SYLLABUS

This class deals with the application of corporate financial theory to cases of financial policy, financial instruments and valuation. In particular, the following topics are studied: cost of capital and capital budgeting, discounted cash flow valuation and financial multiples, payout policy, equity and debt financing, option pricing theory and applications, corporate control and recapitalizations.

Corporate Finance should be considered a capstone course in corporate finance. This is an advanced course in which students are expected to perform professional level work. As such, it has B6301 Business Finance as a prerequisite and B6302 Foundations of Finance as a co-requisite. That is, this course can be taken concurrently with B6302, though the material covered in B6302 is necessary throughout Corporate Finance. In particular, students should be familiar with notions of options pricing including valuation using the Black-Scholes formula.

1. Case Packet. Parts I and II contain those cases that we will cover which are not in FKMPR (see References item 2), as well as several outside readings and teaching notes, for the first five weeks and the rest of the semester, respectively.

2. William Fruhan, W. Carl Kester, Scott Mason, Thomas Piper and Richard Ruback, Case Problems in Finance, Irwin, 11th edition (FKMPR). This is the book from B6301, from which we use one case. Copies are on reserve in the library.

3. Richard Brealey and Stewart Myers, Principles of Corporate Finance, McGraw-Hill, 5th Edition (BM), or Stephen Ross, Randolph Westerfield and Jeffrey Jaffe, Corporate Finance, Irwin, 5th edition (RWJ). These books are recommended for review. The previous edition will also work if you already own it; I have noted when chapter numbering differs across editions. Copies are on reserve in the library.

4. Donald H. Chew, Jr., ed., The New Corporate Finance: Where Theory Meets Practice, 1993 (Chew). Recommended. Copies are on reserve in the library.

5. Tom Copeland, Tim Koller, and Jack Murrin, Valuation: Measuring and Managing the Value of Companies, 2nd edition (CKM). Recommended. Copies are on reserve in the library.

6. Class Handouts. From time to time, I will distribute outside readings or case analysis in class.

A point about the Chew text: The Chew text has a larger number of good readings in it, many of which are assigned in the syllabus. Because all the assignments except the final case are to be done in groups, you could easily get away with buying one copy of Chew per group. If you ultimately find the Chew book to be a good investment because of your needs, then buy a copy for yourself.

A point about the CKM text: Four chapters (5, 6, 7 and 9) of the CKM text are an important recommended reading for the valuation section of the course. Someone in each group should buy a copy of the book so that these chapters can be read by the group members. If you plan to go into investment banking, to do corporate valuations, or to be a user/consumer of valuation services, this book will be a very important part of your library.

My scheduled office hours will be Thursday 11:00-12:50. I will also join students for coffee on Mondays from 4:25 to 4:50 in Hepburn Lounge. I am also available to meet with students by appointment.

 

The breakdown of the performance measurement to be used in the class follows:

5 cases written up by group 1 case done individually as the take home final exam Class participation

50 points (10%) each 125 points (25%) 125 points (25%) 500 points (100%)

Group Assignments

Groups, not to exceed four members, will be formed by the students during the first week of class. Case write-ups are to be handed in by each group (one paper per group) at the beginning of class.

At the end of the semester, you will be asked to give each of your group members (including yourself) a grade on their performance within your group (See the peer review form, page 8). This assessment will enter into each student's class participation grade.

 

You should take the perspective of an external consultant to the decision maker(s) in the case (such as the CEO, CFO, Board of Directors). The format should be: a short executive summary saying what course of action should be followed and a succinct description of why; a short list of the key assumptions made in your analysis; the bulk of your paper should be the logic of the argument(s) leading to your conclusion. Your argument(s) should contain your entire critique and solution.

Case solutions are limited to three pages of text (typed, double-spaced, reasonable point sizes and margins). Supporting tables, spreadsheets and graphs are limited to five pages additional. Tables and graphs should be clearly labeled, with the assumptions made and formulas used obvious to the reader. Care in preparing your tables is important.

 

Class participation grades will be determined, in order of importance, on the basis of 1) participation in the class discussion of the cases; 2) the intra-group peer evaluations.

You are expected to participate in the class. A necessary (but not sufficient) requirement for participation is presence. If you are not in class, you can not have participated. You do not need to tell me that you are going to miss a class, but your performance assessment will reflect if you are not there.

This class starts promptly. Class sessions should be considered to be important business meetings with clients (our clients are CEO's, CFO's, boards of directors, etc.) or with the CEO of your firm, whether the class in question is a session when a case is due or when a lecture is scheduled. You would not be late to such meetings (particularly with any frequency) and expect to keep your clients or your job.

Since you are enrolled in either the 10:00 or the 11:40 or the 3:00 section, this is the section you should attend and you should form groups from within your own section. The reason for this is simple: Finance B8301 has an enrollment restriction because of the difficulty of running a class participation oriented class effectively with more students. Your group responsibility requires you to be in class to provide analysis and discussion with your group. (If you must miss a class in a rare instance, you may attend the other section. Just don't make a habit of it.)

The structure of this class, especially the amount of group work and measurement of performance based on team product, makes the application of the Integrity Code (for both students and teachers) a little trickier than in a midterm/final class. For example, I can not distinguish, other than information that is given to me on peer evaluations, to what extent one group member shirked at their group's expense.

The following examples are concrete violations of the honor code:

1. Using, as a resource to complete any course requirements, any written or verbal account of a solution to any of the cases taught in the class.

2. Any communication to students in other sections of the class for whom a case is due at a later time concerning any details of the class discussion of the case.

3. Any communication with anyone concerning the final case once it has been handed out.

The above examples are very broad, I realize, and certainly do not exhaust the possible Integrity Code concerns. The main issues I am addressing are the "unauthorized aid" and "submit only original work, giving credit to others where appropriate" tenets of the honor code: using any prior solution to the case, be it someone's class notes or cases from a prior quarter, etc., violates both these concerns. Giving out details of the class discussion gives an unfair advantage to other students. These are very clear integrity code issues for Advanced Corporate Finance.

The following topics and cases will be covered on the associated dates. For each class with a case write-up due, each group's written case is to be turned in at the beginning of class. Everyone is expected to be prepared for a class discussion of each case, whether a case solution is due or not.

A list of questions to prepare for each case (class) and the required and recommended readings (including the case) follow the syllabus.

The structure of the detailed assignment pages (beginning on page 9) is as follows: on a day where a case is due, the "Questions to discuss prior to class" are a collection of issues (both key issues and, sometimes, side issues) related to the case which you can use to guide your group discussions and which will usually be brought up at some point in the class discussion. (The case write-up should not simply be a list of answers to the questions, see "Case Solutions" above.) You should be prepared to discuss aspects of the case and to defend your proposal concerning the decision(s) the company should make. The readings refer to the case (or lecture) being covered on the same page: the readings are to be read before the class (most of the readings are not technically required, but to get the most out of the case or lecture, you should look over the readings you intend to read beforehand).

The readings include the cases (the only required reading) and other materials which may prove helpful in doing the cases. The philosophy behind the range of available readings is that different people want to get different things out of Corporate Finance --- people have different backgrounds (so some readings are review and not necessary); people have different interests (so some readings will be preferred to others); people have different career interests (so some readings will be necessary for some students and not for others).

The following is the schedule of topics and cases and their dates.

GROUP MEMBER BEING EVALUATED:

Directions: Rate this member relative to his/her participation in and contribution to your group by circling the appropriate number. (1=unsatisfactory, 3=satisfactory, 5=exceptional)

Introduction to the Course

The lecture will, for the most part, follow the lecture notes contained in the case packet. The lecture is intended to introduce the framework of riskless arbitrage within which we evaluate corporate financial decisions.

1. Hodrick, Laurie Simon. Teaching Note: Riskless Arbitrage and Corporate Finance, 1998. In the case packet.

Lecture on Cost of Capital and Capital Budgeting

The lecture will, for the most part, follow the lecture notes contained in the case packet. The lecture is intended to be a "big picture" discussion of the cost of capital in general (and the WACC in particular), with minutiae related to the estimation of the WACC delegated to the discussion of the Marriott Cost of Capital case

1. 1. Hodrick, Laurie Simon. Teaching Note: Note on the Cost of Capital, 1998. In the case packet.
2. 2. Chapter 8 of CKM.
3. 3. Chew, pages 75-89. "Corporate Strategy and the Capital Budgeting Decision" by Alan Shapiro.
4. Chapters 7-9, 19 of BM or Chapters 9-12, 17 of RWJ, on the cost of capital.
   Chapters 6 and 9 of BM or Chapters 4 and 7 of RWJ, on capital budgeting.
5. Blanton, Peter, Eric Lindenburg and Kevin Thatcher. The Financial Executive's Guide to the Cost of Capital. Salomon Brothers Inc. Financial Strategy Group. In the case packet.
6. "Capital Ideas," CFO Magazine, April 1996, 34-38. In the case packet.
7. Supplementary information to compute the cost of capital. In the case packet.

Marriott Corporation: Cost of Capital

Questions to be discussed prior to class

1. Are the four components of Marriott's financial strategy consistent with its growth objective?
2. How does Marriott use its estimate of the cost of capital? Does this make sense?
3. Using the CAPM, estimate the weighted average cost of capital for

   a. Marriott Corporation
   b. The lodging division
   c. The restaurant division
   

   
   
4. Towards answering #3

   a. What risk-free rate and risk premium did you use to calculate the cost of equity? Why did you choose these numbers?
   b. How did you estimate the required rate of return on the debt of the company and on the divisions? Should the debt cost differ across divisions? Why?
   c. Did you use arithmetic or geometric averages to measure average rates of returns or premia? Why?
   d. How did you measure the beta of each division? Of the firm?
   e. Should you take taxes into account? How?

5. What is the cost of capital for Marriott's contract services division? How can you estimate its equity costs without publicly traded comparable companies?
6. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?

1. Marriott Corporation: The Cost of Capital (Abridged). FKMPR pages 439-451.
2. Supplementary information about Marriott. In the case packet.

Lecture on Discounted Cash Flow Valuation

The lecture will, for the most part, follow the lecture notes contained in the case packet. The lecture is intended to examine various discounted cash flow methods used for valuation, including ANPV and WACC. EVA and the Dividend Discount Model will be presented. Multiples are also discussed.

1. Hodrick, Laurie Simon. Teaching Note: Note on Discounted Cash Flow Valuation, 1998. In the case packet.
2. Chapters 5-7, 9 of CKM.
3. Chew, pages 90-97. "Finance Theory and Financial Strategy" by Stewart Myers.
4. Luehrman, Timothy A. Note on Adjusted Present Value. Harvard Business School teaching note. In the case packet.
5. Tully, Shawn, "The Real Key to Creating Wealth," Fortune, September 20, 1993, pages 38-50. In the case packet.
6. Walbert, Laura, "America's Best Wealth Creators," Fortune, December 27, 1993, pages 64-76. In the case packet.
7. Supplementary information to calculate discounted cash flows. In the case packet.

E.I. du Pont de Nemours and Company: Titanium Dioxide
CASE WRITE-UP TO BE HANDED IN BY GROUP

Questions to discuss prior to class

1. What are Du Pont's competitive advantages in the TiO₂ market as of 1972? How permanent or defensible are they? What must Du Pont do to retain its competitive advantages in the future?
2. Given the forecasts provided in the case, what are the relevant cash flows associated with the following three strategies for managing DuPont's TiO₂ business? <

   Strategy I: Status Quo. Hold production capacity at 325,000 tons per year.
   Strategy II: Maintain Strategy. Build capacity to 482,000 tons by 1985
   Strategy III: Growth Strategy. Build capacity to 685,000 tons per year by 1985.
   

   Notice that the status quo is not directly discussed in the case, but just gives a benchmark of comparison between the two strategies being considered (maintain vs. growth).

3. How much risk and uncertainty surround these future cash flows? What are particular sources of risk facing Du Pont?
4. How might competitors respond to Du Pont's choice of either strategy in the TiO₂ market?
5. What other factors should Du Pont consider in making this decision?
6. Which strategy, maintain or growth, looks more attractive for Du Pont? What are the key factors leading to your conclusion?

   FYI, in 1972, bond yields and recent inflation data were approximately as follows:

   Long-term Treasuries = 6.2%
   Aaa Corporate bonds = 7.2%
   Baa Corporate bonds = 7.8%
   Inflation rate (CPI) = 3.2%
   

1. The continuation or terminal value is especially important for strategies with large CAPEX during the forecast period.
2. Case page 527: "Ongoing capital expenditure for maintenance and replacement were expected to approximate depreciation allowances over time."
3. Case page 527: "Should TiO2 production terminate at any point in the future, it was believed that Du Pont's investment in working capital and the book value of other assets could be completely recovered."

1. E.I. du Pont de Nemours and Company: Titanium Dioxide. FKMPR pages 523-531.
2. Chapters 10-12 of BM or Chapter 8 of RWJ.
3. Supplementary information about DuPont. In the case packet.

Lecture on Payout Policy: Dividends

This lecture will, for the most part, follow the lecture notes contained in the case packet. The lecture will introduce the facts about dividends, and it will discuss the common explanations for the patterns in dividend payout policy.

Readings

1. Hodrick, Laurie Simon. Teaching Note: Payout Policy: Dividends, 1998. In the case packet.
2. Chapter 16 of BM or Chapter 18 of RWJ, on dividends.
3. Chew, pages 151-160. "Behavioral Rationality in Finance: The Case of Dividends" by Merton Miller.
4. Supplementary information about dividends. In the case packet.

General Dynamics: Compensation and Strategy (A)

Questions to be discussed prior to class

1. Evaluate Anders' strategy for reshaping General Dynamics (GD).
2. Describe the major components of GD's compensation system. How do they affect the level, the composition, and the shape/functional form of Anders' compensation?
3. What is the effect of the option exchange program (see Exhibit 6) on executive compensation? Is it good for shareholders?

   (The following table will help you answer this question. It shows the value of call options on General Dynamics stock calculated according to the Black-Scholes option pricing formula for two different exercise prices around the time of GD's option exchange program.)

   Black-Scholes Option Values
   Exercise Price	Market Price: $25.5625	Market Price: $26.5625
   $25.5625	$7.54	$8.09
   $44.94>	$3.74	$4.11

    

4. How does Anders' 1991 Gain/Sharing payments compare to the amounts he gained in 1991 on his stockholdings and his stock options? How much would he receive under Gain/Sharing, stock, and options if GD's stock price reached $100?
5. Should GD eliminate its Gain/Sharing Program? Why or why not?
6. Suppose GD's board decided to eliminate Gain/Sharing and replace it with award of additional stock options. How many options would they have to grant Anders to replicate the incentives he has under the Gain/Sharing program?
7. Should top managers be rewarded for selling assets/shrinking operations/reducing employment?

1. Compensation and Strategy at General Dynamics (A). In the case packet.
2. Ellis, James, "More Instant Cash than a Lottery," Business Week, May 20, 1991, page 42. In the case packet.
3. Ellis, James, "Layoffs on the Line, Bonuses in the Executive Suite," Business Week, October 21, 1991, page 34. In the case packet.
4. Wartzman, Rick, "General Dynamics Head Outlines Plan to Cope with Falling Defense Budgets," Wall Street Journal, October 31, 1991, page A3. In the case packet.
5. Supplementary information about General Dynamics. In the case packet.

Lecture on Payout Policy: Stock Repurchases

This lecture will, for the most part, follow the lecture notes contained in the case packet. The lecture will introduce the facts about stock repurchases, and it will discuss the common explanations for the patterns in stock repurchase payout policy.

1. Hodrick, Laurie Simon. Teaching Note: Payout Policy: Stock Repurchases, 1998. In the case packet.
2. Bagwell, Laurie Simon and John Shoven. Cash Distributions to Shareholders. Journal of Economic Perspectives, 1989. In the case packet.
3. Thatcher, Kevin, Tad Flynn, Joe Elmlinger and Michael Reel. "Equity Put Warrants: Reducing the Costs and Risks of a Stock Repurchase Program," Salomon Brothers, 1994. In the case packet.
4. Supplementary information about repurchases. In the case packet.

Walgreen Company, 1990: The Cash Distribution Decision
CASE WRITE-UP TO BE HANDED IN BY GROUP

1. What are the main sources of Walgreen Company's excess cash flow 1990-1994?
2. What alternatives does Walgreen Company have with respect to what to do with this excess cash?
3. If Walgreen Company were to decide to increase its cash distributions to shareholders, should they increase their dividend? How? Should they repurchase shares? How?
4. Should a payout be financed with borrowing, using the anticipated future excess cash flows to pay off the debt?
5. What signal is sent to the market by such actions (in #3 and #4 above)?
6. Are tax issues important (in #3 and #4 above)?
7. Is Walgreen stock undervalued in January, 1990?

1. The case only provides five years of internal forecasts of financial statements. If you apply some continuing value formulation in your DCFs as of 1994, you will probably mis-estimate firm value. (Why?) You might consider extending the forecast period further (toward the year 2000), since their expansion strategy continues past 1994.
2. While several accounting issues in the case are important, the LIFO provision is hugely so. The LIFO provision on the income statement reduces taxable income, but is not cash out, much like depreciation. The annual change in LIFO reserve on the balance sheet is merely the LIFO provision for that year, so if you estimate net working capital requirements, only consider Inventories at FIFO to be the required inventory investment.

1. Walgreen Company, 1990, The Cash Distribution Decision. In the case packet.
2. Supplementary information about Walgreens. In the case packet.

    

Lecture on Equity Financing and Initial Public Offerings

This lecture will survey equity financing and detail initial public offerings for stock.

Readings

1. Hodrick, Laurie Simon. Teaching Note: Equity Financing and Initial Public Offerings, 1998. In the case packet.
2. Chapter 15 of BM or Chapter 19 of RWJ, on equity financing.
3. Chew, pages 178-194. "Raising Capital: Theory and Evidence" by Clifford
4. Chew, pages 262-269. "Raising Equity in an Efficient Market" by Bruce Jurin.
5. Chew, pages 253-261. "Initial Public Offerings" by Roger Ibbotson, Jody Sindelar and Jay Ritter.
6. Supplementary information about equity financing. In the case packet.

Donaldson, Lufkin and Jenrette, 1995 (Abridged)

Questions to discuss prior to class.

1. Why is Equitable considering selling an interest in DLJ? In answering this question, account for Equitable's perspective, DLJ's strategic position, and major forces of turbulence in the industry.
2. What are the relative advantages and disadvantages of a) carve-out, b) spin-off, c) divestiture through cash sales, and d) continued complete ownership by Equitable? Why did Richard Jenrette choose an equity carve-out for DLJ?
3. Prepare to describe the equity underwriting process, and the particular concerns of an initial public offering. Who is the "lead manager" in this instance, and what is that firm's role? What are the risks?
4. What is your estimate of DLJ's fair value per share? In answering this question please draw on as many valuation approaches as you can. Give special attention to the valuation multiples of DLJ's peers. Who are those peers? Why do they qualify as peers? How would you do a discounted cash flow valuation?
5. At what price should DLJ be offered? Think carefully about your answer here. The offering price need not be identical to your answer to question 4. If answers to 4 and 5 differ, however, please explain why.

Assignment hints:

1. Notice the mistake in the units in Exhibits 5 and 6: they should be Dollars in Millions.

Readings

1. Donaldson, Lufkin and Jenrette, 1995 (Abridged). In the case packet.
2. Supplementary information about DLJ. In the case packet.

Lecture on Debt Financing and Liability Management

This lecture will develop liability management practices and their motivations.

Readings

1. Chapter 25 of BM or Chapter 25 of RWJ (Chapter 24 in RWJ 4^th edition) , on hedging financial risk.
2. Chew, pages 348-356. "The Evolution of Risk Management Products" by S. Waite Rawls III and Charles Smithson.
3. Chew, pages 357-391. "Strategic Risk Management" by S. Waite Rawls III and Charles Smithson.
4. Froot, Scharfstein and Stein. A Framework for Risk Management. In the case packet.
5. "Untangling the Derivatives Mess." Fortune, 3/20/96. In the case packet.
6. "Too Hot to Handle?" Economist Magazine cover story, 2/10/96. In the case packet.
7. Supplementary information about debt financing. In the case packet.

Liability Management at GM

Questions to discuss prior to class

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 flows? 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 measure its interest rate exposure? How would you propose that GM report the interest rate exposure of its business, and 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 should be studied or changed, and why?

Readings

1. Liability Management at GM. In the case packet.

Lectures on Option Pricing Theory and Applications

This lecture will, for the most part, follow the lecture notes contained in the case packet. The lecture is intended to review option pricing theory and applications.

Readings

1. Hodrick, Laurie Simon. Teaching Note: Option Pricing Theory and Applications, 1998. In the case packet.
2. Chapters 20 and 22 of BM or Chapters 21-23 of RWJ (Chapters 21 and 22 in RWJ 4^th edition), on option pricing.
3. Chew, pages 419-425. "How to Use the Holes in Black-Scholes" by Fischer Black.

Chrysler's Warrants (1983)
CASE WRITE-UP TO BE HANDED IN BY GROUP

Questions to discuss prior to class

1. Value the Chrysler warrants held by the government on five dates: September 14, 1979 (see case exhibit 5); January 7, 1980 (see case exhibit 6); April 8, 1980 (see case exhibit 7); May 12, 1980 (see case exhibit 8) and September 1, 1983 (see case exhibit 4). Why did the warrants' value change over this time?
2. To test the estimate of the standard deviation given in exhibit 4, use the data in case exhibit 10 on Chrysler's publicly traded warrants to solve for the standard deviation implied by the warrant's price.

   Hint: The implied standard deviation for the September 1, 1983 numbers seems big.

    

3. Value the government's loan guarantee as of May 12, 1980. Remember that it amounts to a put option, which allows the banks to put their risky Chrysler loans to the government. The variance of returns on Chrysler debt is suggested by case exhibit 11.
4. What is the prospective internal rate of return to the government on the loan guarantee as of May 12, 1980, taking into account the expected fees and the current value of the warrants? How does this IRR compare with Chrysler-type risks in the market?
5. What price should Chrysler bid for its warrants in September 1983?

Readings

1. Chrysler's Warrants (1983). In the case packet.
2. Supplementary information about Chrysler. In the case packet.

Lectures on Corporate Control

These lectures will introduce the market for corporate control. Both theoretical arguments and empirical evidence will be presented.

Readings

1. Hodrick, Laurie Simon. Teaching Note: Corporate Control, 1998. In the case packet.
2. Hodrick, Laurie Simon. Anatomy of a Hostile Takeover, 1998. In the case packet.
3. Chapter 33 of BM or Chapter 30 of RWJ (Chapter 29 in RWJ 4^th edition), on corporate control.
4. Chew, pages 465-491. "The Takeover Controversy: Analysis and Evidence" by Michael Jensen.
5. Chew, pages 502-525. "The Causes and Consequences of Hostile Takeovers" by Amar Bhide.
6. Chew, pages 52-61. "Do Bad Bidders Become Good Targets?" by Mark Mitchell and Kenneth Lehn.
7. Chew, pages 620-640. "Corporate Control and the Politics of Finance" by Michael Jensen.
8. Chew, pages 492-501. "The Quiet Restructuring" by John Kensinger and John Martin.
9. Supplementary information about corporate control. In the case packet.

Paramount Communications, Inc. - 1993
CASE WRITE-UP TO BE HANDED IN BY GROUP

Questions to discuss prior to class

1. Why do you think Paramount is a takeover target?
2. Which of the two firms - Viacom or QVC - would make it better fit for Paramount?
   Which would Paramount management, i.e., Martin Davis, prefer, if it had to choose?
3. What effect would Viacom have on the costs at Paramount if it bought the company?
   What effect would Viacom have on Paramount's growth rate? What would happen to costs and sales growth if QVC bought Paramount instead?
4. What is Paramount worth as is? to Viacom? to QVC? In class, I will expect you to argue for the particular cost savings and / or synergies that Viacom and QVC will be able to achieve.

Hint: Begin by calibrating your valuation to the current stock price.

5. How should Redstone proceed?
   • What price should he offer?
   • Should the offer be a cash offer, a stock offer, or some combination?
   • What should he do about the lock-out option and the termination fees?
   • Should he bother trying to buy Paramount at all?

   Assume:

   • Paramount's marginal tax rate is 37%.
   • Expected inflation is 4%.

Readings

1. Paramount Corporations, Inc. 1993. In the case packet.
2. Supplementary information about Paramount. In the case packet

Paramount Communications, Inc. - 1994.

Questions to discuss

1. What do you think of Redstone's tactics in making the initial offer to Paramount? The Price? The Deal structure? The lock-up option? The termination fee? What did the market think of the initial offer?
2. Why did Viacom change its bid on October 21?
3. What do you think of the actions of Paramount's board before the November 24, 1993 Delaware Chancery Court decision? What do you think of the auction procedure devised by Paramount's board after the Delaware Court decisions?
4. Explain what has happened with the stock prices of the three players, Paramount, Viacom and QVC, from September of 1993 to February of 1994. Specifically, explain the movements of QVC and Viacom stock as the likelihood of their winning changes.

   Hint: November 24 and January 7 are particularly interesting.

5. What is the impact of the Contingent Valuation Rights (CVRs)? What are their key features?
6. What did the changes in QVC's final bid accomplish?
7. Which of the two final bids is more attractive at the current stock prices of QVC and Viacom? Which should Paramount shareholders accept in February of 1994? Why?

Readings

1. Paramount Corporations, Inc.- 1994.

AT&T/McCaw Merger Negotiation

Questions to discuss prior to class

1. What is the situation this company faces? What are the strengths and weaknesses of this company, and of its counter party? Why should your company and the counter party company want to negotiate?
2. What are the high and low likely values of McCaw? How did you estimate those values? What are the key value drivers?
3. What are the risks to AT&T and to McCaw in this transaction?
4. What should the decision-maker do? What steps should the decision-maker take? What should be said to whom?

Assignment hints:

1. For simplicity, assume that McCaw buys the rest of LIN in 1995. The only effect on free cash flows is the (negative) net proceeds of the purchase in 1995.
2. Consider the implications of using the monthly versus weekly Betas.

Readings

1. American Telephone and Telegraph (AT&T): The AT&T / McCaw Merger Negotiation. In the case packet.
2. McCaw Cellular Communications: The AT&T / McCaw Merger Negotiation. In the case packet.
3. Supplementary information about AT&T and McCaw. In the case packet.

Anatomy of a Hostile Takeover

filmed October 31, 1987
Professor Laurie Simon Hodrick, revised October 1998

I. The Panel:

1. Robert Mercer: Chairman and CEO, Goodyear Tire and Rubber Co., Inc.

In response to a takeover bid by Sir James Goldsmith in November 1986, Mercer unveiled an ambitious restructuring plan for Goodyear, including a 40 million share ($2 billion) stock repurchase, the sale of three major units, and reduced employment including early retirement of 4900 employees. He told reporters at the time, "I'm not sure where we go from here."

At the same time, he prodded a special House judiciary subcommittee hearing on hostile takeovers in November 1986 at which Goldsmith appeared. Mercer, in Congressional testimony, voiced his opinion by saying that "While I heartily agree that the shareholder is the major constituency of any public company, I regret the concept that such secondary constituencies as the company's customers, employees and suppliers, and the communities host to the company's facilities have no rights."

Mercer says he refused to address Goldsmith as anything other than Mr. Goldsmith; "I never called him Sir James."

After a settlement with Goldsmith, Goodyear was burdened with debt, was forced to sell 25% of its assets, and abandoned long-range diversification plans.

This deal explains why, when considering a hypothetical takeover bid from Goldsmith, he says it is "deja vu all over again."

Mercer joined T. Boone Pickens in April 1987 in urging Congress (Senate Antitrust Committee) to adopt measures to curb takeover abuses and to outlaw "greenmail", despite heated exchanges between the two. Mercer told Congress that "what I think is going on on Wall Street right now is the economic equivalent of AIDS."

Mercer retired as CEO in 1989 after a 42 year career, including being CEO since 1983.

2. Jane Bryant Quinn: Newsweek Magazine

3. James Bere: Chairman and CEO, Borg-Warner Corp.

In April 1986, it was announced that Bere would retire as chairman and CEO in August 1987. He died in January 1992.

In October 1986, Irwin Jacobs and Minstar Inc. bought a 6.1% stake in Borg-Warner, which he then raised to 7.7%, proposing to buy Borg-Warner for between $3.4 billion and $3.8 billion. Bere refused to respond to the bid. Jacobs exercised stock options (obtained from Bear, Stearns and Co.) to increase its stake to 12.44% in January 1987. In March, Borg-Warner refused Jacobs access to its books, and Minstar sold the shares at a $1/share profit.

Also in October 1986, GAF Corp. acquired a 9.6% stake, which it increased to 9.96% in December, and to 19.9% in March 1987, bought from Jacobs. GAF made a $3.19 billion proposal to buy the 80.1% it didn't already own.

Borg-Warner's directors approved instead a $3.76 billion cash tender offer from Merrill Lynch Capital Partners, taking the firm private in a leveraged buy-out. GAF sold its stake into the offer.

4. Warren Buffet: Chairman, Berkshire Hathaway Inc.

Considered one of the most clever investors extant and the second richest man in America with a net worth in excess of $10 billion, Omaha financier Buffet is a Columbia Business School graduate, a student of Ben Graham.

In 1988, he was Salomon's largest shareholder. Temporarily, he took the helm of Salomon Brothers in 1992 for 18 months following Salomon Treasury auction violations. He now sits on the board as a non-executive director.

He once tested a microphone by saying "Testing, one million, two million, three million." He has spoken against incentive stock options.

5. Joseph Flom: Attorney, Skadden, Arps, Slate, Meagher and Flom, specializing in mergers and acquisitions.

6. Arthur Liman: Attorney, Paul, Weiss, Rifkind, Wharton, and Garrison

Defended Michael Milken against racketeering charges.

Former chief counsel for the Senate, Liman conducted the Senate's Iran-Contra probe.

7. T. Boone Pickens, Jr.: General Partner, Mesa Ltd. Partnership

Pickens unsuccessfully attempted to take over Phillips Petroleum in 1984, though he made $89 million on the aborted attempt. His reference to being willing to move to Bartlesville, Oklahoma stems from this deal.

Pickens was awarded an $18.6 million cash bonus for his 1984 performance.

Pickens unsuccessfully attempted to take over Unocal Corp. for $3.4 billion in 1985, describing Unocal's conciliatory plan to raise its stock value as "too little, too late." Unocal did an exclusionary self-tender for $3.6 billion. The Delaware Supreme Court upheld that Unocal could legally exclude Mesa from the repurchase.

In March 1986, Mesa acquired Pioneer Corp. for $800 million.

Proposed a $2 billion securities swap in December 1986 for Diamond Shamrock Corp., then made a $300 million cash tender offer for 20 million Diamond Shamrock shares in 1987. The offer was withdrawn.

In 1987, unsuccessfully acquired a 9.1% stake in Newmont Mining Corp.

In 1988, Pickens asked the Federal Trade Commission for permission to take over Texaco, Inc.

Pickens often criticizes management for entrenching themselves. In 1986, he founded United Shareholders Association, which became the largest shareholder rights groups in the country. It disbanded in December 1993, feeling that the agenda had been achieved, with notable improvements in corporate governance.

8. Rudolph Giuliani: US Attorney, Southern District of New York

Brought a 98 count racketeering charge against Michael Milken under the RICO statute. Currently mayor of New York city.

9. Timothy Wirth: Senator, Colorado

Currently Undersecretary of State for Global Affairs.

10. Edward Jay Epstein: Author, Who Owns the Corporation: Management versus Shareholders

Also author of "Deception" and "The Rise and Fall of Diamonds," Epstein is currently completing a biography of Armand Hammer.

11. Lester Thurow: Dean, Sloan School of Management, MIT

12. Sir James Goldsmith

Head of Cavenham Foods and Generale Ocidentale, purchaser of Grand Union supermarkets, his bids for firms in the 1980s included Diamond International (timber), Continental group and Crown Zellerbach (forest products). Describing himself as "richer than I had ever dreamed of," he sold the bulk of his stock market holdings on the eve of the 1987 crash, consolidating much of his fortune in cash.

Goldsmith acquired an 11.5% stake in Goodyear in November 1986, then proposed to pay $49 a share ($4.71 billion) for the 88.5% he didn't already own. Goodyear agreed to buy back the 11.5% stake for $49.50 a share ($618.8 million), ending the takeover threat.

Goodyear went to Congress to thwart this deal. Representative John Seiberling (D. Ohio), whose grandfather founded Goodyear Tire and Rubber of Akron, Ohio, asked Goldsmith "My question is, who the hell are you?" Sir James replied that he was an "active investor" trying to prevent the "European disease" of "big business, big unions, and big government absolutely throttling out entrepeneurialism." This explains Goldsmith's bitterness that takeovers are deterred by changing laws in Congress.

Having written the protectionist anti-GATT book "Le Piege (The Trap)" in 1993, he was elected member of the European Parliament in 1994, leading the L' Autre Europe (Other Europe) party. He next launched the Referendum Party in Britain, committing 20 million pounds to this campaign.

Goldsmith died in July of 1997.

13. Frederick Joseph: CEO, Drexel Burnham Lambert Inc.

Following Milken debacle, Joseph was banned for life from running another securities firm.

14. John Gutfreund: Chairman and CEO, Salomon Brothers

Champion of liar's poker, reputed to have bet $10m on one bill.

Chairman of Salomon 1978-1991. Quit soon after firm admitted in August 1991 that it violated bidding rules at several U.S. Treasury bond auctions. Regulators ruled he could never again run an American securities business and fined him $100,000.

Asked the Supreme Court of New York to overturn NYSE arbitration decision denying him $55.3m in pay and other compensation; he was paid nothing. Alleges that Buffet broke a verbal promise to treat Gutfreund "fairly".

Now consults at Gutfreund and Company.

15. Harrison Goldin: Comptroller, New York City

New York Comptroller 1977-1989 and former NY state senator.

Senior partner of Goldin Associates L.P.

16. Lewis Kaden: Columbia Law School

Partner in New York Davis, Polk and Wardwell, specializing in labor law.

Spoke to baseball owners immediately preceding strike vote, December 1994.

17. Fred Friendly: Columbia University

President of CBS News 1964-1966. He then became a professor at the Journalism School in 1966. Ultimately the Edward R. Murrow Professor Emeritus of Journalism. He was inducted into Academy of Television Arts and Sciences Hall of Fame 1994.

He died in March, 1998 at the age of 82.

1. Whose best economic interests are paramount in firm decisions?
2. Does the government have a role to play?
3. What responsibility does the firm have to disclose information?
4. What obligation does the firm have to its stakeholders?
5. Do insider trading laws create a level playing field? Should they even try to?
6. Was the merger wave of the 1980's a correction of the mistakes made during the conglomeration merger wave of the 1960's?
7. Does the fear of takeover improve the performance of all companies, even those that aren't targets directly?
8. Are firms responsible to the communities within which they operate?
9. What percentage holding should be disclosed in the SEC 13-d? How much time should stockholders be allowed before the acquisition of stock is disclosed?
10. What are the interests and responsibilities of the board of directors in a takeover contest?
11. Where do takeover gains come from?

Lecture on Spinoffs, Carveouts and Leveraged Buyouts

This lecture examines recapitalizations, including spinoffs, carveouts and leveraged buyouts.

Readings

1. Chapter 18 of BM or Chapter 16 of RWJ, on the limits of debt financing.
2. Steve Kaplan and Jeremy Stein. The Evolution of Buyout Pricing and Financial Structure (or, what went wrong) in the 1980s. In the case packet.
3. Inselbag and Kaufold. How to value recapitalizations and leveraged buyouts. In the case packet.
4. Chew, pages 584-599. "The Motives and Methods of Corporate Restructuring" by G. Bennett Stewart III and David Glassman.
5. Chew, pages 613-619. "Leverage" by Merton Miller.
6. Chew, pages 551-560. "Equity Carve-Outs" by Katherine Schipper and Abbie Smith.
7. Supplementary information about recapitalizations. In the case packet.

Revco DS, Inc. (A)

Questions to be discussed prior to class

1. Was Revco a good leveraged buyout candidate? Why or why not? At any price?
2. Evaluate the financial, ownership and governance structure of Revco's LBO. How do these factors affect an LBO's future performance? What, if anything, would you change about the Revco deal?
3. What, in your opinion, are the major factors contributing to the failure of Revco's LBO? Was it bad luck, bad strategy, or bad execution?
4. Would it ever pay management or financial advisers to go ahead with a deal even if the price was too high and if the deal was badly structured?
5. Why did Revco spend so much time in Chapter 11? Do you agree with the assessment of a Drug Store News article that Revco's bankruptcy was "a case of bankruptcy done right?"

Readings

1. Revco D.S., Inc. In the case packet.
2. Chew, pages 654-667. "What Really Went Wrong at Revco?" by Karen Wruck.
3. Chew, pages 243-252. "An Introduction to Mezzanine Finance and Private Equity" by John Willis and David Clark.

Bankruptcy and Restructuring at Marvel Entertainment Group
CASE WRITE-UP TO BE HANDED IN BY GROUP

Questions to be discussed prior to class

1. Why did Marvel file for Chapter 11? Were the problems caused by bad luck, bad strategy, or bad execution?
2. Evaluate the Proposed restructuring plan. Will it solve the problems that caused Marvel to file chapter 11? As Carl Icahn, the largest unsecured debt-holder, would you vote for the proposed restructuring plan? Why or why not?
3. How much is Marvel's equity worth per share under the proposed restructuring plan assuming it acquires Toy Biz as planned? What is your assessment of the pro forma financial projections and liquidation assumptions? What alternative valuation methods might justify Perelman's valuation of the equity?
4. Will it be difficult for Marvel or other companies in the MacAndrews and Forbes holding company to issue debt in the future?
5. Why did the price of Marvel's zero-coupon bonds drop on Tuesday, November 12, 1996? Why did the portfolio managers at Fidelity and Putnam sell their bonds on Friday, November 8, 1996?

Readings

1. Bankruptcy and Restructuring at Marvel Entertainment Group. In the case packet.
2. Supplementary information about Marvel. In the case packet.