invest ret_invest analysis

8/17/2019 Invest Ret_Invest Analysis

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The Investment DecisionInvest in assets that earn a

return greater than theminimum acceptable hurdle

rate

The Financing DecisionFind the right kind of debtfor your rm and the rightmix of debt and equity to

fund your operations

The Dividend DecisionIf you cannot nd investments

that make your minimumacceptable rate, return the cash

to owners of your business

The hurdle rateshould reect theriskiness of theinvestment andthe mix of debt

and equity usedto fund it.

The return shouldreect the

magnitude andthe timing of the

cashows as welllas all side effects.

The optimalmix of debtand equity

maximizes rm

value

The right kindof debt

matches thetenor of your

assets

How muchcash you can

returndepends upon

current &potential

investmentopportunities

How you chooseto return cash tothe owners will

depend onwhether they

prefer dividendsor buybacks

Maximize the value of the business (rm)


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12.5% of bookvalue at end ofprior year($3,000)


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(a) Based upon book capital at the start of each year (b) Based upon average book capital over the year


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To get from income to cash ow, we

I. added back all non-cash charges such as depreciation. Tax

benets:

II. subtracted out the capital expenditures

III. subtracted out the change in non-cash working capital

Aswath Damodaran

0 1 2 3 4 5 6 7 8 9 10

After-tax Operating Income Wdhi Wdom Wdfk dmn diei diko dioo dhfi dkje dkij+ Depreciation & Amortization de dfe dkif dkmo dkkk dhli dhml dhmk dhmk dhmm dhmn- Capital Expenditures diLfee djLeee djLjnn dlfi dilm difn dinf dhjk dhhe dhkl dhfe

- Change in non-cash Work Capital $0 $63 $25 $38 $31 $16 $17 $19 $21 $5

Cashow to rm ($2,500) ($982) ($921) ($361) $198 $285 $314 $332 $367 $407 $434


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$ 500 million hasalready been spent & $50 million indepreciation will existanyway

2/3rd of allocated G&A is xed.

Add back this amount (1-t) Tax rate = 36.1%

Aswath Damodaran


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0 1 2 3 4 5 6 7 8 9 10

Revenues $0 $1,250 $1,750 $2,500 $3,125 $3,438 $3,781 $4,159 $4,575 $4,667Direct Expenses $0 $788 $1,103 $1,575 $1,969 $2,166 $2,382 $2,620 $2,882 $2,940Incremental Depreciation $0 $375 $419 $394 $322 $317 $314 $314 $316 $318Incremental G&A $0 $63 $88 $125 $156 $172 $189 $208 $229 $233Incremental Operating Income $0 $25 $141 $406 $678 $783 $896 $1,017 $1,148 $1,175- Taxes $0 $9 $51 $147 $245 $283 $323 $367 $415 $424

Incremental after-tax Operating income $0 $16 $90 $260 $433 $500 $572 $650 $734 $751+ Incremental Depreciation $0 $375 $419 $394 $322 $317 $314 $314 $316 $318- Capital Expenditures $2,000 $1,000 $1,188 $752 $276 $258 $285 $314 $330 $347 $350- Change in non-cash Working Capital $0 $63 $25 $38 $31 $16 $17 $19 $21 $5

Cashow to rm ($2,000) ($1,000) ($859) ($267) $340 $466 $516 $555 $615 $681 $715

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Aswath Damodaran


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Aswath Damodaran

-$3,000.00

-$2,000.00

-$1,000.00

$0.00

$1,000.00

$2,000.00

$3,000.00

$4,000.00

$5,000.00

8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24% 25% 26% 27% 28% 29% 30%

N P V

Discount Rate

Internal Rate of Return=12.60%


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Aswath Damodaran


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(D+ s &d lLlkf]iMhfs d hLiom !BGGB5:(D+ BC 8ZA?G 95 (D+ B: K5GG?= 98=7C

Discount at $R cost of capital

= (1.0846) (1.09/1.02) – 1 = 15.91%Expected Exchange Rate

t

= Exchange Rate today * (1.09/1.02) t

Aswath Damodaran


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48

%:E8=9?B:9; B: D=5^8E9 #:?G;CBC- \4?9 E?: 68K5_

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48

! Y?C8K 5: 5A= 8NF8E98K E?C4 I56C ?:K 948 8CJ7?98K E5C9 5< E?FB9?GL 948F=5F5C8K 94878 F?=V G55VC GBV8 ? H8=; @55K B:H8C978:9


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49

0:8 CB7FGBCJE C5GAJ5:- $88 456 ZABEVG;;5A E?: @89 ;5A= 75:8; O?EVa

! '< ;5A= OB@@8C9


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50

# CGB@49G; 75=8 C5F4BCJE?98K ?FF=5?E4-$8:CBJHB9; #:?G;CBC q \4?9WB< xA8CJ5:Ca! ,48 (D+L '&& ?:K ?EE5A:J:@ =89A=:C


52/77


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52

,48 P:?G C98F AF- ':E5=F5=?98 F=5O?OBGBCJE8CJ7?98CMM &?948= 94?: 8NF8E98K H?GA8CM

Actual Revenues as % of Forecasted Revenues (Base case = 100%)

Operating Expenses at Parks as % of Revenues (Base Case = 60%)

Country Risk Premium (Base Case = 3%(Brazil))

Aswath Damodaran


54/77

53

,48 =8CAGJ:@ CB7AG?J5:a

Average = $3.40 billion Median = $3.28 billion

NPV ranges from -$1 billion to +$8.5 billion. NPV is negative 12% of thetime.

Aswath Damodaran


55/77

54

35A ?=8 948 K8EBCB5: 7?V8=a

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54

! #CCA78 94?9 ;5A ?=8 948 F8=C5: ?9 `BC:8; 645 BC @BH8:948 =8CAG9C 5< 948 CB7AG?J5:M ,48 ?H8=?@8 ?:K 78KB?:(D+ ?=8 EG5C8 95 ;5A= O?C8 E?C8 H?GA8C 5< dhMio OBGGB5:M.568H8=L 948=8 BC ? jep F=5O?OBGB9; 94?9 948 F=5^8E9

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56/77

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57/77

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58/77

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59/77

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60/77

59

(89 ':E578- +?G8 '=5: 0=8 !B:8

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59

1 2 3 4 5 6 7 8 9 10

Production (millions of tons) 4.00 6.00 8.00 8.00 8.00 8.00 8.00 8.00 8.00 8.00

* Price per ton 102 104.04 106.12 108.24 110.41 112.62 114.87 117.17 119.51 121.9

= Revenues (millions US$) $408.00 $624.24 $848.97 $865.95 $883.26 $900.93 $918.95 $937.33 $956.07 $975.20

- Variable Costs $180.00 $275.40 $374.54 $382.03 $389.68 $397.47 $405.42 $413.53 $421.80 $430.23

- Fixed Costs $125.00 $127.50 $130.05 $132.65 $135.30 $138.01 $140.77 $143.59 $146.46 $149.39- Depreciation $200.00 $160.00 $128.00 $102.40 $81.92 $65.54 $65.54 $65.54 $65.54 $65.54EBIT -$97.00 $61.34 $216.37 $248.86 $276.37 $299.91 $307.22 $314.68 $322.28 $330.04- Interest Expenses $20.25 $18.57 $16.82 $14.99 $13.10 $11.13 $9.07 $6.94 $4.72 $2.41

Taxable Income -$117.25 $42.77 $199.56 $233.87 $263.27 $288.79 $298.15 $307.74 $317.57 $327.63- Taxes ($39.87) $14.54 $67.85 $79.51 $89.51 $98.19 $101.37 $104.63 $107.97 $111.40

= Net Income (millions US$) -$77.39 $28.23 $131.71 $154.35 $173.76 $190.60 $196.78 $203.11 $209.59 $216.24 Book Value and Depreciation

Beg. Book Value $1,250.00 $1,050.00 $890.00 $762.00 $659.60 $577.68 $512.14 $446.61 $381.07 $315.54- Depreciation $200.00 $160.00 $128.00 $102.40 $81.92 $65.54 $65.54 $65.54 $65.54 $65.54+ Capital Exp. $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00

End Book Value $1,050.00 $890.00 $762.00 $659.60 $577.68 $512.14 $446.61 $381.07 $315.54 $250.00- Debt Outstanding $458.45 $415.22 $370.24 $323.43 $274.73 $224.06 $171.34 $116.48 $59.39 $0.00

End Book Value of Equity $591.55 $474.78 $391.76 $336.17 $302.95 $288.08 $275.27 $264.60 $256.14 $250.00


61/77

60

# &0" #:?G;CBC

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60

Year Net Income Beg. BV:Assets Depreciation Capital

Expense Ending BV:

Assets BV of

WorkingCapital

Debt BV: Equity Average BV:Equity ROE

0 $0.00 $0.00 $1,250.00 $1,250.00 $81.60 $500.00 $831.601 ($77.39) $1,250.00 $200.00 $0.00 $1,050.00 $124.85 $458.45 $716.40 $774.00 -10.00% 2 $28.23 $1,050.00 $160.00 $0.00 $890.00 $169.79 $415.22 $644.57 $680.49 4.15% 3 $131.71 $890.00 $128.00 $0.00 $762.00 $173.19 $370.24 $564.95 $604.76 21.78% 4 $154.35 $762.00 $102.40 $0.00 $659.60 $176.65 $323.43 $512.82 $538.89 28.64% 5 $173.76 $659.60 $81.92 $0.00 $577.68 $180.19 $274.73 $483.13 $497.98 34.89% 6 $190.60 $577.68 $65.54 $0.00 $512.14 $183.79 $224.06 $471.87 $477.50 39.92% 7 $196.78 $512.14 $65.54 $0.00 $446.61 $187.47 $171.34 $462.74 $467.31 42.11% 8 $203.11 $446.61 $65.54 $0.00 $381.07 $191.21 $116.48 $455.81 $459.27 44.22% 9 $209.59 $381.07 $65.54 $0.00 $315.54 $195.04 $59.39 $451.18 $453.50 46.22%

10 $216.24 $315.54 $65.54 $0.00 $250.00 $0.00 $0.00 $250.00 $350.59 61.68% Average ROE over the ten-year period = 31.36%

US $ ROE of 31.36% is greater thanVale Iron Ore US$ Cost of Equity of 11.13%


62/77

61

1=57 D=5^8E9 &0" 95 1B=7 &0"

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! ,4BC 78?CA=8 BC F?=JEAG?=G; AC8


63/77

62

#: ':E=878:9?G /1 #:?G;CBC

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62

0 1 2 3 4 5 6 7 8 9 10 Net Income ($77.39) $28.23 $131.71 $154.35 $173.76 $190.60 $196.78 $203.11 $209.59 $216.24

+ Depreciation & Amortization $200.00 $160.00 $128.00 $102.40 $81.92 $65.54 $65.54 $65.54 $65.54 $65.54- Capital Expenditures $750.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00- Change in Working Capital $81.60 $43.25 $44.95 $3.40 $3.46 $3.53 $3.60 $3.68 $3.75 $3.82 ($195.04) - Principal Repayments $41.55 $43.23 $44.98 $46.80 $48.70 $50.67 $52.72 $54.86 $57.08 $59.39+ Salvage Value of mine $250.00

Cashow to Equity ($831.60) $37.82 $100.05 $211.33 $206.48 $203.44 $201.86 $205.91 $210.04 $214.22 $667.42


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63

#: "ZAB9; (D+

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63

Discounted at US$ cost ofequity of 11.13% for Vale’siron ore business


65/77

64

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66/77

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67/77

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70/77

Will the benets persist if investors hedgethe risk instead of the rm?

NoYes

NoYes

Can marginal investorshedge this risk cheaper

than the rm can?

NoYes

Is there a signicant benet interms of higher expected cashows or a lower discount rate?

NoYes

Is there a signicant benet interms of higher cash ows ora lower discount rate?

What is the cost to the rm of hedging this risk?

Negligible High

Do not hedge this risk.The benets are smallrelative to costs

Hedge this risk. Thebenets to the rm willexceed the costs


Let the risk passthrough to investorsand let them hedgethe risk.


Indifferent tohedging risk

Cash ow benets - Tax benets

- Better project choices

Discount rate benets - Hedge "macro" risks (cost of equity)- Reduce default risk (cost of debt or debt ratio)

Survival benets (truncation risk)- Protect against catastrophic risk- Reduce default risk

Value Trade Off

Earnings Multiple - Effect on multiple

Earnings - Level- Volatility

X

Pricing Trade

!"#$%& ($)*+$,$-69


71/77

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72/77


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74/77

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76

The Investment DecisionInvest in assets that earn a

return greater than theminimum acceptable hurdle

rate

The Financing DecisionFind the right kind of debtfor your rm and the rightmix of debt and equity to

fund your operations

The Dividend DecisionIf you cannot nd investments

that make your minimumacceptable rate, return the cash

to owners of your business

The hurdle rateshould reect theriskiness of theinvestment andthe mix of debt

and equity used

to fund it.

The return shouldreect the

magnitude andthe timing of the

cashows as welllas all side effects.

The optimalmix of debtand equity

maximizes rmvalue

The right kindof debt

matches thetenor of your

assets

How muchcash you can

returndepends upon

current &potential

investmentopportunities

How you chooseto return cash tothe owners will

depend onwhether they

prefer dividendsor buybacks

Maximize the value of the business (rm)

invest ret_invest analysis

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