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1) Macroeconomic Policy and Corporate Valuation: The Big PictureCOLLAPSE
Macroeconomic policy mainly consists of monetary policy and fiscal policy. The Federal Reserve is in charge of the monetary policy. Fiscal policy is conducted by the executive and legislative branches and deals with managing the federal budget, i.e. government spending and taxation: bills are passed by the Congress and signed into law by the President, then implemented by the Treasury Department:
How do monetary and fiscal policies affect corporate or project valuation (Module 2, 5, & 6)?
Based on the DCF approach to valuation (see the pictures in the box at the beginning of chapter 7, 9, 10, & 11), monetary policy directly affects risk-free rate, and consequently the WACC, it also affects FCF; fiscal policy, especially taxation, affects free cash flow; tax rate also affects WACC, but this effect is secondary compared to either the effect of tax rate on FCF or the effect of monetary policy on WACC.
2) Cost of Capital Applications: WACC and Regulated IndustriesCOLLAPSE
Utility companies are natural monopolies, so regulators determine their cost of capital and set rates designed to permit them to earn their cost of capital (IRR = WACC), no more and no less.
3) Cost of Capital Application: WACC and DCF Valuation in CourtsCOLLAPSE
If you enter “WACC”, “Delaware” in Google search box, you will find that financial theories are actually adopted by the courts in deciding business disputes (many big companies are incorporated in Delaware, so business law suits settled by Delaware courts often serve examples for other states to follow). Examples:
Harvard Law School Forum on Corporate Governance and Financial Regulation
Appraisal Rights Litigation Blog: Valuation Basics: Determining a Discount Rate, or WACC
4) Executive Compensation, Stock Option, and Billionaire Tax: Elon MuskCOLLAPSE
It’s all started with a tweet from Elon Musk about “unrealized capital gains”:
Executive compensation is an important part of corporate governance. The compensation package usually consists of salary, cash bonus, and performance shares and/or stock options. Elon Musk doesn’t get any cash pay from Tesla: his compensation comes entirely from stock options, and it’s huge (due to the underlying stock price increases)! As the world’s richest person worth about $200b (almost two times richer than former No. 1 Warren Buffett https://www.forbes.com/real-time-billionaires/#102b6bcc3d78), Elon Musk’s wealth is mostly in Tesla stocks (founder’s shares and shares subsequently acquired through exercising the options): the capital gains are not realized as long as he holds those stocks, so are not taxed under the current tax law. (When he exercises his options, he does need to pay taxes at the ordinary income rate on the profit, which is the difference between the market price of Tesla stock at that time and the exercise price specified in the compensation document: which is mentioned in the previous article.)
How might the taxation of capital gains be improved?
How might the taxation of capital gains be improved?The Tax Reform Act of 1986, signed by President Ronald Reagan, raised tax rates on capital gains and lowered rates on ordinary income, but set…
5) StockTrak: Diversification and Sectors/IndustriesCOLLAPSE
In the second half of StockTrak simulation, you may try to construct a well-diversified equity portfolio by picking some stocks from each of the 11 sectors in the S&P 500 index. Another purpose of this exercise is to get familiar with the different sectors of the economy. The following link lists sectors and industries, and also provides a market weighting recommendation.
Sectors & Industries Overview – U.S. Sectors- FidelityResearch the performance of U.S. sectors & industries. Find the latest news, analysis reports and Fidelity insights on specific sectors or industries.
Example Comment: This is something I need to attempt. Trying to diversify is hard when you’re just buying and trading based on your own musings. For me, it was brands I have affinity with as well as local companies. My best results from the first half were from diversified ETFs from different sectors. This was my major take-away of the need to have a more balanced and strategic approach. Now we will see if I can actually execute on that.
6) Corporate GovernanceCOLLAPSE
Boeing Board Strips CEO of Chairman Title amid 737 Max Crisis
Corporate Governance, Shareholder Activism, Corporate (Diversification) Strategy, and Shareholder Value Maximization: AT&T
Intel Shareholders Reject Executive Pay:
Intel shareholders reject executive payThe vote won’t immediately affect the compensation of Intel’s executives.Kif LeswingCNBC
7) Financing & Organizational Structure: the Decision to Go PublicCOLLAPSE
There are advantages and disadvantages for going public. One of the disadvantages is increased time and resources spent on investors relations. Every public company has an investor relations department/unit, and their websites maintain an investor relations section. (Of course, the biggest advantage is to gain access to the public capital market so the firm can use external capital (debt, equity, or alternatives) to grow much faster.)
Walmart Corporate Website: https://corporate.walmart.com/
Click the “Investors” tab at the top: https://stock.walmart.com/investors/default.aspx
The front page covers such items: Annual Reports, SEC Filings, Corporate Governance, ESG and Diversity etc.
8) Financing & Organizational Structure: the Decision to Go PrivateCOLLAPSE
Private companies go public with the help of investment banks. Public companies may be taken private by private equity funds. Chapter 18 discusses some advantages/disadvantages of taking public company private from corporate perspective. Further, this thread introduces the tax advantage for private equity funds partners, an often debated issue in tax policies: carried interest and tax loophole. The below link provides a good yet concise summary on the issue:
A recent example of going private transaction: Dunkin’ Stock Soars after Chain Confirms Sale Talks with Inspire Brands
The take-private transaction was completed on Dec. 15, 2020, and now Dunkin’ Donuts LLC (not even in corporate form) is a subsidiary of Inspire Brands.
9) Alternative Sources of Funds: Lease FinancingCOLLAPSE
Many big manufacturer provide financing to the users of their equipments through leasing (or loans). Some may even have their own captive financial subsidiaries/affiliates to handle the issue: e.g. John Deere Financial
Ford Motor Credit Company
Finance or Lease Ford Cars & Trucks, Apply for Ford Credit & Pay Bill | Official Site of Ford CreditWelcome to the Official Site of Ford Credit. Learn about automotive financing & options when buying or leasing a Ford car, truck or SUV. Estimate monthly payments with the payment calculator, review statements & pay your bill within Account Manager.
(Commercial Finance and Consumer Finance)
10) Corporate Governance, Hostile Takeover, Poison Pill, Going Private, Valuation, and Politics: All in Elon Musk’s Twitter DramaCOLLAPSE
Elon Musk is offering $43 billion to take Twitter private (its market cap is about $34 billion at the close on 4/14 counting the stock price increase after the disclosure of Elon Musk’s more than 9% stake in the company), but the board may have different thoughts:
Twitter board adopts ‘poison pill’ after Musk’s $43 billion bid to buy companyThe board voted unanimously to adopt the plan.Lauren FeinerCNBC
11) Bond Rating and Access to Capital MarketsCOLLAPSE
one of the three biggest credit rating agencies Fitch Ratings cut Boeing’s credit rating to BBB from A- on 3/24/2020:
Bond ratings indicate default risk, so the discount rate/yield to maturity (= risk-free rate + risk premium) in the DCF-based bond valuation formula would increase due to the increase in default risk, and consequently the price of Boeing’s existing bonds should fall ceteris paribus.
In terms of access to capital markets, if Boeing is going to issue new bonds to raise capital, it has to offer higher interest rate/yield to maturity to attract investors, from the firm’s perspective, which means its financing cost would increase: that’s exactly the significance of bond ratings to a corporation.
12) Valuation and Expectation: Insider Trading for the Well-ConnectedCOLLAPSE
Regarding #1 in the previous post, clearly you will have an advantage if you possess insider information not available to the public yet: that’s unfair to other investors and that’s exactly why insider trading is illegal in the united states and most other countries with a developed capital market. Does the rule apply to members of Congress?
DOJ still investigating coronavirus stock sales by Sen. Burr, but drops probes of Loeffler, Inhofe, FeinsteinFederal prosecutors are still investigating stock sales by Sen. Richard Burr in advance of a coronavirus-fueled share price plunge, but are dropping investigations of sales connected to Sens. Kelly Loeffler, Jim Inhofe and Dianne Feinstein.Dan ManganCNBC72 members of Congress have violated a law designed to prevent insider trading and stop conflicts-of-interestInsider has identified numerous members of Congress who have violated the STOCK Act. Congress is now considering banning lawmakers from trading stocks.Business Insider
Due to the COVID-19 pandemic, the Dow Jones Industrial Average dropped more than 37% from its peak on 2/12/2020 (29551.42) to close at 18591.93 on 3/23/2020 in less than six weeks. Why are stock prices so volatile in terms of both the speed and magnitude of the adjustment, especially in a crisis scenario? Section 7-10 of the textbook discusses the explanation, and the COVID-19 crisis may help to further understand the phenomenon.
According to the DCF approach to valuation, the value/price of any financial asset is simply the present value of the cash flows the asset is expected to produce, discounted at a rate (investor’s required rate of return) commensurate with the riskiness of the cash flow streams. Apply the DCF approach to the pandemic situation:
1. The speed of adjustment: the stock market acts like an information processing center: as new information arrives, investors continually update their expectations on future cash flows and their assessments of risks. The expectations can change quickly, especially in a fluid situation such as the COVID-19 pandemic, which consequently causes stock prices to adjust quickly. (Here is the difference between accounting and finance: the numbers in the financial statements reflect past activities, while valuation is all about the expectations of the future. The connection? We need the past to predict the future, particularly under normal circumstances.)
2. The magnitude of adjustment: as demonstrated by the numerical simulation in section 7-10 of the textbook, even small changes in expected growth in future cash flows and the discount rate can cause large changes in stock prices. More specifically for the pandemic situation,
A. The numerator in the DCF formula: the future cash flows stocks are expected to produce would decrease compared to prior expectations, which cause the current stock prices to drop;
B. The denominator in the DCF formula: the discount rate/investors’ required rate of return = risk-free rate + risk premium. The risk-free rate is essentially controlled by the Federal Reserve, and we know the Fed had cut the federal funds rate to near zero, which should increase stock prices ceteris paribus (that’s exactly the Fed’s intention to stabilize the financial markets). However, the risk premium component certainly becomes larger during a time of great uncertainty, and this effect appeared to dominate the degree of Fed rate cut, which makes the overall discount rate for the risky equity investment to increase, and consequently causes the current stock prices to drop.
2: A+B: this double whammy, then +1, caused the stock prices to drop precipitously.
How about the current situation that the Fed is increasing interest rates to combat inflation and the world economy is facing strong headwinds?
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