Cases and Readings in Corporate Finance

FI 8320, Fall 2003 Cases and Readings in Corporate Finance

Instructor

Professor David C. Nachman Office: RCB 1239 Phone: 651-1696 email: [email protected] Office Hours: M W, 10:00 – 12:00 A. M., or by appointment Prerequisites

FI 8000 CSP: 1, 2, 6 Course Description

This course focuses on financial policy-making through case analyses, contemporary readings from the professional literature, and problem solving. The emphasis in the course is on investment and financing decisions and their impact on firm value and on capital market imperfections and their impact on the raising of corporate capital. The course also provides an opportunity for the study of additional topics of special current significance such as capital structure and dividend policy, corporate restructuring and the market for corporate control, real options, risk management, international capital budgeting and financing, financial planning and working capital management, project financing, reorganizations and advanced equity valuation. Course Material

Required text material • (BM) R. A. Brealey and S. C. Myers, Principles of Corporate Finance, 7th ed., McGraw- Hill/Irwin, Inc., 2003.

•(RP) Reading Packet

•(CP) Case Packet

FI 8320. Cases and Readings in Corporate Finance. 1 Prof. D. C. Nachman The required text (BM) and the materials that make up the Case Packet (CP) are available at the GSU Book Store. The Reading Packet (RP) is available at DocuWeb. Contents of (CP) and (RP) (with DocuWeb access instructions) follow at the end of this syllabus.

The CD-ROM that comes with your text has the Financial Tutor Series with three modules, PowerPoint presentations for the text, Financial Analysis Spreadsheet Templates (F.A.S.T.) tied to specific problems in the text, video clips and Web links that make using this text easier and more fun. The website for this text is www.mhhe.com/bm7e and has in addition chapter summaries with news, articles, links and PowerPoint slides for each chapter and some selected advanced topics. The PowerPoint slides for assigned material will be used in class.

The course is in the process of being put on the web. Many lecture notes and spreadsheets are available at my web site at http://www.gsu.edu/~fncdcn/website/index.htm, under Teaching, Cases and Readings in Corporate Finance. Make a copy of each and bring them to each class. I will try to alert you ahead of time when each will be covered.

Course Work and Grades

A topic outline with reading and case assignments follows. Each assignment should be done before the class for which it is scheduled and students should be prepared to answer questions and to partake in discussion in class on this material. Classes will be a mixture of lecture and discussion and problem solving.

Case Assignments. There are five cases assigned. These appear in boldface on the topic outline that follows. You must prepare each assignment before the class for which it is scheduled. Each assignment will be handed in for grading at the beginning of the class for which it is scheduled, so make a copy for class discussion and for your records. NO late work will be accepted.

Your solution to these assignments will be an individual effort. The case report consists of answering a list of questions pertaining to the case. The list of questions for each assignment follows at the end of this syllabus. The report must be typewritten, double-spaced, with one inch margins top, bottom, and sides. Please use a binder clip to secure your report. I must be able to see and read your work. Reports in improper format or improper use of the English language will be penalized severely. NO handwritten work will be accepted.

The case assignments require use of spreadsheets. If you use a spreadsheet or spreadsheet template that you get from my website of some other source, you must cite the source. Failure to do so is plagiarism. First offense gets you a grade of zero. Second offense gets you a grade of F for the course.

Exams. There will be two exams, a midterm exam (ME), and a final exam (FE). These exams will be multiple choice questions with a mix of verbal and problem type questions. (ME) This is an open book, open note exam based on the material covered prior to it. (ME) is scheduled for class 8, Monday, October 13, 2003. NO makeup exam will be given. (FE) This is an open book, open note exam based on all the material covered in the course. According to the Final Exam Schedule for Fall 2003, (FE) will be at 7:15 P. M., Monday, December 15, 2003. NO makeup exam will be given.

FI 8320. Cases and Readings in Corporate Finance. 2 Prof. D. C. Nachman Course Grade. A student's grade will be determined from a weighted average of scores on the exams and the case assignments using the following weighting schemes:

Scheme I Scheme II (FE) < (ME) (FE) > (ME) Case Assignments 40* 40* (ME) 25 20 (FE) 35 40

*Each case score counts eight percent for a total of forty percent.

Topic Outline and Reading/Case Assignments**

Class Day/Date Topic/Assignments.

1 M 8/25 Review and overview of financial management. (BM) Chapters 1-4. Financial Management, Value Creation Orientation, Economic Profit, A Firm’s Accounting Profit, lecture notes at website.

2 M 9/8 Net present value and other criteria. (BM) Chapter 5. Relevant cash flows. (BM) Chapter 6, Sections 6.1 - 6.3. Characteristics of an Evaluation Technique ..., Investments as Cash Flow Streams, Relevant Cash Flow, Projects One and Two, Payback Period, Accounting ROI, IRR Decision Rules, NPV Decision Rules, PI Decision Rules, MIRR Decision Rules, MIRR Procedures, lecture notes at website.

3 M 9/15 (CP) Case: Diamond Chemicals PLC. (A): The Merseyside Project. (BM) Chapter 11. (RP) “Corporate Strategy and the Capital Budgeting Decision,” Shapiro.

4 M 9/22 Real Options. (RP) Class Notes I – V. (BM) Chapter 20-22.

5 M 9/29 Continued. (RP) Class Notes VI. “Valuing Managerial Flexibility,” Trigeorgis and Mason, “To Wait or Not to Wait,” Corman, “Getting Real,” Mintz, “Real Options in the Digital Economy.” Kulatilaka and Venkatraman., “Exploiting Uncertainty,” Coy.

6 M 10/6 (CP) Case: Diamond Chemicals PLC. (B): Merseyside and Rotterdam Projects. Capital Structure. (BM) Chapters 13-16.

7 M 10/13 (ME) Midterm Exam.

F 10/17 Full Semester Midpoint

FI 8320. Cases and Readings in Corporate Finance. 3 Prof. D. C. Nachman 8 M 10/20 Capital Structure continued. (BM) Chapter 17, 18. Perfect Capital Markets, Irrelevance Propositions, Circular File, lecture notes at website. (RP) “After the Revolution,” Gifford.

9 M 10/27 Hypotheses for Explaining Capital Structure, lecture note at website. (RP) “The Determinants of Corporate Leverage and Dividend Policies,” Barclay, Smith, and Watts. (RP) “On Financial Architecture: Leverage, Maturity, and Priority,” Barclay and Smith.

10 M 11/3 (BM) Chapter 19. (RP) “Using APV: A Better Tool for Valuing Operations,” Luehrman. (CP) Note on Adjusted Present Value.

11 M 11/10 (CP) Case: MW Petroleum Corporation (A). (RP) “How Financial Engineering Can Advance Corporate Strategy,” Tufano.

12 M 11/17 (BM) Chapter 27. (RP) Class Notes VII.

13 M 11/24 (CP) Case: MW Petroleum Corporation (B). (RP) “Cover Your Assets,” Reason.

14 M 12/1 (RP) “Framework for Risk Management,” Froot, Scharfstein, and Stein, “A New Approach to Evaluating Natural Resource Investments,” Brennan and Schwartz.

15 M 12/8 (CP) Case: American Barrick Resources: Managing Gold Price Risk. Review.

**This topic/assignment outline provides a general plan for the course. Changes may be necessary. If such changes are necessary, they will be announced in class and students will be responsible for accommodating them. Withdrawals

The last day to withdraw from this course with the possibility of receiving a grade of “W” is Friday, October 17, 2003. This is the midpoint of the grading period. A grade of “W” is not automatic. When a student withdraws (or is withdrawn) from a course, University regulations (pages 50-52, GSU Graduate Catalog) require that the instructor assign the grade WF under any of the following circumstances:

(i) The student has been forced to withdraw because of excessive absences. The Department of Finance's policy is to deem absences of more than two weeks of classes in a full semester as excessive.

(ii) The student withdraws from the course before the midpoint of the grading period while doing failing work.

(iii) The student withdraws from the course after the midpoint of the grading period.

FI 8320. Cases and Readings in Corporate Finance. 4 Prof. D. C. Nachman Failing work (for item (ii) above) consists of having failed to earn a grade of C or better on exams taken and cases due by the date the student withdraws. Class Attendance

An attendance sheet will be passed around each class (perhaps more than once per class). It is your responsibility to see that you have signed the sheet. If you have not signed the sheet, you will be considered absent from that class. Any student who is absent for more than two classes, including the first class, will be dropped from the course. Keeping track of your attendance record is your responsibility. You will not receive any formal update of your attendance record. Late arrivals to any class will not be permitted to sign the attendance sheet. Academic Honesty

The Department of Finance adheres to the University's policy on academic honesty as contained in the Academic Regulations section of the GSU Graduate Catalog and in the Faculty Handbook and On Campus: The Undergraduate Co-Curricular Affairs Handbook. This section contains some examples of unacceptable conduct, such as plagiarism, cheating on examinations, unauthorized collaboration, etc. This policy applies to the homework, case assignments, and exams for this course.

Case Assignment: Diamond Chemicals PLC. (A): The Merseyside Project

1. What changes, if any, should Lucy Morris ask Frank Greystock to make in his discounted-cash-flow analysis? Why? What should Morris be prepared to say to the Transport Division, the Director of Sales, her assistant plant manager, and the analyst from the Treasury staff? 2. How attractive is the Merseyside project? By what criteria? 3. Should Morris continue to promote the project for funding? Case Assignment: Diamond Chemicals PLC. (B): Merseyside and Rotterdam Projects

1. Why are the Merseyside and Rotterdam projects mutually exclusive? 2. How do the two projects compare on the basis of Diamond Chemicals’ investment criteria? What might account for the differences in rankings? 3. Is it possible to quantify the value of managerial flexibility associated with the Merseyside project? How, if at all, does flexibility affect the economic attractiveness of the project? 4. What are the differences in the ways Elizabeth Eustace and Lucy Morris have advocated their respective projects? How might these differences in style affect the outcome of the decision? 5. Which project should James Fawn propose to the chief executive officer and board of directors?

Case Assignment: MW Petroleum Corporation(A)

FI 8320. Cases and Readings in Corporate Finance. 5 Prof. D. C. Nachman 1. Evaluate Amoco’s and Apache’s corporate objectives and strategies. Is it reasonable to expect that the MW properties are more valuable to Apache than to Amoco? What sources of value most plausibly account for the difference between buyer and seller? 2. Structure and execute a discounted cash flow valuation of all the MW reserves using APV. How much are the reserves worth? Is your estimate more likely to be biased high or low? What are the sources of bias? 3. How would you structure an analysis of MW as a portfolio of assets-in-place and options? Specifically, which parts of the business should be regarded as assets-in-place and which as options? What kinds of options are present? Should this approach yield a higher or lower value than the all-APV approach you employed above? 4. Execute the analysis you structured in question 3, beginning with assets-in-place. How risky are the assets that underlie the options; i. e., how would you estimate  for each? How much is the whole portfolio worth? 5. Assuming a sale goes through, how does Apache exercise each of the various options? When should it do so? Case Assignment: MW Petroleum Corporation (B)

1. What problems face Amoco and Apache in bringing this transaction to completion? What are the firms’ objectives? 2. What possible alternatives might exist to solve the stalled negotiations? 3. How can the proposed solution in Exhibit 7 be expressed in terms of financial contracts? Why do you think the deal is structured as given in Exhibit 7? 4. How much are the price-sharing and price-support arrangements worth? 5. Should Amoco accept the proposed deal from Apache, including the price-sharing and price-support arrangements?

Case Assignment: American Barrick Resources: Managing Gold Price Risk

1. In the absence of a hedging program using financial instruments, how sensitive would Barrick stock be to gold price changes? For every 1% change in gold prices, how might its stock be affected? How could the firm manage its gold price exposure without the use of financial contracts? 2. What is the stated intent of ABX’s hedging program? What should be the goal of a gold mine’s price risk management program? 3. What would convince you that a price risk management program created value for its shareholders ex ante? 4. How would you characterize the evolution of Barrick’s price risk management activities? Are they consistent with the stated policy goals? 5. How should a gold mine which wants to moderate its gold price risk compare strategies (using futures, forwards, gold loans, or spot deferred contracts) with insurance strategies (using options)? On what basis should these decisions be made? Once a firm has decided on either a hedging or an insurance strategy, how should it choose from among specific alternatives? 6. What is a “spot deferred contract?” Is it an option? a forward contract? Why has ABX chosen to rely on spot deferred contracts relative to other gold derivatives?

FI 8320. Cases and Readings in Corporate Finance. 6 Prof. D. C. Nachman Contents of (CP): items sold separately at GSU Bookstore

• Diamond Chemicals PLC. (A): The Merseyside Project, (UVA-F-1351, Version 1.4).

• Diamond Chemicals PLC. (B): Merseyside and Rotterdam Projects, (UVA-F-1352, Version 1.4).

• American Barrick Resources: Managing Gold Price Risk, (HBS 9-293-128).

• Note on Adjusted Present Value, (HBS 9-293-092).

• MW Petroleum Corporation (A), (HBS 9-295-029).

• MW Petroleum Corporation (B), (HBS 9-295-045).

Contents of (RP): at DocuWeb (access instructions follow)

Readings:

• A. C. Shapiro, 1985, Corporate Strategy and the Capital Budgeting Decision, Midland Corproate Finance Journal, 3: 22-36.

• L. Trigeorgis and S. Mason, 1987, Valuing Managerial Flexibility, Midland Corporate Finance Journal, 15: 14-21.

• L. Gorman, 1997, To Wait or Not to Wait, CFO, 13: 91-94.

• S. L. Mintz, 1999, Getting Real, CFO, 15: 52-60.

• P. Coy, Exploiting Uncertainty, Business Week, June 7, 1999, 118-124.

• N. Kulatilaka and N. Venkatraman, Real Options in the Digital Economy, Financial Times Mastering Management Review, October, 1999, 26-31.

• D. Gifford, 1998, After the Revolution, CFO, 14: 75-79.

• M. J. Barclay, C. W. Smith, and R. L. Watts, 1995, The determinants of corporate leverage and dividend policies, Journal of Applied Corporate Finance, 7: 4-19.

• M. J. Barclay and C. W. Smith, 1996, On financial architecture: leverage, maturity, and priority, Journal of Applied Corporate Finance, 8: 4-17.

• T. Luehrman, 1997, “Using APV: A Better Tool for Valuing Operations.” Harvard Business Review, May-June: 145-154.

FI 8320. Cases and Readings in Corporate Finance. 7 Prof. D. C. Nachman • K. A. Froot, D. S. Scharfstein, and J. C. Stein, 1994, A Framework for Risk Management, Journal of Applied Corproate Finance, 7: 22- 32.

• M. Brennan and E. Schwartz, 1993, “A New Approach to Evaluating Natural Resource Investments,” in The New Corporate Finance: Where Theory Meets Practice, D. Chew, ed., New York, McGraw Hill.

• P. Tufano, “How Financial Engineering Can Advance Corporate Strategy,” Harvard Business Review, January-February, 1996, 136-146.

• T. Reason, 2001, “Cover Your Assets,” CFO, 17: 33-36.

Class Notes: These are also at the website for this course.

I. Investment Decisions

II. Option to Defer Investment: A Simple Example

III. A Primer on Option Pricing

IV. Two Valuation Heuristics

V. Risk Neutral Valuation

VI. Oil Extraction Problem

VII. Investment Incentives and Risk Management

Access Instructions:

Please provide your students with the following steps to use the DocuWeb System after they have connected to the URL: http://docuweb.gsu.edu

1. Login with USER NAME and PASSWORD (both to be given in class). 2. Click on the course name in the left frame. 3. Click on a reading selection from the window in the right hand frame. 4. Click on the View button below the list of readings. Your first view of the document will be a fast loading single page at a time version for viewing only. 5. Click on a thumbnail page for a full-screen view or ... 6. Click on the green lettered "PRINT - download" to print the entire file. 7. Select the green "PRINT - download" option again to download the high resolution PDF version for printing. Then click on the small printer icon above the displayed document. 8. In the final Print window here you select the page range and number of copies check on "Fit to Page" and "Print as Image". 9. Select the "Help" option above the red bar at any time for detailed instructions.

FI 8320. Cases and Readings in Corporate Finance. 8 Prof. D. C. Nachman As an alternative, you may find it easier after logging in to click on the "Search" option above the red bar, then select your class name and click on the blue "search" button at the bottom of the screen. The Search display provides more details including authors.

Downloading the PDF printfile requires that the Adobe Acrobat Reader software be installed on the computer. This software is already installed on all GSU lab and library PCs and is available for free from www.adobe.com/prodindex/acrobat/readstep.html . After downloading the program file remember to run it (choose Start-Run-Browse and select the file "rp500enu.exe" that was just downloaded. After the software is installed you should have an Adobe Acrobat 5.0 icon on your desktop and the next time you access a pdf file on the web your browser will automatically recognize it.

NOTE: Downloading print files will work 10-100 times faster from a PC at GSU in the Library or any of the computer labs on campus as opposed to trying it at home over a modem and phone line. Printing at GSU is free for the first 150 pages and costs 5 cents per page thereafter. A free computer account can be established at the main computer lab on the first floor of the Library South building.

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FI 8320. Cases and Readings in Corporate Finance. 9 Prof. D. C. Nachman