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FM p.i-xvi.qxd12/8/113:31 PMPage iiFounded in 1807, John Wiley & Sons is the oldest independent publishing company in theUnited States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services forour customers’ professional and personal knowledge and understanding.The Wiley Finance series contains books written specifically for finance and investmentprofessionals as well as sophisticated individual investors and their financial advisors.Book topics range from portfolio management to e-commerce, risk management, financialengineering, valuation and financial instrument analysis, as well as much more.For a list of available titles, please visit our Web site at www.WileyFinance.com.
FM p.i-xvi.qxd12/8/113:31 PMPage iiiInvestmentValuationTools and Techniques forDetermining the Value of Any AssetThird EditionASWATH DAMODARANwww.damodaran.comWILEYJohn Wiley & Sons, Inc.
FM p.i-xvi.qxd12/8/113:31 PMPage ivCopyright 2012 by Aswath Damodaran. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any formor by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except aspermitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the priorwritten permission of the Publisher, or authorization through payment of the appropriate per-copy feeto 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 permissionshould 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 effortsin preparing this book, they make no representations or warranties with respect to the accuracy orcompleteness of the contents of this book and specifically disclaim any implied warranties ofmerchantability or fitness for a particular purpose. No warranty may be created or extended by salesrepresentatives or written sales materials. The advice and strategies contained herein may not besuitable for your situation. You should consult with a professional where appropriate. Neither thepublisher nor author shall be liable for any loss of profit or any other commercial damages, includingbut not limited to special, incidental, consequential, or other damages.For general information on our other products and services or for technical support, please contact ourCustomer 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 printmay not be available in electronic books. For more information about Wiley products, visit our website at www.wiley.com.Library of Congress Cataloging-in-Publication Data:ISBN 978-1-118-01152-2Printed in the United States of America10 9 8 7 6 5 4 3 2 1
FM p.i-xvi.qxd12/8/113:31 PMPage vI would like to dedicate this book to Michele, whose patienceand support made it possible, and to my four children—Ryan, Brendan, Kendra, and Kiran—who provided the inspiration.
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FM p.i-xvi.qxd12/8/113:31 PMPage viiPreface to the Third Editionhis is a book about valuation—the valuation of stocks, bonds, options, futuresand real assets. It is a fundamental precept of this book that any asset can be valued, albeit imprecisely in some cases. I have attempted to provide a sense of notonly the differences between the models used to value different types of assets, butalso the common elements in these models.The last decade has been an eventful one for those interested in valuation forseveral reasons. First, the growth of Asian and Latin American markets broughtemerging market companies into the forefront and you will see the increased focuson these companies in this edition. Second, we saw the havoc wreaked by macroeconomic factors on company valuations during the bank crisis of 2008, and a blurring of the lines between developed and emerging markets. The lessons I learnedabout financial fundamentals during the crisis about risk-free rates, risk premiumsand cash flow estimation are incorporated into the text. Third, the last year has seenthe influx of social media companies, with small revenues and outsized market capitalizations, in an eerie replay of the dot-com boom from the late 1990s. More thanever, it made clear that the more things change, the more they stay the same. Finally,the entry of new players into equity markets (hedge funds, private equity investorsand high-frequency traders) has changed markets and investing dramatically. Witheach shift, the perennial question arises, “Is valuation still relevant in “this” market?”, and my answer remains unchanged, “Absolutely and more than ever”.As technology increasingly makes the printed page an anachronism, I have triedto adapt in many ways. First, this book will be available in eBook format, andhopefully will be just as useful (if not more so) than the print editions. Second, everyvaluation in this book will be put on the web site that will accompany this book(www.damodaran.com) as will a significant number of datasets and spreadsheets. Infact, the valuations in the book will be constantly updated online, allowing thebook to have a much closer link to real time valuations.In the process of presenting and discussing the various aspects of valuation, Ihave tried to adhere to four basic principles. First, I have attempted to be as comprehensive as possible in covering the range of valuation models that are availableto an analyst doing a valuation, while presenting the common elements in thesemodels and providing a framework that can be used to pick the right model for anyvaluation scenario. Second, the models are presented with real world examples,warts and all, so as to capture some of the problems inherent in applying thesemodels. There is the obvious danger that some of these valuations will appear to behopelessly wrong in hindsight, but this cost is well worth the benefits. Third, inkeeping with my belief that valuation models are universal and not market-specific,illustrations from markets outside the United States are interspersed throughout thebook. Finally, I have tried to make the book as modular as possible, enabling areader to pick and choose sections of the book to read, without a significant loss ofcontinuity.Tvii
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FM p.i-xvi.qxd12/8/113:31 PMPage ixContentsCHAPTER 1Introduction to ValuationA Philosophical Basis for ValuationGeneralities about ValuationThe Role of ValuationConclusionQuestions and Short Problems112699CHAPTER 2Approaches to ValuationDiscounted Cash Flow ValuationRelative ValuationContingent Claim ValuationConclusionQuestions and Short Problems111119232525CHAPTER 3Understanding Financial StatementsThe Basic Accounting StatementsAsset Measurement and ValuationMeasuring Financing MixMeasuring Earnings and ProfitabilityMeasuring RiskOther Issues in Analyzing Financial StatementsConclusionQuestions and Short Problems272729364247535555CHAPTER 4The Basics of RiskWhat is Risk?Equity Risk and Expected ReturnAlternative Models for Equity RiskA Comparative Analysis of Equity Risk ModelsModels of Default RiskConclusionQuestions and Short Problems5858597176778182CHAPTER 5Option Pricing Theory and ModelsBasics of Option PricingDeterminants of Option Value878789ix
FM p.i-xvi.qxd12/8/113:31 PMPage xxCONTENTSOption Pricing ModelsExtensions of Option PricingConclusionQuestions and Short Problems90107109109CHAPTER 6Market Efficiency—Definition, Tests, and EvidenceMarket Efficiency and Investment ValuationWhat Is an Efficient Market?Implications of Market EfficiencyNecessary Conditions for Market EfficiencyPropositions about Market EfficiencyTesting Market EfficiencyCardinal Sins in Testing Market EfficiencySome Lesser Sins That Can Be a ProblemEvidence on Market EfficiencyTime Series Properties of Price ChangesMarket Reaction to Information EventsMarket AnomaliesEvidence on Insiders and Investment ProfessionalsConclusionQuestions and Short 149150CHAPTER 7Riskless Rates and Risk PremiumsThe Risk-Free RateEquity Risk PremiumDefault Spreads on BondsConclusionQuestions and Short Problems154154159177180180CHAPTER 8Estimating Risk Parameters and Costs of FinancingThe Cost of Equity and CapitalCost of EquityFrom Cost of Equity to Cost of CapitalBest Practices at FirmsConclusionQuestions and Short Problems182182183209221221222CHAPTER 9Measuring EarningsAccounting versus Financial Balance SheetsAdjusting EarningsConclusionQuestions and Short Problems228228229246248
FM p.i-xvi.qxd12/8/113:31 PMPage xiContentsxiCHAPTER 10From Earnings to Cash FlowsThe Tax EffectReinvestment NeedsConclusionQuestions and Short Problems249249257267268CHAPTER 11Estimating GrowthThe Importance of GrowthHistorical GrowthAnalyst Estimates of GrowthFundamental Determinants of GrowthQualitative Aspects of GrowthConclusionQuestions and Short Problems270270271281284301302302CHAPTER 12Closure in Valuation: Estimating Terminal Value304Closure in ValuationThe Survival IssueClosing Thoughts on Terminal ValueConclusionQuestions and Short Problems304318320321321CHAPTER 13Dividend Discount ModelsThe General ModelVersions of the ModelIssues in Using the Dividend Discount ModelTests of the Dividend Discount ModelConclusionQuestions and Short Problems323323324344345348349CHAPTER 14Free Cash Flow to Equity Discount ModelsMeasuring What Firms Can Return to Their StockholdersFCFE Valuation ModelsFCFE Valuation versus Dividend Discount Model ValuationConclusionQuestions and Short Problems351351357372376376CHAPTER 15Firm Valuation: Cost of Capital and Adjusted Present Value ApproachesFree Cash flow to the FirmFirm Valuation: The Cost of Capital Approach380380383
FM p.i-xvi.qxd12/8/113:31 PMPage xiixiiCONTENTSFirm Valuation: The Adjusted Present Value ApproachEffect of Leverage on Firm ValueAdjusted Present Value and Financial LeverageConclusionQuestions and Short Problems398402415419419CHAPTER 16Estimating Equity Value per ShareValue of Nonoperating AssetsFirm Value and Equity ValueManagement and Employee OptionsValue per Share When Voting Rights VaryConclusionQuestions and Short Problems423423440442448450451CHAPTER 17Fundamental Principles of Relative ValuationUse of Relative ValuationStandardized Values and MultiplesFour Basic Steps to Using MultiplesReconciling Relative and Discounted Cash Flow ValuationsConclusionQuestions and Short Problems453453454456466467467CHAPTER 18Earnings MultiplesPrice-Earnings RatioThe PEG RatioOther Variants on the PE RatioConclusionQuestions and Short Problems468468487497508508CHAPTER 19Book Value MultiplesPrice-to-Book EquityApplications of Price–Book Value RatiosUse in Investment StrategiesValue-to-Book RatiosTobin’s Q: Market Value/Replacement CostConclusionQuestions and Short Problems511511521530532537539539CHAPTER 20Revenue Multiples and Sector-Specific MultiplesRevenue MultiplesSector-Specific Multiples542542571
FM p.i-xvi.qxd12/8/113:31 PMPage xiiiContentsConclusionQuestions and Short Problemsxiii577577CHAPTER 21Valuing Financial Service FirmsCategories of Financial Service FirmsWhat is Unique about FinancialService Firms?General Framework for ValuationDiscounted Cash Flow ValuationAsset-Based ValuationRelative ValuationIssues in Valuing Financial Service FirmsConclusionQuestions and Short Problems581581582583584599599605607608CHAPTER 22Valuing Firms with Negative EarningsNegative Earnings: Consequences and CausesValuing Negative Earnings FirmsConclusionQuestions and Short Problems611611615639639CHAPTER 23Valuing Young or Start-Up FirmsInformation ConstraintsNew Paradigms or Old Principles:A Life Cycle PerspectiveVenture Capital ValuationGeneral Framework for AnalysisValue DriversEstimation NoiseImplications for InvestorsImplications for ManagersThe Expectations GameConclusionQuestions and Short R 24Valuing Private FirmsWhat Makes Private Firms Different?Estimating Valuation Inputs at Private FirmsValuation Motives and Value EstimatesValuing Venture Capital and PrivateEquity StakesConclusionQuestions and Short Problems667667668689693699699
FM p.i-xvi.qxd12/8/113:31 PMPage xivxivCONTENTSCHAPTER 25Aquisitions and TakeoversBackground on AcquisitionsEmpirical Evidence on the Value Effects of TakeoversSteps in an AcquisitionTakeover Valuation: Biases and Common ErrorsStructuring the AcquisitionAnalyzing Management and Leveraged BuyoutsConclusionQuestions and Short Problems702702705705724725730734735CHAPTER 26Valuing Real EstateReal versus Financial AssetsDiscounted Cash Flow ValuationComparable/Relative ValuationValuing Real Estate BusinessesConclusionQuestions and Short Problems739739740759761763763CHAPTER 27Valuing Other AssetsCash-Flow-Producing AssetsNon-Cash-Flow-Producing AssetsAssets with Option CharacteristicsConclusionQuestions and Short Problems766766776778778779CHAPTER 28The Option to Delay and Valuation ImplicationsThe Option to Delay a ProjectValuing a PatentNatural Resource OptionsOther ApplicationsConclusionQuestions and Short Problems781781789796802802803CHAPTER 29The Options to Expand and to Abandon: Valuation ImplicationsThe Option to ExpandWhen Are Expansion Options Valuable?Valuing a Firm with the Option to ExpandValue of Financial FlexibilityThe Option to AbandonReconciling Net Present Value and Real Option ValuationsConclusionQuestions and Short Problems805805812815817820823823824
FM p.i-xvi.qxd12/8/113:31 PMPage xvContentsxvCHAPTER 30Valuing Equity in Distressed FirmsEquity in Highly Levered Distressed FirmsImplications of Viewing Equity as an OptionEstimating the Value of Equity as an OptionConsequences for Decision MakingConclusionQuestions and Short Problems826826828831836839839CHAPTER 31Value Enhancement: A Discounted Cash Flow Valuation FrameworkValue Creating and Value-Neutral ActionsWays of Increasing ValueValue Enhancement ChainClosing Thoughts on Value EnhancementConclusionQuestions and Short Problems841841842859864865865CHAPTER 32Value Enhancement: Economic Value Added, Cash Flow Return on Investment,and Other ToolsEconomic Value AddedCash Flow Return on InvestmentA Postscript on Value EnhancementConclusionQuestions and Short Problems869870884890891891CHAPTER 33Probabilistic Approaches in Valuation: Scenario Analysis, Decision Trees,and SimulationsScenario AnalysisDecision TreesSimulationsAn Overall Assessment of Probabilistic Risk-Assessment ApproachesConclusionQuestions and Short Problems894894899908919921921CHAPTER 34Overview and ConclusionChoices in Valuation ModelsWhich Approach Should You Use?Choosing the Right Discounted Cash Flow ModelChoosing the Right Relative Valuation ModelWhen Should You Use the Option Pricing 9Index954
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Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the . valuation and ﬁnancial instrument analysis, as well as much more. . Introduction to Valuation 1 A Philosophical Basis for Valuation 1 Generalities about Valuation 2
Automated Valuation Models (AVMs) are computer-based systems which encompass all data concerning real estate in a particular area and are capable of producing more consistent valuation reports within a short time. Traditional valuation methods employed by valuers somewhat delay the valuation process. For
John Wiley & Sons, Inc. C1.jpg. EQUITY ASSET VALUATION. . 1 Introduction to Free Cash Flows 108 2 FCFF and FCFE Valuation Approaches 109 . 11 Valuation Indicators and Investment Management 231 12 Summary 233 Problems 236. CHAPTER 5 Residual Income Valuation 243. Learning Outcomes 243
pre-money valuation. Post- money valuation is a simple sum-mation of the pre money and the investment made. E.g.- If the pre money valuation of a startup is 5 million and an invest-ment of 2.5 million is made. The post-money valuation would be 7.5 million. Thus, the new investor will own 2.5/7.5 33.33% of the company.
Aswath Damodaran INVESTMENT VALUATION: SECOND EDITION Chapter 1: Introduction to Valuation 3 Chapter 2: Approaches to Valuation 16 Chapter 3: Understanding Financial Statements 37 Chapter 4: The Basics of Risk 81 Chapter 5: Option Pricing Theory and Models 121 Chapter 6: Market Efficiency: Theory and Models 152 .
Wiley & Sons, 2003. Print. Fishman, Jay E., Shannon P. Pratt, and James R. Hitchner, PPC’s Guide to Business Valuations. Business Valuation Review. American Society of Appraisers. Business Valuation Update. Business Valuation Resources. A .pdf copy of the ASA’s Business Valuation Standards can be downloaded from the following
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Annual Book of ASTM Standards, Vol 04.02. 3 For referenced ASTM standards, visit the ASTM website, www.astm.org, or contact ASTM Customer Service at firstname.lastname@example.org. For Annual Book of ASTM Standards volume information, refer to the standard’s Document Summary page on the ASTM website. *A Summary of Changes section appears at the end of this .