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Advanced Corporate Finance Spring 2008 Stephen Sapp Room: 3N58 Phone: 519-661-3006 Fax: 519-661-3959 Email: [email protected] Assistant: Cheryl Lojzer Room: 3N55 Phone: 519-661-3684 Overview:

The goal of this course is to provide students with the skills necessary to evaluate the important interplay between corporate financial decisions and international financial markets. The course builds directly on the core finance course. By taking the perspective of a financial manager we will evaluate the risk and benefits to various methods of managing a firm’s cashflows and maximizing the value of its assets. Whether the business is primarily focused on the domestic market or has substantial international operations changes in global financial markets can significantly impact the business. This course investigates how changes in the risks and opportunities faced by firms as a result of changes in the domestic and/or global economy can influence the firm’s operations and overall value. Understanding the influence of these changes on the firm, we will discuss how financial and operational techniques can be used to manage the risks and maximize value.

The first part of the course introduces some of the basic methods to identify and manage the business and financial risks faced by firms doing business in an international environment. Recognizing these risks, we identify the relevant issues and evaluate many of the available alternatives. We consider, for example, the use of derivative instruments and other financial or operational means of managing the business and financial risks faced by firms. Each alternative has different costs and benefits so significant time is spent ensuring that the trade-offs in choosing one alternative over another are understood. The second part of the course considers the role of financial markets in firm decisions. Specifically, we will discuss the costs and benefits to international investment; alternatives for raising capital in international financial markets; valuation of international projects and international issues in different corporate growth strategies (e.g., mergers and acquisitions, and joint ventures). Overall, this course is designed for individuals who are interested in understanding the complexities of operating in a global environment. This includes both evaluating and managing risks as well as understanding how to use the different financial tools that exist to take advantage of opportunities as they arise. Course Organization: The course employs lectures, case discussions, and a problem assignment. Course sessions are roughly divided into 30% lectures/discussions and 70% cases. Each student is expected to actively contribute to classroom discussions. The classroom contribution is a unique opportunity for you to present your ideas and develop your skills at convincing others of your position on particular issues. The grade that is assigned for your classroom contribution is a careful (but still subjective) assessment of the value of your input to the classroom learning environment. That contribution can take many forms. These can include a good assessment

Advanced Corporate Finance: Course Outline

of the problem, identification of imaginative solutions to the problem, a carefully thought out analysis, an effective implementation strategy or an interesting line of questioning that helps the class better understand the relevant issues and theory to help make the final decision. Absences, particularly without a reasonable excuse, may have a negative impact on your contribution grade. Course Materials: There is a required case packet. It is strongly recommended that students do regular reading of the financial press. This includes newspapers such as the Globe and Mail, National Post, Wall Street Journal, and Financial Times. For another perspective, it is also useful to read more general sources such as The Economist. If you find articles that may be of interest to the class, you are strongly encouraged to bring them to class. There is a website on which copies of the slides used in class and other materials will be posted. The address is: http://www.ivey.uwo.ca/faculty/ssapp/Teaching/Fin_563/Adv_Corp_Fin_2008.htm Course Evaluation: Individual Classroom Contribution. Each student is expected to prepare for each class using the assigned questions and readings. Students will be evaluated on the basis of the quality of their contribution to lecture discussions, case analysis, and general classroom discussions. Assignment. There will be one case report that all students are expected to do. It is due in the second week of the course but is based on material covered in the first week. The case brief is intended to provide a forum to demonstrate your knowledge and understanding of the concepts discussed in class. Final Exam: There will be an exam at the end of the course. The exam will treat the material covered in the course including the classroom discussions and required readings. The exam will be a four -hour “open-book” case exam. There will be specific questions regarding the analysis to guide your discussion. Weighting Case Report 15% Class Contribution 25% Final Exam/Project 60% 100% Attendance: Attendance at all sessions in this course is mandatory. Circumstances may arise which make it impossible for you to attend. For example, if you are unable to attend a class due to health-related reasons, you are expected to advise your professor in advance. Under University regulations, the professor can determine at what point absenteeism has become excessive and thus can prevent you writing the final exam. (www.uwo.ca/univsec/handbook/exam/attend.pdf ). Expectations: You are expected to be fully engaged in the entire learning process. This means devoting time and energy to preparation before class, including learning team meetings, listening to others during class discussions and engaging in class discussions. Collective reasoning and discovery are critical to the successful application of the case method. Prior to any case discussion, engaging in discussions with (or examining notes from) others who may have already experienced a case is a clear violation of our norms. Using your computer during class for personal activities such as reading/writing email, writing letters, surfing the Web, playing games, etc. is also distracting and counter productive and violates our norms. Plagiarism: Students must write their essays and assignments (at Ivey this includes case exams and reports) in their own words. Whenever students take an idea, or a passage from another author, they must acknowledge their debt both by using quotation marks where appropriate and by proper referencing such as footnotes or citations. Plagiarism is a major academic offence (see Scholastic Offense Policy in the Western Academic Calendar). All required papers (at Ivey this includes case exams and reports) may be subject to submission for


textual similarity review to the commercial plagiarism detection software under license to the University for the detection of plagiarism. All papers submitted will be included as source documents in the reference database for the purpose of detecting plagiarism of papers subsequently submitted to the system. Use of the service is subject to the licensing agreement, currently between The University of Western Ontario and Turnitin.com (hyperlink www.turnitin.com).


General Outline: Topic One: Introduction to Advanced Corporate Finance 1. Introduction and Course Overview 2. Introduction to Financial Markets 3. Managing and Identifying Financial Risks Topic Two: The Use of Derivative Securities 4. Structured Financial Products: RFA Capital Management's Commercial Mortgage Backed Security

Decision 5. Forwards and Options in Hedging Foreign Exchange Risk: Lufthansa 6. Introduction to Swaps 7. Analysis of Foreign Exchange Risk Management Strategies: Clearwater Seafoods 8. Global Portfolio Allocation and Swaps: Ontario Teacher’s Pension Plan Board 9. Risk Management with Swaps: Walt Disney Company’s Yen Financing Topic Three: Global Financing Strategies 10. Raising Capital in Global Financial Markets 11. American Depositary Receipts (ADR): Compania Telefonos de Chile 12. Eurobond: Maskwa Resources 13. Capital Raising Decisions: Geeli Topic Four: Valuation in an International Context 14. Global Capital Budgeting 15. International Acquisitions: ICN Pharmaceuticals 16. International Joint Ventures: QI Tech – A Chinese Technology Company For Sale 17. External Risks/Project Financing: Antamina 18. Review and Wrap-up: KTM – Venture Capitalist Exit


DETAILED COURSE OUTLINE AND ASSIGNMENTS Topic 1: Introduction to Advanced Corporate Finance Class 1: Introduction to the course Part 1: Lecture on Identifying Global Opportunities Assigned Readings:

• “Why Manage Risk?” (HBS Case) • “Slackers Beware the 80-cent Dollar”, John Manley, Globe and Mail, October 9, 2004 • “Global Challenges, Canadian Opportunities” Speech by Bank of Canada Governor David

Dodge (November 17, 2003) excerpts used at Ivey on December 8, 2003 Questions:

1. How does managing a business operating in markets outside of its home market (e.g. outside of Canada) differ from managing a business with its focus solely on the domestic market?

2. How has the increase in the value of the Canadian dollar impacted business in Canada over the past two years?

3. Consider the following quote from John Bragg (Canadian entrepreneur who is a major food processor and owner of a major telecommunications business): “In fact, if we were completely objective, we are better off over all with a strong Canadian dollar.”

Part 2: Lecture on Financial Markets Assigned Readings:

• “The Foreign Exchange Market and the Canadian Dollar: some history and background” (Ivey case)

• “Managing the World Economy”, Economist Questions:

1. How has the value of the Canadian dollar been determined over the past 150 years? What are the differences between the different exchange rate regimes? Why did Canada switch between these regimes?

2. Should we have a fixed exchange rate today? Should Canada adopt the U.S. dollar? Be prepared to discuss your position in class.

Class 2: Identifying Global Risks Part 1: Structured Financial Products Assigned Readings:

• “RFA Capital Management” (Ivey Case) • “CDO not cash on delivery: Structured finance”, Jul 26th 2001 From The Economist print

edition • “CDOh no!”, Nov 8th 2007 From The Economist

Note: This case will be presented by Ben Rodney, BA, MBA. Mr. Rodney has been with the RFA Group since 1998 where he is the Executive Vice President and President of Realty Financial Advisors Inc. Mr Rodney has structured, priced and performed due diligence on over $8.0 billion of Canadian commercial mortgages. Mr. Rodney holds an MBA from the Richard Ivey School of Business and a Bachelor of Arts from the University of Victoria.

Questions:

1. What is the function of the Asset Backed Commercial Paper market? How do the borrowing firms benefit from the market? How do the lenders benefit from the market? How do the investors buying the ABCP benefit?

2. As an institutional investor, what are the pros and cons of investing in the CMBS asset class as presented in the case?


3. As Pyle and Rodney, given your assessment of the risks of the investment, what yields would you demand from Column Canada for each bond class (i.e., choose among the three possible scenarios)? Please be prepared to support your answer.

4. Given the required yields from question 3, what price would you pay for each class of bonds? 5. As Pyle and Rodney, would you consider pursuing this opportunity? If so, how would you market

the bonds to your clients? If not, why? Part 2: Managing and Identifying Financial Risks Assigned Readings:

• “Transaction and Translation Risk” (HBS Case) and “Operating Risk” (HBS Case) • “The Reins on Risk”, Financial Executive 1995

Questions: 1. When the Bank of Canada changes interest rates, what happens to the value of the Canadian

dollar? Does this make sense? What happens to the value of the Canadian dollar when the value of the stock markets in the U.S. is rising? In Europe? What happens to the value of the Canadian dollar when the value of wheat increases? Oil? Why do you expect these reactions?

2. What are 2 examples of a Transaction exposure for a Canadian firm doing business in Germany? Translation exposure for a Canadian firm with extensive operations in Europe and Asia? And finally of operating exposure for a Hong Kong-based company doing business with several neighbouring countries?

3. How would you determine whether these are risks that should be mitigated or viewed as opportunities?

Topic 2: The Use of Derivative Securities Class 3: Identifying and Hedging Foreign Exchange Risk Part 1: Managing Transaction Risk with Forwards and Options Assigned Readings:

• “Lufthansa: To Hedge or Not to Hedge …” (Ivey case) Questions:

1. What are the hedging alternatives being faced by Herr Ruhnau? 2. If the DM/US$ exchange rate were 2.4DM/US$ in January 1986, what would be the all in cost of

the aircraft purchase under each alternative? If the exchange rate were 3.4DM/US$? Consider both fully hedging the cost and hedging exactly one half of the cost (why may you only want to hedge part of the purchase price?). Note: It may be helpful to draw pay-off diagrams showing how the cost of purchasing the aircraft will change as the exchange rate changes under the different alternatives you are considering.

3. Which alternative would you choose and why?

Note: Because of the size of this contract, the prices are only available for the stated transaction (e.g. the forward is only the price to purchase US dollars with German Marks and not for selling US dollars to buy German Marks). An interesting question to consider is: why would the banks not necessarily be willing to buy and sell this large a quantity of German Marks for US dollars at the same price? Part 2: Lecture on Swaps

Assigned Readings: • “Note on Swaps” (Ivey case)


Questions: 1. Consider how you would answer the questions at the end of the note on swaps. 2. What is a Credit Default Swap (CDS)? Please consider how the payments for a CDS would compare

to those for a plain vanilla swap. 3. How have CDS been associated with the recent events in the US subprime market? (for two articles

from the NYT please see the link on the course webpage) Class 4: Advanced Risk Management Strategies Part 1: Risk Management for Global Operations Assigned Readings:

• “Clearwater Seafoods” (Ivey case) • Giddey, Ian and Gunther Dufey “Uses and Abuses of Currency Options”

Questions:

1. What are the sources of the problem facing Wight? 2. What role does the appreciation of the Canadian dollar play in the current situation? 3. What are the alternatives before Wight? 4. How should Wight deal with the value of the Canadian dollar in determining the strategy to be pursued going forward? 5. How should Wight deal with Clearwater’s stated goals of diversification and the need for cash both to fund growth and resume distribution?

Part 2: Risk Management for Global Investments Assigned Readings:

• “Ontario Teachers’ Pension Plan Board: Hedging Foreign Currency Exposure” (Ivey case) • “Home Sweet Home” The Economist

Questions: 1. What are the key objectives of the OTPPB? 2. Why has the OTPPB decided to diversify internationally? 3. Why is the board considering a currency hedging program now? 4. What is the role of the Core International group? 5. What is the appropriate target ratio? 6. How could you evaluate the success of this hedging program? 7. What would you recommend to the board?

Class 5: Advanced Risk Management Strategies Part 1: Using Currency Swaps Assigned Readings:

• “Walt Disney Company’s Yen Financing” (HBS case) Questions:

1. Should Disney hedge its Yen royalty cash flow? Why or why not? If so, how much should be hedged and over what time frame?

2. Assuming a hedge is desirable, what hedging techniques are available to the treasurer and what are the advantages and disadvantages of each?

3. In light of the various other techniques for hedging currency exposures, why does a market for currency swaps exist? Who benefits and who loses in such an arrangement? Can a swap really create value for a corporation, and if so, where does the value come from? What risks does a swap carry for the various parties involved?

4. Evaluate Goldman’s proposal for an ECU bond issue accompanied by an ECU/Yen swap. How does its “all in” yen cost compare to that of the proposed yen term loan? Is it superior to hedging using outright forwards? (Note: “all in” costs refers to the internal rate of return (IRR)


for the financing. The IRR is the discount rate which equates the present discounted value of future debt service payments with the financing proceeds, less the front-end fees.)

Topic 3: Global Financing Strategies Part 2: Lecture on Raising Capital in Global Financial Markets Assigned Readings:

• Lessard and Shapiro, “Guidelines for Global Financing Choices”, in New Developments in International Finance (Eds. Stern and Chew), 1988, pp. 181-193.

• (skim) Karolyi, “Why do Companies List Shares Abroad? A Survey of the Evidence and Managerial Implications”, Ivey WP97-35 (casebook)

• “Does the Islamic bond market comply with Sharia law?” Economist -- Link on course website Questions:

1. If you were the CFO of a Canadian company wishing to raise funds in US dollars, how would you try to raise the funds?

a. Would you use debt or equity? b. If you were to use equity, would you sell shares in the U.S.? Could you do that? c. If you were to use debt, would you go to a U.S. bank and borrow the money? Would

you go to a Canadian bank and borrow the U.S. dollars? Or would you just borrow Canadian dollars or sell more shares in Canada and convert the proceeds to U.S. dollars?

2. What criteria would you use in making your decision? Class 6: Raising Capital Internationally Part 1: Equity Raising – ADRs and Private Equity Assigned Readings:

• “Compania de Telefonos de Chile” (HBS case) Questions:

1. Was Compania de Telefonos de Chile (CTC) helped or hindered by the Bond Group’s ownership after privatization? Why did Chile select the Bond Group’s bid at the time of privatization?

2. What are CTC’s external funding needs for the next three years? The next seven years? What are its most viable sources of financing over these periods?

3. What is an American Depositary Receipt (ADR)? Why might U.S. investors wish to own an ADR? Why might CTC want to issue an ADR?

4. How effectively can the U.S. ADR market meet CTC’s financing needs for the next three to five years? How attractive would CTC’s ADR be for US investors?

Part 2: Debt Raising – Eurobonds Assigned Readings:

• “Maskwa Resources” (Ivey case) Questions: 1. Why is Maskwa turning towards the high yield bond market for financing? 2. How would the payments and conditions associated with bank debt compare to those for the

proposed Eurobond? 3. If you were to use the Eurobond, would you manage the foreign exchange risk? If so, how

would you manage the foreign exchange exposure created by this new bond? 4. Using the base case scenario, what do you expect as the firm’s cashflows as a result of

purchasing the proposed refinery? 5. Why are the bond investors placing certain requirements on Maskwa’s Euro-denominated

bond, especially the convertible feature? What implications does this have for Heyer and Maskwa if the project succeeds? Fails?


6. What alternative would you propose and why? Class 7: Advanced Topics Part 1: Survey of Global Capital Raising Assigned Readings:

• “Geeli” (HBS case) Questions: 1. From the perspective of US investors, what are the opportunities and challenges of investing in an

emerging market economy like China? 2. As a U.S. investor contemplating investing in Geeli, how would you value the expansion plan?

Assume the cost of capital is 17%. Please comment on the appropriateness of 17% as the cost of capital in this case.

3. How would the value of Geeli change if you were to take the perspective of a Chinese investor? 4. What are the alternative ways for Geeli to raise the required fund if they decide to proceed with the

expansion plan? What are the benefits and costs of each one of the alternatives for Geeli? 5. How might Geeli's financing strategy differ if it were operating in Canada rather than China?

Assume you are Mr. Hastie Friedman and prepare an Executive Summary for your recommendation to Geeli. Make sure to address the main alternatives and why your proposal is the best for their business. This is due at the beginning of the class session (i.e., 3pm). Topic 4: Valuation in an International Context Part 2: Lecture on International Capital Budgeting Assigned Readings:

• Lessard, “Incorporating Country Risk in the Valuation of Offshore Projects”, Journal of Applied Corporate Finance 9, 1996, pp. 52-63.

• Stulz, “Globalization, Corporate Finance and the Cost of Capital”, Journal of Applied Corporate Finance 12 (3), 1999, pp. 8–25

• Penman “Handling Valuation Models” Journal of Applied Corporate Finance 18 (2) , 2006, pp. 48–55

Questions: 1. How do the ideas presented in the assigned readings differ from the techniques discussed in the

core finance course? For example, how would you have performed a standard discounted cashflow (DCF) analysis the core finance course and how do these authors suggest modifying the process (e.g., how would you have estimated the free cashflows and the discount rate)?

2. If you were the CFO of a medium-sized Canadian firm and the CEO of your firm asked to value a company in Germany, which assumptions that you used in the standard DCF would you re-assess if the CEO said that s/he thought that your valuation was too low?

Class 8: Advanced Valuation Part 1: International Valuation – Acquisition Assigned Readings:

• “ICN Pharmaceuticals” (Ivey case) Questions:

1. Why has ICN acquired firms in Eastern Europe? Does Polfa Rzeszow fit the objectives of this strategy?

2. Is the previous bid of US $29 million too “low”? Please justify your response using a sound valuation of both the financial and strategic aspects of the business.

3. As Teodor Olic, how would you respond to the Polish government’s request to submit a revised bid for Polfa Rzeszow?


Part 2: International Valuation – Joint Venture Assigned Readings:

• “QI Tech” (HBS case) Questions:

In this session we will discuss the exit decision from an entrepreneurial joint venture. In this case, the foreign investor must value the joint venture and develop a viable deal structure and negotiation strategy to ensure the ability to exit the firm. To do this, please consider the following questions: 1. What are the objectives of the different parties on the seller’s side? Specifically, of Indivers? QI-

TECH’s local management? And QQMF? 2. What is the value of Indiver’s stake in QI-TECH? 3. What are the terms of the deal that Kollbrunner and Li should look for in a deal with B&S? 4. What concerns might Phil James, VP of Brown & Sharpe's CMM division, have? How could the

seller mitigate these concerns? Class 9: Project Finance Assigned Readings:

• “Antamina – Political Risk Insurance” (Ivey case) • “Note on Project Finance” (Ivey case) Questions: 1. How would you characterize the main differences between the alternatives being considered by

the finance committee? How do these differences impact the different stakeholders in CMA? 2. What is the value of political risk insurance for the banks? For the other stake holders? How

does the use of political risk insurance influence the decision being made by the finance committee?

3. Doing a very simple valuation, how attractive is this project to the sponsoring firms under the case where all of the projections come true? What if the price of the metals were to be 10% higher than forecasted? What if the prices were 10% lower than forecasted? What if terrorist activities started again in that part of the country so production decreased by 25% over the entire life of the project? How would these impact the value of the project to the sponsoring firms under the different financing alternatives?

4. Which financing alternative would you recommend to the Finance committee?

Some information that may be useful: • The cost of extraction for zinc and the profit from its sale are included in the prices for copper

(that is what the expression “including the zinc credits” refers to). • The current interest rates being charged to BBB-rated firms in the US is 7.78% per annum and

8.22% per annum in Canada. Class 10: Review and Wrap-up Part 1: Private Equity and International Valuation Assigned Readings:

• “KTM – Venture Capitalist Exit” Questions:

1. What is your qualitative assessment of each of the alternatives? 2. Which alternative would maximize the proceeds to KTM? 3. Which alternative would maximize the control of KTM’s current owners? 4. What are the financial implications of the debt offering versus an equity offering? 5. What would be a fair value for KTM and thus for BC’s current position? 6. What option would you go with? Why? How will this affect KTM’s competitive positioning

going forward? Part 2: Wrap-up

advanced corporate finance - ivey business school · pdf fileadvanced corporate finance:...

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