0
CORPORATE
FINANCE
WHAT
IS
IT?
Aswath
Damodaran
What
is
corporate
nance?
1
Every
decision
that
a
business
makes
has
nancial
implicaFons,
and
any
decision
which
aects
the
nances
of
a
business
is
a
corporate
nance
decision.
Dened
broadly,
everything
that
a
business
does
ts
under
the
rubric
of
corporate
nance.
ObjecFves
2
To
give
you
the
capacity
to
understand
the
theory
and
apply,
in
real
world
situaFons,
the
techniques
that
have
been
developed
in
corporate
nance.
MoOo
for
class:
If
it
cannot
be
applied,
who
cares?.
To
give
you
the
big
picture
of
corporate
nance
so
that
you
can
understand
how
things
t
together.
MoOo
for
class:
You
can
forget
the
details,
but
dont
miss
the
storyline.
To
show
you
that
corporate
nance
is
fun.
MoOo
for
class:
Are
we
having
fun
yet?
The
TradiFonal
AccounFng
Balance
Sheet
3
The Balance Sheet
Assets
Liabilities
Long Lived Real Assets
Fixed Assets
Current
Liabilties
Short-term liabilities of the firm
Short-lived Assets
Current Assets
Debt
Debt obligations of firm
Investments in securities &
assets of other firms
Financial Investments
Other
Liabilities
Other long-term obligations
Assets which are not physical,
like patents & trademarks
Intangible Assets
Equity
Equity investment in firm
The
Financial
View
of
the
Firm
4
Assets
Existing Investments
Generate cashflows today
Includes long lived (fixed) and
short-lived(working
capital) assets
Expected Value that will be
created by future investments
Liabilities
Assets in Place
Debt
Growth Assets
Equity
Fixed Claim on cash flows
Little or No role in management
Fixed Maturity
Tax Deductible
Residual Claim on cash flows
Significant Role in management
Perpetual Lives
First
Principles
&
The
Big
Picture
5
Maximize the value of the business (firm)
The Investment Decision
Invest in assets that earn a
return greater than the
minimum acceptable hurdle
rate
The hurdle rate
should reflect the
riskiness of the
investment and
the mix of debt
and equity used
to fund it.
The return
should relfect the
magnitude and
the timing of the
cashflows as welll
as all side effects.
The Financing Decision
Find the right kind of debt
for your firm and the right
mix of debt and equity to
fund your operations
The optimal
mix of debt
and equity
maximizes firm
value
The right kind
of debt
matches the
tenor of your
assets
The Dividend Decision
If you cannot find investments
that make your minimum
acceptable rate, return the cash
to owners of your business
How much
cash you can
return
depends upon
current &
potential
investment
opportunities
How you choose
to return cash to
the owners will
depend whether
they prefer
dividends or
buybacks
Theme
1:
Corporate
nance
is
common
sense
6
There
is
nothing
earth
shaOering
about
any
of
the
rst
principles
that
govern
corporate
nance.
AVer
all,
arguing
that
taking
investments
that
make
9%
with
funds
that
cost
10%
to
raise
seems
to
be
staFng
the
obvious
(the
investment
decision),
as
is
noFng
that
it
is
beOer
to
nd
a
funding
mix
which
costs
10%
instead
of
11%
(the
nancing
decision)
or
posiFng
that
if
most
of
your
investment
opportuniFes
generate
returns
less
than
your
cost
of
funding,
it
is
best
to
return
the
cash
to
the
owners
of
the
business
and
shrink
the
business.
Shrewd
business
people,
notwithstanding
their
lack
of
exposure
to
corporate
nance
theory,
have
always
recognized
these
fundamentals
and
put
them
into
pracFce.
6
Theme
2:
Corporate
nance
is
focused
7
It
is
the
focus
on
maximizing
the
value
of
the
business
that
gives
corporate
nance
its
focus.
As
a
result
of
this
singular
objecFve,
we
can
Choose
the
right
investment
decision
rule
to
use,
given
a
menu
of
such
rules.
Determine
the
right
mix
of
debt
and
equity
for
a
specic
business
Examine
the
right
amount
of
cash
that
should
be
returned
to
the
owners
of
a
business
and
the
right
amount
to
hold
back
as
a
cash
balance.
This
cerFtude
does
come
at
a
cost.
To
the
extent
that
you
accept
the
objecFve
of
maximizing
rm
value,
everything
in
corporate
nance
makes
complete
sense.
If
you
do
not,
nothing
will.
7
Theme
3:
The
focus
changes
across
the
life
cycle
8
Con Eds Financial Balance Sheet
Assets
$ 15 billion
$ 3 billion
Liabilities
Investments already
made
Debt
Investments yet to
be made
Equity
$ 7 billion
$ 11 billion
Linkedin's Financial Balance Sheet
Assets
Liabilities
$0.25 billion
Investments already
made
Debt
13.35 billion
Investments yet to
be made
Equity
$ 0.00 billion
$ 13.6 billion
Theme
4:
Corporate
nance
is
universal
9
Every
business,
small
or
large,
public
or
private,
US
or
emerging
market,
has
to
make
investment,
nancing
and
dividend
decisions.
The
objecFve
in
corporate
nance
for
all
of
these
businesses
remains
the
same:
maximizing
value.
While
the
constraints
and
challenges
that
rms
face
can
vary
dramaFcally
across
rms,
the
rst
principles
do
not
change.
A
publicly
traded
rm,
with
its
greater
access
to
capital
markets
and
more
diversied
investor
base,
may
have
much
lower
costs
of
debt
and
equity
than
a
private
business,
but
they
both
should
look
for
the
nancing
mix
that
minimizes
their
costs
of
capital.
A
rm
in
an
emerging
markets
may
face
greater
uncertainty,
when
assessing
new
investments,
than
a
rm
in
a
developed
market,
but
both
rms
should
invest
only
if
they
believe
they
can
generate
higher
returns
on
their
investments
than
they
face
as
their
respecFve
(and
very
dierent)
hurdle
rates.
Theme
5:
If
you
violate
1st
principles,
you
will
pay!
10
There
are
some
investors/analysts/managers
who
convince
themselves
that
the
rst
principles
dont
apply
to
them
because
of
their
superior
educaFon,
standing
or
past
successes,
and
then
proceed
to
put
into
place
strategies
or
schemes
that
violate
rst
principles.
Sooner
or
later,
these
strategies
will
blow
up
and
create
huge
costs.
Almost
every
corporate
disaster
or
bubble
has
its
origins
in
a
violaFon
of
rst
principles.
10
And
it
will
be
applied
11
Disney
Sector: Entertainment
Incorporated in: US
Operations: Multinational
Size: Large market cap
Vale
Sector: Mining/Metals
Incorporated in: Brazil
Operations: Multinational
Size: Large market cap
Other: Government stake
Bookscape
Sector: Book Retail
Incorporated in: US
Operations: New York
Other: Privately owned
Applied Corporate Finance
Tata Motors
Sector: Automotive
Incorporated in: India
Operations: Multinational
Size: Mid market cap
Other: Family Group
Deutsche Bank
Sector: Bank/ Investment Bank
Incorporated in: Germany
Operations: Multinational
Size: Large market cap
Other: Regulated
Baidu
Sector: Online Search
Incorporated in: Cayman Isl
Operations: China
Size: Mid market cap
Other: Shell company (VIE)
11
Set Up and Objective
1: What is corporate finance
2: The Objective: Utopia and Let Down
3: The Objective: Reality and Reaction
The Investment Decision
Invest in assets that earn a return
greater than the minimum acceptable
hurdle rate
Hurdle Rate
4. Define & Measure Risk
5. The Risk free Rate
6. Equity Risk Premiums
7. Country Risk Premiums
8. Regression Betas
9. Beta Fundamentals
10. Bottom-up Betas
11. The "Right" Beta
12. Debt: Measure & Cost
13. Financing Weights
The Financing Decision
Find the right kind of debt for your
firm and the right mix of debt and
equity to fund your operations
Financing Mix
17. The Trade off
18. Cost of Capital Approach
19. Cost of Capital: Follow up
20. Cost of Capital: Wrap up
21. Alternative Approaches
22. Moving to the optimal
Financing Type
23. The Right Financing
Investment Return
14. Earnings and Cash flows
15. Time Weighting Cash flows
16. Loose Ends
12
36. Closing Thoughts
The Dividend Decision
If you cannot find investments that make
your minimum acceptable rate, return the
cash to owners of your business
Dividend Policy
24. Trends & Measures
25. The trade off
26. Assessment
27. Action & Follow up
28. The End Game
Valuation
29. First steps
30. Cash flows
31. Growth
32. Terminal Value
33. To value per share
34. The value of control
35. Relative Valuation
Chapter
1
13
