Aswath Damodaran

CORPORATE  FINANCE  
WHAT  IS  IT?  
Aswath  Damodaran  
 What  is  corporate  finance?  
2

¨  Every  decision  that  a  business  makes  has  financial  implicaFons,  and  any  
decision  which  affects  the  finances  of  a  business  is  a  corporate  finance  
decision.    
¨  Defined  broadly,  everything  that  a  business  does  fits  under  the  rubric  of  
corporate  finance.  

Aswath Damodaran

2

 ObjecFves  
3

¨  To  give  you  the  capacity  to  understand  the  theory  

and  apply,  in  real  world  situaFons,  the  techniques  
that  have  been  developed  in  corporate  finance.    
¤  MoOo  for  class:  If  it  cannot  be  applied,  who  cares?.  

¨  To  give  you  the  big  picture  of  corporate  finance  so  
that  you  can  understand  how  things  fit  together.  
¤  MoOo  for  class:  You  can  forget  the  details,  but  don’t  miss  
the  storyline.  
¨  To  show  you  that  corporate  finance  is  fun.    
¤  MoOo  for  class:  Are  we  having  fun  yet?  

Aswath Damodaran

3

 The  TradiFonal  AccounFng  Balance  Sheet  
4

The Balance Sheet

Assets Liabilities
Current Short-term liabilities of the firm
Long Lived Real Assets Fixed Assets Liabilties

Short-lived Assets Current Assets Debt Debt obligations of firm

Investments in securities & Financial Investments Other

assets of other firms Liabilities Other long-term obligations

Assets which are not physical, Intangible Assets

like patents & trademarks Equity Equity investment in firm

Aswath Damodaran

4

 The  Financial  View  of  the  Firm  
5

Assets Liabilities
Existing Investments Fixed Claim on cash flows
Generate cashflows today Assets in Place Debt Little or No role in management
Includes long lived (fixed) and Fixed Maturity
short-lived(working Tax Deductible
capital) assets

Expected Value that will be Growth Assets Equity Residual Claim on cash flows
created by future investments Significant Role in management
Perpetual Lives

Aswath Damodaran

5

 First  Principles  &  The  Big  Picture  
6

Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
should reflect the The optimal The right kind
should relfect the cash you can to return cash to
riskiness of the mix of debt of debt
magnitude and return the owners will
investment and and equity matches the
the timing of the depends upon depend whether
the mix of debt maximizes firm tenor of your
cashflows as welll current & they prefer
and equity used value assets
as all side effects. potential dividends or
to fund it. investment buybacks
opportunities

Aswath Damodaran

6

 Theme  1:  Corporate  finance  is  “common  sense”  
7

¨  There  is  nothing  earth  shaOering  about  any  of  the  first  
principles  that  govern  corporate  finance.  AVer  all,  arguing  
that  taking  investments  that  make  9%  with  funds  that  cost  
10%  to  raise  seems  to  be  staFng  the  obvious  (the  investment  
decision),  as  is  noFng  that  it  is  beOer  to  find  a  funding  mix  
which  costs  10%    instead  of  11%  (the  financing  decision)  or  
posiFng  that  if  most  of  your  investment  opportuniFes  
generate  returns  less  than  your  cost  of  funding,  it  is  best  to  
return  the  cash  to  the  owners  of  the  business  and  shrink  the  
business.  
¨  Shrewd  business  people,  notwithstanding  their  lack  of  
exposure  to  corporate  finance  theory,  have  always  
recognized  these  fundamentals  and  put  them  into  pracFce.    
Aswath Damodaran

7

 Theme  2:  Corporate  finance  is  focused…  
8

¨  It  is  the  focus  on  maximizing  the  value  of  the  business  
that  gives  corporate  finance  its  focus.  As  a  result  of  this  
singular  objecFve,  we  can  
¤  Choose  the  “right”  investment  decision  rule  to  use,  given  a  
menu  of  such  rules.  
¤  Determine  the  “right”  mix  of  debt  and  equity  for  a  specific  
business  
¤  Examine  the  “right”  amount  of  cash  that  should  be  returned  to  
the  owners  of  a  business  and  the  “right”  amount  to  hold  back  
as  a  cash  balance.  
¨  This  cerFtude  does  come  at  a  cost.  To  the  extent  that  
you  accept  the  objecFve  of  maximizing  firm  value,  
everything  in  corporate  finance  makes  complete  sense.  
If  you  do  not,  nothing  will.    
Aswath Damodaran

8

 Theme  3:  The  focus  in  corporate  finance  
changes  across  the  life  cycle…  
9

Con Ed’s Financial Balance Sheet

Assets Liabilities
$ 15 billion $ 7 billion
Investments already Debt
made

$ 3 billion Investments yet to Equity $ 11 billion

be made

Linkedin's Financial Balance Sheet

Assets Liabilities

$0.25 billion Investments already Debt $ 0.00 billion

made

Investments yet to Equity

13.35 billion be made $ 13.6 billion

Aswath Damodaran

9

 Theme  4:  Corporate  finance  is  universal…  
10

¨  Every  business,  small  or  large,  public  or  private,  US  or  emerging  
market,  has  to  make  investment,  financing  and  dividend  decisions.  
¨  The  objecFve  in  corporate  finance  for  all  of  these  businesses  
remains  the  same:  maximizing  value.  
¨  While  the  constraints  and  challenges  that  firms  face  can  vary  
dramaFcally  across  firms,  the  first  principles  do  not  change.  
¤  A  publicly  traded  firm,  with  its  greater  access  to  capital  markets  and  more  
diversified  investor  base,  may  have  much  lower  costs  of  debt  and  equity  
than  a  private  business,  but  they  both  should  look  for  the  financing  mix  
that  minimizes  their  costs  of  capital.  
¤  A  firm  in  an  emerging  markets  may  face  greater  uncertainty,  when  
assessing  new  investments,  than  a  firm  in  a  developed  market,  but  both  
firms  should  invest  only  if  they  believe  they  can  generate  higher  returns  
on  their  investments  than  they  face  as  their  respecFve  (and  very  different)  
hurdle  rates.  

Aswath Damodaran

10

 Theme  5:  If  you  violate  first  principles,  you  will  
pay  a  price  (no  maOer  who  you  are..)  
11

¨  There  are  some  investors/analysts/managers  who  

convince  themselves  that  the  first  principles  don’t  
apply  to  them  because  of  their  superior  educaFon,  
standing  or  past  successes,  and  then  proceed  to  put  
into  place  strategies  or  schemes  that  violate  first  
principles.  
¨  Sooner  or  later,  these  strategies  will  blow  up  and  
create  huge  costs.  
¨  Almost  every  corporate  disaster  or  bubble  has  its  
origins  in  a  violaFon  of  first  principles.  

Aswath Damodaran

11

 Class  Structure  &  Chapter  references  
12

Session 2-4, 24-25

Maximize the value of the business (firm): Chapter 2 & 12

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
The optimal The right kind
should reflect the should relfect the cash you can to return cash to
mix of debt of debt
riskiness of the magnitude and return the owners will
and equity matches the
investment and the the timing of the depends upon depend whether
maximizes firm tenor of your
mix of debt and cashflows as welll current & they prefer
value assets
equity used to fund as all side effects. potential dividends or
Chapters 7,8 Chapter 9
it. Chapters 5,6 investment buybacks
Chapters 3,4 opportunities Chapter 11
Sessions 13-15 Sessions 16-19 Session 20 Chapter 10
Sessions 5-12 Sessions 22-23
Session 21

Aswath Damodaran

12

 And  it  will  be  applied…  
13

Disney Bookscape
Sector: Entertainment Sector: Book Retail
Incorporated in: US Incorporated in: US
Operations: Multinational Operations: New York
Size: Large market cap Other: Privately owned

Vale
Deutsche Bank
Sector: Mining/Metals
Sector: Bank/ Investment Bank
Incorporated in: Brazil
Incorporated in: Germany
Operations: Multinational Applied Corporate Finance Operations: Multinational
Size: Large market cap
Size: Large market cap
Other: Government stake
Other: Regulated

Tata Motors Baidu

Sector: Automotive Sector: Online Search
Incorporated in: India Incorporated in: Cayman Isl
Operations: Multinational Operations: China
Size: Mid market cap Size: Mid market cap
Other: Family Group Other: Shell company (VIE)

Aswath Damodaran

13