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Valuations

Aswath Damodaran

Aswath Damodaran

169

Companies Valued
Company Model Used Con Ed Stable DDM ABN Amro 2-Stage DDM S&P 500 2-Stage DDM Sony Stable FCFE Nestle 2-Stage FCFE Brahma 3-Stage FCFE DaimlerChrysler Stable FCFF The Home Depot 2-stage FCFF Bristol Myers 2-stage FCFF Amazon.com n-stage FCFF Remarks Dividends=FCFE, Stable D/E, Low g FCFE=?, Regulated D/E, g>Stable Collectively, market is an investment Understated Earnings? Dividends≠FCFE, Stable D/E, High g Dividends≠FCFE, Stable D/E,High g Normalized Earnings; Stable Sector Capitalizing Operating Leases Capitalizing R&D Varying margins over time

Aswath Damodaran

170

General Information
n

n

The risk premium that I will be using in the 1999 and 2000 valuations for mature equity markets is 4%. This is the average implied equity risk premium from 1960 to 2000. For the valuations from 1998 and earlier, I use a risk premium of 5.5%.

Aswath Damodaran

171

DDM model firm • The beta is 0. based upon size and the area that it serves.2% Aswath Damodaran 172 . – Average Annual FCFE between 1994 and 1999 = $553 million – Average Annual Dividends between 1994 and 1999 = $ 532 million – Dividends as % of FCFE = 96.Con Ed: Rationale for Model n n The firm is in stable growth. It is unlikely that the regulators will allow profits to grow at extraordinary rates. • The firm is in stable leverage. • The firm pays out dividends that are roughly equal to FCFE. Firm Characteristics are consistent with stable.80 and has been stable over time. Its rates are also regulated.

1% + 0.15 Dividend Payout Ratio over the 4 quarters = 69.03 / (.03) = $ 42. 2000 Aswath Damodaran 173 .083 -. 2000 n n n n n n Earnings per share for trailing 4 quarters = $ 3.21% Dividends per share for last 4 quarters = $2.18 *1.80*4% = 8.60 on December 31.Con Ed: A Stable Growth DDM: December 31.18 Expected Growth Rate in Earnings and Dividends =3% Con Ed Beta = 0.80 (Bottom-up beta estimate) Cost of Equity = 5.37 The stock was trading at $ 38.30% Value of Equity per Share = $2.

00 $30.60 $40.00 $10.Con Ed: Break Even Growth Rates Con Ed Value versus Growth Rate $80.00% -2.00 $20.00 Implied Growth Rate: Value per share = $ 38.00% -3.00% 2.00% Expected Growth Rate Aswath Damodaran 174 .00% 0.00 $60.00% 4.00% 1.00% 3.00 $70.00% -1.00 5.00 $0.00 Value per Share $50.

083 -g) • Implied growth rate = 2.10) = 3.08% Aswath Damodaran 175 .60 = $2.Estimating Implied Growth Rate n To estimate the implied growth rate in Con Ed’s current stock price. and solve for the growth rate: • Price per share = $ 38.79% and its return on equity in 1999 of 10%. we set the market price equal to the value.3079*.51% n Given its retention ratio of 30. the fundamental growth rate for Con Ed is: Fundamental growth rate = (.18 *(1+g) / (.

The first is that you are right and the market is wrong. The second is that the market is right and that you are wrong. Will you definitely profit from your investment? Yes No Aswath Damodaran 176 .Implied Growth Rates and Valuation Judgments n When you do any valuation. The third is that you are both wrong. there are three possibilities. and that you are right and the market is wrong. which is the most likely scenario? n o o Assume that you invest in a misvalued firm. In an efficient market.

00 $1: December 1997 2: December 1998 Date of Valuaton 3: June 1999 Aswath Damodaran 177 .00 Estimated Value Price per Share $20.Con Ed: A Look Back Con Ed: Valuations over Time $60.00 $40.00 $50.00 Per Share $30.00 $10.

56% and a retention ratio of 62. estimating FCFE or FCFF is very difficult.73%.5% is 9. The expected growth rate based upon the current return on equity of 15.ABN Amro: Rationale for 2-Stage DDM n n As a financial service institution. This is higher than what would be a stable growth rate (roughly 5% in Euros) Aswath Damodaran 178 .

33% (b=g/ROE) Expected growth .02% • Risk Premium = 4% (U.95 1.56% 15% (Industry average) Payout Ratio 37.60 Eur.02% n Aswath Damodaran 179 .0973 5% (Assumed) Beta 0.00(4%) =8.00 Cost of Equity 5.02%+1.5% 33.82% =9.02%+0.5% 66.67% Retention Ratio 62.S.1556*.60 Eur. premium : Netherlands is AAA rated) Current Earnings Per Share = 1.ABN Amro: Summarizing the Inputs n Market Inputs • Long Term Riskfree Rate (in Euros) = 5.625=. Variable High Growth Phase Stable Growth Phase Length 5 years Forever after yr 5 Return on Equity 15.95(4%) 5. Current DPS = 0.

62+0.05) = 2.87 0.72 0.79 Eur Value Per Share = 0.62+0.05) = 42.41 Eur PV of Terminal Price = 42. 2000 Aswath Damodaran 180 .60 2 1.79 0.32 0.61 3 2.61+0.66 0.79 = 30.76 0.63 Expected EPS in year 6 = 2.0882)5 = 27.42/(1.0902-.54(1.62 4 2.95 0.667=1.60 + 0.67 Eur Expected DPS in year 6 = 2.11 0.33 Euros on December 31.62 5 2.78 Eur Terminal Price (in year 5) = 1.87 Eur The stock was trading at 24.63+27.93 0.ABN Amro: Valuation Year EPS DPS PV of DPS 1 1.54 0.78/(.67*0.

667)/(..02% + Beta 0.82% Riskfree Rate : Long term bond rate in the Netherlands 5.95 X Risk Premium 4% Average beta for European banks = 0.5% * 15.0902-..41 Value of Equity per share = 30.67.87 Eur 0. avg) Beta = 1.00 Payout = (1.VALUING ABN AMRO Dividends EPS = 1..60 Eur Expected Growth 62..60 Eur * Payout Ratio 37.79 Eur 0.5/15) = .99 Mature Market 4% Country Risk 0% Aswath Damodaran 181 .. Forever Discount at Cost of Equity Cost of Equity 5.87 Eur 0.02% + 0.72 Eur 0.667 Terminal Value= EPS 6*Payout/(r-g) = 2.95 (4%) = 8..95 Eur ..66 Eur 0.05) = 42.5% DPS = 0..56% = 9.73% g =5%: ROE =15% (Ind.

r (r-gn ) + DPS 0 r Value of Stable Assets in Growth Place DPSt = Expected dividends per share in year t r = Cost of Equity Pn = Price at the end of year n gn = Growth rate forever after year n Aswath Damodaran 182 Value of High Growth .The Value of Growth n In any valuation model. In the case of the 2-stage DDM. it is possible to extract the portion of the value that can be attributed to growth. and to break this down further into that portion attributable to “high growth” and the portion attributable to “stable growth”. this can be accomplished as follows: t=n P0 = DPS Pn ∑ (1+r)tt + (1+r)n t=1 - DPS 0 *(1+g n ) (r-gn ) + DPS 0 *(1+g n ) DPS 0 .

6.(6.60 Eur/.05)/(.0882-.87 .(6.02) = 15.0882 = 6.60 (1.65+ 9.65 Eur Value of Stable Growth = 0.05) .65+9.20 Eur Aswath Damodaran 183 .ABN Amro: Decomposing Value n n n Value of Assets in Place = Current DPS/Cost of Equity = 0..65 NG = 9.02 Eur Value of High Growth = Total Value .02) = 30.

The consensus estimate of growth in earnings (from Zacks) is roughly 10%. The dividends during the year should provide a reasonable (albeit conservative) estimate of the cash flows to equity investors from buying the index. Though it is possible to estimate FCFE for many of the firms in the S&P 500. there is reason to believe that the earnings at U. Aswath Damodaran 184 .S & P 500: Rationale for Use of Model n n While markets overall generally do not grow faster than the economies in which they operate. companies (which have outpaced nominal GNP growth over the last 5 years) will continue to do so in the next 5 years.S. it is not feasible for several (financial service firms).

25% 5.25% Expected Growth 7.1% • Risk Premium for U.00 Aswath Damodaran 185 .5% Beta 1. Equities = 4% • Current level of the Index = 1320 Inputs for the Valuation High Growth Phase Length 5 years Dividend Yield 1.S.5% (Nominal US g) 1.00 n Stable Growth Phase Forever after year 5 1.S &P 500: Inputs to the Model (12/31/00) n General Inputs • Long Term Government Bond Rate = 5.

35 $16.55 $17.07 3 $20.74 2 $19.55 $462.1% Terminal Value = 23.091 -.50 4 $22.055) = 691.69*1.S & P 500: 2-Stage DDM Valuation 1 Expected Dividends = Expected Terminal Value= Present Value = Intrinsic Value of Index = $16.73 Cost of Equity = 5.04 5 $23.055/(.55 Aswath Damodaran 186 .1% + 1(4%) = 9.26 $526.69 $691.02 $15.78 $15.

Aswath Damodaran 187 . • The expected growth in earnings over the next 5 years will be much higher than 7.5%. • The risk premium used in the valuation (4%) is too high • The market is overvalued. This indicates that one or more of the following has to be true. while the model valuation comes in at 526. • The dividend discount model understates the value because dividends are less than FCFE.Explaining the Difference n The index is at 1320.

S. nThe implied risk premium between 1960 and 1970. nWith these inputs in the model: 1 2 3 4 5 Expected Dividends = $35. which was when long term rates were as well behaved as they are today.44 Intrinsic Value of Index = $1.62 At a level of 1320.27 $1.25%/.00 $44.459.A More Realistic Valuation of the Index nThe median dividend/FCFE ratio for U. Thus the FCFE yield for the S&P 500 should be around 2. is 3%.329.5).48 $38.07 $47.45 $32.915.5% (1. Aswath Damodaran 188 .63 $32.38 Expected Terminal Value = $1.14 $41. firms is about 50%.07 Present Value = $32. the market is undervalued by about 10%.82 $32.

Sony: Background on Japanese firms n Japanese firms have proved to be among the most difficult of all firms to value for several reasons: • The earnings in 1999 for most Japanese firms was depressed relative to earnings earlier in the decade and in the 1980s. as firms are allowed to set aside provisions for unspecified expenses • The earnings of many export oriented Japanese firms tends to be heavily influenced by exchange rate movements • The cross holdings that Japanese firms have in other firms. Aswath Damodaran 189 . and the lack of transparency in these holdings. makes it difficult to value these holdings. reflecting the Japanese economy • Japanese accounting standards tend to understate earnings and overstate book value of equity.

The firm paid out dividends of 21 billion JPY in 1999. The long term government bond rate in Japan was 2% at the time of this valuation. Capital expenditures in 1999 amounted to 103 billion JPY. Aswath Damodaran 190 .13% in 1999. The return on equity at Sony dropped from 5.48%. yielding a non-cash working capital to revenue ratio of 8. Non-cash working capital at Sony in 1999 was 220 billion JPY on revenues of 2593 billion yet. down from 76 billion JPY in 1997 and 38 billion in 1998.25% in 1997 to 2. whereas depreciation is 76 billion JPY.Valuing Sony: August 2000 n n n n Sony had net income of 31 billion JPY in 1999.

25%. To normalize earnings.48% of revenues Sony’s current book debt to capital ratio is 25.8%.5%.10. the growth rate in revenues has been 3. We will assume a long term stable growth rate of 3% (higher than the Japanese economy due to global exposure) We will assume that the net capital expenditures will grow at the same rate and that non-cash working capital will stay at 8. which is the return on equity that Sony had last year and is close to return on equity it used to earn in the early 1990s. we will use the return on equity of 5. we will assume that they will finance reinvestment with this ratio (rather than the market value) We will use a beta of 1. We will assume that the firm’s dominant market share will keep it from posting high growth. to reflect the unlevered beta of electronic firms (globally) and Sony’s market value debt to equity ratio (16%) Aswath Damodaran 191 .Sony: Rationale for Model n n n n n We will normalize earnings to reflect the fact that current earnings are depressed. Over the last 5 years.

81 billion Current Revenues = 2593 billion Expected Revenues next year = 2593(1.60 billion JPY n n Book Value Debt Ratio = 25.10 (4%) = 6.76) = 27 billion JPY Expected Net Capital Expenditures = 27 billion (1.Estimating the Inputs n Normalized Earnings: • Book Value of Equity (3/1999) = 1795 billion JPY • Estimated Return on Equity = 5.24 billion n Reinvestment Needs • • • • • Current Net Capital Expenditures = (103 .25% • Normalized Net Income next year = 1795 billion * .8% Cost of Equity = 2% + 1.03) = 2671 billion Expected Change in non-cash Working Capital = (2671 .0525 = 94.40% 192 Aswath Damodaran .0848 = 6.2593)*.03) = 27.

Value of Equity = 68.89 =68..71 billion / (. Stable growth rate = 3%.31) FCFE = 94.(Net Cap Ex) (1.0 (1-.31) .The Valuation n Expected FCFE next year Expected Net Income .(∆ Non-cash WC) (1-Debt ratio) = 6.64 = 4.6 (1-.4%.Debt Ratio)= 27.03) = 2021 billion JPY n Sony was trading at a market value of equity of 7146 billion JPY Aswath Damodaran 193 .24 billion = 20.064 .71 billion JPY Valuation n Cost of Equity = 6.

The Effect of Cross-holdings n n n When firms have minority passive holdings in other companies. they report only the dividends they receive from these holdings as part of net income. we have to estimate the value of the companies in which these holdings are. To value them right. Aswath Damodaran 194 . Consequently. and then take the percentage of the value of these firms owned by the firm you are valuing. we tend to understate the value of these crossholdings in valuations.

6% and is unlikely to change that leverage materially. Nestle has paid less in dividends than it has available in FCFE. (How do I know? I do not. but the fundamentals at the firm suggest growth in EPS of about 11%.) Like many large European firms.Nestle: Rationale for Using Model n n n Earnings per share at the firm has grown about 5% a year for the last 5 years. I am just making an assumption. (Analysts are also forecasting a growth rate of 12% a year for the next 5 years) Nestle has a debt to capital ratio of about 37. Aswath Damodaran 195 .

00% 9.63% 65.85 16% NA 5.Nestle: Summarizing the Inputs n General Inputs • Long Term Government Bond Rate (Sfr) = 4% • Current EPS = 108.85 23.88 Sfr.820 Sfr • Capital Expenditures/Share=114. Depreciation/Share=73.2 Sfr.38% 9.10% (Current) 15.60% Current Ratio Stable Growth Forever after yr 5 0.30% (Existing) 37.8 Sfr Length Beta Return on Equity Retention Ratio Expected Growth WC/Revenues Debt Ratio Cap Ex/Deprecn Aswath Damodaran High Growth 5 years 0.60% 150% 196 . Current Revenue/share =1.30% (Grow with earnings) 37.

Estimating the Risk Premium for Nestle Revenues Weight Risk Premium North America 17.26% n Cost of Equity = 4% + 0.85 (5.8 8.10% 12.1 1.10% 4.00% Eastern Europe 4 5.00% Switzerland 1.5 100.00% 5.00% Rest of W.00% Total 70.82% 4.67% 8.5 24.47% Aswath Damodaran 197 .4 26.56% 4.00% Italy/Spain 6.50% Asia 5.4 9.26%) = 8.00% South America 4.00% Germany/France/UK 18.3 6.44% 4.23% 9.26% n The risk premium that we will use in the valuation is 5.08% 5. Europe 13 18.

1999 Aswath Damodaran 198 .05)(.85(1-.5)= 78.04 2 3 4 5 $144.79 $92.25 $192.5 Sfr Chg in WC6 =( Rev6 .50 =73.65 $51.54 $38.093)=13.13.1538)5(.57 .35 $78.05) = 3890.70 $44.75 $21.7 Earnings .(Net CpEX)*(1-DR) -∆ WC*(1-DR) Free Cashflow to Equity Present Value Earnings per Share in year 6 = 222.376) .0847-.85 Sfr FCFE6 = 231.25 $80.Nestle: Valuation 1 $125.92 $123.78 +$89.07 $16.52 $18.8(1.57 Net Capital Ex 6 = Deprecn’n6 * 0.37 $142.7 +3890/(1.04 +$78.12 $94.1538)5(1.0847)5=3011Sf The stock was trading 2906 Sfr on December 31.78 $89.76 $83.376)= 173.66 $33.95 $167.66(1.63 $29.Rev5)(.78.76 +$83.05)(.093) = 1538(1.31 $74.96 $28.63 $24.98 $222.16 Sfr Value=$74.93/(.67 $106.93 Sfr Terminal Value per Share = 173.5(1-.05) = 231.12 +$94.

the terminal value would have been: FCFE6 = 231.13.91 Sfr n Aswath Damodaran 199 .7 + 4986/(1.78 +$89.Nestle: The Net Cap Ex Assumption In our valuation of Nestle.93/(.12 +$94. we had assumed that net cap ex was zero. If. instead. we assumed that cap ex would be 150% of depreciation in steady state.0847)5= 3740.05) = 4986 Sfr Value= =$74.93 Sfr Terminal Value per Share = 222.04 +$78.85(1-.0847 -.76 +$83.376) = 222.57 . as many analysts do.

.2363=15.35 Sfr .67 Sfr 106.88 .651*...19 .85.05) = 3890 Forever Value of Equity per Share = 3011 Sfr 80.31 Sfr 92.DR) 25. Discount at Cost of Equity Cost of Equity 4%+0.6% A VALUATION OF NESTLE (PER SHARE) Expected Growth Retention Ratio * Return on Equity =.38% Cashflow to Equity Net Income 108.26% Aswath Damodaran 200 .93/(.37 Sfr 142..92 Sfr 123.85(5.28 Firm is in stable growth: g=5%..79 Market D/E=11% Base Equity Premium: 4% Country Risk Premium:1.. Beta=0..Depr) (1.26%)=8. Cap Ex/Deprec=150% Debt ratio stays 37.0847-.26% Bottom-up beta for food= 0.Financing Weights Debt Ratio = 37.6% Terminal Value= 173.85 X Risk Premium 4% + 1.41 = FCFE 79.47% Riskfree Rate : Swiss franc rate = 4% + Beta 0..(Cap Ex .Change in WC (!-DR) 4.

The Effects of New Information on Value n No valuation is timeless. Each of the inputs to the model are susceptible to change as new information comes out about the firm. • Market Wide Information – Interest Rates – Risk Premiums – Economic Growth • Industry Wide Information – Changes in laws and regulations – Changes in technology • Firm Specific Information – New Earnings Reports – Changes in the Fundamentals (Risk and Return characteristics) Aswath Damodaran 201 . its competitors and the overall economy.

which was 5.5 Sfr instead of 108.8 Sfr. n There are two effects on value: • The drop in earnings will make the projected earnings and cash flows lower. is expected to shrink to 5. The after-tax margin. This will reduce expected growth.Nestle: Effects of an Earnings Announcement n Assume that Nestle makes an earnings announcement which includes two pieces of news: • The earnings per share come in lower than expected. The base year earnings per share will be 105.79%. • Increased competition in its markets is putting downward pressure on the net profit margin. even if the growth rate remains the same • The drop in net margin will make the return on equity lower (assuming turnover ratios remain unchanged).98% in the previous analysis. Aswath Damodaran 202 .

26% Aswath Damodaran 203 ..Depr) (1.48 Sfr 88.04 Sfr 101.79 Market D/E=11% Base Equity Premium: 4% Country Risk Premium:1.85.84/(.26% Bottom-up beta for food= 0.Change in WC (!-DR) 4.32 Sfr .47% Riskfree Rate : Swiss franc rate = 4% + Beta 0.DR) 25.41 = FCFE 75..6% A RE-VALUATION OF NESTLE (PER SHARE) Expected Growth Retention Ratio * Return on Equity =. Beta=0.12% Cashflow to Equity Net Income 105..2323 =15.0847-.85(5.Financing Weights Debt Ratio = 37..05) = 3687 Forever Value of Equity per Share = 2854 Sfr 76.35 Sfr 116.50 .68 Sfr 134..26%)=8.19 ..90 Firm is in stable growth: g=5%. Discount at Cost of Equity Cost of Equity 4%+0...6% Terminal Value= 164. Cap Ex/Deprec=150% Debt ratio stays 37.(Cap Ex .85 X Risk Premium 4% + 1.651*.

it has done so while maintaining high returns on capital.Brahma: Rationale for Using Model n n n n Brahma has not only maintained high growth rates in the face of strong competition in the last few years in Brazil.50% will remain unchanged. The fundamentals suggest that growth will continue to be high. growth seems sustainable for a longer period. Real 3-Stage FCFE Model Aswath Damodaran 204 . The analysis will be done in real BR to avoid inflation estimation problems. Given the size of the market and potential growth (as well as the strong brand name identification). The current debt to capital ratio of 43. The leverage is stable.

Premium + 6.70 BR/share Depreciation per Share = 25.S.Brahma: Summarizing the Inputs n General Inputs • • • • • Riskfree Rate = 5% (Set equal to real growth rate in Brazil) Risk Premium = 11.8% (U.33 BR/share Aswath Damodaran 205 .28 BR/share Revenues per Share = 328.3% based on country risk) Capital Expenditures per Share = 54.

00 Risk Premium 5.5%+2% ROE (Real) 22.80 Moves to 1.Brahma: Inputs for the 3 Stages High Growth Transition Phase Stable Growth Length 5 years 5 years Forever after yr 10 Beta 0.5%+6.00 1.3% 5.23% Retention Ratio 66.82% Moves to 5% 5% Cap Ex/Deprecn Current Current 150% Working Capital 5% of Revenues. which grow at same rate as earnings Aswath Damodaran 206 .50%+3% 5.64% Not used to estimate growth Expected Growth 14.

53 BR 19.28 3 BR 67.81 BR 40.07 6 12.51 BR 2.36 BR 1.35 BR 84.96 8 8.56 BR 48.89% 25.58 BR 35.00% 53.Brahma: Projected Cash Flows n High Growth Phase 1 BR 51.43 BR 2.06 BR 45.25 2 BR 59. WC*(1-DR) FCFE n Transition Phase Year Real Growth Rate Cumulated Growth Earnings (CapEx-Deprn)*(1-DR) Chg.08 BR 47.76 BR 80.85% BR 101.09 BR 50. WC *(1-DR) FCFE Aswath Damodaran 207 .37 BR 31.96% 45.09% BR 137.93% 36.85% 12.93 BR 25.38 BR 61.16 BR 21.06 BR 37.14% BR 112.55 BR 33.89 BR 2.21 BR 2.06 BR 41.39 BR 53.07 BR 74.02 9 6.17 BR 2.27 BR 68.96 Year Earnings (CEx-Depr)*(1-DR) Chg.99 BR 28.31% BR 122.78 BR 1.78 4 BR 77.16 BR 1.44 5 BR 89.91 BR 1.99 10 5.67 7 10.80% BR 130.09 BR 1.

48% 12.88 0.96 1.62 BR Terminal Price = 119.125-.54 BR WC change in year 11= 2.98 BR n Value = PV of FCFEHigh Growth + PV of FCFETransition+ PV of Term price = 136.80 0.40.435) .50% n Terminal Price Earnings in Year 11 = 137.51 BR FCFE in year 11=143.59 = 712.63+131.51(1-.94(1-.94 BR Net Cap Ex in year 11 = 40.62 BR/(.84 .09 (1.44% 12.14% 12.05) = 1594.82% 13.53 BR The stock was trading at about 650 BR on June 5.05) = 143.92 0.16% 13.2. 1998 n Aswath Damodaran 208 .00 Cost of Equity 14.435) = 119.84 0.31+444.Brahma: Valuation Costs of Equity Year 1-5 6 7 8 9 10 Beta 0.

since the real discount rate is so much lower than the nominal discount rate.S.Brahma: Real versus Nominal Valuation n o o n This valuation was done in real terms. Assume now that you are told that you are over valuing the stock. dollars. What inflation rate should you use to estimate the cash flows? Aswath Damodaran 209 . Is this true? Yes No You are also looking at a valuation of Brahma done in U.

we will use the FCFF model. the debt ratio will probably change over time. Since this is a relatively new organization. Hence. with two different cultures on the use of debt (Daimler has traditionally been more conservative and bank-oriented in its use of debt than Chrysler). We will therefore assume that the firm is in stable growth.DaimlerChrysler: Rationale for Model n n DaimlerChrysler is a mature firm in a mature industry. Aswath Damodaran 210 .

211 Aswath Damodaran .324 million DM and had an effective tax rate of 46. Daimler Chrysler had earnings before interest and taxes of 9. The long term German bond rate is 4. We will assume that the firm will maintain a long term growth rate of 3%.5 billion The bottom-up unlevered beta for automobile firms is 0. DaimlerChrysler had an after-tax return on capital of 7. while the estimated market value of debt is 64.94%.Daimler Chrysler: Inputs to the Model n n n n n n In 1999. Based upon this operating income and the book values of debt and equity as of 1998.3 billion DM. The market value of equity is 62.87% (in DM) and the mature market premium of 4% is used. and Daimler is AAA rated.15%.61.

Daimler/Chrysler: Analyzing the Inputs n n Expected Reinvestment Rate = g/ ROC = 3%/7.5/62.3+64.62% Aswath Damodaran 212 .69% (64.95 Cost of Equity = 4.15% = 41.98% Cost of Capital • • • • Bottom-up Levered Beta = 0.87% + 0.5)) = 5.87% + 0.3/(62.1%(62.5/(62.61 (1+(1-.94 (4%) = 8.20%) (1-.65% After-tax Cost of Debt = (4.5))+ 2.3)) = 0.4694)(64.4694)= 2.69% Cost of Capital = 8.3+64.

847 mil DM 18.03) = + Cash + Marketable Securities = Value of Firm = .7 DM per share Stock was trading at 62.915 mil DM 64.Debt Outstanding = Value of Equity = Value per Share = 72.068 mil DM 130.Daimler Chrysler Valuation n Estimating FCFF Expected EBIT (1-t) = 9324 (1.957 mil DM 112.096(.056-.412) = Expected FCFF next year = 5. 2000 Aswath Damodaran 213 .488 mil DM 66.4694) = Expected Reinvestment needs = 5.139 mil DM 2.427 mil DM n Valuation of Firm Value of operating assets = 5096 / (.096 mil DM 2.2 DM per share on August 14.03) (1-.

can you think of a way around this problem? Aswath Damodaran 214 . which is calculated using the market values of equity and debt. we use the cost of capital. We then use the present value of the FCFF as our value for the firm and derive an estimated value for equity.Circular Reasoning in FCFF Valuation n o o n In discounting FCFF. Is there circular reasoning here? Yes No If there is.

While its growth rate has been anemic.Tube Investment: Rationale for Using 2-Stage FCFF Model n n Tube Investments is a diversified manufacturing firm in India. The firm’s financing policy is also in a state of flux as the family running the firm reassesses its policy of funding the firm. there is potential for high growth over the next 5 years. Aswath Damodaran 215 .

120 $2.158 0 61.073 15.20% Stable Growth g = 5%.Nt CpX 843 .23% Unlevered Beta for Sectors: 0.Reinvestment FCFF $4.30) = 9.Debt: =Equity -Options Value/Share 19.080 $5.558) + 9.653 18.092-= .195 $5.8% D = 44.292 $2.775 Discount at Cost of Capital (WACC) = 22.150 = FCFF .17 X Risk Premium 9.60*.487 $3.45% Weights E = 55.2% Country Premium= 3% ROC= 9.2% Riskfree Rate : Real riskfree rate = 12% + Beta 1.079 3.22% Reinvestment Rate=54.304 2.00.23% Aswath Damodaran 216 .378 Firm Value: + Cash: .1478-.868 $4.75 Firm’s D/E Ratio: 79% Mature risk premium 4% Country Risk Premium 5.Chg WC 4.05) = 28.50%)(1-.790 $3.425 .578 13.52 % Return on Capital 9.80% Cost of Debt (12%+1.57 EBIT(1-t) .802 $1.Tube Investments: Status Quo (in Rs) Current Cashflow to Firm Reinvestment Rate 60% EBIT(1-t) : 4.928 $2.957 $1.0552 5.82% Expected Growth in EBIT (1-t) .971 $5. Beta = 1.35% Terminal Value 5= 2775/(.670 $2.568 Reinvestment Rate =112.90% Cost of Equity 22.316 Term Yr 6. Debt ratio = 44.200 $3.8% (.442) = 16.474 $2.45% (0.

The Effects of Return Improvements on Value n n The firm is considering changes in the way in which it invests. Aswath Damodaran 217 . The value of the firm will be higher. which management believes will increase the return on capital to 12.20% on just new investments (and not on existing investments) over the next 5 years. because of higher expected growth.

188 $5.921 Firm Value: + Cash: .Debt: =Equity -Options Value/Share 25.0732 7.75 Firm’s D/E Ratio: 79% Mature risk premium 4% Country Risk Premium 5.122-= .23% Unlevered Beta for Sectors: 0.82% Expected Growth in EBIT (1-t) .425 .2% Country Premium= 3% ROC=12.22% Reinvestment Rate= 40.871 $3.097 $3.520 Discount at Cost of Capital (WACC) = 22.1478-.20% Stable Growth g = 5%.Reinvestment FCFF $4.8% D = 44.073 20.32 % Return on Capital 12.348 $6.Tube Investments: Higher Marginal Return(in Rs) Current Cashflow to Firm Reinvestment Rate 60% EBIT(1-t) : 4.780 $2.568 Reinvestment Rate =112.Nt CpX 843 .05) = 39.765 0 84.17 X Risk Premium 9.282 $2.30) = 9.900 $5.23% Aswath Damodaran 218 .8% (.522 $2. Beta = 1.Chg WC 4.150 = FCFF .442) = 16.653 18.185 13.850 $1.470 $3. Debt ratio = 44.34 Term Yr 6.2% Riskfree Rate : Real riskfree rate = 12% + Beta 1.45% Weights E = 55.98% Terminal Value 5= 3904/(.00.45% (0.60*.558) + 9.50%)(1-.058 $2.749 $2.711 3.300 $3.904 EBIT(1-t) .039 $5.615 2.90% Cost of Equity 22.80% Cost of Debt (12%+1.

092)1/5-1} =.Return Improvements on Existing Assets n n n If Tube Investments is also able to increase the return on capital on existing assets to 12.122-.20%. its value will increase even more.60 +{ (1+(.122*.1313 or 13.13% Aswath Damodaran 219 .092)/. The expected growth rate over the next 5 years will then have a second component arising from improving returns on existing assets: Expected Growth Rate = .20% from 9.

45% (0.20% Improvement on existing assets { (1+(.653 18.50%)(1-.563 $7.529 5.90% Cost of Equity 22. Debt ratio = 44.13 % Terminal Value 5= 5081/(.1313 13.407 $3.22% Reinvestment Rate= 40.568 Reinvestment Rate =112.82% Return on Capital 12.122-.2% Riskfree Rate : Real riskfree rate = 12% + Beta 1.265 $6.122 + .30) = 9.003 $5.45% Weights E = 55.Chg WC 4.092) 1/5-1} Stable Growth g = 5%.558) + 9.829 13.610 3.23% Unlevered Beta for Sectors: 0.081 EBIT(1-t) .425 .Nt CpX 843 .Reinvestment FCFF $5.Tube Investments: Higher Average Return(in Rs) Current Cashflow to Firm Reinvestment Rate 60% EBIT(1-t) : 4.409 0 111.956 Firm Value: + Cash: .004 $2.80% Cost of Debt (12%+1.200 $4.280 Discount at Cost of Capital (WACC) = 22.00.8% (.98% Expected Growth 60*.442) = 16.073 27.899 $8.8% D = 44.920 $3.2% Country Premium= 3% ROC=12.150 = FCFF .006 $3.17 X Risk Premium 9.664 $3.23% Aswath Damodaran 220 .75 Firm’s D/E Ratio: 79% Mature risk premium 4% Country Risk Premium 5.05) = 51.3 Term Yr 8.Debt: =Equity -Options Value/Share 31. Beta = 1.248 $4.398 $2.844 $2.0581 = .1478-.092)/.349 $2.

When doing firm valuation. in turn. it does have significant operating leases. Aswath Damodaran 221 .Dealing with Operating Leases: A Valuation of the Home Depot n n The Home Depot does not carry much in terms of traditional debt on its balance sheet. these operating leases have to be treated as debt. However. will mean that operating income has to get restated. This.

00 $259.00 $222.70 n Aswath Damodaran 222 .92 4 $ 245.513.00 $1.88 2 $ 291.53 5 $ 236.80% Year Commitment Present Value 1 $ 294.647.00 $178.03 6 and beyond $ 270.97 3 $ 264.00 $195.00 $277.Operating Leases at The Home Depot in 1998 The pre-tax cost of debt at the Home Depot is 5.37 n Debt Value of leases = $ 2.

829 mil $ 4.433 mil Operating Lease converted to Debt $ 2.081 mil EBIT EBIT (1-t) Debt Aswath Damodaran 223 .661mil $1.Other Adjustments from Operating Leases Operating Lease Expensed $ 2.730 mil $1.815 mil $1.

45% Riskfree Rate : Government Bond Rate = 5% + Beta 0.9555) + 3.486 Firm Value: 68.799 .949 + Cash: 62 .77% (0.5% Country Risk Premium 0% Aswath Damodaran 224 .87 X Risk Premium 5.52% Cost of Equity 9. Beta = 0.1637= .1451 14. D/(D+E) = 30%.55% D = 4.79% (0.Chg WC 190 = FCFF <160> Reinvestment Rate =108.55 EBIT(1-t) 2095 .05) = 164.86 Firm’s D/E Ratio: 4.021 Value/Share $42.77% Weights E = 95.1% Reinvestment Rate=35.37% Stable Growth g = 5%.8862*.829 88.081 =Equity 64.The Home Depot: A Valuation Current Cashflow to Firm Reinvestment Rate EBIT(1-t) : 1.51 % Return on Capital 16.Reinv 1857 FCFF 238 2399 2126 273 2747 2434 313 3146 2788 358 3602 3192 410 4125 3655 469 4723 4186 538 5409 4793 616 6194 5489 705 7092 6285 807 Discount at Cost of Capital (WACC) = 9.0445) = 9.ROC=14.76% Historical US Premium 5.79% Cost of Debt (5%+ 0.75% Expected Growth in EBIT (1-t) .0792-.Debt: 4.Nt CpX 1.35) = 3.46% Terminal Value 10 = 4806/(.87.5% Unlevered Beta for Sectors: 0.80%)(1-.930 -Options 2.62% .

are really capital expenditures. though treated as operating expenditures. has a significant amount of research and development expenses.Dealing with R&D: Bristol Myers n n Bristol Myers. like most pharmaceutical firms. When R&D expenses are reclassified as capital expenditures. there is a ripple effect on the following: • • • • • Operating income Capital Expendiutures Depreciation and Amortization Reinvestment Rates Return on Capital Aswath Damodaran 225 . by accountants. These expenses.

20 -8 983.10 78.80 -6 1128.00 0.20 176.00 0.30 -5 1108.80 1020.40 433.90 -9 881.00 0.30 294.Converting R&D Expenses to Capital Expenses Year R&D Expense Unamortized portion -1 1577.90 Value of Research Asset = $6.60 664.90 1246.00 0.80 -4 1199.50 -3 1276.70 839.00 0.00 1577.50 564.20 -10 789.00 0.00 -7 1083.00 0.895.00 -2 1385.00 1.00 0.00 0.60 Aswath Damodaran 226 .

2641) = $234 (26.577 million $ 690 million $ 887 million (Increase) n Tax Effect of R&D Expensing • The entire R&D expense of $1. rather than just the net effect of $ 887 million • This creates a tax benefit that can be computed as follows: Additional tax benefit of expensing = (1577 .41% is the tax rate) Aswath Damodaran 227 .577 million is tax-deductible.887) (.56 Adjustment to Operating Income : • Add back the R& D Expenses • Subtract out the amortization • Net Effect on Operating Expenses $1.The Consequences of a Research Asset n n Amortization of asset for current year = $ 689.

050 mil 24.114 mil 29.68% R&D capitalized $6.4% BV of Equity $7.769 mil Capital Exp $ 788 mil Depr & Amortn $ 625 mil Net Cap Ex $ 163 mil Reinvestment Rate 6.22% In general Increase Increase Increase Increase Increase Increase Increase Decrease Aswath Damodaran 228 .656 mil $2.219 mil ROC 41.Capitalizing R& D: The Effects R&D expensed EBIT $5.24% $14.315 mil $1.365 mil $1.121 mil EBIT(1-t) $3.008 mil $4.

966/(.171 $ 4. Beta = 0.0134) = 9.46% Historical US Premium 5.56% (0.230 .529 Firm= $111.66% D = 1.467 $4.20%) (1-.80 X Risk Premium 4% + 0% Average Unlevered Beta for Sector: 0.20% (0.Chg WC 78 = FCFF 3527 WC : 5.Debt= $ 1.0914-.384 /Share: $ 55.9866) + 4.924 Forever Discount at Cost of Capital (WACC) = 9.700 + Cash =$ 2.00% Cashflow to Firm EBIT(1-t) : 4656 . ROC = 20% Reinvestment rate = 25% Terminal Value 5= $5.56% Weights E = 98.17% of Revenues Value = $108.20% Cost of Debt (6% + 0.08 $3.Nt CpX 1050 .05) = $ 144.Bristol Myers: A Valuation Reinvestment Rate 35.34% Riskfree Rate : T.2641) =4.80.846 Equity= $109.14% Cost of Equity 9.053 Expected Growth in EBIT (1-t) 35% * 29.677 $4.335 $3.5% Country Risk Premium 0% Aswath Damodaran 229 .23% Return on Capital 29.22% Stable Growth g = 5%.79 BM’s D/E Ratio: 1.22% = 10.Bond Rate = 6% + Beta 0.

edu/~adamodar Aswath Damodaran 230 .stern.The Dark Side of Valuation Aswath Damodaran http://www.nyu.

To make our estimates. we draw our information from. we might not have too much historical data but we have lots of comparable firms. Revenue growth… Reinvestment needs… Risk) We often substitute one type of information for another.. n The firm’s current financial statement • How much did the firm sell? • How much did it earn? n The firm’s financial history. in valuing a software firm. usually summarized in its financial statements. in valuing Ford. Aswath Damodaran 231 n . • How fast have the firm’s revenues and earnings grown over time? What can we learn about cost structure and profitability from these trends? • Susceptibility to macro-economic factors (recessions and cyclical firms) n The industry and comparable firm data • What happens to firms as they mature? (Margins.. we have 70 years+ of historical data. for instance. but not too many comparable firms.

n Valuation is most difficult when a company • Has negative earnings and low revenues in its current financial statements • No history • No comparables ( or even if they exist.The Dark Side. they are all at the same stage of the life cycle as the firm being valued) Aswath Damodaran 232 ...

Discounted Cash Flow Valuation: High Growth with Negative Earnings
Current Revenue EBIT Tax Rate - NOLs Current Operating Margin Reinvestment Stable Growth Sales Turnover Ratio Revenue Growth Competitive Advantages Expected Operating Margin Stable Revenue Growth Stable Stable Operating Reinvestment Margin

FCFF = Revenue* Op Margin (1-t) - Reinvestment Value of Operating Assets + Cash & Non-op Assets = Value of Firm - Value of Debt = Value of Equity - Equity Options = Value of Equity in Stock FCFF1 FCFF2 FCFF3 FCFF4

Terminal Value= FCFF n+1 /(r-gn) FCFF5 FCFFn ......... Forever

Discount at WACC= Cost of Equity (Equity/(Debt + Equity)) + Cost of Debt (Debt/(Debt+ Equity))

Cost of Equity

Cost of Debt (Riskfree Rate + Default Spread) (1-t)

Weights Based on Market Value

Riskfree Rate : - No default risk - No reinvestment risk - In same currency and in same terms (real or nominal as cash flows

+

Beta - Measures market risk

X

Risk Premium - Premium for average risk investment

Type of Business

Operating Leverage

Financial Leverage

Base Equity Premium

Country Risk Premium

Aswath Damodaran

233

Amazon’s Bottom-up Beta

Unlevered beta for firms in internet retailing = 1.60 Unlevered beta for firms in specialty retailing = 1.00
n

Amazon is a specialty retailer, but its risk currently seems to be determined by the fact that it is an online retailer. Hence we will use the beta of internet companies to begin the valuation but move the beta, after the first five years, towards the beta of the retailing business.

Aswath Damodaran

234

Estimating Synthetic Ratings and cost of debt
n

n

The rating for a firm can be estimated using the financial characteristics of the firm. In its simplest form, the rating can be estimated from the interest coverage ratio Interest Coverage Ratio = EBIT / Interest Expenses Amazon.com has negative operating income; this yields a negative interest coverage ratio, which should suggest a low rating. We computed an average interest coverage ratio of 2.82 over the next 5 years. This yields an average rating of BBB for Amazon.com for the first 5 years. (In effect, the rating will be lower in the earlier years and higher in the later years than BBB)

Aswath Damodaran

235

Estimating the cost of debt n n n The synthetic rating for Amazon.50% Pre-tax cost of debt = Riskfree Rate + Default spread = 6.00% (1. the after tax cost of debt will change as well.00% 7.0) = 8. 1 2 3 4 5 6 7 8 9 10 Pre-tax 8.50% + 1. As the firm’s tax rate changes and its cost of debt changes.00% 8.98% 4.71% 5.50% 7.75% 7.com is BBB.00% 8.00% 8.00% 8.00% Tax rate 0% 0% 0% 16.00% 6.00% 8.50% = 8.20% 5.00% 8.07% 5.00%: The firm is paying no taxes currently.55% Aswath Damodaran 236 . The default spread for BBB rated bonds is 1.00% After-tax cost of debt right now = 8.04% 4.1% 35% 35% 35% 35% 35% 35% After-tax 8.88% 4.67% 7.80% 7.

com has a book value of equity of $ 138 million and a book value of debt of $ 349 million.2%) Cost of Capital Cost of Capital = 12. Shows you how irrelevant book value is in this process.988) + 8. 237 Aswath Damodaran .8%) n Debt • Cost of debt = 6.9 % (.com n Equity • Cost of Equity = 6.626 mil (98.00% (1.90% • Market Value of Equity = $ 84/share* 340.84% n n Amazon.50% + 1.00% • Market Value of Debt = $ 349 mil (1.60 (4.00%) = 12.79 mil shs = $ 28.Estimating Cost of Capital: Amazon.012)) = 12.0) (.50% + 1.50% (default spread) = 8.

it is better to use 12-month trailing estimates for earnings and revenues than numbers for the most recent financial year.Calendar Years. n As a general rule. One of the problems with using financial statements is that they are dated.117 million EBIT . This rule becomes even more critical when valuing companies that are evolving and growing rapidly.$ 410 million n Aswath Damodaran 238 . Last 10-K Trailing 12-month Revenues $ 610 million $1. Financial Years and Updated Information The operating income and revenue that we use in valuation should be updated numbers.$125 million .

which will make many of these firms profitable. Should Amazon.com’s selling expenses be treated as cap ex? Aswath Damodaran 239 . It will also mean that they are reinvesting far more than we think they are. however.Are S. G & A expenses capital expenditures? n n n Many internet companies are arguing that selling and G&A expenses are the equivalent of R&D expenses for a high-technology firms and should be treated as capital expenditures. we should be computing earnings before these expenses. It will. make not their cash flows less negative. If we adopt this rationale.

628 $570 $1.058 35% $0 After year 5. the tax rate becomes 35%.038 $167 $871 16. Aswath Damodaran 240 .13% $560 $1.com’s Tax Rate Year 1 2 3 4 5 EBIT Taxes EBIT(1-t) Tax rate NOL -$373 $0 -$373 0% $500 -$94 $0 -$94 0% $873 $407 $0 $407 0% $967 $1.Amazon.

com n n n n n n EBIT (Trailing 1999) = -$ 410 million Tax rate used = 0% (Assumed Effective = Marginal) Capital spending (Trailing 1999) = $ 243 million (includes acquisitions) Depreciation (Trailing 1999) = $ 31 million Non-cash Working capital Change (1999) = .410 (1-0) .$542 million Aswath Damodaran 241 .80 million Estimating FCFF (1999) Current EBIT * (1 .Change in Working Capital Current FCFF = .$410 million = $212 million = -$ 80 million = .(Capital Spending .Estimating FCFF: Amazon.Depreciation) .tax rate) = .

87% 21.00 3.868 $1.00% 30.587 $1.59% 25.00% 50.466 $4.00 3. Earnings and Reinvestment: Amazon Year Revenue Chg in New 1 2 3 4 5 6 7 8 9 Growth 150.82% 21.00 3.189 $1.80% Revenue Investment $1.00 3.Growth in Revenues.676 $559 $2.629 $4.623 $4.96% 20.00 was based on what Amazon accomplished last year and the averages for the industry.398 $1.00 ROC -76.19% 10 6.00 3.00% 100.39% The sales/capital ratio of 3.887 $1.20% 20. Aswath Damodaran 242 .00% 75.601 $4.00 3.00 3.16% 22.40% 15.00 20.803 $1.23% 22.00% 25.00% $2.482 $1.793 $931 $4.00 3.396 $4.196 Sales/Capital 3.208 $736 3.62% -8.60% 10.494 $3.30% 21.

Amazon.20% Negative NMF >100% 1.com: Stable Growth Inputs High Growth Stable Growth • • • • • Beta Debt Ratio Return on Capital Expected Growth Rate Reinvestment Rate 1.60 1.00 15% 20% 6% 6%/20% = 30% Aswath Damodaran 243 .

79 million n Value of options outstanding (using dilution-adjusted Black-Scholes model) • Value of equity options = $ 2.50% 38 million 340.Estimating the Value of Equity Options n Details of options outstanding • • • • • • • Average strike price of options outstanding = Average maturity of options outstanding = Standard deviation in ln(stock price) = Annualized dividend yield on stock = Treasury bond rate = Number of options outstanding = Number of shares outstanding = $ 13.00% 0.4 years 50.375 8.892 million Aswath Damodaran 244 .00% 6.

13% 28.0961-.5% + Beta 1.90% 8.883 $2.30% 7.059 $1.15% 39.67% 4.629 $1.148 Term.5%+1.75% 5.174 9 11.00 Revenue Growth: 42% Competitive Advantages Expected Margin: -> 10.Equity Options $ 2.71% 12.90% 8.2% -> 15% Riskfree Rate : T.00% 12.84% Forever Cost of Equity 12.00% 12.96% 33.370 $1.00% Stable Growth Stable Stable Operating Revenue Margin: Growth: 6% 10.81% 23.00 X Risk Premium 4% Amazon.90% 8.06) =52.90% 8.788 10 10.0% Tax rate = 0% -> 35% Weights Debt= 1.84% 14.768 $1.60 -> 1.038 $1.10% 7.00% 6.211 $3.623 $177 7 12.70% 7.71% Cap ex includes acquisitions Working capital is 3% of revenues Sales Turnover Ratio: 3.00% 8.80% 5.00% 35.117 EBIT -410m NOL: 500 m Revenues EBIT EBIT (1-t) .646 $2.261 $2.00% 12.892 Value per share $ 34.661 19.438 $1.346 10.585 -$373 -$94 -$373 -$94 $559 $931 -$931 -$1.00% Stable ROC=20% Reinvest 30% of EBIT(1-t) Terminal Value= 1881/(.50% 7.524 $736 $1.42% 7.90% Cost of Debt 6.88% 11.Reinvestment FCFF Current Margin: -36.466 -$758 -$408 4 12.00% 8.196 $1.910 + Cash $ 26 = Value of Firm $14.396 -$989 3 12.04% 11.55% 9.798 $3.83% 5 12.69% 36.006 $3.212 $1.119 $1.628 $871 $1.00% 4.50% 4.07% 12.793 5.Value of Debt $ 349 = Value of Equity $14.21% Base Equity Premium Country Risk Premium Aswath Damodaran 245 .774 $407 $407 $1.494 $625 8 12.32 $2.729 $2.799 $1.84% 9. Bond rate = 6.90% 8. Year $41.862 $2.587 .com January 2000 Stock Price = $ 84 Internet/ Retail Operating Leverage Current D/E: 1.5%=8.00% 5.00% 8.00% $2.Reinvestment: Current Revenue $ 1.61% Cost of Equity Cost of Debt AT cost of debt Cost of Capital 12.024 1 2 12.20% 12.98% 11.881 Value of Op Assets $ 14.058 $1.688 $ 807 $1.601 -$163 6 12.936 .

27 35.48 97.53 8% 2.72 120.54 137.33 25.10 10% 7.50 59.47 33.59 21.41 6.84 156.60 85.94) 1.71 22.34 67.54 53.66 12% 12.22 14% 17.57 29.77 30% 35% 40% 45% 50% 55% 60% $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Aswath Damodaran 246 .What do you need to break-even at $ 84? 6% (1.10 12.53 111.93 26.52 85.95 191.34 40.21 45.95 8.84 15.37 15.47 49.05 59.74 40.77 78.

5% of EBIT(1-t) Terminal Value= 1064/(.263 = Value of Firm $10.55% 8.596 $2.32% Stable ROC=16.777 $774 $774 $900 -$126 4 27.77% 4 $11.27% 2.057 10 15.465 EBIT -853m NOL: 1.36% 5.98% 9 $22.18 13.81% 10. Year $24.81% Cost of Debt 6.534 $1.244 $687 $558 8 23.052 .77% 3 $9.00% 12.20% 1.00% 12.95% 6.10 X Risk Premium 4% Amazon.60% Cap ex includes acquisitions Working capital is 3% of revenues Sales Turnover Ratio: 3.Equity Options $ 845 Value per share $ 20. Bond rate = 5.81% 9.18 13.18 13.356 $554 $802 9 21.912 $2.76% Term.431 $374 $1.62% 8 $20.509 $ 445 $1.85% 9.11% 11.849 $1.32 10.059 $347 $347 $857 -$510 3 27.0876-.32% Stable Growth Stable Stable Operating Revenue Margin: Growth: 5% 9.18 13.09% 6.692 $1.314 EBIT -$545 EBIT(1-t) -$545 .173 .81% 10.53% 9.100 $766 $333 7 24.Reinvestment: Current Revenue $ 2.41% Competitive Advantages Expected Margin: -> 9.Value of Debt $ 1.52% Forever Cost of Equity 13.132 $1.53 11.83 1 Revenues $4.18-> 1.27% 2.3% -> 15% Riskfree Rate : T.01% 10.5% Base Equity Premium Country Risk Premium Aswath Damodaran 247 .81% 10.914 $1.00% 12.10 9.05) =$ 28.50% 4.com January 2001 Stock price = $14 Internet/ Retail Operating Leverage Current D/E: 37.81% 10.34% 10 $23.22% 5.302 $1.789 + Cash & Non-op $ 1.96 12.879 = Value of Equity $ 8.00% 12.00% 1.310 6 $16.25% 7 $18.726 $2.5%+3.471 -$107 -$107 $714 -$822 2 27.922 $1.18 13.Reinvestment $612 FCFF -$1.0% Tax rate = 0% -> 35% Weights Debt= 27.02 Revenue Growth: 25.06% 12.064 Value of Op Assets $ 8.201 $1.428 $928 $796 $132 6 24.27% 2.13% 1.77% 5 $14.75 12.77% 2 $6.123 $1.289 m Current Margin: -34.5%=10.94% Reinvest 29.18% 1.1% + Beta 2.27% 2.087 $1.157 1 Debt Ratio Beta Cost of Equity AT cost of debt Cost of Capital 27.27% 2.017 $780 $237 5 27.81% 1.

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