7000 words paper Target Company: Voadfone - Business & Finance
i
On line Assignment Submission
Student ID Number: 180906257
Name and Surname: Zeliha Kasapoglu
MSc Programme: Business Finance
Title: Business analysis and valuation of Apple, Inc.
Name of Supervisor: Dr. Panagiotis Koutroumpis
Deleting as appropriate:
I do agree to allow my dissertation to be seen by future students
Online Dissertation submission:
Please ensure that you complete and attach this submission form to the front of your
work
By submitting your work online you are confirming that your work is your own and
that you understand and have read the University’s rules regarding plagiarism
ii
BUSINESS ANALYSIS AND VALUATION OF APPLE, INC.
M.Sc. Dissertation
Abstract
This paper investigates a target share price for Apple, Inc. using the discounted cash flow model
as the valuation technique and aims to provide an investment recommendation based on the
comparison between the market price and the estimated target price. The foundation of the
valuation approach is to forecast 10-year future cash flows based on their historical growth
trends to estimate annual free cash flow to firm. These cash flows are discounted back to 2019
with the weighted average cost of capital to find the present value of the company. Under the
guidelines of capital asset pricing model, this discount rate is estimated at 7.30\%. The paper
concludes a target price of $218.62, which is +12.78\% above the market price as of 10/06/2019
and provides an in-debt analysis of the price sensitivity to the model’s assumptions that impacts
Apple’s economic growth and its market position. This paper recommends investors a strong
buy position based on the estimated target price, Apple’s latest strategic decisions, its strong
bargaining power, and its liquidity management.
AUGUST 15, 2019
ZELIHA KASAPOGLU
QUEEN MARY UNIVERSITY OF LONDON
iii
Table of Contents
Abstract .......................................................................................................................... ii
Table of Contents............................................................................................................. iii
List of Tables ....................................................................................................................v
List of Figures .................................................................................................................. vi
1. Introduction ............................................................................................................. 1
2. Literature Review ..................................................................................................... 2
3. Data ........................................................................................................................ 3
3.1. Free cash flow to firm .................................................................................................. 3
3.1.1. Earnings before interest and debt ...................................................................................................3
3.1.2. Depreciation and amortization ........................................................................................................3
3.1.3. Capital expenditures ........................................................................................................................3
3.1.4. Effective tax rate ..............................................................................................................................4
3.1.5. Change in net working capital ..........................................................................................................4
3.2. Weighted average cost of capital .................................................................................. 4
3.2.1. Cost of equity ...................................................................................................................................4
3.2.2. Cost of debt ......................................................................................................................................5
3.3. Perpetuity growth rate ................................................................................................. 6
3.4. Terminal value ............................................................................................................. 7
3.5. Enterprise value and equity value ................................................................................. 7
4. Methodology ........................................................................................................... 8
4.1. Discounted cash flow model ......................................................................................... 8
4.1.1. Step 1: Forecasting cash flows .........................................................................................................8
4.1.2. Step 2: Free cash flow to firm ....................................................................................................... 10
4.1.3. Step 3: Discounted cash flows ...................................................................................................... 11
4.2. Sensitivity Analysis..................................................................................................... 12
iv
4.2.1. Internal justification ...................................................................................................................... 13
4.2.2. External justification ..................................................................................................................... 13
5. Results ....................................................................................................................14
5.1. Preliminary fundamental analysis............................................................................... 14
5.2. Forecasting cash flows ............................................................................................... 21
5.3. The discounted cash flow model................................................................................. 26
5.4. Sensitivity analysis ..................................................................................................... 31
6. Conclusion...............................................................................................................34
7. References ..............................................................................................................35
8. Abbreviations and acronyms ...................................................................................38
9. Appendix.................................................................................................................39
v
List of Tables
Table 1: Revenues by product segments (Bloomberg L.P., 2019) .......................................... 16
Table 2: Profitability ratios (Bloomberg L.P., 2019) ............................................................... 18
Table 3: Solvency and liquidity ratios (Bloomberg L.P., 2019) .............................................. 18
Table 4: Working capital ratios (Bloomberg L.P., 2019) ........................................................ 19
Table 5: Assumptions for forecasting future cash flows ......................................................... 22
Table 6: Free cash flow to firm ................................................................................................ 25
Table 7: Regression analysis variables (Yahoo Finance, 2019) .............................................. 27
Table 8: The cost of equity ...................................................................................................... 27
Table 9: The cost of debt ......................................................................................................... 28
Table 10: The cost of capital .................................................................................................... 28
Table 11: The terminal value ................................................................................................... 28
Table 12: Target equity value of Apple Inc. (Bloomberg L.P., 2019) ..................................... 30
Table 13: Price sensitivity to changes of revenue and COGS ................................................. 32
Table 14: Price sensitivity to market wide factors ................................................................... 32
Table 15: Upside / downside potential of target price due to changes in market .................... 33
Table 16: Standardized balance sheet total assets (Bloomberg L.P., 2019) ............................ 40
Table 17: Standardized balance sheet total liabilities (Bloomberg L.P., 2019) ....................... 41
Table 18: Standardized balance sheet total equities (Bloomberg L.P., 2019) ......................... 42
Table 19: Adjusted income statement (Bloomberg L.P., 2019) .............................................. 43
Table 20: Standardized cash flow statement operating and investing activities (Bloomberg
L.P., 2019)................................................................................................................................ 44
Table 21: Standardized cash flow statement financing activities (Bloomberg L.P., 2019) ..... 45
vi
List of Figures
Figure 1: U.S. economy real GDP growth rate. (IMF, 2019) .................................................... 6
Figure 2: Discounting cash flow model general outlook ........................................................... 8
Figure 3: Comparison of revenues, COGS, gross profit (Bloomberg L.P., 2019)................... 14
Figure 4: Growth rates of the revenues and the COGS (Bloomberg L.P., 2019) .................... 15
Figure 5: Sales distribution by products (Bloomberg L.P., 2019) ........................................... 16
Figure 6: Comparison of the gross profit, the EBIT and the FCFF (Bloomberg L.P., 2019) .. 17
Figure 7: Apple, Inc. stock price and Nasdaq composite index (Yahoo Finance, 2019)......... 20
Figure 8: Apple stock price movements in the last 5-years (Yahoo Finance, 2019) ............... 21
Figure 9: Revenues and cost of goods sold forecasted (Bloomberg L.P., 2019) ..................... 23
Figure 10: Regression analysis ................................................................................................ 26
Figure 11: The target price is $218.62 (Yahoo Finance, 2019) ............................................... 29
Figure 12: Revenue growth forecast sensitivity analysis ......................................................... 31
Figure 13: COGS growth forecasts sensitivity analysis .......................................................... 31
Figure 14: Stock price curve in the last 10-years (Yahoo Finance, 2019) ............................... 39
1
1. Introduction
Apple, Inc. is a California based technology company that is developing consumer electronics
goods together with their accessories, computer software, media devices, third-party digital
content and software applications (Apple Inc., 2018). The multinational company sells and
delivers its products worldwide to retailers and wholesalers. Apple’s stock price is trading
today, 10/06/2019, at $193.85 per share in the securities market under Nasdaq Stock Exchange
(Yahoo Finance, 2019). This work aims to determine a target share price of Apple, Inc. by the
end of 2019 using the discounted cash flow model1. The model is conducted by the forecasting
free cash flow to firm based on historical trends. As a conclusion, an investment
recommendation by comparing the target price to the current price is provided.
The financial assessment of the valuation technique is based on the discounted cash flow
approach. First, the free cash flow available to the firm is forecasted for ten years including the
terminal value, then the free cash flows are discounted back to the current year using the cost
of capital to determine the present value of future cash flows. Long-term forecasting is based
on the historical trends of sales growth and its ratio to other variables. Cash flows are estimated
by applying the same historical growth trend to future cash flows assuming that the investment
policy and capital structure of the company will remain the same. The discount rate is the
weighted average of the cost of equity and the cost of debt. The cost of equity calculation is
based on the capital asset pricing model (CAPM) and the cost debt depends on the default rate
given by the credit rating agencies. The present value of all projected cash flows is the
enterprise value of the company. The equity value, or the target price, is the residual value of
the company once the net debt is paid to debt holders by liquidizing all cash and cash equivalent
securities. Hence, after obtaining the target price, its sensitivity to the assumptions is analysed.
This paper is structured as follows. Section 3 introduces the data and variables that are used for
the DCF model. Section 4 presents the ratios and methodology used for forecasting and
modelling. Section 5 indicates the results of the DCF model, presents the target price and
assesses its sensitivity to the assumptions. Finally, section 6 advises an investment strategy
based on the conclusions.
1 According to the 2018 annual statement, yearend is reported from September to September (Apple Inc., 2018)
2
2. Literature Review
The work closely follows the business valuation techniques addressed by the “Business
Analysis and Valuation” book (Palepu, et al., 2013) and the “Corporate Finance” book (Ross,
et al., 2016). The financial information used in the assessment is based on the 2018 annual
report and proxy statement to the shareholders that are provided by the company itself (Apple
Inc., 2018). The Corporate Finance Institute’s guidelines are followed to provide the most
trustworthy valuation techniques (CFI, 2019).
The Bloomberg Terminal is used as a data source of financial data to support assumptions that
are taken for forecasting future cash flows and valuing the business (Bloomberg L.P., 2019).
The Terminal provides standardized and financial statements which allow easy comparison
between companies and industry benchmarks. Analyst reports and recommendations provided
in Bloomberg Terminal are studied to provide a professional outlook.
Forecasts of the International Monetary Fund are used for macroeconomic data such as
inflation and real GDP growth (IMF, 2019). Stock price movements and related up-to-date
price data are downloaded from Yahoo Finance (Yahoo Finance, 2019). The yield of the 10-
year U.S. treasury bonds is taken from Yahoo Finance to obtain the risk-free rate of return.
Online media resources such as highly reputable and trustworthy newspapers such as Financial
Times, CNBC, Time Magazine and the Guardian Magazine are referenced to provide
background information about Apple’s financial statement, its strategic decision and price
curve.
This paper references the book “Investment Philosophies” (Damoran, 2012) for financial ratio
calculation and technical assessment. Finally, the regression analysis technique is based on the
methodology explained by the “Introductory Econometrics for Finance” book (Brooks, 2014).
3
3. Data
The applied valuation approach to calculate Apple’s fair value is the discounted cash flow
method (DCF), where forecasted future cash flows are discounted to the current year, 2019, to
obtain the total present value of the company (Palepu, et al., 2013, p. 278). The methodology
is based on a 10-year valuation technique starting from 27/09/2008 until 29/09/2018. Historical
financial statements of Apple are analysed to build a foundation for forecasting. This section
briefly explains the financial background of variables and addresses how to access them.
3.1. Free cash flow to firm
The valuation technique used in this work is based on the total cash available to the firm that
is obtained from its operations and ready to distribute for internal purposes, paying off debt or
returning to shareholders (Damoran, 2012, p. 109). It is the free cash flow from operating
activities that is available to debt- and credit-holders when all fixed asset investments, net
working capital and tax obligations are paid (Ross, et al., 2016, p. 32).
3.1.1. Earnings before interest and debt
The DCF model focuses on the value generation from operating income, not from financing or
investing income. Hence, the foundation of the model is estimating earnings before interest
and debt (EBIT) that is generated by the sales of good and services and subtracted by the costs
of goods sold (COGS) and the other operating expenses. These items are taken from the income
statement of Apple.
3.1.2. Depreciation and amortization
Depreciation and amortization (D&A) are non-cash accountancy items from the cash flow
statement under operating activities (Ross, et al., 2016, p. 25). It amounts to the cost of assets
that are depreciating over time. The remaining asset value is the economic value of the asset
that is used up (Ross, et al., 2016, p. 25).
3.1.3. Capital expenditures
Capital expenditures are payments to purchase fixed assets, machinery, equipment or tools to
improve the operation. These are taken from the cash flow statement under “Payments for
acquisition of property, plant and equipment”.
4
3.1.4. Effective tax rate
Tax expenses are other non-cash accountancy items from the balance sheet. A business is
obliged to pay taxes from its income due to the corporate income tax. However, not only the
income but also all value generating/destroying items in a company are subject to various type
of taxes such as capital gain tax, dividend tax, payroll tax, property tax etc. Instead of
considering every single tax item separately, the effective tax rate covers all tax expenses and
computes their annual ratio to pre-tax income.
The 2017 U.S. corporate tax legislation under the President Trump administration reduced the
corporate taxes from 35\% to 21\%, which also reduced overseas income tax to 15.5\%, which
allowed many multinational companies to reinvest in their operations using their overseas
profit (CNBC, 2018).
3.1.5. Change in net working capital
Change in net working capital is a measurement of accountancy components that identify if
the basic requirements of the business to run its daily operations are fulfilled at an adequate
level (Palepu, et al., 2013, p. 194). These balance sheet items are the change in trade
receivables, the change in payables to suppliers and the change in inventory. According to the
Corporate Finance Institute, the calculation technique might slightly vary depending on the
analysts’ perspective2.
3.2. Weighted average cost of capital
The discounting rate with which present value of the company is calculated is the cost of capital
that the investors are paying to receive a minimum required rate of return to bear the risk and
achieve extra returns (Ross, et al., 2016, p. 397). The cost of capital (𝑟𝑊𝐴𝐶𝐶 ) is a function of
the cost of equity (re), the market value of total equity (E), the after-tax cost of debt (rd) and
the market value of total debt (D) (Palepu, et al., 2013, p. 335). The market value of the equity
is the market capitalization of the stock in the equities market.
3.2.1. Cost of equity
The cost of equity (re) calculation method is derived from the capital asset pricing model
(CAPM) that is the expected return-beta relationship of a security relative to its market. Its
2 https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-net-working-capital/
5
graphical representation is the Securities Market Line (Bodie, et al., 2014, p. 297). The
expected return on an asset is expressed as a function of the equity beta (𝛽𝑒), the market risk
premium 𝑟𝑝 = 𝐸(𝑟𝑀 ) − 𝑟𝑓and the risk-free rate of return (𝑟𝑓).
The risk-free rate of return is the historical daily average yield of 10-year U.S. government
bonds from 20093 until 2018 (Palepu, et al., 2013, p. 334). The average risk-free rate is at
2.46\% (Yahoo Finance, 2019). The 10-year maturity of government bonds are chosen exactly
to match the forecasting period (Ross, et al., 2016, p. 400).
The market risk premium (𝑟𝑝) is the extra return investors require from the market portfolio
(𝑟𝑀 ) to bear the market wide risk above the risk-free rate of return (Palepu, et al., 2013, p. 334).
The market risk varies depending on the country and its macroeconomic state. Duff & Phelps,
a global advisory expert company in valuation and corporate finance areas, recommends 5.5\%
for the U.S. market risk premium in 2018 (Duff&Phelps, 2019).
The equity beta, also called as the levered beta or the systematic risk (𝛽𝑒) is the non-
diversifiable market-wide risk that indicates the impact of the market-wide risk on the equity’s
return (Palepu, et al., 2013, p. 331). The market portfolio is usually the market index where the
company is traded or where its headquarter is located. In Apple’s case, instead of the US
benchmark S&P500 index, the tech-heavy index Nasdaq Composite Index, where Apple’s
stocks are traded, is chosen. This allows investors to compare Apple within the technology
industry and to observe its correlation to the market-wide risk that impacts technology firms
the most.
3.2.2. Cost of debt
Since the DCF model is based on after-tax cash flows, the cost of debt is calculated after-tax
basis considering the tax-deductibility of interest expenses and the tax shield that is created
(Palepu, et al., 2013, p. 334). Hence, the cost of debt is the sum of the risk-free rate and the
credit default risk of the company after-tax. The credit default is the default rate at which a
long-term corporate bond issued by a company, which is graded by the credit rating agencies
depending on their ability to repay the debt (David, et al., 2002, pp. 47, 48). Credit rating
3 Year 2008 is bypassed due to the financial crisis in the United States in order to assess normal years.
6
agencies rate the potential risk of repayment of the debt by specific degrees and define the
creditworthiness of the corporations by these rates over their lifetime. The spread is defined by
the extra cost that the investor is paying to bear the default risk of the firm. The higher a firm
is rated, the lower is the cost of debt and hence its interest rate is closer to the risk-free rate of
return (Damoran, 2012, p. 50).
The credit default of the long-term corporate bonds of Apple are rated by the Moody’s agency
at AA1 and by the Standard & Poor’s agency at AA+ (Bloomberg L.P., 2019). The AA1 level
traded corporate bonds in the United States have in average a 1.00\% spread (NYU Stern, 2019).
3.3. Perpetuity growth rate
The perpetuity growth rate is the constant rate at which the terminal value of FCFF growing
forever. It is assumed that in an economy, cash flows do not grow at a higher rate than the
economies perpetuity growth rate. As a benchmark rate, the expected growth rate of the U.S.
economy is taken (Damoran, 2012, p. 102). Herewith, the real GDP growth assumption by the
International Monetary Fund is applied as the perpetuity growth rate.
Figure 1: U.S. economy real GDP growth rate. (IMF, 2019)
IMF estimates the real GDP growth at 1.6\% from 2022 to 2024 (IMF, 2019). After 2024 the
growth rate of the US economy is hardly foreseeable and uncertain. Therefore, the expected
perpetuity growth rate of the FCFF after 2029 is assumed to follow the same trend and remain
stable at 1.6\% as the IMF projections presume.
7
3.4. Terminal value
The terminal year is the last cash flow forecasting year that is covered in the DCF model.
However, cash flows beyond the terminal year are generating value as well and are important
to include in the valuation exercise. The terminal value is the estimated present value of all
cash flows beyond the terminal year and they are assumed to be growing at a perpetuity growth
rate (Damoran, 2012, p. 107).
3.5. Enterprise value and equity value
The sum of all discounted cash flows determines the fair enterprise value of the company at
the calculation date that is the date to which free cash flows to firm are discounted back. The
enterprise value is defined as the asset value if the company had been financed 100\% with
equity (Palepu, et al., 2013, p. 347). However, in reality, there is the tax-shield advantage of
debt that adds value to equity as a whole. As a result, the remaining equity value becomes the
residual claim to shareholders once all debt is paid. The estimated equity value is the fair
(target) value of the companies’ stocks that are driven by the cash flow structure of the
company. The target price of a share is a benchmark value for the investor when compared
with the market price. With the valuation approach, this paper introduces a target price that is
driven by the fair value of the firm and compares it with the current trading price.
8
4. Methodology
The following section introduces the techniques that are used for the valuation of Apple, Inc.
following two sections: the first section explains how to obtain the target price of the company
and the valuation method behind it. The second section examines how the assumptions are
justified and assesses the sensitivity of the obtained target price to both external and internal
assumptions.
4.1. Discounted cash flow model
The first step of the discounted cash flow model (DCF) is analysing historical 10-years of cash
flows and forecasting them based on their growth trend or their ratio to the sales revenues. The
second step is calculating the free cash flow to firm (FCFF). The last step is discounting FCFF
to current year to obtain the present value of the company.
Figure 2: Discounting cash flow model general outlook
4.1.1. Step 1: Forecasting cash flows
The forecasting future cash flows starts with analysing historical financial statements. The goal
is to seek trends and consistent ratios to estimate future cash flows based on that conclusion.
Below are the forecasting methods applied to obtain all necessary variables for the free cash
flow calculation.
4.1.1.1. Sales revenues growth trend
The foundation of the forecasting cash flow is sales revenues. First, the historical 10-year
growth trend is analysed considering the business cycles, the U.S. economic growth and the
recent strategies of the company. Second, the trend is extended to the future 10-years and
additionally the growth rate of the terminal year is expected be exactly to equal as the U.S.
economic growth forecasts.
9
4.1.1.2. Gross profit margin and EBIT margin
The cost of goods sold (𝐶𝑂𝐺𝑆) to revenues margin is analysed to obtain the historical gross
profit margin of the company:
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 =
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑂𝐺𝑆
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
(1)
The same gross margin interval of the past 10-years is kept as the benchmark projection of
future predictions. Next, other operating expenses such as selling, general and administration
expenses, research and development expenses and other operating expenses are summed up to
compute their ratio to the cost of goods sold. As a result, EBIT is the gross profit subtracted by
the other operating expenses and EBIT margin is simply the ratio of EBIT to the revenues.
Hence, the following equation can be applied:
𝐸𝐵𝐼𝑇 = 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 − 𝑂𝑡ℎ𝑒𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 (2)
4.1.1.3. Capital expenditures to depreciation and amortization ratio
First, the ratio of depreciation and amortization expenses (D&A) to EBIT is calculated to obtain
a benchmark ratio of how the future organic growth trend might evolve. Second, historical
CapEx to D&A ratio is analysed, and the same ratio is applied to future estimations to maintain
a similar performance. If the CapEx is higher than the D&A, meaning their ratio is greater than
one (or 100\%), the business can not only maintain its current state but can also invest in its
fixed assets to improve production and its operating performance. However, the terminal year
is the year at which the company is just expected to maintain organic growth and to follow …
BUSINESS ANALYSIS
& VALUATION
USING FINANCIAL STATEMENTS
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
BUSINESS ANALYSIS
& VALUATION
USING FINANCIAL STATEMENTS
5e
KRISHNA G. PALEPU, PhD
Ross Graham Walker Professor of Business Administration
Harvard University
PAUL M. HEALY, PhD, ACA
James R. Williston Professor of Business Administration
Harvard University
Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
This is an electronic version of the print textbook. Due to electronic rights restrictions,
some third party content may be suppressed. Editorial review has deemed that any suppressed
content does not materially affect the overall learning experience. The publisher reserves the right
to remove content from this title at any time if subsequent rights restrictions require it. For
valuable information on pricing, previous editions, changes to current editions, and alternate
formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for
materials in your areas of interest.
Business Analysis & Valuation: Using
Financial Statements, 5th edition
Krishna G. Palepu and Paul M. Healy
Senior Vice President, LRS/Acquisitions &
Solutions Planning: Jack W. Calhoun
Editor-in-Chief: Rob Dewey
Senior Acquisitions Editor: Matt Filimonov
Senior Developmental Editor: Craig Avery
Editorial Assistant: A. J. Smiley
Senior Market Development Manager:
Natalie Livingston
Senior Brand Manager: Kristen Hurd
Marketing Manager: Heather Mooney
Marketing Communications Manager:
Sarah Greber
Marketing Coordinator: Eileen Corcoran
Senior Art Director: Stacy Shirley
Production Management, Internal Design,
and Composition: PreMediaGlobal
Media Editor: Bryan England
Rights Acquisition Director: Audrey
Pettengill
Rights Acquisition Specialist, Text and
Image: Audrey Pettengill
Senior Manufacturing Planner: Doug Wilke
Cover Designer: Red Hangar Design
Cover Image(s): ©iStock Photo/
franckreporter
© 2013, 2008 South-Western, Cengage Learning.
ALL RIGHTS RESERVED. No part of this work covered by the copyright
herein may be reproduced, transmitted, stored, or used in any form or by
any means graphic, electronic, or mechanical, including but not limited
to photocopying, recording, scanning, digitizing, taping, web distribution,
information networks, or information storage and retrieval systems,
except as permitted under Section 107 or 108 of the 1976 United States
Copyright Act, without the prior written permission of the publisher.
For product information and technology assistance, contact us at
Cengage Learning Customer & Sales Support, 1-800-354-9706
For permission to use material from this text or product, submit all
requests online at www.cengage.com/permissions.
Further permissions questions can be emailed to
[email protected]
Library of Congress Control Number: 2012948788
Student Edition ISBN 13: 978-1-111-97230-1
Student Edition ISBN 10: 1-111-97230-3
Student Edition with CD ISBN 13: 978-1-285-42618-1
Student Edition with CD ISBN 10: 1-285-42618-5
South-Western
5191 Natorp Boulevard
Mason, OH 45040
USA
Cengage Learning is a leading provider of customized learning solu-
tions with office locations around the globe, including Singapore, the
United Kingdom, Australia, Mexico, Brazil, and Japan. Locate your local
office at: www.cengage.com/global
Cengage Learning products are represented in Canada by
Nelson Education, Ltd.
For your course and learning solutions, visit www.cengage.com
Purchase any of our products at your local college store or at our
preferred online store www.cengagebrain.com.
Printed in the United States of America
1 2 3 4 5 6 7 16 15 14 13 12
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
PREFACE
F
inancial statements are the basis for a wide range of business analysis. Managers
use them to monitor and judge their firms’ performance relative to competitors,
to communicate with external investors, to help judge what financial policies they
should pursue, and to evaluate potential new businesses to acquire as part of their invest-
ment strategy. Securities analysts use financial statements to rate and value companies
they recommend to clients. Bankers use them in deciding whether to extend a loan to a
client and to determine the terms of the loan. Investment bankers use them as a basis for
valuing and analyzing prospective buyouts, mergers, and acquisitions. And consultants
use them as a basis for competitive analysis for their clients.
Not surprisingly, therefore, we find that there is a strong demand among business stu-
dents for a course that provides a framework for using financial statement data in a vari-
ety of business analysis and valuation contexts. The purpose of this book is to provide
such a framework for business students and practitioners. The first four editions of this
book have succeeded far beyond our expectations in equipping readers with this useful
framework, and the book has gained proponents in accounting and finance departments
in business schools in the United States and around the world.
CHANGES FROM THE FOURTH EDITION
In response to suggestions and comments from colleagues, students, and reviewers, we
have incorporated the following changes in the fifth edition:
• Data, analyses, and issues have been thoroughly updated.
• Where appropriate, lessons have been drawn from current events such as the
global financial crisis of 2008 and the ongoing European debt crisis.
• The financial analysis and valuation chapters (Chapters 6–8) have been updated
with a focus on firms in the U.S. retail department store sector, primarily TJX and
Nordstrom. In addition, we have provided a more cohesive overall discussion of
the four key components of effective financial statement analysis that this book
examines by introducing these companies in our discussion of strategy analysis
in Chapter 2 and staying with them through the accounting, financial, and
prospective analyses that follow.
• We have provided a greatly expanded examination of the impact of accounting
adjustments (introduced in Chapter 4) on company analysis by analyzing both
unadjusted and adjusted financial ratio and cash flow measures for TJX and
Nordstrom in Chapter 5, and by then using adjusted numbers for TJX in the
prospective analysis of Chapters 6–8.
• The topic of U.S. GAAP/IFRS convergence is introduced and examined, with
discussion and examples in comparing companies reporting under U.S. GAAP and
IFRS, and a brief discussion on important remaining differences between U.S.
GAAP and IFRS.
• An expanded discussion of fair value accounting is included, given its increasing
use globally and also its much discussed role in the 2008 financial crisis.
• We have streamlined and greatly enhanced the readability of the discussion on the
theory behind valuation techniques in Chapters 7 and 8.
• In our Text and Cases edition, we have included new and updated Harvard
Business School cases. In all, we include 27 cases in this edition.
v
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
• We are introducing with this edition an online version of the BAV modeling tool,
which represents a significant enhancement of the tool over the previous
spreadsheet-based version. This comprehensive modeling tool implements the
analytical framework and techniques discussed in this book, and allows students to
easily import the financial statements of a company into the model from three
major data providers—Thomson ONE, Capital IQ, and the Compustat database of
the Wharton Research Data Services—as well as to import manually created state-
ments. A user-friendly interface allows the analyst to navigate through the tool
with ease. The tool facilitates the following activities: (1) recasting the reported
financial statements in a standard format for analysis; (2) performing accounting
analysis as discussed in Chapters 3 and 4, making desired accounting adjustments,
and producing restated financials; (3) computing ratios and free cash flows as
presented in Chapter 5; (4) producing forecasted income, balance sheet, and cash
flow statements for as many as 15 years into the future using the approach dis-
cussed in Chapter 6; (5) preparing a terminal value forecast using the abnormal
earnings, the abnormal returns, and discounted cash flow methods as discussed in
Chapters 7 and 8; and (6) valuing a company (either assets or equity) from these
forecasts as also discussed in Chapters 7 and 8. We have seen that the BAV
modeling tool can make it significantly easier for students to apply the framework
and techniques discussed in the book in a real-world context, and we feel that the
new online version, with its enhanced data import flexibility and improved overall
interface, further enhances the usability and usefulness of this tool.
KEY FEATURES
This book differs from other texts in business and financial analysis in a number of
important ways. We introduce and develop a four-part framework for business analysis
and valuation using financial statement data. We then show how this framework can be
applied to a variety of decision contexts.
Framework for Analysis
We begin the book with a discussion of the role of accounting information and
intermediaries in the economy, and how financial analysis can create value in well-
functioning markets (Chapter 1). We identify four key components, or steps, of effective
financial statement analysis:
• Business strategy analysis
• Accounting analysis
• Financial analysis
• Prospective analysis
The first step, business strategy analysis (Chapter 2), involves developing an under-
standing of the business and competitive strategy of the firm being analyzed. Incorporat-
ing business strategy into financial statement analysis is one of the distinctive features of
this book. Traditionally, this step has been ignored by other financial statement analysis
books. However, we believe that it is critical to begin financial statement analysis with a
company’s strategy because it provides an important foundation for the subsequent anal-
ysis. The strategy analysis section discusses contemporary tools for analyzing a com-
pany’s industry, its competitive position and sustainability within an industry, and the
company’s corporate strategy.
vi Preface
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Accounting analysis (Chapters 3 and 4) involves examining how accounting rules
and conventions represent a firm’s business economics and strategy in its financial state-
ments, and, if necessary, developing adjusted accounting measures of performance. In
the accounting analysis section, we do not emphasize accounting rules. Instead we
develop general approaches to analyzing assets, liabilities, entities, revenues, and
expenses. We believe that such an approach enables students to effectively evaluate a
company’s accounting choices and accrual estimates, even if they have only a basic
knowledge of accounting rules and standards. The material is also designed to allow stu-
dents to make accounting adjustments rather than merely identify questionable account-
ing practices.
Financial analysis (Chapter 5) involves analyzing financial ratio and cash flow mea-
sures of the operating, financing, and investing performance of a company relative to
either key competitors or historical performance. Our distinctive approach focuses on
using financial analysis to evaluate the effectiveness of a company’s strategy and to
make sound financial forecasts.
Finally, in prospective analysis (Chapters 6–8) we show how to develop forecasted
financial statements and how to use these to make estimates of a firm’s value. Our dis-
cussion of valuation includes traditional discounted cash flow models as well as techni-
ques that link value directly to accounting numbers. In discussing accounting-based
valuation models, we integrate the latest academic research with traditional approaches
such as earnings and book value multiples that are widely used in practice.
Although we cover all four steps of business analysis and valuation in the book, we
recognize that the extent of their use depends on the user’s decision context. For exam-
ple, bankers are likely to use business strategy analysis, accounting analysis, financial
analysis, and the forecasting portion of prospective analysis. They are less likely to be
interested in formally valuing a prospective client.
Application of the Framework to Decision Contexts
The next section of the book shows how our business analysis and valuation framework
can be applied to a variety of decision contexts:
• Equity securities analysis (Chapter 9)
• Credit analysis and distress prediction (Chapter 10)
• Merger and acquisition analysis (Chapter 11)
• Communication and governance (Chapter 12)
For each of these topics we present an overview to provide a foundation for the class
discussions. Where possible we bring in relevant real-world scenarios and institutional
details, and also examine the results of academic research that are useful in applying
the analysis concepts developed earlier in the book. For example, the chapter on credit
analysis shows how banks and rating agencies use financial statement data to develop
analyses for lending decisions and to rate public debt issues. This chapter also presents
academic research on how to determine whether a company is financially distressed.
USING THE BOOK
We designed the book so that it is flexible for courses in financial statement analysis for
a variety of student audiences—MBA students, master’s in accounting students, executive
program participants, and undergraduates in accounting or finance. Depending upon the
audience, the instructor can vary the manner in which the conceptual materials in
the chapters and end-of-chapter questions are used. To get the most out of the book,
Preface vii
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
students should have completed basic courses in financial accounting, finance, and either
business strategy or business economics. The text provides a concise overview of some of
these topics. But it would probably be difficult for students with no prior knowledge in
these fields to use the chapters as stand-alone coverage of them.
If the book is used for students with prior working experience or for executives, the
instructor can use almost a pure case approach, adding relevant lecture sections as
needed. When teaching students with little work experience, a lecture class can be pre-
sented first, followed by an appropriate case or other assignment material. Alternatively,
lectures can be used as a follow-up to cases to more clearly lay out the conceptual issues
raised in the case discussions. This may be appropriate when the book is used in under-
graduate capstone courses. In such a context, cases can be used in course projects that
can be assigned to student teams.
ACKNOWLEDGMENTS
The first edition of this book was co-authored with our colleague and friend, Victor
Bernard. Vic was the Price Waterhouse Professor of Accounting and Director of the
Paton Accounting Center at the University of Michigan. He passed away unexpectedly on
November 14, 1995. While we no longer list Vic as a co-author, we wish to acknowledge
his enduring contributions to our own views on financial analysis and valuation, and to the
ideas reflected in this book.
We also wish to thank Scott Renner for his tireless research assistance in the revision
of the text chapters and in refining the online BAV model; Trenholm Ninestein of the
HBS Information Technology Group for his help in the development of the online
BAV model; Chris Allen and Kathleen Ryan of HBS Knowledge and Library Services
for assistance with data on financial ratios for U.S. companies; the Division of Research
at the Harvard Business School for assistance in developing materials for this book; and
our past and present MBA students for stimulating our thinking and challenging us to
continually improve our ideas and presentation.
We especially thank the following colleagues who gave us feedback as we wrote this
edition: Patricia Beckenholdt, University of Maryland University College; Timothy P.
Dimond, Northern Illinois University; Jocelyn Kauffunger, University of Pittsburgh;
Suneel Maheshwari, Marshall University; K. K. Raman, University of North Texas; Lori
Smith, University of Southern California; Vic Stanton, University of California, Berkeley;
Charles Wasley, University of Rochester.
We are also very grateful to Laurie Palepu and Deborah Marlino for their help
and assistance throughout this project. Special gratitude goes to Rob Dewey and Matt
Filimonov for their publishing leadership on this edition, to our colleagues, and to
Craig Avery and Heather Mooney at Cengage and Kalpana Venkatramani, project
manager at PreMediaGlobal, for their developmental, marketing, and production help.
We would like to thank our parents and families for their strong support and encourage-
ment throughout this project.
Krishna G. Palepu
Paul M. Healy
viii Preface
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
AUTHORS
Krishna G. Palepu is the Ross Graham Walker Professor of Business Administration and
Senior Associate Dean for International Development at the Harvard Business School,
Harvard University. He also serves as Senior Adviser to the President for Global Strategy
at Harvard University. Prior to assuming his current leadership positions, Professor Palepu
held other positions at the School, including Senior Associate Dean, Director of Research,
and Unit Chair.
Professor Palepu’s current research and teaching activities focus on strategy and gover-
nance. In the area of strategy, his recent focus has been on the globalization of emerging
markets. He is a co-author of the book on this topic, Winning in Emerging Markets:
A Road Map for Strategy and Execution. He developed and taught a second year MBA
course, “Globalization of Emerging Markets,” which focuses on these issues. In addition,
Professor Palepu chairs the HBS executive education programs “Global CEOs Program
for China” and “Building Businesses in Emerging Markets.”
In the area of corporate governance, Professor Palepu’s work focuses on board engage-
ment with strategy. Professor Palepu teaches in several HBS executive education programs
aimed at members of corporate boards: “How to Make Corporate Boards More Effective,”
“Audit Committees in the New Era of Governance,” “Compensation Committees: New
Challenges, New Solutions.” Professor Palepu has served on a number of public company
and nonprofit Boards. He has also been on the Editorial Boards of leading academic jour-
nals, and has served as a consultant to a wide variety of businesses. In addition, he is a
researcher at the National Bureau of Economic Research (NBER).
Professor Palepu has a doctorate in management from the Massachusetts Institute of
Technology and an honorary doctorate from the Helsinki School of Economics and Busi-
ness Administration.
Paul M. Healy is the James R. Williston Professor of Business Administration and Senior
Associate Dean, Director of Research at the Harvard Business School, Harvard University.
Professor Healy joined Harvard Business School as a Professor of Business Administration
in 1997. His primary teaching and research interests include corporate governance and
accountability, equity research at financial services firms, strategic financial analysis and
financial reporting. Professor Healy teaches in several executive education programs
and is faculty co-chair of Strategic Financial Analysis for Business Evaluation. Professor
Healy received his B.C.A. Honors (1st Class) in Accounting and Finance from Victoria
University, New Zealand, in 1977, his M.S. in Economics from the University of Rochester
in 1981, his Ph.D. in Business from the University of Rochester in 1983, and is a
New Zealand CPA. In New Zealand, Professor Healy worked for Arthur Young and ICI.
Prior to joining Harvard, Professor Healy spent fourteen years on the faculty at the M.I.T.
Sloan School of Management, where he received awards for teaching excellence in 1991,
1992, and 1997. In 1993–94 he served as Deputy Dean at the Sloan School, and in 1994–95
he was a visiting professor at London Business School and Harvard Business School.
Professor Healy’s research includes studies of the performance of financial analysts, corporate
governance, the performance of mergers, corporate disclosure, and managers’ financial reporting
decisions. His work has been published in leading journals in accounting and finance. In 1990, his
article “The Effect of Bonus Schemes on Accounting Decisions,” published in Journal of Account-
ing and Economics, was awarded the AICPA/AAA Notable Contribution Award. His text Busi-
ness Analysis and Valuation was awarded the AICPA/AAA’s Wildman Medal for contributions
to the practice in 1997, and the AICPA/AAA Notable Contribution Award in 1998.
ix
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
CONTENTS
PART 1 FRAMEWORK
Chapter 1 A Framework for Business Analysis and Valuation
Using Financial Statements 1-3
The Role of Financial Reporting in Capital Markets 1-4
From Business Activities to Financial Statements 1-6
Influences of the Accounting System on Information Quality 1-6
Feature 1: Accrual Accounting 1-6
Feature 2: Accounting Conventions and Standards 1-7
Feature 3: Managers’ Reporting Strategy 1-8
Feature 4: Auditing 1-9
From Financial Statements to Business Analysis 1-10
Analysis Step 1: Business Strategy Analysis 1-11
Analysis Step 2: Accounting Analysis 1-12
Analysis Step 3: Financial Analysis 1-12
Analysis Step 4: Prospective Analysis 1-12
Summary 1-13
Discussion Questions 1-13
Notes 1-14
PART 2 BUSINESS ANALYSIS AND VALUATION TOOLS
Chapter 2 Strategy Analysis 2-3
Industry Analysis 2-3
Degree of Actual and Potential Competition 2-4
Bargaining Power in Input and Output Markets 2-7
Applying Industry Analysis: The U.S. Retail Department Store Industry 2-8
Competition in the U.S. Retail Department Store Industry 2-8
The Power of Buyers and Suppliers 2-10
Limitations of Industry Analysis 2-11
Competitive Strategy Analysis 2-11
Sources of Competitive Advantage 2-12
Achieving Competitive Advantage 2-13
Sustaining Competitive Advantage 2-13
Applying Competitive Strategy Analysis 2-14
x
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Corporate Strategy Analysis 2-16
Sources of Value Creation at the Corporate Level 2-17
Applying Corporate Strategy Analysis 2-18
Summary 2-21
Discussion Questions 2-22
Notes 2-23
Chapter 3 Overview of Accounting Analysis 3-1
The Institutional Framework for Financial Reporting 3-1
Accrual Accounting 3-1
Delegation of Reporting to Management 3-2
Generally Accepted Accounting Principles 3-3
External Auditing 3-5
Legal Liability 3-6
Factors Influencing Accounting Quality 3-6
Noise from Accounting Rules 3-7
Forecast Errors 3-7
Managers’ Accounting Choices 3-7
Steps in Performing Accounting Analysis 3-9
Step 1: Identify Principal Accounting Policies 3-9
Step 2: Assess Accounting Flexibility 3-9
Step 3: Evaluate Accounting Strategy 3-10
Step 4: Evaluate the Quality of Disclosure 3-10
Step 5: Identify Potential Red Flags 3-12
Step 6: Undo Accounting Distortions 3-13
Accounting Analysis Pitfalls 3-14
1. Conservative Accounting Is Not “Good” Accounting 3-14
2. Not All Unusual Accounting Is Questionable 3-14
Value of Accounting Data and Accounting Analysis 3-15
Summary 3-16
Discussion Questions 3-16
Notes 3-17
Chapter 4 Implementing Accounting Analysis 4-1
Recasting Financial Statements 4-2
Making Accounting Adjustments 4-7
Asset Distortions 4-7
Liability Distortions 4-20
Equity Distortions 4-23
Comparing Companies Using U.S. GAAP and IFRS 4-24
Application to TJX and Nordstrom 4-28
Contents xi
Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Summary 4-30
Discussion Questions 4-31
Notes 4-36
Appendix A: Recasting Financial Statements into Standardized
Templates 4-37
Appendix B: Nordstrom, Inc. Operating Lease Adjustment 4-45
Chapter 5 Financial Analysis 5-1
Ratio Analysis 5-1
Measuring Overall Profitability 5-3
Decomposing Profitability: Traditional Approach 5-4
Decomposing Profitability: …
INVESTMENT
PHILOSOPHIES
Successful Strategies and the
S E C O N D E D I T I O N
Investors Who Made Them Work
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Investment
Philosophies
i
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Founded in 1807, John Wiley & Sons is the oldest independent publish-
ing company in the United States. With offices in North America, Europe,
Australia, and Asia, Wiley is globally committed to developing and market-
ing print and electronic products and services for our customers’ professional
and personal knowledge and understanding.
The Wiley Finance series contains books written specifically for finance
and investment professionals as well as sophisticated individual investors
and their financial advisors. Book topics range from portfolio manage-
ment to e-commerce, risk management, financial engineering, valuation, and
financial instrument analysis, as well as much more.
For a list of available titles, visit our Web site at www.WileyFinance.com.
ii
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Investment
Philosophies
Successful Strategies and the
Investors Who Made Them Work
Second Edition
ASWATH DAMODARAN
www.damodaran.com
John Wiley & Sons, Inc.
iii
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Copyright C© 2012 by Aswath Damodaran. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
First Edition Copyright C© 2003 by John Wiley & Sons, Inc. All rights reserved.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in
any form or by any means, electronic, mechanical, photocopying, recording, scanning, or
otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright
Act, without either the prior written permission of the Publisher, or authorization through
payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222
Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web
at www.copyright.com. Requests to the Publisher for permission should be addressed to the
Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030,
(201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their
best efforts in preparing this book, they make no representations or warranties with respect to
the accuracy or completeness of the contents of this book and specifically disclaim any implied
warranties of merchantability or fitness for a particular purpose. No warranty may be created
or extended by sales representatives or written sales materials. The advice and strategies
contained herein may not be suitable for your situation. You should consult with a
professional where appropriate. Neither the publisher nor author shall be liable for any loss of
profit or any other commercial damages, including but not limited to special, incidental,
consequential, or other damages.
For general information on our other products and services or for technical support, please
contact our Customer Care Department within the United States at (800) 762-2974, outside
the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in
print may not be available in electronic books. For more information about Wiley products,
visit our web site at www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Damodaran, Aswath.
Investment philosophies : successful strategies and the investors who made them
work / Aswath Damodaran.—2nd ed.
p. cm.—(Wiley finance series)
Includes index.
ISBN 978-1-118-01151-5 (cloth); ISBN 978-1-118-22192-1 (ebk);
ISBN 978-1-118-23561-4 (ebk); ISBN 978-1-118-26049-4 (ebk)
1. Investment analysis. I. Title.
HG4529.D36 2012
332.6—dc23
2012005823
Printed in the United States of America.
10 9 8 7 6 5 4 3 2 1
iv
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Contents
CHAPTER 1
Introduction 1
What Is an Investment Philosophy? 2
Why Do You Need an Investment Philosophy? 3
The Big Picture of Investing 4
Categorizing Investment Philosophies 7
Developing an Investment Philosophy 10
Conclusion 12
Exercises 13
CHAPTER 2
Upside, Downside: Understanding Risk 15
What Is Risk? 16
Equity Risk: Theory-Based Models 16
Assessing Conventional Risk and Return Models 32
Equity Risk: Alternative Measures 34
Equity Risk: Assessing the Field 45
Default Risk 46
Conclusion 50
Exercises 51
CHAPTER 3
Numbers Don’t Lie—Or Do They? 53
The Basic Accounting Statements 53
Asset Measurement and Valuation 55
Measuring Financing Mix 62
Measuring Earnings and Profitability 69
Measuring Risk 75
Differences in Accounting Standards and Practices 82
Conclusion 82
Exercises 85
v
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
vi CONTENTS
CHAPTER 4
Show Me the Money: The Basics of Valuation 87
Intrinsic Value 87
Relative Valuation 110
Valuing an Asset with Contingent Cash Flows (Options) 119
Conclusion 121
Exercises 122
CHAPTER 5
Many a Slip: Trading, Execution, and Taxes 125
The Trading Cost Drag 125
The Components of Trading Costs: Traded Financial Assets 127
Trading Costs with Nontraded Assets 146
Management of Trading Costs 148
Taxes 150
Conclusion 159
Exercises 160
CHAPTER 6
Too Good to Be True? Testing Investment Strategies 163
Why Does Market Efficiency Matter? 163
Efficient Markets: Definition and Implications 164
Behavioral Finance: The Challenge to Efficient Markets 170
A Skeptic’s Guide to Investment Strategies 204
Conclusion 206
Exercises 207
CHAPTER 7
Smoke and Mirrors? Price Patterns, Volume Charts, and
Technical Analysis 209
Random Walks and Price Patterns 209
Empirical Evidence 211
The Foundations of Technical Analysis 239
Technical Indicators and Charting Patterns 240
Conclusion 255
Exercises 256
CHAPTER 8
Graham’s Disciples: Value Investing 259
Who Is a Value Investor? 259
The Passive Screener 260
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Contents vii
The Contrarian Value Investor 284
Activist Value Investing 293
Conclusion 326
Exercises 326
CHAPTER 9
The Allure of Growth: Small Cap and Growth Investing 329
Who Is a Growth Investor? 329
Passive Growth Investing 330
Activist Growth Investing 365
Conclusion 372
Exercises 373
CHAPTER 10
Information Pays: Trading on News 375
Information and Prices 376
Trading on Private Information 378
Trading on Public Information 398
Implementing an Information-Based Investment Strategy 421
Conclusion 422
Exercises 423
CHAPTER 11
A Sure Profit: The Essence of Arbitrage 425
Pure Arbitrage 425
Near Arbitrage 450
Speculative Arbitrage 460
Long/Short Strategies—Hedge Funds 465
Conclusion 469
Exercises 470
CHAPTER 12
The Impossible Dream? Timing the Market 473
Market Timing: Payoffs and Costs 473
Market Timing Approaches 477
The Evidence on Market Timing 506
Market Timing Strategies 514
Market Timing Instruments 518
Connecting Market Timing to Security Selection 521
Conclusion 521
Exercises 522
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
viii CONTENTS
CHAPTER 13
Ready to Give Up? The Allure of Indexing 525
The Mechanics of Indexing 525
A History of Indexing 527
The Case for Indexing 530
Why Do Active Investors Not Perform Better? 554
Alternative Paths to Indexing 562
Conclusion 571
Exercises 572
CHAPTER 14
A Road Map to Choosing an Investment Philosophy 575
A Self-Assessment 575
Finding an Investment Philosophy 579
The Right Investment Philosophy 581
Conclusion 583
Exercises 584
Index 585
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
Investment
Philosophies
ix
JWBT716-fm JWBT716-Damodaran Printer: Yet to Come May 30, 2012 8:34 Trim: 6in × 9in
x
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
CHAPTER 1
Introduction
W ho wants to be an average investor? We all dream of beating the marketand being super investors, and we spend an inordinate amount of time
and resources in this endeavor. Consequently, we are easy prey for the magic
bullets and the secret formulas offered by salespeople pushing their wares.
In spite of our best efforts, though, most of us fail in our attempts to be
more than average. Nonetheless, we keep trying, hoping that we can be
more like the investing legends—another Warren Buffett, George Soros, or
Peter Lynch. We read the words written by and about successful investors,
hoping to find in them the key to their stock-picking abilities, so that we can
replicate them and become like them.
In our search, though, we are whipsawed by contradictions and anoma-
lies. On one corner of the investment town square stands an adviser, yelling
to us to buy businesses with solid cash flows and liquid assets because that’s
what worked for Buffett. On another corner, another investment expert
cautions us that this approach worked only in the old world, and that in the
new world of technology we have to bet on companies with great growth
prospects. On yet another corner stands a silver-tongued salesperson with
vivid charts who presents you with evidence of the charts’ capacity to get
you in and out of markets at exactly the right times. It is not surprising that
facing this cacophony of claims and counterclaims we end up more confused
than ever.
In this chapter, we present the argument that to be successful with any
investment strategy, you have to begin with an investment philosophy that is
consistent at its core and matches not only the markets you choose to invest
in but your individual characteristics. In other words, the key to success in
investing may lie not in knowing what makes others successful but in finding
out more about yourself.
1
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
2 INVESTMENT PHILOSOPHIES
W H A T I S A N I N V E S T M E N T P H I L O S O P H Y ?
An investment philosophy is a coherent way of thinking about markets,
how they work (and sometimes do not), and the types of mistakes that you
believe consistently underlie investor behavior. Why do we need to make
assumptions about investor mistakes? As we will argue, most investment
strategies are designed to take advantage of errors made by some or all
investors in pricing stocks. Those mistakes themselves are driven by far
more basic assumptions about human behavior. To provide an illustration,
the rational or irrational tendency of human beings to join crowds can result
in price momentum: stocks that have gone up the most in the recent past
are more likely to go up in the near future. Let us consider, therefore, the
ingredients of an investment philosophy.
H u m a n F r a i l t y
Underlying every investment philosophy is a view about human behavior. In
fact, one weakness of conventional finance and valuation has been the short
shrift given to behavioral quirks. It is not that conventional financial theory
assumes that all investors are rational, but that it assumes that irrationalities
are random and cancel out. Thus, for every investor who tends to follow
the crowd too much (a momentum investor), we assume there is an investor
who goes in the opposite direction (a contrarian), and that their push and
pull in prices will ultimately result in a rational price. While this may, in
fact, be a reasonable assumption for the very long term, it may not be a
realistic one for the short term.
Academics and practitioners in finance who have long viewed the ratio-
nal investor assumption with skepticism have developed a branch of finance
called behavioral finance that draws on psychology, sociology, and finance
to try to explain both why investors behave the way they do and the con-
sequences for investment strategies. As we go through this book, examining
different investment philosophies, we will try at the outset of each phi-
losophy to explore the assumptions about human behavior that represent
its base.
M a r k e t E f f i c i e n c y
A closely related second ingredient of an investment philosophy is the view
of market efficiency or inefficiency that you need for the philosophy to be a
successful one. While all active investment philosophies make the assump-
tion that markets are inefficient, they differ in their views on what parts of
the market the inefficiencies are most likely to show up in and how long
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
Introduction 3
they will last. Some investment philosophies assume that markets are cor-
rect most of the time but that they overreact when new and large pieces
of information are released about individual firms: they go up too much on
good news and down too much on bad news. Other investment strategies are
founded on the belief that markets can make mistakes in the aggregate—the
entire market can be undervalued or overvalued—and that some investors
(mutual fund managers, for example) are more likely to make these mistakes
than others. Still other investment strategies may be based on the assump-
tion that while markets do a good job of pricing stocks where there is a
substantial amount of information—financial statements, analyst reports,
and financial press coverage—they systematically misprice stocks on which
such information is not available.
T a c t i c s a n d S t r a t e g i e s
Once you have an investment philosophy in place, you develop investment
strategies that build on the core philosophy. Consider, for instance, the views
on market efficiency expounded in the previous section. The first investor,
who believes that markets overreact to news, may develop a strategy of
buying stocks after large negative earnings surprises (where the announced
earnings come in well below expectations) and selling stocks after positive
earnings surprises. The second investor, who believes that markets make
mistakes in the aggregate, may look at technical indicators (such as cash
held by mutual funds or short selling by investors in the stock) to find out
whether the market is overbought or oversold and take a contrary position.
The third investor, who believes that market mistakes are more likely when
information is absent, may look for stocks that are not followed by analysts
or owned by institutional investors.
It is worth noting that the same investment philosophy can spawn mul-
tiple investment strategies. Thus, a belief that investors consistently overes-
timate the value of growth and underestimate the value of existing assets
can manifest itself in a number of different strategies ranging from a passive
one of buying low price-earnings (P/E) ratio stocks to a more active one of
buying cheap companies and attempting to liquidate them for their assets.
In other words, the number of investment strategies will vastly surpass the
number of investment philosophies.
W H Y D O Y O U N E E D A N I N V E S T M E N T P H I L O S O P H Y ?
Most investors have no investment philosophy, and the same can be said
about many money managers and professional investment advisers. They
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
4 INVESTMENT PHILOSOPHIES
adopt investment strategies that seem to work (for other investors) and
abandon them when they do not. Why, you might ask, if this is possible, do
you need an investment philosophy? The answer is simple. In the absence
of an investment philosophy, you will tend to shift from strategy to strategy
simply based on a strong sales pitch from a proponent or perceived recent
success. There are three negative consequences for your portfolio:
1. Lacking a rudder or a core set of beliefs, you will be easy prey for
charlatans and pretenders, with each one claiming to have found the
magic strategy that beats the market.
2. As you switch from strategy to strategy, you will have to change your
portfolio, resulting in high transaction costs, and you will pay more
in taxes.
3. While there may be strategies that do work for some investors, they
may not be appropriate for you, given your objectives, risk aversion,
and personal characteristics. In addition to having a portfolio that un-
derperforms the market, you are likely to find yourself with an ulcer
or worse.
With a strong sense of core beliefs, you will have far more control over
your destiny. Not only will you be able to reject strategies that do not fit
your core beliefs about markets, but you will also be able to tailor investment
strategies to your needs. In addition, you will be able to get much more of
a big picture view of both what it is that is truly different across strategies
and what they have in common.
T H E B I G P I C T U R E O F I N V E S T I N G
To see where the different investment philosophies fit into investing, let us
begin by looking at the process of creating an investment portfolio. Note
that this is a process that we all follow—amateur as well as professional
investors—though it may be simpler for an individual constructing his or
her own portfolio than it is for a pension fund manager with a varied and
demanding clientele.
S t e p 1 : U n d e r s t a n d i n g t h e C l i e n t
The process always starts with the investor and understanding his or her
needs and preferences. For a portfolio manager, the investor is a client, and
the first and often most significant part of the investment process is under-
standing the client’s needs, the client’s tax status, and, most importantly,
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
Introduction 5
the client’s risk preferences. For an individual investor constructing his or
her own portfolio, this may seem simpler, but understanding one’s own
needs and preferences is just as important a first step as it is for the portfo-
lio manager.
S t e p 2 : P o r t f o l i o C o n s t r u c t i o n
The next part of the process is the actual construction of the portfolio, which
we divide into three subparts.
The first of these is the decision on how to allocate the portfolio across
different asset classes, defined broadly as equities, fixed income securities,
and real assets (such as real estate, commodities, and other assets). This asset
allocation decision can also be framed in terms of investments in domestic
assets versus foreign assets, and the factors driving this decision.
The second component is the asset selection decision, where individual
assets are chosen within each asset class to make up the portfolio. In practical
terms, this is the step where the stocks that make up the equity component,
the bonds that make up the fixed income component, and the real assets
that make up the real asset component are selected.
The final component is execution, where the portfolio is actually put
together. Here investors must weigh the costs of trading against their per-
ceived needs to trade quickly. While the importance of execution will vary
across investment strategies, there are many investors who fail at this stage
in the process.
S t e p 3 : E v a l u a t e P o r t f o l i o P e r f o r m a n c e
The final part of the process, and often the most painful one for professional
money managers, is performance evaluation. Investing is, after all, focused
on one objective and one objective alone, which is to make the most money
you can, given your particular risk preferences. Investors are not forgiving
of failure and are unwilling to accept even the best of excuses, and loyalty
to money managers is not a commonly found trait. By the same token,
performance evaluation is just as important to the individual investor who
constructs his or her own portfolio, since the feedback from it should largely
determine how that investor approaches investing in the future.
These parts of the process are summarized in Figure 1.1, and we will
return to this figure to emphasize the steps in the process as we consider
different investment philosophies. As you will see, while all investment
philosophies may have the same end objective of beating the market, each
philosophy will emphasize a different component of the overall process and
require different skills for success.
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
U
til
ity
F
u
n
ct
io
n
s
R
is
k
To
le
ra
n
ce
/
A
ve
rs
io
n
In
ve
st
m
e
n
t
H
o
ri
zo
n
Ta
x
S
ta
tu
s
Ta
x
C
o
d
e
T
h
e
C
li
e
n
t
T
h
e
P
o
rt
fo
li
o
M
a
n
a
g
e
r’
s
J
o
b
A
ss
e
t
C
la
ss
e
s:
C
o
u
n
tr
ie
s:
A
ss
e
t
A
llo
ca
to
r
S
to
ck
s
B
o
n
d
s
D
o
m
e
st
ic
N
o
n
d
o
m
e
st
ic
R
e
a
l
A
ss
e
ts
V
ie
w
s
o
n
•
In
fla
tio
n
•
R
a
te
s
•
G
ro
w
th
R
is
k
a
n
d
R
e
tu
rn
•
M
e
a
su
ri
n
g
r
is
k
•
E
ff
e
ct
s
o
f
d
iv
e
rs
ifi
ca
tio
n
M
a
rk
e
t
E
ff
ic
ie
n
cy
•
C
a
n
y
o
u
b
e
a
t
th
e
m
a
rk
e
t?
Tr
a
d
in
g
S
ys
te
m
s
•
H
o
w
d
o
e
s
tr
a
d
in
g
a
ff
e
ct
p
ri
ce
s?
R
is
k
M
o
d
e
ls
•
T
h
e
C
A
P
M
•
T
h
e
A
P
M
S
to
ck
S
e
le
ct
io
n
Tr
a
d
in
g
S
p
e
e
d
P
ri
va
te
In
fo
rm
a
tio
n
S
e
cu
ri
ty
S
e
le
ct
o
r
•
W
h
ic
h
s
to
ck
s?
W
h
ic
h
b
o
n
d
s?
W
h
ic
h
r
e
a
l a
ss
e
ts
?
E
xe
cu
to
r
P
e
rf
o
rm
a
n
c
e
E
v
a
lu
a
ti
o
n
•
H
o
w
o
ft
e
n
d
o
y
o
u
t
ra
d
e
?
•
H
o
w
la
rg
e
a
re
y
o
u
r
tr
a
d
e
s?
•
D
o
y
o
u
u
se
d
e
ri
va
tiv
e
s
to
m
a
n
a
g
e
o
r
e
n
h
a
n
ce
r
is
k?
1
. H
o
w
m
u
ch
r
is
k
d
id
t
h
e
p
o
rt
fo
lio
m
a
n
a
g
e
r
ta
ke
?
2
. W
h
a
t
re
tu
rn
d
id
t
h
e
p
o
rt
fo
lio
m
a
n
a
g
e
r
m
a
ke
?
3
. D
id
t
h
e
p
o
rt
fo
lio
m
a
n
a
g
e
r
u
n
d
e
rp
e
rf
o
rm
o
r
o
u
tp
e
rf
o
rm
?
V
ie
w
s
o
n
M
a
rk
e
ts
V
a
lu
a
tio
n
B
a
se
d
o
n
•
C
a
sh
F
lo
w
s
•
C
o
m
p
a
ra
b
le
s
•
C
h
a
rt
s
&
I
n
d
ic
a
to
rs
Tr
a
d
in
g
C
o
st
s
•
C
o
m
m
is
si
o
n
s
•
B
id
-A
sk
S
p
re
a
d
•
P
ri
ce
I
m
p
a
ct
M
a
rk
e
t
T
im
in
g
FI
GU
RE
1.
1
T
h
e
In
ve
st
m
en
t
P
ro
ce
ss
6
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
Introduction 7
C A T E G O R I Z I N G I N V E S T M E N T P H I L O S O P H I E S
We present the range of investment philosophies in this section, using the
investment process to illustrate each philosophy. While we will leave much
of the detail for later chapters, we attempt to present at least the core of
each philosophy here.
M a r k e t T i m i n g v e r s u s A s s e t S e l e c t i o n
The broadest categorization of investment philosophies is by whether they
are based on timing overall markets or finding individual assets that are
mispriced. The first set of philosophies can be categorized as market tim-
ing philosophies, while the second can be viewed as security selection
philosophies.
Within each, though, are numerous strands that take very different
views about markets. Consider market timing. While most of us consider
market timing only in the context of the stock market, there are investors
who consider market timing to include a much broader range of markets:
currency markets, commodities, bond markets, and real estate come to
mind. The range of choices among security selection philosophies is even
wider and can span charting and technical indicators; fundamentals (earn-
ings, cash flows, or growth); and information (earnings reports, acquisition
announcements).
While market timing has allure to all of us (because it pays off so well
when you are right), it is difficult to succeed at for exactly that reason.
There are all too often too many investors attempting to time markets, and
succeeding consistently is very difficult to do. If you decide to pick stocks,
how do you choose whether you pick them based on charts, fundamentals,
or growth potential? The answer, as we will see in the next section, will
depend not only on your views of the market and what works, but also on
your personal characteristics.
A c t i v i s t v e r s u s P a s s i v e I n v e s t i n g
At a general level, investment philosophies can also be categorized as activist
or passive strategies. (Note that activist investing is not the same as active
investing.) In a passive strategy, you invest in a stock or company and wait
for your investment to pay off. Assuming that your strategy is successful,
this will come from the market recognizing and correcting a misvaluation.
Thus, a portfolio manager who buys stocks with low price-earnings ratios
and stable earnings is following a passive strategy. So is an index fund
manager, who essentially buys all stocks in the index. In an activist strategy,
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
8 INVESTMENT PHILOSOPHIES
you invest in a company and then try to change the way the company is run
to make it more valuable. Venture capitalists can be categorized as activist
investors since they not only take positions in promising businesses but
also provide significant inputs into how these businesses are run. In recent
years, we have seen investors bring this activist philosophy to publicly traded
companies, using the clout of large positions to change the way companies
are run. We should hasten to draw a contrast between activist investing and
active investing. Any investor who tries to beat the market by picking stocks
is viewed as an active investor. Thus, active investors can adopt passive
strategies or activist strategies. In the popular vernacular, active investing
includes any strategy where you try to beat the market by steering your
money to either undervalued asset classes or individual stocks/assets.
T i m e H o r i z o n
Different investment philosophies require different time horizons. A philos-
ophy based on the assumption that markets overreact to new information
may generate short-term strategies. For instance, you may buy stocks right
after a bad earnings announcement, hold for a few weeks, and then sell
(hopefully at a higher price, as the market corrects its overreaction). In
contrast, a philosophy of buying neglected companies (stocks that are not
followed by analysts or held by institutional investors) may require a much
longer time horizon.
One factor that will determine the time horizon of an investment phi-
losophy is the nature of the adjustment that has to occur for you to reap
the rewards of a successful strategy. Passive value investors who buy stocks
in companies that they believe are undervalued may have to wait years for
the market correction to occur, even if they are right. Investors who trade
ahead of or after earnings reports, because they believe that markets do not
respond correctly to such reports, may hold the stock for only a few days.
At the extreme, investors who see the same (or very similar) assets being
priced differently in two markets may buy the cheaper one and sell the more
expensive one, locking in arbitrage profits in a few minutes.
C o e x i s t e n c e o f C o n t r a d i c t o r y S t r a t e g i e s
One of the most fascinating aspects of investment philosophy is the co-
existence of investment philosophies based on contradictory views of the
markets. Thus, you can have market timers who trade on price momentum
(suggesting that investors are slow to learn from information) and mar-
ket timers who are contrarians (which is based on the belief that markets
overreact). Among security selectors who use fundamentals, you can have
JWBT716-c01 JWBT716-Damodaran Printer: Yet to Come May 25, 2012 23:52 Trim: 6in × 9in
Introduction 9
value investors who buy value stocks because they believe markets overprice
growth, and growth investors who buy growth stocks using exactly the
opposite justification. The coexistence of these contradictory impulses for
investing may strike some as irrational, but it is healthy and may actually be
necessary to keep the market in balance. In addition, you can have investors
with contradictory philosophies coexisting in the market because of their
different time horizons, views on risk, and tax statuses. For instance, tax-
exempt investors may find stocks that pay large dividends a bargain, while
taxable investors may reject these same stocks because dividends are taxed.
I n v e s t m e n t P h i l o s o p h i e s i n C o n t e x t
We can consider the differences between investment philosophies in the
context of the investment process, described in Figure 1.1. Market timing
strategies primarily affect the asset allocation decision. Thus, investors who
believe that stocks are undervalued will invest more of their portfolios in
stocks than would be justified given their risk preferences. Security selection
strategies in all their forms—technical analysis, fundamentals, or private
information—center on the security selection component of the portfolio
management process. You could argue that strategies that are not based
on grand visions of market efficiency but are designed to take advantage
of …
with MyFinanceLab™Prepare, Apply, and Confirm
• Enhanced eText —The Pearson eText gives students
access to their textbook anytime, anywhere. In addition to
notetaking, highlighting, and bookmarking, the Pearson eText
offers interactive and sharing features. Students actively read
and learn, through embedded and auto-graded practice,
animations, author videos, and more. Instructors can share
comments or highlights, and students can add their own,
for a tight community of learners in any class.
• Dynamic Study Modules—Work by continuously assessing
student performance and activity, then using data and analytics to
provide personalized content in real time to reinforce concepts
that target each student’s particular strengths and weaknesses.
• Learning Catalytics—Generates classroom
discussion, guides lecture, and promotes
peer-to-peer learning with real-time analytics.
Now, students can use any device to interact in
the classroom.
• Hallmark Features—Personalized Learning Aids,
like Help Me Solve This, View an Example, and instant
feedback are available for further practice and mastery
when students need the help most!
• Worked Solutions—Provide step-by-step explanations on
how to solve select problems using the exact numbers and
data that were presented in the problem. Instructors will have
access to the Worked Solutions in preview and review mode.
• Algorithmic Test Bank—Instructors have the ability
to create multiple versions of a test or extra practice
for students.
123
• Mobile Ready—Students and instructors can access
multimedia resources and complete assessments right
at their fingertips, on any mobile device.
• Financial Calculator—The Financial Calculator is available
as a smartphone application, as well as on a computer, and
includes important functions such as cash flow, net present
value, and internal rate of return. Fifteen helpful tutorial videos
show the many ways to use the Financial Calculator
in MyFinanceLab.
• LMS Integration—Link from any LMS platform to access
assignments, rosters, and resources, and synchronize MyLab grades
with your LMS gradebook. For students, new direct, single sign-on
provides access to all the personalized learning MyLab resources
that make studying more efficient and effective.
• Reporting Dashboard—View, analyze, and report
learning outcomes clearly and easily. Available via the
Gradebook and fully mobile-ready, the Reporting
Dashboard presents student performance data at
the class, section, and program levels in an accessible,
visual manner.
• Adaptive Study Plan—Assists students in monitoring
their own progress by offering them a customized study plan
powered by Knewton, based on Homework, Quiz, and Test
results. Includes regenerated exercises with unlimited practice
and the opportunity to prove mastery through quizzes on
recommended learning objectives.
A01_BERK8334_04_GE_FM.indd 1 8/22/16 8:34 PM
COMMON SYMBOLS AND NOTATION
A market value of assets, premerger
total value of acquirer
APR annual percentage rate
B risk-free investment
in the replicating portfolio
C cash flow, call option price
Corr(Ri , Rj ) correlation between returns of i and j
Cov(Ri , Rj ) covariance between returns of i and j
CPN coupon payment
D market value of debt
d debt-to-value ratio
Divt dividends paid in year t
dis discount from face value
E market value of equity
EAR effective annual rate
EBIT earnings before interest and taxes
EBITDA earnings before interest, taxes,
depreciation, and amortization
EPSt earnings per share on date t
E [R i ] expected return of security i
F, FT one-year and T-year forward
exchange rate
FCFt free cash flow at date t
FV future value, face value of a bond
g growth rate
I initial investment or initial capital
committed to the project
Intt interest expense on date t
IRR internal rate of return
K strike price
k interest coverage ratio, compounding
periods per year
L lease payment, market value of liabilities
ln natural logarithm
MVi total market capitalization of security i
N number of cash flows, terminal date,
notational principal of a swap contract
Ni number of shares outstanding of
security i
NPER annuity spreadsheet notation
for the number of periods or dates
of the last cash flow
NPV net present value
P price, initial principal or deposit,
or equivalent present value,
put option price
Pi price of security i
P/E price-earnings ratio
PMT annuity spreadsheet notation
for cash flow
PV present value; annuity spreadsheet
notation for the initial amount
q dividend yield
p risk-neutral probability
r interest rate, discount rate of cost
of capital
Ri return of security i
Rmkt return of the market portfolio
RP return on portfolio P
RATE annuity spreadsheet notation
for interest rate
rE, rD equity and debt costs of capital
rf risk-free interest rate
ri required return or cost of capital
of security i
rU unlevered cost of capital
rwacc weighted average cost of capital
S stock price, spot exchange rate,
value of all synergies
SD(R i ) standard deviation (volatility)
of return of security i
T option expiration date, maturity date,
market value of target
U market value of unlevered equity
Vt enterprise value on date t
Var (R ) variance of return R
xi portfolio weight of investment in i
YTC yield to call on a callable bond
YTM yield to maturity
αi alpha of security i
βD, βE beta of debt or equity
βi beta of security i with respect to
the market portfolio
βPs beta of security i with respect to
portfolio P
βU beta of unlevered firm
Δ shares of stock in the replicating portfolio;
sensitivity of option price
to stock price
σ volatility
τ tax rate
τc marginal corporate tax rate
Berk-DeMarzo_CF2e_EP_FRONT 12/11/09 1:46 AM Page 02
A01_BERK8334_04_GE_FM.indd 2 8/22/16 8:34 PM
Corporate
FinanCe:
tHe Core
F O U RT H E D I T I O N
G l O b a l E D I T I O N
A01_BERK8334_04_GE_FM.indd 3 8/22/16 8:34 PM
the pearson Series in Finance
Berk/DeMarzo†
Corporate Finance*
Corporate Finance: The Core*
Berk/DeMarzo/Harford†
Fundamentals of Corporate Finance*
Brooks†
Financial Management: Core Concepts*
Copeland/Weston/Shastri
Financial Theory and Corporate Policy
Dorfman/Cather
Introduction to Risk Management
and Insurance
Eakins/McNally
Corporate Finance Online*
Eiteman/Stonehill/Moffett†
Multinational Business Finance*
Fabozzi
Bond Markets: Analysis and Strategies
Foerster†
Financial Management: Concepts
and Applications*
Frasca
Personal Finance
Gitman/Zutter†
Principles of Managerial Finance*
Principles of Managerial Finance––Brief
Edition*
Haugen
The Inefficient Stock Market: What Pays
Off and Why
Modern Investment Theory
Holden
Excel Modeling in Corporate Finance
Excel Modeling in Investments
Hughes/MacDonald
International Banking: Text and Cases
Hull†
Fundamentals of Futures and Options Markets
Options, Futures, and Other Derivatives
Keown
Personal Finance: Turning Money into Wealth*
Keown/Martin/Petty†
Foundations of Finance: The Logic
and Practice of Financial Management*
Madura
Personal Finance*
Marthinsen
Risk Takers: Uses and Abuses of Financial
Derivatives
McDonald
Derivatives Markets
Fundamentals of Derivatives Markets
Mishkin/Eakins†
Financial Markets and Institutions
Moffett/Stonehill/Eiteman†
Fundamentals of Multinational Finance
Pennacchi
Theory of Asset Pricing
Rejda/McNamara†
Principles of Risk Management
and Insurance
Smart/Gitman/Joehnk†
Fundamentals of Investing*
Solnik/McLeavey
Global Investments
Titman/Keown/Martin
Financial Management: Principles
and Applications*
Titman/Martin
Valuation: The Art and Science
of Corporate Investment Decisions
Weston/Mitchel/Mulherin
Takeovers, Restructuring, and Corporate
Governance
*denotes titles with Log onto www.myfinancelab.com to learn more.
†Global Edition available
A01_BERK8334_04_GE_FM.indd 4 8/22/16 8:34 PM
www.myfinancelab.com
Corporate
FinanCe:
tHe Core
F O U R T H E D I T I O N
JONaTHaN bERk
STaNFORD UNIvERSITy
PETER DemaRzO
STaNFORD UNIvERSITy
G l O b a l E D I T I O N
The NaTure aNd
ProPerTies of soils
fifTeeNTh ediTioN
Global ediTioN
Ray R. Weil
Professor of Soil Science
University of Maryland
Nyle C. Brady (late)
Professor of Soil Science, Emeritus
Cornell University
Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney • Dubai • Singapore • Hong Kong
Tokyo • Seoul • Taipei New Delhi • Cape Town • Sao Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan
A01_BRAD2232_04_SE_FM.indd 3 7/29/16 8:06 PM
Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney • Dubai • Singapore • Hong Kong
Tokyo • Seoul • Taipei • New Delhi • Cape Town • Sao Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan
A01_BERK8334_04_GE_FM.indd 5 8/22/16 8:34 PM
To Rebecca, Natasha, and Hannah, for the love and for being there —J. b.
To kaui, Pono, koa, and kai, for all the love and laughter —P. D.
Vice President, Business Publishing: Donna Battista
Editor-in-Chief: Adrienne D’Ambrosio
Acquisitions Editor: Kate Fernandes
Editorial Assistant: Kathryn Brightney
Vice President, Product Marketing: Roxanne McCarley
Product Marketing Manager: Katie Rowland
Field Marketing Manager: Ramona Elmer
Product Marketing Assistant: Jessica Quazza
Team Lead, Program Management: Ashley Santora
Program Manager: Nancy Freihofer
Team Lead, Project Management: Jeff Holcomb
Project Manager: Meredith Gertz
Project Manager, Global Edition: Nitin Shankar
Associate Acquisitions Editor, Global Edition: Ananya Srivastava
Senior Project Editor, Global Edition: Daniel Luiz
Manager, Media Production, Global Edition: M. Vikram Kumar
Senior Manufacturing Controller, Production, Global Edition:
Trudy Kimber
Operations Specialist: Carol Melville
Creative Director: Blair Brown
Art Director: Jonathan Boylan
Vice President, Director of Digital Strategy and Assessment:
Paul Gentile
Manager of Learning Applications: Paul DeLuca
Digital Editor: Brian Hyland
Director, Digital Studio: Sacha Laustsen
Digital Studio Manager: Diane Lombardo
Digital Studio Project Managers: Melissa Honig, Alana Coles,
Robin Lazrus
Digital Content Team Lead: Noel Lotz
Digital Content Project Lead: Miguel Leonarte
Full-Service Project Management and Composition:
SPi Global
Cover Image: Shutterstock
Printer/Binder: Vivar, Malaysia
Microsoft and/or its respective suppliers make no representations about the suitability of the information contained in the documents and
related graphics published as part of the services for any purpose. All such documents and related graphics are provided “as is” without war-
ranty of any kind. Microsoft and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information,
including all warranties and conditions of merchantability, whether express, implied or statutory, fitness for a particular purpose, title and
non-infringement. In no event shall Microsoft and/or its respective suppliers be liable for any special, indirect or consequential damages
or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action,
arising out of or in connection with the use or performance of information available from the services.
The documents and related graphics contained herein could include technical inaccuracies or typographical errors. Changes are periodically
added to the information herein. Microsoft and/or its respective suppliers may make improvements and/or changes in the product(s)
and/or the program(s) described herein at any time. Partial screen shots may be viewed in full within the software version specified.
Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A. and other countries. This book is not
sponsored or endorsed by or affiliated with the Microsoft Corporation.
Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
England
and Associated Companies throughout the world
Visit us on the World Wide Web at:
www.pearsonglobaleditions.com
The rights of Jonathan Berk and Peter DeMarzo to be identified as the authors of this work have been asserted by them in accordance with
the Copyright, Designs and Patents Act 1988.
Authorized adaptation from the United States edition, entitled Corporate Finance: The Core, 4th edition, ISBN 978-0-13-420264-8, by
Jonathan Berk and Peter DeMarzo, published by Pearson Education © 2017.
Copyright © 2017, 2014, 2011, 2007 by Jonathan Berk and Peter DeMarzo. All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom
issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS.
All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or
publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorse-
ment of this book by such owners.
ISBN 10: 1-292-15833-6
ISBN 13: 978-1-292-15833-4
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library.
10 9 8 7 6 5 4 3 2 1
17 16
A01_BERK8334_04_GE_FM.indd 6 9/14/16 2:15 PM
www.pearsonglobaleditions.com
7
part 1
introDUCtion
Chapter 1 The Corporation 34
Chapter 2 Introduction to Financial Statement analysis 55
Chapter 3 Financial Decision making and the law of One Price 93
part 2
tiMe, MoneY,
anD intereSt rateS
Chapter 4 The Time value of money 130
Chapter 5 Interest Rates 175
Chapter 6 valuing bonds 205
part 3
VaLUinG proJeCtS
anD FirMS
Chapter 7 Investment Decision Rules 244
Chapter 8 Fundamentals of Capital budgeting 271
Chapter 9 valuing Stocks 309
part 4
riSK anD retUrn
Chapter 10 Capital markets and the Pricing of Risk 350
Chapter 11 Optimal Portfolio Choice and the Capital asset
Pricing model 389
Chapter 12 Estimating the Cost of Capital 439
Chapter 13 Investor behavior and Capital market Efficiency 477
part 5
CapitaL StrUCtUre
Chapter 14 Capital Structure in a Perfect market 520
Chapter 15 Debt and Taxes 551
Chapter 16 Financial Distress, managerial Incentives,
and Information 583
Chapter 17 Payout Policy 629
part 6
aDVanCeD VaLUation
Chapter 18 Capital budgeting and valuation with leverage 672
Chapter 19 valuation and Financial modeling: a Case Study 723
Brief Contents
A01_BERK8334_04_GE_FM.indd 7 8/22/16 8:34 PM
8
part 1 introDUCtion
Chapter 1 the Corporation 34
1.1 the Four types of Firms 35
Sole Proprietorships 35
Partnerships 36
Limited Liability Companies 37
Corporations 37
Tax Implications for Corporate Entities 38
■ Corporate Taxation Around
the World 39
1.2 ownership Versus Control of
Corporations 39
The Corporate Management Team 39
■ INTERvIEw with David Viniar 40
The Financial Manager 41
■ GlObal FINaNCIal CRISIS
The Dodd-Frank Act 42
The Goal of the Firm 42
The Firm and Society 43
Ethics and Incentives within
Corporations 43
■ GlObal FINaNCIal CRISIS
The Dodd-Frank Act on Corporate
Compensation and Governance 44
■ Citizens United v. Federal Election
Commission 44
■ Airlines in Bankruptcy 46
1.3 the Stock Market 46
Primary and Secondary Stock Markets 47
Traditional Trading Venues 47
■ INTERvIEw with
Frank Hatheway 48
New Competition and Market
Changes 49
Dark Pools 50
MyFinanceLab 51 ■ Key Terms 51 ■
Further Reading 52 ■ Problems 52
Chapter 2 introduction to Financial
Statement analysis 55
2.1 Firms’ Disclosure of Financial
information 56
Preparation of Financial
Statements 56
■ International Financial Reporting
Standards 56
■ INTERvIEw with Ruth Porat 57
Types of Financial Statements 58
2.2 the Balance Sheet 58
Assets 59
Liabilities 60
Stockholders’ Equity 61
Market Value Versus Book Value 61
Enterprise Value 62
2.3 the income Statement 62
Earnings Calculations 63
2.4 the Statement of Cash Flows 64
Operating Activity 65
Investment Activity 66
Financing Activity 66
2.5 other Financial Statement
information 67
Statement of Stockholders’ Equity 67
Management Discussion and
Analysis 68
Notes to the Financial
Statements 68
2.6 Financial Statement analysis 69
Profitability Ratios 69
Liquidity Ratios 70
Working Capital Ratios 71
Interest Coverage Ratios 72
Leverage Ratios 73
Valuation Ratios 75
■ COmmON mISTakE
Mismatched Ratios 75
Operating Returns 76
The DuPont Identity 78
2.7 Financial reporting in practice 80
Enron 80
WorldCom 80
Sarbanes-Oxley Act 81
■ GlObal FINaNCIal CRISIS
Bernard Madoff’s Ponzi Scheme 82
Dodd-Frank Act 82
MyFinanceLab 83 ■ Key Terms 84 ■
Further Reading 85 ■ Problems 85 ■
Data Case 92
Detailed Contents
A01_BERK8334_04_GE_FM.indd 8 8/22/16 8:34 PM
Contents 9
Chapter 3 Financial Decision Making
and the Law of one price 93
3.1 Valuing Decisions 94
Analyzing Costs and Benefits 94
Using Market Prices to Determine Cash
Values 95
■ When Competitive Market Prices
Are Not Available 97
3.2 interest rates and the time Value
of Money 97
The Time Value of Money 97
The Interest Rate: An Exchange Rate
Across Time 97
3.3 present Value and the npV Decision
rule 100
Net Present Value 100
The NPV Decision Rule 101
NPV and Cash Needs 103
3.4 arbitrage and the Law of one price 104
Arbitrage 104
Law of One Price 105
3.5 no-arbitrage and Security
prices 105
Valuing a Security with the Law
of One Price 105
■ An Old Joke 109
The NPV of Trading Securities
and Firm Decision Making 109
Valuing a Portfolio 110
■ GlObal FINaNCIal CRISIS
Liquidity and the Informational
Role of Prices 111
■ Arbitrage in Markets 112
Where Do We Go from Here? 113
MyFinanceLab 114 ■ Key Terms 115 ■
Further Reading 115 ■ Problems 115
appendix the price of risk 119
Risky Versus Risk-Free Cash Flows 119
Arbitrage with Transactions Costs 124
part 2 tiMe, MoneY, anD
intereSt rateS
Chapter 4 the time Value of Money 130
4.1 the timeline 131
4.2 the three rules of time travel 132
Rule 1: Comparing and Combining
Values 132
Rule 2: Moving Cash Flows Forward
in Time 133
Rule 3: Moving Cash Flows Back
in Time 134
■ Rule of 72 135
Applying the Rules of Time Travel 136
4.3 Valuing a Stream of Cash Flows 138
4.4 Calculating the net present Value 141
■ USING EXCEl Calculating Present
Values in Excel 142
4.5 perpetuities and annuities 143
Perpetuities 143
■ Historical Examples of
Perpetuities 144
■ COmmON mISTakE Discounting One
Too Many Times 146
Annuities 146
■ Formula for an Annuity Due 149
Growing Cash Flows 149
4.6 Using an annuity Spreadsheet
or Calculator 154
4.7 non-annual Cash Flows 156
4.8 Solving for the Cash payments 157
4.9 the internal rate of return 160
■ USING EXCEl
Excel’s IRR Function 163
MyFinanceLab 164 ■ Key Terms 165 ■
Further Reading 166 ■ Problems 166 ■
Data Case 172
appendix Solving for the number of
periods 173
Chapter 5 interest rates 175
5.1 interest rate Quotes and
adjustments 176
The Effective Annual Rate 176
■ COmmON mISTakE Using the
Wrong Discount Rate in the Annuity
Formula 177
Annual Percentage Rates 178
5.2 application: Discount rates
and Loans 180
5.3 the Determinants of interest
rates 181
■ GlObal FINaNCIal CRISIS Teaser
Rates and Subprime Loans 182
Inflation and Real Versus Nominal
Rates 182
Investment and Interest Rate
Policy 183
The Yield Curve and Discount Rates 184
A01_BERK8334_04_GE_FM.indd 9 8/22/16 8:34 PM
10 Contents
The Yield Curve and the Economy 186
■ COmmON mISTakE Using the
Annuity Formula When Discount
Rates Vary by Maturity 186
■ INTERvIEw with
Kevin M. Warsh 188
5.4 risk and taxes 189
Risk and Interest Rates 190
After-Tax Interest Rates 191
5.5 the opportunity Cost of Capital 192
■ COmmON mISTakE States Dig
a $3 Trillion Hole by Discounting
at the Wrong Rate 193
MyFinanceLab 194 ■ Key Terms 195 ■
Further Reading 195 ■ Problems 195 ■
Data Case 200
appendix Continuous rates and Cash Flows 202
Discount Rates for a Continuously
Compounded APR 202
Continuously Arriving Cash Flows 202
Chapter 6 Valuing Bonds 205
6.1 Bond Cash Flows, prices,
and Yields 206
Bond Terminology 206
Zero-Coupon Bonds 206
■ GlObal FINaNCIal CRISIS
Negative Bond Yields 208
Coupon Bonds 209
6.2 Dynamic Behavior of Bond prices 211
Discounts and Premiums 211
Time and Bond Prices 212
Interest Rate Changes and Bond
Prices 214
■ Clean and Dirty Prices for Coupon
Bonds 215
6.3 the Yield Curve and Bond
arbitrage 217
Replicating a Coupon Bond 217
Valuing a Coupon Bond Using
Zero-Coupon Yields 218
Coupon Bond Yields 219
Treasury Yield Curves 220
6.4 Corporate Bonds 220
Corporate Bond Yields 221
■ Are Treasuries Really Default-Free
Securities? 221
Bond Ratings 223
Corporate Yield Curves 224
6.5 Sovereign Bonds 224
■ GlObal FINaNCIal CRISIS The
Credit Crisis and Bond Yields 225
■ GlObal FINaNCIal CRISIS
European Sovereign Debt Yields:
A Puzzle 227
■ INTERvIEw with
Carmen M. Reinhart 228
MyFinanceLab 229 ■ Key Terms 230 ■
Further Reading 231 ■ Problems 231 ■
Data Case 235 ■ Case Study 236
appendix Forward interest rates 238
Computing Forward Rates 238
Computing Bond Yields from Forward
Rates 239
part 3 VaLUinG proJeCtS
anD FirMS
Chapter 7 investment Decision
rules 244
7.1 npV and Stand-alone
projects 245
Applying the NPV Rule 245
The NPV Profile and IRR 245
Alternative Rules Versus the NPV
Rule 246
■ INTERvIEw with Dick Grannis 247
7.2 the internal rate of return rule 248
Applying the IRR Rule 248
Pitfall #1: Delayed Investments 248
Pitfall #2: Multiple IRRs 249
■ COmmON mISTakE
IRR Versus the IRR Rule 251
Pitfall #3: Nonexistent IRR 251
7.3 the payback rule 252
Applying the Payback Rule 252
Payback Rule Pitfalls in Practice 253
■ Why Do Rules Other Than the NPV
Rule Persist? 254
7.4 Choosing Between projects 254
NPV Rule and Mutually Exclusive
Investments 254
IRR Rule and Mutually Exclusive
Investments 255
The Incremental IRR 256
■ When Can Returns Be
Compared? 257
■ COmmON mISTakE
IRR and Project Financing 259
7.5 project Selection with resource
Constraints 259
Evaluating Projects with Different
Resource Requirements 259
A01_BERK8334_04_GE_FM.indd 10 8/22/16 8:34 PM
Contents 11
Profitability Index 260
Shortcomings of the Profitability
Index 262
MyFinanceLab 262 ■ Key Terms 263 ■
Further Reading 263 ■ Problems 263 ■
Data Case 269
appendix Computing the npV profile Using
excel’s Data table Function 270
Chapter 8 Fundamentals of Capital
Budgeting 271
8.1 Forecasting earnings 272
Revenue and Cost Estimates 272
Incremental Earnings Forecast 273
Indirect Effects on Incremental
Earnings 275
■ COmmON mISTakE The Opportunity
Cost of an Idle Asset 276
Sunk Costs and Incremental
Earnings 277
■ COmmON mISTakE
The Sunk Cost Fallacy 277
Real-World Complexities 278
8.2 Determining Free Cash Flow
and npV 279
Calculating Free Cash Flow
from Earnings 279
Calculating Free Cash Flow
Directly 281
Calculating the NPV 282
■ USING EXCEl Capital Budgeting
Using a Spreadsheet Program 283
8.3 Choosing among alternatives 284
Evaluating Manufacturing
Alternatives 284
Comparing Free Cash Flows for Cisco’s
Alternatives 285
8.4 Further adjustments to Free
Cash Flow 286
■ GlObal FINaNCIal CRISIS
The American Recovery and
Reinvestment Act of 2009 290
8.5 analyzing the project 290
Break-Even Analysis 290
Sensitivity Analysis 291
■ INTERvIEw with
David Holland 293
Scenario Analysis 294
■ USING EXCEl Project Analysis
Using Excel 295
MyFinanceLab 296 ■ Key Terms 298 ■
Further Reading 298 ■ Problems 298 ■
Data Case 305
appendix MaCrS Depreciation 307
Chapter 9 Valuing Stocks 309
9.1 the Dividend-Discount Model 310
A One-Year Investor 310
Dividend Yields, Capital Gains, and Total
Returns 311
■ The Mechanics of a Short Sale 312
A Multiyear Investor 313
The Dividend-Discount Model
Equation 314
9.2 applying the Dividend-Discount
Model 314
Constant Dividend Growth 314
Dividends Versus Investment
and Growth 315
■ John Burr Williams’ Theory
of Investment Value 316
Changing Growth Rates 318
Limitations of the Dividend-Discount
Model 320
9.3 total payout and Free Cash Flow
Valuation Models 320
Share Repurchases and the Total Payout
Model 320
The Discounted Free Cash Flow
Model 322
9.4 Valuation Based on Comparable
Firms 326
Valuation Multiples 326
Limitations of Multiples 328
Comparison with Discounted Cash Flow
Methods 329
Stock Valuation Techniques: The Final
Word 330
■ INTERvIEw with Douglas
Kehring 331
9.5 information, Competition, and Stock
prices 332
Information in Stock Prices 332
Competition and Efficient Markets 333
Lessons for Investors and Corporate
Managers 335
■ Kenneth Cole Productions—What
Happened? 337
The Efficient Markets Hypothesis Versus
No Arbitrage 338
MyFinanceLab 338 ■ Key Terms 340 ■
Further Reading 340 ■ Problems 341 ■
Data Case 346
A01_BERK8334_04_GE_FM.indd 11 8/22/16 8:34 PM
12 Contents
part 4 riSK anD retUrn
Chapter 10 Capital Markets and the pricing
of risk 350
10.1 risk and return: insights from 89 Years
of investor History 351
10.2 Common Measures of risk
and return 354
Probability Distributions 354
Expected Return 354
Variance and Standard Deviation 355
10.3 Historical returns of Stocks
and Bonds 357
Computing Historical Returns 357
Average Annual Returns 359
The Variance and Volatility of
Returns 361
Estimation Error: Using Past Returns
to Predict the Future 362
■ Arithmetic Average Returns Versus
Compound Annual Returns 364
10.4 the Historical trade-off Between risk
and return 364
The Returns of Large Portfolios 365
The Returns of Individual Stocks 366
10.5 Common Versus independent
risk 367
Theft Versus Earthquake Insurance:
An Example 367
The Role of Diversification 368
10.6 Diversification in Stock portfolios 369
Firm-Specific Versus Systematic
Risk 370
No Arbitrage and the Risk
Premium 371
■ GlObal FINaNCIal CRISIS
Diversification Benefits During
Market Crashes 373
■ COmmON mISTakE A Fallacy
of Long-Run Diversification 374
10.7 Measuring Systematic risk 375
Identifying Systematic Risk: The Market
Portfolio 375
Sensitivity to Systematic Risk: Beta 375
10.8 Beta and the Cost of Capital 378
Estimating the Risk Premium 378
■ COmmON mISTakE
Beta Versus Volatility 378
The Capital Asset Pricing Model 380
MyFinanceLab 380 ■ Key Terms 382 ■
Further Reading 382 ■ Problems 382 ■
Data Case 387
Chapter 11 optimal portfolio Choice
and the Capital asset pricing
Model 389
11.1 the expected return of a
portfolio 390
11.2 the Volatility of a two-Stock
portfolio 391
Combining Risks 391
Determining Covariance
and Correlation 392
■ COmmON mISTakE
Computing Variance, Covariance,
and Correlation in Excel 394
Computing a Portfolio’s Variance
and Volatility 395
11.3 the Volatility of a Large portfolio 397
Large Portfolio Variance 397
Diversification with an Equally Weighted
Portfolio 398
■ INTERvIEw with John Powers 400
Diversification with General
Portfolios 401
11.4 risk Versus return: Choosing
an efficient portfolio 401
Efficient Portfolios with Two Stocks 402
The Effect of Correlation 404
Short Sales 405
Efficient Portfolios with Many
Stocks 406
■ NObEl PRIzES Harry Markowitz
and James Tobin 407
11.5 risk-Free Saving and Borrowing 409
Investing in Risk-Free Securities 409
Borrowing and Buying Stocks
on Margin 410
Identifying the Tangent Portfolio 411
11.6 the efficient portfolio and required
returns 413
Portfolio Improvement: Beta
and the Required Return 413
Expected Returns and the Efficient
Portfolio 415
11.7 the Capital asset pricing Model 417
The CAPM Assumptions 417
Supply, Demand, and the Efficiency
of the Market Portfolio 418
Optimal Investing: The Capital
Market Line 418
A01_BERK8334_04_GE_FM.indd 12 8/22/16 8:34 PM
Contents 13
11.8 Determining the risk premium 419
Market Risk and Beta 419
…
Assessment Criteria for MSc Dissertations – Empirical/Valuation Project
General Criteria/
Marker’s
Comments
Introduction Literature Review Empirical/Valuation
Framework and Data
Description
Empirical/Valuation
Analysis
Conclusion Written Communication
(Presentation)
80+
High
Distinction
• -Incisive introduction
• -Comprehensive and
persuasive rationale
• -Clear statement of the
research problem and
associate objectives
•
-Sources used with
discrimination
-Coherent and entirely
justified conceptual
framework to support the
research undertaken
-Sophisticated use of
examples
-Fully appropriate choice
and application of data
collection methods which
is entirely justified
-Correct sourcing
-Highly original and
creative selection of data
-Strong and broad
evidence of an excellent
level of analysis and use of
appropriate techniques
-Exceptional analysis of
key concepts with very
clear originality and
autonomy
• -Strong original conclusion
• -Extensive evidence of the
ability to critically evaluate
the research results
-Excellent typography and
layout
-Lucid expressions
-Sophisticated vocabulary
-Excellent citation and
bibliography norms
70 – 79.9
Distinction
-Focused introduction
-Subject well justified
-Clear statement of the
research problem and
associate objectives
-A wide range of sources
consulted
-Evidence of a sound
discussion of the literature
relevant to the study
-Good use of examples
- Fully appropriate choice
and application of data
collection methods, well
justified
-Correct sourcing
-Original, well-researched
selection of data
-Critical appraisal and
synthetic analysis
-Excellent analysis of key
concepts demonstrating
independence of thought
and a high level of
intellectual rigour and
consistency
-Conclusion advances
debates
-Extensive evidence of the
ability to critically evaluate
the research results
-Structured appropriately
to the purposes of the
assignment
-Lucid expression with few
flaws
-Good use of vocabulary
-Excellent citation and
bibliography norms
60 – 69.9
Merit
-Clear and thoughtful
introduction
-Subject valid and relevant
-Appropriate selection and
justification of the
methodology adopted
-Well selected range of
sources consulted
-Evidence of a
comprehensive review of
the literature relevant to
the study
-Appropriate examples
-Appropriate choice and
application of data
collection methods which
is also well supported.
- Well – researched
selection of data
-Good analysis of key
concepts
-Development of
conceptual structures and
argument making
consistent use of scholarly
conventions
-Clear conclusions
-Satisfactory evidence of
the ability to critically
evaluate the research
results
-Good typography and
layout
-Good expression
-Appropriate use of
vocabulary
-Few errors of grammar
-Well – structured
Accurate and full citation
and bibliography
50 – 59.9
Pass
-Fair introduction
-Subject has some validity
and relevance
-Rationale present but of
marginal relevance
-A range of sources
consulted
-Indication of a satisfactory
review of the literature
relevant to the study but
with some evident gaps
and omissions
-Limited range of
examples sometimes
inappropriate ones
-Mainly appropriate choice
and application of data
collection methods with
some evidence of
justification
-Some errors and
omissions in sourcing
-Mainly standard range of
data used
-Evidence of a satisfactory
level of analysis and of use
of appropriate techniques
-Satisfactory knowledge of
key concepts, descriptive in
parts but some ability to
synthesize scholarship and
argument.
-Fair conclusions
- Some evidence of
appropriate justification for
critical comment on and
logical development but
incomplete and / or
illogically developed.
-Adequate typography and
layout
-Few serious errors of
grammar;
-Limited vocabulary
-inconsistent citation and
bibliography with
significant omissions
<50
Fail
-Weak introduction
-Descriptive with large
gaps or misses the point
-Minimal range of sources
consulted
-Little attempt to support
any assertions
-Minimal range use of
examples
-Inappropriate choice and
application of data
collection with no
justification
-Narrow or unskilled range
of data used
-Limited knowledge of key
concepts
-Use of scholarly
conventions inconsistent,
largely descriptive with little
synthesis of existing
-Weak conclusions
-Conclusions sketchy or ill-
matched
-Poor presentation
-Flawed expression
-Inaccurate citation and
gaps in bibliography
scholarship and limited
argument
On line Assignment Submission
Student ID Number:
Name and Surname:
MSc Programme:
Title:
Name of Supervisor:
Deleting as appropriate:
I do agree to allow my dissertation to be seen by future students
Online Dissertation submission:
Please ensure that you complete and attach this submission form to the front of your work
By submitting your work online you are confirming that your work is your own and that you understand and have read the University’s rules regarding plagiarism
Aim and Objectives
} Enable students to advance their knowledge of
the field covered by their degree programme
} Independent research project (it can be either
an empirical project or a valuation project)
} Ability to evaluate, challenge, modify and
develop theory and practice.
} Offer synthetic and coherent solutions
2
} The dissertation can be either an empirical project or a
valuation project
◦ For Empirical projects: ECOM146 is strongly recommended
◦ You can change your optional modules in January 2021
◦ Data Analysis for Research, is part of the Dissertation
module
◦ Ungraded
◦ Compulsory
◦ Starts in Sem B
3
} Topics discussed during Data Analysis for
Research
} Topics proposed by supervisors
} Students need to discuss with their supervisor
their topic before the proposal submission
} 1st meeting with supervisor will be in March 2021
◦ Specific dates for each supervisor to be confirmed
4
} Topic selection: Friday 5th of February 2021
} Proposal submission: Friday 16th of April 2021
} Final submission: Monday 23rd of August 2021
} Dissertations that are submitted late will be penalised at
the rate of 5 marks deduction for each 24 hour period
after the set submission time, down to the pass mark.
} Work submitted 7 calendar days or more after the
deadline will be awarded zero (check your handbook).
This rule applies for all days including weekends.
5
} Supervisory activities start on the 7th of June
2021 which is the first Monday after the end of the
exam period.
} The last day of supervision is Thursday the 5th
of August 2021. After that date you can no longer
arrange any further meetings with your supervisor
and/or your teaching assistant
} It is your responsibility to arrange your meetings
with your supervisor and teaching assistant on
time.
6
} 7,000 words (ECOM107)
◦ Do not forget, this is equal to a 45 credits module!
} 4,000 words (ECOM093)
◦ Do not forget, this is equal to a 30 credits module!
} Work that exceeds the stated word limit shows a
failure to synthesise material and edit work as to
present argument/data concisely.
◦ This will be noted in the feedback and reflected in
the grade awarded.
7
} There will be an online session straight after the
exam period in June about citing and referencing.
The exact date and time will be announced at a
later stage.
8
Plagiarism
} Your dissertation should be the output of your
own work.
} Incorrect referencing and citations may be
considered plagiarism.
} For detecting plagiarism, the School uses
Turnitin.
} Before your final submission, you will be able to
check your work on Turnitin
9
} The dissertation is intended to provide an opportunity for
students to pursue a valuation/research project
independently
} Students are entirely responsible for the work for their
dissertation.
} The role of the supervisor is to offer advice and
guidance, not to direct the research.
} Your supervisor will help you to identify a topic, to draw
up a suitable preliminary bibliography and to plan the
primary and secondary research you will need to do for
the dissertation.
} He/she will be available to advise you on approach,
coverage, questions to be asked and the outline
structure and research design.
10
} More specifically, the supervisor is expected to:
◦ assist you in the definition and organisation of
your project in the early stages of preparation;
◦ offer you advice about sources;
◦ advise you on the feasibility of what you plan to
do;
◦ approve your dissertation proposal.
11
} You must not expect the teaching assistants to do the work for
you!
} The role of the teaching assistant is to offer assistance at
various stages of your dissertation
} For empirical projects
◦ the teaching assistant will assist you on how to download data
and use library resources. If you also need help with the
statistical package (Eviews, STATA etc) you use, teaching
assistant will give you guidance.
◦ the teaching assistant will assist you on how to download
papers using the QMUL library resources and/or show you
alternative ways to do so.
} Teaching assistant will not give you suggestions about your
research approach and will not recommend research methods
and literature. Teaching assistants have a supportive role only.
12
} Four (4) meetings in total
◦ One meeting before the proposal submission
deadline (16/04/2021)
◦ Three meetings during the supervisory period
(07/06/2021 – 05/08/2021).
13
} Four (4) meetings in total during the period of
supervisory activities (14/06/2021 – 05/08/2021)
} Students can pick up available slots that teaching
assistants will release well in advance
} Only one (1) meeting until the end of June
} Then, one (1) meeting every two weeks
◦ Students are expected to stay in close proximity to the
campus during the whole supervisory period
14
} Applications for extensions will only be considered if
accompanied by a medical certificate (in English) (see
your handbook for more details)
} Extenuating Circumstances are ultimately verified by
the Exam Board and can be rejected.
} Students that fail to submit by the deadline may
submit the following year but this attempt will be
capped at 50\%
16
CATEGORIES
Economics
Nursing
Applied Sciences
Psychology
Science
Management
Computer Science
Human Resource Management
Accounting
Information Systems
English
Anatomy
Operations Management
Sociology
Literature
Education
Business & Finance
Marketing
Engineering
Statistics
Biology
Political Science
Reading
History
Financial markets
Philosophy
Mathematics
Law
Criminal
Architecture and Design
Government
Social Science
World history
Chemistry
Humanities
Business Finance
Writing
Programming
Telecommunications Engineering
Geography
Physics
Spanish
ach
e. Embedded Entrepreneurship
f. Three Social Entrepreneurship Models
g. Social-Founder Identity
h. Micros-enterprise Development
Outcomes
Subset 2. Indigenous Entrepreneurship Approaches (Outside of Canada)
a. Indigenous Australian Entrepreneurs Exami
Calculus
(people influence of
others) processes that you perceived occurs in this specific Institution Select one of the forms of stratification highlighted (focus on inter the intersectionalities
of these three) to reflect and analyze the potential ways these (
American history
Pharmacology
Ancient history
. Also
Numerical analysis
Environmental science
Electrical Engineering
Precalculus
Physiology
Civil Engineering
Electronic Engineering
ness Horizons
Algebra
Geology
Physical chemistry
nt
When considering both O
lassrooms
Civil
Probability
ions
Identify a specific consumer product that you or your family have used for quite some time. This might be a branded smartphone (if you have used several versions over the years)
or the court to consider in its deliberations. Locard’s exchange principle argues that during the commission of a crime
Chemical Engineering
Ecology
aragraphs (meaning 25 sentences or more). Your assignment may be more than 5 paragraphs but not less.
INSTRUCTIONS:
To access the FNU Online Library for journals and articles you can go the FNU library link here:
https://www.fnu.edu/library/
In order to
n that draws upon the theoretical reading to explain and contextualize the design choices. Be sure to directly quote or paraphrase the reading
ce to the vaccine. Your campaign must educate and inform the audience on the benefits but also create for safe and open dialogue. A key metric of your campaign will be the direct increase in numbers.
Key outcomes: The approach that you take must be clear
Mechanical Engineering
Organic chemistry
Geometry
nment
Topic
You will need to pick one topic for your project (5 pts)
Literature search
You will need to perform a literature search for your topic
Geophysics
you been involved with a company doing a redesign of business processes
Communication on Customer Relations. Discuss how two-way communication on social media channels impacts businesses both positively and negatively. Provide any personal examples from your experience
od pressure and hypertension via a community-wide intervention that targets the problem across the lifespan (i.e. includes all ages).
Develop a community-wide intervention to reduce elevated blood pressure and hypertension in the State of Alabama that in
in body of the report
Conclusions
References (8 References Minimum)
*** Words count = 2000 words.
*** In-Text Citations and References using Harvard style.
*** In Task section I’ve chose (Economic issues in overseas contracting)"
Electromagnetism
w or quality improvement; it was just all part of good nursing care. The goal for quality improvement is to monitor patient outcomes using statistics for comparison to standards of care for different diseases
e a 1 to 2 slide Microsoft PowerPoint presentation on the different models of case management. Include speaker notes... .....Describe three different models of case management.
visual representations of information. They can include numbers
SSAY
ame workbook for all 3 milestones. You do not need to download a new copy for Milestones 2 or 3. When you submit Milestone 3
pages):
Provide a description of an existing intervention in Canada
making the appropriate buying decisions in an ethical and professional manner.
Topic: Purchasing and Technology
You read about blockchain ledger technology. Now do some additional research out on the Internet and share your URL with the rest of the class
be aware of which features their competitors are opting to include so the product development teams can design similar or enhanced features to attract more of the market. The more unique
low (The Top Health Industry Trends to Watch in 2015) to assist you with this discussion.
https://youtu.be/fRym_jyuBc0
Next year the $2.8 trillion U.S. healthcare industry will finally begin to look and feel more like the rest of the business wo
evidence-based primary care curriculum. Throughout your nurse practitioner program
Vignette
Understanding Gender Fluidity
Providing Inclusive Quality Care
Affirming Clinical Encounters
Conclusion
References
Nurse Practitioner Knowledge
Mechanics
and word limit is unit as a guide only.
The assessment may be re-attempted on two further occasions (maximum three attempts in total). All assessments must be resubmitted 3 days within receiving your unsatisfactory grade. You must clearly indicate “Re-su
Trigonometry
Article writing
Other
5. June 29
After the components sending to the manufacturing house
1. In 1972 the Furman v. Georgia case resulted in a decision that would put action into motion. Furman was originally sentenced to death because of a murder he committed in Georgia but the court debated whether or not this was a violation of his 8th amend
One of the first conflicts that would need to be investigated would be whether the human service professional followed the responsibility to client ethical standard. While developing a relationship with client it is important to clarify that if danger or
Ethical behavior is a critical topic in the workplace because the impact of it can make or break a business
No matter which type of health care organization
With a direct sale
During the pandemic
Computers are being used to monitor the spread of outbreaks in different areas of the world and with this record
3. Furman v. Georgia is a U.S Supreme Court case that resolves around the Eighth Amendments ban on cruel and unsual punishment in death penalty cases. The Furman v. Georgia case was based on Furman being convicted of murder in Georgia. Furman was caught i
One major ethical conflict that may arise in my investigation is the Responsibility to Client in both Standard 3 and Standard 4 of the Ethical Standards for Human Service Professionals (2015). Making sure we do not disclose information without consent ev
4. Identify two examples of real world problems that you have observed in your personal
Summary & Evaluation: Reference & 188. Academic Search Ultimate
Ethics
We can mention at least one example of how the violation of ethical standards can be prevented. Many organizations promote ethical self-regulation by creating moral codes to help direct their business activities
*DDB is used for the first three years
For example
The inbound logistics for William Instrument refer to purchase components from various electronic firms. During the purchase process William need to consider the quality and price of the components. In this case
4. A U.S. Supreme Court case known as Furman v. Georgia (1972) is a landmark case that involved Eighth Amendment’s ban of unusual and cruel punishment in death penalty cases (Furman v. Georgia (1972)
With covid coming into place
In my opinion
with
Not necessarily all home buyers are the same! When you choose to work with we buy ugly houses Baltimore & nationwide USA
The ability to view ourselves from an unbiased perspective allows us to critically assess our personal strengths and weaknesses. This is an important step in the process of finding the right resources for our personal learning style. Ego and pride can be
· By Day 1 of this week
While you must form your answers to the questions below from our assigned reading material
CliftonLarsonAllen LLP (2013)
5 The family dynamic is awkward at first since the most outgoing and straight forward person in the family in Linda
Urien
The most important benefit of my statistical analysis would be the accuracy with which I interpret the data. The greatest obstacle
From a similar but larger point of view
4 In order to get the entire family to come back for another session I would suggest coming in on a day the restaurant is not open
When seeking to identify a patient’s health condition
After viewing the you tube videos on prayer
Your paper must be at least two pages in length (not counting the title and reference pages)
The word assimilate is negative to me. I believe everyone should learn about a country that they are going to live in. It doesnt mean that they have to believe that everything in America is better than where they came from. It means that they care enough
Data collection
Single Subject Chris is a social worker in a geriatric case management program located in a midsize Northeastern town. She has an MSW and is part of a team of case managers that likes to continuously improve on its practice. The team is currently using an
I would start off with Linda on repeating her options for the child and going over what she is feeling with each option. I would want to find out what she is afraid of. I would avoid asking her any “why” questions because I want her to be in the here an
Summarize the advantages and disadvantages of using an Internet site as means of collecting data for psychological research (Comp 2.1) 25.0\% Summarization of the advantages and disadvantages of using an Internet site as means of collecting data for psych
Identify the type of research used in a chosen study
Compose a 1
Optics
effect relationship becomes more difficult—as the researcher cannot enact total control of another person even in an experimental environment. Social workers serve clients in highly complex real-world environments. Clients often implement recommended inte
I think knowing more about you will allow you to be able to choose the right resources
Be 4 pages in length
soft MB-920 dumps review and documentation and high-quality listing pdf MB-920 braindumps also recommended and approved by Microsoft experts. The practical test
g
One thing you will need to do in college is learn how to find and use references. References support your ideas. College-level work must be supported by research. You are expected to do that for this paper. You will research
Elaborate on any potential confounds or ethical concerns while participating in the psychological study 20.0\% Elaboration on any potential confounds or ethical concerns while participating in the psychological study is missing. Elaboration on any potenti
3 The first thing I would do in the family’s first session is develop a genogram of the family to get an idea of all the individuals who play a major role in Linda’s life. After establishing where each member is in relation to the family
A Health in All Policies approach
Note: The requirements outlined below correspond to the grading criteria in the scoring guide. At a minimum
Chen
Read Connecting Communities and Complexity: A Case Study in Creating the Conditions for Transformational Change
Read Reflections on Cultural Humility
Read A Basic Guide to ABCD Community Organizing
Use the bolded black section and sub-section titles below to organize your paper. For each section
Losinski forwarded the article on a priority basis to Mary Scott
Losinksi wanted details on use of the ED at CGH. He asked the administrative resident