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									Finance 552                                                          C. Haley
Winter 2002                                                          357 Mackenzie
                                                                     MTWTh 10:30-12:00


Text (on reserve):   Higgins, Analysis for Financial Management, 6th Edition (H)
                     Case Packet--Bookstore

General Information:

This class deals with two problems in the financial management of business firms: managing
the cash flowing through the business and external financing of operations and capital
investment. In addressing the first problem, we will cover financial statement analysis,
forecasting and financial planning, managing growth, and working capital strategies. Our
examination of the second problem will consider banking relationships and the principal
sources of capital for corporations including the use of derivative securities. The focus
throughout is the design and management of a firm’s financial structure--the right-hand side
of the balance sheet.

The course is built around a series of case problems which will be found either in the case
packet or included in the handout ―Supplementary Cases and Readings‖ denoted as ―HO‖. The
case method is the ideal way to study the topics addressed in this course because existing
theory has comparatively little of practical value to say about many of them. The best way to
learn the material, therefore, is to examine a sequence of practical problems to better
understand the nature of the problems and to master the logic by which alternative policies
can be evaluated.

Reading assignments are from the Higgins book or handouts. They are intended to be helpful,
but do not necessarily cover all aspects of any given situation. The daily assignments do not
require written work to be handed in unless specifically indicated as such. Grades will be
based on class participation and other assignments as follows:

                                 Class discussion       35 %
                                 Written assignments    60 %
                                 Team presentation       5%

See ―Hints on Case Write-ups‖ at the end of the assignments. There are no exams. The data
in the exhibits for most of the cases are available in the form of Excel worksheets on my web
page (us.badm.Washington.edu/Haley/F552). Students should download the worksheets to their own
computers. Use of a PC is highly recommended for this class. This is a relatively low cost
opportunity for you to gain hands-on experience with spreadsheet use in an applied setting
where you have realistic problems to work on..

Daily class preparation is essential for obtaining the maximum benefit from this course. It
is not expected that students have the "right" answer coming into class, but that everyone is
prepared to participate in an informed class discussion. The philosophy of the class is
―learning by doing‖. If you don’t try to deal with the problems assigned, you don’t learn.
Discussing the case in a group before class is very helpful.
          SECTION I - Financial Analysis, Forecasting, and Bank Financing

1. 1/8    Introduction: Unidentified Industries (attached)

2. 1/10   Financial Analysis: Durham Furniture Company (attached) (Readings: H pp 3-
                     20, Ch. 2, and ―Ratios‖ note attached)

          a.     Assume that you are Mr. Ralphson and that Mr. Allan has asked you to
                 analyze the financial statements of Hiram’s and Bassett Brothers. What
                 are the strong points and weak points of each company as revealed by
                 your analysis?
          b.     Based on your analysis, can you identify any apparent business strategies
                 being used by these two companies?
          c.     What action(s) would you recommend for each company?

3. 1/15   Financial Planning and Strategies:        Grieg Lumber Company (attached)
                    (Reading: H Ch 3)

          a.     Why does Mr. Grieg have to borrow money to support this profitable
                 business? How would you describe his business and financial strategies?
          b.     How large, in your opinion, should Grieg’s line of credit be?
          c.     Assuming 1995 sales are $3.5 million, how much money will he need to be
                 borrowing from the bank on December 31, 1995? (Hint: Try forecasting
                 Grieg's balance sheet as of this date.)
          d.     As a financial advisor to Mr. Grieg, would you recommend that he
                 continue his current strategies or not?

4. 1/17   Seasonal Financial Planning I: Playtime Toy Company (attached)

          a.     What factors should Mr. King consider in deciding whether or not to
                 adopt the level production plan?
          b.     Estimate the funds required and their timing if the level production plan
                 is adopted. Use pro-forma balance sheets (as compared to a cash budget)
                 following the format used in the case. Evaluate your results. It is highly
                 recommended that you use a PC spreadsheet for this purpose.
          c.     If you were Playtime's banker, would you have any concerns about
                 making the indicated loans to this firm?

5. 1/22   Problems in Forecasting: Lastmore Shears, Inc. (attached)

          a.     Why was Lastmore Shears unable to repay its loan by March 31, 1991 as
                 planned? Were the forecasts prepared by Mr. Sheehan based on
                 unreasonable assumptions? How do assess the banker’s attitude in this
          b.     What is the significance of the differences between forecast and actual
                 labor and material additions to work-in-process inventory? Do they
                 provide any insight into what happened in this company and might they
                 have anything to do with Lastmore Shears' capital expenditure program?
          c.     How long will it take Lastmore Shears to repay its loans if sales do not
                 recover from current, depressed levels (making allowance for
                 seasonality)? What are the critical assumptions that must be made to
                 answer this question? (Don’t try to forecast past March, 1992)

6. 1/24              Financing Growth through Bank Loans and Private Equity:
                     Advanced Cardiovascular Systems (Attached, Read: ―Note on Bank

          a.    What do you think Mr. Haskins' primary objectives for ACS are and how
                do those objectives affect his management of ACS? Does the existence of
                Lilly’s option have anything to do with Haskins’ objectives?
          b.    How much money will ACS need by year-end 1988 assuming that sales
                grow at 30% and current operating strategies are maintained?
          c.    What business strategies would have to change to make this a "bankable"
                loan situation? What terms or conditions would have to be imposed?
                (The terms must protect the bank and yet permit ACS to operate in a
                manner consistent with management's objectives.)

7. 1/29   Written Case (To Be Assigned)

8. 1/31   Forecasting and Planning an IPO: Netscape Communications, Inc (attached)

          This is a slightly different version of a case you had last year with Jennifer
          Koski. Her ―solution‖ to the problem she posed to you is available on the F552
          web page. You could use this worksheet to answer the questions below.
          Alternatively you can try and work with an one based on the ―Proforma‖ model
          provided with the Higgins book. It is also available on the web page.

          a.    Does Netscape need to go public to meet its capital needs? How much
                money do you think that it will need over the next 3-5 years? In
                answering this question you might find the following assumptions useful
                although you are free to use others if you have good reasons to do so:

                     Cost of revenues and R&D maintain their current percentages of
                      total revenues 10.4% and 36.8% respectively.
                     Other operating expenses decline as a straight-line percentage of
                      revenues from 80.9% in 1995 to 20.9% in 2001 which would give
                      Netscape operating income to revenues about equal to Microsoft at
                     Capital expenditures decline from 45.8% of revenues in 1995 to 10.8%
                      of revenues in 2001, again close to Microsoft.
                     Depreciation each year is 13.6% of net property and equipment at the
                      beginning of the year. (Compute ending net P&E = beginning net
                      P&E + capital expenditures – depreciation.)
                     Two problems that you will need to consider are working capital
                      requirements and revenue growth. One way to deal with the revenue
                      growth problem is to make the annual growth rate a separate
                      forecast variable and look at a range of values for this number; e.g.
                      30%, 50%, etc. Alternatively, you might start with very high growth
                      rates initially and have them decrease to more ―reasonable‖ numbers.
                      Note that your approach depends on the model you are using. It will
                      worthwhile to compare the Koski model with the Proforma model.
                      Working capital requirements should be based on your assessment as
                      to the minimum levels needed. Remember ―excess cash‖ is not part of
                      the requirements.

          b.    What other sources of financing other than the IPO might be available?
                How much money will the underwriters be raising for Netscape at a price
                of $28 per share? How does this number compare with the ―needs‖

figures from b) above.   What is your assessment of the underwriters’

                              Finance 552 Assignments

                  SECTION II - Long Term Financing Strategies

9. 2/5    Effects of Financial Leverage: Sealed Air Corporation' Leveraged
          Recapitalization (Reading: Brealey and Myers, Chapter 18 "How Much Should
          a Firm Borrow")

          a.    Why did Sealed Air undertake a leveraged recapitalization? Was it a
                good idea? For whom? What has happened to the company's "financial
                slack" (Brealey and Myers)?
          b.   What is creating value to the stockholders in this transaction? What is the
                theoretical value per share created by the tax shield on the $170 million
                in 10-year notes at an interest rate of 12.625%?
          c.    Why did the company's investor base turnover completely after the recap?
                Is this something managers should be concerned about in general?
          d.    Was the constraint on capital expenditures imposed on the company by
                the bank lending agreement good or bad for the company? Do you think
                that the managers will be able to renegotiate this constraint?
          e.    What kinds of companies might benefit from a significant increase in
                their leverage? What kinds of companies might be hurt by it?

10. 2/7   Leverage, Cash Flows, and Put Options: Ertsberg Project Financing (HO)
          Read ―Beyond Debt and Equity: Options in Corporate Finance‖—pp1-10 and
          Appendix A

          a.    Review the financing and operating characteristics of the Ertsberg
                project. If Freeport invested $120 million in this project as an ―ordinary
                business investment‖ without all the complicated legal and financial
                arrangements, how risky would this be for the company?
          b.    How do the actual arrangements affect the risk to Freeport? What are
                the major remaining sources of risk? How much money is at risk for
                Freeport in this situation?
          c.    How important are the government guarantees here? Do the government
                guarantees add value to the equity investor, Freeport? How might the
                value of such guarantees be estimated (option pricing or ??)?
          d.    Examine the proposed debt repayment schedule and cash flow
                statements in Exhibits 4-6. What things might go wrong? How seriously
                would they affect project cash flows. Is there any systematic way you can
                think of to measure the risk of default here?

          Notes: In December 1969   the following long-term bond yields were available to
                US Treasury          6.95%
                Aaa Corporate        7.72%
                Baa Corporate        8.65%

11. 2/12   Introduction to Convertible Bonds: Boston Chicken, Inc. (HO) (Reading: The
           rest of the "Options" handout)

           Please complete C.K. Pao’s tasks. In addition, consider the following questions:

           a.     Why is BC issuing convertible bonds so soon after its IPO? What are the
                  advantages of convertible debt relative to straight debt and to common
                  stock issues?
           b.     Is the value of this bond very sensitive to the volatility estimates?
           c.     Can you solve for the implicit volatility in the redemption option? Does
                  its value seem reasonable to you?

12. 2/14   Financial Flexibility and Bond Ratings: Polaroid Corporation (Reading: H Ch.

           a.     What are the main objectives of the debt policy that Ralph Norwood must
                  recommend to the Board of Directors?
           b.     Based on the data in Exhibit 9, how much debt could Polaroid have
                  outstanding at each rating level? How does this compare with the
                  amount the company currently has outstanding?
           c.     Is the maturity structure of Polaroid’s debt appropriate? Why or why
           d.     What would you recommend to Polaroids’s Board of Directors regarding:
                  --the target bond rating
                  --the level of flexibility or ―reserves‖
                  --the mix of debt and equity
                  --the maturity structure of debt

13. 2/19   Financial Strategy and Business Strategy: The Home Depot, Inc. (Reading: H
           Ch. 6)

           a.     How would you describe Home Depot’s business strategy? Its financial
                  strategy? Do they fit?
           b.     Exhibit 6 predicts that HD will need $1.46 billion in external financing
                  over the next five years. What is driving that financial requirement?
                  What are the risks in this situation that could significantly affect it?
           c.     What is your recommendation for financing funds needed during the next
                  12 months? Is this consistent with the firm’s past strategy? If not,
                  please justify your recommendation.
           d.     What is their ―call‖ strategy with respect to convertible bonds? What you
                  recommend they do about the 6.0% convertible?

           Notes: S&P rated the 6.0% convertible as BBB in February. That convertible
                  was selling at a price of $124 at the end of March. It has a call price of
                  $104 through June 30, 1993, decreasing thereafter.
                  Home Depot stock returns over the 30 days ending March 31, 1991
                  showed a monthly variance of 0.015, which may be considered a typical
                  variance for the stock over the past three years. Note that this
                  represents an annual volatility of 42%.

14. 2/21   Financing Early Stage Growth Planet Copias & Imagen           including revised
           forecast handout. See Planet_Rev.xls for details.

           a. How would you describe Planet’s business strategy? Its financial strategy?
              How do the goals of the founders affect their strategies?
           b. Do you believe Planet fits the description of a ―breakout growth‖ firm? What
              do you think about the magnitude of today’s equity value shown in Exhibit 9?
           c. Given the alternatives that appear to be available, what would you
              recommend regarding the company’s financing? How much and from what
                            SECTION III - Special Topics

15. 2/26   Far Eastern Textile Ltd: The SiZeS Offering

           a.    Why is FET thinking about raising more money so soon after their
                 US$170 million GDS issue in October?
           b.    Goldman Sachs is pushing for FET to raise US$130 million through an
                 ―innovative‖ convertible debt issue. Why would FET (or any company, for
                 that matter) be interested in being an ―innovator‖ in the capital markets?
           c.    How would the SiZeS offering compare with a straight debt issue by FET,
                 advantages and disadvantages? How can you assess the relative ―costs‖?
                 What about an equity issue instead?
           d.    If you were a member of the FET executive committee, what would you

16. 2/28         Financial Structure in an LBO: Keith Lofton Company (HO)            (Read
                       "Convertibles and Warrants" )

           a.    Should Wayne Lau and the other managers seriously consider buying
                 Lofton? Does the price seem fair?
           b.    If things work out as planned/forecast, what is your estimate of the value
                 of the equity in 1990; for example if they did an IPO at that time.?
           c.    How much money does Mr. Lau still have to raise from external sources?
                 What terms and conditions should he attempt to obtain on the external
                 financing? What should he be willing to settle for? Are the conditions on
                 the present commitments satisfactory? How are they going to service all
                 this debt?
           d.    Looking at the ―mezzanine‖ securities that will be issued to a venture
                 capital investor, would it make any difference if convertible debt were
                 used rather than debt plus warrants? What is the difference between
                 them from the perspective of the stockholders (managers) and from the
                 perspective of investors? Can you come up with a package of debt plus
                 warrants that will provide investors with pay offs identical to those of a
                 convertible bond? Which form of financing might be preferred by the

17. 3/5       Financial Structure Design and Asssessing the Risk of Default: Revco D.S., Inc.

              a.    Was Revco a good LBO candidate? Why?
              b.    What is the financial structure of this transaction? Look at the sources of
                    financing on page 429 especially the footnotes. What might account for
                    the mix in the structure? Who is getting what?
              c.    Given the forecasts in Exhibit 7, how likely was Revco to default on its
                    debt? How did Revco’s probability of default compare with that of Jack
                    Eckard? (Hint: Try using the ―scenario analysis‖ feature of Excel to get a
                    general idea or use Crystal Ball to generate a probability distribtion of
                    the cumulative cash flow for the first three years.)

18. 3/7       Team Presentations (10 points)

Select one of the following for your presentation or come up with a company or topic of your
choice. All choices must be approved by February 28 to insure no duplications. Each
presentation should be limited to a MAXIMUM of 12 minutes to allow some time for questions.
Use overhead transparencies and handouts. We will not have a computer display available
unless you obtain one yourself or ask me in advance. Grading will be based on content not
style. The focus should be on financial structure/financing issues.

Teams should be 3-5 people so that we have five teams. Plan that one person be selected to do
the presentation--all members available to field questions. Divide tasks among team

Followups on companies --what has happened since we last looked at the company?

      1.   Sealed Air
      2.   Polaroid
      3.   Home Depot
      4.   Freeport Sulfur (now Freeport-McMoran)

New companies--review financing problems and issues 1995--2000.
        4. Amazon
        5. Starbucks (Review their financing over the past five years. How are they financing
their foreign expansion? What are the issues in this strategy?)
        6. Xerox (What is going on? Would you describe them as being in a condition of
"financial distress"? How serious are their problems?)

Other topics:
       7. What are the problems with failed IPOs? Examples?
       8. What are the sources of venture capital in Western Washington? What kinds of
securities do VCs want (equity or ???)?
       9. Financial implications of 3G for telecoms? (Pick a particular company?)
       10. LBO activity was picking up last year. Has it stopped? What kind of financial
structures have been used recently?

19. 3/12   Reorganization in Financial Distress: Caledonian Newspapers Ltd.

           a.      What happened? What are the alternatives available to Ian Stirling?
           b.      Compare and contrast the two new restructuring proposals. As part of
                   this comparison, what is your estimate of Caledonian’s market value in
                   1993? Suppose that the potential value of Caledonian is within the range
                   of £3 million and £10 million, what would be the rates of return earned
                   by the bank, by EV, by Ealing, and by management under each proposal
                   from different 1993 values of Caledonian?
           c.      If you were Ian Stirling, what would you do?

           Note:    You might find the following sections in Brealey/Myers of interest—
                   ―Allowing for the risk of default‖ in Ch 23 and ―Costs of financial distress‖
                   in Ch 18.

20. 3/14   Venture Capital: The Knot (HO)

           a.      Has The Knot been a success story to date? What appears to be its
                   strategy? How risky is it? What must it do to be successful in the
                   long run? Do you agree with its business plan?
           b.      What might be a basis for valuing this company? What would you
                   say to a venture capitalist that would encourage investment of $10
                   million for 25%?
           c.      Do you think that Hummer Windblad’s offer of $3 million for 50% is
           d.      David Liu has some questions at the end of the case. How would you
                   answer them?

21. 3/19   Financing Choices and Financial Structure:       Written 35% TBA

                           GUIDELINES FOR WRITTEN CASES

(1)    Do not summarize the case situation in any great detail. The reader should be
       assumed to be familiar with the general situation as usually the report is addressed to
       management. However you may wish to highlight aspects of the situation that might
       not be obvious to the reader or that you believe are especially important to your

(2)    Identify the basic problem or problems for which recommendations are needed.

(3)    Summarize the issues or factors which must be analyzed in order to come to
       recommendations. Try to anticipate questions that might be asked.

(4)    A semi-outline form for numbers (2) and (3) above is an acceptable way to present
       them. However, the write-up overall should be standard exposition.

(5)    Perform your analysis. Quality of this analysis is important. You may wish to do
       some of the numerical analysis in a group; however the written part should be done on
       your own.

(6)    Make recommendations which are consistent with your                    analysis.     The
       recommendations and your basis for them are very important.

(7)    One possible format for presentation is to make the write-up a report to management
       in the case. However, it is not necessary to "jazz" things up with "letters of
       transmittal" or similar devices. A one-page (or less) "executive summary" of the
       report is optional. If you wish to get some practice writing these, I encourage you to
       do so.

(8)    It is slightly more desirable for you to take a objective view of the problem and your
       recommendations than to try to "sell" your solution unless it is clearly suggested in
       the assignment--see (11) below.

(9)    You should try to present a clear and concise discussion. The page limitations on case
       write-ups are intended to be reasonable guidelines -- try to stay within them. They do
       not include graphs, tables, financial statements, or other significant (in size) exhibits.
       Such exhibits may be included within the body of the paper or at the end depending
       on your own preferences and the extent to which you want the reader to refer to them.
       Short, summary tables of complex exhibits are very helpful in the body of the paper.

(10)   I am not grading you on the quality of your exposition unless it is confusing to the

(11)   Read the assignment carefully and follow the guidelines, especially as they specify
       the role you are supposed to take. You should adopt that role. You will be preparing
       a report to management. If you are in doubt as to what is expected, ask before you
       write the paper. These are not set up as purely academic exercises. They are
       intended to develop your skills in a low cost environment--remember that you are
       not dealing with real money here.


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