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FINANCE 580. Cases in Managerial Finance. Today’s class. Introductions and house keeping Financial planning and analysis Seminal ideas in corporate finance. My Background. NAME : Ken Shah BORN : Bombay, India PhD : University of Oregon INDUSTRY EXPERIENCE :

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finance 580

FINANCE 580

Cases in Managerial Finance

today s class
Today’s class...
  • Introductions and house keeping
  • Financial planning and analysis
  • Seminal ideas in corporate finance
my background
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 Quantitative Portfolio Management Research, Portland, Oregon
academic experience
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
Recent Research
  • Analyst Forecasts
  • Bond Returns
  • M&A Fairness Opinions
  • Capital Structure
  • Initial Public Offerings
course objectives
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
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
Anticipate...
  • About 5 hours of work outside of classper week
  • Frustrations with unstructured problem solving!
  • Frustrations with computer work!
texts
Texts
  • Required:
    • Bruner, Case Studies in Finance (online – no physical text)
    • Packet of Readings – at Copymart
  • Optional:
    • Brealey & Myers, Principles of Corporate Finance
    • Higgins, Analysis for Financial Management
evaluation
Evaluation
  • Group Case Presentation 300
  • Participation 100
  • Midterm Case 300*
  • Final Case 300*
  • TOTAL 1000
  • * Please correct the syllabus
grading policy
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
Class Attendance
  • Mandatory
    • Discussion particularly important in a case class
  • Please inform me of anticipated absences
    • More than 1 absence will adversely affect your grade
  • Please include in email subject “FINC 580 F06”
    • Please send an introductory email and feel free to tell me about yourself, and any concerns/absences you anticipate
case presentations
Case Presentations
  • About 30-40 minutes in length
  • Formal write-up & Class Handout
  • Field questions
non presenting students
Non-presenting students
  • Demonstrate preparedness
  • Come to class with analytical solution
    • E.g. see Gulf Oil solution
  • No formal write-up
midterm final
Midterm & Final
  • Formal 3 page case analytical solution
  • Take home
  • One week to complete
  • Individual effort
readings
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
Course Design

Growing Pains - Private enterprise

Midlife crisis - Managing growth

Over the hill - Restructurings

case progression
Case Progression
  • Managing Growth / Private enterprise:
    • Short term financing / Managing growth
    • Going public
    • WACC
  • Sustaining Growth / Financing Policy:
    • Payout policy
    • Capital structure policy
  • Lower Growth / Corporate Reorganizations:
    • Takeovers
    • LBOs
    • Bankruptcy
cases
Cases...
  • Are deliberately vague!
  • Have information deliberately presented in random order - not in the order of importance
  • Offer little guidance on method of solution
case solution strategy
Case Solution Strategy
  • Reading the case
    • First time just read it like a magazine article – look at forest, not the trees
    • Leaf through the exhibits
    • Go back and read it more thoroughly taking notes
develop your awareness
Develop your awareness
  • Who are the decision makers and what pressures do they face?
  • What is the business of the company?
  • What are the goals of the firm?
  • How well has the firm performed in its pursuit of the goals?
defining the problem
Defining the problem
  • Common trap – symptom not the real problem
  • Believability of key assumptions
  • Assumptions drive results
analysis
Analysis
  • Run the numbers and go to the heart of the matter
  • Perform analysis on key assumptions
  • Get down to the key bets
  • Get to business issues quickly
recommendation
Recommendation
  • Prepare to participate: take a stand
  • In Class: Participate actively in support of your conclusions but be open to new insights as they emerge
  • Trust the process:
    • Case learning is cumulative over time
my approach to a case
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
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 case27
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 case28
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 case29
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
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
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
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
Elements of Financial Planning
  • Forecasting
    • Pro-forma statements
  • Finding the optimal financial plan
    • Analysis
  • Watching the plan unfold
analyzing performance
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
Analytical Tools
  • Sensitivity (what-if) analysis
  • Scenario analysis
  • Monte Carlo simulation
  • Decision Trees
sensitivity analysis
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
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
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
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
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
  • Theory does provide a framework to start the analysis
caution
Caution…
  • Do not try to force a solution to fit the theory
  • Real world problems cannot conform to theory precisely
  • Common techniques and theory’s guidance must be adapted to suit the problem at hand
  • Do not take ‘cookie cutter’ approach!
bridging finance theory and managerial finance
Bridging Finance Theory and Managerial Finance...
  • CAPM
    • NPV, capital budgeting, WACC
  • Modigliani-Miller Propositions
    • Dividends, capital structure, WACC
  • Agency Theory
    • Corporate governance, compensation, optimal contracts
  • Asymmetric Information Models
    • Signalling, stock price reactions
  • Option Pricing
    • Risk management, real options in capital budgeting
slide43
CAPM
  • Widely used in NPV, capital budgeting
  • Efficient Portfolios, CML, SML
  • Recently under attack (is beta dead?)
  • Rivals:
    • APT
    • Empirical Multifactor Models
      • Book-to-market and Size effects
m m propositions
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 propsitions
M-M Propsitions
  • Many of the ‘perfect market’ assumptions have been relaxed without affecting core conclusions
  • Teach us that it is important to focus on the business, not finance, if an enterprise is to be successful
agency theory
Agency Theory
  • Inability to write perfect contracts between principal and agent that ensures agent acts in the best interest of the principal
  • Agency problem arises from delegation of decision making and imperfect information and imperfect monitoring
agency costs
Agency Costs
  • Conflicts are inherent between
    • Shareholder - Management
    • Shareholder - Bondholder
  • Firm value is reduced by
    • Excessive perk consumption
    • Taking unwarranted risk
    • Forgoing profitable investments

with debt

agency cost models
Agency Cost Models
  • Used successfully in explaining
    • LBOs, Takeovers, restructuring activity
    • Debt covenants
    • Design of board of directors
    • Design of incentive compensation
    • Use of convertible securities
asymmetric information models
Asymmetric Information Models
  • Actions taken by better informed agents convey information to those less informed
  • Management have superior information about own firm value
  • Successful in explaining stock price reactions to announcements of corporate actions
  • Do managers deliberately signal?
option pricing models
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 models51
Option Pricing Models
  • Binomial
    • When outcomes at each node are discreet and limited in number
  • Black - Scholes
    • For continuous range of outcomes such as market prices
finance in international context
Finance in International context
  • Basic finance theory is universal
  • Two additional issues arise:
    • Exchange rates (PPP, IRP)
    • The extent to which global financial markets are integrated:
      • Affects risk and discount rate
gulf corp takeover
Gulf Corp Takeover
  • An example of case ‘solving’, and my approach
  • An example of 1-page analytical solution
    • Getting to the heart of the problem
    • Running numbers
    • Drawing conclusions