University of Maryland

BMGT 741

Advanced Financial Management

Professor Gordon M. Phillips

Office: 4425

Office Hours: W 10:45-12:00, or W 1:00-2:00

Phone: 405-0347

E-mail:

FAX: 314-9157

Course WEB Site: http://www.mbs.umd.edu/finance/gphillips/bmgt741home.html

Course Overview:

This course is an advanced topics course in Corporate Finance. The course covers five major subject areas. Each area can be viewed as a self contained topic area. The first area focuses on advanced project and firm valuation. It is an extension of topics addressed in your previous finance courses. The second area deals with initial public offerings (IPOs). Third, we will examine leveraged buyouts and advanced security pricing. Forth, we will then apply facets of the debt/equity decisions to bankruptcy and restructuring. We will end with a discussion of risk management & international capital markets.

Method:

The pedagogy is lectures interspersed with case studies. Sections begin with lecture-discussion. Students have substantial responsibility (and incentives) for coming to class prepared to engage in active discussion. Each student is expected to work in a team to analyze the cases. Teams will be 3-4 students each. The team will turn in a brief memo on the case (see following page).

Course Examination: There is only one exam in the course. It is thus given about 3/4 of the way through the course. It will either be a comprehensive case or several long problems that require conceptual and numerical analysis.

Final Project: The final project is a large research project that is described on the last two pages of this handout. It is because of this large project that there is only one test in the course. You should choose this project with care as it is expected that you will be spending a large amount of your time working on it. The final project will be done individually or with a maximum of 2 individuals.

 

Readings:

Lecture notes and cases will be the primary source of material for this course.

There will be a case packet that you can pick up at the copy center (CP)

The suggested textbook for the course is: Financial Markets and Corporate Strategy, by Mark Grinblatt and Sheridan Titman, publisher: Irwin-McGraw Hill.

The BMGT 640 Textbook is also useful for reviewing specific sections of the course and gives alternative treatments to several of the topics in the course: Ross, Westerfield, and Jaffe, Corporate Finance, Fourth Edition, Chicago: Irwin, 1995. (RW&J).

Grading: Course grades are based on

Case Presentation

10%

Case Memos Written (5% each)

20%

Advanced Security Pricing assignment

10%

Course Examination

30%

Final Project (5% of project grade based on presentation to class)

30%

Case Studies:

4 case write-ups are required and 1 presentation - for a total of 5/8 cases to be analyzed. You may also do 1 extra case writeup for extra credit. The case studies are placed at the end of a particular topic and are to be used as analytical and discussion tools. The objective in using case studies is to provide examples of companies or individuals that have faced the topic at hand and to apply theoretical tools to real problems. Included in this syllabus are questions and ideas that you may use as guidelines for analyzing the case. The content of the case write-up is as follows:

  1. The cases may be done in groups with all group members receiving the same grade for the write-up. Note: For the written case-writups it is not necessary to work in groups.

    2. If your name is on the report as part of the group, it means you participated in the analysis. You are on the honor code to observe this requirement.

  2. The case write-up to be a two-page single spaced (maximum) report. The two page maximum does not apply to exhibits such as graphs and tables, but please keep these to a minimum. You may use as many exhibits as necessary but the exhibit must be referred to in your write-up. The case write-up should be in 12 point type with 1 inch margins.
  3. The case questions are designed to help you streamline the issues to be addressed. If you believe that these questions do not effectively address the problems in the case, feel free to go outside the parameters of the questions.
  4. It is not necessary to rehash the case situation in your write-up. Do not, however, assume that I know every single number and detail. Use your best judgment on how much of the case to include in your write-up.
  5. Most importantly, you must take a position regarding the problem in the case and make specific recommendations on how to solve it. Support your recommendation as succinctly and as effectively as you can.

Class Participation: It is important that everyone come prepared to "open the case" and to discuss in detail the problem and its potential resolution. After the class as a whole has discussed the basic problem of the case, a group of students will prepare a team presentation presenting their analysis of the problem facing the firm and their proposed "solution". Following each presentation the discussion will then open to the whole class. Questions are encouraged both during and after the presentation. Ideally the class as a whole will interactively come to an understanding of the problems presented in the case.

Each group will be responsible for one case presentation of approximently 30 minutes. Note that groups presenting the case need not turn in a case write-up.

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Daily Class Schedule

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I. Overview of Course - Valuation and Financing Decisions

Monday, August 31

Valuation/Capital Budgeting

Read: "Note on the Free Cash Flow Valuation Models"

Grinblatt & Titman, Chapter 9

Reference: REVIEW: Ross, Westerfield, and Jaffe, Chapter 7

Wednesday, September 2 - Wednesday, September 9

Topic: Risk and Sensitivity in Valuation

Read: "Risk Analysis in Capital Budgeting", D. Hertz

Read: Grinblatt & Titman, Chapter 10

Reference: REVIEW: Ross, Westerfield, and Jaffe, Chapter 8

Monday, September 14: Case Analysis - Dynatronics

Topic: Interaction of Financing and Investment Decisions,

Security Design, Why issue different securities?

Case Questions:
      1. What is an appropriate set of base case (i.e. no new product or inventory policies) pro forma financial statements for Dynatronics for the next 3 years?
      2. Using these pro forma statements, estimate the company’s external financing requirements for the 3 years 1989, 1990, 1991. What financing would you use?
      3. What is the company’s weighted average cost of capital (WACC)?
      4. Is the new product line worth introducing? What about increasing the stocks of finished goods?
      5. If you do either or both of the alternatives in #4, what are the new companies external financing requirements?
      6. As Ms. Kraft, what financing plan would you recommend to your fellow officer-stockholders to meet the funds requirements in #2 and #5? In your answer, make sure your plan details both the source (debt vs. equity), maturity (short term vs. long term debt) and source (firm’s commercial bank vs. public debt).

 

II. Initial Public Offerings: Birth of Public Corporations

Wednesday, September 16 & Monday, September 21

Read: Going Public: Initial Public Offerings

"Initial Public Offerings", Ibbotson, Sindelar, and Ritter

"The Costs of Going Public," J. Ritter

"Note on the Financial Perspective: What Should Entrepreneurs Know?"

"A Method For Valuing High-Risk Long Term Investments"

Reference: Grinblatt & Titman, Chapter 3.

Wednesday, September 23

Topic: Going Public: Case Analysis – Thermo Electron

Thermo Electron Case Questions:

      1. Describe Thermo Electron's products and its expertise.
      2. What are the benefits and costs of Thermo Electron's past policy of spinning off past subsidiaries. What differentiates Thermo Electron Technologies from past equity carve-outs.
      3. Why does the company place equity privately before taking a subsidiary public?
      4. Come up with a value for Thermo Electron Technologies products described on pages 11-12 of the case. You will have to make some large assumptions. From this value come up with an offer price per share for the company.
      5. Should Thermo Electron Technologies go public?

 

 

Monday, September 28

Topic: Initial Public Offerings Continued- Case Analysis: Easel Corp.

NOTE: Easel (B) (C) will be handed out in class

This is a very long case - but I encourage everyone to examine it closely. It is perhaps one of the most interesting and realistic cases in the package.

Because of its length and to organize the class debate in order to focus our analysis on choosing an underwriter, 2 groups will present analyses before the class. If you are doing a written analysis of this case pick two of the 4 underwriters and analyze their strengths and weakness.

Group 1: Evaluate Hambrecht & Quist and Alex Brown

Group 2: Donaldson, Lufkin & Jenrette & Robertson, Stephens, & Co.:

You will have 15 minutes to present your case. The rest of the class is responsible for asking questions. Following each presentation we will have a 5-10 minute question and answer session.

After the 2 presentations we will attempt to pick out the best elements of each presentation and decide what EASEL wants its ideal investment bank proposal to look like.

Content: Clearly present your firm's case responding to the Request For Quotation in Exhibit 6. Evaluate the following from exhibit 6. Where relevant use data specific to your firm. Feel free however to change details such as pricing from that in exhibits 9-11 that your firm is "thinking" about presenting. Be prepared to defend and explain why you choose specific features and assumptions.

 

  1. Capital Structure and Leveraged Buyouts

Wednesday, September 30 & Monday, October 5

Topic: Leveraged Buyouts & High Risk Securities

Read: "How to Value Recapitalizations and Leveraged Buyouts"

"Leveraged Buyouts", Kohlberg, Kravis, Roberts & Co.

"Eclipse of the Public Corporation", M. Jensen.

Reference: Grinblatt & Titman, Chapter 19, Section 6.

Wednesday, October 7

Topic: Capital Structure and Strategy

Read: Chapter 16, Grinblatt and Titman

 

Monday, October 12

Case Analysis: USG Corp.

 Case Questions:
        1. What is the situation facing Robert Day? What are his alternatives?
        2. Value the proposed recapitalization using both discounted cashflow techniques and multiples of cash flow? Explain any differences.
        3. Give advice to shareholders whether or not to tender their shares to Desert Partners or wait for USG's proposed recapitalization.

 

  1. Advanced Security Design

Wednesday, October 14

Topic: Advanced Security Design, valuing complex securities

using option theory (includes review of option theory)

Read: Grinblatt and Titman, Chapter 11 Section 2

Review: Ross, Westerfield, Jaffe, Chapter 21 and

Grinblatt and Titman, Chapter 8 (Review)

 

Monday, October 19

Topic: Pricing Convertible Debt, Financial innovation

Read: Ross, Westerfield, Jaffe, Chapter 22.

 

Wednesday, October 21: Case Analysis: Flowers Industries

 

Case Questions:
      1. How does the company's option to call the convertible affect the decision to issue and the convertible's value.
      2. Determine both the value of the convertible bond and the effect its issuance will have on the company's cost of capital. Assume the Flowers' asset risk is the same as the average of the market.
      3. How should the company's basic business risk and acquisition strategy should affect its long-term capital structure policy.
      4. Make the decision of whether or not to issue the convertible debt or issue some other security or package of securities in the context of its overall capital structure policy.

 

IV. Bankruptcy & High Risk Securities

Monday, October 26

Topics: Financial Distress and Bankruptcy

Read: "Managing Default: Some evidence on How Firms Choose between

Workouts and Chapter 11", S. Gilson

"The Economics of Pre-packaged Bankruptcy", J. McConnell and H. Servaes

Reference: Grinblatt & Titman, Chapter 15.

Wednesday, October 28

Topic: Bankruptcy continued: Legal Code & Financing Decisions

Affect of Capital Structure on Investments

Read: "Bankruptcies, Workouts and Turnarounds: A Roundtable Discussion"

Haugen, R.A. and L.W. Senbet, 1978, The Insignificance of Bankruptcy Costs to the Theory of Optimal Capital Structure, Journal of Finance, Vol. 33 383-93.

Monday, November 2

Case Analysis: Marvel Entertainment  
      1. Why did Marvel file for Chapter 11? Were the problems caused by bad luck, bad strategy, or bad execution?
      2. Evaluate the proposed restructuring plan. Will it solve the problems that caused Marvel to file Chapter 11? As Carl Icahn, the largest unsecured debtholder, would you vote for the proposed restructuring plan? Why or why not?
      3. How much is Marvel's equity worth per share under the proposed restructuring plan assuming it acquires Toy Biz as planned? Carefully consider the proforma financial projections and other assumptions.
      4. Will it be difficult for Marvel or other companies in the holding company to issue debt in the future?
      5. Why did the price of Marvel's zero-coupon bonds drop on Tuesday, November 12, 1996? Why did the portfolio managers at Fidelity and Putnam sell their bonds on November 8?

 

V. Risk Management

Wednesday, November 4 & Monday, November 9

Topics: Interest Rate Risk

Read: Interest Rate Derivatives, Harvard Business School Note

Reference: Grinblatt & Titman, Chapter 20, Chapter 21, pp. 743-750.

Wednesday, November 11: Case Analysis

Topic: Interest Rate Risk Management,

Read: Grinblatt & Titman, Chapter 22.

 

Wednesday, November 11: Case: Liability Management at General Motors

Case Questions:

      1. What is the interest rate risk that GM faces on the issue
      2. Evaluate each of the options that Stephane Bello faces to hedge interest rate risk. Evaluate how each of the options affects the risk of the issue.
      3. Should GM hedge?

 

Monday, November 16 & Wednesday, November 18

Topics: Risk Management, Hedging Exchange Rate Risk

Read: Currency Swaps, Harvard Business School Note

Reference: Grinblatt & Titman, Chapter 20, pp. 732-740,

Chapter 21, especially pp. 767-780.

Read for Nov. 18:

"Identifying, Measuring, and Hedging Currency Risk at Merck

"Managing Currency Exposure: The Case of Western Mining

 

Monday, November 23: Case Analysis - Walt Disney Yen Financing

 Case Questions:
      1. Should Disney hedge its yen royalty cash flow? Why or why not? If so, how much should be hedged and over what time frame?
      2. Assuming a hedge is desirable, what hedging techniques are available to the treasurer and what are the advantages and disadvantages of each?
      3. In light of the various other techniques for hedging currency exposures, why does a market for currency swaps exist? Who benefits and who loses in such an arrangement? Is any value created for the corporation, and if so, where does the value come from?
      4. Evaluate Goldman's proposal for an ECU bond issue accompanied by an ECU/Yen Swap. How does its "all-in yen cost" compare to that of the proposed yen term loan? Is it superior to using outright forwards?

Exam: Wednesday, November 25,

Exam will be a case or a sequence of problems. You can take the exam at 5:30PM on Tuesday, November 24th (Thus getting out early for Thanksgiving) or 8:30AM on the 25th and you will have 3 1/2 hours to complete the case. I will make arrangements for rooms based on the number of students choosing either time.

Presentation of Final Projects

December 7 and December 9: Student Presentations

& Remaining Presentations during Final Exam Period

 

 

Final Project

Now its time for some real world analysis! This project will determine 30% of your grade. The reports can vary in length but should be no more than 30 pages including exhibits. Reports should be double spaced with normal margins. I strongly recommend that you talk directly to the company’s executives when possible. Many companies in the area are willing to talk to MBAs and it will give you some direct (hopefully high level) exposure.

The project will involve groups of 2 people. (2 people maximum)

The following represent potential topics for projects: Financial Restructuring, Leveraged Buyouts, Bankruptcy Proceedings and Initial Public Offerings. Pick a topic area that you can consult with some firms in the Washington area to both improve your analysis and report and to gain additional insights.

I. Leveraged Buyouts/Financial Restructuring/Bankruptcy Proceedings:

Several sample industries include:

- The Gypsum Industry- U.S. Gypsum, National Gypsum, Republic Gypsum

- Athletic Footwear: Interco Inc.

- Airline Industry

- Tractor Trailer Industry- Fruehauf, Monan, Trailmobile, Dorsey

- Retail Industry - Woodword and Lathrop (Woodies), Macys, Campeau Corporation (owners of Bloomingdales and other major department stores.)

1. A discussion of debt and capital structures over time - Address how the existing securites affect the restructuring experience/ bankrupcy or workouts.

2. How did the firm's cash flows and business risk affect its "performance".

3. The influences and factors leading to changes in the capital structures of firms.

4. What happens to required rates of return for stocks, bonds. If you bought into the firm's securities, how would you have done? What about buying the securities after bankruptcy filings.

5. Discuss the changes in investment, after any capital structure change or bankruptcy, if any, for firms in the industry.

6. Discuss the experience of its creditors in Chapter 11.

 

II. Going Public: Analyze the performance of Initial Public Offerings after going public to determine whether you should continue to invest in initial public offerings. Also consider the perspective of the company going public. Why are they going public? Is the price set "right"? What factors are important for this firm.

Examples of Industries:

A. The Computer Industry: AOL etc.

B. The Biotechnology Industry: Focus on Genetic, Amgen and others -

C. The Medical Technology Industry:

Your Analysis should include (again not merely comprise) the following issues:

  1. A discussion and analysis of annual financial statements for the company and its competitors. Discuss industry and competitor's ratios, identifying financial strengths and weaknesses. What made the company decide to go public?
  2. Has the company done "well" following the IPO? Investment/market share relative to its competitors?
  3. Cost of Capital: Estimate the required rate of return for stock, bonds for at least one company in the industry using stock market data from the Daily Stock Price Record or from the Wall Street Journal.
  4. Given information in the prospectus and other competitors what should be the offering price?
  5. Discuss the price set by the investment banker vs. the closing price after the first day of trading. Is there any difference? If so, should management be "upset"? Was the company priced incorrectly? If so, why?
  6. Your Suggestions: Do you recommend the company for an investment - What are the risks, potential rewards?

 

BMGT 741: Advanced Financial Management

Case Package

CASES

  1. 9-289-063 Dynatronics, Inc:
  2. 9-292-104 Thermo Electron Corporation
  3. 9-291-041 Easel Corp.: Going Public (A)
  4. 9-297-052 USG Corp.
  5. 9-298-059 Marvel Entertainment Group
  6. UVA-F-0812 Darden Case: Flowers Industries, Inc.
  7. 9-293-123 Liability Management at General Motors:
  8. 9-287-058 Walt Disney Yen Financing:

SUPPLEMENTAL ARTICLES

  1. 9-288-023 Note on Free Cash Flow Valuation Models
  2. Hertz, David, Risk Analysis in Capital Investment, Harvard Business Review, #79504, 1979, pp. 169-181.
  3. Ritter, Jay, The Costs of Going Public, Journal of Financial Economics, 1987, Vol. 19, pp. 269-281.
  4. Ibbotson, I., J. Sindelar, J. Ritter, Initial Public Offerings, Journal of Applied Corporate Finance, VOLUME 1 NUMBER 2 SUMMER 1988, pp. 38-45.
  5. 9-285-087 Note on the Financial Perspective: What Should Entrepreneurs Know?
  6. 9-288-006 A Method for Valuing High-Risk, Long-Term Investments
  7. Roach, S., Living with Corporate Debt, Journal of Applied Corporate Finance, VOLUME 2 NUMBER 1 SPRING 1989, pp. 19-29.
  8. Jensen, M., Eclipse of the Public Corporation, Harvard Business Review, Sept-Oct 1989, pp. 61-74.
  9. Kohlbert, Kravis, Roberts, Leveraged Buyouts, Journal of Applied Corporate Finance, VOLUME 2 NUMBER 1 SPRING 1989, pp. 64-72.
  10. Inselberg, I. and H. Kaufold, How to Value Recapitalizations and Leveraged Buyouts, Journal of Applied Corporate Finance, VOLUME 2 NUMBER 2 SUMMER 1989, pp. 87-96.
  11. Gilson, Stuart, Managing Default: Evidence on How Firms Choose between Workouts and Ch. 11., Journal of Applied Corporate Finance, VOLUME 4 NUMBER 2 SUMMER 1991, pp. 62-70.
  12. McConnell, John, and Henri Servaes, The Economics of Pre-packaged Bankruptcy, Journal of Applied Corporate Finance, VOLUME 4 NUMBER 2 SUMMER 1991, pp. 93-97.
  13. Harris, Ira Center, Bankruptcies, Workouts, and Turnarounds: A Roundtable Discussion, Journal of Applied Corporate Finance, VOLUME 4 NUMBER 2 SUMMER 1991, pp. 34-61.
  14. Senbet, Lemma, The Insignificance of Bankruptcy Costs to the Theory of Optimal Capital Structure, Journal of Finance, 1978, Vol. 53, pp. 383-393.
  15. 9-294-005 Interest Rate Derivatives
  16. 9-286-073 Currency Swaps
  17. Lewent, Judy C. and A. John Kearney, 1991, "Identifying, Measuring, and Hedging Currency Risk at Merck" Journal of Applied Corporate Finance. pp. 19-28.