Advanced Financial Management

Lecture 1
Introduction to the Course
and Corporate Finance

Professor Janis Skrastins

 Outline

 Introduction to the Course

 Course information
 Discussion of syllabus

 Introduction to corporate finance

 Types of firms and securities
 Role of the financial manager
 Agency problems & corporate governance

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 Waitlist Policies and Procedures

 Course caps are set to provide the best experience for

both students and faculty.
 Faculty are not able to raise the cap or add students off
the waitlist.
 The only way to get off a waitlist and enrolled in the
course is by students currently enrolled dropping the
course.
 If you have specific questions, please see a BSBA
Advisor

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 Course Overview

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 Key Questions of Corporate Finance

 Valuation:
 How do we distinguish between good investment projects
and bad ones?
 What assets/project should a firm invest in?
 When do we initiate an investment?
 How do we measure the value of flexibility in real investment
decisions over time?

 Financing:
 How should we finance the investment projects we choose
to undertake?
 How can financial structure affect decisions and firm value?

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 Course Structure

Capital Capital
Budgeting Structure
Advanced
Financial
Management
Payout Market
Policy Frictions

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 Tentative Course Topics
 Capital Budgeting
 Valuation
 Discounted Cash Flows
 Multiples
 Capital Structure
 Perfect Capital Markets
 Incorporating Market Frictions
 Taxes
 Distress
 Asymmetric Information
 Raising Equity
 Raising Debt
 If we have time:
 Payout Policy
 Mergers and Acquisitions

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 Course Philosophy

 This is an advanced course:

 Build on finance and accounting core

 This is a comprehensive course:

 Covers many aspects of corporate finance

 This is an applied course:

 Real-world problem solving in case studies
 We will tilt more towards application early in the term

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 Course Objectives

 Develop a coherent/logical framework for addressing

problems.
 To provide you with a structure for thinking about corporate
finance theory.
 To show you how to address corporate finance problems in a
systematic manner.

 Develop a deeper understanding of finance:

 How to apply fundamental ideas of finance to solve practical
financial situations and problems.
 How to deal with the gap between setting of a particular
practical problem and assumptions underlying finance theory.

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 Our Approach

What we will do What we won’t do

 Acquire a set of general tools  Pretend to be experts in any

that are crucial to sound industry, financial or other.
business decisions by:
 Financial managers
 Discuss many institutional
 General managers
aspects in detail.

 Apply and confront them to a

number of real business
Discussions will be complimented
cases.
by reviews of recent research in
 Usefulness corporate finance.
 Limitations

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 Getting the Most From This Course
 Understanding of basic finance theory.
 Have handy your notes from previous finance and accounting
classes/textbooks.

 Be Prepared
 Know the cases.
 Do the readings.
 Be on time.
 Bring your name card.

 Be curious

 Be collegial

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 Course Readings

 Berk and DeMarzo,

Corporate Finance, 4e
 Recommended
 Relevant chapters
 Useful reference
 Earlier versions should
be fine

 Lecture notes

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 Other Reference Books
 Brealey, Myers, & Allen. Principles of Corporate Finance.
 Damodaran. Corporate Finance Theory and Practice.
 Grinblatt & Titman. Financial Markets and Corporate
Strategy.
 Ross, Westerfield, & Jaffe. Corporate Finance.
 Koller, Goedhart and Wessels (McKinsey). Valuation:
Measuring and Managing the Value of Companies.

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 Course Packet

 Required as the cases included in the packet are

copyrighted materials.

 Always bring the cases to the case discussion, as we

will discuss and reference their exhibits frequently.

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 Course Requirements & Grading
Requirement Weight Note
Group Case Lowest score will be dropped only if your
25%
Reports group completes and submits all cases

Midterm Exam 30% Mid-March: TBD

Final Exam 35% Cumulative, April 27

Class Come prepared to add quality to the class

5%
Participation discussions.

Peer Your group members will assess your

5%
Evaluation overall contribution during the course.
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 Group Case Reports

 A group must consist of 4-5 people

 Sign up for your group through Canvas by January 26.

 Deliverable:
 Each group will submit a 3 page memorandum of analysis and
recommendations covering the case study questions plus any
accompanying tables you wish to include as appendices.
 One electronic copy
 Must be submitted by 1:00PM of the due date

 Six case reports together account for at least 25% of your grade.
 Case discussions are also critical opportunities for class participation.

 I will provide a hard copy only of case slides.

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 Group Cases

Case Title
#1 Expansion and Risk at Hansson Private Label, Inc.
#2 Valuing the Opportunity at Mercury Athletic Footwear
#3 Cost of Capital of Midland Energy Resources, Inc.
#4 Debt Policy at UST
#5 Google IPO
#6 Hertz LBO
#7 Dividend Policy at FPL Group (tentative)

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 Exam Schedules & Policies
 Exam schedules – inform me any conflicts by the end of the
second week
 Midterm Exam: TBD, first half of the course
 Final Exam: Last Day of Class, cumulative

 Inform me of any special accommodations (with documentation)

by the end of the second week.

 Important policies on exams:

 Closed-book and closed-notes
 Financial calculators allowed and necessary
 No cell phones, laptops, tablets, and other electronic devices
 May bring one 8.5” by 11” crib sheet with hand-written notes for both
exams, no cutting, photocopying, or pasting
 The crib sheet must be turned in with the exam.

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 Expectations and Availability
My Expectations of You
 Preparation for class
 Class participation
 Cold calling
 Missed work
 Regrade Policy
 Code of Conduct:
 Academic integrity
 Classroom etiquette
 Phones, etc.
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My Availability
 Office: Simon Hall 221
 Email:
jskrastins@wustl.edu
 Subject “FIN448 – [x]”
 Office hours (see syllabus)
 If you have any questions,
ask me!
FIN 448 / Janis Skrastins
 Any Questions?

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 Introduction to
Corporate Finance

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 The Four Types of Firms

 Sole Proprietorship

 Partnership

 Limited Liability Company (LLC)

 Corporation

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 The Four Types of Firms

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 Emergence of the Public Corporation

 Firm size and growth

 Projects are much larger than the wealth of individuals

 Risk sharing and transfer

 Same wealth can be invested in multiple projects,
diversifying the investment

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 Debt

 Characteristics of debt:  Sources of debt:

 Specified interest
payment
 Face value
 Fixed maturity
 First priority
 Covenants  Examples:
 Interest payments
are tax deductible
 Banks
 Public debt markets
 Finance companies
 Insurance companies
 Suppliers (trade credit)
 Loans, notes, corporate
bonds, commercial
paper, lines of credit

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 Equity
 Characteristics of equity:
 Dividends are set by the
board of directors
 Minimal par value
 Last priority – residual
claimant
 No maturity
 Voting rights
 Dividend payments are
not tax deductible
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 Sources of equity:
 Private equity
 Public markets
 NYSE, AMEX, NASDAQ
 International markets
 Market indices
 Dow Jones Industrial
Average (DJIA)
 S&P 500
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 Dow Jones Industrial Average (DJIA)
 When one asks, “How is the market doing?” it is usually implicit that the
question refers to the DJIA.

 Beginning March 18, 2015, after the close, DJIA includes the following
30 blue-chip stocks in the U.S.:
3M (MMM) General Electric (GE) Nike (NKE)
American Express (AXP) Goldman Sachs (GS) Pfizer (PFE)
Apple (APPL) Home Depot (HD) Procter & Gamble (PG)
Boeing (BA) IBM (IBM) Travelers (TRV)
Caterpillar (CAT) Intel (INTC) UnitedHealth Group (UNH)
Chevron (CVX) Johnson & Johnson (JNJ) United Technologies (UTX)
Cisco Systems (CSCO) JPMorgan Chase (JPM) Verizon (VZ)
Coca-Cola (KO) McDonald's (MCD) Visa (V)
DuPont (DD) Merck (MRK) Wal-Mart (WMT)
Exxon Mobil (XOM) Microsoft (MSFT) Walt Disney (DIS)

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 History of the DJIA

 On May 26, 1896, it was officially published with 12 stocks:

American Cotton Oil Laclede Gas
American Sugar National Lead
American Tobacco North American
Chicago Gas Tenn. Coal, Iron and Railroad
Distilling & Cattle Feeding US Leather
General Electric US Rubber

 The first official Dow:

 40.94

 The lowest official Dow:

 28.48 on August 8, 1896

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 The DJIA since the Beginning

Source: https://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average#/media/File:DJIA_historical_graph_to_jul11_(log).svg

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 The DJIA in the last 10 years

Source: http://www.macrotrends.net/1358/dow-jones-industrial-average-last-10-years

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 S&P 500 Index and DJIA

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 How Firms Issue Securities

 Primary market
 Firms issue new securities through underwriters to the
public  investors get new securities; firm gets funding

 Secondary market
 Investors trade previously issued securities among
themselves  ownership is transferred

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 Facebook (FB) IPO
• IPO on May 18, 2012
• $38/share and $104 billion market value
• First day “disappointment”  a “fiasco”
• Damaged reputation for lead underwriter
(Morgan Stanley) and exchange (Nasdaq)
• Litigation faced by underwriters (MS, JPM,
GS), Facebook CEO and the board

Source: Yahoo Finance (8/28/2017)

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 Facebook, Google, and S&P 500

Source: Yahoo Finance (8/28/2017)

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 Alibaba (BABA) IPO
• IPO on September 19, 2014
• IPO price at US$68, opening price at
US$92.70, the largest IPO in history,
exceeding Facebook, market value at
US$231 billion

Source: Yahoo Finance (8/28/2017)

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 Alibaba, Google, and S&P 500

Source: Yahoo Finance (8/28/2017)

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 Decisions of the Financial Manager

 Allocating Capital
Capital Budgeting Policy

 Raising Capital
Capital Structure or Financing Policy

 Dispersing Excess Capital

Dividend or Payout Policy

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 Decisions of the Financial Manager

(2) (1)

Firm’s Financial Financial

(4a)
operations manager markets

(3) (4b)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
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 Objective of the Financial Manager

 Maximize Shareholder Value

 Maximize Manager’s Wealth

 Maximize Utility of Other Stakeholders

 Maximize Firm Size (Assets or Sales)

 Minimize Firm Risk

 Maximize Current Income

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 Separation of Ownership and Control

 Shareholders

 Board of Directors

 Management

 Other Stakeholders

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 Agency Problems

 Separation of ownership and management

 Shareholders board of directors  managers
 Managers’ ideal objective: Maximize shareholder value

 Agency problems: Managers pursue their own interests

 Compensation ties managers’ income to firm performance
 Internal monitoring by board of directors
 External monitoring by security analysts and large
institutional investors
 Threat of takeover to bad performers

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 Corporate Governance

 Accounting scandals, e.g., WorldCom, Enron, Rite Aid,

HealthSouth, Global Crossing, Qwest (2000-2002)
 Auditors – watchdogs of the firms
 Auditor/analyst scandals, e.g., Arthur Andersen
 Sarbanes-Oxley Act (passed in 2002): To tighten the rules of
corporate governance
 More independent directors (neither managing nor affiliated)
 Top management (e.g., CFO) to personally certify the accuracy
of financial information/accounting statements
 Oversight board to oversee the auditing of public firms
 More independent outside auditors

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 Key Points

 Identify main areas of concerns (decisions to make) for

corporate finance are: (1) capital budgeting, (2) capital
structure (or financing), and (3) dividend (or payout).

 Understand the goal of financial management (in a for-

profit firm) is to maximize the market value of the firm
equity.

 Recognize agency problems between shareholders and

managers (as well as in financial markets).
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