University of Southern California s24

ATTENTION STUDENTS:

The following pages contain a SAMPLE syllabus for this course to give you a better idea of what you can expect to experience and learn in class.

This information may be from a previous semester.

All information is subject to change without notice. Please do not rely solely on this information for scheduling or to purchase any books or materials. You will get an updated syllabus from the professor specifically for Fall 2009.

If you have a specific question about the course or the course content, please contact the instructor or department directly as listed on the USC Schedule of Classes (www.usc.edu/soc).

of 8 UNIVERSITY OF SOUTHERN CALIFORNIA Marshall School of Business Fall 2008 FBE 529 Tuesday, Thursday Class Financial Analysis and Valuation

Instructor: Lloyd Levitin Office: Accounting 301E Office Hours: Tue., Thu. 3:30–5:30 P.M., or by appointment. Additional office hours will be scheduled before exams. Office Phone (USC): 213-740-6524 Office Phone (Home): 310-858-0260 Email Address: [email protected] (preferred method of communication) Teaching Assistant: Oren Tuchin. Email: [email protected] Course Website: On Blackboard http://blackboard.usc.edu

COURSE OBJECTIVE

Understanding what determines the value of a firm and how to estimate that value is a prerequisite for making rational business decisions. Entire industries (investment banking, securities analysis, and consulting) have grown prosperous providing valuation skills to investors and managers. The objective of this course is to give a general grounding in the valuation approaches used by successful practitioners. We cover discounted cash flow models, market multiple models which use comparables to obtain valuation estimates, residual income models, as well as specialized models used for M&A transactions, LBOs, and venture capital deals. The applications we cover include valuation of public and private companies, mergers and acquisitions, corporate restructurings, leveraged buyouts and venture capital deals. The course is of interest to those contemplating careers in investment banking, security analysis, consulting, private equity, and corporate finance. And it will also help with personal investing. The course will be in the form of lectures, discussions, and class problems.

By the end of the course, students should be able to:

 Value any publicly traded firm, small or large, healthy or troubled.  Value a private firm for sale to another person or company, or for purposes of going public in an IPO  Value a division of a firm for sale or purchase  Value the synergy in an acquisition  Understand the differences between intrinsic value and the publicly traded stock price  Assess whether a company is creating value  Pull apart the financial statements to get at the relevant information for valuing equities and to identify “red flags”

of 8 REQUIRED COURSE MATERIALS

1. Instructor’s Valuation Handbook to be posted to “Blackboard”. 2. Course Reader containing supplemental readings and Harvard Cases available at USC Bookstore. 3. Financial calculator capable of performing discounted cash flows (please bring calculator to each class).

INSTRUCTOR’S CORPORATE VALUATION HANDBOOK

Chapters from the Corporate Valuation Handbook will be posted as they are available. At the end of most chapters, there are a number of problems to solve. The Instructor plans to go over these problems, and provide solutions, in class as time permits. Be sure to bring these problems to class and be prepared to insert the solutions in the space provided for each problem. These problems, with solutions, will be an excellent resource for exams. Students are not required to work out these problems before class.

List of Chapters 1. Valuation: An Overview 2. A Guide To The Players 3. Where To Find Information 4. Financial Statements – What Do They Tell Us; How Can They Mislead Us? 5. Strategy and Financial Analysis 6. DCF Models – Enterprise Valuation 7. Other DCF Models 8. Market Multiples 9. Mergers and Acquisitions 10. Leveraged Buyouts 11. Restructuring 12. Advanced Valuation Issues

GRADING

Five Group Projects (written case analyses to be done in groups) 30% Two Midterms 30% Final Exam 30% Class Participation (individual) 5% Peer Evaluation (individual) 5% 100%

GROUP PROJECTS (30% of your grade); each team project is 6% of your grade).

Students are to organize themselves into a group of 4-8 by September 4 and elect a team leader who in turn notifies the TA of the names of group members by September 4. The due dates, and the requirements for each project are set forth in the attached Topics, Readings and Assignments. If you have problems finding a group, you must let the teaching assistant know by September 2, and he will assign you to groups already formed, and notify the welcoming group. Groups, once formed, cannot be changed

of 8 without unanimous written consent of all members. Grades on group projects will be posted to Blackboard. You have 2 weeks from the time of posting to inform the Instructor of any error in posting.

MIDTERM

Each midterm is 15% of your grade. The midterm will be closed-book, closed notes. Laptops or any hand-held device with email capabilities cannot be used in an exam. You should bring a calculator to perform calculations. If you are unable to take a midterm, the following rules apply:

(1) If you fail to inform me in writing before the midterm begins, you will receive a zero grade, even if you have a valid excuse. An exception will be made if you have a note from your doctor that you were unable to communicate your excuse. (2) If you inform me in writing before the midterm begins, and you have an acceptable excuse, then at my discretion, either a make-up exam will be given, or the score you receive on the other midterm exam will be doubled. (3) If you come to class to take the midterm, and then leave ill, you receive a grade based on work completed unless you provide a note from your doctor verifying the sudden illness.

FINAL EXAM (30% of your grade)

A final examination will be held in the regularly-scheduled final exam period for this class. The exam will be closed-book, closed-notes. Laptops or any hand-held device with email capabilities cannot be used. You should bring a calculator to perform calculations. The final exam is cumulative from the beginning of the course.

CLASS PARTICIPATION (5% of your grade)

Five percent of the course grade is awarded for class participation. In order to earn the full five percent, it is necessary:

(1) to display your name card during all classes (2) to attend class (you are permitted to miss three classes) (3) to not open your laptop (see below). (4) to discuss the assignment for the day when called upon.

LAPTOPS

Laptops should be closed during class. Make sure to bring printouts of any materials that you may want to refer to in the class discussion.

of 8 PEER EVALUATION (5% of your grade)

Study groups provide a valuable learning experience – how to work effectively and efficiently in groups (a common practice in Corporate America), learning from others, and sharpening a student’s ability to communicate to others. However, human nature being what it is, some students are tempted to relax and let others carry their load. In order to provide an incentive for all students to make maximum contributions to the study group, students will be asked to grade each team member’s contributions on a 0 to 5 point scale. This evaluation is to be submitted by an email to the Instructor before the last day of classes. Any team member that does not email his (her) evaluation of team members will be deemed to have given a 5 point score to each member of the team.

ABOUT YOUR INSTRUCTOR

Lloyd Levitin is a Professor of Clinical Finance and Business Economics at Marshall. He was Executive Vice President and CFO of Pacific Enterprises from 1982-1995 (now Sempra Energy), and was actively involved in the firm’s diversification program which included numerous acquisitions. He testified as an expert on utility diversification to the Senate Finance Committee of the U.S. Congress and recently has been a consultant for JurEcon, Inc., a nationwide consulting and research firm for management and counsel. He has a MBA from Wharton and a JD from University of San Francisco. He practiced as a CPA after receiving his MBA, and as an attorney after receiving his JD.

RESCHEDULED CLASSES

Classes for September 30, October 9, 14 and 21 are cancelled due to Jewish holidays. These classes will be made up on October 3, 10, and 17 at 2:00pm to 3:20pm at JKP 202. Students unable to attend these make-up classes will not be penalized and materials covered during these classes will be made available to students shortly thereafter.

UNCLAIMED PAPERWORK

Returned assignments unclaimed by a student will be discarded after two weeks, and hence, will not be available should a grade appeal be pursued by a student following receipt of his/her course grade.

EXTRA-CREDIT ASSIGNMENTS

In fairness to other students, there will be no extra-credit assignments. Requests for extra-credit assignments to make up poor performance on a test will not be granted.

ACADEMIC INTEGRITY

The use of unauthorized material, communication with fellow students during an examination, attempting to benefit from the work of another student, and similar behavior that defeats the intent of an examination or other class work, is unacceptable to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior resulting from the nervous tensions accompanying examinations. Where a clear

of 8 violation has occurred, however, the Instructor may disqualify the student’s work as unacceptable and assign a failing mark on the paper.

STUDENT DISABILITY

Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained from DSP. Please be sure the letter is delivered to be as early in the semester as possible. DSP is located in STU 301 and is open 8:30 AM to 5:00 PM, Monday through Friday. The phone number for DSP is (213) 740-0776.

of 8 TOPICS, READINGS AND ASSIGNMENTS Topics Discussed Date In Class Readings Group Projects Due 8/26 V.H. Chapter 1 8/28 V.H Chapters 2 and 3 9/2 V.H. Chapters 4; Understanding Financial Statements (HBS) 9/4 Tread Lightly Through Those Accounting Minefields (HBS) 9/9 V.H. Chapter 5 9/11 9/16 9/18 9/23 Home Depot Case (Project #1) 9/25 MIDTERM I (Chapters 1-5) 9/30 V.H. Chapter 6 10/2 Note: Valuing a Business Acquisition Opportunity (HBS) 10/7 Coke vs. Pepsi (Project #2) 10/9 V.H. Chapter 7 10/14 10/16 V.H. Chapter 8 10/21 Corporate Valuation and Market Multiples (HBS) 10/23 10/28 Nike Inc. Cost of Capital (Project #3) 10/30 MIDTERM II (Chapters 6-8) 11/4 V.H. Chapter 9 11/6 11/11 Acquisition of Conrail (Project #4) 11/13 V.H. Chapter 10 11/18 V.H. Chapter 11 11/20 11/25 Pinkerton (Project #5) 11/27 THANKSGIVING 12/2 Review Cross-Border Valuation (HBS) 12/4 Review 12/11 FINAL EXAMINATION 2-4 PM

V.H. = Valuation Handbook (posted to Blackboard)

of 8 Team Project #1

Home Depot, Inc. in the New Millennium (HBS 9-101-117)

Question 1. Assess Home Depot’s financial performance from 1986 to 1999. What explains the decline in performance in 2000?

Question 2. What is your estimate of the intrinsic value of Home Depot’s stock as beginning of 2001, assuming that it will have a constant growth rate of 6% and maintain its same ROE as in 2000? Prepare a sensitivity analysis varying the cost of equity and ROE.

Question 3. Compare Home Depot’s performance to that of Lowe’s.

Question 4. Analyze Home Depot’s Cash Flow Statements. Is Home Depot funding its investments out of internal cash flow or from external financing? Are dividends financed out of internal cash flow or by external financing? If Home Depot is using external financing, what percentage is debt financing? Common stock financing?

You may find reading the older Home Depot Case (HBS 188148) interesting to obtain the history before this case begins.

Team Project #2

Coke versus Pepsi, 2001 (Darden UV00089)

Question 1. What are the advantages and disadvantages of using EVA as a measure of company performance?

Question 2. Based on your examination of historical performances of Coca-Cola and PepsiCo in terms of EVA, what trends do you observe? What are the factors behind those trends?

Question 3. Calculate the WACCs for Coca-Cola and PepsiCo based on the latest data in the case (see Exhibit 8). Assume a 35% tax rate.

Question 4. Value the stock of Coca-Cola and PepsiCo at the end of year 2000 assuming a stable ROIC and growth at a constant rate. How does this value differ from the 12/4/00 share prices of Coke and Pepsi? What combination of WACC and growth rates will yield the 12/4/00 values? (Accept your forecasted ROIC, just change WACC and growth).

Instructors Note: You will find the term “invested capital” throughout the case. This is just another term for “total operating capital” which the Instructor uses in his materials. Also, in Exhibit 9, the case writer discusses adjustments to “NOPAT” and “invested capital” when calculating EVA. For simplicity, ignore these adjustments.

of 8 Team Project #3

Nike, Inc.: Cost of Capital (Darden UFA-F-1353)

Question 1. Do you agree with Joanna Cohen’s WACC calculation? Why or why not?

Question 2. If you disagree with Cohen’s analysis, calculate your own WACC for Nike.

Question 3. Based upon your computation of WACC, is NIKE over or undervalued?

Question 4. Compute EVA for 2002 using forecasted NOPAT for 2002 (Exhibit 2), total operating capital computed from Exhibit 3, and your estimate of WACC.

Question 5. Assuming the ROIC of 2002 remains stable for the long term, and growth is maintained at a constant rate, what is the value of Nike’s stock at end of 2001?

Question 6. Evaluate the DCF forecast in Exhibit 2 for reasonableness and comment on any assumptions that you would question.

Team Project #4

The Acquisition of Consolidated Rail Corporation (A) and (B) (HBS 9-298-006 and 9-298-095)

Question 1. What is the maximum amount CSX should pay for Conrail? Prepare a valuation range based on multiples and by discounting merger synergies.

Question 2. What is the maximum amount Norfolk Southern should pay for Conrail? Prepare a valuation range based on multiples and discounting merger synergies.

Team Project #5

Pinkerton (A)

Question 1. How can Wathen justify a $100 million bid for Pinkerton? Provide a range of values using the “high” and “low” forecasts in the case, and use the APV method for valuing Pinkerton.

Question 2. Value what Pinkerton is worth on a standalone basis to American Brands.

Question 3. Value what CPP is worth on a standalone basis (pre-acquisition) using the equity cash flow DCF method.

Question 4. If Wathen elects the $75 million financing alternative, what gain (loss) does he have on sale of 45% equity stake in combined enterprise?