CL11lnC 1C 1PL C1lMAL:

1lMlnC Anu llnAnClnC

CPClCLS
?ou can Lake lL slow.. Cr perhaps noL.
Aswath Damodaran 1
2
8lg lcLure.
Aswath Damodaran
2
The Investment Decision
Invest in assets that earn a
return greater than the
minimum acceptable hurdle
rate
The Financing Decision
Find the right kind of debt
for your rm and the right
mix of debt and equity to
fund your operations
The Dividend Decision
If you cannot nd investments
that make your minimum
acceptable rate, return the cash
to owners of your business
The hurdle rate
should reect the
riskiness of the
investment and
the mix of debt
and equity used
to fund it.
The return
should reect the
magnitude and
the timing of the
cashows as welll
as all side effects.
The optimal
mix of debt
and equity
maximizes rm
value
The right kind
of debt
matches the
tenor of your
assets
How much
cash you can
return
depends upon
current &
potential
investment
opportunities
How you choose
to return cash to
the owners will
depend on
whether they
prefer dividends
or buybacks
Maximize the value of the business (rm)
3
now LhaL we have an opumal.. And an acLual..
WhaL nexL?
Aswath Damodaran
3
! AL Lhe end of Lhe analysls of nanclng mlx (uslng
whaLever Lool or Lools you choose Lo use), you can
come Lo one of Lhree concluslons:
1. 1he rm has Lhe rlghL nanclng mlx
2. lL has Loo llule debL (lL ls under levered)
3. lL has Loo much debL (lL ls over levered)
! 1he nexL sLep ln Lhe process ls
! uecldlng how much qulckly or gradually Lhe rm should
move Lo lLs opumal
! Assumlng LhaL lL does, Lhe rlghL klnd of nanclng Lo use ln
maklng Lhls ad[usLmenL
4
A lramework for Cemng Lo Lhe Cpumal
Aswath Damodaran
4
Is the actual debt ratio greater than or lesser than the optimal debt ratio?
Actual > Optimal
Overlevered
Actual < Optimal
Underlevered
Is the rm under bankruptcy threat? Is the rm a takeover target?
Yes No
Reduce Debt quickly
1. Equity for Debt swap
2. Sell Assets; use cash
to pay off debt
3. Renegotiate with lenders
Does the rm have good
projects?
ROE > Cost of Equity
ROC > Cost of Capital
Yes
Take good projects with
new equity or with retained
earnings.
No
1. Pay off debt with retained
earnings.
2. Reduce or eliminate dividends.
3. Issue new equity and pay off
debt.
Yes
No
Does the rm have good
projects?
ROE > Cost of Equity
ROC > Cost of Capital
Yes
Take good projects with
debt.
No
Do your stockholders like
dividends?
Yes
Pay Dividends
No
Buy back stock
Increase leverage
quickly
1. Debt/Equity swaps
2. Borrow money&
buy shares.
5
ulsney: Applylng Lhe lramework
Is the actual debt ratio greater than or lesser than the optimal debt ratio?
Actual > Optimal
Overlevered
Actual < Optimal
Actual (11.58%) < Optimal (40%)
Is the rm under bankruptcy threat? Is the rm a takeover target?
Yes No
Reduce Debt quickly
1. Equity for Debt swap
2. Sell Assets; use cash
to pay off debt
3. Renegotiate with lenders
Does the rm have good
projects?
ROE > Cost of Equity
ROC > Cost of Capital
Yes
Take good projects with
new equity or with retained
earnings.
No
1. Pay off debt with retained
earnings.
2. Reduce or eliminate dividends.
3. Issue new equity and pay off
debt.
Yes
No. Large mkt cap & positive
Jensens !
Does the rm have good
projects?
ROE > Cost of Equity
ROC > Cost of Capital
Yes. ROC > Cost of capital
Take good projects
With debt.
No
Do your stockholders like
dividends?
Yes
Pay Dividends
No
Buy back stock
Increase leverage
quickly
1. Debt/Equity swaps
2. Borrow money&
buy shares.
6
" Appllcauon 1esL: Cemng Lo Lhe Cpumal
Aswath Damodaran
6
! 8ased upon your analysls of boLh Lhe rms caplLal
sLrucLure and lnvesLmenL record, whaL paLh would
you map ouL for Lhe rm?
a. lmmedlaLe change ln leverage
b. Cradual change ln leverage
c. no change ln leverage
! Would you recommend LhaL Lhe rm change lLs
nanclng mlx by
a. aylng o debL/8uylng back equlLy
b. 1ake pro[ecLs wlLh equlLy/debL
7
1he Mechanlcs of Changlng uebL 8auo qulckly.
Aswath Damodaran
7
Assets Liabilities
Opearing
Assets in place
Debt
Equity
Growth Assets
Cash
To decrease the debt ratio
To increase the debt ratio
Borrow money and buy
back stock or pay a large
special dividend
Sell operating assets
and use cash to buy
back stock or pay or
special dividend
Issue new stock to retire
debt or get debt holders to
accept equity in the rm.
Sell operating assets
and use cash to pay
down debt.
8
1he mechanlcs of changlng debL rauos over
ume. gradually.
Aswath Damodaran
8
! 1o change debL rauos over ume, you use Lhe same mlx
of Lools LhaL you used Lo change debL rauos gradually:
! ulvldends and sLock buybacks: ulvldends and sLock buybacks
wlll reduce Lhe value of equlLy.
! uebL repaymenLs: wlll reduce Lhe value of debL.
! 1he compllcauon of changlng debL rauos over ume ls
LhaL rm value ls lLself a movlng LargeL.
! lf equlLy ls falrly valued Loday, Lhe equlLy value should change
over ume Lo reecL Lhe expecLed prlce appreclauon:
! LxpecLed rlce appreclauon = CosL of equlLy - ulvldend ?leld
! uebL wlll also change over ume, ln con[uncuon as rm value
changes.
9
ueslgnlng uebL: 1he lundamenLal rlnclple
Aswath Damodaran
9
! 1he ob[ecuve ln deslgnlng debL ls Lo make Lhe cash
ows on debL maLch up as closely as posslble wlLh
Lhe cash ows LhaL Lhe rm makes on lLs asseLs.
! 8y dolng so, we reduce our rlsk of defaulL, lncrease
debL capaclLy and lncrease rm value.
10
llrm wlLh mlsmaLched debL
Aswath Damodaran
10
Firm Value
Value of Debt
11
llrm wlLh maLched uebL
Aswath Damodaran
11
Firm Value
Value of Debt
12
ueslgn Lhe perfecL nanclng lnsLrumenL
Aswath Damodaran
12
! 1he perfecL nanclng lnsLrumenL wlll
! Pave all of Lhe Lax advanLages of debL
! Whlle preservlng Lhe exlblllLy oered by equlLy
Duration Currency Effect of Inflation
Uncertainty about Future
Growth Patterns
Cyclicality &
Other Effects
Define Debt
Characteristics
Duration/
Maturity
Currency
Mix
Fixed vs. Floating Rate
* More floating rate
- if CF move with
inflation
- with greater uncertainty
on future
Straight versus
Convertible
- Convertible if
cash flows low
now but high
exp. growth
Special Features
on Debt
- Options to make
cash flows on debt
match cash flows
on assets
Start with the
Cash Flows
on Assets/
Projects
Commodity Bonds
Catastrophe Notes
Design debt to have cash flows that match up to cash flows on the assets financed
13
Lnsurlng LhaL you have noL crossed Lhe llne
drawn by Lhe Lax code
Aswath Damodaran
13
! All of Lhls deslgn work ls losL, however, lf Lhe
securlLy LhaL you have deslgned does noL dellver Lhe
Lax beneLs.
! ln addluon, Lhere may be a Lrade o beLween
mlsmaLchlng debL and gemng greaLer Lax beneLs.
Overlay tax
preferences
Deductibility of cash flows
for tax purposes
Differences in tax rates
across different locales
If tax advantages are large enough, you might override results of previous step
Zero Coupons
14
Whlle keeplng equlLy research analysLs, raungs
agencles and regulaLors applaudlng
Aswath Damodaran
14
! 8aungs agencles wanL companles Lo lssue equlLy, slnce lL
makes Lhem safer.
! LqulLy research analysLs wanL Lhem noL Lo lssue equlLy
because lL dlluLes earnlngs per share.
! 8egulaLory auLhorlues wanL Lo ensure LhaL you meeL Lhelr
requlremenLs ln Lerms of caplLal rauos (usually book value).
! llnanclng LhaL leaves all Lhree groups happy ls nlrvana.
Consider
ratings agency
& analyst concerns
Analyst Concerns
- Effect on EPS
- Value relative to comparables
Ratings Agency
- Effect on Ratios
- Ratios relative to comparables
Regulatory Concerns
- Measures used
Can securities be designed that can make these different entities happy?
Operating Leases
MIPs
Surplus Notes
15
uebL or LqulLy: 1he SLrange Case of 1rusL
referred
Aswath Damodaran
15
! 1rusL preferred sLock has
! A xed dlvldend paymenL, specled aL Lhe ume of Lhe lssue
! 1haL ls Lax deducuble
! And falllng Lo make Lhe paymenL can glve Lhese
shareholders voung rlghLs
! When LrusL preferred was rsL creaLed, raungs
agencles LreaLed lL as equlLy. As Lhey have become
more savvy, raungs agencles have sLarLed glvlng
rms only parual equlLy credlL for LrusL preferred.
16
uebL, LqulLy and Cuasl LqulLy
Aswath Damodaran
16
! Assumlng LhaL LrusL preferred sLock geLs LreaLed as
equlLy by raungs agencles, whlch of Lhe followlng
rms ls Lhe mosL approprlaLe rm Lo be lssulng lL?
a. A rm LhaL ls under levered, buL has a raung consLralnL
LhaL would be vlolaLed lf lL moved Lo lLs opumal
b. A rm LhaL ls over levered LhaL ls unable Lo lssue debL
because of Lhe raung agency concerns.
17
SooLhe bondholder fears
Aswath Damodaran
17
! 1here are some rms LhaL face skepuclsm from
bondholders when Lhey go ouL Lo ralse debL,
because
! Cf Lhelr pasL hlsLory of defaulLs or oLher acuons
! 1hey are small rms wlLhouL any borrowlng hlsLory
! 8ondholders Lend Lo demand much hlgher lnLeresL
raLes from Lhese rms Lo reecL Lhese concerns.
Factor in agency
conflicts between stock
and bond holders
Observability of Cash Flows
by Lenders
- Less observable cash flows
lead to more conflicts
Type of Assets financed
- Tangible and liquid assets
create less agency problems
Existing Debt covenants
- Restrictions on Financing
If agency problems are substantial, consider issuing convertible bonds
Convertibiles
Puttable Bonds
Rating Sensitive
Notes
LYONs
18
And do noL lock ln markeL mlsLakes LhaL work
agalnsL you
Aswath Damodaran
18
! 8aungs agencles can someumes under raLe a rm, and
markeLs can under prlce a rms sLock or bonds. lf Lhls
occurs, rms should noL lock ln Lhese mlsLakes by lssulng
securlues for Lhe long Lerm. ln parucular,
! lssulng equlLy or equlLy based producLs (lncludlng converubles),
when equlLy ls under prlced Lransfers wealLh from exlsung
sLockholders Lo Lhe new sLockholders
! lssulng long Lerm debL when a rm ls under raLed locks ln raLes
aL levels LhaL are far Loo hlgh, glven Lhe rms defaulL rlsk.
! WhaL ls Lhe soluuon
! lf you need Lo use equlLy?
! lf you need Lo use debL?
19
ueslgnlng uebL: 8rlnglng lL all LogeLher
Aswath Damodaran
19
Duration Currency Effect of Ination
Uncertainty about Future
Growth Patterns
Cyclicality &
Other Effects
Dene Debt
Characteristics
Duration/
Maturity
Currency
Mix
Fixed vs. Floating Rate
* More oating rate
- if CF move with
ination
- with greater uncertainty
on future
Straight versus
Convertible
- Convertible if
cash ows low
now but high
exp. growth
Special Features
on Debt
- Options to make
cash ows on debt
match cash ows
on assets
Start with the
Cash Flows
on Assets/
Projects
Overlay tax
preferences
Deductibility of cash ows
for tax purposes
Differences in tax rates
across different locales
Consider
ratings agency
& analyst concerns
Analyst Concerns
- Effect on EPS
- Value relative to comparables
Ratings Agency
- Effect on Ratios
- Ratios relative to comparables
Regulatory Concerns
- Measures used
Factor in agency
conicts between stock
and bond holders
Observability of Cash Flows
by Lenders
- Less observable cash ows
lead to more conicts
Type of Assets nanced
- Tangible and liquid assets
create less agency problems
Existing Debt covenants
- Restrictions on Financing
Consider Information
Asymmetries
Uncertainty about Future Cashows
- When there is more uncertainty, it
may be better to use short term debt
Credibility & Quality of the Firm
- Firms with credibility problems
will issue more short term debt
If agency problems are substantial, consider issuing convertible bonds
Can securities be designed that can make these different entities happy?
If tax advantages are large enough, you might override results of previous step
Zero Coupons
Operating Leases
MIPs
Surplus Notes
Convertibiles
Puttable Bonds
Rating Sensitive
Notes
LYONs
Commodity Bonds
Catastrophe Notes
Design debt to have cash ows that match up to cash ows on the assets nanced
20
Approaches for evaluaung AsseL Cash llows
Aswath Damodaran
20
l. lnLuluve Approach
! Are Lhe pro[ecLs Lyplcally long Lerm or shorL Lerm? WhaL ls Lhe cash
ow pauern on pro[ecLs?
! Pow much growLh poLenual does Lhe rm have relauve Lo currenL
pro[ecLs?
! Pow cycllcal are Lhe cash ows? WhaL speclc facLors deLermlne Lhe
cash ows on pro[ecLs?
ll. ro[ecL Cash llow Approach
! LsumaLe expecLed cash ows on a Lyplcal pro[ecL for Lhe rm
! uo scenarlo analyses on Lhese cash ows, based upon dlerenL macro
economlc scenarlos
lll. PlsLorlcal uaLa
! Cperaung Cash llows
! llrm value
21
l. lnLuluve Approach - ulsney
Aswath Damodaran
21
Business Project Cash Flow Characteristics Type of Financing
Studio
entertainment
Movie projects are likely to
Be short-term
Have cash outflows primarily in dollars (because Disney makes most of its
movies in the U.S.), but cash inflows could have a substantial foreign currency
component (because of overseas revenues)
Have net cash flows that are heavily driven by whether the movie is a hit, which
is often difficult to predict
Debt should be
1. Short-term
2. Mixed currency debt,
reflecting audience make-
up.
3. If possible, tied to the
success of movies.
Media networks Projects are likely to be
1. Short-term
2. Primarily in dollars, though foreign component is growing, especially for ESPN.
3. Driven by advertising revenues and show success (Nielsen ratings)
Debt should be
1. Short-term
2. Primarily dollar debt
3. If possible, linked to
network ratings
Park resorts Projects are likely to be
1. Very long-term
2. Currency will be a function of the region (rather than country) where park is
located.
3. Affected by success of studio entertainment and media networks divisions
Debt should be
1. Long-term
2. Mix of currencies, based
on tourist makeup at the
park.

Consumer
products
Projects are likely to be short- to medium-term and linked to the success of the
movie division; most of Disneys product offerings and licensing revenues are
derived from their movie productions
Debt should be
1. Medium-term
2. Dollar debt
Interactive Projects are likely to be short-term, with high growth potential and significant risk.
While cash flows will initially be primarily in US dollars, the mix of currencies will
shift as the business ages.
Debt should be short-term,
convertible US dollar debt.

22
" Appllcauon 1esL: Chooslng your llnanclng
1ype
Aswath Damodaran
22
! 8ased upon Lhe buslness LhaL your rm ls ln, and Lhe
Lyplcal lnvesLmenLs LhaL lL makes, whaL klnd of
nanclng would you expecL your rm Lo use ln Lerms
of
a. uurauon (long Lerm or shorL Lerm)
b. Currency
c. llxed or lloaung raLe
d. SLralghL or Converuble
23
ll. ro[ecL Speclc llnanclng
Aswath Damodaran
23
! WlLh pro[ecL speclc nanclng, you maLch Lhe
nanclng cholces Lo Lhe pro[ecL belng funded. 1he
beneL ls LhaL Lhe Lhe debL ls Lruly cusLomlzed Lo Lhe
pro[ecL.
! ro[ecL speclc nanclng makes Lhe mosL sense
when you have a few large, lndependenL pro[ecLs Lo
be nanced. lL becomes boLh lmpracucal and cosLly
when rms have poruollos of pro[ecLs wlLh
lnLerdependenL cashows.
24
uurauon of ulsney 1heme ark
Aswath Damodaran
24
Duration of the Project = 62,355/3296 = 18.92 years
25
1he perfecL Lheme park debL.
Aswath Damodaran
25
! 1he perfecL debL for Lhls Lheme park would have a
durauon of roughly 19 years and be ln a mlx of Laun
Amerlcan currencles (slnce lL ls locaLed ln 8razll),
reecung where Lhe vlslLors Lo Lhe park are comlng
from.
! lf posslble, you would ue Lhe lnLeresL paymenLs on
Lhe debL Lo Lhe number of vlslLors aL Lhe park.
26
lll. llrm-wlde nanclng
Aswath Damodaran
26
! 8aLher Lhan look aL lndlvldual pro[ecLs, you could conslder Lhe rm Lo be a
poruollo of pro[ecLs. 1he rms pasL hlsLory should Lhen provlde clues as Lo
whaL Lype of debL makes Lhe mosL sense.
! Cperaung Cash llows
# 1he quesuon of how sensluve a rms asseL cash ows are Lo a varleLy
of facLors, such as lnLeresL raLes, lnauon, currency raLes and Lhe
economy, can be dlrecLly LesLed by regresslng changes ln Lhe operaung
lncome agalnsL changes ln Lhese varlables.
# 1hls analysls ls useful ln deLermlnlng Lhe coupon/lnLeresL paymenL
sLrucLure of Lhe debL.
! llrm value
# 1he rm value ls clearly a funcuon of Lhe level of operaung lncome, buL
lL also lncorporaLes oLher facLors such as expecLed growLh & cosL of
caplLal.
# 1he rm value analysls ls useful ln deLermlnlng Lhe overall sLrucLure of
Lhe debL, parucularly maLurlLy.
27
ulsney: PlsLorlcal uaLa
27
Date Operating Income Enterprise Value (V) % Chg in OI % Chg in V
2013 9450 $126,815 6.62% 21.09%
2012 8863 $104,729 13.91% 56.85%
2011 7781 $66,769 15.69% -9.19%
2010 6726 $73,524 18.06% 22.84%
2009 5697 $59,855 -23.06% -18.11%
2008 $7,404 $73,091 8.42% -6.27%
2007 $6,829 $77,980 27.53% 2.98%
2006 $5,355 $75,720 30.39% 27.80%
2005 $4,107 $59,248 1.46% 2.55%
2004 $4,048 $57,776 49.21% 9.53%
2003 $2,713 $52,747 13.80% 20.45%
2002 $2,384 $43,791 -15.82% -9.01%
2001 $2,832 $48,128 12.16% -45.53%
2000 $2,525 $88,355 -22.64% 35.67%
1999 $3,264 $65,125 -15.07% -5.91%
1998 $3,843 $69,213 -2.59% 6.20%
1997 $3,945 $65,173 30.46% 18.25%
1996 $3,024 $55,116 33.69% 77.65%
1995 $2,262 $31,025 25.39% 39.75%
1994 $1,804 $22,200 15.64% 9.04%
1993 $1,560 $20,360 21.21% 6.88%
1992 $1,287 $19,049 28.19% 23.89%
1991 $1,004 $15,376 -21.99% 26.50%
1990 $1,287 $12,155 16.05% -23.64%
1989 $1,109 $15,918 40.56% 101.93%
1988 $789 $7,883 11.60% -23.91%
1987 $707 $10,360 53.03% 83.69%
1986 $462 $5,640 25.20% 61.23%
1985 $369 $3,498 157.99% 24.37%
28
1he Macroeconomlc uaLa
28
Date
Change in
T.Bond rate
% Chg in GDP % Change in CPI % Change in US $
2013 1.07% 1.83% 1.18% 4.89%
2012 -0.11% 2.20% -1.03% 2.75%
2011 -1.37% 1.81% 1.48% -4.59%
2010 -0.53% 2.39% 1.97% -3.64%
2009 1.29% -3.07% -3.98% 5.79%
2008 -1.44% -1.18% -4.26% 10.88%
2007 -0.65% 2.93% 2.19% -11.30%
2006 0.30% 3.40% -1.84% -2.28%
2005 0.16% 3.68% 0.66% 3.98%
2004 0.13% 3.72% 1.34% -3.92%
2003 0.05% 4.32% -0.65% -14.59%
2002 -0.97% 2.80% 1.44% -11.17%
2001 -0.18% -0.04% -2.50% 7.45%
2000 -0.98% 2.24% 0.96% 7.73%
1999 1.56% 4.70% 1.04% 1.68%
1998 -1.03% 4.51% 0.11% -4.08%
1997 -0.63% 4.33% -1.43% 9.40%
1996 0.80% 4.43% 0.31% 4.14%
1995 -2.09% 2.01% -0.08% -0.71%
1994 1.92% 4.12% 0.27% -5.37%
1993 -0.83% 2.50% -0.72% 0.56%
1992 -0.02% 4.15% 0.64% 6.89%
1991 -1.26% 1.09% -2.89% 0.69%
1990 0.12% 0.65% 0.43% -8.00%
1989 -1.11% 2.66% 0.51% 2.04%
1988 0.26% 3.66% 0.60% 1.05%
1987 1.53% 4.49% 2.54% -12.01%
1986 -1.61% 2.83% -2.33% -15.26%
1985 -2.27% 4.19% 3.89% -13.51%
29
l. SensluvlLy Lo lnLeresL 8aLe Changes
Aswath Damodaran
29
! Pow sensluve ls Lhe rms value and operaung
lncome Lo changes ln Lhe level of lnLeresL raLes?
! 1he answer Lo Lhls quesuon ls lmporLanL because lL
! lL provldes a measure of Lhe durauon of Lhe rms pro[ecLs
! lL provldes lnslghL lnLo wheLher Lhe rm should be uslng
xed or oaung raLe debL.
30
llrm value versus lnLeresL 8aLe Changes
Aswath Damodaran
30
! 8egresslng changes ln rm value agalnsL changes ln
lnLeresL raLes over Lhls perlod ylelds Lhe followlng
regresslon -
Change ln llrm value = 0.1790 - 2.3231 (Change ln lnLeresL 8aLes)
(2.74) (0.39)
! 1 sLausucs are ln brackeLs.
! 1he coemclenL on Lhe regresslon (-2.33) measures
how much Lhe value of ulsney as a rm changes for
a unlL change ln lnLeresL raLes.
31
Why Lhe coemclenL on Lhe regresslon ls
durauon..
Aswath Damodaran
31
! 1he durauon of a sLralghL bond or loan lssued by a company
can be wrluen ln Lerms of Lhe coupons (lnLeresL paymenLs)
on Lhe bond (loan) and Lhe face value of Lhe bond Lo be -

! 1he durauon of a bond measures how much Lhe prlce of Lhe
bond changes for a unlL change ln lnLeresL raLes.
! Poldlng oLher facLors consLanL, Lhe durauon of a bond wlll
lncrease wlLh Lhe maLurlLy of Lhe bond, and decrease wlLh
Lhe coupon raLe on Lhe bond.
Duration of Bond =
dP/P
dr/r
=
t*Coupon
t
(1+r)
t
t=1
t=N
!
+
N*Face Value
(1+r)
N
"
#
$
%
&
'
Coupon
t
(1+r)
t
t=1
t=N
!
+
Face Value
(1+r)
N
"
#
$
%
&
'
32
uurauon: Comparlng Approaches
Aswath Damodaran
32
!P/!r=
Percentage Change
in Value for a
percentage change in
Interest Rates
Traditional Duration
Measures
Regression:
!P = a + b (!r)
Uses:
1. Projected Cash Flows
Assumes:
1. Cash Flows are unaffected by
changes in interest rates
2. Changes in interest rates are
small.
Uses:
1. Historical data on changes in
firm value (market) and interest
rates
Assumes:
1. Past project cash flows are
similar to future project cash
flows.
2. Relationship between cash
flows and interest rates is
stable.
3. Changes in market value
reflect changes in the value of
the firm.
33
Cperaung lncome versus lnLeresL 8aLes
Aswath Damodaran
33
! 8egresslng changes ln operaung cash ow agalnsL
changes ln lnLeresL raLes over Lhls perlod ylelds Lhe
followlng regresslon -
Change ln Cperaung lncome = 0.1698 - 7.9339 (Change ln lnLeresL 8aLes)
(2.69
a
) (1.40)
Concluslon: ulsneys operaung lncome has been
aecLed a loL more Lhan lLs rm value has by
changes ln lnLeresL raLes.
34
ll. SensluvlLy Lo Changes ln Cu/ Cn
Aswath Damodaran
34
! Pow sensluve ls Lhe rms value and operaung lncome
Lo changes ln Lhe Cn/Cu?
! 1he answer Lo Lhls quesuon ls lmporLanL because
! lL provldes lnslghL lnLo wheLher Lhe rms cash ows are cycllcal
and
! wheLher Lhe cash ows on Lhe rms debL should be deslgned
Lo proLecL agalnsL cycllcal facLors.
! lf Lhe cash ows and rm value are sensluve Lo
movemenLs ln Lhe economy, Lhe rm wlll elLher have Lo
lssue less debL overall, or add speclal feaLures Lo Lhe
debL Lo ue cash ows on Lhe debL Lo Lhe rms cash
ows.
35
8egresslon 8esulLs
Aswath Damodaran
35
! 8egresslng changes ln rm value agalnsL changes ln Lhe
Cu over Lhls perlod ylelds Lhe followlng regresslon -
Change ln llrm value = 0.0067 ! 6.7000 (Cu CrowLh)
(0.06) (2.03
a
)
Concluslon: ulsney ls sensluve Lo economlc growLh
! 8egresslng changes ln operaung cash ow agalnsL
changes ln Cu over Lhls perlod ylelds Lhe followlng
regresslon -
Change ln Cperaung lncome = 0.0142 + 6.6443 ( Cu CrowLh)
(0.13) (2.03
a
)
Concluslon: ulsneys operaung lncome ls sensluve Lo
economlc growLh as well.
36
lll. SensluvlLy Lo Currency Changes
Aswath Damodaran
36
! Pow sensluve ls Lhe rms value and operaung
lncome Lo changes ln exchange raLes?
! 1he answer Lo Lhls quesuon ls lmporLanL, because
! lL provldes a measure of how sensluve cash ows and rm
value are Lo changes ln Lhe currency
! lL provldes guldance on wheLher Lhe rm should lssue debL
ln anoLher currency LhaL lL may be exposed Lo.
! lf cash ows and rm value are sensluve Lo changes
ln Lhe dollar, Lhe rm should
! gure ouL whlch currency lLs cash ows are ln,
! and lssued some debL ln LhaL currency
37
8egresslon 8esulLs
Aswath Damodaran
37
! 8egresslng changes ln rm value agalnsL changes ln Lhe dollar over
Lhls perlod ylelds Lhe followlng regresslon -
Change ln llrm value = 0.1774- 0.3703 (Change ln uollar)
(2.76) (0.67)
Concluslon: ulsneys value ls sensluve Lo exchange raLe changes,
decreaslng as Lhe dollar sLrengLhens. Powever, Lhe eecL ls
sLausucally lnslgnlcanL.
! 8egresslng changes ln operaung cash ow agalnsL changes ln Lhe
dollar over Lhls perlod ylelds Lhe followlng regresslon -
Change ln Cperaung lncome = 0.1680 - 1.6773 (Change ln uollar)
(2.82
a
) (2.13
a
)
Concluslon: ulsneys operaung lncome ls more sLrongly lmpacLed by
Lhe dollar Lhan lLs value ls. A sLronger dollar seems Lo hurL operaung
lncome.
38
lv. SensluvlLy Lo lnauon
Aswath Damodaran
38
! Pow sensluve ls Lhe rms value and operaung
lncome Lo changes ln Lhe lnauon raLe?
! 1he answer Lo Lhls quesuon ls lmporLanL, because
! lL provldes a measure of wheLher cash ows are posluvely
or negauvely lmpacLed by lnauon.
! lL Lhen helps ln Lhe deslgn of debL, wheLher Lhe debL
should be xed or oaung raLe debL.
! lf cash ows move wlLh lnauon, lncreaslng
(decreaslng) as lnauon lncreases (decreases), Lhe
debL should have a larger oaung raLe componenL.
39
8egresslon 8esulLs
Aswath Damodaran
39
! 8egresslng changes ln rm value agalnsL changes ln lnauon over
Lhls perlod ylelds Lhe followlng regresslon -
Change ln llrm value = 0.1833 + 2.9966 (Change ln lnauon 8aLe)
(2.96) (0.90)
Concluslon: ulsneys rm value does seem Lo lncrease wlLh lnauon, buL noL
by much (sLausucal slgnlcance ls low)
! 8egresslng changes ln operaung cash ow agalnsL changes ln
lnauon over Lhls perlod ylelds Lhe followlng regresslon -
Change ln Cperaung lncome = 0.1919 + 8.1867 (Change ln lnauon 8aLe)
(3.43
a
) (2.76
a
)
Concluslon: ulsneys operaung lncome lncreases ln perlods when
lnauon lncreases, suggesung LhaL ulsney does have prlclng power.
40
Summarlzlng.
Aswath Damodaran
40
! Looklng aL Lhe four macroeconomlc regresslons, we
would conclude LhaL
! ulsneys asseLs collecuvely have a durauon of abouL 2.33
years
! ulsney ls lncreaslngly aecLed by economlc cycles
! ulsney ls hurL by a sLronger dollar
! ulsneys operaung lncome Lends Lo move wlLh lnauon
! All of Lhe regresslon coemclenLs have subsLanual
sLandard errors assoclaLed wlLh Lhem. Cne way Lo
reduce Lhe error (a la bouom up beLas) ls Lo use
secLor-wlde averages for each of Lhe coemclenLs.
41
8ouom-up LsumaLes
Aswath Damodaran
41
These weights
reect the
estimated values
of the businesses

42
8ecommendauons for ulsney
Aswath Damodaran
42
! 1he debL lssued should be long Lerm and should have
durauon of abouL 4.3 years.
! A slgnlcanL poruon of Lhe debL should be oaung raLe debL,
reecung ulsneys capaclLy Lo pass lnauon Lhrough Lo lLs
cusLomers and Lhe facL LhaL operaung lncome Lends Lo
lncrease as lnLeresL raLes go up.
! Clven ulsneys sensluvlLy Lo a sLronger dollar, a poruon of
Lhe debL should be ln forelgn currencles. 1he speclc
currency used and Lhe magnlLude of Lhe forelgn currency
debL should reecL where ulsney makes lLs revenues. 8ased
upon 2013 numbers aL leasL, Lhls would lndlcaLe LhaL abouL
18 of lLs debL should be ln forelgn currencles (and perhaps
more, slnce even Lhelr uS dollar lncome can be aecLed by
currency movemenLs).
43
Analyzlng ulsneys CurrenL uebL
Aswath Damodaran
43
! ulsney has $14.3 bllllon ln lnLeresL-bearlng debL wlLh a face-value
welghLed average maLurlLy of 7.92 years. Allowlng for Lhe facL LhaL Lhe
maLurlLy of debL ls hlgher Lhan Lhe durauon, Lhls would lndlcaLe LhaL
ulsney's debL may be a llule longer Lhan would be opumal, buL noL by
much.
! Cf Lhe debL, abouL 3.49 of Lhe debL ls ln non-uS dollar currencles (lndlan
rupees and Pong kong dollars), buL Lhe resL ls ln uS dollars and Lhe
company has no Luro debL. 8ased on our analysls, we would suggesL LhaL
ulsney lncrease lLs proporuon of Luro debL Lo abouL 12 and ue Lhe
cholce of currency on fuLure debL lssues Lo lLs expanslon plans.
! ulsney has no converuble debL and abouL 3.67 of lLs debL ls oaung raLe
debL, whlch looks low, glven Lhe company's prlclng power. Whlle Lhe mlx
of debL ln 2013 may be reecuve of a deslre Lo lock ln low long-Lerm
lnLeresL raLes on debL, as raLes rlse, Lhe company should conslder
expandlng lLs use of forelgn currency debL.
44
Ad[usung uebL aL ulsney
Aswath Damodaran
44
! lL can swap some of lLs exlsung xed raLe, dollar debL for
oaung raLe, forelgn currency debL. Clven ulsneys
sLandlng ln nanclal markeLs and lLs large markeL
caplLallzauon, Lhls should noL be dlmculL Lo do.
! lf ulsney ls plannlng new debL lssues, elLher Lo geL Lo a
hlgher debL rauo or Lo fund new lnvesLmenLs, lL can use
prlmarlly oaung raLe, forelgn currency debL Lo fund
Lhese new lnvesLmenLs. AlLhough lL may be mlsmaLchlng
Lhe fundlng on Lhese lnvesLmenLs, lLs debL maLchlng wlll
become beuer aL Lhe company level.
45
uebL ueslgn for 8ookscape & vale
Aswath Damodaran
45
! !""#$%&'() Clven 8ookscape's dependence on revenues aL lLs new ?ork
booksLore, we would deslgn Lhe debL Lo be
8ecommendauon: Long-Lerm, dollar denomlnaLed, xed raLe debL
AcLual: Long Lerm operaung lease on Lhe sLore
! *&+() vale's mlnes are spread around Lhe world, and lL generaLes a large
poruon of lLs revenues ln Chlna (37). lLs mlnes Lyplcally have very long
llves and requlre large up-fronL lnvesLmenLs, and Lhe cosLs are usually ln
Lhe local currencles buL lLs revenues are ln uS dollars.
! 8ecommendauon: Long Lerm, dollar-denomlnaLed debL (wlLh hedglng of local
currency rlsk exposure) and lf posslble, ued Lo commodlLy prlces.
! AcLual: 1he exlsung debL aL vale ls prlmarlly uS dollar debL (63.48), wlLh an
average maLurlLy of 14.70 years. All of Lhe debL, as far as we can assess, ls
xed raLe and Lhere ls no commodlLy-llnked debL.
46
And for 1aLa MoLors and 8aldu
! ,&-& /"-"0$: As an manufacLurlng rm, wlLh blg chunks of lLs
of lLs revenues comlng from lndla and Chlna (abouL 24
aplece) and Lhe resL spread across developed markeLs.
! 8ecommendauon: Medlum Lo long Lerm, xed raLe debL ln a mlx of
currencles reecung operauons.
! AcLual: 1he exlsung debL aL 1aLa MoLors ls a mlx of lndlan rupee debL
(abouL 71) and Luro debL (abouL 29), wlLh an average maLurlLy of
3.33 years and lL ls almosL enurely xed raLe debL.
! !&123) 8aldu has relauvely llule debL aL Lhe momenL,
reecung lLs sLaLus as a young, Lechnology company.
! 8ecommendauon: Converuble, Chlnese ?uan debL.
! AcLual: AbouL 82 of 8aldu's debL ls ln uS dollars and Luros currenLly,
wlLh an average maLurlLy of 3.80 years. A small poruon ls oaung raLe
debL, buL very llule of Lhe debL ls converuble.
Aswath Damodaran
46