Finance 552 C.

Haley
Winter 2002 357 Mackenzie
MTWTh 10:30-12:00
543-7697
chiph@u.---

CORPORATE PLANNING AND FINANCING

Text (on reserve): Higgins, Analysis for Financial Management, 6th Edition (H)
Case Packet--Bookstore

General Information:

This class deals with two problems in the financial management of business firms:
managing the cash flowing through the business and external financing of operations
and capital investment. In addressing the first problem, we will cover financial
statement analysis, forecasting and financial planning, managing growth, and working
capital strategies. Our examination of the second problem will consider banking
relationships and the principal sources of capital for corporations including the use of
derivative securities. The focus throughout is the design and management of a firm’s
financial structure--the right-hand side of the balance sheet.

The course is built around a series of case problems which will be found either in the
case packet or included in the handout “Supplementary Cases and Readings” denoted
as “HO”. The case method is the ideal way to study the topics addressed in this course
because existing theory has comparatively little of practical value to say about many of
them. The best way to learn the material, therefore, is to examine a sequence of
practical problems to better understand the nature of the problems and to master the
logic by which alternative policies can be evaluated.

Reading assignments are from the Higgins book or handouts. They are intended to be
helpful, but do not necessarily cover all aspects of any given situation. The daily
assignments do not require written work to be handed in unless specifically indicated
as such. Grades will be based on class participation and other assignments as follows:

Class discussion 35 %
Written assignments 60 %
Team presentation 5%

See “Hints on Case Write-ups” at the end of the assignments. There are no exams.
The data in the exhibits for most of the cases are available in the form of Excel
worksheets on my web page (us.badm.Washington.edu/Haley/F552). Students should
download the worksheets to their own computers. Use of a PC is highly recommended
for this class. This is a relatively low cost opportunity for you to gain hands-on
experience with spreadsheet use in an applied setting where you have realistic
problems to work on..

Daily class preparation is essential for obtaining the maximum benefit from
this course. It is not expected that students have the "right" answer coming into
class, but that everyone is prepared to participate in an informed class discussion. The
philosophy of the class is “learning by doing”. If you don’t try to deal with the
problems assigned, you don’t learn. Discussing the case in a group before class is very
helpful.
 SECTION I - Financial Analysis, Forecasting, and Bank Financing

1. 1/8 Introduction: Unidentified Industries (attached)

2. 1/10 Financial Analysis: Durham Furniture Company (attached) (Readings: H

pp 3-20, Ch. 2, and “Ratios” note attached)

a. Assume that you are Mr. Ralphson and that Mr. Allan has asked you
to analyze the financial statements of Hiram’s and Bassett
Brothers. What are the strong points and weak points of each
company as revealed by your analysis?
b. Based on your analysis, can you identify any apparent business
strategies being used by these two companies?
c. What action(s) would you recommend for each company?

3. 1/15 Financial Planning and Strategies: Grieg Lumber Company

(attached) (Reading: H Ch 3)

a. Why does Mr. Grieg have to borrow money to support this profitable
business? How would you describe his business and financial
strategies?
b. How large, in your opinion, should Grieg’s line of credit be?
c. Assuming 1995 sales are $3.5 million, how much money will he
need to be borrowing from the bank on December 31, 1995? (Hint:
Try forecasting Grieg's balance sheet as of this date.)
d. As a financial advisor to Mr. Grieg, would you recommend that he
continue his current strategies or not?

4. 1/17 Seasonal Financial Planning I: Playtime Toy Company (attached)

a. What factors should Mr. King consider in deciding whether or not to

adopt the level production plan?
b. Estimate the funds required and their timing if the level production
plan is adopted. Use pro-forma balance sheets (as compared to a
cash budget) following the format used in the case. Evaluate your
results. It is highly recommended that you use a PC spreadsheet
for this purpose.
c. If you were Playtime's banker, would you have any concerns about
making the indicated loans to this firm?

5. 1/22 Problems in Forecasting: Lastmore Shears, Inc. (attached)

a. Why was Lastmore Shears unable to repay its loan by March 31,
1991 as planned? Were the forecasts prepared by Mr. Sheehan
based on unreasonable assumptions? How do assess the banker’s
attitude in this situation?
b. What is the significance of the differences between forecast and
actual labor and material additions to work-in-process inventory?
Do they provide any insight into what happened in this company
and might they have anything to do with Lastmore Shears' capital
expenditure program?
c. How long will it take Lastmore Shears to repay its loans if sales do
not recover from current, depressed levels (making allowance for
seasonality)? What are the critical assumptions that must be made
to answer this question? (Don’t try to forecast past March, 1992)

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6. 1/24 Financing Growth through Bank Loans and Private Equity:
Advanced Cardiovascular Systems (Attached, Read: “Note on
Bank Loans”)

a. What do you think Mr. Haskins' primary objectives for ACS are and
how do those objectives affect his management of ACS? Does the
existence of Lilly’s option have anything to do with Haskins’
objectives?
b. How much money will ACS need by year-end 1988 assuming that
sales grow at 30% and current operating strategies are maintained?
c. What business strategies would have to change to make this a
"bankable" loan situation? What terms or conditions would have to
be imposed? (The terms must protect the bank and yet permit ACS
to operate in a manner consistent with management's objectives.)

7. 1/29 Written Case (To Be Assigned)

8. 1/31 Forecasting and Planning an IPO: Netscape Communications, Inc

(attached)

This is a slightly different version of a case you had last year with Jennifer
Koski. Her “solution” to the problem she posed to you is available on the
F552 web page. You could use this worksheet to answer the questions
below. Alternatively you can try and work with an one based on the
“Proforma” model provided with the Higgins book. It is also available on
the web page.

a. Does Netscape need to go public to meet its capital needs? How

much money do you think that it will need over the next 3-5 years?
In answering this question you might find the following assumptions
useful although you are free to use others if you have good reasons
to do so:

 Cost of revenues and R&D maintain their current percentages of

total revenues 10.4% and 36.8% respectively.
 Other operating expenses decline as a straight-line percentage
of revenues from 80.9% in 1995 to 20.9% in 2001 which would
give Netscape operating income to revenues about equal to
Microsoft at 34%.
 Capital expenditures decline from 45.8% of revenues in 1995 to
10.8% of revenues in 2001, again close to Microsoft.
 Depreciation each year is 13.6% of net property and equipment
at the beginning of the year. (Compute ending net P&E =
beginning net P&E + capital expenditures – depreciation.)
 Two problems that you will need to consider are working capital
requirements and revenue growth. One way to deal with the
revenue growth problem is to make the annual growth rate a
separate forecast variable and look at a range of values for this
number; e.g. 30%, 50%, etc. Alternatively, you might start with
very high growth rates initially and have them decrease to more
“reasonable” numbers. Note that your approach depends on
the model you are using. It will worthwhile to compare the
Koski model with the Proforma model. Working capital
requirements should be based on your assessment as to the
minimum levels needed. Remember “excess cash” is not part
of the requirements.
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b. What other sources of financing other than the IPO might be
available? How much money will the underwriters be raising for
Netscape at a price of $28 per share? How does this number
compare with the “needs” figures from b) above. What is your
assessment of the underwriters’ proposal?

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 Finance 552 Assignments

SECTION II - Long Term Financing Strategies

9. 2/5 Effects of Financial Leverage: Sealed Air Corporation' Leveraged

Recapitalization (Reading: Brealey and Myers, Chapter 18 "How Much
Should a Firm Borrow")

a. Why did Sealed Air undertake a leveraged recapitalization? Was it a

good idea? For whom? What has happened to the company's
"financial slack" (Brealey and Myers)?
b. What is creating value to the stockholders in this transaction? What
is the theoretical value per share created by the tax shield on the
$170 million in 10-year notes at an interest rate of 12.625%?
c. Why did the company's investor base turnover completely after the
recap? Is this something managers should be concerned about in
general?
d. Was the constraint on capital expenditures imposed on the
company by the bank lending agreement good or bad for the
company? Do you think that the managers will be able to
renegotiate this constraint?
e. What kinds of companies might benefit from a significant increase
in their leverage? What kinds of companies might be hurt by it?

10. 2/7 Leverage, Cash Flows, and Put Options: Ertsberg Project Financing
(HO) Read “Beyond Debt and Equity: Options in Corporate Finance”—pp1-
10 and Appendix A

a. Review the financing and operating characteristics of the Ertsberg

project. If Freeport invested $120 million in this project as an
“ordinary business investment” without all the complicated legal
and financial arrangements, how risky would this be for the
company?
b. How do the actual arrangements affect the risk to Freeport? What
are the major remaining sources of risk? How much money is at
risk for Freeport in this situation?
c. How important are the government guarantees here? Do the
government guarantees add value to the equity investor, Freeport?
How might the value of such guarantees be estimated (option
pricing or ??)?
d. Examine the proposed debt repayment schedule and cash flow
statements in Exhibits 4-6. What things might go wrong? How
seriously would they affect project cash flows. Is there any
systematic way you can think of to measure the risk of default
here?

Notes: In December 1969 the following long-term bond yields were

available to investors:
US Treasury 6.95%
Aaa Corporate 7.72%
Baa Corporate 8.65%

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11. 2/12 Introduction to Convertible Bonds: Boston Chicken, Inc. (HO)
(Reading: The rest of the "Options" handout)

Please complete C.K. Pao’s tasks. In addition, consider the following

questions:

a. Why is BC issuing convertible bonds so soon after its IPO? What are
the advantages of convertible debt relative to straight debt and to
common stock issues?
b. Is the value of this bond very sensitive to the volatility estimates?
c. Can you solve for the implicit volatility in the redemption option?
Does its value seem reasonable to you?

12. 2/14 Financial Flexibility and Bond Ratings: Polaroid Corporation

(Reading: H Ch. 5)

a. What are the main objectives of the debt policy that Ralph Norwood
must recommend to the Board of Directors?
b. Based on the data in Exhibit 9, how much debt could Polaroid have
outstanding at each rating level? How does this compare with the
amount the company currently has outstanding?
c. Is the maturity structure of Polaroid’s debt appropriate? Why or
why not?
d. What would you recommend to Polaroids’s Board of Directors
regarding:
--the target bond rating
--the level of flexibility or “reserves”
--the mix of debt and equity
--the maturity structure of debt

13. 2/19 Financial Strategy and Business Strategy: The Home Depot,
Inc. (Reading: H Ch. 6)

a. How would you describe Home Depot’s business strategy? Its

financial strategy? Do they fit?
b. Exhibit 6 predicts that HD will need $1.46 billion in external
financing over the next five years. What is driving that financial
requirement? What are the risks in this situation that could
significantly affect it?
c. What is your recommendation for financing funds needed during
the next 12 months? Is this consistent with the firm’s past
strategy? If not, please justify your recommendation.
d. What is their “call” strategy with respect to convertible bonds?
What you recommend they do about the 6.0% convertible?

Notes: S&P rated the 6.0% convertible as BBB in February. That

convertible was selling at a price of $124 at the end of March. It
has a call price of $104 through June 30, 1993, decreasing
thereafter.
Home Depot stock returns over the 30 days ending March 31, 1991
showed a monthly variance of 0.015, which may be considered a
typical variance for the stock over the past three years. Note that
this represents an annual volatility of 42%.

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14. 2/21 Financing Early Stage Growth Planet Copias & Imagen including
revised forecast handout. See Planet_Rev.xls for details.

a. How would you describe Planet’s business strategy? Its financial

strategy? How do the goals of the founders affect their strategies?
b. Do you believe Planet fits the description of a “breakout growth” firm?
What do you think about the magnitude of today’s equity value shown
in Exhibit 9?
c. Given the alternatives that appear to be available, what would you
recommend regarding the company’s financing? How much and from
what sources?
SECTION III - Special Topics

15. 2/26 Far Eastern Textile Ltd: The SiZeS Offering

a. Why is FET thinking about raising more money so soon after their
US$170 million GDS issue in October?
b. Goldman Sachs is pushing for FET to raise US$130 million through
an “innovative” convertible debt issue. Why would FET (or any
company, for that matter) be interested in being an “innovator” in
the capital markets?
c. How would the SiZeS offering compare with a straight debt issue by
FET, advantages and disadvantages? How can you assess the
relative “costs”? What about an equity issue instead?
d. If you were a member of the FET executive committee, what would
you recommend?

16. 2/28 Financial Structure in an LBO: Keith Lofton Company (HO)

(Read "Convertibles and Warrants" )

a. Should Wayne Lau and the other managers seriously consider

buying Lofton? Does the price seem fair?
b. If things work out as planned/forecast, what is your estimate of the
value of the equity in 1990; for example if they did an IPO at that
time.?
c. How much money does Mr. Lau still have to raise from external
sources? What terms and conditions should he attempt to obtain
on the external financing? What should he be willing to settle for?
Are the conditions on the present commitments satisfactory? How
are they going to service all this debt?
d. Looking at the “mezzanine” securities that will be issued to a
venture capital investor, would it make any difference if convertible
debt were used rather than debt plus warrants? What is the
difference between them from the perspective of the stockholders
(managers) and from the perspective of investors? Can you come
up with a package of debt plus warrants that will provide investors
with pay offs identical to those of a convertible bond? Which form
of financing might be preferred by the stockholder/managers?

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17. 3/5 Financial Structure Design and Asssessing the Risk of Default:
Revco D.S., Inc. (HO)

a. Was Revco a good LBO candidate? Why?

b. What is the financial structure of this transaction? Look at the
sources of financing on page 429 especially the footnotes. What
might account for the mix in the structure? Who is getting what?
c. Given the forecasts in Exhibit 7, how likely was Revco to default on
its debt? How did Revco’s probability of default compare with that
of Jack Eckard? (Hint: Try using the “scenario analysis” feature of
Excel to get a general idea or use Crystal Ball to generate a
probability distribtion of the cumulative cash flow for the first three
years.)

18. 3/7 Team Presentations (10 points)

Select one of the following for your presentation or come up with a company or topic of
your choice. All choices must be approved by February 28 to insure no duplications.
Each presentation should be limited to a MAXIMUM of 12 minutes to allow some time
for questions. Use overhead transparencies and handouts. We will not have a
computer display available unless you obtain one yourself or ask me in advance.
Grading will be based on content not style. The focus should be on financial
structure/financing issues.

Teams should be 3-5 people so that we have five teams. Plan that one person be
selected to do the presentation--all members available to field questions. Divide tasks
among team members.

Followups on companies --what has happened since we last looked at the company?

1. Sealed Air
2. Polaroid
3. Home Depot
4. Freeport Sulfur (now Freeport-McMoran)

New companies--review financing problems and issues 1995--2000.

4. Amazon
5. Starbucks (Review their financing over the past five years. How are they
financing their foreign expansion? What are the issues in this strategy?)
6. Xerox (What is going on? Would you describe them as being in a condition
of "financial distress"? How serious are their problems?)

Other topics:
7. What are the problems with failed IPOs? Examples?
8. What are the sources of venture capital in Western Washington? What kinds
of securities do VCs want (equity or ???)?
9. Financial implications of 3G for telecoms? (Pick a particular company?)
10. LBO activity was picking up last year. Has it stopped? What kind of
financial structures have been used recently?

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19. 3/12 Reorganization in Financial Distress: Caledonian Newspapers Ltd.

a. What happened? What are the alternatives available to Ian Stirling?

b. Compare and contrast the two new restructuring proposals. As
part of this comparison, what is your estimate of Caledonian’s
market value in 1993? Suppose that the potential value of
Caledonian is within the range of £3 million and £10 million, what
would be the rates of return earned by the bank, by EV, by Ealing,
and by management under each proposal from different 1993
values of Caledonian?
c. If you were Ian Stirling, what would you do?

Note: You might find the following sections in Brealey/Myers of interest

—“Allowing for the risk of default” in Ch 23 and “Costs of financial
distress” in Ch 18.

20. 3/14 Venture Capital: The Knot (HO)

a. Has The Knot been a success story to date? What appears to be its
strategy? How risky is it? What must it do to be successful in the
long run? Do you agree with its business plan?
b. What might be a basis for valuing this company? What would you
say to a venture capitalist that would encourage investment of $10
million for 25%?
c. Do you think that Hummer Windblad’s offer of $3 million for 50% is
acceptable?
d. David Liu has some questions at the end of the case. How would you
answer them?

21. 3/19 Financing Choices and Financial Structure: Written 35% TBA

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 GUIDELINES FOR WRITTEN CASES

(1) Do not summarize the case situation in any great detail. The reader should be
assumed to be familiar with the general situation as usually the report is
addressed to management. However you may wish to highlight aspects of the
situation that might not be obvious to the reader or that you believe are
especially important to your analysis.

(2) Identify the basic problem or problems for which recommendations are needed.

(3) Summarize the issues or factors which must be analyzed in order to come to
recommendations. Try to anticipate questions that might be asked.

(4) A semi-outline form for numbers (2) and (3) above is an acceptable way to
present them. However, the write-up overall should be standard exposition.

(5) Perform your analysis. Quality of this analysis is important. You may wish to
do some of the numerical analysis in a group; however the written part should
be done on your own.

(6) Make recommendations which are consistent with your analysis. The
recommendations and your basis for them are very important.

(7) One possible format for presentation is to make the write-up a report to
management in the case. However, it is not necessary to "jazz" things up with
"letters of transmittal" or similar devices. A one-page (or less) "executive
summary" of the report is optional. If you wish to get some practice writing
these, I encourage you to do so.

(8) It is slightly more desirable for you to take a objective view of the problem and
your recommendations than to try to "sell" your solution unless it is clearly
suggested in the assignment--see (11) below.

(9) You should try to present a clear and concise discussion. The page limitations
on case write-ups are intended to be reasonable guidelines -- try to stay within
them. They do not include graphs, tables, financial statements, or other
significant (in size) exhibits. Such exhibits may be included within the body of
the paper or at the end depending on your own preferences and the extent to
which you want the reader to refer to them. Short, summary tables of complex
exhibits are very helpful in the body of the paper.

(10) I am not grading you on the quality of your exposition unless it is confusing to
the reader.

(11) Read the assignment carefully and follow the guidelines, especially as
they specify the role you are supposed to take. You should adopt that
role. You will be preparing a report to management. If you are in
doubt as to what is expected, ask before you write the paper. These
are not set up as purely academic exercises. They are intended to
develop your skills in a low cost environment--remember that you are
not dealing with real money here.

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