FINANCE 580

1. FINANCE 580 Cases in Managerial Finance

2. Today’s class... • Introductions and house keeping • Financial planning and analysis • Seminal ideas in corporate finance

3. My Background • NAME: Ken Shah • BORN: Bombay, India • PhD: University of Oregon • INDUSTRY EXPERIENCE: • 4 yrs Floor Trader / Stock Broker - Bombay Stock Exchange • 3 yrs Quantitative Portfolio Management Research, Portland, Oregon

4. Academic Experience • Taught at • University of Oregon • University of Auckland • Southern Methodist University • Courses in capital budgeting, corporate finance, investments, and money and banking

5. Recent Research • Analyst Forecasts • Bond Returns • M&A Fairness Opinions • Capital Structure • Initial Public Offerings

6. Course Objectives • Expose you to anticipated managerial decisions in finance • Inculcate financial way of thinking • Bridge theory and practice • Increase proportion of good financial decisions to bad ones!!

7. Course Prerequisites • Willingness to learn & work hard! • Understanding of: • Financial statements • Rudimentary statistics • Spreadsheets • Fundamentals corporate finance • Valuation, M&M propositions, agency theory • Pre-requisite: FINC 515

8. Anticipate... • About 5 hours of work outside of classper week • Frustrations with unstructured problem solving! • Frustrations with computer work!

9. Texts • Required: • Bruner, Case Studies in Finance (online – no physical text) • Packet of Readings – at Copymart • Optional: • Brealey & Myers, Principles of Corporate Finance • Higgins, Analysis for Financial Management

10. Evaluation • Group Case Presentation 300 • Participation 100 • Midterm Case 300* • Final Case 300* • TOTAL 1000 • * Please correct the syllabus

11. Grading Policy • If you attend all classes and diligently complete all required work, you would be assured of a B- grade • In order to get an A/A-, you must show work of superior quality and make a meaningful contribution to the class discussions • roughly top 15% of the class

12. Class Attendance • Mandatory • Discussion particularly important in a case class • Please inform me of anticipated absences • More than 1 absence will adversely affect your grade • Please include in email subject “FINC 580 F06” • Please send an introductory email and feel free to tell me about yourself, and any concerns/absences you anticipate

13. Case Presentations • About 30-40 minutes in length • Formal write-up & Class Handout • Field questions

14. Non-presenting students • Demonstrate preparedness • Come to class with analytical solution • E.g. see Gulf Oil solution • No formal write-up

15. Midterm & Final • Formal 3 page case analytical solution • Take home • One week to complete • Individual effort

16. Readings • Required: • Please be prepared to discuss them in class • Background: • To expose you to practice, analysis, and theory in the case subjects • Necessary but not explicitly discussed

17. Course Design Growing Pains - Private enterprise Midlife crisis - Managing growth Over the hill - Restructurings

18. Case Progression • Managing Growth / Private enterprise: • Short term financing / Managing growth • Going public • WACC • Sustaining Growth / Financing Policy: • Payout policy • Capital structure policy • Lower Growth / Corporate Reorganizations: • Takeovers • LBOs • Bankruptcy

19. Cases... • Are deliberately vague! • Have information deliberately presented in random order - not in the order of importance • Offer little guidance on method of solution

20. Case Solution Strategy • Reading the case • First time just read it like a magazine article – look at forest, not the trees • Leaf through the exhibits • Go back and read it more thoroughly taking notes

21. Develop your awareness • Who are the decision makers and what pressures do they face? • What is the business of the company? • What are the goals of the firm? • How well has the firm performed in its pursuit of the goals?

22. Defining the problem • Common trap – symptom not the real problem • Believability of key assumptions • Assumptions drive results

23. Analysis • Run the numbers and go to the heart of the matter • Perform analysis on key assumptions • Get down to the key bets • Get to business issues quickly

24. Recommendation • Prepare to participate: take a stand • In Class: Participate actively in support of your conclusions but be open to new insights as they emerge • Trust the process: • Case learning is cumulative over time

25. My approach to a case... • Read it twice, ignore numbers • List all issues • Rank issues in order of importance • Articulate the central issue • Identify relevant theory and evidence • Formulate assumptions for analysis • Perform data analysis • Recommend a course of action Repeat

26. Analyzing a case... • At first, see the forest, not the trees • Analyzing numbers is necessary but NOT an end in itself • it is presumed that you know how to analyze numbers • Put yourself in the shoes of the decision maker

27. Analyzing a case... • Identify the decision makers and their pressures and stakes in the situation • Thoroughly understand the nature of the business, product, firm’s competence, competitors, structure of the industry etc. • What are firms goals? How well has it pursued them? • DuPont, ratio analysis, growth rates, measures of value creation

28. Analyzing a case... • Is the problem at hand a symptom of a larger problem? • E.g. a lender is often asked to provide cash to tide over shortfall. • Study may reveal that it’s really the product obsolescence, unexpected competition etc.

29. Analyzing a case... • An executive rarely thinks of a problem as an exercise in forecasting techniques or discounting method • But rather, thinks of it as a problem of judgement, deciding on which people, concepts or environmental conditions to bet. • Get the #’s right - but go further!! • Prepare to take a stand - and defend it!

30. Case Write-up • Do NOT simply regurgitate the information in the case in your introduction to the case • Distill and analyze the information and present it only if you believe it has an impact on your analysis and solution

31. Learning from case method • It’s not passive - the more you participate and think, the more you learn • It’s cumulative - should not measure the success of your progress on the basis of any single case discussion • You will arrive at a better understanding over time, after many cases - sometimes after the course is over!

32. Financial Planning • Analyze financing and investment decisions • Project future consequences of present decisions • Decide on which alternative to undertake • Measure subsequent performance against goals

33. Elements of Financial Planning • Forecasting • Pro-forma statements • Finding the optimal financial plan • Analysis • Watching the plan unfold

34. Analyzing performance • Financial ratios • Beware of accounting definitions • Choosing a benchmark • trend over time • industry counterparts (Dept. of Commerce, Dun & Bradstreet, Robert Morris Assoc.)

35. Analytical Tools • Sensitivity (what-if) analysis • Scenario analysis • Monte Carlo simulation • Decision Trees

36. Sensitivity Analysis • Analyze the impact of changing a single variable one at a time • e.g. Formulate “Optimistic”, “Pessimistic”, “Expected” cases • Identifies key variables • Ignores interrelations among variables

37. Scenario Analysis • Consider alternative plausible combinations of variables • Account for interrelations among variables • e.g. rise in oil prices -> increase scooter sales AND increase costs • Overcomes limitations of sensitivity analysis

38. Monte Carlo Simulations • Model the strategy • Identify key variables • Draw from probability distributions of key variables • Calculate results of strategy • Do that many, many times (computer) • Get distribution of outcomes • Range of answers - difficult to reconcile

39. Decision Trees • Used for sequential decisions • Evaluate decisions at each node starting backwards (reverse iteration) • Compute expected value • Trees can quickly become complex • Incorrect handling of risk (discount rate)

40. Is theory a dirty word? • Theory is simply an exercise in ridding distractions • It can aid to clarify thinking • However, theory for its own sake serves no useful purpose • Theory does provide a framework to start the analysis

41. Caution… • Do not try to force a solution to fit the theory • Real world problems cannot conform to theory precisely • Common techniques and theory’s guidance must be adapted to suit the problem at hand • Do not take ‘cookie cutter’ approach!

42. Bridging Finance Theory and Managerial Finance... • CAPM • NPV, capital budgeting, WACC • Modigliani-Miller Propositions • Dividends, capital structure, WACC • Agency Theory • Corporate governance, compensation, optimal contracts • Asymmetric Information Models • Signalling, stock price reactions • Option Pricing • Risk management, real options in capital budgeting

43. CAPM • Widely used in NPV, capital budgeting • Efficient Portfolios, CML, SML • Recently under attack (is beta dead?) • Rivals: • APT • Empirical Multifactor Models • Book-to-market and Size effects

44. M-M Propositions • Proposition I: Firm cannot change its total value by splitting cash flow into different streams (ie shareholders, debtholders) • Proposition II: Expected return on common stock increases in proportion to its market debt to equity ratio

45. M-M Propsitions • Many of the ‘perfect market’ assumptions have been relaxed without affecting core conclusions • Teach us that it is important to focus on the business, not finance, if an enterprise is to be successful

46. Agency Theory • Inability to write perfect contracts between principal and agent that ensures agent acts in the best interest of the principal • Agency problem arises from delegation of decision making and imperfect information and imperfect monitoring

47. Agency Costs • Conflicts are inherent between • Shareholder - Management • Shareholder - Bondholder • Firm value is reduced by • Excessive perk consumption • Taking unwarranted risk • Forgoing profitable investments with debt

48. Agency Cost Models • Used successfully in explaining • LBOs, Takeovers, restructuring activity • Debt covenants • Design of board of directors • Design of incentive compensation • Use of convertible securities

49. Asymmetric Information Models • Actions taken by better informed agents convey information to those less informed • Management have superior information about own firm value • Successful in explaining stock price reactions to announcements of corporate actions • Do managers deliberately signal?

50. Option Pricing Models • The most successful pricing models in finance • Used to value complex securities • convertibles, callables, warrants • Adjustments to NPV in sequential decisions • Real options in capital budgeting • Value incentive compensation • ESOPs