Faculty
Professor Rafael LaPorta
Objectives
Corporate Financial Management is an advanced corporate finance course. The course focuses on the tools necessary to perform the job of Corporate Financial Officer. As a consequence, the course is appropriate for students who intend to pursue careers in the finance area of corporations or servicing corporate clients in an investment bank.
In today’s capital markets, financing decisions have become challenging. Firms use financial derivatives and complex project structures (e.g. project finance) to allocate risks and shape incentives. Moreover, firms raise capital efficiently by tailoring securities to particular investors’ needs, or by exploiting tax, regulatory, or other arbitrages.
Early sessions in the course will provide students with an introduction to simulation techniques in finance and tools for pricing securities. The remainder of the course will draw upon the analytic tools and intuition developed to examine capital investments projects (i.e. real options) as well as risk management strategies. We will then examine the design and pricing of a wide range of securities and their role in capital structure. Finally, we will study the role of project structure in raising capital and allocating risk.
Requirements
Teaching Methods
The course is taught entirely with cases. The objective of the case method in finance is to use the logic of financial theory to arrive at coherent and defensible conclusions when faced with real world problems presented in cases. One should keep in mind that there is no “right” answer to a case; different assumptions may lead to different solutions and decisions. There are, however, good arguments and weak arguments. Furthermore, there is always a theoretically correct methodology and technique that are proper for the problems encountered in a case.
The case method of instruction offers some distinct benefits. Solving cases requires moving beyond “plug and chug” and memorization. Instead, the goal is to learn how to use financial theories and models to solve business problems. In preparing cases, students learn more than just the financial theory required to analyze a case. Students learn about the agents, institutions, and transactions that comprise the modern financial system. Students also learn to contribute effectively to fast paced discussions about complex financial issues and test their solutions to these issues. These benefits come with a substantial cost, however. Students first need to do the assigned readings by skimming through the material to identify the tools and concepts that are useful for solving the case. Moreover, solving cases is a time consuming process. Sometimes a critical piece of information is buried in the case. In other instances, critical information is missing and students must make plausible assumptions. Moreover, discussion-based classes succeed only if all students come prepared to discuss the case material.
To help manage workload, students are encouraged to form groups of three during the first week of class. Groups offer an invaluable opportunity to leverage their efforts with regard to calculation intensive study questions. They also enable students to try out ideas prior to class discussion. Suggested study questions often require full blown calculations and/or valuations. Each student is responsible for these questions. All questions are fair game if you are cold called.
To sum up, we are going to learn a great deal and have fun in the process. However, you should expect a heavy workload. There are some courses where common sense and a bit of effort around exam time will get you a long way. CFM is not such a course. My guess is that most students are likely to need at least 10 hours per week of prep time in order to master the course material. If you are unable to make the necessary time commitment, you are better off not signing up for CFM.
Materials
Course Packets
A paper syllabus and course pack can be obtained from the Copy Center, located in Tuck 13. Handouts and additional material will be provided throughout the course.
Class Attendance
Students are expected to attend every class, unless you have an excused absence due to illness or an emergency. It is Tuck School policy that recruiting activities and interviews are not considered an excused absence from class. It is your responsibility to work with recruiters and Career Services to minimize these kinds of disruptions. The Professor recognizes, however, the importance of your job search and understands that in some cases, such conflicts are unavoidable. If you must miss a class, please submit in advance your answers to the assignments for that day. More than two unexcused absences during the term will result in a failing grade for the day’s class participation. The only valid excuse for missing an exam is documented evidence that you were seriously ill or had a serious emergency at the scheduled time of the exam.
Honor Code
In every aspect of the course, students are required to adhere to the standards of conduct as stated in the Tuck School Academic Honor Principle. Note that some of the cases and homework assignments used in this class may have been used before at Tuck or other institutions. Students may not consult with students previously enrolled in similar classes, their class notes, or other materials that were otherwise provided in the past. Moreover, students may not use material or solutions from other institutions (e.g. posted on the Internet), unless otherwise instructed in class for a particular assignment.
Use of Laptops
The Tuck Laptop Policy applies in all respects to this course. Laptops may be used in class only when required for the class session. When not in direct use, the screen should be closed. Checking email or surfing the Internet during class is unacceptable, and will be considered a serious violation of Tuck’s Honor Principle.
Grading
Grading and Requirements
There will be a take-home mid-term exam on Tuesday, October 13 (due back before 9:00 a.m. Monday, October 19). There will be a take-home final exam on Tuesday, November 17 (due back before 9:00 a.m. Monday, November 23).
Your grade for the course will be computed as follows:
• Class participation: 40%
• Mid-term exam: 30%
• Final exam: 30%
Schedule
Session 1
Monday, Sept. 14
MODULE I -
BASIC TOOLS
Basic Captial Structure Theory
Case:
"Diageo plc", G. Chacko, P. Tufano, and J. Musher [HBS 201033], Boston, MA: Harvard Business School Publishing, 2001 (Rev. August 2003).
Required Readings:
1. Ross, Stephen A., Randolph W. Westerfield, and Jeffrey Jaffe. “Capital Structure: Limits to the Use of Debt.” Corporate Finance Eighth Edition. New York: McGraw-Hill Irwin, 2008. 45–487 (chapter 16, with a focus on section 16.4).
2. HBS Inc. Simulation Model", P. Tufano and J. Musher, [Harvard Business Note N9-201-095], Boston, MA: Harvard Business School Publishing, 2001 (Revised January 2007).
3. “How Much Cash Does Your Company Need?” R. Passov, [HBR R0311J], Boston, MA: Harvard Business School Publishing, 2003.
Assignment Questions:
1. Describe Diageo’s current approach to managing its capital structure. What are the key variables that guide its capital structure policy?
2. What factors should Diageo consider in determining its capital structure? What information would you collect and what analyses would you conduct in order to determine the appropriate level of gearing?
3. What is the textbook approach to trading off the benefits and costs of higher gearing?
4. Simulation analysis enables the decision maker to get a better grasp of uncertainty. What is the uncertainty facing Diageo and how might better understanding this uncertainty enlighten their financial policy decision?
5. Using the HBSInc Simulation Model, answer the next four questions:
a. If HBS Inc. borrows $45 million, what is the distribution of the value of the firm’s unlevered cash flows and the value of the levered firm? How do these distributions differ from each other? Why?
b. What happens if the firm’s pre-tax cash flows become more volatile?
c. What happens if the firm borrows more or less than $45 million?
d. How can you make the model more realistic?
6. How does the Treasury Group’s simulation work? What aspects of Diageo’s business does it capture? What does it ignore? What key assumptions does it make? How could you improve the model?
7. What are the managerial implications of the summary results shown in Figure 2 of the case? As Ian Cray, what questions would you ask the Treasury team in reviewing their work? What should Cray recommend for Diageo’s gearing when it becomes a pure beverage alcohol business? Frame your recommendation in terms of a target level of interest coverage or a target bond rating.
Session 2:
Tuesday, Sept. 15
Real and Financial Options
Case:
“PKO Resources, Inc.”, John D. Martin and J. Douglas Ramsey, January 23, 2008 (Rev. February 5, 2008).
Required Readings:
1. Copeland, Tom, and Vladimir Antikarov. “Comparing Net Present Value, Decision Trees, and Real Option” and “Going from One Step per Time Period to Many.” Real Options: A Practitioner’s Guide. New York: Texere, 2003, 84–117 and 193–218 (chapters 4 and 7).
2. Charnes, John. “Simulating Financial Time Series.” Financial Modeling with Crystal Ball and Excel. Hoboken, NJ: John Wiley & Sons, Inc., 2007. 147–169 (chapter 11).
The Copeland book mentioned above is on reserve in Feldberg Library. Permission was not granted to make paper copies. Sorry for the inconvenience.
Please refer to the Session 2 folder in the course folder for the assignment questions. There is a table used in the assignment questions which cannot be duplicated in TuckStreams (due to TuckStreams limitations).
Session 3:
Monday, Sept. 21
Real Options -- PKO Resources, Inc. (continued)
Case:
“PKO Resources, Inc.”, John D. Martin and J. Douglas Ramsey, January 23, 2008 (Rev. February 5, 2008).
Required Reading:
"A Real-World Way to Manage Real Options", T. Copeland and P. Tufano., [HBR R0403G], Boston, MA: Harvard Business School Publishing, 2004.
Assignment Questions:
1. Build a Geometric Brownian Motion (GBM) model for the prices of oil and gas between 2008 and 2032.
2. Based on the prices generated by your GBM model, in each year between 2008 and 2032, compute the DCF value of the operating cash flows (i.e. ignore CAPEX) associated with probable reserves on Exhibit 1.c.
a. Recall that the level of reserves will become known to investors in 2010.
3. Based on your previous calculations, on each year between 2008 and 2032, compute the average return and its standard deviation.
a. The easiest way to do this in CB is to use the function “CB.GetForeStatFN”.
4. Build a binomial tree to value the property taking into account CAPEX.
Session 4:
Tuesday, Sept. 22
Financial Options
Case:
“First American Bank: Credit Default Swaps”, G. Chacko and E. Peter Strick, [HBS 203033], Boston, MA: Harvard Business School Publishing, 2002.
Required Readings:
1. “Note on Credit Derivatives”, G. Chacko, P. Hecht, A. Sjoman and K. Hao, [HBS 205111], Boston, MA: Harvard Business School Publishing, 2009.
2. Ross, Stephen A., Randolph W. Westerfield, and Jeffrey Jaffe. "Stocks and Bonds as Optoins." Corporate Finance Eighth Edition. New York: McGraw-Hill Irwin, 2008, 651-656 (chapter 22).
Assignment Questions:
1. What fee should Kittal charge for the default swap?
2. How should Kittal subsequently offload the risk of a CEU default from FAB’s balance sheet?
Note: To help you solve the FAB case, the professor has posted an Excel template in the course folder.
Session 5:
Monday, Sept. 28
MODULE II -
RISK MANAGEMENT
Tools for Optimal Hedging
Case:
“Tucker Oil: PKO Revisited.” Andrew Grimson, September 2008.
Required Readings:
1. Jorion, Philippe. “Hedging Linear Risk.” Financial Risk Manager Handbook. Hoboken, NJ: John Wiley & Sons, Inc., 2007. 292–308 (chapter 12).
2. "Framework For Risk Management", K. Froot, D. Scharfstein, and J. Stein, [HBS 94604], Boston, MA: Harvard Business School Publishing, 1994.
Please refer to the Session 5 folder in the course folder for the assignment questions. There are symbols used in the assignment questions which cannot be duplicated in TuckStreams (due to TuckStreams limitations).
Session 6:
Tuesday, Sept. 29
Value at Risk (VAR)
Case:
"Aspen Technology, Inc.: Currency Hedging Review", C. Poetzscher and P. Tufano, [HBS 296027], Boston, MA: Harvard Business School Publishing, 1995 (Rev. July 1996).
Required Readings:
1. “Understanding Corporate-Value-at-Risk Through a Comprehensive and Simple Example”, Marc L. Bertoneche, and Frantz Maurer, [HBS 9-206-046], Boston, MA: Harvard Business School Publishing, 2006.
2. Charnes, John. “Value at Risk.” Financial Modeling with Crystal Ball and Excel. Hoboken, NJ: John Wiley & Sons, Inc., 2007. 140–146, (chapter 10).
Assignment Questions:
1. What are Aspen Technology’s main exchange rate exposures? How does Aspen Tech’s business strategy give rise to these exposures as well as to the firm’s financing needs?
2. Calculate Aspen’s exposure by currency for the past year. What currencies is it long and short?
3. What goal would you recommend for the firm’s currency risk management program? Why? Based on your goal, what type of exposure should Aspen be measuring?
4. Should the firm maintain its policy of completely eliminating all exposure on booked sales?
5. How would you implement a policy of maximizing the value of hedged cash flows subject to the constraint that the 10th percentile exceed -$10,980?
6. How, if at all, should Aspen’s recent transactions from a private to a publicly-traded firm affect its approach to risk management?
Note: To help you solve the Aspen case, the professor has posted an Excel template in the course folder.
Session 7:
Monday, Oct. 5
Liability Management
Case:
"Liability Management at General Motors”, Peter Tufano, [HBS 293123], Boston, MA: Harvard Business School Publishing, 1993 (Rev. July 2008).
Required Readings:
“Introduction to Interest Rate Options”, G. Chacko and A. Sjoman, [HBS 205112], Boston, MA: Harvard Business School Publishing, 2005 (Rev. February 2006).
Assignment Questions:
1. How will changes in interest rates affect General Motors' business? Speculate on the various ways in which changes in interest rates influence the demand for autos, the prices the firm can charge, its input costs, etc. Apart from engaging in derivative securities, like those discussed in the case, how could a firm like GM control its exposure to interest rates?
2. How does managing interest rate exposure differ for a bank and for an industrial firm like GM?
3. What should be GM's over-arching policy toward managing interest rate exposure? For example, should GM seek to ensure that changes in interest rates do not affect operating cash flow? The market value of the firm's equity? GM's ability to invest in new technologies? Should it abandon all efforts to manage its interest rate exposure? Be prepared to discuss GM's stated policies. How do you interpret these policies?
4. How has GM measured its exposure? How would you propose that GM measures its interest rate exposure? How would you propose that GM report the interest rate exposure of its business, and of its liabilities?
5. What is a "rate view"? What role does it play in the liability management policy at GM? What role should it play in the liability management program? Why?
6. Explain each of the interest rate derivatives that Bello is considering (listed in Exhibit 7.) How do they work, and how would they affect the incremental interest rate exposure of the five-year fixed-rate note that GM is about to issue? Assuming that each of the instruments is fairly priced, what should Bello recommend? Why?
7. As a director or institutional investor in GM, how would you evaluate the liability management program at GM? What might you suggest be studied or changed, and why?
Session 8:
Tuesday, Oct. 6
Managing Differences in Opinion
Case:
“MW Petroleum Corp. (B)”, T. Luehrman, P. Tufano, and B. Wall. [HBS 295045], Boston, MA: Harvard Business School Publishing, 1995 (Rev. April 1996).
Required Readings:
1. Charnes, John. “Financial Options.” Financial Modeling with Crystal Ball and Excel. Hoboken, NJ: John Wiley & Sons, Inc., 2007. 170–186, (chapter 12).
2. Arzac, Enrique R. “Deal Making with Differences of Opinion.” Valuation for Mergers, Buyouts, and Restructuring. Danvers, MA: John Wiley & Sons, Inc., 2008. 198–222 (chapter 10).
3. Caselli, Stefano, and Stefano Gatti, “Managing M&A Risk with Collars, Earn-outs, and CVRs,” Journal of Applied Corporate Finance, Fall 2006. Pp. 91-104.
Assignment Questions:
1. What problems face Amoco and Apache in bringing this transaction to completion? What are the firms' objectives?
2. What possible alternatives might exist to solve the stalled negotiations? Do not necessarily limit yourself to the ones mentioned in the case--be creative!(br>
3. How can you express the proposed solution in terms of the financial contracts studied in this course? Why do you think the deal is structured as given in Exhibit 7? What other ways might it have been structured? What might have been the pros and cons of other structures?
4. How much are the pricing-sharing and support agreements worth? The spreadsheet mwb.xls provides a Monte Carlo simulation program that you can use to value the contract. For comparability in class, please use the assumptions given in the spreadsheet regarding interest rates, spot prices, and volatility, but you are also free to conduct sensitivity analysis. The model used here is very simple, assuming (a) the convenience yield is fixed; (b) oil and gas prices are uncorrelated; (c) oil and gas prices follow a random walk; and (d) there is no credit risk. How do you think your valuations would change if you were to incorporate these factors?
5. Should Amoco accept the proposed deal from Apache, including the price-sharing and price-support arrangements?
Session 9:
Monday, Oct. 12
MODULE III -
MIDTERM REVIEW
Midterm Review -- Pacific Salmon Co., Inc.
Case:
“Pacific Salmon Co., Inc.,” Nabil N. El-Hage, K. A. Froot, and C. E.J. Payton. [HBS 205031], Boston, MA: Harvard Business School Publishing, 2004 (Rev. May 2006).
Please refer to the Session 9 folder in the course folder, for the assignment questions (assumptions). There are financial symbols used in the assignment questions which cannot be duplicated in TuckStreams (due to TuckStreams limitations).
Session 10:
Tuesday, Oct. 13
MODULE IV -
LIMITS TO ARBITRAGE
Global Equity Markets: The Case of Royal Dutch and Shell
Exam
Case:
"Global Equity Markets: The Case of Royal Dutch and Shell", K. Froot and A. Perold, [HBS 296077], Boston, MA: Harvard Business School Publishing, 1996 (Rev. April 2006).
Required Readings:
Ross, Stephen A., Randolph W. Westerfield, and Jeffrey Jaffe. “Corporate Financing Decisions and Efficient Capital Markets.” Corporate Finance Eighth Edition. New York: McGraw-Hill Irwin, 2008. 368–404 (chapter 13).
Assignment Questions:
1. Identify price differentials between different equity listings of the Royal Dutch/Shell Group. How can they be explained? What percentage of the particular price differentials you identified can be due to the explanations that you suggested?
2. Is there an arbitrage opportunity in the price differentials you identified? What kind of arbitrage transactions would you propose to exploit these opportunities?
3. Calculate the net payoffs of the arbitrage transactions you suggested. Can such transactions enforce market discipline?
Midterm Exam
A take-home midterm exam will be handed out in class. It will be due back before 9:00 a.m. on Monday, October 19.
Session 11:
Monday, Oct. 26
MODULE V -
CAPITAL STRUCTURE POLICY
Stock Splits
Case:
“Livedoor,” R. Greenwood and M. Schor, [HBS 206138], Boston, MA: Harvard Business School Publishing, 2006.
Assignment Questions:
1. What opportunity did Murakami see in owning shares of NBS? What created the opportunity? Describe the possible arbitrage strategies that Murakami might have taken.
2. Explain the pricing of Livedoor stock in January 2005.
3. Evaluate Livedoor’s acquisition strategy and its current attempt to gain control of Fuji TV. What are the implications for shareholder value?
4. Evaluate the Lehman Brothers financing vehicle. Be sure to consider sources of value from Lehman’s perspective and from Livedoor’s. What alternatives might Horie have considered?
5. How should Hieda respond?
Session 12:
Tuesday, Oct. 27
Stock-Market Driven Acquisitions
Case:
“The MCI Takeover Battle: Verizon versus Qwest”, M. Baker and J. Quinn, [HBS 206045], Boston, MA: Harvard Business School Publishing, 2005 (Rev. May 2009).
Required Readings:
1. Sheffrin, Hersh. “Capital Structure” and “Mergers and Acquisitions.” Behavioral Corporate Finance. New York: McGraw-Hill Irwin, 2005. 92–109 and 161–180 (chapters 6 and 10).
2. Arzac, Enrique R. “Special Offer Structures: Price Guarantees and Collars.” Valuation for Mergers, Buyouts, and Restructurings. Danvers, MA: John Wiley & Sons, 2008. 223–238 (chapter 11).
Assignment Questions:
1. What are the strengths and weaknesses of Verizon, MCI, and Qwest? Where are the synergies in the proposed combinations?
2. Evaluate the two offers in Exhibit 7. What explains the two structures? In each case, what is the value to MCI shareholders?
3. Merger arbitrage (or risk arbitrage) funds speculate on the completion of stock and cash mergers, typically buying the target and hedging the risk of the acquirer's shares according the exchange ratio in stock mergers. What positions would risk arbs take in this deal? How would their positions change if the board appeared to favor the Qwest offer?
4. Consider the WorldCom-MCI merger and the Qwest-US West merger? Trying to avoid hindsight bias, should the boards of MCI and US West have accepted those offers? What is the obligation to shareholders? Was that obligation fulfilled? What about WorldCom and Qwest? Did their shareholders benefit?
5. Which offer should MCI accept?
6. What approach should Verizon take to win the takeover contest? Qwest?
Session 13:
Monday, Nov. 2
Convertible Debt
Case:
“Wells Fargo Convertible Bonds”, M. Baker and L. Kind, [HBS 206022], Harvard Business School Publishing, 2006.
Required Reading:
Ross, Stephen A., Randolph W. Westerfield, and Jeffrey Jaffe. “Warrants and Convertibles.” Corporate Finance Eighth Edition. New York: McGraw-Hill Irwin, 2008. 695–713 (chapter 24).
Assignment Questions:
1. Evaluate Wells Fargo’s overall financing strategy. How has the firm raised capital in the past?
2. Why is Morgan Stanley proposing this particular security? Is Wells Fargo a typical convertible bond issuer? Why do firms issue convertible securities?
3. Describe and, where possible, quantify the sources of value for Wells Fargo. What is the purpose of “remarketing” the bonds?
4. Draw a payoff diagram for the convertible security described in Exhibit 9. Value the security relative to plain vanilla Wells floating rate debt, and as the sum of its parts. Would you buy the Wells convertible bonds at par?
A suggestion: This is a complicated security, and the first of its kind. In marketing the bonds, Morgan Stanley argued that, because of the redemption clause, investors should treat the bond as a 5-year convertible, with the “remarketing” feature, the contingent interest feature, and the $120 trigger having little effect on value to investors. These complications ensured the proper tax and accounting treatment, but had no other economic effect.
5. What should Atkins do?
Session 14:
Tuesday, Nov. 3
Convertible Preferred
Case:
“Corning: Convertible Preferred Stock”, M. Baker and J. Quinn, [HBS 206018], Harvard Business School Publishing, 2005 (Rev. November 2006).
Required Reading:
Smithson, Charles W. “Hybrid Securities.” Managing Financial Risk: A Guide to Derivative Products, Financial Engineering, and Value Maximization. New York: McGraw-Hill, 1998. 319-359 (chapter 15).
Assignment Quetions:
1. Describe Corning's business. How has the firm performed? What accounts for the changes in valuation in Corning stock in Exhibit 2? Trying to avoid hindsight bias – and this is very hard to do - could Corning's troubles have been forecasted before 2001?
2. Evaluate Corning's financing strategy. How has the firm raised capital in the past?
3. Why does Corning need to raise capital? Why might it be difficult or undesirable to raise equity, given its financial leverage and credit rating? Working through the example below will help you understand the "debt overhang" problem. Why might it be difficult or undesirable to raise equity, even if its financial leverage were lower?
4. Debt and Incentives Exercise: Suppose that the face value of Corning debt is $4 billion and that the value of its assets will either be $10 billion (to creditors and shareholders) or $2 billion (to creditors in bankruptcy), with equal probability. Compute the market value of debt and the market value of equity per share, ignoring discounting. What happens to the market value of equity per share if Corning raises $400 million and invests the proceeds in projects that deliver $500 million in value for sure, i.e. regardless of the value of the rest of Corning's assets?
5. Why is JP Morgan proposing this particular security? Who are the likely buyers?
6. Draw a payoff diagram for the convertible security in Exhibit 10. Value the security as the sum of its parts. Would you buy the Corning convertible preferred shares at par? If your answer is yes, what other investments, if any, would you make concurrently?
7. What are the risks of this offering for Corning?
8. What should Flaws do?
Session 15:
Monday, Nov. 9
Hybrid Securities
Case:
“Cox Communications, Inc.--1999”, G. Chacko and Peter Tufano, [HBS 201003], Harvard Business School Publishing, 2000 (Rev. August 2003).
Required Readings:
1. Arzac, Enrique R. “PERCS, DECS, and Other Mandatory Convertibles.” Journal of Applied Corporate Finance Spring 1997, Vol. 10, Issue 1: 54–63.
2.Henry, David. “Cross-Dressing Securities.” BusinessWeek. March 13, 2006, Issue 3975: 58–59.
Assignment Questions:
1. Why is CCI acquiring Gannett? Does the Gannett acquisition make sense at $2.7 billion?
a. Assume Gannett’s working capital equals 0.22*EBITDA. Moreover, you may assume that ∆WC in the year 2000 equals 0.
2. Assuming that the Gannett acquisition goes through, estimate CCI's short-term (1½ years) and, long-term (4½ years) funding needs. How much of each funding need must be met through external financing?
3. What constraints does Clement face in satisfying CCI's funding needs? You may assume that CCI has mandated a 65% floor on their economic stake.
4. Analyze the solutions proposed in Exhibit 8. What is a FELINE PRIDES security? What are the advantages/disadvantages to firms using this security? Decompose this security into its debt and equity components. What, economically, is a firm doing when it issues FELINE PRIDES?
5. Which solution in Exhibit 8 seems to satisfy the financing constraints determined above and why?
Session 16:
Tuesday, Nov. 10
Contingent Capital
Case:
“Cephalon, Inc.” P. Tufano, G. Verter, and M. Mullarkey, [HBS 298116], Harvard Business School Publishing, 1998.
Required Reading:
1. Culp, Christopher L. “Contingent Capital.” Structured Finance & Insurance: The ART of Managing Capital and Risk. Hobeken, NJ: John Wiley & Sons, Inc., 2006. 320–339 (chapter 15).
Assignment Questions:
1. As the date of the FDA meeting approaches and the possible need for cash looms, Cephalon faces a number of choices, not just whether or not to buy the options. Look at the decision tree on page six. How should Cephalon make its choices along this tree? Sketch out the tradeoffs between costs and benefits at each decision point. Identify how to quantify the costs and benefits at each decision point.
2. Does Cephalon have enough cash to buyback the rights from the partnership? What about debt capacity? Equity capacity?
3. How would you quantify Cephalon’s cost of raising external funds?
4. Give a concise statement for why the options are useful. What is the problem they resolve? How do they resolve it?
5. Is there a cost of issuing the options? How would you try to estimate it? What would be the difficulties?
6. Why would you expect the cost of issuing the options to be less than the costs of any of the other means for accessing external financing sources?
7. Discuss key dangers in the design of these options. Can you think of alternatives that serve the same purpose, but avoid these dangers?
8. Is the need for “backwards insurance” a common financing problem, or is it unique to Cephalon?
9. Is it true that Cephalon doesn’t need any money in the event that the FDA does not approve Myotrophin?
Session 17:
Monday, Nov. 16
MODULE VI -
PROJECT STRUCTURE
Project Finance
Case:
“Calpine Corporation: The Evolution from Project to Corporate Finance”, B. Esty and M. Kane, [HBS 201098], Harvard Business School Publishing, 2001 (Rev. January 2003).
Required Reading:
1. Finnerty, John D. “What is Project Financing?” and “The Rationale for Project Financing.” Project Financing: Asset-Based Financial Engineering. New York: John Wiley & Sons, Inc., 2007. 1–30 (chapters 1 and 2).
Assignment Questions:
1. Did Calpine's strategy of using project finance make sense prior to 1998? What are the benefits of using project finance for power plants with long-term power purchase agreements (PPA)?
2. If you were Calpine's CEO, would you embark on the high-growth strategy? How big are the potential returns? What are the most significant risks? (Hint: How valuable is a new 1000MWgas-fired plant like the one described in Exhibit 5? Assume a 6.0% market risk premium).
3. How should Calpine finance the high-growth strategy: with equity (new issues or retained earnings), project finance, corporate finance, or the hybrid construction facility? What are the most important criteria for making this decision? (Hint: What is the total financing and refinancing cost to build plants under each option assuming a two-year horizon).
4. Does your answer to Question 3 change if the corporate goal shifts from 15,000 MW to 25,000 MW of generating capacity by 2004? to 70,000 MW by 2005?
Session 18:
Tuesday, Nov. 17
MODULE VII -
FINAL REVIEW
Course Overview
Exam
Final Exam:
A take home final exam will be handed out in class. It will be due back before 9:00a.m. on Monday, November 23.
