Faculty
Professor Rafael LaPorta
Objectives
This course examines two fundamental decisions of multinational firms - the investment decision and the financing decision. Topics discussed in the course include: risk management, valuation of foreign investments, cross-border mergers and acquisitions, real options, financial distress and restructurings, corporate governance practices, and project finance. In contrast, we will not have time to focus on exchange rate systems, currency and banking crises, global offerings of securities, and foreign exchange derivatives.
The course mostly benefits students interested in pursuing careers in investment banking, or in managing/advising international corporations.
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 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 “chuck and plug” 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. Solving cases is time consuming. 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.
Materials
Course Packets
Course packets, containing case studies and required readings, 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. Documented evidence that you were seriously ill or had a serious emergency at the scheduled time of the midterm, are the only valid excuses for missing 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 17 (due back on Friday, October 20). In addition, you have the option to: (1) participate in a case competition on Friday, November 17; or (2) complete a research project before Monday, November 27.
Your grade for the course will be computed as follows:
• Class participation: 40%
• Mid-term exam: 30
• Case competition or research project: 30%
Case Competition
Each team will receive a case on Tuesday, November 14 and challenged to identify the business problem and work through it by addressing a set of questions. Questions should be answered in your team’s written document, similar to discussion materials often used in investment banking (a 10 page PowerPoint Slide document with up to 3 pages of Exhibits). Teams will present their solutions to a jury on Wednesday, November 15.
Research Project
The paper may be done individually or in groups of no more than three persons. More than one individual or group can work on the same paper topic. (After all, if there were to be a traditional final exam, every student would be writing on the same topic).
Most students typically adopt one of the following formats for the paper:
1. A case study of a cross-border transaction. In addition to presenting the facts of a case, this type of paper, unlike a true Harvard case study, should also include an analysis of the transaction, and make specific recommendations for dealing with the company’s problems and structure the transaction (i.e., the paper should include both the case study and the “teaching note”). Students could either write about a transaction in progress, or one that has already taken place. In the latter case, students could retrospectively analyze what the company did to address its problems and structure the transaction, and suggest possible alternatives that might have been preferable to the actual actions taken. Students' “case study” can be written in any style that they feel comfortable with, and need not follow the classic Harvard case study format.
2. A financial analyst's report on an international company. This type of paper contains the same substantive information and analysis as the preceding “case study” type of paper, but the presentation follows the format seen in a typical Wall Street analyst report. Among other things, students could analyze the source of the company’s problems, make a buy, or sell recommendation to their clients (backing up this recommendation with hard analysis), critically evaluate actions the company has taken to address its problems, and propose possible alternative actions the company could take (including a specific analysis of how your proposal, if enacted, would affect the company’s value).
3. An investment proposal. This type of paper makes a case for investing (long or short) in a particular company or set of companies. Students' proposal should include specific recommendations based on a fundamental analysis of the firm’s situation, describe the various risks involved with your strategy, and provide a specific estimate of future investment returns. Another possibility would be to propose a portfolio investment strategy, and simulate returns using historical data.
4. A survey or analysis of some international corporate finance transaction or phenomenon. For example, students may write about the pros and cons of ADRs, project finance, how to adapt the US venture capital model to foreign markets, corporate governance systems, etc. Use a few case examples to illustrate the main points.
Before students begin work on their papers, each group should first clear their paper topic with the Professor to ensure that it is broadly related to the course. For this purpose, a student can outline their proposed paper topic in a short memo (conveyed to the Professor by e-mail). There is no formal deadline for doing this but, given the importance of the paper in the overall grade, it is suggested that students start the process of searching for a topic no later than the end of September.
Schedule
Tuesday, Sept. 12
Session 1
MODULE I - REVIEW OF COPORATE FINANCE
Diageo plc (Day 1)
Case:
"Diageo plc", G. Chacko and P. Tufano, [HBS 9-201-033], Boston, MA: Harvard Business School Publishing, 2001 (Rev. August 2003).
Assignment Questions:
1. Describe Diageo's current approach to managing it's 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. The courseware HBS Inc. Simulation Model provides a very stylized version of Diageo's analysis. How does the spreadsheet capture the value of the unlevered firm, interest tax shields, and the value destruction from financial distress. (You are not expected to run the Crystal Ball simulation prior to class).
Required Readings:
1. "HBS Inc. Simulation Model", P. Tufano, [Harvard Business Note 9-201-095] Boston, MA: Harvard Business School Publishing, 2001 (Rev. April 2004).
2. "How Much Cash Does Your Company Need?", R. Passov, [Harvard Business Review Reprint R0311J], Boston, MA: Harvard Business School Publishing, 2003.
Note: To help you solve the Diageo case, the Professor has posted an Excel template in the course folder.
Optional: Background Reading:
Section 8.3 (pages 219-223 in Chapter 8), and Chapter 16 (with a focus on section 16.4) in Ross, Stephen A., R.W. Westerfield, and J. Jaffe. Corporate Finance (7th edition). New York: McGraw-Hill Irwin, 2005. Available on reserve at Feldberg Library.
Wednesday, Sept. 13
Session 2
Diageo plc (Day 2)
Assignment Questions:
1. Using the HBS Inc. Simulation Model, answer the next four questions:
1.1. 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?
1.2. What happens if the firm's pre-tax cash flows become more volatile?
1.3. What happens if the firm borrows more or less than $45 million?
1.4. How can you make the model more realistic?
2. 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?
3. 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.
Monday, Sept. 18
Session 3
MODULE II - RISK MANAGEMENT
The Case of the Missing Profits
Case:
"The Case of the Missing Profits", Copeland, Tom, [HBS 9-202-099], Boston, MA: Harvard Business School Publishing, 2002.
Assignment Questions:
1. How much did the hedge actually reduce volatility?
2. Was the firm over- or under-hedged relative to the optimal volatility-minimizing hedge?
3. How high would the correlation between the operating cash flows and cash flows of the hedge have had to be to reduce volatility by 50%?
4. What was the expected time to bankruptcy given the optimal volatility-minimizing hedge? What was the expected time to bankruptcy without the hedge?
a. Hint: Use HBSinc.xls as a template. You may assume that the std deviation of the hedged CFs is 33.68%. Figuring out where that number comes from is a plus. However, it also important that you don’t get stuck and get some practice building CB models.
5. Given the optimal hedge, what was the ratio of benefits to costs?
Required Reading:
Page 718-728 in Copeland, Thomas E., J.F. Weston, and K. Shastri. Financial Theory and Corporate Policy (4th edition). New York: Pearson/Addison Wesley, 2005. Available on reserve at Feldberg Library.
Background Reading:
Section 25.1-25.3 (pages 697-706 in Chapter 25) in Ross, Stephen A., R.W. Westerfield, and J. Jaffe. Corporate Finance (7th edition). New York: McGraw-Hill Irwin, 2005. Available on reserve at Feldberg Library.
Tuesday, Sept. 19
Session 4
Aspen Technology, Inc.: Currency Hedging Review
Case:
"Aspen Technology, Inc.: Currency Hedging Review", C. Poetzscher and P. Tufano, [HBS 9-296-027], Boston, MA: Harvard Business School Publishing, 1996.
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? If not, what policy would you advocate and why?
5. 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.
Required Readings:
1. "A Framwork for Risk Management", K. Froot, D. Scharfstein, and J. Stein, [HBS Reprint 94604], Boston, MA: Harvard Business School Publishing, 1994.
2. "Could companies use value-at-risk?", J. MeVay, and C. Turner [p.84-86, Euromoney], October 1995. Available on reserve at Feldberg Library.
Monday, Sept. 25
Session 5
Foreign Exchange Hedging Strategies at General Motors (Day 1)
Case:
"Foreign Exchange Hedging Strategies at General Motors", M. Desai, [HBS 9-204-024], Boston, MA: Harvard Business School Publishing, 2004 (Rev. May 2005).
Assignment questions:
1. Should multinational firms hedge foreign exchange rate risk? If not, what are the consequences? If so, how should they decide which exposures to hedge?
2. What do you think of GM's foreign exchange hedging policies? How would you advise them in terms of changing it?
Required Reading:
"Note on Transaction and Translation Exposure", W.C. Kester and R. Melnick, [HBS 9-288-017], Boston, MA: Harvard Business School Publishing, 1987 (Rev. November 1992).
Tuesday, Sept. 26
Session 6
Foreign Exchange Hedging Strategies at General Motors (Day 2)
Assignment Questions:
1. Should GM deviate and change its hedging decision on the CAD? Is such a deviation consistent with policy?
2. If it does, what instruments should it use to accomplish that hedging?
3. Should GM increase its hedge with respect to the ARS? How costly would it be and would it be worth it?
4. Why is GM worried about the yen? How important is the competitive exposure?
Monday, Oct. 2
Session 6
MODULE III - CROSS-BORDER VALUATION
Valuing a Cross-Border LBO: Bidding on the Yell Group (Day 1)
Case:
"Valuing a Cross-Border LBO: Bidding on the Yell Group", M. Desai, P. Notarnicola and M. Veblen, [HBS 9-204-033], Boston, MA: Harvard Business School Publishing, 2003.
Assignment Questions:
1. Is Yell a good buyout candidate?
2. How similar are the U.K. and U.S. businesses? Do the management projections in Exhibit 6 and Exhibit 7 make sense to you? In other words, if you were part of the Apax/Hicks Muse team, would you trust them?
3. How does Yell's projected debt affect its valuation?
4. How does the cross-border nature of the Yell deal affect the valuation of the firm?
5. How much is Yell worth? How much would you bid?
6. If you were Apax/Hicks Muse would you do the deal?
7. How much is this deal worth to the private equity investors?
Required Reading:
"Cross-Border Valuation", W. C. Kester, J. Morley (abridged by K. Froot), [HBS 9-295-100], Boston, MA: Harvard Business School Publishing, 1995 (Rev. August 1997).
Tuesday, Oct. 3
Session 8
Globalizing the Cost of Capital and Capital Budgeting at AES
Case:
"Globalizing the Cost of Capital and Capital Budgeting at AES ", M. Desai, [HBS 9-204-109], Boston, MA: Harvard Business School Publishing, 2004.
Assignment Questions:
1. How would you evaluate the capital budgeting method used historically by AES? What's good and bad about it?
2. If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world?
3. Does this make sense as a way to do capital budgeting?
4. What is the value of the Pakistan project using the cost of capital derived from the new methodology? If this project was located in the U.S., what would its value be?
5. How does the cost of capital modification for the Pakistan project reflect the probabilities of real events? What does the financial analysis imply is likely to occur because the project is located in Pakistan and not the U.S.?
Background Reading:
Section 31.5, pages 858-862 in Ross, Stephen A., R.W. Westerfield, and J. Jaffe. Corporate Finance (7th edition). New York: McGraw-Hill Irwin, 2005. Available on reserve at Feldberg Library.
Monday, Oct. 9
Session 9
Dow Chemical's Bid for the Privatization of PBB in Argentina
Case:
"Dow Chemical's Bid for the Privatization of PBB in Argentina ", M. Desai, [HBS 9-204-021], Boston, MA: Harvard Business School Publishing, 2003 (Rev. March 2006).
Assignment Questions:
1. How would you convince Dow headquarters to invest in this project?
2. How would you conduct a valuation of this project?
3. What would you bid for this project?
Tuesday, Oct. 10
Session 10
Penelope's Personal Pocket Phones
Case:
"Penelope's Personal Pocket Phones", P. Gompers, [HBS 9-200-004], Boston, MA: Harvard Business School Publishing, 1999 (Rev. September 2001).
Assignment Questions:
1. What is the NPV of Penelope’s first generation phone if we ignore the possibility of investing in a second generation project? What valuation methodology would you use to get a value? Does it seem appropriate for the first stage?
a. Assume that the market premium is 7.5%.
2. How large does the current expected NPV of the second stage project have to be in order to justify a $10 million investment in the first year on the first generation phone project? What happens to the value of the opportunity to invest in the second project if the volatility of expected value increases? What does this say about investments in young, high technology companies?
3. If we ignore the option to invest in the second generation phone, how valuable is the ability to sell the equipment in year 2? Would Penelope want to invest under this scenario? Why?
Required Reading:
Chapter 4, pages 84-117 in Copeland, Tom , and V. Antikarov. Real Options: A Practitioner's Guide, New York: Thomson/Texere, 2003. Available on reserve at Feldberg Library.
Background Reading:
Section 8.4 (pages 223-227 in Chapter 8) in Ross, Stephen A., R.W. Westerfield, and J. Jaffe. Corporate Finance (7th edition). New York: McGraw-Hill Irwin, 2005. Available on reserve at Feldberg Library.
Monday, Oct. 16
Session 11
Xylene's Basement
Case:
"Xylene’s Basement", T. Copeland, [HBS N9-202-097], Boston, MA: Harvard Business School Publishing (Rev. March 2002).
Assignment Questions:
1. Generate an NPV estimate of the project.
2. Use Monte Carlo simulation to estimate the annual rate of return uncertainty of the project.
3. Build a binomial tree to simulate each of the three component options.
4. Estimate the sequential value of the compound option.
Required Readings:
1. "A Real-World Way to Manage Real Options", T. Compeland and P. Tufano., [Harvard Business Review Reprint R0403G], Boston, MA: Harvard Business School Publishing, 2004.
2. Chapter 7, pages 208-214 in Copeland, Tom , and V. Antikarov. Real Options: A Practitioner's Guide, New York: Thomson/Texere, 2003. Available on reserve at Feldberg Library.
Tuesday, Oct. 17
Session 12
MODULE IV - LIMITS TO ARBITRAGE
Global Equity Markets: The Case of Royal Dutch and Shell
Case:
"Global Equity Markets: The Case of Royal Dutch and Shell", K. Froot and A. Perold, [HBS 9-296-077], Boston, MA: Harvard Business School Publishing, 1996 (Rev. April 2006).
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?
Friday, Oct. 20 - Monday, Oct. 23
MIDTERM EXAM
Exam
Monday, Oct. 30
Session 13
The MCI Takeover Battle
Case:
"The MCI Takeover Battle: Verizon versus Qwest", M. Baker and J. Quinn, [HBS 9-206-045], Boston, MA: Harvard Business School Publishing, 2005.
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?
Required Reading:
“Stock market driven acquisitions”, Shleifer, Andrei, and R.W. Vishny, Journal of Financial Economics, 2003.
Tuesday, Oct. 31
Session 14
MODULE V - INCENTIVE PROBLEMS AND CONTRACTS
Alphatec Electronics Pcl
Case:
"Alphatec Electronics Pcl", P. Fagen, C. F. Foley, and S. Gilson, [HBS 9-200-004], Boston, MA: Harvard Business School Publishing, 2000 (Rev. March 2001).
Assignment Questions:
1. How much is management to blame for ATEC's problems? Bad business or bad capital structure?
2. As one of ATEC's banks, would you have voted for its February 1998 out-of-court restructuring proposal? Any changes?
3. As one of ATEC's banks, would you have voted for its modified bankruptcy reorganization plan?
4. Why are AIG and Investor AB willing to invest in ATEC? Returns and risks?
5. What are the problems with Thailand's old bankruptcy law? Would you change anything in the new law?
6. How would the outcome have differed in the U.S.? In the U.K.?
Monday, Nov. 6
Session 15
Buenos Aires Embotelladora S.A. (BAESA): A South American Restructuring
Case:
"Buenos Aires Embotelladora S.A. (BAESA): A South American Restructuring", S. Gilson, [HBS 9-202-009], Boston, MA: Harvard Business School Publishing, 2001 (Rev. November 2004).
Assignment Question:
1. Is an out-of-court restructuring the best approach for dealing with the company's problems?
2. As a bondholder, should you tender your bond to the company under the proposed exchange offer? As a financial advisor to BAESA, would you have designed the exchange offer any differently?
3. As a shareholder, should you subscribe to the proposed equity rights offering? Since the rights offering gives shareholders a way to retain their ownership in the company, and reduces the company's leverage as well, do you think it represents a sensible approach to restructuring distressed companies in general?
4. Does the proposed financial restructuring provide a permanent solution to BAESA's problems?
5. How will PepsiCo's involvement in this case affect the nature of the negotiations and the likely outcome of the restructuring?
Tuesday, Nov. 7
Session 16:
Czech Mate: CME and Vladimir Zelezney (A)
Case:
"Czech Mate: CME and Vladimir Zelezny (A)", M. Desai and A. Moel, [HBS 9-204-118], Boston, MA: Harvard Business School Publishing, 2004.
Assignment Question:
1. Would you buy CET 21’s (i.e. Zelezny’s) 5.8% stake in CNTS?
Monday, Nov. 13
Session 17
Australia-Japan Cable: Structuring the Project Company
Case:
"Australia-Japan Cable: Structuring the Project Company", B. Esty and C. Ferman, [HBS 9-203-029], Boston, MA: Harvard Business School Publishing, 2002 (Rev. January 2003).
Assignment Questions:
1. How would you characterize the project assets? What makes them different or unique?
2. Who are the capital providers for the AJC project? Are they likely to earn an appropriate risk adjusted return on their investment? What potential problems could arise that would prevent them from earning a return on their invested capital?
3. How would you structure the project company to mitigate these problems? What are your recommendations in terms of:
3.1. ownership structure (how many sponsors and which ones?)
3.2. capital structure (project vs. corporate finance, leverage, type of debt, etc.)
3.3. organizational structure
3.4. board structure (how many directors? Should they be insiders or outsiders?)
3.5. management compensation
Required Reading:
"An Overview of Project Finance-2004 Update", B. Esty and A. Sesia Jr., [HBS 9-205-065], Boston, MA: Harvard Business School Publishing, 2005.
Tuesday, Nov. 14
Session 18
Petrolera Zuata, Petrozuata C.A.
Case:
"Petrolera Zuata, Petrozuata C.A.", B. Esty, [HBS 9-299-012], Boston, MA: Harvard Business School Publishing, 1998 (Rev. March 2002).
Assignment Questions:
1. Should PDVSA use project financing for the development of the Orinoco Basin?
2. How much debt should Petrozuata have? How does leverage affect the project's debt service coverage ration and IRR?
3. Use Crystal Ball to assess financial risks and equity returns. Please assume that the asset beta for an integrated drilling, pipeline, and refining firm is 0.60.
i. Will project bonds receive an investment grade rating? What is the "weakest link" in the project?
4. Would you invest in the project? Why or why not?
Required Reading:
1. "Improved Techniques for Valuing Large-Scale Projects", B. Esty, [p.9-25, Journal of Project Finance], vol. 5 (1), Spring 1999.
Note: To help you solve the Petrozuata case, the Professor has posted an Excel template in the course folder.
Wednesday, Nov. 15
CASE COMPETITION
Monday, Nov. 27
RESEARCH PAPERS DUE
