The University of Alberta

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The University of Alberta Department of Finance & Management Science

FIN 488 Selected Topics in Finance – Advanced Corporate Finance Winter 2006 X5 W 18:30-21:30 BUS 1-6

Instructor: András Marosi Office: 2-32C Phone: 492-5365

Office Hours: Wednesday 3:00 – 5:00pm and by appointment

Objective: Advanced Corporate Finance is a case study and teamwork based course that applies the material learnt in FIN 301, primarily from the standpoint of the corporation. Topics covered include capital budgeting, the valuation of companies, the cost of capital, initial public offerings, dividend policy, capital structure, leveraged buyouts, and applications of option pricing to corporate finance. FIN 301 is a prerequisite for this course.

Text: A packet of cases will be made available. (Estimated cost: $55.00.) Students registered for this course are required to purchase the case packet. Additional required and suggested readings may be handed out in class or posted on the class web site as the term progresses. There is no textbook but most students will probably find it helpful to consult the relevant chapters of their FIN301 textbook:

Fundamentals of Corporate Finance, 5

^th

Canadian edition by Ross, Westerfield, Jordan and Roberts, 2005, McGraw-Hill Ryerson, Toronto.

Office Hours: Office hours are as stated above and by appointment. I am also available by e- mail. E-mail questions will be answered within 48 hours. Answers to email questions will be either a posting to the course homepage or a direct response to the sender.

Requirements and procedures: The course consists of lectures and case discussions. Lecture classes will be devoted to issues and concepts underlying the topic to be covered. Case classes will be spent presenting and discussing the case assigned for that day. By the end of the first week of classes students are expected to form groups of four or five people. (There cannot be more than 12 groups due to the number of cases available.) In case some students have not joined a group by the deadline, the instructor will assign students to groups arbitrarily. Each group will be responsible for a formal presentation of 20 minutes maximum at the beginning of class.

Depending on the number of students in the class, each group may be assigned up to two cases for presentation (this will be finalized during the first week).

By the end of the second week of classes, each group is expected to pick the case(s) the group wishes to present. The instructor will randomly assign non-selected cases to the groups that have not yet picked their cases for presentation. Each group must hand in a typewritten report of maximum 4 pages containing both analysis and recommendations. The four-page limit is for the text only; you may attach as many tables and numerical calculations as you wish. Groups are required to turn in six case write-ups in total (including the one they present in class). Three of the submitted write-ups must be cases covered after the midterm exam. The reports are to be submitted in class on the day the given case is scheduled to be presented. Assignments handed in late (after the due date) will not be accepted. Team members should remember to bring an extra copy of their write-up to class; this will help the team during the discussion.

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Following the formal presentation, another group will evaluate and discuss the presentation. After this critique the discussion will be opened up to all class participants. At the end of the class the instructor will attempt to resolve any remaining uncertainty by providing a summary of the major issues in the case.

Grading: Course grades will be determined by combining points earned on case write-ups and presentations, class participation, a mid-term and a final examination. Peer evaluation forms will be used to assess individual students’ contribution to case write-ups and presentations. Peer evaluation forms will have to be submitted before the midterm and again before the final exam.

Only the evaluation forms submitted after the midterm and before the final exam will be used in assigning grades. For further details regarding peer evaluation, please see the course website. If you miss the midterm examination, I require official documentation of the reason you missed the exam. Official documentation entails a doctor’s excuse or a police report. If you have official documentation, the weight of the midterm will be applied to your final exam. If you do not have official documentation, you will receive a zero on the exam. These represent the only marks available to students. Make-up or extra work to improve your grade is not possible. Once assigned, the final grade in the class will not be changed except in the case of a recording error.

If you feel that your grade is incorrect, you must notify me in writing during the one-week period following the return of the midterm. After that, the problem will not be researched. Please note that a request to have a question on your midterm re-graded entails a request to have the entire exam re-graded.

Deferred final examinations will be allowed for students following University procedures for obtaining deferrals. Students interested in deferred final examinations should consult the Undergraduate Office. For more information on what a deferred exam is, go to http://www.bus.ualberta.ca/BCom/Current/PolicyProcedures/deferredexams.htm#1.

The weights given to the exams, case write-ups and presentation etc. are:

% of total grade

Six case write-ups 40%

Presentation, critique and participation 15%

Mid-term 15%

Final 30%

Total 100%

The final will focus primarily on the material covered following the mid-term. I do point out that Finance is a cumulative discipline so core dumping the materials in the first half of the class after the mid-term is not advisable.

Grade assignment will be based on the total points accumulated through the semester. Students acquiring 90% or more of the total points available will receive a grade of A or A+. Please note that depending on the overall performance of the class, an A grade can be obtained with fewer than 90% of the total points. Students accumulating fewer than 50% of the total points available will not receive a grade above F. Students accumulating 50% or more of the total points available will not receive a grade below D. Grades for students accumulating between 90% of the points and 50% of the points will be based on the overall performance of the class.

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Accumulated Points Class Grade

90% or more Guaranteed A or A+

50%-89% D to A– depending on class performance

Less than 50% F (FAIL)

You should bring picture ID with you to all examinations in addition to your calculator and writing implements (no red or green pens allowed). Be sure to bring your own calculator and that the batteries have sufficient power. For both the midterm and the final examination I will provide an appropriate formula sheet.

It is expected that all students are familiar with Excel (or other spreadsheet software). I believe that you will also find a financial calculator extremely useful in this class. However, you will not require a financial calculator. You should have a calculator that has

y

^x,

e

^x and

ln x

functions.

Programmable calculators must be “de-programmed” before exams. If you have a programmable calculator, I suggest that you bring a different calculator for exams if you want to retain any programmed information.

Your computer and calculator are tools and cannot substitute for an understanding of the problem solving process. As far as use of your calculator is concerned, I suggest you consult your users’

manual.

Missed classes are solely your responsibility. If you want to know what was covered in a class that you missed (including administrative announcements), or receive handouts from a class missed, you will have to find a classmate who attended class and is willing to share her/his notes.

I have doubts about any student’s ability to pass this course if she/he fails to attend class. Regular class attendance is required: in class participation is an important component of your grade.

I would like to ask group members to sit next to each other to facilitate discussion among teams.

It will also help me to learn your names if you keep the same seat the entire semester.

I expect honesty and integrity from my students. Cheating of any sort will be dealt with as sternly as University policy allows.

Attached is a schedule to guide you in your readings and class preparation. As mentioned earlier, additional required and suggested readings may be handed out in class or posted on the class web site as the term progresses.

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Date Topics Covered Related Ross Chapters (Fund. Of Corp. Fin.,54^th

Can. ed.)

Readings & comments

11-Jan-2006 Introduction. Valuation and Cash Flows 11-Jan-2006 Valuation and Cash

Flows cont’d

10 and 11 18-Jan-2006 Cost of Capital 13, 14 and 16 18-Jan-2006 Case#1: Telus: The Cost

Of Capital

Case discussion (Instructor presents case) 25-Jan-2006 Case#2: Marriott

Corporation Case discussion

25-Jan-2006 Venture Capital and Valuing Young Companies

1-Feb-2006 Case#3: Diabetogen Case discussion

1-Feb-2006 Capital Structure Decisions

15 and 16 Michael J. Barclay and Clifford W. Smith, Jr., 1999, “The Capital Structure Puzzle:

Another Look At The Evidence,” Journal of Applied Corporate Finance (JACF), vol 12 num 1, pp. 8-20.

Michael J. Barclay and Clifford W. Smith, Jr., 1996, “On Financial Architecture:

Leverage, Maturity, And Priority,” JACF, vol 8 num 4, pp. 4-17.

John Graham and Campbell Harvey, 2002, “How Do CFOs Make Capital Budgeting And Capital Structure Decisions?,”, JACF, vol 15 num 1, pp. 8-23

8-Feb-2006 Case#4 AT&T Case discussion

8-Feb-2006 Dividend Policy 13 and 17

15-Feb-2006 Case#5 Iridium LLC. Case discussion

15-Feb-2006 Case#6 Torstar Corp. Case discussion

1-Mar-2006 Midterm

1-Mar-2006 The decision to go public

15

8-Mar-2006 Real Options 22 and 23 Timothy Luehrman, "Capital Projects as Real Options: An Introduction," HBS 9- 295-074

Copeland Thomas E. and Philip T. Keenan, 1998, “Making Real Options Real”, The McKinsey Quarterly 3, 129-141.

Leslie Keith J. and Max P. Michaelis, 1997, “The Real Power of Real Options”, The McKinsey Quarterly 3, 4-22

8-Mar-2006 Case#7 T. Eaton

Company Ltd’s IPO Case discussion

15-Mar-2006 Case#8 Tiffany & Co Case discussion

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Date Topics Covered Related Ross Chapters (Fund. Of Corp. Fin.,54^th

Can. ed.)

Readings & comments

15-Mar-2006 Financial Innovation in Canada

Michael R. King, “Income Trusts—Understanding the Issues”, Bank of Canada Working Paper 20030-25

http://www.bankofcanada.ca/publications/working.papers/2003/wp03-25.pdf Hayward, P. 2002. “Income Trusts: A ‘Tax-Efficient’ Product or the Product of Tax Inefficiency?” Canadian Tax Journal 50(5): 1529–69.

http://www.ctf.ca/pdf/ctjpdf/2002ctj5_hayward.pdf 22-Mar-2006 Case #9: Arundel

Partners

Case discussion 22-Mar-2006 LBOs and MBOs

29-Mar-2006 Case #10 MW Petroleum A

Case discussion (Probably hardest case) 29-Mar-2006 Case #11: Amtelecom

Group Inc.

Case discussion 5-Apr-2006 Case #12: RJR Nabisco Case discussion

5-Apr-2002 Case #13: ATS Inc. Case discussion

12-Apr-2006 Final

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Questions

Case 1: Telus: The Cost of Capital

1. Compute the cost of capital for Telus Corporation.

2. How would you recommend that Telus should employ this cost of capital?

Case 2: Marriott Corporation

1. What is the Weighted Average Cost of Capital for Marriott Corporation?

2. What is the cost of capital for the lodging, restaurant and contract services divisions of Marriott?

3. If Marriott uses a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?

Case 3: Diabetogen

1. What is the business model for the company (from startup to exit) and is it viable?

2. What do you think the entire equity of Diabetogen is worth today?

3. What portion of the company’s common shares is the venture capitalist likely to want in return for the $7.5 million investment?

4. As Crowley how would you propose to divide the ownership interest among the remaining participants such as the scientists, Robarts, and the executive including Crowley?

Case 4: AT&T

1. Review AT&T’s past financial policies and financing choices. Were these appropriate for the nature of its business? In what fundamental ways will its business change in the near future? What are the implications for financial policy?

2. What is the range of AT&T’s financial needs for the next 5 years?

3. In view of AT&T’s changing strategic and economic environment, what debt policy would you recommend? What other financial policies are appropriate for the ‘new’ AT&T?

Case 5: Iridium LLC

1. Assuming the market was rational at the time (i.e. market prices reflect fundamental values), how much was Iridium worth at the end of 1998 according to the projections in Exhibit 5? What are the important determinants of value? How confident are you in your answer?

2. What caused Iridium to fail: was it a bad strategy, bad execution, or bad luck?

3. With regard to Iridium’s financial strategy, did it have the wrong target capital structure, issue the wrong kinds of capital, or issue capital in the wrong sequence? Which capital structure theory justifies its target debt-to-total book capitalization rate of 60%?

4. Why did Motorola finance Iridium with project debt instead of corporate debt?

Case 6: Torstar

1. Why do firms pay dividends? What is dividend policy? Are dividends irrelevant?

2. What is the logic underlying the conjectures that information is conveyed, i.e, signaled, via dividend policy ,share repurchases and stock splits? Evidence?

3. As a Torstar shareholder would you prefer regular dividends, special dividends or irregular share repurchases as a means of gaining a return on your investment?

4. As Robert Steacy, what recommendation would you make?

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Case 7: T Eaton Ltd.

1. Assess the appropriateness of the timing of the Eaton IPO. As a potential investor, what is your assessment of the prospects of the Eaton’s IPO and of Eaton’s in general?

2. What valuation method appears to be the most appropriate in this situation? What method would you use to value Eaton’s?

3. Determine the value of Eaton’s equity.

4. As Mary Vitug, what share price would you recommend to Sandra Schumacher? How many shares would you issue? What other recommendations would you make?

Case 8: Tiffany & Co.

1. Review Tiffany’s operations since the LBO. How attractive does the company look compared to other retailing operations?

2. As the lead manager of the underwriting syndicate, how far would you be willing to go in accommodating Tiffany’s pricing preferences?

3. As Tiffany’s top management, what is the highest gross spread you would be willing to settle for?

4. As the lead investment bank’s syndicate manager, what ‘short position’, if any, would you build into your offering strategy?

Case 9: Arundel Partners

1. Why do the principals of Arundel Partners think they can make money buying movie sequels rights? Why do the partners want to buy a portfolio of rights in advance rather than negotiating film-by-film to buy them?

2. Estimate the per-film value of a portfolio of sequel rights such as Arundel proposes to buy. [There are several ways to approach this problem, all of which require some part of the dataset in Exhibits 6-9. You may find it helpful to consult the Appendix, which explains how these figures were prepared. Use 12% for Arundel’s discount rate, and if you need a risk-free rate, use 6%.] Please highlight the advantages and disadvantages of your approach.

3. What are the primary advantages and disadvantages of the approach you took to valuing the rights? What further assistance or data would you require to refine your estimate of the rights’

value?

4. What problems or disagreements would you expect Arundel and a major studio to encounter in the course of a relationship like that described in the case? On what contractual terms and provisions should Arundel insist? Does their idea sound feasible and/or realistic?

Case 10: MW Petroleum Corporation (A)

1. Evaluate Amoco’s and Apache’s corporate objectives and strategies. Is it reasonable to expect that the MW properties are more valuable to Apache than to Amoco? What sources of value most plausibly account for the difference between buyer and seller?

2. Structure and execute a discounted cash flow valuation of all the MW reserves using APV. How much are the reserves worth? Is your estimate more likely to be biased high or low? What are the sources of bias?

3. How would you structure an analysis of MW as a portfolio of assets-in-place and options?

Specifically, which parts of the business should be regarded as assets-in-place and which as options? What kinds of options are present? Should this approach yield a higher or lower value than the all-APV approach you employed above?

4. Execute the analysis you structured in question 3, beginning with assets-in-place. How risky are the assets that underlie the options; i.e., how would you estimate s for each? How much is the whole portfolio worth?

5. Assuming a sale goes through, how does Apache exercise each of the various options? When

should it do so?

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Case 11: Amtelecom Group Inc.

1. What does it mean when a company “trades at a discount”? Is Amtelecom Group Inc. really trading at a discount?

2. Do you agree with AGI’s decision to break up the company? To sell the communications business rather than the courier business?

3. Assess the value of Amtelecom Communications using all available valuation methods. Which valuation method is most appropriate for each sales alternative? What are the expected net proceeds for each alternative?

4. As Stanley Stewart, what sales proposal would you recommend? How would you pitch it to the board? How would you market it to potential investors/acquirers?