Fall 2015

Corporate Finance

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

Fast Track to Course Calendar


Monday & Wednesday 8:35-9:50
Skinner 216
Office hours: TBD

Satya J. Gabriel
Professor of Economics and Finance
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/projects and arrange for financing such investments, create (or, alternatively, destroy) value for shareholders by planning and managing the transformation of a set of variable inputs (labor efforts, including the creative efforts required for innovations, raw materials, components and other forms of technology consumed in production processes) 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 net 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 results from complex social interactions, including, but certainly not limited to, transactions in various markets. Thus, the course provides students with a basic analytical framework for understanding how the various strategies for transforming variable inputs into more highly valued outputs, combined with 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, given specific competitive, regulatory, and market conditions.

Because the future surplus value/cash flows of any set of corporate investments are sensitive to constantly changing political, macroeconomic, competitive, and other conditions, students will be taught analytical techniques for taking into consideration alternative macroeconomic and competitive environments. After all, estimated value is a function of the particular model employed and each model is constructed around a specific stylized context (a model structure where elements are limited to a subset of possible phenomena). The model serves as a proxy for the real world: the overdetermined interactions of actual phenomena, whether identified/defined within the model in question or the vast expanse of other phenomena not defined within and therefore invisible to the model. This is important for anyone interested in predicting outcomes of corporate projects. In other words, it matters what type of model you use (and, therefore, what paradigms you employ in constructing models). Models constructed within the conceptual framework of specific paradigms (e.g. neoclassical, Marxian, Institutionalist, Post-Keynesian economics) provide alternative ways to predict the future (the outcomes of future observations) Students are advised to read broadly (history, psychology, sociology, etc.) and to learn multiple paradigms with which to construct models or carry out analyses of corporate projects and strategies..

Financial models are designed to predict economic outcomes. How do you know if a model works? The model must provide results which allow reasonably accurate predictions of economic outcomes, such as the future revenue of General Electric. Your model does not have to be perfect. Indeed, it is impossible to be perfect. To succeed in the world of finance, you just have to be very good at building models (perhaps even excellent) in comparison to other people's models. In the case of financial models, we want to predict outcomes that would shape the results of financial statements, such as future cash flows, earnings, and various growth rates of variables that are measured within financial statements. Once you have chosen a particular model to test against empirical data, it is possible to use statistical analysis to verify that the model has utility (can achieve acceptable results). One of the more common forms of models are simulations. Simulations may 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 argued, 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.  During bubbles and crashes this mispricing can reach extremes. The valuation techniques learned in this course provide students with a means for identifying such mispricing.  Mispricing is addressed by research in behavioral finance, an alternative paradigm to neoclassical economics and rejects the fictions of rationality and representative agents in favor of incorporating psychological research and empirical studies. This is a positive move by finance economists and may represent a tentative step towards more widespread adoption of the scientific method in economics, writ large.

If an economist is unable to use his or her theoretical tools to make predictions about future developments in financial markets or has no clue about whether an economy is likely to boom or bust, then it is best to spend very little time with that economist. It is one of the goals of this course to provide students with tools that improve their ability and confidence in using publicly available data and events for predicting changes in macroeconomic conditions, corporate share price growth or decline and the future direction of financial markets, more generally. In the spring of 1999, the corporate finance class discussed the coming end to the "speculative bubble" in internet stocks (which dramatically deflated in 2000).  In 2006 and 2007, we discussed the bubble in the housing market and predicted the bursting of that bubble, which had severe and still lingering consequences for global financial, labor, and goods markets. More recently, we discussed the manner in which the U.S. bond market was bolstered by decisions of the Chinese central bank (the People's Bank of China) to purchase billions of dollars worth of U.S. treasury bonds, accumulating approximately $1.5 trillion of U.S. dollars in U.S. treasury bonds, pushing up government bond prices and and pushing down the interest rates on those bonds (and putting downward pressure on all the related interest rates, including mortgage interest rates, that influence investment and housing construction in the U.S. economy). Our prediction that the bond market bubble would burst this summer has proven incorrect and we will further discuss the likely course of interest rates over the next three plus months (which still gives us time to be correct) and in 2016. What factors might have short-sighted a bursting of the bond bubble? We will discuss the possible impact of unanticipated wars in the Ukraine and the Middle East, as well as the extreme debt/insolvency crisis in Greece.

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 .  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.

Some financial data sources can be accessed from the course's own corporate finance hotlinks page. If you notice dead links or mistakes on the hotlinks page, please bring them to the attention of Professor Gabriel.

Course Objectives:


Fall 2015

  • Text 
  • Primary Text: Aswath Damodaran, Investment Valuation, 3rd. edition, which is hereafter referred to as "The Text."
  • Secondary Text: Corporate Finance Compendium
  • Recommended but Not Required: George Soros, The Alchemy of Finance, 2004.
  • Recommended but Not Required: de Kluyver, Cornelis A., Corporate Governance v. 1.0, 2012, available on Flat World Knowledge website (can be read for free).
  • Recommended but Not Required: Micklethwait, John and Wooldrige, Adrian, The Company: A Short History of a Revolutionary Idea (Text optional)
  • Recommended but Not Required: Doug Henwood, 1997, Wall Street  This text is now available as a free download on the Internet (click here).
  • 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 (revision in progress)

    Sept.9 Intro to Finance
    We begin with the long introduction to corporate structures and value creation. Read the following introductory questions on finance:
    Questions to Ponder. Also, read the following Intro to Finance. The questions and introduction will help us in our discussion of the role of finance in society. We will use a heuristic diagram of a firm and discuss various component parts of the overall social and technical processes that determine the success or failure of the firm: financing and access to tangible and intangible assets, nexus with labor markets and access to necessary skill-sets, the immediate process of production, transportation of products, marketing of products, final sales by which cash flows are generated, the receipt and distribution of the surplus value flows necessary to meet the demands of claimants. Click on "Intro to Finance?" above to read the introduction to the course. Read chapter one of text. Read the following short introductory essays on cash flow issues (click here) and cash flows, more generally, (click here).

    Sept. 14-16 Present Value: The Text, chapters 1 & 2

    This week we will explore some of the critical concepts at the foundation of corporate finance, generally, and valuation, specifically. You will want to make certain that you understand the meaning of present value and the related concepts of discounting, time value of money, and opportunity cost. Do not hesitate to ask lots of questions.
    Sept. 21-23 Stock and Bond Valuation (Perpetuities and Annuities) : The Text, chapter 3

    Always remember that the value of assets, including those legal fictions called corporations, is ultimately derived from the ability of those assets to generate cash and that the timing of receipt of cash and the probability that cash will not fall short of investors' expectations are important to the magnitude of the contribution that cash payments make to intrinsic value. In other words, financial value is not a subjective phenomenon, but is, rather, a function of actual cash received and the opportunity cost of receiving that cash in future.
    Sept. 28-30 Introduction to Capital Budgeting : The Text, Chapter 4
    October 5-7 Perpetuities, Annuities, and Non-constant Growth

    One of the simplest valuation problems is the valuation of an asset that generates a single future cash payment at a time definite in future. This problem may be solved by using the present value formula for a single future cash flow. If you can estimate the value of a single future cash flow, then you have the basic tools for valuing assets that generate multiple future cash flows, although these more complex assets require some algebraic manipulation to obtain shortcut formulas that greatly simplify the valuation estimate..

    Bonds: The most popular annuity used in corporate funding.

    Bonds are loans to the corporation from those other firms, institutions, and individuals who purchase the primary issue of bonds. A bond is a financial contract. This contract stipulates that, in exchange for the purchase price of the bond, the holder has a right to receive specific cash payments. These cash payments are usually in the form of periodic coupon payments (aka interest payments) and the time definite repayment of principal. The dates for the periodic coupon payments and the repayment of principal at maturity are clearly stipulated in the contract (which is also called a bond indenture). In Europe, the coupon payments are sometimes annual. However, in the United States, these payments are typically made semi-annually (twice a year at six month intervals).

    Bonds are liabilities of the issuer. They are a form of a loan made to the issuer by the original purchaser. A marketable bond can be sold by the original purchaser to other economic agents, who then possess the claim to the coupon payments and the repayment of the original principal. Bonds are assets of the purchaser (because they represent claims to positive cash flows in future). The purchase price of a marketable bond need not be equal to the original purchase price of the bond. Indeed, fluctuations in interest rates for similar types of bonds makes it unlikely that the market price and the purchase price of a bond will be equal over the life of the bond (unless the bond has a very short lifespan).

    Oct. 5-7 Risk, Return, and the Capital Asset Pricing Model
    (NB: We will not have class on Wednesday, October 14)

    Cash Flow Estimation
    Oct. 12-14 Introduction to Investments and Portfolio Theory: The Text, chapters 7 & 8

    Scenario, Sensitivity, and Simulation Analysis
    Oct. 19-21 Capital Asset Pricing Model: The Text, chapter 9.

    Capital Asset Pricing Calculator

    Stock Valuation with Dividend Valuation and CAPM Method

    Oct 26-28 Market Efficiency & Behavioral Finance: The Text, chapters 10 & 11
    Nov. 2-4 Capital Budgeting, Real Options, & NPV: The Text, chapter 12
    Nov. 9-11 From Financial Statements to Cash Flows:
    The Text, chapter 13
    Nov. 16-18 Valuation from Comparables and Financial Ratios:
    The Text, chapter 14

    Microfinance Models: Gabriel, Hinckley, and Jawaid text.

    "Market Models," Chapter 4, from Wall Street by Henwood
    Nov. 23 & 30 Pro Forma Financial Projections & Analysis:
    The Text, part VI
    Dec. 2 Mergers, Acquisitions, and Corporate Control: Reading to be determined.
    Dec. 9 Review Session

    Explore the Securities Industry Corporate Finance Basics Corporate Finance Hot Links
    Hypertextual Finance Glossary Flat World Knowledge Online Textbooks 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

    click symbol above to search SEC database

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    Copyright © 1998-2015, Satya Gabriel, Economics Department, Mount Holyoke College.