Course Outline: PRINCIPLES OF FINANCE. Dr Shahab Q Khokhar Dr S Q Khokhar. Aims & Objectives

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1 Course Outline: PRINCIPLES OF FINANCE Dr Shahab Q Khokhar 2003 Dr S Q Khokhar Aims & Objectives The course aims to provide a pedagogical introduction to the area of financial management The level of difficulty of the course material is elementary to medium The core (focus) areas to be covered in the course are: financial statement analysis, valuation, working capital management and financial markets The course will provide theoretical knowledge, while consistently linking the theoretical issues to the real-world (i.e. practical) cases The objective of the course is to enable students to develop clear understanding of the (corporate) financial issues 2003 Dr S Q Khokhar 2 1

2 Course Information Instructor: Dr Shahab Q Khokhar skhokhar@lums.edu Recommended course prior to Principles of Finance : Financial Accounting-I Sessions: 20 (interactive) sessions of 100 minutes each Class Timings: Mondays and Wednesdays, 11.45am to 1.25pm Venue: TBC Start Date: September 1, 2003 End Date: November 5, Dr S Q Khokhar 3 Course Information The course is divided into four modules Introduction to Financial Management Valuation Financing Financial Markets Grading Class Contribution 5% Quizzes and Problem Solving Exercises 15% o 4 quizzes and 6 problem solving exercises (in Microsoft Excel, where applicable) Project 20% o The project will provide a chance for students to work (in teams) on real-world financial problems o Submission of an executive summary of the proposed project is mandatory Mid-term Examination (85 min) 20% Final Examination (175 min) 40% 2003 Dr S Q Khokhar 4 2

3 Reading Material Textbook Block, S. B. and G. A. Hirt, Foundations of Financial Management, Ninth Edition, McGraw-Hill Irwin. (B&H) Other Books Ross, S. A., R. W. Westerfield and B. D. Jordan, Fundamentals of Corporate Finance, Second Edition, Irwin. (RWJ) Weston, J. S., S. Besley and E. F. Brigham, Essentials of Financial Management, Eleventh Edition, The Dryden Press Harcourt Brace College Publishers. (WBB) Financial Newspapers Business Recorder Financial Times (FT.com) paper copy is available in the library The Wall Street Journal (WSJ.com) paper copy is available in the library Further supplementary material (such as, book chapters, newspaper / journal / magazine articles, etc.) may be assigned as additional readings during the period of the course 2003 Dr S Q Khokhar 5 Sessions 1 & 2 Session 1: The Framework of Financial Management In this session we will discuss the process of financial management. We will also examine the financial managers activities, as well as distribution of their time spent on each activity. Other topics, such as agency problem, business ethics, stock price/value maximization, signalling theory, will also be considered. Readings: B&H, Chapter 1; WBB Chapter 1 (optional) Article: Millman, G. J., CFOs in Tune With the Times, Financial Executive, July/August 2000 Session 2: Understanding of Financial Statements and Reports For a financial manager it is absolutely essential to have full command over the understanding of financial statements the balance sheet, the income statement and the cash flow statement. Note that Notes in the financial reports are also an integral part of financial statements and must be scrutinized carefully. During this session a review of financial statements will be presented. Readings: B&H, Chapter 2; RWJ Chapters 2 and 3 (optional) Article: Tergesen, A., The Ins and Outs of Cash Flow, Business Week, January 22, Dr S Q Khokhar 6 3

4 Sessions 3 & 4 Session 3: Financial Analysis Financial analysis is vital to financial managers. The scope of financial analysis depends on its purpose, which may range from a total analysis of a firm s strengths and weaknesses to a relatively simple analysis of its short-term liquidity. In this session we will concentrate on ways of reading between the financial statements. Readings: B&H, Chapter 3; Same as Session 2 (optional) Article: Miller, P. B. W., Will You Adopt Quality Financial Reporting?, Strategic Finance, January 2001 Session 4: Financial Forecasting In this session we will look into developing pro forma financial statements. These refer to forecasted financial statements, which are essential for corporate (future) planning and for securing finances required to successfully operate the business. We will discuss various methods for forecasting sales, cost of goods sold (COGS) and other variables. Readings: B&H, Chapter Dr S Q Khokhar 7 Sessions 5, 6 & 7 Sessions 5 6: Short Term Financing In this session we will discuss working capital policy and its management. This involves financing decision relating to current assets and effectively managing current liabilities. We will also examine how to evaluate a firm s liquidity management. Liquidity management involves the planned acquisition and use of liquid resources over time to meet cash obligation as they become due. The sources of short-term financing will also be identified Readings: B&H, Chapters 6-8; WBB Chapters 8-12 (optional) Articles: Myers, R., Cash Crop: The 2000 Working Capital Survey, CFO, August 2000; Leibs, S., Internet Explorers, e-cfo, April 2000 Session 7: Risk and Return A financial manager acting for a firm s shareholders should not make an investment decision solely on the basis of expected return. Financial managers must also assess the riskiness of an investment. Hence, risk and return analysis is an important area for a financial manager. In this session we will examine topics like probability distributions and measures of risk. Here we will also discuss one of the pillars of modern finance, namely capital market efficiency Readings: WBB, Chapter 5 and B&H, Chapter 14 (pages ) Article: Barton, T. L., W. G. Shenkir, and P. L. Walker, Managing Risk: An Enterprise-Wide Approach, Financial Executive, March/April Dr S Q Khokhar 8 4

5 Sessions 8, 9 & 10 Sessions 8 9: Time Value of Money During this session we will get acquainted with the processes of discounting and compounding. We will briefly touch upon the problem of determining the right discount rate, but will go into greater details during the next session. Readings: B&H, Chapter 9; Other hand outs to be given Session 10: Cost of Capital / Financing Cost In this session we will examine costs attached to various types of financing. In developing the firm s overall cost of capital, we first identify and then determine the cost of each component, and then we combine the components costs to obtain the total cost of capital known as Weighted Average Cost of Capital (WACC). Mainly we will discuss cost of equity capital and cost of debt financing Readings: B&H, Chapter 11; WBB Chapter 15 (optional) 2003 Dr S Q Khokhar 9 Sessions 11 & 12 Session 11: Business Leader Series : Talk by Mr. Zaffar A. Khan, President & Chief Executive Engro Chemical Pakistan Ltd. Session 12: Stock & Bond Valuation In this session we will examine various models for valuing common stocks. We will look into valuing dividend and non-dividend paying stocks. Here we will again deal with the correct cost of equity to be used in the valuation. In this session two main approaches full valuation approach and duration / convexity approach of valuing bonds will also be covered. We will concentrate on the full valuation approach, which is a relatively straightforward method for valuing bonds. The duration/convexity approach will be examined more carefully in the next course. Readings: B&H Chapter 10; RWJ Chapter 6 (optional) Article: Valance, N., Bright Minds, Big Theories, CFO, January Dr S Q Khokhar 10 5

6 Session 13: Capital Budgeting Sessions 13, 14 and 15 This session will utilize the knowledge gained in sessions 7-10 to enable us to evaluate various projects. We will discuss various capital budgeting techniques, such as Net Present Value, Internal Rate of Return, Pay Back Period among others. We will also discuss risk analysis in capital budgeting, as well as the characteristic of the optimal capital budget Readings: B&H Chapter 12; RWJ Chapters 7 9 (optional) Article: Migliore, R. H. and D. E. McCracken, Tie Your Capital Budget to Your Strategic Plan, Strategic Finance, June 2001 Session 14: Mid-term Examination Session 15: Capital Structure Policy One of the perplexing questions facing financial managers is, how much debt financing, as opposed to equity financing should a firm use? We will discuss some theoretical issues attached to the capital structure of a firm. The Modigliani-Miller models will be briefly introduced, but will be discussed in greater details in the next course Readings: RWJ Chapter 15; WBB Chapter 16 (optional) 2003 Dr S Q Khokhar 11 Sessions 16 & 17 Session 16: Dividend Policy In this session, we will discuss the dividend policy, which is the decision to payout earnings or to retain and reinvest them in the firm. We will discuss whether shareholders prefer cash dividends or capital gains. We will examine three well known theories of investor preference: i) The dividend irrelevance theory ii) The bird-in-the-hand theory iii) The tax differential theory Readings: B&H Chapter 18; WBB Chapter 17 Session 17: Financing through Common and Preferred Stocks When a firm s requirements for additional equity cannot be met by retained earnings, the company must sell new stock. In this session we will examine: the market for common stock, the decision to list a stock on an exchange and procedures for selling new stock. We will also discuss the characteristic of preferred stock Readings: B&H Chapter 17; WBB Chapters 18 (pages ) & 20 (pages ) and RWJ Chapter 13 (optional) Article: Gregory. N., and S. Tenev, The Financing of Private Enterprise in China, Finance & Development, March Dr S Q Khokhar 12 6

7 Sessions 18 & 19 Session 18: Long term Debt and Other Related Instruments In this session we will discuss various issues linked to long-term debt financing. We will examine the implications of bond rating, as well as the role of rating agencies. Other instruments, such as, leases and hybrid debt will also be covered. A brief introduction to financial distress / bankruptcy and liquidation / reorganization will also be presented Readings: B&H, Chapter 16; WBB Chapters 19 and 20 (optional) Session 19: Investment Banks and Other Financial Institutions In this session we will discuss the role of various financial institutions. In particular, we will discuss the role and activities of Investment banks. Investment banks are financial advisors to the corporate world and governments to raise finance in the capital markets. Investment banks also advise corporations in mergers, de-mergers, management buyouts and leverage buyouts Readings: B&H, Chapters 14 (pages ) and 15 Article: Myers, R., A Case for Conglomerates, CFO, March Dr S Q Khokhar 13 Session 20 Session 20: Corporate Control and Governance Here we will discuss the implications of corporate control and the hot topic of Corporate Governance. Under the umbrella of corporate control we will examine mergers and acquisitions, leverage and management buyouts. Corporate governance has received much needed publicity in the wake of Enron Saga. We will also discuss the characteristics of effective corporate governance systems Readings: B&H Chapter 20; Other hand outs to be given Article: Desai, R. and I. Goldberg, Stakeholders, Governance, and the Russian Enterprise Dilemma, Finance & Development, June Dr S Q Khokhar 14 7