Preface xv Chapter 1 Introduction to Valuation 1 A Philosophical Basis for Valuation 1 Pricing versus Valuation 2 The Bermuda Triangle of Valuation 2 Market Efficiency 6 The Role of Valuation 7 Conclusion 10 Questions and Short Problems 10 Chapter 2 Approaches to Valuation 13 Intrinsic Valuation 13 Pricing or Relative Valuation 21 Contingent Claim Valuation 25 Conclusion 27 Questions and Short Problems 27 Chapter 3 Understanding Financial Statements 29 The Basic Accounting Statements 29 Asset Measurement and Valuation 31 Measuring Financing mix 38 Measuring Earnings and Profitability 44 Measuring Risk 50 Other Issues in Analyzing Financial Statements 56 Conclusion 57 Questions and Short Problems 58 Chapter 4 The Basics of Risk 61 What Is Risk? 61 Equity Risk and Expected Return 62 Alternative Models for Equity Risk 74 A Comparative Analysis of Equity Risk Models 80 Models of Default Risk 81 Conclusion 85 Questions and Short Problems 85 Chapter 5 Option Pricing Theory and Models 91 Basics of Option Pricing 91 Option Pricing Models 94 Extensions of Option Pricing 109 Conclusion 110 Questions and Short Problems 111 Chapter 6 Market Efficiency—Definition, Tests, and Evidence 113 Market Efficiency and Investment Valuation 113 What Is an Efficient Market? 114 Testing Market Efficiency 118 Cardinal Sins in Testing Market Efficiency 123 Some Lesser Sins That Can Be a Problem 124 Evidence on Market Efficiency 125 Time Series Properties of Price Changes 125 Market Reaction to Information Events 133 Market Anomalies 137 Evidence on Insiders and Investment Professionals 146 Conclusion 152 Questions and Short Problems 153 Chapter 7 Riskless Rates and Risk Premiums 157 The Risk-Free Rate 157 Equity Risk Premium 162 Default Spreads on Bonds 182 Conclusion 185 Questions and Short Problems 186 Chapter 8 Estimating Risk Parameters and Costs of Financing 189 The Cost of Equity and Capital 189 Cost of Equity 190 From Cost of Equity to Cost of Capital 221 Best Practices at Firms 233 Conclusion 234 Questions and Short Problems 234 Chapter 9 Measuring Earnings 241 The Lead-in: From Accounting Data to Financial Information 241 Adjusting Earnings 243 Measuring Earnings Power: Clean Up and Time Differences 256 Conclusion 266 Questions and Short Problems 267 Chapter 10 From Earnings To Cash Flows 269 The Tax Effect 269 Reinvestment Needs 279 Conclusion 291 Questions and Short Problems 292 Chapter 11 Estimating Growth 295 The Importance of Growth 295 Historical Growth 296 Outsourcing Growth 307 Fundamental Determinants of Growth 311 Top-Down Growth: From Revenue Growth to Free Cash Flows 324 Qualitative Aspects of Growth 336 Conclusion 337 Questions and Short Problems 338 Chapter 12 Closure in Valuation: Estimating Terminal Value 341 Closure in Valuation 341 The Survival Issue 357 Closing Thoughts on Terminal Value 360 Conclusion 361 Questions and Short Problems 361 Chapter 13 Narrative and Numbers – Story to Value 363 Valuation as a Bridge 363 The Importance of Storytelling 364 The Dangers in Storytelling 366 From Story to Numbers: The Process 368 Narrative and Numbers Across the Life Cycle 380 Story Resets, Changes, and Breaks 382 Conclusion 384 Questions and Short Problems 385 Chapter 14 Equity Intrinsic Value Models 387 Equity Valuation 387 The Dividend Discount Model 388 The Augmented Dividend Discount Model 404 Potential Dividend or FCFE Models 408 FCFE Valuation Versus Dividend Discount Model Valuation 428 Conclusion 430 Questions and Short Problems 431 Chapter 15 Firm Valuation: Cost of Capital and Adjusted Present Value Approaches 437 Free Cash Flow to the Firm 437 Firm Valuation: The Cost of Capital Approach 440 Firm Valuation: The Adjusted Present Value Approach 453 Firm Valuation: Sum of the Parts 458 Effect of Leverage on Firm Value 468 Conclusion 477 Questions and Short Problems 477 Chapter 16 Estimating Equity Value per Share 481 Value of Nonoperating Assets 481 Firm Value and Equity Value 500 Stock-based Compensation 501 Value Per Share When Voting Rights Vary 510 Conclusion 512 Questions and Short Problems 512 Chapter 17 Fundamental Principles of Relative Valuation 515 Use of Relative Valuation 515 Standardized Values and Multiples 516 Four Basic Steps to Using Multiples 518 Reconciling Relative and Discounted Cash Flow Valuations 530 Conclusion 530 Questions and Short Problems 531 Chapter 18 Earnings Multiples 533 Price-Earnings Ratio 533 The PEG Ratio 555 Other Variants on the PE Ratio 565 Enterprise Value to EBITDA Multiple 569 Conclusion 577 Questions and Short Problems 578 Chapter 19 Book Value Multiples 581 Price-to-Book Equity 581 Value-to-Book Ratios 603 Tobin’S Q: Market Value/Replacement Cost 608 Conclusion 610 Questions and Short Problems 610 Chapter 20 Revenue Multiples and Sector-Specific Multiples 613 Revenue Multiples 613 Sector-Specific Multiples 644 Conclusion 653 Questions and Short Problems 653 Chapter 21 Valuing Financial Service Firms 657 Categories of Financial Service Firms 657 What Is Unique About Financial Service Firms? 658 General Framework for Valuation 659 Discounted Cash Flow Valuation 660 Relative Valuation 675 The Crisis Effect 680 Nonbank Financial Service Firms 688 Conclusion 691 Questions and Short Problems 692 Chapter 22 Valuing Money-Losing Firms 695 Negative Earnings: Consequences and Causes 695 Valuing Money-Losing Firms 700 Conclusion 728 Questions and Short Problems 728 Chapter 23 Valuing Young or Start-Up Firms 733 Information Constraints 733 General Framework for Analysis 738 Value Drivers 750 Estimation Noise 751 The Expectations Game 753 Conclusion 755 Questions and Short Problems 756 Chapter 24 Valuing Private Firms 757 What Makes Private Firms Different? 757 Estimating Valuation Inputs at Private Firms 758 Valuation Motives and Value Estimates 781 Valuing Venture Capital and Private Equity Stakes 786 Pricing Private Businesses 789 Conclusion 793 Questions and Short Problems 793 Chapter 25 Acquisitions and Takeovers 795 Background on Acquisitions 795 Steps in an Acquisition 799 Takeover Valuation: Biases and Common Errors 818 Structuring the Acquisition 820 Improving the Odds 825 Analyzing Management and Leveraged Buyouts 828 Conclusion 832 Questions and Short Problems 833 Chapter 26 Valuing Real Estate 837 Real Versus Financial Assets 837 Real Estate: The Underfollowed Investment Class 838 Intrinsic Valuation of Real Estate 843 Comparable/Relative Valuation 860 Valuing Real Estate Businesses 862 Conclusion 864 Questions and Short Problems 865 Chapter 27 Valuing Other Assets 867 Investment classification 867 Cash-Flow–Producing Assets 869 Collectibles 883 Trophy Assets 897 Conclusion 904 Questions and Short Problems 904 Chapter 28 The Option to Delay and Valuation Implications 907 Real Options: Promise and Pitfalls 907 The Option to Delay a Project 910 Valuing a Patent 918 Natural Resource Options 925 Other Applications 931 Conclusion 932 Questions and Short Problems 932 Chapter 29 The Options to Expand and to Abandon: Valuation Implications 935 The Option to Expand 935 When Are Expansion Options Valuable? 942 Valuing a Firm with the Option to Expand 945 Valuing the Optionality in Users and Data 947 Value of Financial Flexibility 950 The Option to Abandon 953 Reconciling Net Present Value and Real Option Valuations 956 Conclusion 956 Questions and Short Problems 957 Chapter 30 Valuing Equity in Distressed Firms 959 Equity in Highly Levered Distressed Firms 959 Optionality in Valuation: A Corporate Life Cycle Perspective 961 Implications of Viewing Equity as an Option 963 Estimating the Value of Equity as an Option 966 Distressed Equity as an Option: Consequences for Decision-Making 972 Conclusion 975 Questions and Short Problems 975 Chapter 31 Value Enhancement: A Discounted Cash Flow Valuation Framework 977 Value-Creating and Value-Neutral Actions 977 Ways of Increasing Value 978 Value Enhancement Chain 996 Closing Thoughts on Value Enhancement 1001 Conclusion 1002 Questions and Short Problems 1003 Chapter 32 Value Enhancement: Economic Value Added, Cash Flow Return on Investment, and Other Tools 1007 Economic Value Added 1008 Cash Flow Return on Investment 1023 A Postscript on Value Enhancement 1028 Conclusion 1029 Questions and Short Problems 1030 Chapter 33 Probabilistic Approaches in Valuation: Scenario Analysis, Decision Trees, and Simulations 1033 Scenario Analysis 1033 Decision Trees 1038 Simulations 1047 An Overall Assessment of Probabilistic Risk-Assessment Approaches 1058 Conclusion 1060 Questions and Short Problems 1061 Chapter 34 Overview and Conclusion 1065 Choices in Valuation Models 1065 Which Approach Should You Use? 1066 Choosing the Right Intrinsic Valuation Model 1069 Choosing the Right Pricing Model 1074 When Should You Use the Option Pricing Models? 1076 Conclusion 1078 References 1079 Index 1091

AT THE HEART OF EVERY SMART INVESTMENT DECISION IS A THOROUGH AND ACCURATE VALUATION Valuation is the art and science of pricing assets of all kinds, so that you can correctly make buy, sell, or hold decisions. In modern markets, valuation is extremely complex, accounting for many kinds of uncertainty, as well as novel asset structures that bring nuance to the pricing process. This revised Fourth University Edition of Investment Valuation provides expert instruction on how to value almost any type of financial or real asset, including options, start-up firms, cryptocurrencies and other digital assets, real estate, private companies, and more. Written by Aswath Damodaran, an acclaimed professor at New York University’s Stern Business School and a noted valuation authority, this reliable resource uses real-world examples and the most current valuation tools to guide you through the theory and application of various valuation models. Along the way, it covers how to: Apply valuation lessons learned from recent events in the global marketplaceUse real option theory and option pricing models in valuing business and equityPrice unconventional assets, financial service firms, start-ups, emerging market companies, and many other traditionally valued assetsUnderstand probabilistic approaches in valuation, such as scenario analysis, decision trees, and simulationsChoose the right model for any given asset valuation scenario A comprehensive guide for those who need to know more about the tricky business of valuation, the Fourth University Edition of Investment Valuation—which includes an expanded set of online resources for instructors and students—presents essential information about this critical part of the investment process.