HBA1 Finance Course

“Finance” course, taught in the first term of HBA1.

Course Content

Module 1: Time Value of Money

Lecture: Time Value of Money

Primer

Note: below information is all duplicates of their respective notes. There exists atomic notes for all concepts including mathematical formulas and documentation on excel functions.

Concept	Mathematical Formula	Excel Function
Future Value	$FV=PV\times (1+r{)}^n$ - PV is the present value - r is the required rate of return - n is the period	=FV(rate, nper, pmt, [pv], [type]) - rate is the required rate of return - nper is the number of periods - pmt is the value of recurring payment - pv is the present value
Present Value	$PV=FV\times \frac{1}{(1+r{)}^n}$ - FV is the future value - r is the required rate of return - n is the period	=PV(rate, nper, pmt, [pv], [type]) - rate is the required rate of return - nper is the number of periods - pmt is the value of recurring payment - fv is future value
Net Present Value	$NPV=-C_0+\frac{C_1}{(1+r{)}^1}+\frac{C_2}{(1+r{)}^2}+\dots$ - C is cash flow in a given period - r is the required rate of return	=NPV(rate, value1, value2, ...) - rate is the required rate of return - values are the undiscounted future cash flows beginning in period 1
Internal Rate of Return	No closed for expression, cannot be easily calculated analytically.	=IRR(values) - values are undiscounted cash flows beginning in time zero

Module 2: Financial Markets and Alternatives to Raising Capital

There is a lot of content here, but the main concepts are:

• Bond
• Financial Security Types
• Debt Securities

Additionally, we have some extra information here regarding terms:

• Bond Spread
• Flight to Quality
• Currency Matching and Exchange Rate Risk

Bonds vs. Stocks

Bonds:

• Fixed obligations
• Payment structure is generally known when issued.
• Indirect control only through debt contract terms
• Relatively high priority in bankruptcy

Stocks

• Residual claim on the firm
  • No guarantee of dividends or return of capital
  • Lowest priority in bankruptcy
  • Voting control

Equity

• Equity
• Preferred Shares
• Common Shares

We also note a important strategy Dividend Discount Model

Module 3: Capital Structure

• Capital Structure
  • references: Modigliani and Miller Capital Structure “irrelevance” theory

Cases

Roche Holding AG: Funding the Genentech Acquisition

Goal: To raise 32 billion through bond issuance

Qual Structure:

1. Our financing options?
2. What is our overarching goal?
3. Why consider different currencies?
4. What factors determine spreads on corporate debt (bonds)?
5. What risks are there associated with bond issuance?
6. Final Decision?

Assignment Questions:

1. Is a bond offering the best choice to finance this acquisition? What risks are involved?
2. Will this offering affect Roche’s bond rating? How?
3. What is the yield to maturity (YTM) on comparable corporate bonds? (Hint: use the “Yield” function in Excel, and be careful when choosing the settlement date)
4. What are your estimates of investors’ required yield and credit spread for the Roche 5-year U.S. dollar bonds?
5. What is your recommendation for the yield on the 7-year bond in euros?

Harley-Davidson Inc.: Dividend Discount Valuation

Goal: To value Harley-Davidson stock using the Dividend Discount Model (DDM)

Qual Structure:

1. Who are we?
2. When?
3. What’s the issue?
4. How should we approach this decision?
5. Options? (buy hold sell…)
6. Qualitative Size-up
   1. External Analysis
      1. Economy
      2. Industry
   2. Internal Analysis
      1. Strategy
      2. Financials
7. Quantitative size-up
   1. Ratios

Assignment Questions:

1. How would you describe Harley-Davidson’s business and strategy?  What are the industry growth prospects? How competitive is the business?
2. What are Harley-Davidson’s strengths and weaknesses?  What are the greatest threats and opportunities? As part of your analysis, financially size up the company using data in Exhibits 4 to 7.
3. Develop a single-stage valuation model for Harley-Davidson given information in the case. Assess the reasonableness of your model and consider appropriate sensitivities.
4. Develop a two-stage DDM model for Harley-Davidson given information in the case.  Assess the reasonableness of your model and consider appropriate sensitivities.  What is your target price for Harley-Davidson’s stock?
5. As Aditi Basu, what recommendation would you make regarding the attractiveness of Harley-Davidson stock for Dimensional Wealth Group?

5 Fortune: One of Many Chinese Restaurants

Qual Structure:

• Make a FRICTO table with columns for each options and a “Importance for 5 Fortune”

Assignment Questions:

1. Do a qualitative size-up of the new business venture.
2. Prepare an estimate of the beginning balance sheet for 5 Fortune for both of the financial proposals. Assume that Li’s “start-up costs” are related to other equipment purchases, and thus are capitalized in the Balance Sheet (not expensed in the Income Statement).
3. What is the earnings before interest and taxes (EBIT) assuming 100% capacity? 75% capacity? 50% capacity? Ignore any amortization of start-up costs.
4. What are the net income, ROE and interest coverage (EBIT/Annual Interest Payment) under the two financing proposals and each of the three different capacity assumptions? (note that the annual mortgage payment is $31,592).
5. Which financing option do you think Li should pursue?
6. How attractive is the mortgage alternative to potential investors? How could the terms of the alternative be changed to be more favourable for investors? How would the changes affect the attractiveness from 5 Fortune’s perspective?
7. How attractive is the common stock alternative to the potential investor? How could the terms of the alternative be changed to be more favourable for investors? How would the changes affect the attractiveness from 5 Fortune’s perspective?

Blaine Kitchenware, Inc.: Capital Structure

Qual Structure:

• Net Debt

Assignment Questions

1. Do you believe Blaine’s current capital structure and payout policies are appropriate?
2. Consider the following share repurchase proposal: Blaine will use $209millionofcashfromitsbalancesheetand$50 million in new debt-bearing interest at the rate of 6.75% to repurchase 14.0 million shares at a price of $18.50 per share.  How would such a buyback affect Blaine? Consider the impact on, among other things, Blaine’s earnings per share and ROE, its interest coverage and debt ratios and the family’s ownership interest. What impact would the change have on Blaine’s tax obligation?  How might this impact Blaine’s value?
3. As a member of Blaine’s controlling family, would you be in favor of the proposal?  Would you be in favor of it as a non-family shareholder?

Completed Analysis

First FLEXIBILITY Analysis

Flexibility:
 $209millionlesscash+$50m on new debt
 Two key questions related to the impact on flexibility:

1. Are we able to issue more debt in the future if needed?
    Most likely, yes:
    Int. coverage = 18.9
    Debt / Assets = 13%
2. Are there significant external capital needs in the future?
    Future acquisitions may be important
    Capex: “modest” ~ $10 million on average during past 3 years
    Overall, not likely to have large impact
    In general, the impact of an increase in debt is negative on flexibility.
    Here however, the proposed CS change doesn’t appear to lead to
   significant concerns in terms of flexibility

Then TAX Analysis

We calculate tax shield before and after to see tax savings for one year. Then we do a present value of perpetuity to see change in value for company. We can also do relative terms to compute a percentage firm value increase

Then a CONTROL analysis

If the firm wanted to maximize control, how much would they ultimately obtain? If they went this this CS decision.

Then a OTHER analysis

Others (signals, timing)  Firm more likely to buyback shares if ‘undervalued’; more likely to issue new shares if ‘overvalued’  If CEO and team are confident about the firm and their ability to do well, more likely to take on debt

FINALE