Uday Damodaran

XLRI Jamshedpur

Session 4:
Financing And Valuation: Where Does
Value Come From? Part I

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Financing and Valuation

Valuation and Financing

Does valuation get unhinged from fundamentals and why?
(Dot-com Boom and Bust, Bladelogic, Bloomberg article
on Unicorns .Chirags Doubt)

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Your Business Plan..

What is your major source of value/ competitive advantage?

Your value driver?
Reason I didnt want to postpone submission

By the way, any

interesting start up
financing stories?

And, interested in
FB chat with Debu
Mishra of Hay
Group and
others?

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Your Business Plan..

What is your major source of value/ competitive advantage?

Your value driver?
Looking back at BFA, COMA, FMI what creates business
value? What are the fundamental value drivers?

Bladelogic, Marvin
How do we arrive at
a pre/post money
valuation and
therefore the value
per share?
BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Theorizing, Abstracting..

Let us start off by building up a theory of value

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Starting Point?

What is a good starting point to start describing a business?

What characteristic of a business do we normally use what
would you look at first?
And, why?

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Tata Steel, L&T: 2004-05

Tata Steel
14646 crores

Income

L&T
13788.32 crores

Your Business?
Revenues Justified?
Market Feasibility
versus Commercial
Feasibility

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

The Firm

Sales

Not enough (remember the

dot-com valuations?) What
next?

BM 15-17: FM II
Session 4

Uday Damodaran
XLRI Jamshedpur

Tata Steel, L&T: 2004-05

Income
Expenditure
PAT

Tata Steel
14646 crores
9259.17 crores
3474.16 crores

BM 15-17: FM II
Session 4

L&T
13788.32 crores
12522.82 crores
983.85 crores

Uday Damodaran
XLRI Jamshedpur

The Firm

Sales

Earnings

Business Value Driver!

How do we compute it?
What do we call it?

BM 15-17: FM II
Session 4

Your biz: did

you give
thought to it?

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Uday Damodaran
XLRI Jamshedpur

Business Value Drivers!

1. Net Profit Margin: Invoicing Power!

What does it depend on? What is it a function of?
Intensity of competition in the sector, customer power,
supplier power, threat of entry, threat of substitutes

Dot-com case,
Capital Market
Myopia article

BM 15-17: FM II
Session 4

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Uday Damodaran
XLRI Jamshedpur

Business Value Drivers!

1. Net Profit Margin: Invoicing Power!

What does it depend on? What is it a function of?
Intensity of competition in the sector, customer power,
supplier power, threat of entry, threat of substitutes

Your Business?
How can you
justify your
margins?
Kumar Ankit and
Fruit Juice Parlors

BM 15-17: FM II
Session 4

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Uday Damodaran
XLRI Jamshedpur

The Firm

Sales

Earnings

Business Value Driver!

NPM

BM 15-17: FM II
Session 4

And now,
what next?

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Uday Damodaran
XLRI Jamshedpur

Tata Steel, L&T: 2004-05

Income
Expenditure
PAT

Tata Steel
14646 crores
9259.17 crores
3474.16 crores

L&T
13788.32 crores
12522.82 crores
983.85 crores

Dividends

821.37 crores

406.62 crores

BM 15-17: FM II
Session 4

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Uday Damodaran
XLRI Jamshedpur

The Firm

Sales

Earnings

Dividend

Business Value Driver!

How do we compute? What
do we call it?

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Session 4

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Uday Damodaran
XLRI Jamshedpur

Business Value Drivers!

2. The Retention Ratio: Growth Driver!

What does it depend on? What is it a function of?
Investment Opportunities, Capital Intensity

Cash Flows!

BM 15-17: FM II
Session 4

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Uday Damodaran
XLRI Jamshedpur

The Firm

Sales

Earnings

Dividend

Business Value Driver!

Retention Ratio

BM 15-17: FM II
Session 4

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Uday Damodaran
XLRI Jamshedpur

Tata Steel, L&T: 2004-05

Income
Expenditure
PAT

Tata Steel
14646 crores
9259.17 crores
3474.16 crores

L&T
13788.32 crores
12522.82 crores
983.85 crores

Dividends

821.37 crores

406.62 crores

Now, which firm is better? Why?

BM 15-17: FM II
Session 4

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Uday Damodaran
XLRI Jamshedpur

Tata Steel, L&T: 2004-05

Income
Expenditure
PAT
Dividends

Tata Steel
14646 crores
9259.17 crores
3474.16 crores
821.37 crores

L&T
13788.32 crores
12522.82 crores
983.85 crores
406.62 crores

Shareholder Funds
Total Funds Employed

7059.92 crores
12143.3 crores

3369.13 crores
5446.67 crores

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Uday Damodaran
XLRI Jamshedpur

Investor Value: What Constitutes It?

Returns!
Not Revenues, Not Profits

Your Business?
Did you talk about
returns? Did you
look at it?

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Uday Damodaran
XLRI Jamshedpur

The Firm

Equity

Debt

Assets

Sales

Earnings

Dividend

Business Value Driver!

How do we compute? What
do we call it?

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Session 4

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Uday Damodaran
XLRI Jamshedpur

Business Value Drivers!

3. The Asset Turnover Ratio: Asset Productivity!

What does it depend on? What is it a function of?
Nature of Industry, Efficiency of Operations

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Session 4

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Uday Damodaran
XLRI Jamshedpur

The Firm

Equity

Debt

Assets

Sales

Earnings

Dividend

Business Value Driver!

Asset Turnover Ratio

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Session 4

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Uday Damodaran
XLRI Jamshedpur

Efficiency

Return Ratios measure the efficiency of this engine; they

measure the efficiency of utilization of investor funds
What are these return ratios?
ROE, ROCE

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Uday Damodaran
XLRI Jamshedpur

Returns, an important marker

In our quest for value, in our search for a theory of value,

returns are important markers
But then how high should returns be, at the least
ROE? ROCE?

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Uday Damodaran
XLRI Jamshedpur

Hurdle Rates

At the minimum:
ROE should be > ke, the equity investors desired rate of
return or the the cost of equity
And ROCE should be > ko, the desired rate of return of all
long term capital providers, or the the cost of capital, or
the weighted average cost of capital (WACC)

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Uday Damodaran
XLRI Jamshedpur

Value Drivers

And what are the drivers of ROE? What are the value drivers?
Can we decompose it?

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Uday Damodaran
XLRI Jamshedpur

Du Pont Ratio Analysis

ROE = PAT/S Funds

=PAT/S * S/Total Assets * Total Assets/S Funds

Net Profit Margin

Asset Turnover Ratio

Another variation of
Debt/Equity

X=a*b*c

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