Transcript FINANCE 541 - Seattle University

FINANCE 580
Cases in Managerial Finance
Today’s class...
• Introductions and house keeping
• Financial planning and analysis
• Seminal ideas in corporate finance
My Background
•
•
•
•
NAME: Ken Shah
BORN: Bombay, India
PhD:
University of Oregon
INDUSTRY EXPERIENCE:
– 4 yrs Floor Trader / Stock Broker - Bombay Stock
Exchange
– 3 yrs Quantitative Portfolio Management Research,
Portland, Oregon
Academic Experience
• Taught at
– University of Oregon
– University of Auckland
– Southern Methodist University
• Courses in capital budgeting, corporate finance,
investments, and money and banking
Recent Research
• Analyst Forecasts
• Bond Returns
• M&A Fairness Opinions
• Capital Structure
• Initial Public Offerings
Course Objectives
• Expose you to anticipated managerial decisions in
finance
• Inculcate financial way of thinking
• Bridge theory and practice
• Increase proportion of good financial decisions to bad
ones!!
Course Prerequisites
• Willingness to learn & work hard!
• Understanding of:
–
–
–
–
Financial statements
Rudimentary statistics
Spreadsheets
Fundamentals corporate finance
• Valuation, M&M propositions, agency theory
• Pre-requisite: FINC 515
Anticipate...
• About 5 hours of work outside of class
per week
• Frustrations with unstructured problem solving!
• Frustrations with computer work!
Texts
• Required:
– Bruner, Case Studies in Finance (online – no
physical text)
– Packet of Readings – at Copymart
• Optional:
– Brealey & Myers, Principles of Corporate Finance
– Higgins, Analysis for Financial Management
Evaluation
•
•
•
•
•
Group Case Presentation
Participation
Midterm Case
Final Case
TOTAL
• * Please correct the syllabus
300
100
300*
300*
1000
Grading Policy
• If you attend all classes and diligently complete
all required work, you would be assured of a Bgrade
• In order to get an A/A-, you must show work of
superior quality and make a meaningful
contribution to the class discussions
– roughly top 15% of the class
Class Attendance
• Mandatory
– Discussion particularly important in a case class
• Please inform me of anticipated absences
– More than 1 absence will adversely affect your grade
• Please include in email subject “FINC 580 F06”
– Please send an introductory email and feel free to
tell me about yourself, and any concerns/absences
you anticipate
Case Presentations
• About 30-40 minutes in length
• Formal write-up & Class Handout
• Field questions
Non-presenting students
• Demonstrate preparedness
• Come to class with analytical solution
– E.g. see Gulf Oil solution
• No formal write-up
Midterm & Final
• Formal 3 page case analytical solution
• Take home
• One week to complete
• Individual effort
Readings
• Required:
– Please be prepared to discuss them in class
• Background:
– To expose you to practice, analysis, and theory in
the case subjects
– Necessary but not explicitly discussed
Course Design
Growing Pains - Private enterprise
Midlife crisis - Managing growth
Over the hill - Restructurings
Case Progression
• Managing Growth / Private enterprise:
– Short term financing / Managing growth
– Going public
– WACC
• Sustaining Growth / Financing Policy:
– Payout policy
– Capital structure policy
• Lower Growth / Corporate Reorganizations:
– Takeovers
– LBOs
– Bankruptcy
Cases...
• Are deliberately vague!
• Have information deliberately presented in
random order - not in the order of importance
• Offer little guidance on method of solution
Case Solution Strategy
• Reading the case
– First time just read it like a magazine article – look at
forest, not the trees
– Leaf through the exhibits
– Go back and read it more thoroughly taking notes
Develop your awareness
• Who are the decision makers and what
pressures do they face?
• What is the business of the company?
• What are the goals of the firm?
• How well has the firm performed in its pursuit of
the goals?
Defining the problem
• Common trap – symptom not the real problem
• Believability of key assumptions
• Assumptions drive results
Analysis
• Run the numbers and go to the heart of the
matter
• Perform analysis on key assumptions
• Get down to the key bets
• Get to business issues quickly
Recommendation
• Prepare to participate: take a stand
• In Class: Participate actively in support of your
conclusions but be open to new insights as they
emerge
• Trust the process:
– Case learning is cumulative over time
My approach to a case...
•
•
•
•
•
•
•
•
Read it twice, ignore numbers
List all issues
Rank issues in order of importance
Articulate the central issue
Identify relevant theory and evidence
Formulate assumptions for analysis
Perform data analysis
Recommend a course of action
Repeat
Analyzing a case...
• At first, see the forest, not the trees
• Analyzing numbers is necessary but NOT an end
in itself
– it is presumed that you know how to analyze
numbers
• Put yourself in the shoes of the decision maker
Analyzing a case...
• Identify the decision makers and their pressures and
stakes in the situation
• Thoroughly understand the nature of the business,
product, firm’s competence, competitors, structure of
the industry etc.
• What are firms goals? How well has it pursued them?
– DuPont, ratio analysis, growth rates, measures of value
creation
Analyzing a case...
• Is the problem at hand a symptom of a larger
problem?
– E.g. a lender is often asked to provide cash to tide
over shortfall.
• Study may reveal that it’s really the product
obsolescence, unexpected competition etc.
Analyzing a case...
• An executive rarely thinks of a problem as an
exercise in forecasting techniques or discounting
method
• But rather, thinks of it as a problem of
judgement, deciding on which people, concepts
or environmental conditions to bet.
• Get the #’s right - but go further!!
• Prepare to take a stand - and defend it!
Case Write-up
• Do NOT simply regurgitate the information in the
case in your introduction to the case
• Distill and analyze the information and present it
only if you believe it has an impact on your
analysis and solution
Learning from case method
• It’s not passive - the more you participate and
think, the more you learn
• It’s cumulative - should not measure the success
of your progress on the basis of any single case
discussion
– You will arrive at a better understanding over time,
after many cases - sometimes after the course is
over!
Financial Planning
• Analyze financing and investment decisions
• Project future consequences of present
decisions
• Decide on which alternative to undertake
• Measure subsequent performance against goals
Elements of Financial Planning
• Forecasting
– Pro-forma statements
• Finding the optimal financial plan
– Analysis
• Watching the plan unfold
Analyzing performance
• Financial ratios
• Beware of accounting definitions
• Choosing a benchmark
– trend over time
– industry counterparts (Dept. of Commerce, Dun &
Bradstreet, Robert Morris Assoc.)
Analytical Tools
• Sensitivity (what-if) analysis
• Scenario analysis
• Monte Carlo simulation
• Decision Trees
Sensitivity Analysis
• Analyze the impact of changing a single variable
one at a time
– e.g. Formulate “Optimistic”, “Pessimistic”, “Expected”
cases
• Identifies key variables
• Ignores interrelations among variables
Scenario Analysis
• Consider alternative plausible combinations of
variables
• Account for interrelations among variables
– e.g. rise in oil prices -> increase scooter sales AND
increase costs
• Overcomes limitations of sensitivity analysis
Monte Carlo Simulations
• Model the strategy
• Identify key variables
• Draw from probability distributions of key
variables
• Calculate results of strategy
• Do that many, many times (computer)
• Get distribution of outcomes
• Range of answers - difficult to reconcile
Decision Trees
• Used for sequential decisions
• Evaluate decisions at each node starting
backwards (reverse iteration)
• Compute expected value
• Trees can quickly become complex
• Incorrect handling of risk (discount rate)
Is theory a dirty word?
• Theory is simply an exercise in ridding
distractions
• It can aid to clarify thinking
• However, theory for its own sake serves no
useful purpose
• Theory does provide a framework to start the
analysis
Caution…
• Do not try to force a solution to fit the theory
• Real world problems cannot conform to theory precisely
• Common techniques and theory’s guidance must be
adapted to suit the problem at hand
• Do not take ‘cookie cutter’ approach!
Bridging Finance Theory and
Managerial Finance...
• CAPM
– NPV, capital budgeting, WACC
• Modigliani-Miller Propositions
– Dividends, capital structure, WACC
• Agency Theory
– Corporate governance, compensation, optimal contracts
• Asymmetric Information Models
– Signalling, stock price reactions
• Option Pricing
– Risk management, real options in capital budgeting
CAPM
• Widely used in NPV, capital budgeting
• Efficient Portfolios, CML, SML
• Recently under attack (is beta dead?)
• Rivals:
– APT
– Empirical Multifactor Models
• Book-to-market and Size effects
M-M Propositions
• Proposition I: Firm cannot change its total value
by splitting cash flow into different streams (ie
shareholders, debtholders)
• Proposition II: Expected return on common
stock increases in proportion to its market debt
to equity ratio
M-M Propsitions
• Many of the ‘perfect market’ assumptions have
been relaxed without affecting core conclusions
• Teach us that it is important to focus on the
business, not finance, if an enterprise is to be
successful
Agency Theory
• Inability to write perfect contracts between
principal and agent that ensures agent acts in
the best interest of the principal
• Agency problem arises from delegation of
decision making and imperfect information and
imperfect monitoring
Agency Costs
• Conflicts are inherent between
– Shareholder - Management
– Shareholder - Bondholder
• Firm value is reduced by
– Excessive perk consumption
– Taking unwarranted risk
– Forgoing profitable investments
with debt
Agency Cost Models
• Used successfully in explaining
–
–
–
–
–
LBOs, Takeovers, restructuring activity
Debt covenants
Design of board of directors
Design of incentive compensation
Use of convertible securities
Asymmetric Information Models
• Actions taken by better informed agents convey
information to those less informed
• Management have superior information about
own firm value
• Successful in explaining stock price reactions to
announcements of corporate actions
• Do managers deliberately signal?
Option Pricing Models
• The most successful pricing models in finance
• Used to value complex securities
– convertibles, callables, warrants
• Adjustments to NPV in sequential decisions
– Real options in capital budgeting
• Value incentive compensation
– ESOPs
Option Pricing Models
• Binomial
– When outcomes at each node are discreet and
limited in number
• Black - Scholes
– For continuous range of outcomes such as market
prices
Finance in International context
• Basic finance theory is universal
• Two additional issues arise:
– Exchange rates (PPP, IRP)
– The extent to which global financial markets are
integrated:
• Affects risk and discount rate
Gulf Corp Takeover
• An example of case ‘solving’, and my approach
• An example of 1-page analytical solution
– Getting to the heart of the problem
– Running numbers
– Drawing conclusions