FIN 374C Financial Planning and Policy for Large Corporations

Fall 2013

Alejandro H. Drexler

, phone 232-6826, office CBA 6.316

Office Hours: Tuesday & Thursday 11:15-12:15, and by appointment at other times

Course Overview

The objective of this course is to develop an understanding of the decisions financial managers face. The core part of the course will provide students with practical tools and methods to value a broad range of assets/projects and to choose the best financing strategy.

The course starts with a broad overview and discussion of valuation techniques. There are a number of different ways to estimate the value of an asset, and it is many times recommended to use more than one valuation method. Following the overview of valuation techniques, we start with methods for calculating the discount rate used in cash flow valuation methods. Our discount rate discussion involves determining the firm’s cost of capital – both debt and equity capital – and the effect of leverage (debt) on the firm’s cost of equity and the firm’s overall cost of capital. Following our discount rate discussion we cover valuation effects of a firm’s capital structure.

After our discount rate and capital structure classes we start coverage of cash flow valuation techniques used to value businesses and equity. We start with the discounted cash flow method (DCF), which is the most widely used cash flow valuation method. DCF valuation models are well-suited for sensitivity analysis, and we will cover methods for modeling the effects of varying material inputs of the DCF model. Cash flow valuation methods include many uncertain inputs, and sensitivity analysis help reveal the effects of varying the major inputs of the valuation. Following the DCF work we will cover two additional cash flow valuation methods, the Adjusted Present Value method (APV) and the Capital Cash Flow method (CCF), and work a Harvard Business School (HBS) case covering the DCF, APV, and CCF methods. After our coverage of cash flow valuation methods, we will cover the use of relative valuation multiples (e.g., EV/EBITDA, P/E). We conclude the section on business and equity valuation with a discussion of control premiums and liquidity discounts, and a look at valuation in both LBO and M&A contexts.

The course also covers the valuation of options. Option valuation tools are some of the most powerful valuation tools developed in financial economics. In this class we are going to focus on option valuation applied to real projects. The idea is that if the project we are valuating has a cash flow structure that is similar to the cash flow of an option, then we can use the value of the option to improve the valuation of the project. We will work a HBS case related with this matter.

Finally we discuss how the capital structure we choose to finance a project will affect the incentives of the different parties involved in the project; managers, equity holders, bond holders and potential investors.

Prerequisites:

FIN 357

Books and Materials:

(Required) Lecture Notes and Class Handouts

·  These will be available on Blackboard as the course develops.

(Optional)

·  Sheridan Titman and John H. Martin, Valuation: The Art and Science of Corporate Investment Decisions, Pearson Education, Inc.

·  Robert C. Higgins, Analysis for Financial Management, Irwin/McGraw-Hill.

Note that there is no required textbook. A good attendance and a careful study of the notes, handouts and other material given out in classes should be enough to do well in the course.

Other Sources

·  The Wall Street Journal, Financial Times, the New York Times business section, the Economist, or Business Week are all recommended (pick one). We will cover the conceptual material to help you think through financial decisions. However, details of a particular issue a recruiter might ask your thoughts on may come from the press.

Cases For The Class

1.  Sampa Video, Inc. (HBS 9-201-094), can be purchased on line http://hbr.org/product/sampa-video-inc/an/201094-PDF-ENG?Ntt=sampa

2.  Arundel Partners (HBS 9-292-140), can be purchased on line http://hbr.org/product/arundel-partners-the-sequel-project/an/292140-PDF-ENG?Ntt=arundell

Homework Assignments

Assignment 1: Will cover NPV, APV and WACC

Assignment 2: Will cover capital structure, mergers, VC, options

Grading:

Exam 1 25%

Exam 2 25%

Exam 3 25%

Exam 4 25%

·  Grades will be assigned according to the following criteria:

A (4.0) 10%

A- (3.67) 15%

B+ (3.33) 25%

B (3.0) 40%

B- or below (2.67) 10%

How to do well on the exams:

·  Problem sets and in-class exercises provide the best preparation for the exams. Even if you work in groups make sure you are able to replicate the calculations of all the assignments you hand in. That is the best way to do well in the exam.

·  The exams will be open book. Computers are not allowed during exams. Calculators are A MUST for the exams; please do not forget to bring one.

·  If you miss an exam due to a personal emergency, please inform me in advance. No make-up exam will be administered for exams 1, 2 and 3. If you miss exam 1, your exams 2, 3 and 4 will count 33.3% each, if you miss exam 2 your exams 3 and 4 will count 37.5% each (note that exam 1 will still count 25%), if you miss exam 3 your exam 4 will count 50% (note that exams 1 and exam 2 will still count 25% each). A make-up exam will be administered for people who miss exam 4 for a medical reason.

Students with disabilities

Upon request, the University of Texas at Austin provides appropriate academic accommodations for qualified students with disabilities. Services for Students with Disabilities (SSD) is housed in the Office of the Dean of Students, located on the fourth floor of the Student Services Building. Information on how to register, downloadable forms, including guidelines for documentation, accommodation request letters, and releases of information are available online at http://deanofstudents.utexas.edu/ssd/index.php. Please do not hesitate to contact SSD at (512) 471-6259, Video Phone: (866) 329-3986 or via e-mail if you have any questions.

FIN 374C – FINANCIAL PLANNING AND POLICY FOR LARGE CORPORATIONS
day / date / class / Topic / reference
TH / 29-Aug / 1 / Review of main accounting concepts. Free cash flow estimation / H, C1
T&M, C2
TU / 3-Sep / 2 / Discussion of Valuation Methods. Discounted cash flow (DCF) theory and example / H, C9
T&M, C2
TH / 5-Sep / 3 / Discount Rate: The CAPM. Risk premium. Estimation of betas theory / T&M, C4
TU / 10-Sep / 4 / Estimation of betas example. Alternatives to CAPM. Example of cost of equity estimation / T&M, C4
TH / 12-Sep / 5 / Estimation of cost of debt. Introduction to WACC. Cost of debt and trade off theory / T&M, C4
TU / 17-Sep / 6 / Frictions: Taxes and Bankruptcy costs. Conflict between debt-holders and equity holders. Weighted average cost of capital (WACC) / Higgins,
C6
TH / 19-Sep / 7 / Example of WACC. Sensibility analysis / H, C3
T&M, C7
TU / 24-Sep / 8 / Valuing a Company using the WACC model. HOC case (HW Assignment 1 DUE at the beginning of the class)
TH / 26-Sep / 9 / EXAM 1
TU / 1-Oct / 10 / Adjusted Present Value (APV) Theory / T&M, C7
TH / 3-Oct / 11 / APV example. Example of consistency between APV and WACC
TU / 8-Oct / 12 / Valuation Case 1: Sampa Video, Inc.
(Valuation Case 1 DUE at the beginning of the class)
http://hbr.org/product/sampa-video-inc/an/201094-PDF-ENG?Ntt=sampa
TH / 10-Oct / 13 / Valuation using multiples
/ T&M, C6
TU / 15-Oct / 14 / Other valuation methods. Introduction to Mergers and Acquisitions
day / date / class / Topic / reference
TH / 17-Oct / 15 / Mergers and Acquisitions
TU / 22-Oct / 16 / EXAM 2
TH / 24-Oct / 17 / Leverage Buyout / T&M, C8
TU / 29-Oct / 18 / No arbitrage theory and Law of One Price
TH / 31-Oct / 19 / Introduction to Options / H, C5
T&M, C10
TU / 5-Nov / 20 / Option Pricing / H, C5
T&M, C10
TH / 7-Nov / 21 / Black-Sholes and Introduction to Real Options / T&M, C10
TU / 12-Nov / 22 / EXAM 3
TH / 14-Nov / 23 / Valuation of Real Options / T&M, C11
TU / 19-Nov / 24 / NPV and Real Options , Valuation Case 2: Arundel Partners.
(Valuation Case 2 DUE at the beginning of the class) http://hbr.org/product/arundel-partners-the-sequel-project/an/292140-PDF-ENG?Ntt=arundell / T&M, C11 C12
TU / 21-Nov / 25 / Venture Capital / H, C9
T&M, C8
TH / 26-Nov / 26 / Managerial Compensation
(HW Assignment 2 DUE at the beginning of the class) / T&M, C9
TU / 3-Dec / 27 / Review Session
TH / 5-Dec / 28 / EXAM 4