Chapter 14 Real Options Intermediate Financial Management

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Chapter 14 Real Options Intermediate Financial Management Powered By Docstoc
					EMB 660
Intermediate Financial Management
Dr. Bruce Gordon

Office:                  217 Keller Hall

Office Hours:            Tuesday and Thursday: 9:30 – 11:00 and 12:15 – 3:45

                         Office Phone:     (256) 765-4415 or (256) 974-9261
                         Home Phone:       (256) 974-4465
                         E-mail:  or
                         Web Page:
                         Pager:            (256) 920-5855

Prerequisite:            EMB 503

Text:                    Intermediate Financial Management by Brigham, Gapenski & Daves
                         Cases in Financial Management
Objectives:         1. To reinforce the principles and concepts covered in the Principles of Finance course

                    2. To extend your knowledge of corporate financial management beyond the principles

                    3. To give you an opportunity to apply the principles and concepts of financial management
                    in a more realistic (case) setting.

                    4. To give you an opportunity to practice effective communication techniques, both written
                    and oral. I consider it crucial that you be able to communicate effectively.

You should obtain, as quickly as possible, a Hewlett Packard 10B, 12C, or similar calculator.

It is the policy of UNA to afford equal opportunity in education to qualified students. If you have a disability that
may prevent you from meeting the course requirements contact me within the first three class sessions to file a
Student Disability Statement and to develop an accommodation plan. Course requirements will not be waived,
but accommodations will be made to allow you to meet the requirements provided that you are timely in working
with the instructor to develop an accommodation plan.


Note: Please do all of your work in a professional and organized fashion and attach as a file to an e-mail
message. Please use descriptive file names as much as possible and include your name at the top of each

Background Material:     An Overview of Financial Management (read on your own)
                         Basic Financial Tools: A Review (read on your own)
                         Financial Statements Analysis

Weeks 1 - 3:             Read Chapter Four: Valuing the Firm: The Cash Flow Model
                         Read the Articles:   Valuing Companies – A Star to Sail By?
                                              Debate: Duking it Out Over EVA
                                              The Real Key to Creating Wealth
                                              What is EVA?
                                              A New Way to Find Bargains
                                              How Much is a Tulip Worth?
   •   Write a brief essay (one to two pages) that clearly describes what happens during EVA analysis and
       contrasts it with more traditional techniques of determining value, such as NPV.

   •   How do you think that management would behave differently if they were compensated on EVA rather
       than NPV, IRR, or profitability?

   •   Write a brief summary of How Much is a Tulip Worth?. (A couple of paragraphs) Do the problems
       discussed in the article have any application at all in the corporate world? Explain.

                       View the Videos:         La Madeline French Bakery & Café (Tape 1, #1)
                                                Timberland Corporation (Tape 3, #3)
                                                Note that on Tape 3 (The Excellence Files) doesn’t start for a
                                                couple of minutes into the tape.

   •   Write a page or so that describes your viewpoint on corporate citizenship. In essence, since the goal of
       the corporation is to maximize shareholder wealth, is it wrong of a corporation to use corporate
       (stockholder) money for “social” purposes? Most corporations do spend at least some money on social
       or public projects. How do you think they would justify it?

First Class Meeting on October 23rd

Weeks 4 - 6:           Work is due by Saturday, November 13th

                       Read Chapter 8: Risk Analysis and Real Options
                       View the Video: Coca-Cola (Tape 3, #8)

   •   What do you see as the most difficult aspect of capital budgeting and risk analysis? Why?

   •   Draw a simple decision tree reflecting the future as Coca-Cola might have seen it prior to their
       introduction of new Coke.

   •   How does the ability to change course, either subtly, or dramatically as in the case of Coke, affect the
       value of a project? Explain

   •   GE is a highly diversified corporation while Boeing is predominantly focused in one industry. Assuming
       that they had identical expected cash flows and ROE’s, would GE be worth more than Boeing? Why or
       why not?

   •   How could a company effectively control “management bias,” that is the tendency of many managers to
       be overly optimistic about a project’s prospects?

   •   Read: Chapter 12: Dividend Policy

   •   Read: Follow That Dividend (Article)

   •   Read: Case 46 – AT&T (Be prepared to work this case in class)

Weeks 7 - 9:           Work is due by Saturday, December 4th

   •   Read Chapters 13 and 21 in the text and also read the articles on the RJR Nabisco takeover that will be
       e-mailed to you.
   •   An optional part of this assignment is to watch the James Garner movie Barbarians at the Gate. I'm
       not going to require this because of the rough language (substantial amount) and brief nudity that is a
       part of the movie, but it is very interesting to watch. If you choose not to watch the movie (which is a
       perfectly acceptable choice) then you might want to hunt down some additional resources on mergers
       and acquisitions. The Financial Analysts Journal article I cited in the e-mail would probably be

   •   The rest of you may or may not need additional resources to answer these questions.

       Write three + pages answering the following questions: (Support all of your answers)

           1. What were the problems of RJR Nabisco prior to the takeover?

           2. Would a takeover (in general) have been good for RJR Nabisco?

           3. What are the positive arguments (possible benefits) for takeovers in general?

           4. What mistakes did both sides make during the actual takeover and what would you have done

           5. Was the final outcome good for the company's stockholders?

           6. REGARDLESS of what you believe about this case, do you believe that takeovers and mergers
              are primarily good for our economy? Please support your answer.

   •   Read Chapters 14, 16, and 17

Weeks 10 - 11:          Work is due by Saturday, December 18th

Case 45 – Stinson Paving

   •   Answer the questions at the end of the case.

   •   Watch the second segment from the Excellence Files (Defense Personnel Support Center.)

   •   Write a brief analysis, two pages or so, that describes efforts that your company makes to be efficient
       with working capital. If, for some reason, this is impractical for your firm, find an article that describes a
       company’s efforts to use working capital more efficiently and summarize the article.

   •   Case 16 – Reed’s Clothier, Inc.

   •   Answer the questions at the end of the case.

   •   Solutions to this section’s work can be turned in at the October 16 meeting.

Weeks 12 – 13:                           ENJOY THE HOLIDAYS!
Weeks 14 – 15:          Work due by Saturday, January 15, 2000

Class Meeting on January 15, 2000
   •   The topic of derivatives is one of the most interesting in the entire body of finance. However,
       understanding them can be a bit tricky. A derivative is any asset whose value is derived from another
       asset and this includes both options and futures. I don’t want to get deeply into derivatives prior to our
       class since I think that this would be unfair to you.

   •   What I would like for you to do is to read the chapter on derivatives (Chapter 19) and also find at least
       two articles on options and two on futures (print or web) that do a good job of explaining the basic
       concepts involved.

   •   Also, find at least one article that introduces either interest rate or currency swaps. An article on swaps
       might be more difficult to find, but do the best you can. We will spend almost the entire period on
       January 15 discussing derivatives. Please come prepared to discuss your articles.

   •   For additional help see web sites like Equity Analytics, Financial Pipeline, or Especially recommended is the Chicago Board Options
       Exchange,, and the Chicago Mercantile Exchange,

Weeks 16 - 18:          Work is due by Saturday, February 5, 2000

   •   Purchase one call option and one put option. These can be options on individual stocks, indexes, or
       options on futures contracts. Track their price for at least two weeks and then at your option (pun
       intended) sell the security when you think best. Sell by the Friday of Week 18 (February 5) at the
       latest. Go to if you need help.

   •   Buy or sell a futures contract. This could be on a commodity like cattle, pork bellies, or orange juice
       concentrate or a financial futures contract like T-bonds, currencies, etc. Assume that your margin is
       only five percent of the total contract value. Remember that you would buy a contract on an asset you
       think will rise in value and sell a contract on an asset you think will fall in value. Be sure to explain the
       logic behind your purchase or sale. E-mail me if you need help on this. The Chicago Mercantile
       Exchange, along with the others mentioned, is an excellent source of help on this topic.

   •   Write a report detailing your trades and what you learned from the experience. What were the results
       of your investment?

   •   On the Internet: Find a description of how futures contracts can be used for hedging (risk reduction).
       Cut and paste this into what you hand in and also include the url (address) for the site.

   •   Read the article What Options Tell You About Your Stock

Weeks 19 – 21:          Work is due by Saturday, February 26, 2000

   •   Read Chapter 22. Briefly discuss (one page or so) the primary challenges of conducting business

   •   Find an article (print or web) that details one firm’s (or more) trials and tribulations when conducting
       business internationally. Come to class prepared to discuss your article.

   •   Read the article What Makes a Leader
   •   Compare Herb Kelleher of Southwest Airlines (See 1st Company Profile from Tape 3 and also the 5th
       segment from Tape 2) to the model outlined in this article. Can Southwest hope to have another leader
       like Kelleher after he retires? Should they want another? Do you think the profile outlined in this article
       is the profile of a true leader? How would you rate the leadership at your company or institution?
       Explain. (This information will be kept totally confidential and deleted after the semester.) Write at
       least two pages evaluating yourself according to the criteria set forth in the article. (Please use this as
       a very good opportunity for growth and not just another assignment to be completed.)

   •   Find at least two good articles on leadership. Come prepared to discuss these at our final class
       meeting. Please turn in a copy of the article by February 26, 2000. It can be mailed to me at: Box
       5188, UNA Florence, AL 35632.

Weeks 22 – 24:         Work is due by Satuday, March 18, 2000

   •   Read the article Timing Isn’t Everything

   •   Read the article Why It’s Risky Not to Invest More in Stocks

   •   Read the article They Might Be Moguls

   •   Watch the video from Tape 3 Whole Foods Market (5th Company Profile)

   •   Watch the video from Tape 3 USAA (6th Company Profile)

Last class meeting will be on Saturday, March 18, 2000. We will have some class time
on this day, followed by an exam. There will be no further assignments after this date.
Chapter Coverage:

Chapter Nine:         Long-Term Financial Planning

Chapter Twelve:       Dividend Policy

Chapter Thirteen:     Investment Banking and Financial Restructuring

Chapter Fourteen:     Lease Financing

Chapter Fifteen:      Hybrid Financing (partial)

Chapter Sixteen:      Current Asset Management

Chapter Seventeen:    Short-Term Financing

Chapter Eighteen:     Other Topics in Working Capital Management

Chapter Nineteen:     Derivatives and Risk Management

Chapter Twenty:       Bankruptcy, Reorganization, and Liquidation

Chapter Twenty-One:   Mergers, LBO's, Divestitures, and Holding Companies

Chapter Twenty-Two:   Multinational Financial Management

Chapter Five:         Determining the Cost of Capital

Chapter Six:          Capital Budgeting Decision Criteria

Chapter Seven:        Cash Flow Estimation

Chapter Ten:          Capital Structure, Part 1

Chapter Eleven:       Capital Structure, Part 2

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