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STRATEGIC FINANCIAL MANAGEMENT

Strategic Financial Management Great Lakes Institute of Management Gurgaon PGPM 2012-13 TERM IV Sanjoy Sircar sanjoy.s@greatlakes.edu.in COURSE OBJECTIVES CAREER TRACK: This course in Strategic Financial Management builds on the concepts developed in Finance during the earlier terms. The goal is to develop the financial tools, both theoretical and practical, essential to a thorough understanding of the issues that plague managerial decision making at any level across all functional areas. The overriding objective is to demonstrate that contrary to popular belief, while financing decisions are not the all and only criterion for decision making, but given that any enterprise, whether commercial or not, is finally judged by its financial performance, so a Corporate Financial Officer CAN create value through financing, strategic and operating decisions. Any corporate action has its consequent financial implications even if it does not become apparent in the near term and students build the knowledge and skills critical to an effective managers responsibilities of proposing, assessing and implementing financial investment decisions. The course would introduce advanced valuation techniques, and explore the empirical difficulties and judgmental ambiguities inherent in applying the valuation process. It seeks to identify the conditions under which each valuation technique is appropriate. WHEN to use a technique is as important as knowing HOW and our objective would be to reinforce that in this class. An overriding objective of the course will be to demonstrate that financial strategies of corporations are usually a complex amalgam of multiple factors, both exogenous and endogenous and some financial and some outside the realm of the finance professional. Nevertheless, the finance professional is very often constrained and / or influenced by the decisions taken beyond his / her own area of expertise. A large part of the course deals in cases that are simply applications of concepts you have already covered under other core / elective courses with only a different perspective that of the user corporation rather than the financial institution which is a counter party to the transaction. We would also build on the latest thoughts on issues like cost of capital that have been discussed in earlier trimesters / first year in the traditional,
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standardized form and while the ideas may not have any immediate application, the purpose is to get you thinking along hitherto unexplored channels about concepts that appear to be quite elementary. The principal difference between the traditional corporate finance course in earlier periods and the current course is that so far we have looked at each topic as a self contained and normative element in decision making now we will proceed to focus on each event as a chain reaction / complex combination of multiple elements and the main deliverable of the course will be if we can slice up a decision event in the corporate finance officers life as into component parts just in the fashion of the first year courses and then put them back together again as a coherent whole some kind of macabre combination of Humpty Dumpty run amok and Granger causality ! We would deliberately stay away from the issues of financial risk as that is covered under Financial Risk Management/ Derivatives except to examine them in the context of specific risk management products used by corporations to manage specific parameters of their financial risk . It is next to impossible to discuss the various issues encompassing corporate finance without straying into areas covered by other courses, viz., acquisition finance, corporate restructuring, uses and pricing of derivatives, cross border valuation and financing, performance measurement like EVA etc. We would make the best efforts to avoid such issues, but be forewarned that there may be some overlapping across subjects. PEDAGOGY: I plan to teach the course entirely with cases except for a few review lectures on topics / issues, which were not, covered thoroughly in the first year curriculum. The cases shall be discussed in the class. The questions relating to every case is given in the course outline. However, please keep in mind that the questions are merely to serve as pointers to enable you to organize your thought processes along specific chains of thought. The questions are simply to serve as demonstration and not in any way meant to be exhaustive. It is also not necessary that every case must have a UNIQUE solution. I look at cases as specific examples of events in the past that can be used as a demonstration tool. Please always bear in mind that it is quite dangerous to try to generalize the conclusions from a case as every case brings along with a set of extraneous or endogenous factors that are unique to that case. I look upon a case as the context to a discussion about what are the most feasible alternatives and choosing among them based upon some criteria. It
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is quite possible that every manger may use a different set of parameters to reach a decision. Furthermore, just because a specific decision has been taken in the past does not mean it was correct as we cannot recreate in any way or form the impact of having taken an alternate route. Your case discussions and presentations submissions should proceed along the lines I have outlined above. Focus on the decision after evaluating the available information and also examining the information, which is not available in the case. Given that these are finance cases, you do need to use numbers. Strategy and matrices are fine but hard numerical backup arguments MUST be presented. Also please bear in mind that ALL the exhibits in a case have a purpose and are meant to be used. EVALUATION: A combination of class participation, case presentations and group assignments will constitute the bulk of the evaluation. A mid term and end term test will make up the balance. Written Case / Topic reports (Group) Mid term and End Term Contribution to Class Discussions CASE WRITE UPS: Each group must provide a short write up on the cases to be presented based on its questions. The memorandum will consist of a brief analysis and recommendations and must be submitted at the BEGINNING of every class. Write these as if you were writing a recommendation to the major decision maker in this case. Since you are preparing your reports in advance of class discussions, I will not grade your reports for the correct (assuming there is one) answer but on the following criteria: My estimate of the effort you put in; Ability to identify the main issues; Theoretical soundness and coherence of your approach to your decision; Clarity and succinctness of the report.
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15%

30% each 25%

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CLASS PARTICIPATION: I have mentioned the rules for class participation already. Very typically, corporate financial decisions are made in a group. In a group setting, a well articulated expression of confusion is often more valuable than an abruptly delivered right answer. In determining your grades, I shall consider the degree to which your comments advance everyones learning. Your comments impact on our overall understanding of the managerial decision at hand is more important than the right answer per se. I assess your class participation on this metric, not on air time or just the number of comments you make. Cold calling is the only incentive strong enough to ensure adequate preparation. I will cold call at least one student/ group to open each days discussion. REQUIRED TEXT: No texts are prescribed, but students may look up the following for a basic understanding of the theoretical issues and approaches to be used in case analysis: Principles of Corporate Finance, Richard A. Brealey and Stewart C. Myers, McGraw Hill, Sixth Edition, 2000. Applied Corporate Finance, A Users Manual, Aswath Damodaran, John Wiley, 1999.

Corporate Finance: Theory and Practice, Aswath Damodaran, John Wiley, 1997.

I may decide to supplement the lectures with articles and papers from time to time.

STRATEGIC FINANCIAL MANAGEMENT


REFERENCE TEXT: The following texts are meant strictly for reference in case any student wishes to pursue the topics in much greater depth purely out of personal interest. The texts often are quite complex, so caveat emptor or whatever is the bibliographic version of it!!! Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, Aswath Damodaran, John Wiley, 1994. Corporate Finance, A Valuation Approach, Simon Z. Benninga and Oded H. Sarig, McGraw Hill, International Edition, 1997.

Options, Futures and Other Derivative Securities, John Hull, Prentice Hall, Second Edition, 1996. Real Options: Managing Strategic Investments in an Uncertain World, Martha Amram and Nalin Kulatilaka, Harvard Business School Press, 1999.

Corporate Financial Distress and Bankruptcy, Edward I Altman, John Wiley, 1993. Capital Markets and Corporate Governance, Nicholas Dimsdale and Martha Prevezer, Oxford / Clarendon Press, 1994.

STRATEGIC FINANCIAL MANAGEMENT


Financial Engineering: Tools and Techniques to Manage Financial Risks, Lawrence C. Galitz, and Irwin, 1995. Cases in Financial Engineering: Applied Studies of Financial Innovation, Scott Mason, Robert Merton, Andre Perold and Peter Tufano, Prentice Hall, 1995Real Options : Managing Flexibility and Strategy in Resource Allocation, Leon Trigeorgis, MIT Press, 1999.

STRATEGIC FINANCIAL MANAGEMENT


TENTATIVE OUTLINE: SESSIONS 1-4: GLOBAL COST OF CAPITAL Reading :1. Country Risk and Company Exposure: Theory and Practice: Aswath Damodaran, Journal Of Applied Finance, Fall/Winter2003, pp 63-76 CASE 1 : Globalizing the Cost Of Capital and Capital Budgeting at AES 1. How would you evaluate the capital budgeting method used historically by AES ? Whats good and bad about it ? 2. If Venerus implements the suggested methodology, what would be the range of discount rates that AES could 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 US, what would its value be ? 5. How does the adjusted cost of capital for the Pakistan project reflect the probabilities of real events ? What does the discount rate adjustment imply about expectations for the project because it is located in Pakistan and not the US ? CASE 2 : The Walt Disney Companys Yen Financing 1. Should Disney hedge its yen royalty cash flow ? Why or why not ? If so, how much should be hedged and over what time frame ? 2. Assuming a hedge is desirable, what hedging techniques are available to the treasurer and what are the advantages and disadvantages of each ? 3. In light of the various other techniques for hedging currency exposures, why does a market for currency swaps exist ? Who benefits and who loses in such an arrangement ? Can a swap really create value for a corporation, and if so, where does the value come from ? What risks does a swap carry for the various parties involved ? 4. Evaluate Goldmans proposal for an ECU bond issue accompanied by an ECU / yen swap. How does its all-in yen cost compare to that of the proposed yen term loan ? is it superior to hedging using outright forwards ? ( Note all in cost generally refers to that discount rate which equates the present discounted value of future debt service payments with the financing proceeds les front end fees [ i.e., the internal rate of return ] expressed as an annual rate ).
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CASE 3: Foreign Exchange Hedging Strategies at General Motors : Transactional and Translational Exposure 1. 2. 3. 4. Why do companies hedge ? What are the different types of foreign exchange risks ? What has to be considered in developing a hedging policy ? What is GMs hedging policy ?

CASE 4: Foreign Exchange Hedging Strategies at General Motors: Competitive Exposures 1. Why is GM worried about the level of the yen ? 2. How important is GMs competitive exposure to the yen? 3. How would you go from the information in the case about competitive interactions with Japanese manufacturers to a value exposure for GM ? 4. Are there less information intensive methods that might allow you to assess the competitive exposures of GM, specifically, or other firms generally ? How would you implement such a method ? SESSIONS 5-7 :LARGE PROJECTS, LEVERAGE AND FIRM VALUATION CASE 5: TEXAS HIGH SPEED RAIL CORPORATION 1. Consider the economic merits of the high speed rail system described in the case. Before performing any discounted cash flow analyses, do you expect the project to have a positive NPV ? 2. Exhibit 3 presents the projects free cash flows (FCF). Make sure you understand the definition and calculation of free cash flow. What is the weighted average cost of capital at its fully expanded capital structure ? What do you conclude about the projects NPV based on Exhibits 3 and 4, and your own calculations ? 3. Study the equity cash flows (ECF) presented in Exhibit 7 and make sure you understand the difference between them and the Exhibit 7 cash flows be discounted to give an estimate of the projects NPV ? What is the NPV according to your calculations ? How does it compare with the estimate based in Exhibit 3 ? 4. Should THSRC proceed with the next phase of the project ? NOTE: For the sake of simplicity, assume the risk premium at 7.5%

STRATEGIC FINANCIAL MANAGEMENT


CASE 6: Dow Chemicals Bid for Privatization of PBB Argentina 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 ?

Readings: 1. Measuring Free Cash Flows for Equity Valuation: Juliet Estridge and Barbara Lougee, Journal of Applied Corporate Finance, Spring 2007, pp. 60-71. 2.Accounting for Sovereign Risk When Investing in Emerging Markets: V. Ravi Angshuman, Sheridan Titman and John Martin, Journal of Applied Corporate Finance, Spring 2011, pp.41-48. SESSIONS 8-9: FINANCIAL RISK MANAGEMENT Reading: 1. Rethinking Risk Management, Rene M Stulz, The Ohio University, The New Corporate Finance: Where Theory Meets Practice, pp. 411-427, Donald H Chew, Jr. ed., McGraw Hill International 3 rd edition 2.The Theory and Practice of Corporate Risk Management: Henri Servaes, Peter Tufano, and Ane Tamao, Journal of Applied Corporate Finance, Fall 2009, pp. 60-78. CASE 7: AMERICAN BARRICK RESOURCES CORPORATION: MANAGING GOLD PRICE RISK 1. In the absence of a hedging program using financial instruments, how sensitive would Barrick stock be to gold price changes ?For every 1% change in gold prices, how might its stock be affected ? How could the firm manage its gold price exposure without the use of financial contracts ? 2. What is the stated intent of ABXs hedging program ? What should be the goal of a goldmines price risk management program ? 3. What would convince you that a price risk management program would create value for its shareholders ex ante ?
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4. How would you characterize the evolution of Barricks risk management activities ? Are they consistent with their stated policy goals ? 5. How should a gold mine that wants to moderate its gold price risk compare hedging strategies ( using futures, forwards, gold loans or spot deferred contracts ) with insurance strategies ( using options ) ? On what basis should these decisions be made ? Once a firm has decided on an insurance or hedging strategy, how should its choose among specific alternatives ? 6. What is a spot deferred contract ? Is it an option ? A forward contract ?Why has ABX chosen to rely on spot deferred contracts relative to other gold derivatives ? SESSIONS 10-11 : VALUATION WITH REAL OPTIONS READINGS : 1. Real Power of Real Options Options Primer , Keith J Leslie and Max P Michaels, The McKinsely Quarterly, Vol. 3, 1997, pp. 423. 2.Valuation in Emerging Markets: James, Mimi and Timothy M. Koller, The McKinsey Quarterly, No.4, 2000, pp 78 -85 3 The Promise of Real Options : Damodaran, Aswath, Journal of Applied Corporate Finance, Vol. 13, No.2, Summer 2000, pp 29 -44 4 Strategy as a Portfolio of Real Options: Luehrman, Timothy A., Harvard Business Review, September October 1998, pp 88 -99 5 Real Options Valuation: A Case Study of an E Commerce Company : Roceo Saenz Diez and Ricardo Gimeno, Journal of Applied Corporate Finance, Vol. 20, No.2, Spring 2008, pp. 129-142. CASE 8: MW PETROLEUM CORPORATION (A) 1. Evaluate Amocos and Apaches corporate objectives and strategies. Is it reasonable to expect that the MW properties are more valuable to Apache than to Amoco? What sources of value most plausibly account for the difference between buyer and seller? 2. Structure and execute a discounted cash flow valuation of all MWs reserves using APV. How much are the reserves worth?

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3. How would you structure an analysis of MW as a portfolio of assets in place and options? Specifically, which parts of the business should be regarded as assets in place and which as options? What kinds of options are present? 4. Execute the analysis you structured in question 3, beginning with the assets in place. How risky are the assets that underlie the options? How much is the whole portfolio worth? Assuming a sale goes through, how does Apache exercise each of the options ?

SESSSIONS 12-13: INTEGRATED FINANCIAL DECISION MAKING READINGS: 1. Learnings from Financial Innovation : Nigel Jenkinson, Adrian Penalver and Nicholas Vause 2. Postmodern Corporate Finance: Gregory V Milano, Journal of Applied Corporate Finance, Spring 2010, pp. 48 -59. Case 9 : Intergen and the Quezon Power Project: Building Infrastructure in Emerging Markets 1. How does Intergen create and add value in the power industry ? 2. Why does Intergen appear to have only a handful of competitors ? 3. Given what was known in late 1994, would you have recommended that Intergen invest in the Quezon project ? What would have been your main concerns ? 4. Given the situation in late 1997, what should Greg Daul recommend to Carlos Riva at the upcoming board meeting ?

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