James Dow jdow@london.edu http://www.london.edu/faculty/jdow     Corporate Finance Course Outline London Business School JEMBA 2003 April-June 2002. Last revised October 14, 2002

This outline, designed to be read and used on the internet, serves as the main organizing device for the course material.  I will update it regularly, so please be sure to visit it before every session.

The Corporate Finance course is made up of fifteen sessions.  There is a long gap over the summer between the first part of the course (sessions 1-8) and the second part (sessions 9-15), taught in the Autumn.  To find out more about me, take a look at other parts of my web site.

The primary goal of this course is to provide an integrated overview of the most important ideas in corporate finance from the point of view of the manager of a non-financial corporation.  It also provides an introduction and some experience in standard techniques in corporate finance.  Finally, it serves as the foundation for the package of finance courses that you select within the MBA degree.

The main theoretical principle of the course is the concept of shareholder value.  Using this as the central organizing principle, we will cover the following topics:

Capital Allocation
Overview of External Financing
Risk in the Corporation and in Financial Markets
Capital structure
Options and real options
Valuation
Corporate governance and executive compensation

The teaching materials for the course consist of:

The course outline
Two assigned books:
           Principles of Corporate Finance, by Brealey and Myers (6th edition)
           The Essays of Warren Buffett, edited by Lawrence Cunningham
Two bulk packs of supplementary readings and cases
My lecture slides (handed out in class)

Brealey and Myers is the standard MBA textbook on Corporate Finance that is used in business schools across the world.  The most naive reader, armed with nothing but a superhuman degree of perseverance, could start at the beginning of this encylopaedia and be a financial expert by the time he reached the end.  Warren Buffet's Essays, on the other hand, is an easy read but requires a degree of maturity and sophistication on the part of the reader.  Despite Buffett's frequent and colourful denunciations of managers, investment bankers, MBA's, and finance professors, this is essentially a highly focused exposition of all the main ideas in corporate finance arranged around the theme of shareholder value (I also recommend a visit to the Berkshire Hathaway home page).

The bulk pack readings are not logically necessary for understanding the course, but they give some extra background to the material.

This web page is the main organizing device for the course.  Please check it often.  You can either bookmark it, or you can go into the forum and find a direct link to it.  I will put my lecture slides and other material such as problem sets, past exams, etc., up on it.  When I update it with important information, I will notify you by email.

My lecture slides will be available here on the web, but a hard copy will also be handed out in class.  There is no need for you to print off from here unless you miss a session.  However, you are welcome to preview them before the lectures.  Note that the version on the web may be slightly updated nearer the time so if you do print off the slides before the class, please discard them and rely on the version I hand out.

Overall Philosophy

My overall philosophy for the course is to try to provide you with a structured setting in which you can familiarise yourself with the most important ideas in corporate finance.  Although we will cover a range of different topics, they are all applications of the concept of value maximization.  My main goal for the course is for you learn how to apply this concept in general corporate finance settings -- this is a realistic goal for a course and, if you attain it, it is an extremely valuable skill.  The secondary goal is for you to learn how to carry out standard financial techniques such as capital budgeting, project valuation, and cost of capital calculations. To this end, I have included quite a large number of case studies and exercises.  However, this secondary goal is less realistic in the sense that a single course does not give you enough practice to learn these techniques really well.  You will need further courses to consolidate these techniques.

The workload is intended to be manageable and well-defined, not excessive or open-ended.   As well as attending the lectures, it is important to spend a few hours preparing the assignment before each lecture, and to spend time after each lecture going over the readings and the class notes.  It is very important to complete the assignments.

Participants on this course have a wide range of backgrounds and skills.  Most of you will find the material new and occasionally difficult to master, while some will already be familiar with corporate finance or financial markets, and others may find some of the arithmetic boringly easy (or boringly hard!).  My hope is to make the course as inclusive as possible, consistent with the presumption that an introductory course such as this one should be aimed primarily at the neophytes.  I've indicated below some further reading for those of you who want to look at more advanced material, as well as some tips for those of you who fell you need more practice in the basics. If you feel yourself excluded, let me know and I will try to point you in a suitable direction.

Readings

It is very important for you to read the designated portions of the two assigned books carefully after each meeting, together with the class notes.  Make sure to set aside enough time for these essential reviews.  The readings from the bulk pack can be read more quickly if you are pressed for time. It is up to you to decide whether to preview the reading and the lecture notes ahead of the lectures - generally this is not necessary, but a quick look would be helpful.  The exception is the first meeting, where some preparation is needed because I ask you to turn in an assignment (details are given below).

Assessment

There will be assignments in advance of each weekend meeting.  These will either be case studies or problem sets, designed to help you acquire important skills and to consolidate understanding of ideas from the lectures.  I will ask you to hand in assignments at the beginning of the meeting.  A significant portion of the grade will reflect whether you have made a conscientious attempt to study the problem. You are encouraged to work on these problems in a study group if you prefer, so long as whatever you hand in is your own work.

There will be an exam for each part of the course.  For the first part of the course  the exam is on Friday, 21 June.  The grading for this part of the course will be based mostly on the exam, partly on having completed the assignments in a timely way.  If you have completed all the assignments on time, the weights will be approximately 10% for the assignments and 90% for the exam.  But, if you have missed the due date for more than one assignment I will penalise you more heavily. This is because hardly anybody ever neglects the assignments on this course, but experience shows that if ever anybody does, he or she will probably fail the exam - very few people fail on this course, and I'd like to keep it that way. Please note that once I have arrived at a numerical score, if the average is very different from the LBS norms, I will scale it back to ensure a class average that is consistent with LBS practice.

For the second part of the course, the grading will be 80% on the final exam, 20% on the two group assignments (i.e. 10% on valuation, 10% on UST).

Again, scaling will be used if necessary to ensure an average in line with LBS norms and the scores for both parts of the course will then be averaged (with a small amount of further scaling if required - aargh!).  I do realise it's rather unwieldy to grade both parts of the course separately and then aggregate them, but initially I anticipated that a different professor would teach the second part of the course.

I am well aware that the combined pressures of your job, the MBA course and perhaps family life may sometimes combine to make life very difficult.  On the other hand, if you start falling behind on the assignments and on preparation time you will simply not be able to keep up with the rather steep learning curve on this course.  Please let me know immediately if you are having problems in meeting these requirements.

Continuous feedback and development

I want my courses to change and improve continuously, and I want to be able to react quickly to comments and feedback.  I welcome comments on the content of the course, on the way the sessions are organized, or on any aspect of the course.  I will hand out assessment forms for each session of the course, and you are also welcome to send me your comments by email, or to come and talk to me about how the course is going.

Optional advanced material

A substantial minority of participants in the class have an appetite for more advanced material and find the pace a little slow.  This is inevitable given the technical nature of some of the material: some of you find mathematics and statistics trivial and others find it daunting.  Although I teach the course in a way that is as inclusive as possible and hence, does not emphasize the technical side of things, I would like to make some modifications to cater for those who want to see more advanced material.  I think the best solution is for me to indicate optional advanced readings at each meeting.  I also suggest that you buy a copy of Grinblatt and Titman's text, Financial Markets and Corporate Strategy which is an excellent advanced textbook.  I'll give references to the appropriate chapters as we go.  Feel free to contact me by email or come by and talk.  Let me stress that this is optional and is not necessary for the course.  It is not supposed to help you do better on this course, but to satisfy an intellectual appetite.  The majority of course participants should ignore it.

Optional practice with problems

In the course we will do a number of capital budgeting problems and other exercises.  If you understand these problems and review their solutions carefully, you do not need to any other practice. You'll find that we return to some of the capital budgeting problems repeatedly to review them and extend their solutions. If, after we have reviewed these problems in class, you still feel you have not mastered the material, I think the best solution is for you is to review your notes again and come to talk to me if necessary.  Still, I know that some of you will want the extra reassurance that comes from doing more problems.  If you would like extra practice on problems and examples, consider buying the student study guide that goes with the Brealey and Myers text.  It has lots of problems with solutions.  This is strictly an optional extra for people who are looking for reassurance and practice on the basics.  It is not required for this course.  The majority of course participants should ignore it..

Capital Allocation

Session 1: Friday, 26 April, 5 -7:30 p.m.
Overview of finance and corporate finance
Introduction to the course and links to other courses
Discounting and net present value
Eagle Industries

Session 2: Saturday, 27 April , 9 -11:30 a.m.
Some useful formulas for discounting
NPV and other rules for capital budgeting
    Mini-Case Study: United Metal

Reading, Preparation and Course Materials for sessions 1 and 2

Session 3: Friday, 10 May, 2-4:30 p.m.
Different types of securities
Empirical facts in financing patterns
International comparisons
Review session on capital budgeting

Session 4: Saturday, 11 May 2, 9-11:30 a.m.
Interest rates and the fixed-income market
    Case Study: Airbus

Reading, Preparation and Course Materials for sessions 3 and 4

Session 5: Friday, 24 May, 5 -7:30 p.m.
Efficient markets theory
Modelling and measuring risk
Diversification and market risk

Reading and Preparation for session 5

Session 7: Saturday 8 June, 9-11:30 a.m.
    Case Study: Boeing 777
Review session on risk and financial markets

Reading and Preparation for sessions 6 and 7

Reading and Preparation for session 8

Session 9:  Friday 11 October, 3:15 - 5:45 p.m.
Capital structure
Default and financial distress

Session 10: Saturday 12 October 3:30 pm - 6 p.m.
Review of midterm exam

Options and Real Options
Valuing options and flexibility

Reading, Preparation and Course Materials for sessions 9 and 10

Session 11: Friday 25 October, 17:00-19:30 p.m.
Valuation project

Reading, Preparation and Course Materials for session 11

Session 12:  Friday 8 November, 9:00-11:30 a.m.
case study: UST
Finance questionnaire (no advance preparation required for questionnaire)

Corporate governance

Session 13: Saturday 9 November, 9:00-11:30 a.m.
Corporate governance and executive compensation

Reading, Preparation and Course Materials for sessions 12 and 13

Reading, Preparation and Course Materials for session 14

In the schedules below, BM stands for the Brealey and Myers book, WB for the Essays of Warren Buffett, and BP for the Bulk Pack (= the binder with course the course materials).

Downloadable course materials are available here, if you would like to preview the materials before the lectures.  All materials will also be handed out in hard copy at the course meetings (the handouts will be slightly updated versions of the ones here).

I suggest that in advance of the meeting, you read chapters 2, 3, and 6 in BM, chapter 1 of WB, and the note by Paul Marsh which are all essential readings.  After the lecture read the remaining material in BM (ch 4 and 5).

Eagle Industries (in the BP) is something I will present in class as an example. I will not use it as a case study, I will not expect class participation from you nor do you have to hand it in.

On Saturday, we'll go through United Metal.  I would like you to hand in an individual solution to this, just a simple spreadsheet printout and a few notes on the points raised.  (one or two pages overall, no more).  Don't worry, I will allow for the fact that your write-up is done without the benefit of  Friday's lecture. It will seem quite compressed, but I hope that after these two sessions the work we do in class on Eagle and United will end up giving up you a good understanding of basic capital budgeting.  We can then use that to move forward to the Airbus case next meeting. In your write-up, I suggest you try to solve it ignoring tax altogether and assuming zero inflation. (Assume that the £50,000 referred to in the third line of the case includes the salary of the chief operator.) If you feel confident and would like to try United with taxes, refer to my slides or to BM chapter 6.  You can simplify the taxes by assuming straight-line depreciation, if you like. I will hand out three solutions: one without taxes, one with simplified taxes (assuming 5 year straight-line depreciation) and one with capital allowances as described in the case.

Assignment due:  please hand in one or two pages on United on Saturday at the start of the lecture.  Because this is right at the start of the course, the grading for this assignment will be based on conscientious effort, not on getting a correct solution.

Reading:

BM: chapters  2 (except section 2-2), 3 (except 3.5), 4, 5 and 6.
WB: ch 1, "Corporate Governance," pp 29-61
BP: Marsh

Download slides on "Capital Allocation" (PDF format) for sessions 1 and 2.

Here are the spreadsheets for Eagle, United Metal, and for the example used in my slides on capital allocation.

Strictly Optional advanced reading.

Make sure to review the readings in BM from the previous sessions first.  Go through the Eagle and United cases again until. If you want to preview the material for next time, read the chapters from BM below.  Among the bulk pack (course binder)  readings, the papers by Pruitt and Gitman, and by Mukherjee and Hingorani paper are  interesting recent surveys on how large corporations make capital allocations and how their methods compare to the textbook methods.  If you're interested in this kind of survey, there are many, many more on all aspects of capital budgeting and cost-of-capital methods (the journal Financial Practice and Education is a good place to look for these, e.g. a survey by Kester et al. on capital allocation methods in the Asia-Pacific region in the Spring/Summer 1999 edition).  John Graham and Cam Harvey have an excellent recent survey covering broad aspects of corporate financial policy for US corporations.

If you would like more practice with examples, Kate Wyse has pointed out to me that Brealey and Myers have a new publication which is a set of solutions to all the problems in their text (its available in Waterstones).  Maybe some of you who were thinking of buying the study guide would prefer this instead (see my remarks above on "optional practice with problems").  If you would like a book to help with terminology, see my recommendation for the Wall Street Journal guide on the teaching section of my  main webpage.

Assignment due:  Airbus.  You have to assess the critical decisions described in the conclusions: should they commit to launch the A3XX?  To answer this you will need to evaluate the assumptions underlying the forcasts, and assess the sensitivity of the estimates under different possible scenarios.  I recommend you do a simplified cash flow forecast for 2001-2009 and use the gordon growth formula (growing perpetuity formula) to estimate the terminal value.  Use sales forecasts and extimates of the margin to get a net figure for revenues net of costs.  Don't panic.

Reading:
BM:  Chapters 14 and 15 accompany the session on external financing.  The fixed-income market is covered in Chapters 3 (section 3-5) and 23 (up to the middle of page 688).
WB: read any remaining bits you find interesting.
BP: Pruitt and Gitman, Mukherjee and Hingorani  (if you are overwhelmed, just defer this till next session).

Download Slides on  "external financing" and "interest rates."

After the very intensive start to the course, this time you get a bit of a break because we only meet once at the weekend, instead of meeting on both Friday and Satrurday. This is a good time to finish up reading the bulk pack readings on cash flow and value.

Optional reading: my lectures on market efficiency will be based, in part, on Ken Rogoff's excellent, and highly readable, article on exchange rates, "Perspectives on exchange rate volatility."  If you are interested you can get it at http://www.economics.harvard.edu/~krogoff/exchange.htm. See section 8.2.3 of his paper especially.

Assignment due: problem set as handed out.  Here is the answer.

Reading:
BM: The material on efficient markets is covered in chapter 13 (up to page 356, also "lesson 2" on p 369).  The material on risk is in chapter 7.
BP: Esty and Dreyfus

Download slides on   "risk management"  and "market efficiency".

Make sure to read the Dimson article ahead of time.  It is an excellent simple introduction to the cost of capital.

Assignment due: Prepare the Boeing case (in the BP).  The Boeing case is primarily about capital allocation, but will also provide an applied exercise in the cost of capital.   The case is designed to allow simultaneous discussion of  1) project evaluation methods (DCF,IRR, questioning assumptions, etc); 2) cost of capital methods (CAPM);  3) setting all this in a strategic context for the company as whole.

Obviously you cannot prepare 2) since we have not covered that material, although you can do some reading in advance if you like and think about this angle as you prepare the case.  In my class discussion, I will cover (2) as an aplication of the CAPM which we will have done in class the day before.  But I will not expect you to have done that in your write-up. I will use 16% as the nominal discount rate.

I would like you to address the other points in your write up, perhaps you might want to consider the following suggested angles on this:

      what is the alternative to going ahead?  (consider delay, the impact on other model ranges...)
     are the cash flow forecasts realistic, cautious, overoptimistic...?
     payback period, and its relevance to the decision
     impact of the war
     stock market (behaviour of the share price)

You might also take a look at the boeing website or other sources that could allow you to see what has actually happened to the 777 model and  whether it's been
succesful.
 

Assignment due: Boeing case.

Reading:
BM: 7, 8, 9
BP:  Dimson

Download slides on "cost of capital."  For reference only as required: a quick statistics review on expected value, variance, covariance (I will not distribute hard copies of the statistics review, since it will not be emphasized in my lecture).

Review the course material.   If you attend all the sessions, and complete all the readings and assignments carefully,  you will not find any nasty surprises in the exam.  You should bring a calculator (no laptops, books, notes, etc.).  There is no need for a special financial calculator.  I will distribute a list of useful formulas with the exam.  Here is a previous exam for comparison.

You will have received a new course binder/ bulk pack referred to below as BP2.

Reading:
BM: 17 (not the appendix), and skim-read 18
BP2: the real options chapter from the new BM edition (the 6th edition does not have this chapter), and article by Andrade and Kaplan.

Assignment due: Valuation project (group assignment with your study group).  In the previous sessions, we will select suitable firms for valuation and the project is for you to value the firms.

Reading:
none, but you may wish to read ahead in BP2.

Assignment due: UST case (group assignment).

Reading: remaining articles by Jensen, Kaplan, etal in BP2.

none.