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									    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
     – 4 yrs Floor Trader / Stock Broker - Bombay Stock
     – 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

• Inculcate financial way of thinking

• Bridge theory and practice

• Increase proportion of good financial decisions to bad
 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
• About 5 hours of work outside of class
  per week

• Frustrations with unstructured problem solving!

• Frustrations with computer work!
• 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
•   Group Case Presentation        300
•   Participation                  100
•   Midterm Case                   300*
•   Final Case                     300*
•   TOTAL                         1000

• * Please correct the syllabus
 Grading Policy
• If you attend all classes and diligently complete
  all required work, you would be assured of a B-

• 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
• 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
• 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
• Run the numbers and go to the heart of the
• Perform analysis on key assumptions
• Get down to the key bets
• Get to business issues quickly
• Prepare to participate: take a stand
• In Class: Participate actively in support of your
  conclusions but be open to new insights as they
• 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                   Repeat

•   Recommend a course of action
 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

• 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
 Analyzing a case...
• Is the problem at hand a symptom of a larger
   – 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
• 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
   – You will arrive at a better understanding over time,
     after many cases - sometimes after the course is
Financial Planning
• Analyze financing and investment decisions

• Project future consequences of present

• 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”
• Identifies key variables
• Ignores interrelations among variables
 Scenario Analysis
• Consider alternative plausible combinations of
• 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
• 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
• It can aid to clarify thinking
• However, theory for its own sake serves no
  useful purpose
• Theory does provide a framework to start the
• 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...
   – 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
• 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
 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
 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
      • 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

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