Presentation on theme: "FINANCE 541 Cases in Managerial Finance. Today’s class... Introductions and house keeping Current Events Financial planning and analysis Seminal ideas."— Presentation transcript:
Today’s class... Introductions and house keeping Current Events 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 Quantitaive 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 Capital Structure –How do investors react to capital structure changes? The nature of information conveyed by capital structure changes, Journal of Financial Economics, 1994 Initial Public Offerings –Investigate/explain perfomance over the long haul after going public The performance of firms that go public, Journal of Financial Economics, 1996
Please Introduce yourself... Please fill out the student information sheet Drop by my office! Name cards
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 6 - 8 hours of work outside of class Frustrations with unstructured problem solving! Frustrations with computer work!
Texts Required: –Bruner, Case Studies in Finance –Packet of Readings Optional: –Brealey & Myers, Principles of Corporate Finance –Higgins, Analysis for Financial Management
Evaluation Group Case Presentation 250 Participation 250 Midterm Case 250 Final Case 250 TOTAL1000
Participation Grade Peer Evaluation At the end of quarter, you will give one point each to roughly 1/3 of the class who contributed, in your opinion, to the discussion in a positive way
Grading Policy If you attend all classes and diligently complete all required work, you would be assured of a B- grade 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 –Particularly important in a case class Please inform me of anticipated absences –More than 1 absence will adversely affect your grade
Case Presentations In groups About 30 minutes in length Formal write up Field questions
Non-presenting groups Demonstrate preparedness Come to class with solution to the selected case question (in bold in the handout) One group will be randomly selected to turn in the solution
Midterm & Final Formal 3 page case evaluation 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
Cases... Are deliberately vague! Have information deliberately presented in random order - not in the order of importance Offer little guidance on method of solution
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 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 in this class Theory does provide a framework to start the analysis
Bridging Finance Theory and Managerial Finance... CAPM –NPV, capital budgeting, WACC Modigliani-Miller Propositions –Dividends, capital structure, WACC Agency Theory –Corporate governance, compensation Option Pricing –Risk management, real options in capital budgeting Asymmetric Information Models
CAPM Widely used in NPV, capital budgeting Efficient Portfolios, CML, SML Recently under attack (is beta dead?) Rivals: APT, Empirical Multifactor Models
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 & Corporate Taxes Firm Value = value if all equity financed + PV(tax shield) Tax shields increase with the proportion of debt in the capital structure All debt firm? absurd
M-M: Add personal taxes Tax gain at corporate level offset by tax at personal level Post-TRA 1995 tax rates favor debt Irrelevance again if : (1-Tp) = (1-Tg) * (1-Tc)
Bankruptcy Costs Higher levels of debt involve –Direct bankruptcy costs –Indirect bankruptcy costs These serve to offset the tax advantage of debt Bankruptcy and liquidation are separate issues!!
Bankruptcy Costs Direct costs estimates 3% of book assets 20% of market equity Quite substantial!
Agency Costs Conflicts are inherent between –Share holder - Management –Share holder - Bond holder Firm value is reduced by –Excessive perk consumption –Taking unwarranted risk –Forgoing profitable investments with debt
Agency Cost Models Used successfully in explaining –LBOs, Takeover, restructuring activity –Debt covenants –Design of board of directors –Design of incentive compensation
Asymmetric Information Models Presupposes management have superior information about own firm value Changes in dividends, capital structure convey information to investors about firm value Do managers deliberately signal?
Optimal Capital Structure Maximizing firm value involves balancing –Tax benefits of debt –Bankruptcy costs –Agency costs of debt –Agency costs of equity –Information signalling costs
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 limited in number Black - Scholes (& variants) –For continuous range of outcomes such as market prices
Working Capital Issues How much cash should a company hold? What collections and payment policies should a company follow? What is the optimal level of inventory?
Working capital Mgmt Common sense rather than theory guides the issue Trial and error!! There is some effort to apply economic principles to account receivables management and trade credit (see readings)
Short term Fin’l Planning Requires forecast of cash requirements Method of raising required cash; consider explicit and implicit costs Monitoring cash inflows and outflows, debt covenants Taking corrective steps as necessary
ST vs. LT sources of funds Again, no clear theory to guide us Attempt is usually made to match duration of assets and liabilities similar to banks Firms can be conservative (using LT sources) or aggressive (using ST sources)