Corporate Finance MBA

Course outline Introduction

Contact Nisan Langberg Office: 210E

“big picture” Assume you are familiar with basic financial tools – Time value of money, accounting for risk, CAPM, portfolio theory I offer a theoretical approach to decisions of CFO – Investing/financial (will talk more in a few minutes) Problem-based learning with applications to real- life examples through cases and mini cases

Class overview What you can find on the web – Syllabus – class notes (incomplete…the gaps together in class) – Homework assignments – Announcements – Handouts

Text books I will teach and assign problems using the book Corporate Finance by Jonathan Berk and Peter DeMarzo, Addison-Wesley, 1 st /2 nd editions There will be two/three HBS cases we will cover in class

Syllabus I recommend buying the book – The course is closely built around the text book – Very good reference book to have handy if one plans to work in corporate finance – Taught in leading business schools in the world All course material is covered in class notes.

Alternative reading Further/alternative reading is Brealey, Myers & Allen, Principles of Corporate Finance, McGraw-Hill Irwin, 8 th edition or higher

Group Assignments I encourage work in groups The idea… – You can learn a lot from each other – Exposure to different approaches – No student left behind

Course grade Homework (4 assignments) 55% Case presentation 35% Discussion questions 10%

Office hours and help Approaching me – Fridays are devoted to problem solving in groups and I will have plenty of opportunities to address difficulties then. – You are welcomed to stop by my office anytime or alternatively set an appointment with me to make sure I am in my office

Course outline Class 1 Introduction Class 2 Capital budgeting (DB Chapter 7) – How to evaluate an investment opportunity – Calculating free cash flows – Predicting future free cash flows – Estimating the project’s risk – Calculating the NPV of the project

Course outline Class 3 Modigliani Miller (DB Chapter 14) – First theory of capital structure – Capital structure doesn’t matter for value! – Leverage and firm value – Leverage, risk, and the cost of capital

Course outline Class 4 Interest tax shield (DB Chapters 15) HW2 due – Interest tax deduction – Valuing the interest tax shield – Recapitalizing – Personal taxes – Optimal capital structure with taxes

Course outline Class 5 Capital budgeting with leverage (DB Ch. 18) – WACC, APV – Project based cost of capital Class 6 Whirlpool Europe Case – Estimating cash flows – Project valuation

Course outline Class 7 Financial distress, and the asset substitution problem (DB Chapter 16) – Bankruptcy cost – Optimal capital structure – The agency cost of leverage – The agency benefit of leverage – Asymmetric information and capital structure

Course outline Class 8 Stock valuation exercise Class 9 American Chemical Corporation HBS case

Introduction

Four types of firms – Sole proprietorships – Partnerships – Limited liability companies – corporations The corporation

Firm distribution

Flow of funds in the public corporation Investors: banks, individuals, corporations, pension funds, mutual funds, …… corporate investments revenues Chief financial officer

Separation of ownership and control Rather than the owner the board of directors and the chief executive officer possess direct control of the corporation Shareholders elect board of directors – Google and one-share-one-vote Board of directors make set the rules and policies for how the corporation is run The manager (CEO) is elected by the board of directors to run the firm according to the guidelines set by the board

CFO’s goal What is the CFO’s goal? a.Maximizing firm value b.Maximizing share holder value c.Maximizing employee satisfaction d.Maximizing profits e.All/some of the above

Who’s company is it? ** Survey of 378 managers from 5 countries Source: Chapter 2, Brealey, Myers and Allen 8/e

What is more important dividends or jobs? ** Survey of 399 managers from 5 countries. Which is more important...jobs or paying dividends? Source: Chapter 2, Brealey, Myers and Allen 8/e

Maximizing shareholder value In sole proprietorship the owner has control and sets the goal of the firm Corporations can have thousands of owners/shareholders Shareholders’ interests and priorities – What if some investors are more risk loving? – How does it affect the firm’s decisions?

Corporate Governance…”how can investors make sure that the manager acts in their best interest?” Board of directors – replacement of management Market for corporate control – mergers and acquisitions Manager’s compensation – Bonus payments, equity, (vesting) options Communication with Investors – Audited financial reports

Methodological background

Cash flow valuation Valuation of cash flows: PV and FV Annuity – A stream of “n” periodic payments “CF” Perpetuity – An annuity that continues forever Growing Annuity/Perpetuity – Payments grow at rate “g” every period

Investment decision rule NPV = PV (benefits) – PV (costs) Any positive NPV project should be adopted to increase firm value When we need to choose among projects we will adopt the project with the highest NPV Can a trading strategy be a positive NPV project?

CAPM r i = r f + β i x(r m – r f ) Expected return depends on the asset’s return beta