero,
your estimate of value would then be zero for the stock.

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