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LAHORE UNIVERSITY OF MANAGEMENT SCIENCES

Course Outline

for

APPLIED CORPORATE FINANCE

Instructor’s Name: Dr. Naim Sipra Room No. 161Telephone Ext: 2161

Office Hours for students: Fridays 3-5 pm________________________________________________________________________

Course Title APPLIED CORPORATE FINANCE

Course Code ACF 465

Introduction

The objective of this course is to reinforce and expand on the previous financial analysis and corporate finance/intermediate finance courses. Many of the topics covered are the same, but the emphasis is different. By using the case-method methodology the emphasis shifts from learning financial techniques to applying them to make managerial decisions,

Textbook

Since the topics covered in this course are those that are contained in any standard text of corporate finance, therefore, no text is assigned for this course. You may use your Brigham and Gapenski text for review and reference.

Grading: CP 40 %Quizzes 10 %Mid-term 25 %Final 25 %

Session 1

Case: Butler Lumber Company

Assignment Questions

1. Why does Mr. Butler have to borrow so much money to support this profitable business?

2. Do you agree with his estimate of the company’s loan requirements? How much will he need to borrow to finance his expected expansion in sales (assume a 1991sales volume of $3.6 million)?

3. As Mr. Butler’s financial adviser, would you urge him to go ahead with, or to reconsider, his anticipated expansion and his plans for additional debt financing? As the banker, would you approve Mr. Butler’s loan request, and, if so, what conditions would you put on the loan?

Session 2

Case: Toy World, Inc.


1. What factors could Mr. McClintock consider in deciding whether or not to adopt the level production plan?

2. What savings would be involved?

3. Estimate the amount of added funds required and the timing of the needs under level production. Prepare pro forma income statements and balance sheets (rather than a cash budget) to make this estimate. Ignore interest expense in making these estimates.

4. Compare the liabilities patterns feasible under the alternative production plans. What implications do their differences have for the risk assumed by the various parties?

Session 3

Case: Hampton Machine Tool Company

Suggested Questions

1. Why can’t a profitable firm like Hampton repay its loan on time and why does it need more bank financing? What major developments between November 1978and August 1979 contributed to this situation?

2. Based on the information in the case, prepare a projected cash budget for the four months September through December 1979, a projected income statement for the same period, and a pro forma balance sheet as of December 31, 1979.

3. Review the results of your forecast. Do the cash budgets and the pro forma financial statements yield the same results? Why?

4. Critically evaluate the assumptions on which your forecasts are based. What developments could alter your results? Is Mr. Cowins correct in his belief that Hampton can repay the loan in December?

5. What action should Mr. Eckwood take on Mr. Cowins’ loan request? What are the major risks associated with the proposed loan? What other alternatives does Mr. Eckwood have, and what are their pros and cons? What would you do?

6. Why did Hampton repurchase a substantial fraction of its outstanding common stock? What is the impact of this repurchase on Hampton’s financial performance? Critically assess Hampton’s dividend policy. Do you agree with Mr. Cowins’ proposal to pay a substantial dividend in December?

Session 4

Case: Tree Values


1. Assume that the appropriate cost of capital is 240 basis points (2.4%) above the ten-year government bond rate. To calculate the cost of capital, should you add the 240 basis points to a ten-year Treasury Bond that yielded 6.04% in June 2000 or a ten-year Treasury Inflation Protected Security (TIPS) that yielded 4.14% in June 2000? How do you decide?

2. When would you recommend cutting a 50 year old tree that is 10” DBH? Assume no grade changes and that a hypothetical tree takes five years to grow one inch in DBH. What if it takes ten years to grow one inch in DBH? If you would recommend different times to cut the tree, please explain why you reach different conclusions.

3. When would you recommend cutting a 50 year old tree that is 10” DBH, grows at the rate of one inch of DBH each five years, and also increases one grade with each 2”growth in DBH? Is the decision the same if the tree is growing at the rate of 1” DBH over ten years? In the following questions, assume all the trees in Mr. Smith’s forest have to be cut at the same time.

4. If Mr. Smith simply lets his trees grow, would they increase in value? When would you recommend cutting the trees if they are simply left to grow? Assume the trees grow at a rate of 1”of DBH over ten years.

5. If Mr. Smith decides to thin and manage his forest, how would this affect its value? Assume that half the trees are thinned and that the remaining trees grow at the rate of 2”in DBH every ten years. Also assume that a forester’s management costs are offset by the value of the thinned trees.

6. What forest management strategy, if any, would you recommend to Mr. Smith?

Session 5

Case: The Super Project


1. What are the relevant cash flows for General Foods to use in evaluating the Super project? In particular, how should management deal with issues such as

a. Test-market expenses?b. Overhead expenses?c. Erosion of Jell-O contribution margin?d. Allocation of charges for the use of excess agglomerator capacity?

2. How attractive is the investment as measured by various capital budgeting techniques (i.e., accounting rate of return, payback period, internal rate of return, net present value)? How useful are each of these measures of investment attractiveness?

3. How attractive is the Super project in strategic and competitive terms? What potential risks and benefits does General Foods incur by either accepting or rejecting the project?

4. Should General Foods proceed with the Super project? Why, or why not?

Session 6

Case: Whirlpool Europe


1. Are all of the benefits of the ERP investment reasonable? Are the costs reasonable?

2. What are the after-tax cash flows for the proposed ERP investment from 1999 through 2007? What is the present value of those cash flows?

3. When valuing the proposed investment, should value be included for possible cash flows that occur beyond 2007? What does it depend on?

4. Would you recommend the ERP investment? What is your major concern?

Session 7

Case: Radio One, Inc.


1. Why does Radio One want to acquire the 12 urban stations from Clear Channel Communications in the top 50 markets along with the nine stations in Charlotte, NC, Augusta, GA, and Indianapolis, ID? What are the benefits and risks?

2. What price should Radio One offer based on a discounted cash flow analysis? Are the cash flow projections reasonable?

3. What price should Radio One offer based on a transaction and trading multiples analysis?

4. Assuming that Radio One’s stock price is 30X BCF, can it offer as much as 30X BCF for the new stations?

5. What should Radio One offer for the new stations?

Session 8

Case: Interco


1. Assess Interco’s financial performance. Why is the company a target of a hostile takeover attempt?

2. As a member of Interco’s board are you persuaded by the premiums paid analysis (Exhibit 10) and the comparable transactions analysis (Exhibit 11)? Why?

3. Wasserstein, perella & Co. established a valuation range of $68-$80 per common share for Interco. Show that this valuation range can follow from the assumptions described in the discounted cash flow analysis section of Exhibit 12. As a member of Interco’s board, which assumptions would you have questioned? Why?

4. How would you advise the Interco board on the $70 per share offer?

5. How would you assess the actions of Interco’s board up to August 8, 1988? Wasserstein, Perella & Co.’s? The Rales brothers’? Drexel Burnham’s?

Session 9

Case: Netscape's Initial Public Offering


Suggested Assignment Questions

1. Why has Netscape been so successful to date? What appears to be its strategy? What must be accomplished if it is to be a highly successful going concern in the long run? How risky is its current competitive position?

2. Does Netscape need to go public to satisfy its capital needs? What would you estimate might be the magnitude of its capital needs over the next 3 to 5 years? What sources other than the public equity market could be tapped to satisfy those needs?

3. Why, in general, do companies go public? What are the advantages and disadvantages of public ownership?

4. The case points out that the IPO market is sometimes characterized as a “hot issue” market, and that many IPO’s are viewed in retrospect as having been “under priced.” What might explain these phenomena? Should the Netscape board be concerned about under pricing? Why or why not?

5. Can the recommended offering price of $28 per share for Netscape’s stock be justified? In valuing Netscape, you might find it helpful to use the following assumptions: Total cost of revenues remains at 10.4% of total revenues; R&D remains at 36.8% of total revenues; Other operating expenses decline on a straight-line basis from 80.9% of revenues in 1995 to 20.9% of

revenues in 2001 (this would give Netscape a ratio of operating income to revenues close to Microsoft’s, which is about34%);

Capital expenditures decline from 45.8% of revenues in 1995 to 10.8% of revenues by 2001 (again, close to Microsoft’s experience);

Depreciation is held constant at 5.5% of revenues; Changes in net working capital of essentially zero; Long-term steady-state growth of 4% annually after 2005; and A long-term riskless interest rate of 6.71%

Given these assumptions, and starting from its current sales base of $16.625 million, how fast must Netscape grow on an annual basis over the next ten years to justify a$28 share value?

6. As an executive of Netscape, what would you recommend with respect to the proposed offering price? As an investor in Netscape, what would you recommend? As the manager of an institutional fund who was willing to buy and hold Netscape’s stock at the originally proposed price of $14 per share, would you be willing to buy and hold at an initial offering price of $28 per share?

Session 10

Case: John M. Case Company


1. What are the most important operating and financial characteristics of the Case Company?

2. Is the company worth Mr. Case’s $20 million asking price?

3. Can the $20 million purchase be financed so that management can retain at least 51% ownership? What sources should management tap? In what amounts? Is the return being sought by the venture capital firm reasonable?

4. How compelling a buyout opportunity is this proposition for the four managers?

5. Would you, as a commercial banking lender, provide the loan needed to finance the seasonal buildup in accounts receivable and inventory? On what terms?

1. Would you, as the venture capital firm, provide the balance of the funds needed? If so, on what terms?

Note: Mr. Case is willing to take a note with a face value of $6 million and an interest rate of 4%. However, the note’s economic value, due to the low interest rate, is only$4 million; the $20 million sale price is based on receiving the note plus $16 million in cash.

Session 11

Case: The Loewen Group, Inc. (Abridged)


2. How was the Loewen Group able to grow explosively for the first half of the 1990s? What were advantages of debt financing enjoyed by the firm in this phase?

3. How did Loewen get to the position it found itself in 1999?

4. (Optional) why do you think SCI was willing to offer Loewen such a substantial premium? What incremental cash flows might SCI expect that could explain this premium?

5. Some might describe Loewen as “financially distressed.” Is this a fair description of its problem? What are the manifestations and apparent costs of this so-called financial distress?

6. What are Loewen’s alternatives? What would you recommend to John Lacey?

Session 12

Case: American Home Products Corporation


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 case Exhibit 3? How much potential value, if any, can American Home Products create for its shareholders at each of the proposed levels of debt?

2. What capital structure would you recommend as appropriate for American Home Products? What are the advantages of leveraging this company? The disadvantages? 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 AHP’s unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his successor to adopt your recommendation?

Session 13

Case: Debt Policy at UST Inc.


1. What are the primary business risks associated with UST Inc.? What are the attributes of UST Inc.? Evaluate from the viewpoint of a bondholder.

2. Why is UST Inc. considering a leveraged recapitalization after such a long history of conservative debt policy?

3. Should UST Inc. undertake the $1 billion recapitalization? Calculate the marginal (or incremental) effect on UST’s value, assuming that the entire recapitalization is implemented immediately (January 1, 1999).

Assume a 38% tax rate.

Prepare a pro-forma income statement to analyze whether UST will be able to make interest payments.

For the basic analysis, assume the $1 billion in new debt is constant and perpetual. Should UST alter the new debt via a different level or a change in the amount of debt through time.

4. UST Inc. has paid uninterrupted dividends since 1912. Will the recapitalization hamper future dividend payments?

Session 14

Case: Stone Container Corporation (A)


1. What was the basis of Stone Container’s successful growth during its first fifty years? What was its product market strategy? What was its financial strategy?

2. How did Roger Stone’s management of the company compare to that of his predecessors? In general, would you judge his leadership to have been successful? Why or why not?

3. How sensitive are Stone Container’s earnings and cash flow to the paper and linerboard pricing cycle? Estimate the effect on earnings and cash flow of a $50 per ton industry-wide increase in prices. Assume Stone Container’s sales volume approximates its 1992 production level of 7.5 million tons per year, and costs, other than interest expense, remain the same. Also assume a 35% tax rate.

4. What would be the effect of a $100 per ton industry-wide increase under the same assumptions given above?

5. What would be the effect under both these pricing scenarios if production and sales volume increased to full capacity of 8.3 million tons per year (for simplicity, assume costs per ton remain constant)?

6. What should be Stone Container’s financial priorities for 1993? What must be accomplished if Stone is to relieve the financial pressures afflicting it?

7. Of the various financing alternatives described at the end of the case, which would be in the best interest of Stone’s shareholders? Which would be in the best interests of its high-yield debt (i.e., junk bond) holders? Of its bank creditors?

8. Which of the financing alternatives would you recommend Stone Container pursue in 1993? If you recommend more than one, which do you view as most important and why? Which would you do first, and which later?

Session 15

Case: MCI Communications Corporation (1983)


1. What is the likely level of MCI’s external needs over the next several years? By how much could they reasonably be expected to vary? Why?

2. Critique MCI’s past financial strategy, giving attention to the types of securities on which it has relied. Why did MCI finance itself in the manner it did?

3. Based upon your analysis of the outlook for MCI and the competitive and regulatory evolution of the industry, recommend a capital structure policy for MCI and defend your proposal against plausible alternatives.

4. Assume that Mr. English, the MCI chief financial officer, has the following financial alternatives available to him as of April 1983:

a)$500 million of 121/2, 20-year subordinated debentures.

b)$400 million of common stock.

c1)$600 million of 75/8, 20-year convertible subordinated debentures with conversion price of $54 per share (i.e., each $1,000 bond would be converted into 18.52 common shares).

c2)$1 billion of a unit package consisting of a $1,000 71/2, 10-year subordinated debenture and 18.18 warrants, each entitling the holder to purchase one share of MCI common stock for $5

5. The warrants would be exercisable until1988 and are callable. The exercise price of the warrants would be payable either in cash or by surrender of the debentures valued at their principal amount. Which, if any, of these alternatives, would you recommend that Mr. English take? Why? In broad outline, what financing steps would you recommend he take over the next several years?

Session 16

Case: Dividend Policy at FPL Group, Inc. (A) and (B)


1. Why do firms pay dividends? What, in general, are the advantages and disadvantages of paying cash dividends?

2. What are the most important issues confronting the FPL Group in May 1994?

3. From FPL’s perspective, is the current payout ratio appropriate? Would a higher payout ratio be more appropriate? a lower payout ratio?

4. From an investor’s perspective, is FPL’s payout ratio appropriate?

5. As Kate Stark, what would you recommend regarding investment in FPL’s stock — buy, sell, or hold?

Session 17

Case: Pioneer Petroleum Corporation


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 18

Case: Ford Motor Co’s Value Enhancement Plan (A)


Come prepared to discuss the case in class

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