Marauders, Napkin Entrepreneurs and IPOs: The Top 5 Blogs of 2011

As 2011 comes to a close, I want to celebrate the blogs that caught my attention, made me think, and taught me a lesson or two. So without further adieu, I present my favorite 5 blogs of 2011.

5. A behemoth competitor entered your space? Here is a textbook response.
The Sincerest Form of Flattery, by Matt Brezina, CEO of Sincerely

When Apple launched Cards, an app for sending physical cards, my heart sank. My close friend of more than 10 years had just launched Sincerely and its flagship product Postagram. Apple entered the exact market my friend Matt was creating.

Before turning in for the night, I checked Twitter one more time and saw that Matt posted this blog. I read it. By the end of the post, I realized Sincerely wasn’t scared of the competition; on the contrary, it was energized by it.

So, if you’re running a company and a bigger competitor enters your space, use the opportunity to change the conversation. This post does three things particularly well.

  1. Historical context – Apple made a similar move with iPhoto and has had little success. Will this time be different?
  2. Define the competitor and differentiate – The blog makes it clear that Sincerely is not in the photo game but the gifting game. Thus, the blog differentiates Sincerely from Apple. And it does it in a meaningful way. To me, the gifting business sounds like a more exciting opportunity than the card business.
  3. Highlight specialization and focus – Physical cards are a distraction to Apple. If every person that bought an iPhone in 2011 sent 1 card per month, it would only equate to 2.5% of Apples total revenue. Sincerely, on the other, is laser-focused on the market. And I’ll bet on focus over distraction any day.

4. Secrets aren’t necessary
What Powers Instagram: Hundreds of Instances, Dozens of Technologies by Instagram
Companies are secretive. Coca-cola locks its recipe in a safe. Apple goes to extraordinary lengths to veil new products. It refreshing, therefore, when a company comes out and says, “Hey, this is how we do things.” And no company did this better than Instagram, the photo sharing mobile app that launched this year and already has more than 12 million users.

In this blog post, Instragram shares its IT strategy. Anyone interested in launching a competitive product could – and should – follow each and every recommendation. And that is the point: when you have a branded product that consumers trust – in Warren Buffett’s terms a “moat” – it does not matter if your competitors or customers know how the product gets delivered. Having the exact recipe or a head-start on a new product does not make it any more likely that Coke or Apple will be disrupted.  The same goes for Instagram. Understanding how Instagram delivers beautiful photos to your mobile devices does not mean a competitor can replace them through replication. A new competitor needs to identify what Instagram is missing and then fill that customer need.

3. IPOs and private markets
IT’S OFFICIAL: The IPO Market Is Crippled — And It’s Hurting Our Country by Alan Patricof

A major story throughout 2011 was Facebook’s valuation on the private markets. As of September, the company was valued at $82 billion on SharePost. But there was a bigger story than just the billions Facebook was worth. If a global brand with profits and exponential growth had not already gone public, what did that say about the IPO market overall?

In a blog on Business Insider, Greycroft’s Alan Patricof poured onto the page the knowledge he has gained from over 30 years of early stage investing. He concluded that companies, particularly smaller ones, no longer have the opportunity to go public and as a result America is losing its technological advantage. The decline in the IPO market is the result of four factors:

  1. Small firms were underwritten by small banks. Small banks no longer exist thanks to two decades of consolidation.
  2. Only big banks remain. Big banks can only invest big amounts. They cannot be bothered with hundreds of small holdings. Thus, it’s a blockbuster IPO or nothing.
  3. Smaller bid-ask spreads make it difficult to trade in small companies that do not have large trading volumes
  4. It is too expensive and complex for small companies to manage the public market regulations.

As a result, venture capitalists are less likely to invest in capital intensive businesses that require the level of funding only found on the public market. This shifts early stage investments to highly scalable services like Facebook and Twitter and away from companies that make technological leaps like Intel. And when that happens we all lose.

2. Added to my lexicon in 2011: “Napkin Entrepreneur”
Napkin Entrepreneurs by Steve Blank

I judge a blog based on how often I reference it in my daily life. This year, I added a new phrase to my lexicon: Napkin Entrepreneur.

Steve Blank, a start-up veteran and thought leader, wrote a perfect summary of today’s start-up environment. Basically, the amount of capital required to start a business has fallen dramatically while the number customers you can reach has risen dramatically. As a result, dreamers no longer need to sketch out a plan on a cocktail napkin. Rather, they can hack the product together and deliver it to millions of users at zero cost. If the feedback is positive, keep going. If it is negative, move onto the next idea. The Napkin has been replaced with the beta product.

1. Don’t worry about Marauders
Speech by Elizabeth Warren, Senate candidate in Massachusetts
(Starts at 00:48)

Last summer I took a class at NYU Stern that forever changed my perspective. The class was called Global Perspectives on Enterprise Systems and it was taught by Robert Wright. The goal of the class was to understand why some countries develop rapidly, like the United States, while others do not develop at all.

It came down to the “Growth Diamond;” Stern professors notoriously love baseball. Home plate is a non-predatory, Lockean government. In other words, growth starts with a government that protects the life, liberty and property of its citizens. Such a government collects taxes transparently, regularly and at a reasonable rate. The government also establishes and enforces reasonable laws. Note that such a government does not need to be a democracy; though they often are.

The next phase of development, or first base, is a financial system in which capital moves from savers to borrowers. First base cannot be reached without home plate; after all, the crux of saving and lending are contracts recognized by the courts established by the government.

With home plate and first base established, the economy is prepared to take second base: entrepreneurship. Individual actors are comfortable investing into a long-term business knowing that the government will not pilfer it in the night. And even if something goes wrong, the actor has faith that the slip of paper called “insurance” will be made good. And lastly, the actor has access to capital, thanks to first base. Interestingly, not all economies move equally between bases. There are countries with non-predatory governments and financial systems that have less entrepreneurship than others.

The final stage, third base, is a management system. Basically, the entrepreneurs that flourished from a stable government and access to capital eventually grow into large, distributed organizations. These organizations have the systems required to undertake large and complex markets like air travel, chip fabrication and automobile manufacturing.

So what does this have to do with Elizabeth Warren? Simple. She understands the Growth Diamond, and more than anything she can articulate it to the American people. This speech lit-up the blogosphere and belongs in the annals of great speeches made by great Americans.


Teaching the Correct Lessons Correctly: The Future of Computer Science and Programming Courses in America’s High Schools

A sound education is based upon teaching the correct lessons correctly. With that in mind, why is one of the most important skills in today’s work force – computer science – barely being taught in American high schools? This is a threat to the economy, and also an opportunity for educational technology companies.

First, the facts. Based on a survey by the Computer Science Teachers Association, I extrapolate that roughly 1 million high school students took a computer science course in 2009. Given that that there are 16.5 million high school students nation-wide, this is a paltry 6%. Foreign languages, on the other hand, had more than 7 million students– or 46% of the high school population – enrolled during the same period.

This imbalance is the result of many factors. First, foreign languages are easy to teach, relatively. The material is stable; languages change over the years as new words and colloquialism are introduced but the overall fundamentals are the same. Programming languages, on the other hand, change rapidly. A core language can quickly be replaced; just look at the evolution from COBOL to the Cs to Ruby. As a result, it is difficult to find competent instructors, because those with skills are gainfully employed and doing what they love to do: code. Also, computer science courses require a larger budget; up-to-date hardware and software is required, whereas textbook and flashcards go a long way in foreign language instruction.

No Child Left Behind is also a factor. NCLB does not consider computer science a core course, so schools marginalize CS  courses and instead invest time, energy and money into general math and reading.

Creating an army
Our nation needs to produce an army of students than can write more than “Hello World.” Just like in the past few decades, the next innovations will be created line-by-line of code. And though every student cannot be the next Wozniak, Gates, Brin or Zuckerberg, understanding basic architecture and programming leads to better employment opportunities. To prove this, I went to and typed in “French Language,” “German Language” and “English Literature” into the skills keyword search. French returned 174 jobs, followed by German at 127 and English Literature at 7….yes, seven. I did the same for Java, C++, .Net and Python. Every search returned “1000+” jobs.

Creating this army will require a non-traditional pedagogy. As previously mentioned, it is difficult to find competent teachers knowledgeable about the ever-changing landscape of computer science. Thus, the old “one-one-thirty” model (1 teacher, 1 classroom, 30 students) will not work effectively on a large scale. Educational software platforms and alternative distribution methods, therefore, are the answer.

There are four basic approaches that companies are using to teach software development:

  • Online Interactive (no instructor) – This is the newest space and the key example is Codecademy. Codecademy launched about three months ago. I’m 86% done with the “Getting Started with Programming” course. Overall, I love the product because it dives into coding immediately. There are no downloads or set-ups. Also, the company is enabling courses to be user-created, which will allow them to scale quickly and stay abreast of new technologies. But Codecademy is all about coding and therefore does not give its students the full picture of how you create and maintain an application.
  • Online Interactive (instructor led) – This is traditional online learning where an instructor delivers lectures, hosts discussions groups, and grades assignments.CodeLesson is an example of this category. With so many touch points, this is an effective method but it is expensive. A course for setting up and running your own web server, for example, costs $225. These courses face competition from the abundance of free material out there. Here is a youtube video on setting up a webserver. And here are step-by-step instructions that I found on a blog.
  • Video Series – Treehouse is an example of a video-focused solution. Treehouse is solely focused on the developer space, whereas others video-based educational companies like offer an array of courses on such things as photography and entrepreneurship. Treehouse also offers the start-to-finish view of development, so students learn coding as well as the architecture of building and launching an application. In terms of pricing, Treehouse has chosen a monthly fee model, as opposed to the per-lesson approach of CodeLesson. Treehouse can underprice CodeLesson — it charges $25-$49 per month — because it does not support instructors. Of course, it faces competition from the abundance of free videos.
  • Game-based learning (Corp/University developed) – There are also a few games, created by large corporations and universities, which are available for free. Major examples include Alice, for teaching object-oriented programming (it was developed by Carnegie Mellon and supported by Oracle and EA), and Greenfoot, which teaches Java (created by University of Kent and supported by Oracle). I have used Alice, and while the program is good at teaching coding concepts it fails to explain the architecture of actually creating an application. Also, these tools are not priorities for the companies and universities that developed them, so transformational innovations are unlikely.

While the above solutions are a step in the right direction, none of them are a silver bullet. To create a coding-literate army, we need a solution that combines the best from each category into one cohesive offering. I would like to see the focused video content of Treehouse coupled with Codecademy’s interactive approach.

One challenge, however, will be integrating an in-person instructor. School districts will be uncomfortable giving students course credit based on an instructor sitting in a remote location outside of the District’s payroll and policies and procedures. Ideally, in-person teachers will play the role of moderator and supporter; in other words they will not teach complex coding but rather ensure that students are progressing and getting the answers they need. To achieve this, vendors will need to develop a back-end system for teachers to track and assist students.

In summary, this is an enormous opportunity for the nation to advance scholastically and economically, as well as for education technology companies to prosper. Success will be predicated on companies developing solutions that are flexible enough to change with the technology landscape, pedagogically effective, and designed to meet the stringent standards of school administrations. Lastly, success depends on politicians and school administrators accepting non-traditional teaching solutions. Given the stakes, they should find the will.

Entrepreneur, The Silver Platter Definition

Today’s Wall Street Journal celebrated the life of Ted Fortsmann. Fortsmann was one of the founding fathers of private equity and a prominent ‘character’ in “Barbarians at the Gate,” a must-read about the RJR Nabisco buyout.

I’m writing about Fortsmann because his firm perfectly summarized what it means to be an entrepreneur. According to the Journal, Fortsmann Little gave their guests at a 25th Anniversary celebration a silver platter engraved with the following:

“The entrepreneur, as a creator of the new and a destroyer of the old, is constantly in conflict with convention. He inhabits a world where belief precedes results, and where the best possibilities are usually invisible to others. His world is dominated by denial, rejection, difficulty, and doubt. And although as an innovator, he is unceasingly imitated when successful, he always remains an outsider to the ‘establishment.'”

This quote perfectly captures entrepreneurship. The opening line – “creator of new and destroyer of the old” – details the phenomena of creative destruction. The second sentence captures the imaginative nature of entrepreneurs;  I’m immediately reminded of Steve Jobs who envisioned a world in which every person would have a computer in light of the day’s leading tech firms (HP, IBM, Xerox) telling him the computer was a business tool. The third sentence encapsulates the difficult path entrepreneurs traverse. Examples of struggles are bountiful, but my favorite is the Music Genome Project; before pivoting to become Pandora, the company burned through its cash and asked employees to take no pay for a year.

The final sentence is interesting. The imitator effect has a positive but hard to measure impact on the economy. The success of one entrepreneur motivates thousands to strike out on their own to seek opportunities “usually invisible to others.”  Prior entrepreneurial successes, in other words, signal to current would-be entrepreneurs that the system works. One person in the new class of entrepreneurs then realizes wild success and the cycle repeats itself. If Steve Jobs and Bill Gates were stripped of their wealth or thrown in prison for challenging the statues quo, would Larry and Sergey have been motivated to start Google? And if Larry and Sergey were not able to capture the value they created, would Mark Zuckerberg have been motivated enough to create Facebook?

Creative Destruction, Literally

Yesterday, I watched a building in Cambridge, MA get dismantled. In speaking to the foreman, I learned that 21 Osbourne Street was previously home to two high-tech companies. The original tenant was an iconic brand whose product quickly become irrelevant in the digital world. The next tenant – who has since moved out –  is still thriving, but faces huge risks as its product becomes a commodity.

Now, the plot on Osbourne will be home to a fast-growing, cutting-edge company in an entirely different space: pharmaceuticals.

Who will be the fourth tenant? In other words, what will be the next industry to require this coveted piece of land in the midst of MIT’s campus?

I shot this iPhone video entitled “Creative Destruction, Literally.” This is my first attempt at shooting and editing video, so thank you for your patience.


Google Tables: A Great Tool with the Potential to be Transformative

Google, rather quietly, released a new Doc product called Fusion Tables. Tables is a database tool, which means that Google is now matched one-for-one with the Microsoft Office Suite. Like all Doc products, Tables is intuitive, collaborative and integrated with the web, especially location-based data. Tables is not nearly as robust as Access. But most people don’t need that much power, which is why Tables is a great tool for anyone with the slightest data analysis needs.

Tables is also focused on being a data repository. In other words, if you have a dataset that you want to share with the world, simply make it “public” on Tables. And vice versa; if you need a dataset, peruse the public tables located here.  Right now there are about 100 sets, including Goals at the 2010 World CupCoffee Production, and Homicides in Colombia.

Testing Tables: Uploading and Analyzing One Data Set
The best feature of Tables is the ability to overlay information onto a map. To familiarize myself with this functionality, I needed a rich data set that was not too cumbersome. The Bureau of Labor and Statistics is a natural, so my first test is an analysis of firm size and employment by each state.

First, I had to create the table. This could not be any easier. To create a new table you are given three options: From this computer (i.e. an Excel or Access file), From a Google Spreadsheet, or Empty Table. Since I downloaded the Excel dataset from the BLS, I chose the first option: From this computer. The next step is to confirm that the columns are correctly formatted. Amazingly, Google correctly recognized every column. For example, the first column was State, which I thought would have been tagged as text but was correctly recognized as location.

The next step is attributing the data. This is key for sharing tables with the public. If you plan on publishing the table, proper attribution is vital, or else it is of little value to the research community.

With the file uploaded and the data attributed, it was time for fun: analysis. My first stop was the Intensity Map, which is located in the Visualize drop-down. At first, the data was skewed because it included employment by firm size for all fifty states as well as the United States as a whole. Also, the data was noisy because it included every firm size, ie 0-4 employees, 5-9 employees, etc. Therefore, I needed filters, which were extremely easy to add; simply click the “options” link.  Here is a screen shot of the Intensity map showing the number of companies with over 500 employees.

Merging Two Tables: Good, as long as you do not need a calculation
I ran into my first problem / bug while merging two tables together and then performing a calculation. Basically, I wanted to understand the data on a per capita basis, so I created a second table with state-by-state population going back to 2004. (I made it public here).  Merging the two tables was simple. In the original table, I simply clicked on “Merge” and was presented a two question “wizard.” The first question was “which columns do you want to match.” This is equivalent to dragging the cursor between two tables in Access. In this instance, I chose to link STATE data together, so that I would see employment by state along with population. The second question is a no-brainer: which table do you want merged.

Next, I wanted calculate the Enterprises per Capita by dividing the population by the number of firms. So I went to Edit, Add Formula and wrote in my command. It didn’t work. For some reason, I could not get a merged table to perform a calculation. My work-a-round was exporting the newly merged table to Google Docs Spreadsheet, and then importing it back in as one table. When I did this, I was able to perform the calculation. This is not an acceptable solution because the table is no longer dynamic. If anyone out there knows what I’m doing wrong, please shoot me a note or write a comment below.

Conclusion: A Key Tool for Any Analyst
Aside from my inability to calculate, Google Tables is a great resource. My intensity map of firm size is just the tip of the iceberg. Check out these amazing examples.

Lastly, Tables has the potential be transformative. Humans advance on data. Right now, there is a vast expanse of data, but it is silo’d across many systems and written in different formats. A central, crowd-sourced repository of data will improve the quality of analysis, all while reducing the time wasted finding, verifying and cleansing.

What Entrepreneurs Can Learn From a Walk in the Woods

A couple weeks ago, I headed into the backcountry of Banff National Park for a 5 day, 40-mile hike. This was my fourth major hike since 2004, and perhaps the most grueling due to the weather. Eight hours into the hike, the skies opened and did not close until the final morning. So as I slogged through the mud, trying not to step on Grizzly Bear paw prints, I asked myself: why am I schlepping a sixty-pound backpack in cold, driving rain and at the risk of a fatal attack by 500-pound mammal?

One reason is that hiking provides an opportunity to see different aspects of life in new ways. During this trip, I realized that backpacking is a lot like launching a startup. Below, in no particular order, are the reasons why.

Limited resources fuels innovation
A hiker’s resources are limited to what he can carry (tent, sleeping bag, clothes) and what the forest provides (wood, water). If you forget – or lose – something, it is gone and you better hope that you don’t need it. After a few days of living with such constraints, the mind becomes incredibly inventive. During this trip, for example, we rigged up a sturdy multi-level clothes-drying rack using nothing but branches and logs. During a past trip, we crafted a way to drag our packs across snowfields in order to limit falling through.

All businesses but especially start-ups are resource limited. Capital, talent, and time are in short order. As a result, start-ups constantly innovate not only in the products they offer but in the way they operate. My favorite story of innovating to survive is Airbnb, which designed Obama O’s cereal and sold the collector-edition munchies to attendees at the Democratic National Convention. They raised $25,000 to fund their start-up.

As start-ups mature, however, they must shed the patchwork operations that they “innovated” during the lean years. Relying too heavily on Excel – or Google Docs – is a prime example. When resources are limited, it is acceptable to cram everything from salary planning to project management into a spreadsheet. As the company proves longevity, it must invest in the proper processes and technologies in order to support sustainable growth. Not doing so is equivalent to using an open fire and rack of branches to dry clothes, despite being out of the woods and having access to an electric dryer.

Risk management takes on a whole new meaning
Hiking is a risky endeavor. Any number of events can happen on the trail, including getting lost, injuring yourself, running into an aggressive animal or getting hit with a major weather event. These events can easily result in death – and it is usually a slow and agonizing death. But they are all avoidable. With the correct maps and trail descriptions and an ability to read a compass, the risk of getting lost is greatly diminished. (Heck, you can even bring a GPS that pinpoints your exact location, but that takes the fun out of it.) Talking on the trail and hanging your food 100-plus meters away from your tent are both actions that reduce the threat of a bear attack. Throw in bear spray and a general understanding of what to do in the event of an encounter and you’re in pretty good shape. Lastly, reducing injury is common sense: never jump; be careful with your knife and around the fire; stay hydrated, dry and warm; carry a first aid kit.

Risk management is dependent upon understanding the probability and severity of an event occurring. Once you understand these two factors, you can triage mitigation. As I walk through the woods, I’m constantly calculating and triage-ing. During this trip, for example, I calculated the risk of a bear encounter to be moderately high; by my calculations there was one Grizzly for every 10 square miles of habitable land, and we were traversing 40 miles. On the other hand, the risk of getting lost was low; the trail was through a valley with steep, rocky mountain faces on each side – the equivalent of bumpers on a bowling alley lane. I adjusted my behavior accordingly.

For start-ups, risks lurk around every corner: system outages, patent trolls, legislatures, unethical employees. A founder’s job is to identify, triage and manage these risks. Unfortunately, though, risk management is often sidelined during the frenzy of creating a new product and winning customers. After all, it is difficult to pull oneself away from the exhilarating and vital task of crafting the next generation of a product to draft a contingency plan that may never be used. Founders also have a difficult time shifting money away from R&D and sales and towards risk management expenses like insurance, lawyers, and monitoring systems.

Remember how fortunate you are
Hiking helps remind me how fortunate I am. I have my legs to carry me, my eyes to take in thevistas and my ears to hear the sounds of rushing mountain waters and high-pass winds. I have also chosen to live a “pre-civilization” lifestyle by sleeping on the ground in a flimsy shelter, pumping water, keeping warm and cooking with fire, and placing myself lower on the food chain. For millions of people this is not a lifestyle choice; 884 million people, for example, do not have access to clean water. Lastly, I’m reminded of the military, who basically hike through the most treacherous places on earth – from the mountains of Afghanistan to the jungles of Vietnam – with one additional risk: enemy fire.

Start-up founders are also fortunate. In many ways, founders are responsible for their destiny. They envision an opportunity and have the courage and talent to execute upon that vision. However, there are factors outside of their control that increase the likelihood of success. Health and physical appearance is one example.

Success is also dependent on origin of birth and residency. Over the last 400 years, the United States has developed systems and institutions that foster entrepreneurship. In the United States it takes 6 days and only a few hundred dollars to establish a legal corporate entity, whereas in Brazil it is four month journey that could cost more than one thousand dollars. Throw in bankruptcy laws that do not discourage risk taking, a court system that upholds property rights and legal contracts and a functioning insurance market, and innovation flourishes. In short, an entrepreneur operating in the United States has a much greater chance of success than his equally talented counterpart in just about any other part of the world.

Stayed tuned to hear the insights from Hike 2012, which will hopefully be in Glacier National.

Understanding the Debt Downgrade: A Fundamental Approach

As I try to understand the debt downgrade and how it will effect the equities markets, I find myself relying on a piece of advice from my valuation professor. “When new information comes to light”, the professor said, “ask yourself: what lever of the ‘value’ formula is being affected?” More specifically, the professor was referring to the perpetuity discounted cash flow (DCF) formula, which is:

Value = Cash Flow / (Cost of Capital – Growth Rate of Cash Flows).

The levers are the cash flows generated by the company, the growth rate of those cash flows, and the opportunity cost of capital, i.e. the minimum return acceptable to investors. The purpose of the formula is to discount future cash flows into a net present value. The formula is not perfect, mainly because it assumes constant growth in cash flows, but it is an excellent rule of thumb. If you’re familiar with finance, this is not new and you can probably stop reading. If finance is not your thing, stick with me – you’ll soon understand, I hope.

So, what is the key lever being affected by S&P downgrade? It is the cost of capital. The downgrade is a signal that a default is more likely than previously thought. The greater the risk of default, the greater the return required by investors to compensate them for that risk. Of course, this is not cut and dry. US debt investors may have already priced in the riskiness of default, which means treasuries may not swing as widely on the news. Also, if sovereign debt of other nations (like the EU or Japan) is more risky than US debt, than the US is still a “safe haven” and the large pool of buyers will keep prices high and rates low. But for the sake of understanding the fundamentals of the downgrade, lets assume that treasury rates rise. Since the cost of capital sits in the denominator of the value formula, an increase results in a decline in value. Put simply, a rise in the cost of capital with everything else remaining constant results in a lower valuation or stock price.

Let’s go one step further and explain how a rise in treasury rates affect the cost of capital of a company. For simplicity purposes, I’m assuming the company is equity-financed, meaning that it does not have any debt.

I need to introduce one more formula: The Capital Asset Pricing Model (CAPM).

CAPM = risk free rate + beta * (market risk premium)

The risk free rate is, well, the treasury rate. Beta, without getting too deep in the weeds, is the riskiness of a particular stock. And the market risk premium is the amount above the risk free rate investors expect to earn by investing in the equities market. If beta and the market risk premium remain constant, than a rise in the risk free rate — i.e. the treasury rate — results in a higher cost of capital.

To put this all together, I have created an example. Let’s assume a company has an equity beta of 1.1, which means that if the entire market rises the company’s stock will increase too, but at a slightly higher rate. And vice versa: if the market falls, the stock will fall slightly more than the wider market. The risk free rate is the ten-year treasury rate which just last week was around 2.6%. The market risk premium is 4%, meaning that if treasuries are 2.6% than the expected return from investing in stocks in 6.6% (2.6% plus 4%). Thus, CAPM equals:

CAPM = 7% = 2.6% + (1.1* 4%)

So now that we have our cost of capital of 7%, let’s look at the value of the company.  Assume that the company is generating $100 of cash flow and that those cash flows will grow at the inflation rate, about 3%. Thus the discounted value of the company is:

DCF = $2,500 = $100 / (7% – 3%)

Now let’s look at what happens if all else remains constant but the treasury rate increases to, say, 3.5%. At this rate the cost of capital is:

CAPM = 7.9% = 3.5% + (1.1*4%)

And the value of the company falls to:

DCF = $2,041 = $100 / (7.9% – 3%).

In short, a 0.90% increase in the treasury rate will cause the value of our hypothetical company to fall 18%. To get a better picture, I have published a Google Spreadsheet.