Finance 461: Financial Cases & Modeling
August 26 - December 2, 2009

Professor: George W. Gallinger | Office: BAC 524 |Telephone: 480.965.4221
  Office Hours: Wednesday 5-6 p.m. & by appointment | Class: Wednesday, 6:05 - 8:55 p.m. - BAC 311
  Web Homepage: http://www.public.asu.edu/~bac524  
  E-mail: george.gallinger@asu.edu  
  Go directly to the assignments
Tentative Version: August 13, 2009

Educational Objective

The primary objective of this course is to provide a framework for analyzing financial decisions within a company to assess whether the decisions benefit shareholders. Discussion will show that there is a clear link between business strategy and finance since managers are under constant surveillance by financial markets to add value to shareholders' investments. The question is: What are the key drivers contributing to value? This course will concentrate on identifying the drivers and show you how to value assets in a risk-return framework.

Content, Organization & Delivery

A major theme in this course is risk versus return. This theme is woven throughout the following modules:  

• Foundational backdrop provides an overview of the financial system, the importance of efficient financial markets, and the integration of managerial finance with business strategy. To understand the strengths and weaknesses of a firm, it is necessary to have an understanding of the strategy management is following and how the firm is able to compete in the factor, product, and financial markets.
• Time value of money concepts are central to financial decision making. Time value of money means that funds have a risk-adjusted opportunity cost because alternative uses for funds exist.
• Valuation of debt and equity examines how to price these securities and, thus, value the firm.
• Capital structure analysis addresses the financing issue of how much debt financing to use and what is the resulting weighted average cost of capital (WACC) for the firm. WACC represents the opportunity cost of capital.
• Capital budgeting techniques examine the proper use of time value of money concepts to aid managers in making value-creating decisions for capital expenditures. The focus is on identification of relevant cash flows, which are then discounted at an appropriate risk-adjusted opportunity cost of capital
• Economic value added (EVA) is an accounting-based approach to measure value creation.

I use both lectures and cases to explain the materials and instill a better understanding of risk-return tradeoffs. While the lectures are not designed to dwell on abstract theory, theory is important because it provides the underpinnings for doing intelligent analysis. You will apply this material to analyze several real case situations.

Textbook, Cases, Readings & Internet

There is no textbook to purchase. Your FIN 361 text, Principles of Corporate Finance, 9th edition (New York, NY: McGraw-Hill Irwin, 2008: ISBN 978-0-07-340510-0), by Brealey, Myers and Allen (BMA), should be used as a reference book. The assigned readings from the text provide foundational knowledge for understanding lectures and doing the cases.

There are some hyperlinks within the syllabus. Click on the link to download articles from different servers. You purchase the case packet from the ASU Bookstore. The packet consists of the following materials from Harvard Business School (HBR/HBS), University of Virginia (UVA), and University of Western Ontario (Ivey).

Future Reading For Enjoyment  

The Quest for Value, G. Bennett Stewart, III (New York: HarperBusiness, 1991). Written in straightforward language by a business consultant, this book discusses how to use free cash flow and economic valued added models to analyze the creation or destruction of value in a firm.

Creating Shareholder Value, Alfred Rappaport (New York: The Free Press, 1998). This book takes a practitioner's approach to discussing the linkages between strategic planning, competitiveness, and asset control for improving a firm's stock price.

Becoming a Better Value Creator, Anjan Thakor (San Francisco, CA: Jossey-Bass, Inc., 2000). The author reveals the five secrets to creating value by incorporating the efforts of marketing, manufacturing, human resources, and finance into an overall strategy that ensures bottom-line success.

Determining Value, Richard Barker (UK: Pearson Education Limited). This book provides an excellent discussion of the weaknesses associated with the PE ratio in valuation analysis.

Quality of Earnings, Thornton O'Glove (New York, NY: Free Press, 1987). As the title implies, this book is about assessing a firm's quality of earnings. O'Glove is often quoted in the business press.

Financial Fine Print: Uncovering a Company's True Value, Michelle Leder (Hoboken, NJ: John Wiley & Sons, Inc., 2003). This book is along the lines of Quality of Earnings. It underscores the necessity of reading the notes in the annual report.

Profits You Can Trust: Spotting & Surviving Accounting Landmines, H. David Sherman, S. David Young, and Harris Collingwood (Upper Saddle River, NJ: Pearson Education, Inc., 2003). This book helps you spot the trouble spots in financial statements.

Freakonomics, Steven D. Levitt and Stephen J. Dubner ((New York: William Morrow, 2005). The authors show that economics is at the root of incentives. This book was on the New York Times best selling list for several weeks.

Sense & Nonsense in Corporate Finance, Louis Lowenstein (Reading, MA: Addison-Wesley Publishing Company, 1991). The author is an attorney, professor, and former president of a large diversified retailer. In his view, the capital asset pricing model—the foundation of modern finance—is elegant nonsense. The book is written in an entertaining, thought provoking style.

The Inefficient Stock Market, Robert A. Haugen (NJ: Pearson Education, 2002). A former academic, Haugen is managing partner of a portfolio management software company. His views on market efficient are contrary to many academicians.

Grading & Course Requirements

I will determine grades as follows:

• 10 points — Class contribution
• 20 points — Two individual "brief" assignments
• 60 points — Two team "detailed" written case reports
• 10 points — Team economic forecast

Class Contribution

The contribution grade takes account of the quality and regularity of your comments and preparation. Effective contribution means moving the analysis and understanding forward for all assignments. Contribution can take the form of asking insightful questions to stimulate the discussion. I expect you to come to class on time, fully prepared, and ready to open the discussion. Missed classes result in missed contribution points. Preparation involves careful analysis of the available quantitative and qualitative evidence presented in the assignments.

I allocate contribution points as follows:

• 9 - 10 points — Excellent
• 7 - 8 points — Average
• 3 - 6 points — Below average
• 0 - 2 points — Simply attends class.

Written Assignments

There are no exams in this class. Instead, you will submit four written case assignments (two "brief" and two "detailed") and one team write-up related to economic forecasting. All assignments are due at the beginning of class. You have some choice for the case assignments, as shown below. If you submit a case as an individual "brief", it can't  be submitted as as "detailed" team assignment", or vice versa. The two "detailed" papers will be completed as team work; thus, form teams of three to five people. Let me know by week three who is in your group.

Each case listed in this syllabus has a series of questions to provide guidance in addressing the issues and writing up the case. You are not restricted to these questions. If you see other issues, you can include them in your analysis. I expect for each of the "detailed" cases to see discussion about the firm's strategy and its business (or operating) and financial risks near the front of the write-up. Your analysis of risk will provide the foundation for other analyses that follow -- both qualitative and quantitative -- and recommendations. Please do not access data / information that occurs after the time period of the case.

BRIEF assignments are individual assignments They require a minimum of two, single-spaced typed pages of analysis, excluding exhibits and attachments. You choose the issue(s) you want to discuss. Attach whatever exhibits you feel are necessary to support your analysis. Don't simply restate facts of the case -- do critical thinking. For any quantitative analysis you do, I should be able to understand how you derive your results.

Choose any two cases included in the course to satisfy the written "briefs" requirement, except the following cases which are NON-GRADED assignments:

• Massey-Ferguson Limited (Session 2)
• Pioneer Petroleum Corporation (Session 4)
• PepsiCo Inc.: Cost of Capital (Session 5)
• Coke versus Pepsi (Session 11)

Although these four cases will not be submitted for grading, you are expected to come to class prepared to discuss them.

DETAILED assignments are team assignments. They have no page limit, although they probably shouldn't be less than five, single-spaced typed pages, excluding exhibits (e.g., spreadsheets, tables, supporting calculations). Do not dwell on restating facts in the case. I expect you to analyze the issues and write in a mature fashion without excessive use of bullets to express yourself. Use headings to separate the various parts of the paper. Needless to say, check the grammar. Treat the assignment as a report you are submitting to top management. In summary, you should be proud of your written work.

• Choose one of the following cases for the first team written case assignment:
  • The Super Project (Session 8)
  • PepsiCo Changchun Joint Venture (Session 9)
  • E. I. du Pont de Nemours & Co.: Titanium Dioxide (Session 10)
• Choose one of the following cases for the second team case written assignment:
  • The Battle for Value - Federal Express vs. UPS (Session 12)
  • Briggs & Stratton (Session 13)

The Economic forecasting assignment is a team assignment based analyzing economic data and graphs provided in an Excel file. You need to update the data. Please do not use other data in your report. The actual assignment is still to be determined and depends on what happens over the next several weeks. You need to provide economic logic and support for your forecasts; in other words, tell me why. There is no page limit on this assignment. I'm looking for substance.

Peer ratings will be conducted for all team assignments. The purpose is to capture member's interaction and contribution to group learning dynamics for the case. Team members will be asked to score each member of the group, including themselves, out of 100 points. Based on the feedback from all team members, individual scores for the group case may be adjusted. For example, assume the average peer rating scores for a three person team are Member 1 = 95%, Member 2 = 90% and Member 3 = 75%. These scores will be revised using the following formula:

    Revised score = (Member's average score / highest score for the team) x 100

Thus, scaled scores for Members 1, 2 and 3 are 100%, 94.7% and 78.9%, respectively. Assume the score for the case is 85%. The individual scores will be 85% for Member 1, 80.5% for Member 2 and 67.1% for Member 3.

The purpose of this scoring system is to reward those who contribute and penalize those who don't. If peer ratings are inconsistent with my observations and intuition, I will ask each team member to provide me with written feedback to support the ratings.

W. P. Carey School of Business Honor Code

You are expected to do your own writing of all individual assignments. I encourage you to speak to other students about the issues, but write the analysis in your own words and share no files whatsoever. Failure to do so may result in zero points for the assignment (or the course) for both the receiver and provider (if involved) of the files if I detect noncompliance. Some of the cases used in this class may have been used before at ASU or other institutions. You may not consult with students previously enrolled in this class, their class notes, or materials that were otherwise provided in the past. Moreover, you may not use materials or solutions from other institutions (e.g., posted on the Internet), unless I instruct you to do so for a particular assignment.

Click on the Appropriate Date to Go Directly to the Assignment

Session 1: August 26

Lecture: Understanding the economy through a graphical examination of economic relationships -- so that you have a better understanding of finance

Assignment:

1. Download this data file and these notes. Study the relationships; they will be discussed during this first class. You and your team members will continue to analyze the relationships throughout the semester and submit a team report on December 2.

Session 2: September 2

Lecture: Examine the foundations of finance and its relationship to business strategy

Notes: Foundation 

Readings in BMA:

1. Chapter 1: Finance and the financial manager
2. Chapter 29: Financial analysis and planning
3. Chapter 14: Efficient markets and behavioral finance

Readings:

1. What is strategy? (HBR 96608)
2. Why strategy matters
3. Is your core competence a mirage?
4. Porter's generic strategies
5. Porter's 5 forces
6. GE matrix

Case: Massey-Ferguson, Limited (1980) (HBS 9-282-043)

Note: This case is for class discussion and will not be graded

Purpose: To explore financing and strategic decisions in a competitive environment using your accounting knowledge of financial analysis

Suggested Questions:

1. Assess the product market strategy and financial strategy Massey pursued through 1976. Where possible, compare Massey's strategy with those of its leading competitors.
2. What went wrong after 1976? How did Massey respond? How did its competitors respond? What were the consequences for Massey?
3. Assess the various alternatives at the current stage of Massey's difficulties. What options are available for alleviating Massey's financial problems?
4. As a financial advisor to Massey's management, what refinancing plan would you propose? Give particular attention to the various interested parties: shareholders, lenders, employees, governments, and management.
5. Why, fundamentally, did Massey get into financial trouble? Were a refinancing plan successfully executed, what would be the outlook for Massey's future? What alternative actions by management would have reduced the severity of Massey's financial difficulties.

Session 3: September 9

Lecture: Discussion of time value of money techniques and risk versus return concepts

Notes: Risk & return 

Readings in BMA:

1. Chapter 2: Present values, the objectives of the firm, and corporate governance
2. Chapter 3: How to calculate present values
3. Chapter 8: Introduction to risk, return, and the opportunity cost of capital
4. Chapter 9: Risk and return

Lecture: Examine valuation of debt and equity

Notes: Valuation 

Readings in BMA:

1. Chapter 4: Valuing bonds
2. Chapter 5: The value of common stocks
3. Chapter 17: Payout policy

Session 4: September 16

Lecture: Extend the discussion of valuation to the firm level

Notes: Capital structure 

Readings in BMA:

1. Chapter 18: Does debt policy matter?
2. Chapter 19: How much should a firm borrow?
3. Chapter 20: Financing and valuation

Case: Pioneer Petroleum Corporation (HBS 9-292-011)

Note: This case is for class discussion and will not be graded

Purpose: To review the basic concepts for estimating the weighted average cost of capital and develop an understanding of the risk-return trade-off in capital budgeting.

Suggested Questions:

1. Does Pioneer estimate its overall corporate weighted average cost of capital correctly?
2. Should Pioneer use a single corporate cost of capital or multiple divisional hurdle rates in evaluating projects and allocating investment funds among divisions? If multiple rates are used, how should they be determined?
3. How should Pioneer set capital budgeting criteria for different projects within a given division? What distinctions among projects might be captured in these criteria? How should these different standards be determined?

Session 5: September 23

Non-Graded Exercise:

1. Use Excel's regression analysis function to calculate beta for a company of your choice using Yahoo Finance and compare to published betas. You access the function in Excel by clicking on TOOLS and then DATA ANALYSIS. Look for REGRESSION in the scrollable menu. If DATA ANALYSIS is not included in the TOOLS menu, then click on ADD-INS in the TOOLS menu and then click ANALYSIS TOOLPAK. This operation should load DATA ANALYSIS.

Case: PepsiCo, Inc.: Cost of Capital (UVA-F-0981)

Note: This case is for class discussion and will not be graded

Purpose: To review the basic concepts for estimating the weighted average cost of capital and develop an understanding of the risk-return trade-off in capital budgeting.

Suggested Questions:

1. How has PepsiCo performed over the last 10 years? How did you measure performance to answer this question? Has the company created value for the stockholders as claimed in its annual report?
2. What are the costs of capital for the individual business segments?
3. Do your business segments "add up" to 11% for the overall corporate cost of capital? Why or why not?
4. What is the danger of using the corporate cost of capital to make investment decisions at the division level? Give examples of the types of errors that could occur.

Case: American Home Products (HBS 9-283-065)

Purpose: To examine the problem of determining an optimal capital structure

Suggested Questions:

1. How much business risk does American Home Products face? How much financial risk would American Home Products face at each of the proposed levels of debt shown in Exhibit 3? How much potential value, if any, can American Home Products create for its shareholders at each of the proposed levels of debt? To answer this last part of the question, estimate stock price at debt levels of 30%, 50%, and 70%, at least.
2. What capital structure would you recommend as appropriate for American Home Products? What are the advantages of leveraging this company? How would leveraging up affect the company's taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure?
3. How might American Home Products implement a more aggressive capital structure policy? What are the alternative methods for leveraging up?
4. In view of American Home Products' unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his successor to adopt your recommendation?

Session 6: September 30

Case: Sealed Air Corporation's Leveraged Recapitalization (A) (HBS 9-294-122)

Purpose: To explore how financing decisions affect organizational structure, management decision making, and firm value

Suggested Questions:

1. Why did Sealed Air undertake a leveraged recapitalization? Do you think that it was a good idea? For whom?
2. How much value was created? Where did it come from?
3. Is pursuing a program of manufacturing excellence such as World Class Manufacturing inconsistent with "levering up"?
4. Why did Dermot Dunphy, the CEO, feel it was necessary to change the company's priorities and incentive structure following the recap?
5. Why did Sealed Air's investor base turnover completely after the recap? Is this something management should be concerned about?
6. Was the constraint imposed on capital expenditures under the bank lending agreement good or bad for the company? Do you think managers will be able to successfully renegotiate this covenant?
7. Would such an increase in leverage be good for all companies? Why or why not?

Assignment: Compare and contrast the financial decisions to be made by managers of American Home Products and Sealed Air Corporation.

Lecture:

1. Catch-up and review of materials to date.

Session 7: October 7

Lecture: Introduction to techniques for evaluating capital expenditures

Notes: Capital budgeting 

Readings in BMA:

1. Chapter 6: Why net present value leads to better investment decisions than other criteria
2. Chapter 7: Making investment decisions with the net present value rule

Session 8: October 14

Lecture: Continuation of the capital budgeting discussion

Case: The Super Project (HBS 9-112-034)

Purpose: To examine the suitability of a company's capital budgeting system for evaluating a proposal to introduce a major new product

Suggested Questions:

1. Should test marketing expenses be included in the analysis of the Super project?
2. Should the Super project be charged for the use of the excess agglomerator and building capacity?
3. Should the Super project have to absorb a charge for overhead expenses?
4. Should the Super project be charged with the lost contribution margin on Jell-O if the project goes forward?
5. What are the relevant cash flows for General Foods to use in the Super project?
6. What is the net present value of the cash flows from the Super project, assuming a 10% discount rate?
7. What is the internal rate of return on the Super project?
8. Should General Foods invest in the Super project?

Session 9: October 21

Lecture: Examine the relationship between strategy and net present value to create shareholder value

Case: PepsiCo Changchun Joint Venture (Ivey 9B00N016)

Note: This case is for class discussion and will not be graded

Purpose: To examine the suitability of a company's capital budgeting system for evaluating a proposal to introduce a major new product

Suggested Questions:

1. Use the information in the case to construct two sets of NPV and IRR analysis on the proposed Changchun bottling joint venture: one set excluding the concentrate sales, the other set including the concentrate sales. Based on the results, what would be your decision on the proposed Changchun joint venture?
2. Comment on the financial projections that PepsiCo used in its capital budgeting exercise, especially the NOPBT Cap, foreign exchange rate projection and the discount rate.
3. What differences might there be as to how the PRC partners do the analysis (or look at the future cash flows) versus PepsiCo?

Session 10: October 28