default spreads – january 2016adamodar/podcasts/cfspr... · effects of country risk and currency...
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DefaultSpreads–January2016
Aswath Damodaran
0.75% 1.00% 1.10% 1.25%1.75%
2.25%
3.25%
4.25%
5.50%
6.50%
7.50%
9.00%
12.00%
16.00%
20.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Aaa/AAA Aa2/AA A1/A+ A2/A A3/A- Baa2/BBB Ba1/BB+ Ba2/BB B1/B+ B2/B B3/B- Caa/CCC Ca2/CC C2/C D2/D
DefaultSpreadsfor10-yearCorporateBonds:January2015vsJanuary2016
Spread:2016 Spread:2015
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Applica9onTest:Es9ma9ngaCostofDebt
AswathDamodaran
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¨ Baseduponyourfirm’scurrentearningsbeforeinterestandtaxes,itsinterestexpenses,es9mate¤ Aninterestcoveragera9oforyourfirm¤ Asynthe9cra9ngforyourfirm(usethetablesfrompriorpages)
¤ Apre-taxcostofdebtforyourfirm¤ AnaKer-taxcostofdebtforyourfirm
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CostsofHybrids
AswathDamodaran
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¨ Preferredstocksharessomeofthecharacteris9csofdebt-thepreferreddividendispre-specifiedatthe9meoftheissueandispaidoutbeforecommondividend--andsomeofthecharacteris9csofequity-thepaymentsofpreferreddividendarenottaxdeduc9ble.Ifpreferredstockisviewedasperpetual,thecostofpreferredstockcanbewriSenasfollows:¤ kps=PreferredDividendpershare/MarketPriceperpreferredshare
¨ Conver9bledebtispartdebt(thebondpart)andpartequity(theconversionop9on).Itisbesttobreakitupintoitscomponentpartsandeliminateitfromthemixaltogether.
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WeightsforCostofCapitalCalcula9on
AswathDamodaran
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¨ Theweightsusedinthecostofcapitalcomputa9onshouldbemarketvalues.
¨ Therearethreespeciousargumentsusedagainstmarketvalue¤ Bookvalueismorereliablethanmarketvaluebecauseitisnotas
vola9le:Whileitistruethatbookvaluedoesnotchangeasmuchasmarketvalue,thisismoreareflec9onofweaknessthanstrength
¤ Usingbookvalueratherthanmarketvalueisamoreconserva9veapproachtoes9ma9ngdebtra9os:Formostcompanies,usingbookvalueswillyieldalowercostofcapitalthanusingmarketvalueweights.
¤ Sinceaccoun9ngreturnsarecomputedbaseduponbookvalue,consistencyrequirestheuseofbookvalueincompu9ngcostofcapital:Whileitmayseemconsistenttousebookvaluesforbothaccoun9ngreturnandcostofcapitalcalcula9ons,itdoesnotmakeeconomicsense.
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Disney:Frombookvaluetomarketvalueforinterestbearingdebt…¨ InDisney’s2013financialstatements,thedebtdueover9mewasfootnoted.
¨ Disney’stotaldebtdue,inbookvalueterms,onthebalancesheetis$14,288millionandthetotalinterestexpensefortheyearwas$349million.Using3.75%asthepre-taxcostofdebt:
¨ Es9matedMVofDisneyDebt=
Aswath Damodaran
Time due Amount due Weight Weight *Maturity
0.5 $1,452 11.96% 0.062 $1,300 10.71% 0.213 $1,500 12.36% 0.374 $2,650 21.83% 0.876 $500 4.12% 0.258 $1,362 11.22% 0.99 $1,400 11.53% 1.0419 $500 4.12% 0.7826 $25 0.21% 0.0528 $950 7.83% 2.1929 $500 4.12% 1.19 $12,139 7.92
349(1− 1
(1.0375)7.92
.0375
"
#
$$$$
%
&
''''
+14, 288
(1.0375)7.92 = $13, 028 million
The debt in this table does not add up to the book value of debt, because Disney does not break down the maturity of all of its debt.
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Opera9ngLeasesatDisney
¨ The“debtvalue”ofopera9ngleasesisthepresentvalueoftheleasepayments,ataratethatreflectstheirrisk,usuallythepre-taxcostofdebt.
¨ Thepre-taxcostofdebtatDisneyis3.75%.
¨ DebtoutstandingatDisney=$13,028+$2,933=$15,961million
Disney reported $1,784 million in commitments after year 5. Given that their average commitment over the first 5 years, we assumed 5 years @ $356.8 million each.
Aswath Damodaran
Year Commitment Present Value @3.75% 1 $507.00 $488.67 2 $422.00 $392.05 3 $342.00 $306.24 4 $272.00 $234.76 5 $217.00 $180.52
6-10 $356.80 $1,330.69 Debt value of leases $2,932.93
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Applica9onTest:Es9ma9ngMarketValue
AswathDamodaran
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¨ Es9matethe¤ MarketvalueofequityatyourfirmandBookValueofequity
¤ Marketvalueofdebtandbookvalueofdebt(Ifyoucannotfindtheaveragematurityofyourdebt,use3years):Remembertocapitalizethevalueofopera9ngleasesandaddthemontoboththebookvalueandthemarketvalueofdebt.
¨ Es9matethe¤ Weightsforequityanddebtbaseduponmarketvalue¤ Weightsforequityanddebtbaseduponbookvalue
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CurrentCostofCapital:Disney
¨ Equity¤ CostofEquity=Riskfreerate+Beta*RiskPremium
=2.75%+1.0013(5.76%)=8.52%¤ MarketValueofEquity= $121,878million¤ Equity/(Debt+Equity)= 88.42%
¨ Debt¤ AKer-taxCostofdebt=(Riskfreerate+DefaultSpread)(1-t)
=(2.75%+1%)(1-.361)= 2.40%¤ MarketValueofDebt=$13,028+$2933= $15,961million¤ Debt/(Debt+Equity)= 11.58%
¨ CostofCapital=8.52%(.8842)+2.40%(.1158)=7.81%
121,878/ (121,878+15,961)Aswath Damodaran
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DivisionalCostsofCapital:DisneyandVale
Disney
Vale
Aswath Damodaran
!!Cost!of!equity!
Cost!of!debt!
Marginal!tax!rate!
After6tax!cost!of!debt!
Debt!ratio!
Cost!of!capital!
Media!Networks! 9.07%! 3.75%! 36.10%! 2.40%! 9.12%! 8.46%!Parks!&!Resorts! 7.09%! 3.75%! 36.10%! 2.40%! 10.24%! 6.61%!Studio!Entertainment! 9.92%! 3.75%! 36.10%! 2.40%! 17.16%! 8.63%!Consumer!Products! 9.55%! 3.75%! 36.10%! 2.40%! 53.94%! 5.69%!Interactive! 11.65%! 3.75%! 36.10%! 2.40%! 29.11%! 8.96%!Disney!Operations! 8.52%! 3.75%! 36.10%! 2.40%! 11.58%! 7.81%!
Business Cost of equity
After-tax cost of debt
Debt ratio
Cost of capital (in US$)
Cost of capital (in $R)
Metals & Mining 11.35% 2.67% 35.48% 8.27% 15.70% Iron Ore 11.13% 2.67% 35.48% 8.13% 15.55% Fertilizers 12.70% 2.67% 35.48% 9.14% 16.63% Logistics 10.29% 2.67% 35.48% 7.59% 14.97% Vale Operations 11.23% 2.67% 35.48% 8.20% 15.62%
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CostsofCapital:TataMotors,BaiduandBookscape
¨ Toes9matethecostsofcapitalforTataMotorsinIndianrupees:Costofcapital=14.49%(1-.2928)+6.50%(.2928)=12.15%
¨ ForBaidu,wefollowthesamepathtoes9mateacostofequityinChineseRMB:Costofcapital=12.91%(1-.0523)+3.45%(.0523)=12.42%
¨ ForBookscape,thecostofcapitalisdifferentdependingonwhetheryoulookatmarketortotalbeta:
Aswath Damodaran
Cost of equity Pre-tax Cost of debt
After-tax cost of debt D/(D+E) Cost of capital
Market Beta 7.46% 4.05% 2.43% 17.63% 6.57% Total Beta 11.98% 4.05% 2.43% 17.63% 10.30%
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Applica9onTest:Es9ma9ngCostofCapital
AswathDamodaran
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¨ UsingtheboSom-upunleveredbetathatyoucomputedforyourfirm,andthevaluesofdebtandequityyouhavees9matedforyourfirm,es9mateaboSom-upleveredbetaandcostofequityforyourfirm.
¨ Baseduponthecostsofequityanddebtthatyouhavees9mated,andtheweightsforeach,es9matethecostofcapitalforyourfirm.
¨ Howdifferentwouldyourcostofcapitalhavebeen,ifyouusedbookvalueweights?
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ChoosingaHurdleRate
AswathDamodaran
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¨ Eitherthecostofequityorthecostofcapitalcanbeusedasahurdlerate,dependinguponwhetherthereturnsmeasuredaretoequityinvestorsortoallclaimholdersonthefirm(capital)
¨ Ifreturnsaremeasuredtoequityinvestors,theappropriatehurdlerateisthecostofequity.
¨ Ifreturnsaremeasuredtocapital(orthefirm),theappropriatehurdlerateisthecostofcapital.
MEASURINGINVESTMENTRETURNSI:THEMECHANICSOFINVESTMENTANALYSIS“Showmethemoney”
fromJerryMaguire
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Measuresofreturn:earningsversuscashflows
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¨ PrinciplesGoverningAccoun9ngEarningsMeasurement¤ AccrualAccoun9ng:Showrevenueswhenproductsandservicesare
soldorprovided,notwhentheyarepaidfor.Showexpensesassociatedwiththeserevenuesratherthancashexpenses.
¤ Opera9ngversusCapitalExpenditures:Onlyexpensesassociatedwithcrea9ngrevenuesinthecurrentperiodshouldbetreatedasopera9ngexpenses.ExpensesthatcreatebenefitsoverseveralperiodsarewriSenoffovermul9pleperiods(asdeprecia9onoramor9za9on)
¨ Togetfromaccoun9ngearningstocashflows:¤ youhavetoaddbacknon-cashexpenses(likedeprecia9on)¤ youhavetosubtractoutcashouplowswhicharenotexpensed(such
ascapitalexpenditures)¤ youhavetomakeaccrualrevenuesandexpensesintocashrevenues
andexpenses(byconsideringchangesinworkingcapital).
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MeasuringReturnsRight:TheBasicPrinciples
AswathDamodaran
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¨ Usecashflowsratherthanearnings.Youcannotspendearnings.
¨ Use“incremental”cashflowsrela9ngtotheinvestmentdecision,i.e.,cashflowsthatoccurasaconsequenceofthedecision,ratherthantotalcashflows.
¨ Use“9meweighted”returns,i.e.,valuecashflowsthatoccurearliermorethancashflowsthatoccurlater.TheReturnMantra:“Time-weighted,IncrementalCash
FlowReturn”
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Seqngthetable:Whatisaninvestment/project?
AswathDamodaran
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¨ Aninvestment/projectcanrangethespectrumfrombigtosmall,moneymakingtocostsaving:¤ Majorstrategicdecisionstoenternewareasofbusinessornewmarkets.
¤ Acquisi9onsofotherfirmsareprojectsaswell,notwithstandingaSemptstocreateseparatesetsofrulesforthem.
¤ Decisionsonnewventureswithinexis9ngbusinessesormarkets.
¤ Decisionsthatmaychangethewayexis9ngventuresandprojectsarerun.
¤ Decisionsonhowbesttodeliveraservicethatisnecessaryforthebusinesstorunsmoothly.
¨ Putinbroaderterms,everychoicemadebyafirmcanbeframedasaninvestment.
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Herearefourexamples…
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¨ RioDisney:WewillconsiderwhetherDisneyshouldinvestinitsfirstthemeparksinSouthAmerica.Theseparks,whilesimilartothosethatDisneyhasinotherpartsoftheworld,willrequireustoconsidertheeffectsofcountryriskandcurrencyissuesinprojectanalysis.
¨ NewironoremineforVale:ThisisanironoreminethatValeisconsideringinWesternLabrador,Canada.
¨ AnOnlineStoreforBookscape:Bookscapeisevalua9ngwhetheritshouldcreateanonlinestoretosellbooks.Whileitisanextensionoftheirbasisbusiness,itwillrequiredifferentinvestments(andpoten9allyexposethemtodifferenttypesofrisk).
¨ Acquisi9onofHarmanbyTataMotors:Across-borderbidbyTataforHarmanInterna9onal,apubliclytradedUSfirmthatmanufactureshigh-endaudioequipment,withtheintentofupgradingtheaudioupgradesonTataMotors’automobiles.Thisinvestmentwillallowustoexaminecurrencyandriskissuesinsuchatransac9on.
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EarningsversusCashFlows:ADisneyThemePark
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¨ ThethemeparkstobebuiltnearRio,modeledonEuroDisneyinParisandDisneyWorldinOrlando.
¨ Thecomplexwillincludea“MagicKingdom”tobeconstructed,beginningimmediately,andbecomingopera9onalatthebeginningofthesecondyear,andasecondthemeparkmodeledonEpcotCenteratOrlandotobeconstructedinthesecondandthirdyearandbecomingopera9onalatthebeginningofthefourthyear.
¨ Theearningsandcashflowsarees9matedinnominalU.S.Dollars.
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KeyAssump9onsonStartUpandConstruc9on
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¨ Disneyhasalreadyspent$0.5Billionresearchingtheproposalandgeqngthenecessarylicensesforthepark;noneofthisinvestmentcanberecoverediftheparkisnotbuilt.Thisexpenditurehasbeencapitalizedandwillbedepreciatedstraightlineovertenyearstoasalvagevalueofzero.
¨ Disneywillfacesubstan9alconstruc9oncosts,ifitchoosestobuildthethemeparks.¤ Thecostofconstruc9ngMagicKingdomwillbe$3billion,with$2billion
tobespentrightnow,and$1Billiontobespentoneyearfromnow.¤ Thecostofconstruc9ngEpcotIIwillbe$1.5billion,with$1billiontobe
spentattheendofthesecondyearand$0.5billionattheendofthethirdyear.
¤ Theseinvestmentswillbedepreciatedbaseduponadeprecia9onscheduleinthetaxcode,wheredeprecia9onwillbedifferenteachyear.
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KeyRevenueAssump9ons
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¨ Revenuees9matesfortheparksandresortproper9es(inmillions)Year MagicKingdom EpcotII ResortProper9esTotal1 $0 $0 $0 $02 $1,000 $0 $250 $1,2503 $1,400 $0 $350 $1.7504 $1,700 $300 $500 $2.5005 $2,000 $500 $625 $3.1256 $2,200 $550 $688 $3,4387 $2,420 $605 $756 $3,7818 $2,662 $666 $832 $4,1599 $2,928 $732 $915 $4,57510 $2,987 $747 $933 $4,667¨
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KeyExpenseAssump9ons
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¨ Theopera9ngexpensesareassumedtobe60%oftherevenuesattheparks,and75%ofrevenuesattheresortproper9es.
¨ Disneywillalsoallocatecorporategeneralandadministra9vecoststothisproject,baseduponrevenues;theG&Aalloca9onwillbe15%oftherevenueseachyear.Itisworthno9ngthatarecentanalysisoftheseexpensesfoundthatonlyone-thirdoftheseexpensesarevariable(andafunc9onoftotalrevenue)andthattwo-thirdsarefixed.