Applied Corporate Finance: A User's Manual
Summary
Damodaran wrote this as a corporate finance text organised around three decisions rather than around topics: the investment decision about where to put capital, the financing decision about the mix of debt and equity, and the dividend decision about returning cash to owners.
The organising principle is that every corporate finance decision should be judged against a single objective, which he takes as maximising firm value, and he is explicit about the assumptions that requires and about what happens when they fail. He is unusually direct about the agency problems: managers who do not act for shareholders, shareholders who cannot control managers, bondholders who lose to shareholders, information that is not accurately conveyed to markets, and social costs that the firm does not bear.
The investment section covers hurdle rates, the estimation of cost of equity and cost of capital including the problems in estimating beta, project evaluation using cash flows rather than earnings, and the treatment of side effects and options embedded in projects. The financing section covers the trade-off between the tax benefit of debt and the costs of financial distress, the determination of an optimal financing mix, and the matching of financing characteristics to asset characteristics. The dividend section covers when a firm should return cash, the choice between dividends and repurchases, and how to assess whether a firm's payout policy is appropriate given its investment opportunities.
The distinguishing feature is that Damodaran applies every framework to real companies throughout, running the same set of firms through each stage so the reader sees the full analysis on actual data. He also maintains public datasets and spreadsheets.
The book is a textbook and does not argue an original position. Its treatment of cost of capital estimation is more honest than most about how uncertain the inputs are. Editions differ and the data examples date quickly.
Key takeaways 7
- Every corporate finance decision reduces to investing, financing or returning cash, and each should be judged against firm value.
- Financing mix should match the characteristics of the assets being financed, particularly their duration and currency.
- The tax benefit of debt is traded against the expected costs of financial distress, and the optimum differs by business.
- Project evaluation must use incremental cash flows rather than accounting earnings, including side effects on other parts of the firm.
- Cost of capital estimates are far less precise than the decimal places used to express them suggest.
- A firm should return cash when it has no investments earning above its cost of capital, regardless of its growth ambitions.
- Agency conflicts between managers, shareholders and bondholders mean the value-maximising decision is frequently not the one taken.
Who should read it
Founders, executives and investors who want corporate finance organised around the decisions they actually face, with worked examples on real companies.
About Aswath Damodaran
Kerschner Family Chair Professor of Finance, NYU Stern School of Business
His valuation textbooks and freely published datasets are the default reference used across academia, banking and investing.
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