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Fall 2008

Corporate Finance

"My job as a businessman is to be a profit center and to maximize return to the shareholder."
                        Jeffrey Skilling, former CEO of Enron

Fast Track to Course Calendar


 
 

Monday and Wednesday, 2:40-3:55
meets in 216 Skinner

Satya J. Gabriel
Professor of Economics
e-mail: sgabrielatmtholyoke.edu
FAX: 413-538-2323


Course Description:
 

The course in corporate finance describes the corporation and its operating environment, the manner in which corporate boards and management evaluate investment opportunities and arrangements for financing such investments, create (or, alternatively, destroy) value for shareholders by planning and managing the transformation of a set of inputs (human labor, raw materials, and technology) into a more highly valued set of outputs (embodying both the original investment value and any surplus value generated), and develop strategies for meeting the claims of financial market participants who are sought as financiers (and, therefore, residual claimants to the cash flows/surplus value of) such investments. It is understood that the shares of surplus value received by various claimants and retained by corporate boards of directors for investment and other uses is the subject of complex social interactions. Thus, the course provides students with a basic analytical framework for understanding how the various struggles over corporate surplus value (in the form of cash flows) may be understood and resolved. In this context, the course is designed to provide students with analytical tools that allow them to determine the "intrinsic value" of a corporation (or any economic institution, including a state-owned enterprise that is to be privatized) and to assess the effectiveness of corporate management in maximizing that value.

Because the future surplus value/cash flows of any set of corporate investments are sensitive to macroeconomic, competitive, and other conditions, students will be taught analytical techniques for taking into consideration alternative macroeconomic and competitive environments. Simulations will be used to project alternative cash flow streams for firms under varying conditions of aggregate demand, inflation, tax rates, interest rates, and exchange rates, among other variables. While these techniques provide students with the tools for valuing enterprises under a wide range of conditions, one must also recognize that the short-term movements in equity valuations in the various stock markets are even more complexly determined.  Such stock price movements are not always determined strictly by intrinsic value, even when intrinsic value is estimated in the context of the aforementioned range of macroeconomic, competitive, and socio-political conditions.  As behavioral finance, and even earlier, John Maynard Keynes, has demonstrated, investors in financial markets are capable of emotional buys and sells (rather than the sort of consistently rational behavior dreamed of in neoclassical economic theory), panics, and herd behavior.  Thus, at any given moment, certain (and sometimes most) stocks can be and are mispriced.  The valuation techniques learned in this course provide students with a means for identifying such mispricing.  However, and regretably, the more interesting conversation on why such mispricing occurs will only be touched on at this level of analysis.  Students who are interested in this issue are encouraged to pursue the literature on behavioral finance outside of the structure of this course and to read carefully those sections of the supplemental text by Doug Henwood that covers this and related topics. It is also possible for the top students in this course to pursue these topics in the advanced corporate finance course in the spring semester.

In the spring of 1999, the corporate finance class discussed the coming end to the "speculative bubble" in internet stocks (which has now become a reality).  More recently, we have discussed the bubble in the housing market. We also discussed the manner in which the U.S. bond market has been bolstered by the decision of the Chinese central bank (the People's Bank of China) to purchase billions of U.S. dollars in U.S. treasury bonds, pushing up the price of those bonds and pushing down the interest rates on those bonds (and all the inter-related interest rates that influence investment and housing construction in the U.S. economy). We correctly predicted a reversal in the direction of interest rate changes and that the housing bubble would begin to deflate in this current period, making use of tools of financial and economic analysis.

What lies ahead?  What will happen to stock prices? Bond prices? Housing prices? The U.S. dollar? As we develop our analytical skills, we shall also have occasion to discuss these questions and possibilities in the context of corporate finance.  This is fair warning then.  This is not a dry course where the professor comes to class and repeats what is in the textbook (I may even disagree with the text from time to time).  We'll learn a lot this semester --- the time value of money, the capital asset pricing model, the dividend valuation model, the advantages and disadvantages of restructuring, mergers and acquisitions --- but, in the spirit of a liberal arts education, we shall not restrict our learning to purely technical questions.  We will also discuss  relevant current topics and controversies.  Be prepared for this.

In this vein, the course will make occasional use of case studies (some of which will be constructed during the semester based on new developments in the corporate world) and students should be prepared, from the very first class and every class, to engage in discussions, to answer questions, and to participate in simulations.  Students who find it "impossible" to answer questions put to them without prior warning (or who suffer lockjaw when it comes to speaking in class) are encouraged to seek alternative courses.

The case studies will be based on actual corporations. Past case studies have included Enron, WorldCom, Microsoft, Google, Dell, Amazon.com, Haier, and WalMart. Students must be prepared to make use of the Internet to gather actual and relatively up-to-date data.  Many of these data sources can be accessed from the course's own corporate finance hotlinks page.

Course Objectives:
 
 


Syllabus

Fall 2008

  • Text 
  • Brealey, Myers, & Marcus, Fundamentals of Corporate Finance, 2007, First edition, McGraw-Hill Irwin, ISBN-13: 978-0-07-301238-4
  • Doug Henwood, 1997, Wall Street  This text is now available as a free download on the Internet (click above link).
  • Web Case Studies & Essays (stay tuned) 
  • Grading policy 
  • Course grades will be based on the total accumulation of points from three sources: oral answers to questions during the normal course time (students should treat such questions as an oral examination), ten quizzes, and the final examination. 
  • In-class questions -- 10 percent of the final grade 
  • Weekly quizzes -- 70 percent of the final grade 
  • Final Examination -- 20 percent of the final grade 
  • Course calendar

    Sept. 5-10 After an introduction to corporate finance on 5 September, we proceed to lectures on corporate structure and processes (What is a corporation?), basic assumptions about corporate objectives and decision rules (such as the Net Present Value Rule), agency issues (What is meant by agency costs?), the structure and role of financial markets, and basic accounting rules and financial statements: Brealey, Myers, & Marcus (henceforth BMM), Read Part One of the text, this includes chapters 1-3
    "Sarbanes-Oxley and the Cascade Effect," by Peter N. Calcara.

    NB: Your first 15 minute quiz will be held on Wednesday, 10 September at 3:30PM and end promptly at 3:50. A 10% penalty will be incurred if you continue working on your quiz after time has been called.
    Sept. 15-17 Introduction to Value and the Valuation of Bonds: BMM, chapters 4 & 5
    Sept. 22-24 Valuing Stocks: BMM, chapter 6
    "Instruments," Chapter 1, from Wall Street by Henwood
    Sept. 29-Oct. 6 Stock Analysis and an Introduction to Capital Budgeting and Project Analysis (including a discussion of alternative decision rules to the NPV approach): BMM, Chapters 7-9
    Oct. 8, 15, and 20 Risk, Capital Asset Pricing Model, Arbitrage Pricing Theory, and the Trade-off Between Risk and Return: BMM, chapters 10-12
    "Players," Chapter 2, from Wall Street by Henwood
    Online Section Objectives
    Victoria Stepanenko's Website on Risk and Return
    Calculate Practice CAPM Required Returns
    Calculate Practice Stock Values using CAPM & DVM
    Paul Krugman's "Dow 36,000: How Silly Is It?"
    Online Section Objectives
    Oct. 22, 27-29 Capital Budgeting Process and Financing (including a discussion of venture capital): BMM, chapters 13 and 14

    Graham and Harvey, "How Do CFOs Make Capital Budgeting and Capital Structure Decisions," Journal of Applied Corporate Finance
    A Few Questions Relating to Corporate Investments
    Nov. 3-5 Financial Statement Analysis: BMM, chapter 17
    Nov. 10-12 Financial Planning Models: BMM, chapters 18 & 19
    Nov. 17-19 Mergers, Acquisitions, and Corporate Control: BMM, chapter 21
    "Ensemble," Chapter 3, from Wall Street by Henwood
    Nov. 24 International Financial Management: BMM, chapter 22
    "Market Models," Chapter 4, from Wall Street by Henwood
    Dec. 1-3 Options and Risk Management: BMM, chapters 23 & 24
    Dec. 8-10 Review Week: BMM, chapter 25

    Featured Student Websites:
    Tzvetelina Ivanova, Mergers and Acquisitions
    Denica Koycheva, Behavioral finance
    Holly Hilt, Case Study of Marvel Comics
    Explore the Securities Industry Corporate Finance Basics Corporate Finance Hot Links
    Hypertextual Finance Glossary Reserved for Mirijana Ujkic Closed End Funds
    European Stock Exchanges The Efficient Market Hypothesis
    Yahoo Financial Glossary Overview of Behavioral Finance Website on Risk and Return
    Why Value a Project? Case Studies A Brief Guide to Options 2



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    Copyright © 1998-2007, Satya Gabriel, Economics Department, Mount Holyoke College.