Corporate Finance and Corporate Policy

Course resources:

Class 1. February 12

Homework:
Practice Question
Agency problem is inevitable. That is, we can never expect managers to give 100% weight to shareholders' interests and non to their own.

Why not?
List the mechanisms that are used around the world to keep agency problem under control.

Comment. Homework is based on Chapter 34 from any of recommended editions. Unfortunately, the problem does not exist in [BM7] and has different numbers in two [BMA]s. So from now on you should consult with this site only.

Readings:
Chapters 1 and 34 from any of recommended editions.

Class 2. February 19

Homework:
Practice Question
Herbal Resources is a small but profitable producer of dietary supplements for pets. This is not a high-tech business, but Herbal’s earnings have averaged around $1.2 million after tax, largely on the strength of its patented enzyme for making cats nonallergenic. The patent has eight years to run, and Herbal has been offered $4 million for the patent rights. Herbal’s assets include $2 million of working capital and $8 million of property, plant, and equipment. The patent is not shown on Herbal’s books. Suppose Herbal’s cost of capital is 15 percent. What is its EVA?

Readings:
Chapter 12 if you use [BM7]/[BMA8]; Chapter 13 if you use [BMA9].

Class 3. February 26

Homework:
(1) Challenge Question
Download MS Word file
(2) CAPM exercise
Using linear regression in MS Excel estimate two types of CAPM for the same company.
Usual CAPM assumes that for estimation a domestic index is in use as a proxy for the market return (RTSI in the case of Russia).
International CAPM (ICAPM) assumes that a foreign index is in use (S&P500 in the case of the USA).
Be sure to estimate both in the terms of the same currency. It will happen automaticallly with RTS data, which are quoted in USD (but not for MICEX).
Interpretation for the results of estimation should be given. CAPM should be treated as a model of return for domestic investor whereas ICAPM should be treated as a model of return for domestic investor (US in this particular case). Now imagine that you are an American who is a corporate director of a Russian company. What will be your suggestion on risk adjustment for NPV calculation of a large investment project for the Russian company? There is no unreserved answer valid for all. Speculate please.

Readings:
(1) Chapter 15 if you use [BM7]/[BMA8]; Chapter 16 if you use [BMA9]. The test will be devoted to IPO.
(2) [Jensen, Mekling, 1976]. Three types of agency costs with examples.

Class 4. March 5

Homework:
(1) Practice Question
Download MS Word file

Readings:
(1) Chapter 16 if you use [BM7]/[BMA8]; Chapter 17 if you use [BMA9]. The test will be devoted to dividend/repurchasing issues.

Class 5. March 12

Homework:
(1) Practice Question
Download MS Word file

Readings:
(1) Chapter 17 if you use [BM7]/[BMA8]; Chapter 18 if you use [BMA9]. The test will be devoted to the problems of borrowing.

Class 6. March 19

Homework:
(1) Practice Question
Download MS Word file

Readings:
(1) Chapter 18 if you use [BM7]/[BMA8]; Chapter 19 if you use [BMA9]. The test will be devoted to the problems from this chapter.
Read please Chapter 20 as well (less deatails, just main concepts) since I will cover this material in the lecture.

Class 7. March 26

Homework:
(1) Practice Questions
Download MS Word file

Readings:
(1) Chapter 19 if you use [BM7]/[BMA8]; Chapter 20 if you use [BMA9]. Special attention on "Your Questions Answered".

Training for the Final

Updated!!! Download MS Word file

The Final and Accounting Bias NEW!!!

One of the main ideas of any modern corporate finance course is the introduction of financial way of thinking, which is different from the accounting approach.

Accounting deals with past data on the base of existing legislation. Accounting is neither about decision making nor about performance measuring/valuation.

Accounting is important because it provides objective information on the past (based on unified methodology fixed by law) for shareholders/investors. "No creativity" principle is important because "creativity" is beyond investors' control. The role of accounting for analysis is limited. Nevertheless, there are many approaches how to transform accounting data into the form useful for financial analysis. EVA and residual income model are among the examples.

Corporate Finance deals with decision making, i.e. events, which will happen in future. Hence it concentrates on expectations, risk (as deviation from expectations), and long-term valuation. Past investments are not important.

For that we need to adjust for intangibles (Chapter 13 [BMA9]), and take into account opportunity cost of capital (Chapters 18-20 [BMA9]). In finance we use market values rather than original expenses. Also many proceeds and expenses are treated as irrelevant for financial analysis.

You may wish to review Chapter 13 [BMA9] again (and make its copy). There will be no Problems on EVA but "accounting bias" material will be used in Questions.

Let me just to recall the following problem, which was done in the course:

Herbal Resources is a small but profitable producer of dietary supplements for pets. This is not a high-tech business, but Herbal’s earnings have averaged around $1.2 million after tax, largely on the strength of its patented enzyme for making cats nonallergenic. The patent has eight years to run, and Herbal has been offered $4 million for the patent rights. Herbal’s assets include $2 million of working capital and $8 million of property, plant, and equipment. The patent is not shown on Herbal’s books. Suppose Herbal’s cost of capital is 15 percent. What is its EVA?

Solution.
EVA = Income earned – (Cost of capital x Investment) =
= $1.2m – [0.15 x ($4m + $2m + $8m)] = $1.2m – $2.1m = –$0.9m

Final Remark. I was told that a pirate version of Solution Manual has appeared in Internet. It is strongly prohibited to take a copy of it to the exam.

Good luck!