Syllabus FIN 540 Corporate Finance I Fall Semester 2015

Transcription

1 Syllabus FIN 540 Corporate Finance I Fall Semester 2015 Course Outline Week Type Topics covered 1 Lecture 1 Introduction, Shareholder Value Models, and the Modigliani-Miller-Theorems Revisited 2 Lecture 2 Value Drivers 3 Lecture 3 Costs of Capital and Financial Structure 4 Lecture 4 Discounted Cash Flow Valuation 5 Case 1 Who is Who? Identifying companies from their financials 6 Lecture 5 Capital Structure and APV, Residual Income Valuation and Financial Ratios 7 Case 2 Ameritrade 8 Lecture 6 Event Studies, Initial Public Offerings 9 No class! 10 Case 3 Puma 11 Lecture 7 Review Session 12 Case 4 ThyssenKrupp 13 No class! 14 Case 5 LinkedIn 15 Exam 1. Lecture: Introduction, Shareholder Value Models, and the Modigliani-Miller- Theorems Revisited Session I (3:30-4:15): Introduction to the curriculum This lecture introduces the Corporate Finance cycle for 2015/2016 and provides an overview of the subjects studied, the teaching methods and also explains the method of evaluation. Session II (4:30-6:45): The Modigliani-Miller-Theorems revisited We will revisit the Modigliani-Miller theorems and introduce the concept of capital structure policy. Finally, we will introduce the notion of shareholder value and discuss the objective of the firm. Downloadable Files: Introduction to the course, Lecture notes on shareholder value. Readings: Berk/DeMarzo, chapter 14 discusses the Modigliani-Miller theorems, we will cover the material on taxes later in the term. Chapter 16 provides a more extensive analysis of the relationship between capital structure and managerial incentives. Chapter 16.6 discusses the free cash flow theory. Further Readings: Karen Hopper Wruck, Financial policy, internal control, and performance - Sealed Air Corporation's leveraged special dividend, Journal of Financial Economics 36 (1994), pp Grinblatt / Titman, chapter , chapter and chapter 18.4 offers an alternative to Berk/DeMarzo. 1

2 2. Lecture: Value Drivers We analyze the channel through which managerial decisions and the company' s strategy affect shareholder value. We identify value drivers as the key link between strategy and the main components of value, cash flows, and the cost of capital. We will also see how value drivers can be identified from balance sheet information using financial ratios. Downloadable files: Lecture notes on value drivers, Excel table with statistics on value drivers, Perpetuity model with earnings and cash flow calculations (this spreadsheet includes macros) Readings: There is no textbook treatment of the subject that is close to the presentation of the lecture, which leans heavily on Rappoport's book (Alfred Rappaport, 1986, Creating Shareholder Value - The New Standard for Business Performance, New York, The Free Press). Weston/Mitchell/Mulherin, chapters 9 and 10 cover value drivers and the percent of sales-approach. Palepu/Healey/Bernard/Peek, chapter 5 covers financial ratios. Berk/DeMarzo cover financial statement analysis in chapter 2 and cash flow projections based on an application in chapter Lecture: Costs of Capital and Financial Structure We will introduce the concept of the cost of capital. We will show that the costs of capital depend on the risk characteristics of projects and can be different across the divisions of a corporation. The analysis will be based on the concept of a tracking portfolio. We will also discuss how to use alternative cost of capital formulae and how to apply the capital asset pricing model (CAPM). These concepts are foundational for many subsequent applications. Downloadable files: Lecture notes on the cost of capital, Excel table on cost of capital and structural breaks. Readings: The cost of capital is discussed in Berk/DeMarzo, chapter 12. For an application see also Berk/DeMarzo, chapter Unlevering and relevering of betas is covered in Berk/DeMarzo, chapter 14.3 and the project-based costs of capital in Berk/DeMarzo, chapter Further Readings: Grinblatt/Titman, chapter 11; this chapter presumes that you are familiar with portfolio theory and the capital asset pricing model at the level of an intermediate finance course. If you need to review these materials, then you should consult Grinblatt/Titman, chapters 4 and Lecture: Discounted Cash Flow Valuation We will introduce and discuss discounted cash flow methods for company valuation: The dividend discount model, the discounted cash-flows method, and the flow to equity method. We will distinguish these approaches and highlight their advantages and pitfalls. We will also discuss why DCF and the DDM are the correct methods for valuing companies. Downloadable files: Lecture notes on DCF, Excel table on DCF, Excel-spreadsheet with Three-Stage- Model. Readings: The dividend discount model is covered in Berk/DeMarzo, chapter 9.2, and the basics of DCF valuation are covered by Berk/DeMarzo, chapter 9.3. Berk/DeMarzo discuss the Modigliani-Miller dividend irrelevance proposition in chapter 17.2 and the Flow-to-Equity method in chapter Further Readings: Grinblatt/Titman have a chapter on this (chapter 9), which is somewhat disappointing for an advanced course. Weston/Mitchell/Mulherin (chapters 9 and 10) is better. A more practical ("cookbook") approach is offered by Damodaran, who wrote various books on valuation (Damodaran on Valuation, Wiley) and also provides many materials (overheads, spreadsheets, data) on his website (follow links to "Valuation"). The book by Benninga and Sarig (Corporate Fiance - A Valuation Approach, McGraw Hill) is good on pro forma forecasting and some other details of valuation, but has an idiosyncratic take on taxes. 2

3 Case 1: Who is Who? Identifying companies from their financials Task: The case study text gives you brief characterizations of companies regarding their lines of product, their business strategy or recent history. Based on the information provided in exhibit 1, please decide which balance sheet and income statement belong to which company. Give detailed reasons for your decision. Please note that all figures in exhibit 1 are normalized (sales = 100, total assets = 100). Downloadable files: The case as well as case exhibits can be downloaded from the according folder on ILIAS. 5. Lecture: Capital Structure and APV, Residual Income Valuation and Financial Ratios Session I ( ): Capital Structure and APV Taxes change some of the results from the previous units and introduce additional complications because the Modigliani-Miller irrelevance results need to be modified. In principle, there are two alternative ways to incorporate the impact of taxes into valuation analysis. The first approach adjusts discount rates and modifies the weighted average cost of capital (WACC). The second approach adjusts cash flows and is referred to as adjusted present value (APV). We will discuss a tax perspective on optimal capital structure and analyze how WACC formulas, formulas for unlevering betas and DCFcalculations need to be adjusted to properly take into account taxes. Downloadable files: Lecture notes on Capital Structure, Excel table with APV valuation. Readings: Berk/DeMarzo discuss the WACC-method in chapter 18.2 and the APV-approach in chapter 18.3 and chapter Further Readings: Grinblatt/Titman, chapter 13. Session II ( ): Residual Income Valuation and Financial Ratios This unit discusses how accounting numbers can be used in a different way to value companies. The residual income approach to company valuation relies on the book value of equity and the concept of residual (abnormal) earnings. In addition, multiples or financial ratios sometimes provide a useful shortcut where the implicit forecasts of the market for comparable companies are transferred to the company to be valued. We will discuss the issues in using multiples and their comparative strengths and shortcomings. Downloadale files: Lecture slides on Residual Income, note on Residual Income, lecture slides on Financial Ratios, Excel table on Multiples. Readings: Palepu/Healy/Bernard/Peek, chapter 5, 6 & 7. Further Readings: Financial Ratios are discussed in Berk/DeMarzo, chapter 9.4, and chapter Case 2: Nike This case puts you in the role of a portfolio manager who considers an investment in Nike. The crucial assumption here centers around the calculation of the weighted average cost of capital (wacc). You should evaluate the wacc calculation provided by your assistant. Do you agree with Joanna Cohen s WACC calculation? Why or why not? Carefully check her methodology. Which assumptions are implicit in the WACC method and are they satisfied for Nike? Calculate your own WACC for Nike and justify your assumptions and when and why you deviate from those of Joanna Cohen. 3

4 Calculate the costs of equity using the CAPM and the dividend discount model (DDM). Why are they different? Justify your assumptions. What should Kimi Ford recommend regarding the investment in Nike? This case has to be purchased (you can do this at the secretary s office, Mon-Thu, 9:00am-1:00pm, Sep 11-Sep 17). Case exhibits can be downloaded from the according folder on ILIAS. 6. Lecture: Event Studies, Initial Public Offerings Session I ( ): Event Studies In an event study, the reaction of the stock price to a specific event is analyzed with statistical tools. This method is frequently used in corporate finance research. The unit presents the event study methodology in detail. It should enable participants to understand and properly interpret the results of event studies and to conduct event studies on their own. Downloadable files: Lecture slides on Event Studies, Excel tabel with Event Studies. Readings: Event study methodology relies on the notion of (semi-strong form) market efficiency and the discussion presumes that you are familiar with that concept, otherwise consult Brealey/Myers/Allen, chapter 13 or an equivalent treatment. Grinblatt/Titman, chapter 19 offers a discussion of the economic intepretation of event studies, but does not discuss the practical problems and statistical issues at all. Weston/Siu/Johnson chapter 6 Appendix B provides a good discussion including an application example. Further Readings: Campbell/Lo/McKinlay, chapter 4 covers the relevant statistical tools, but this is a PhD-level text that goes beyond the requirements of this class. Session II ( ): Initial Public Offerings The decision to go public and issue capital in public equity markets is one of the most complex decision in corporate finance. We discuss some institutional features as well as some basic models to understand the IPO-process. The valuation of IPOs still puzzles financial researchers and we will address these puzzles and some of the answers. Downloadable files: Lecture slides on IPOs. Readings: Berk/DeMarzo, chapter Further Readings: Grinblatt/Titman, chapter 3. Case 3: Puma 1. Puma's profit margin decreased from 16.8 to 16.1 percent in Consensus earnings forecasts for fiscal 2006 (see Exhibit 1) indicate that analysts expect a further decline in Puma's profit margin to 11.1 percent. a. On which strategic factors do Puma's future profit margins critically depend? b. Do you expect these factors to change over the coming years? 2. Assume that investors had perfect foresight of one-year-ahead earnings at the end of each fiscal year between 1993 and Which long-term growth rate assumptions are consistent with the observed end-of-year share prices between 1993 and 2004? Hint: You can solve an appropriately simplified valuation formula for the growth rate. Carefully justify your assumptions and how you parameterize the model. 3. Forecast the one-year-ahead earnings and the long-term earnings growth rate at the end of the fiscal year Justify your results. 4

5 4. Given your expectations about one-year-ahead earnings and long-term earnings growth, what is the value of Puma's shares at the end of fiscal year 2005? How sensitive are your results to your assumption about the long-term growth rate? Case 4: ThyssenKrupp 1. Analyze the reasons for and against the rating change. Think of arguments for and against considering pensions as equity or as debt. Is S&P's methodology coherent before the change in its methodology? After the change? Is the "on balance-sheet" approach suggested by the academics better? Is ThyssenKrupp right in arguing that its rating should not change? 2. Analyze the reaction of stock and bond prices (Exhibits 10 and 11) and comment on the reaction of capital markets to the announcement. How much value was lost for shareholders, bondholder, and for the company as a whole? Which potential problem occurs when interpreting the stock market reaction in terms of the downgrade of S&P? 3. Did this event change the cost of capital for ThyssenKrupp? Management argues that financing costs will increase by EUR 20 million annually. Does this have a significant - if any - impact on the overall cost of capital? 4. Assuming a "BB" rating for ThyssenKrupp, what is the default risk for a one-year horizon? Use these data to work out the increase in the likelihood of default for the rated bonds that were due in February 2009 implied by a rating change from BBB to BB. Compute the impact of the downgrading from BBB to BB on the present value and yield of the bonds due to February Lecture: Review session Students have the opportunity to ask questions about the material of the entire term 13. Case 5: LinkedIn This case is set in early July 2011, seven weeks after LinkedIn Corporation's initial public offering. Its purpose is to help students critically evaluate the market value of LinkedIn's stock following its recent IPO. The case illustrates the challenges of valuing an early-stage high-growth company when there is great uncertainty about its fundamental value and when quoted prices might reflect expectations that are hard to justify. 1. What set of assumptions underlie the $9 billion market valuation for LinkedIn as of the end of July 7, What is your assessment of those assumptions? Note that, based on the first seven weeks of trading for LinkedIn's stock, its estimated beta is What do you think LinkedIn's intrinsic value is? Be ready to support your conclusions. For example, if you use comparables, what companies and metrics do you use? 3. If you wanted to buy LinkedIn's stock, would you be willing to pay more than the value you derived in question (2)? 4. What other factors (e.g, low float, dual class of shares) may be contributing to LinkedIn's market valuation? 5