Ohio State University Advanced topic in Corporate Finance (Spring 2005) Dr. Walkling

1. Ohio State University Advanced topic in Corporate Finance (Spring 2005) Dr. Walkling © 2005 Dr Ralph A. Walkling

2. Index Card (Print) • Name (Phonetic Spelling) • Area of Emphasis • Undergraduate degree - institution • Graduate degrees? • Work experience • Work experience related to finance (List job duties on back) • Long term Career Interests • Hometown • Hobbies © 2005 Dr Ralph A. Walkling

3. Seating chart © 2005 Dr Ralph A. Walkling

4. Introduction to the course © 2005 Dr Ralph A. Walkling

5. "Tell me and I'll forget. Show me and I'll remember. Involve me and I'll understand." • Confucius (551 BC-479 BC) Chinese Philosopher © 2005 Dr Ralph A. Walkling

6. Topics covered • Advanced topics in Corporate Finance • Mergers, Acquisitions and Restructuring • Valuation • Empirical Analysis • Agency Theory © 2005 Dr Ralph A. Walkling

7. Cases • Conoco DuPont • Hershey Foods: Bitter Times in a Sweet Place • Scott’s • Yeat’s/TSE © 2005 Dr Ralph A. Walkling

8. Review of Syllabus © 2005 Dr Ralph A. Walkling

9. The Scientific Revolution in Finance • 1952 • 1958 • 1964 • 1973 • 1976 © 2005 Dr Ralph A. Walkling

10. Question 1.4 • You are analyzing 100 securities • How many inputs do you need to analyze 100 securities under • Markowitz analysis? • The CAPM? © 2005 Dr Ralph A. Walkling

11. For Markowitz • For N securities, we need: • ____ expected returns • ____ variances • How many covariances? • _________ • So for 100 securities, we need • ___ + ___ + ____________ = ______ inputs © 2005 Dr Ralph A. Walkling

12. For CAPM • For N securities, we need • ____ expected returns • ____ expected variances • ____ covariances with the market • So we need ___ estimates + ________ • = ____ estimates © 2005 Dr Ralph A. Walkling

13. Factors That Have Lead to the Scientific Revolution • Technology • Data • Modern business School © 2005 Dr Ralph A. Walkling

14. Ch 1:1 • Think of at least twenty major inventions and services that have developed over your lifetime. Which of these were the most important to you? What business and investment opportunities did these inventions and services create? In what ways have financial markets and the availability of financial information changed over your lifetime? © 2005 Dr Ralph A. Walkling

15. The Art of Finance • Modern Technology and the Availability of Data do not eliminate the need for Judgement • Experience, intuition, and a solid grounding in theory • Knowledge of the possible - • Courage to expand the boundaries • Wisdom to play the odds © 2005 Dr Ralph A. Walkling

16. On the precision of financial models • The level of explanatory power of many financial models is low. • Typical R2 for estimation of Beta? • __% • i.e. ___% of the variation is unexplained • It is not unusual for valuation models to display an enormous range of values for a company © 2005 Dr Ralph A. Walkling

17. The Need for an Analytical Approach to Decision Making • Finance is about decision making • Sound decision making requires awareness of the strengths and limitations of available analytical tools © 2005 Dr Ralph A. Walkling

18. a b c d e f g h i j © 2005 Dr Ralph A. Walkling

19. Valuation – thought questions • Evaluate the following comments: • “The heart of finance is valuation” • “Corporate finance and investments are quite different fields” • “The best corporate executives think like investors” © 2005 Dr Ralph A. Walkling

20. The heart of finance is valuation. • corporate finance - maximizing value. • investments - pricing and identifying undervalued securities. • Two sides of the same coin. © 2005 Dr Ralph A. Walkling

21. The best corporate executives think like investors. • Ultimately, it is return to the investor that matters • "What would our investors want us to do?" • "It's the investors money, how can we make the most of it?" © 2005 Dr Ralph A. Walkling

22. Types of value • something is worth what somewhat else is willing to pay © 2005 Dr Ralph A. Walkling

23. Book Liquidation Going Concern Market Balance sheet value What you’d get if you sold off the pieces Present Value of future revenues from business Market price Types of Value © 2005 Dr Ralph A. Walkling

24. Market value • In theory, • Market value = max (liquidation value, going concern value) • with adjustments made for liquidity, taxes and transaction costs. © 2005 Dr Ralph A. Walkling

25. Discounted Cash Flow © 2005 Dr Ralph A. Walkling

26. Figure 2.1: An illustration of discounted cash flow © 2005 Dr Ralph A. Walkling

27. Unanswered questions • Forecasting? • Discount rate? • Growth and risk? • Time horizon? • Sensitivity? © 2005 Dr Ralph A. Walkling

28. Applying DCF in practice – the science • How do we get to infinity? • Constant growth • Zero growth • Irregular growth • Terminal Value © 2005 Dr Ralph A. Walkling

29. © 2005 Dr Ralph A. Walkling

30. © 2005 Dr Ralph A. Walkling

31. Price as of 9/24/02 • Approximately $47.22 © 2005 Dr Ralph A. Walkling

32. Solving for implied growth © 2005 Dr Ralph A. Walkling

33. Solving for implied growth © 2005 Dr Ralph A. Walkling

34. How realistic are the constant growth or zero growth assumptions? © 2005 Dr Ralph A. Walkling

35. Discounting • What? Why? • Don’t miss required investments • Don’t double count cash flows © 2005 Dr Ralph A. Walkling

36. Valuation Must Be Forward Looking • The past is useful only if it informs us about the future • But it worked yesterday! © 2005 Dr Ralph A. Walkling

37. Time Horizon:Length of Irregular Growth Period • What time period should we use for irregular growth? What are the factors we should consider? © 2005 Dr Ralph A. Walkling

38. Determining the Discount Rate • Intuition: discount rate = ? • opportunity cost © 2005 Dr Ralph A. Walkling

39. Measures of Risk • Standard deviation • Coefficient of variation • Mean absolute deviation • Beta coefficient © 2005 Dr Ralph A. Walkling

40. Review:Determining discount rates • opportunity costs • equals: time premium + risk premium • other names for the discount rate © 2005 Dr Ralph A. Walkling

41. Review of WACC © 2005 Dr Ralph A. Walkling

42. Questions: • Should you use market weights or book weights? • For what type of projects is WACC appropriate? © 2005 Dr Ralph A. Walkling

43. Estimating re • Name three ways to get the required return on equity • __________ • __________ • __________ © 2005 Dr Ralph A. Walkling

44. Other ways to determine discount rates: • CAPM for the entire firm using Asset Betas • APT • Multifactor Models • Multiples as discount rates © 2005 Dr Ralph A. Walkling

45. A Bidding Firm Contemplates Acquiring a Target • What cash flows and discount rate should the it use in the analysis? • Existing or new management? • What discount rate? © 2005 Dr Ralph A. Walkling

46. *Bruner Ch 9Some key points • The mechanics are straightforward, but learn to recognize important nuances, limitations and opportunities to improve valuation estimates • 9 rules for valuation (“think like an investor, etc”) • Types of valuation • Growth rates: sustainable growth and Fisher equation • Importance of terminal value • Triangulation • Value Merge xls • Other comments © 2005 Dr Ralph A. Walkling

47. *SP 9:13 Wolverine Football Booster Company • The Wolverine Football Booster Company is going out of business due to fierce competition and dismal results. Brutus Buckeye, an independent appraiser, has been hired to estimate the liquidation value of Wolverine’s assets. • How much will be left to the owner of Wolverine after liquidation? © 2005 Dr Ralph A. Walkling

48. SP 9:14 • The Unlimited Inc. is a nationwide retail chain specializing in women’s apparel. The company’s most popular lines are MBASTAR and AlumCreekwear. MBA offers executive wear for women in the middle to high-end markets, and AlumCreekwear features casual but stylish clothes, also targeted at women in the middle to high-end markets. The company has 210 million shares outstanding, 25 percent of which are publicly traded with a current market price of $15.27 per share. The company is expected to net $92 million in the next 12 months. Forecast sales and EBITDA are $1721 million and $159 million, respectively. Debt outstanding is $230 million. • What is the current enterprise market value of The Unlimited? • Suppose you are asked to value The Unlimited Inc. given the following information. What is your estimate of equity value? Of enterprise value? • What else would you like to know before you answer part B? © 2005 Dr Ralph A. Walkling

49. SP 9:15 • 15. Fisher Partners, a leveraged buyout firm owned by four Fisher MBAs, is considering an investment in a national retail bookseller. The target is attractive to Fisher because of its low level of debt, which at present makes up just 20 percent of the company’s total capital. The partners at Fisher believe that the debt level can be raised to as much as 45 percent of capital. Although this might mean a lowering of the credit rating from AAA to AA, or even to A, The Fisher partners believe that the interest tax shields would more than offset higher costs of borrowing. The bookseller’s average beta for the past year has been 0.80, and its marginal tax rate is 38 percent. • How would beta change if Fisher completed the acquisition and raised the bookseller’s debt to 45 percent? © 2005 Dr Ralph A. Walkling

50. SP 9:16 • The following is a five-year discounted cast flow (DCF) forecast for Buckeye Electric, Inc., an electric utility company: • (See excel spreadsheet) • Cash flows over the next five years are expected to fluctuate significantly due to key acquisitions and restructuring measures planned by Buckeve. After the fifth year, however, cash flow is expected to stabilize. Economists expect the long-term inflation rate to stabilize at 2 percent, and Buckeye expects real growth in sales to be 1 percent or less. Management has determined that the cost of capital is 11.3 percent. The first year working capital will increase by $355. Thereafter it will change by 20% of the projected change in sales. • Estimate Buckeye’s enterprise value. © 2005 Dr Ralph A. Walkling