Session 10: FCFE across the life cycle and Growth Rate Estimation

(I apologize for the screen sharing snafu, which is about 12 minutes, between minutes 10 and 22 of the class, since you watch an awfully low res video of me in front of the classroom). In the session today, we started by doing a brief test on country risk premiums. We started with an assessment of historical equity risk premiums, and why they are not good predictors of future equity risk premiums, before embarking on a discussion of country risk and how to deal with it, and measure it. We also looked at company risk exposure to country risk, with my core argument being that a company’s exposure to country risk comes from where it dos business, not where it is incorporated:After a brief foray into lambda, a more composite way of measuring country risk, we spent the rest of the session talking about the dynamics of implied equity risk premiums and what makes them go up, down or stay unchanged. We then moved to cross market comparisons, first by comparing the ERP to bond default spreads, then bringing in real estate risk premiums and then extending the concept to comparing ERPs across countries. Finally, I made the argument that you should not stray too far from the current implied premium, when valuing individual companies, because doing so will make your end valuation a function of what you think about the market and the company. If you have strong views on the market being over valued or under valued, it is best to separate it from your company valuation. I am attaching the excel spreadsheet that I used to compute the implied ERP at the start of February 2023. Play with it when you get a chance. Post class test and solution attached. Until next time!Start of the class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/ImplPrem.pdfERP for February 2023: https://pages.stern.nyu.edu/~adamodar/pc/implprem/ERPFeb23.xlsxSlides: https://www.stern.nyu.edu/~adamodar/podcasts/valspr23/session5slides.pdfPost class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session5Atest.pdfPost class test solution: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session5Asoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

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In this class we began by looking at the four rules that keep terminal value in check. We then looked at which model to use in valuing a company and then moved on to the loose ends in valuation, items we often pay little heed to or attach arbitrary premiums/discounts for. We began by looking at cash and whether it should command a premium at some companies (if they have a good track record and have restrictions on raising capital) and a discount at others (if investors don't trust you with the cash). We then looked at cross holdings in other companies and the numerous barriers to valuing them.Start of the class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/termvalue.pdfSlides: http://www.stern.nyu.edu/~adamodar/podcasts/valUGspr17/session11.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session11atest.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session11asoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

We started this class by tying up the last loose ends with risk and return models, talking about how assuming that there are no transactions costs and private information can lead us all to hold the market portfolio, and how risk can be then measured as risk added to that portfolio. We did damn the CAPM with faint praise, arguing that it does not do very well at explaining differences in returns across companies, but that it does at least as well as the alternatives. We then started on the mechanics of the model, taking about risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:http://aswathdamodaran.blogspot.com/2015/04/dealing-with-low-interest-rates.html In fact, risk free rates turned negative in a few currencies, upending what we know about risk free rates in. Here is my post on negative risk free rates.http://aswathdamodaran.blogspot.com/2016/03/negative-interest-rates-unreal.html In the final few minutes of the session, we turned to equity risk premiums and how they are related to risk aversion.Slides: https://pages.stern.nyu.edu/~adamodar/podcasts/cfspr23/session6slides.pdfPost class test: https://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session6atest.pdfPost class test solution: https://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session6asoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices

This session is a grind with numbers building on top of numbers. In specific, we looked at how to estimate the beta for not only a company but its individual businesses by building up to a beta, rather than trusting a single regression. With Disney, we estimated a beta for each of the five businesses it was in, a collective beta for Disney's operating businesses and a beta for Disney as a company (including its cash). If you got lost at some stage in the class, here are some of the ways you can get unlost:1. Review the slides that we covered today.2. Try the post-class test and solution. I think it will really help bring together some of the mechanical issues involved in estimating betas.3. Read this short Q&A on bottom up betas which highlights the estimation process and some of its pitfalls:http://www.stern.nyu.edu/~adamodar/New_Home_Page/TenQs/TenQsBottomupBetas.htmSlides: http://www.stern.nyu.edu/~adamodar/podcasts/cfspr17/session9.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session9test.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session9soln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices