ACF401 Advanced Corporate Finance A Student s Handbook.pdf

ACF401 Module Handbook Page 1 of 14 Revised: January 7, 2014
IBSS Module Handbook
Module Title Advanced Corporate Finance
Module code ACF401
Year 2014/15
Module Leader Name: Associate Professor Dr. Warren Wu
Email: warren.wu@xjtlu.edu.cn
Office: BB 338
Office Hours 2 Hours per Week
Tuesday 11:00-12:00
Wednesday 11:00-12:00
Lecture Hours Tuesday: 15:00 – 16:30 (1.5 hours) Venue: BA 509
Seminar Hours Wednesday: 09:00 – 10:30 (1.5 hours) Venue: BA 509

Aims
1. To develop students’ understanding and knowledge in corporate finance by examining a range of its relevant
topics and issues, including capital budgeting, capital structure, cost of capital, dividend policy, long-term
financing, corporate governance, corporate acquisition & restructuring, and short-term financial management;
2. To equip the students with appropriate analytical tools and decisional techniques to undertake independent and
advanced investigations in those corporate-finance topics and issues above; and
3. To enhance the student’s capability to critically evaluate methodologies, results, and implications of research
findings in the discipline based on their familiarity with major empirical studies in the topics and issues above.
Required Textbooks
Damodaran, Aswath (2001) Corporate Finance: Theory and Practice, 2nd Ed. Wiley. ISBN: 0-471-28332-0
Chapter Chapter Title Reading to be Prepared prior to Class Meeting
1 Introduction to Corporate Finance First Principles of Corporate Financial Decisions
2 The Objective in Corporate Finance Maximization of Stockholder Wealth versus of Stock Price
7 Estimating Hurdle Rates for Firms From Cost of Equity to Cost of Capital
8 Estimating Hurdle Rates for Projects Financing Mix and Cost of Capital for Projects
9 Estimating Cash Flows on Projects Project Cash Flows versus Incremental Cash Flows
10 Investment Decision Rules Categorizing and Comparing Investment Decision Rules
13 Investments in Noncash Working Capital The Tradeoff from Reducing Working Capital
14 Investments in Cash & Marketable Securities Near-cash Investments and Their Effects on Firm Value
16 An Overview of Financing Choices Equity Financing, Debt Financing, Hybrid Securities
18 The Financing Mix: Tradeoffs Debt Tradeoffs and Capital Structure Irrelevance
19 The Optimal Financing Mix Approaches: Cost of Capital, Return Differential, Adjusted PV
20 The Financing Mix and Choices Effects of Asymmetric Information & Implications for Agency Costs
21 Dividend Policy Bad-versus-Good Dividend Schools and Dividend Irrelevance
22 Analyzing Cash Returned to Stockholders A Cash-flow Approach versus A Comparable-firm Approach
23 Beyond Cash Dividends Effects on Outstanding Shares versus on Claims on Assets
26 Acquisitions and Takeovers Background on Acquisitions and Steps in an Acquisition
28 Back to First Principles Interrelationships and Life Cycle Effects
Recommended Readings
 Damodaran, Aswath (1996). Investment Valuation: Tools and Techniques for Determining the Value of Any
Asset, University Edition. John Wiley & Sons. ISBN: 0-471-13393-0
 Ross, Stephen A., Westerfield, Randolph W., and Jaffe, Jeffrey (2010). Corporate Finance, International Edition.
McGraw-Hill Irwin. ISBN: 0-077-33762-x
 Brealey, Richard A., Myers, Stewart C., and Allen, Franklin (2011). Principles of Corporate Finance, Global
Edition. McGraw-Hill Irwin. ISBN: 0-073-53073-5
 Clayman, Michelle R., Fridson, Martin S., and Troughton, George H. (2012). Corporate Finance: A Practical
Approach, 2nd Edition. The CFA Institute. ISBN: 978-1-11810-537-5
 Clayman, Michelle R., Fridson, Martin S., and Troughton, George H. (2012). Corporate Finance Workbook: A
Practical Approach, 2nd Edition. The CFA Institute. ISBN: 978-1-11811-197-4
 Institute of Charted Accountants of England and Wales (ICAEW) (2014). ACA Professional Level – Financial
Management: Study Manual. ICAEW. ISBN: 978-0-85760-808-6
 Institute of Charted Accountants of England and Wales (ICAEW) (2014). ACA Professional Level – Financial
Management: Revision Question Bank. ICAEW. ISBN: 978-0-85760-803-1
Methods of Teaching and Learning
A range of teaching and learning methods will be utilized on this module. Core substantive knowledge will be
delivered via a weekly 2-hour lecture and reinforced by a private-study work (individual or collective) of about 8
hours per week. The case-driven and issue-driven seminars will be organized in a 1-hour session every week to
deepen the students’ problem-solving skills and broaden their critical-thinking talents.
Performance Assessment
Type Weight Assessment Topic
1. Individual Essay I 10%
How to create firm value from alternative processes of investing and raising funds from
diverse providers and returning funds to them amid internal and external frictions.
2. Individual Essay II 10%
How to enhance firm value from strategic investments and divestments; optimal corporate
governance, securities designs, and short-term financial management.
3. Final Examination 80% Comprehensive coverage on all topics taught and learnt from Week 1 through Week 13
Total 100%

Syllabus & Teaching Plan
Week Study Topic Chapter
Week 1
(Mar 2-6)
Introduction to the Module regarding its objectives, knowledge sources and contents, concept
acquisition, skill and talent development, performance assessment, and expected outcomes.
Corporate Finance Decisions based on First Principles in how a firm’s value can be maximized amid
different stakeholders’ interests and how such conflicting interests might be reconciled.
Chapter 1
Week 2
(Mar 9-13)
Capital Budgeting Decisions to drive a firm’s growth value, which require an analysis of relevant cash
flows, capital-budgeting criteria and techniques for investment appraisal.
Seminar #1: Project Cash Flows, Hurdle Rates, and Investment Decision Rules Analysis
Chapters
9 & 10
Week 3
(Mar 16-20)
Cost of Capital Determination to derive a firm’s enterprise value, which requires an assessment of its
risk-adjusted opportunity cost of capital (funding costs or hurdle rates) for discounting its cash flows.
Exercise #1: Capital Budgeting & Cost of Capital
Chapters
7 & 8
Week 4
(Mar 23-27)
Capital Structure Decisions to lower a firm’s funding costs, which require a management of its
capital structure (debt-equity mixes) through theories and practices on financial-leverage issues.
Seminar #2: Capital Structure Choices & Optimal Financing Mix Analysis
Chapters 18
& 19
Week 5
(Mar 31-
Apr 3)
Dividend Policy Decisions to return a firm’s internal funds to its shareholders and retain its funds for
future growth, which require an evaluation of dividend-payout and equity-financing options.
Seminar #3: Dividend Policy Tradeoff & Dividends Analysis
Chapters 21
& 22
Week 6
(Apr 6-10)
Long-term Financing Decisions to raise a firm’s external funds for its investment opportunities,
which require an awareness of funding sources and an assessment of their benefits, costs, and risks.
Seminar #4: Long-term Financing Choices & Financial Transitions Analysis
Chapter 16
Week 7
(Apr 13-17)
Midterm Week: No Class Self-study
Week 8
(Apr 20-24)
Information Asymmetries arising from a firm’s agency relationships with all of its stakeholders that
would affect its optimal investment choices and financing-securities designs.
Submission of Individual Essay I: How to create firm value from alternative processes of investing and
raising funds from providers and returning funds to them amid internal and external frictions.
Chapter 20
Week 9
(Apr 27-30)
Corporate Governance System CGS to lower a firm’s agency costs, which requires a disciplining of
its managers’ behavior via either market-based CGS or stakeholder activism.
Seminar #5: Corporate Governance Analysis
Chapter 2
Week 10
(May 4-8)
Corporate Acquisition Decisions to enhance a firm’s strategic investments and serve as its market-
based CGS to takeover other inefficient firms or replace its incapable managers.
Exercise #2: Corporate Acquisition & Takeover
Chapter 26
Week 11
(May 11-15)
Corporate Restructuring Decisions to enhance a firm’s strategic divestments and serve as its
market-based payout policy to return cash to its shareholders while profiting from its actions.
Exercise #3: Corporate Restructuring & Divestiture
Chapter 23
Week 12
(May 18-22)
Short-term Financial Management I to consider a firm’s working-capital investments in current
assets and liabilities that affect its cash flows, liquidity, and operations through their optimal levels.
Seminar #6: Working Capital Policy Analysis
Chapter 13
Week 13
(May 25-29)
Short-term Financial Management II to consider a firm’s operating cash and marketable securities
to achieve an optimal balance between its liquidity needs and returns on short-term investments.
Seminar #7: Cash & Marketable Securities Analysis
Submission of Individual Essay II: How to enhance firm value from strategic investments and
divestments; optimal corporate governance, securities designs, and short-term financial management.
Chapter 14
Week 14
(Jun 1-5)
Revision of the Module to connect a firm’s overall financial strategies for making investment,
financing, and payout decisions in its life cycle (start-up, expansion, growth, maturity, and decline).
CFA Exam-takers’ Preparation: Reviewing all relevant corporate-finance material
Chapter 28
Study Topic Weighting
 Capital Budgeting & Capital Structure 20%
 Dividend Policy & Long-term Financing 20%
 Agency Relations & Corporate Governance 20%
 Corporate Acquisition & Restructuring 20%
 Short-term Financial Management 20%

Expected Learning Outcomes
Corporate Finance Decisions
 Explain the general objectives of financial management, demonstrate the understanding of First Principles of Corporate
Finance, and describe the financial-strategy process for a business (i.e., investment, financing, payout, corporate-
governance, corporate-restructuring, and balance-sheet management strategies).
 Describe the impact of financial markets and other external factors (e.g., government and society) on a business’s
financial strategy (market efficiency and externalities), using examples to illustrate the impacts.
 Identify in the business and financial environment factors (i.e., risk exposures) that may affect financing for investment
in a different country (e.g., exchange rates, tax rates, and inflation rates).
Capital Budgeting Decisions
 Explain the investment decision-making process and apply various investment-appraisal techniques.
 Select and justify appropriate discount (hurdle) rates and cash-flow values for use in selected investment-appraisal
techniques from information supplied, taking account of inflation and tax.
 Demonstrate how the interpretation of results from the techniques can be influenced by an assessment of risk.
 Recommend and justify a course of actions which is based upon the results of investment appraisal, the consideration
of relevant non-financial factors, and the limitation of the techniques being used.
Capital Structure Decisions
 Assess the suitability of different financing choices for a given business.
 Explain, in non-technical terms with appropriate examples, the effect of capital gearing or financial leverage on investors’
perception of risk and reward.
 Compare the financing costs and benefits (including those that are not separately quantifiable) of various courses of
actions using appropriate financing-appraisal techniques.
 Calculate the costs of different financing methods and the weighted average cost of capital (WACC).
Dividend Policy & Long-term Financing
 Compare the features of different means of making returns to owners and lenders, explain their effects on the firm and
its stakeholders, and recommend options in a given scenario.
 Calculate a firm’s future requirements for capital, considering current and planned activities referring to levels of
uncertainty and making reasonable assumptions which are consistent with the situation.
 Draft a comprehensive investment-and-financing plan for a given business scenario of a firm and calculate its fair
corporate and equity values using alternative valuation approaches with appropriate sensitivity analyses.
Agency Relationships & Corporate Governance
 Explain the roles played by different stakeholders (stockholders, bondholders, managers, government), advisors
(auditors, analysts, credit-raters), and financial institutions (lenders, underwriters, insurers) in how a firm could
effectively address their diverse goals and diverging interests.
 Identify possible conflicting goals among various stakeholders (e.g., stockholder vs. managers, stockholders vs.
bondholders, firm vs. markets, and firm vs. society) and how a firm could strategically tackle such conflicts through a
corporate governance system, an optimal investment tradeoff, and an optimal securities design.
 Evaluate the ethical implications of a firm’s financial strategy (including those for its stakeholders) and suggest
appropriate courses of actions to resolve ethical dilemmas that may arise (i.e., aligning interests of all stakeholders by
optimizing the incentive balances among all conflicting stakeholders).
Corporate Acquisition & Corporate Restructuring
 Explain corporate acquisitions (e.g., merger, consolidation, tender-offer, asset-purchase, leverage buyout, and
management buyout), the process of pricing an acquisition, and the steps in developing an acquisition strategy.
 Explain corporate-restructuring strategies (e.g., stock-split, stock-dividend, divestiture, spin-off, split-off, split-up,
equity-carve-out, and tracking-stock), evaluate their characteristics, and choose from among them.
Short-term Financial Management
 Explain the components of working-capital investments (inventory, receivables, and payables), their measures (e.g.,
revenue-, cost-, and quantity-based), and how they affect a firm’s operating cash flows, liquidity, and value.
 Explain the reasons for investing in near-cash (e.g., T-bill, commercial paper, and repo-agreement) and risky securities
(e.g., high-yield bonds and undervalued stocks) and how they affect a firm’s operating cash and value.

A Guide to Seminar #1
Project Cash Flows, Hurdle Rates, Investment Decision Rules Analysis
 Objectives:
1) To estimate earnings and cash flows on a typical project for a firm.
2) To develop a risk profile for a project and estimate its appropriate hurdle rate.
3) To decide which decision rule the firm should be using in investment analysis.
 Key Questions:
1) Does the firm have a typical investment? If so, can the firm estimate the earnings and cash flow on that investment?
2) What are the different businesses that the firm is involved in? What are the differences in their risk exposures?
3) What are the cost of equity and cost of capital for each of the businesses that the firm is involved in?
4) What investment decision rule does the firm use in analyzing its projects?
5) What investment decision rule should the firm use to analyze investments?
 Analytical Framework:
1) Typical Investments
- Does the firm take a few or several investment each year?
- Do those investments have much in common? If so, what is their commonality? If not, how are they different?
2) Earnings and Cash Flows
- What is the typical life of an investment made by the firm?
- What is the pattern of earnings and of cash flows on such an investment?
- Based on the firm’s aggregate numbers, can its earnings and cash flows be estimated on a hypothetical investment?
3) Business Division Risk Analysis
- Estimate a bottom-up unlevered beta for each business division or project in the firm.
- If historical accounting earnings by business division are available, estimate its accounting beta as a check.
- Examine the reasons for the differences in betas across business divisions by looking at differences in their business
risk and operating leverage.
4) Estimating Business Division’s Cost of Equity
- If business divisions do not carry their own debt, use the debt/equity ratio for the firm to estimate bottom-up levered
betas by division. Use the bottom-up levered beta to estimate divisional cost of equity.
- If business divisions do carry their own debt or debt can be assigned to them on a reasonable basis, use division-
specific debt/equity ratios and bottom-up levered betas to estimate divisional costs of equity.
5) Estimating Business Division’s Cost of Capital
- If business divisions do not carry their own debt, use the firm’s debt/capital ratio and the firm’s cost of debt to
estimate divisional cost of capital.
- If business divisions do carry their own debt or debt can be assigned to them on a reasonable basis, use division-
specific debt/capital ratios and costs of debt to estimate divisional costs of capital.
6) Investment Decision Rules Used
- What investment decision rule does the firm use to decide on investments?
- If the firm has a stated objective, is the investment decision rule consistent with that objective?
7) Correct Investment Decision Rule
- Are the earnings and cash flows on the firm’s investments likely to be very different? Are there significant non-cash
charges and working-capital needs?
- Does the firm face any capital-rationing constraints?
 Information Sources:
1) Firms describe their investments in their annual reports, though not in significant detail. The statement of cash flows
will provide some breakdown, as will the footnotes to the financial statements.
2) To estimate costs of capital for each of the firm’s different businesses, begin by identifying the businesses in its
comprehensive annual report. Then, find comparable firms in each of those businesses and estimate the average beta
and debt/equity ratio for those firms. Use the unlevered beta for each business to estimate a levered beta and cost of
equity. Use the same debt ratio and the cost of debt for the firm to estimate a cost of capital for the business division.
3) Firms sometimes specify their objectives (e.g., double revenues within x years, increase return on equity by x%, etc.) in
their annual reports. They almost never specify investment decision rules, though managers may sometimes mention
them in the context of explaining why they made a specific investment.

Capital Structure Choices & Optimal Financing Mix Analysis
 Objectives:
1) To analyze the tradeoff between debt and equity for a firm and to examine whether it favors the use of debt.
2) To estimate the optimal mix of debt and equity for a firm and to evaluate the effect on firm value of moving to that mix.
 Key Questions:
1) How large, in qualitative or quantitative terms, are the advantages and disadvantages to the firm from using debt?
2) From the qualitative tradeoff, does the firm seem to have too much or too little debt?
3) Based on the cost-of-capital approach, what is the optimal debt ratio for the firm?
4) Bringing reasonable constraints into the decision process, what would be the recommended debt ratio for the firm?
5) Quantitatively, does the firm have too much or too little debt relative to (a) its industry and (b) the market?
1) Benefit of Debt
‒ What marginal tax rate does the firm face, and how does this rate measure up to the marginal tax rates of other
firms?
‒ Does the firm have other tax deductions (e.g., depreciation) that reduce the tax liability?
‒ Does the firm have high free cash flows (e.g., EBITDA/firm value)? Has it taken good investment projects?
‒ How responsive are managers to stockholders?
‒ Would there be any advantage to the use of debt by the firm as a way of keeping managers in line, or do other
cheaper mechanisms exist?
2) Cost of Debt
‒ How high are the current cash flows of the firm to service its debt, and how stable are those cash flows?
‒ How easy is it for bondholders to observe what stockholders are doing? Are the assets tangible or intangible? If they
are intangible, what are the costs of monitoring stockholders or bond covenants?
‒ How well can the firm forecast its future investment opportunities and needs? How much does it value flexibility?
3) Cost of Capital
- What is the current cost of capital for the firm?
- What happens to the cost of capital when the debt ratio is changed?
- At what debt ratio is the cost of capital minimized and firm value maximized? If they are different, explain why.
- What will happen to the firm value if the firm moves to its optimal debt ratio?
- What will happen to the stock price if the firm moves to its optimal debt ratio and if stockholders are rational?
4) Building Constraints into the Process
- What rating does the firm have at the optimal debt ratio? If a rating constraint were imposed, what would it be?
- What is the optimal debt ratio with the rating constraint?
- How volatile is the firm’s operating income? What is the “normalized” operating income of the firm? What is the
optimal debt ratio of the firm at that level of normalized operating income?
5) Relative Analysis
- Does it have too much or too little debt relative to the industry in which the firm operates?
- Does it have too much or too little debt relative to the rest of the firms in the market?
6) Financial Market Concerns
- How many analysts follow the firm?
- How much trading volume is there on the firm’s stock?
7) Societal Constraints
- What does the firm say about its social responsibilities?
- Does the firm have a good or bad reputation as a corporate citizen? If so, how has it earned that reputation?
- If the firm has been a recent target of social criticism, how has it responded?
1) To find out what types of securities and financing the firm has outstanding, check the footnote in the comprehensive
annual report of a company’s financial performance filed with the Securities and Exchange Commission (SEC), known
in the US as the 10-K report. To get the other inputs needed for the analysis, check the historical financials on the firm.
2) To get the input needed to estimate the optimal capital structure, examine the 10-K report or the annual report. The
ratings and interest coverage ratios can be obtained from the rating agencies such as S&P and Moody’s and default
spreads can be estimated by finding traded bonds in each rating class. Value Line also provides information on other
firms in the industry individually in its database.

Dividend Policy Tradeoff & Dividends Analysis
 Objectives:
1) To examine how much cash a firm has returned to its stockholders and in what forms (dividends or stock buybacks),
and to evaluate whether the tradeoff favors returning more or less.
2) To determine whether the firm should change its dividend policy based upon an analysis of its investment opportunities
and comparable firms.
 Key Questions:
1) How has the firm returned cash to its owners? Has it paid dividends, bought back stock, or spun off assets?
2) How would the firm be recommended to return cash to stockholders (assuming that it has excess cash) given its
characteristics today?
3) How much could the firm have returned to its stockholders over the last few years? How much did it actually return?
4) Would the firm be pushed to change its dividend policy (i.e., return more or less cash to its stockholders) given its
current cash balance?
5) How does the firm’s dividend policy compare to those of its peer group and to the rest of the market?
1) Historical Dividend Policy
- How much has the firm paid as cash dividends each year over the last few years?
- How much stock has the firm bought back each year over the last few years?
- Cumulatively, how much cash has been returned to stockholders each year for the last few years?
2) Firm Characteristics
- How easily can the firm convey information to financial markets, i.e., how necessary is it for the firm to use dividend
policy as signal?
- Who are the marginal stockholders in the firm? Do they like dividends, or would they prefer stock buybacks?
- How well can the firm forecast its future financing needs? How valuable is preserving flexibility to this firm?
- Are there bond covenants that restrict the firm’s dividend policy?
- How does the firm’s dividend policy compare to that of other firms in the same industry?
3) Affordable Dividends
- What were the free cash flows to equity that the firm had over the last few years?
- What is the current cash balance for the firm?
4) Management Trust
- How well have the managers of the firm picked investments, historically?
- Is there any reason to believe that future investments of the firm will be different from the historical record?
5) Changing Dividend Policy
- Given the relationship between dividends and free cash flows to equity, and the trust the stockholders have in the
management of the firm, should the firm change its dividend policy?
6) Comparing to Industry and Market
- Relative to the industry in which it operates, does the firm pay too much or too little in dividends? (Do regression, if
necessary)
- Relative to the rest of the firms in the market, does the firm pay too much or too little in dividends? (Use the market
regression, if necessary)
1) Information about dividends paid and stock bought back over time can be obtained from the financial statements of the
firm. (The statement of changes in cash flows is usually the best source of both.) To find typical dividend payout ratios
and yields for the industrial sector in which the firm operates, examine the data set on industry average on the textbook
author’s web site at http://www.stern.nyu.edu/~adamodar/cfin2E/project/data.htm.
2) Information needed to estimate free cash flows to equity and returns on equity can be found from the past financial-
statement analysis, e.g., an equity beta and a debt ratio. Data on stock returns and the returns on a market index over
the period of dividend analysis are also required.

Long-term Financing Choices & Financial Transitions Analysis
 Objectives:
1) To examine a firm’s current financing choices and to categorize them into long-term debt and equity.
2) To analyze the firm’s place in the growth cycle and any financial transitions that it has or will be making soon.
 Key Questions:
1) Where and how does the firm get its current financing?
2) Would these financing choices be classified as debt, equity, or hybrid securities?
3) Where in the growth cycle is the firm? What types of financing would it expect to use?
4) If it is using a different kind of financing than would be expected, what might be some of the reasons for the deviation?
5) What financial transitions has the firm already made, and what are the transitions it would make in the future?
1) Assessing Current Financing
- How does the firm raise equity? If it is a publicly traded firm, it can raise equity from common stock and warrants or
options. If it is a private firm, the equity can come from personal savings and venture capital.
- How, if at all, does the firm borrow money? If it is a public firm, it can raise debt from bank loans or corporate
bonds.
- Does the firm use hybrid securities to raising fund, which combine some of the features of deb and some of equity?
Examples include preferred stock, convertible bonds, and bonds with warrants attached to them.
2) Detailed Description of Current Financing
- If the firm raises equity from warrants or convertibles, what are the characteristics of the options (e.g., exercise
price, maturity, etc.)?
- If the firm has borrowed money, what are the characteristics of the debt (e.g., maturity, coupon or stated interest
rate, call features, fixed or floating rate, secured or unsecured, and currency)?
- If the firm has hybrid securities, what are their special or unique features?
3) Breakdown into Debt and Equity
‒ If the firm has financing with debt and equity components (e.g., convertible bonds), how much of the value can be
attributed to debt and how much to equity?
‒ Given the coupon rate and maturity of the non-traded debt, what is the current estimated market value of that debt?
‒ What is the market value of equity that the firm has outstanding?
4) Stage in the Growth Cycle
‒ How fast are the firm’s revenues growing? How fast are earnings growing?
‒ How much is the firm reinvesting in new investments?
‒ How much do the firm’s existing investments generate in cash flows?
‒ Given this information, at what stage in the life cycle would the firm be placed?
5) Predicted versus Actual Financing
‒ Given where the firm is in the life cycle, what types of financing would it expect to use?
‒ What is the financing that the firm is currently using?
‒ If the actual financing is different from the expected financing, what might be some of the reasons?
6) Financial Transitions
‒ If the firm recently had an initial public offering (IPOs), what were the details of the offering, i.e., who was the
investment banker, what was the offering price, what happened to the stock price after the offering?
‒ If the firm recently had a seasoned equity offering, what were the terms of the offering?
‒ If the firm recently had a seasoned bond offering, what were the terms of the offering?
1) Almost all the information about current financing choices can be extracted from the financial statements. The balance
sheet should provide a summary of the book values of the various financing choices made by the firm, though hybrids
are usually categorized into debt (if they are debt hybrids) and equity (if they are equity hybrids). The description of
warrants outstanding as well as the details of the borrowing that the firm has should be available in the footnotes to the
balance sheets. In particular, the maturity dates for different components of borrowing, the coupon rates, and
information on any other special features should be available in the footnotes.
2) The information on a firm’s current revenue and earnings growth can be obtained from the financial statements. The
information on recent security offerings (equity as well as debt) can be obtained from the filings made by the firm with
the SEC. Firms that are planning to make IPOs or have just made public offering have to file registration statements
with the SEC. There are a number of services that track forthcoming IPOs as well as seasoned offerings.

Corporate Governance Analysis
 Objective:
To analyze a corporate-governance structure of a firm and to assess where the power in the firm lies, i.e., with incumbent
management or with stockholders in the firm?
 Key Questions:
1) Is this a firm where there is a separation between management and ownership? If so, how responsive is management
to stockholders?
2) Is there a potential conflict between stockholders and lenders to the firm? If so, how is it managed?
3) How does the firm interact with financial markets? How do markets get information about the firm?
4) How does the firm view its social obligations and manage its image in society?
1) The Chief Executive Officer (CEO)
- Who is the CEO of the firm? How long has he or she been CEO?
- If it is a family-run firm, is the CEO part of the family? If not, what career path did the CEO take to get to the top?
- How much did the CEO make last year? What from did the compensation take (salary, bonus, stock, or options)?
- How much stock and options in the firm does the CEO own?
2) The Board of Directors (BoD)
- Who are on the BoD of the firm? How long have they served as directors?
- How many of the directors are “inside” directors?
- How many of the directors have other connections to the firm (as suppliers, clients, customers, etc.)?
- How many of the directors are CEOs of other companies?
- Does any of the directors have large stockholdings or represent those who do?
3) Bondholder Concerns
- Does the firm have any publicly traded debt?
- Are there bond covenants that have been imposed on the firm as part of the borrowing?
- Does any bond issued by the firm come with special protections against stockholder expropriation?
4) Financial Market Concerns
- How many analysts follow the firm?
- How much trading volume is there on the firm’s stock?
5) Societal Constraints
- What does the firm say about its social responsibilities?
- Does the firm have a particularly good or bad reputation as a corporate citizen? If so, how has it earned that
reputation?
- If the firm has been a recent target of social criticism, how has it responded?
1) For firms that are incorporated in the US, information on the CEO and the board of directors is primarily in the filings
made by the firm with the Securities and Exchange Commission (SEC). For firms that are not listed in the US, this
information is much more difficult to obtain. However, the absence of readily accessible information on directors and
top management is revealing about the power that resides with incumbent managers.
2) Information on a firm’s relationships with bondholders usually resides in the firm’s bond agreements and loan
covenants. Although this information may not always be available to the public, the presence of constraints shows up
indirectly in the firm’s bond ratings and when the firm issues new bonds.
3) The relationship between firms and financial markets is an uneasy one. The list of analysts following a firm can be
obtained from publications such as the Nelson Directory of Securities Research. For larger and more heavily followed
firms, the archives of financial publications (e.g., the Financial Times, Wall Street Journal, Forbes, Barron’s) can be
useful sources of information.
4) Obtaining clear information on the reputation of a firm as a corporate citizen is very difficult since it is only the outliers
(the worst and the best corporate citizens) that make the news. The proliferation of socially responsible mutual funds,
however, does give us a window on those firms that pass the tests (arbitrary though they sometimes are) imposed by
these funds for a firm to be viewed as “social responsible.”

Working Capital Policy Analysis
 Objective:
To analyze a firm’s working-capital policy and to gauge its effect on cash flows and value.
 Key Questions:
1) How much does the firm have invested in working capital?
2) Are these investments reasonable, i.e., is the firm over/underinvested in working capital relative to others in the
industry?
3) Answer the same questions above but looking specifically at inventory, account receivables, and accounts payable.
1) Assessing Working Capital Investments
- How much does the firm have invested in net working capital, defined in conventional terms?
- How much does the firm have invested in non-cash working capital?
- What is the breakdown of the investment? How much is invested in inventory, accounts receivable and payable?
2) Evaluating Working Capital Investments
- What are the firm’s working-capital holdings (scaled to reflect firm value or revenues) compared to industry
average?
- Can the differences by explained by fundamentals? (Run a peer-group analysis, controlling for firm size and risk,
and examine whether the predicted values are greater or less than the actual values.)
3) Working Capital Components
- How much does the firm hold in inventory compared to its historical holdings and those of other firms in the
industry?
- How much does the firm have in receivables compared to its historical holdings and those of others in the industry?
- How much does the firm have in payables compared to its historical holdings and those of others in the industry?
There should be a complete breakdown of a firm’s investment in the various components of working capital in its financial
statements that are available in the annual report or SEC filings.
Cash & Marketable Securities Analysis
 Objective:
To analyze how much a firm holds in cash and marketable securities, its motives, and the potential impact on its value.
 Key Questions:
1) How much does the firm have invested in operating cash?
2) How much does the firm have invested in near-cash investments, e.g., treasury bills and commercial papers?
3) How much does the firm have invested in risky securities?
4) Are these investments in cash and marketable securities large relative to those of other firms in the same industry?
1) Assessing Operating Cash Needs and Near-cash Investments
- How much does the firm have invested in operating cash?
- How has this investment in operating cash varied over time, including quarterly cash balance?
- How much does the firm have invested in near-cash investments?
2) Assessing Investments in Risky Securities
- How much does the firm have invested in risky securities? What is the breakdown of those holdings?
- How does the firm account for those holdings? How much did the firm show as unrealized gains or losses in such
holdings in the most recent year? How much has the firm earned since it acquired those holdings?
- What is the motivation for the holdings of risky securities?
3) Evaluating Holdings of Cash and Marketable Securities
- Relative to the rest of the firms in the same industry, does the firm have a large or small holding?
- Relative to the market, does the firm have a large or small holding?
- Given its characteristics in terms of past returns and perceived management quality, is this holding likely to be
value-enhancing, value-neutral, or value-diminishing?
A breakdown of a firm’s holdings into cash and marketable securities can be found in its balance sheet. Holdings in equity
securities should be shown in more detail in the 10-K report or in a footnote to the balance sheet. The method of
accounting used by the firm will also be explained as part of its financial statements.

Case Study Exercise #1
Capital Budgeting & Cost of Capital
 Company Background
Abydos PLC (Abydos) is considering a large strategic investment in a significantly different line of business to its existing
operations. The scale of the new venture is such that a significant injection of £12.5 million of new capital will be required.
The current capital gearing of Abydos is 80% equity and 20% debt by market value.
 Project Information
The new project will require initial outlays as follows:
Equipment (purchased on first day of financial year £ 10,000
Working Capital £ 1,500
Equity Issue Costs (not tax allowable) £ 700
Debt Issue Costs (not tax allowable) £ 300
Other project details include:
- Estimates of relevant cash flows and other financial information associated with the possible new investment. These are
shown below:
Year 1 Year 2 Year 3 Year 4
Operating Cash Flow before Tax £ 3,000 £ 3,400 £ 3,800 £ 4,300
- The directors have examined similar companies operating in the same industrial sector as the new project and have
determined that a suitable equity beta is 1.4, using average-industry capital gearing of 60% equity and 40% debt by
market values.
- The risk-free rate is 5% and the market return 12%.
- The £5-million debt with 8% coupon rate will be raised to fund part of the project. The rest will be funded by equity.
- Capital allowances on the project’s investment are at 18% per annum on a reducing-balance basis.
- Tax is payable at 21% in the year that the taxable cash flow arises.
- The after-tax realizable value of the project including any balancing allowance on the equipment as a continuing
operation is estimated to be £4 million including working capital at the end of Year 4.
- Working capital may be assumed to be constant during the four years of project life.
 Directors’ Opinions
The directors are discussing how Abydos should appraise its new project. Two directors have different opinions. The sales
director believes that the net present value (NPV) at the current weighted-average cost of capital (WACC) should be used
as a positive NPV-project should quickly capture any increase in the firm’s share price. The finance director states that the
NPV is not good enough as it is only value in potentially restrictive conditions, and should be replaced by the adjusted
present value (APV).
 Requirements
1) Calculate the adjusted present value of the proposed project.
2) Discuss briefly the validity of the views of the two directors. Use your calculations in (1) to illustrate and support your
discussion.
Corporate Acquisition & Takeover
Printwise PLC (Printwise) is a large printing firm with retail outlets across the UK. Its board of directors is making
an offer to acquire 100% of the 2.1 million shares of Leyton Ltd. (Leyton), its competitor in southeast England.
 Acquisition Target’s Information
Leyton’s financial year-end is 28 February and its most recent financial statements are given below:
Leyton’s Income Statement
For the year ended 28 February 2010
Leyton’s Balance Sheet
As at 28 February 2010 (in million)
Revenues £ 17.3 Cash & Bank Deposits £ 2.8 Trade Payable £ 3.5
Operating Expenses (£ 11.4) Inventories £ 0.5 Tax Payable £ 1.2
Profit before Interest & Tax £ 5.9 Receivables £ 3.0 Dividend Payable £ 1.1
Interest Expense (£ 0.3) Current Assets £ 6.3 Current Liabilities £ 5.8
Profit before Tax £ 5.6 Machinery (costed £8.8) £ 5.3 10% Debentures (matured 2020) £ 3.0
Tax Expense (£ 1.2) Land & Building (costed £4.1) £ 3.5 Ordinary Shares (par £1/share) £ 2.1
Net Profit £ 4.4 Non-current Assets £ 8.8 Retained Earnings £ 4.2
Dividends Declared £ 1.1 Total Assets £ 15.1 Total Claims £ 15.1

Corporate Acquisition & Takeover
Leyton’s management had some of its assets independently revalued in January 2010 as follows:
Inventories £ 3.1m
Machinery £ 4.1m
Land & Building £ 8.3m
- The average price/earnings ratio for listed firms in the printing industry is 9 and the average dividend yield is 6% p.a.
- The cost of equity of firms in the printing industry, considering the industry average level of capital gearing, is 14% p.a.
- Leyton’s finance department has estimated that its pretax net cash inflow after interest for the next four trading years
ending 28 February, before taking into account capital allowances, will be:
Year 1 Year 2 Year 3 Year 4
Pretax Net Cash Inflows after Interest £ 4.6m £ 4.3m £ 5.2m £ 5.7m
- Leyton’s machinery pool for tax purposes had a written-down value (WDV) of £3.6m at 28 February 2010. The pool
attracts 18% capital allowances on a reducing-balance basis in every year of ownership, except the final year where the
difference between WDV and disposal proceeds will be treated either as (i) an additional tax relief if the proceeds are
less than the WDV, or (ii) a balancing charge if the proceeds are more than WDV.
 Acquiring Firm’s Assumptions
Printwise’s board of directors estimates that in four years’ time, it could dispose of Leyton for an amount equal to four
times (4x) its after-tax cash flow for the year to 28 February 2014 (ignoring the effects of capital allowances and the
disposal value of the machinery). The corporation tax rate is 21% in the year that the taxable cash flow arises.
 Requirements
1) Calculate the value of one share in Leyton based on each of the these methods:
- Net Asset Value at Historical Cost
- Net Asset Value at Revalued Cost
- Price/Earnings Ratio
- Dividend Yield
- Present Value of Future Cash Flows
2) Identify and explain the different methods by which Leyton shareholders could be remunerated for their shares.
Corporate Restructuring & Divestiture
Tinkler PLC (Tinkler) operates a large department store in the north of England, which was founded over 100 years ago.
Key figures from its financial statements for the year ended 31 May 2014 are as follows:
Tinkler’s Financial Statements
(in million)
Revenues £ 10.0
Gross Profit £ 3.0
Net Profit £ 0.5
Land & Building (book value) £ 10.0
Land & Building (market value) £ 20.0
Long-term Loans £ 5.0
Bank Overdraft £ 1.0
Shareholders’ Funds £ 4.0
 Restructuring Strategies
The Tinkler family holds 40% of the ordinary voting shares of the company. The shareholdings of the family have become
widely dispersed around family trusts and individual family members. The last family members to be a part of the
management of the business retired two years ago. The family is considering the following restructuring strategies put
forward by the board of directors for their consideration:
1) Borrow £1 million to develop key departments, with an estimated contribution of £200,000 per year before interest.
2) Sell the business in six months’ time to a large rival in exchange for shares with a current market value of £10 million.
3) Sell the business in a management buyout (MBO) transaction for £10 million, with one half payable immediately and
the other half in one year’s time.
4) Close down the business immediately. This would incur estimated closure costs of £5 million.
 Requirement
Prepare a report advising the Tinkler family as to the merits and risks involved in the four corporate restructuring
strategies outline above.

ACF401 Advanced Corporate Finance
Semester 2 of 2014-15
Individual Essay #1
How to create firm value from alternative processes of investing and raising funds
from diverse providers and returning funds to them amid internal and external frictions
Introduction
This module deals primarily with a corporate financial decision-making process of a firm that involves investing,
fundraising, dividend-paying, agency-governing, strategic-resource management, and working-capital management
activities. The objective of this Individual Essay #1 is to allow each student to explore alternative ideas to create
maximum firm value from the perspectives of different players who are able to contribute or affect the firm’s
corporate financial decisions.
Each student is encouraged to utilize actual internal (accounting) and external (market) information from an existing
company of his/her own choice along with necessary hypothetical data and assumptions. This Essay is worth 10% of
the student’s performance.
Instructions
Based on the additional library-research and/or Internet-survey works from the Thomson-Reuters online database,
you are required to perform the following individual learning tasks:
1. Choose one company in which you are MOST interested and look particularly at its financial performance and
value indicators relative to its own historical track record (time series) and its peers within the same industry
(cross section).
2. Identify and describe the company’s value drivers from its operating, investing, financing, governing, and
strategic activities in terms of their current strengths and weaknesses as well as their future opportunities and
challenges. You can combine your quantitative analysis of the firm’s financial information with your qualitative
assessment of the firm’s value implications.
3. Choose only one aspect or scope of the company’s value drivers that you believe is the most compelling,
distinctive, and sustainable on which to expand your alternative ideas of firm-value creation. You can approach
the analysis of your chosen value driver from various stakeholders’ perspectives to see how any friction to value
creation can be effectively minimized.
4. Critically synthesize your stepwise recommendations on how the company should pursue and proceed in order
to achieve its targeted or desired value-creating outcomes. You can reconcile diverging ideas from different
stakeholders’ perspectives in order to come up with a unified approach to firm-value creation specifically
applicable to your chosen company.
5. Write your individual report outlining, detailing, analyzing, and synthesizing the above items in their sequential
order. Please ascertain that you are the only person who authors your report and not somebody else. Your
report will be evaluated based on the following assessment criteria:
(a) Demonstration of learned theories and relevant concepts (40%)
(b) Completeness of explanations, examples, and citations (30%)
(c) Accuracy of definitions, arguments, and calculations (20%)
(d) Timeliness of report submission (10%)
6. There is no minimum number of pages in your report, but its upper limit is NOT to exceed 10 pages using a 12-
point Times New Roman font and a 1.5 line spacing, excluding tables, charts, appendices, citations, or references.
Collaboration
You are allowed to collaborate with one or more students in your class in terms of library-research and/or Internet-
survey works prior to writing your own individual report. This is to help you save your information-search time while
enhancing your analytical and critical thinking processes to concisely derive strategic conclusions and
recommendations. However, plagiarism is prohibited. Please make sure you inspect and clear your report through
Turn-it-in plagiarism detection software before you submit it.
Submission
The deadline for you to submit your Individual Essay #1 is Wednesday April 22, 2015. You must hand in your
report directly to the lecturer for acknowledgement on or before that deadline date. Failure to do so shall result in
your zero mark on this Essay. Your inquiry should be made directly to the lecturer of this module.

ACF401 Advanced Corporate Finance
Semester 2 of 2014-15
Individual Essay #2
How to enhance firm value from strategic investments and divestments,
optimal corporate governance, securities designs, and short-term financial management
Introduction
Following the tasks performed earlier in Individual Essay #1, the objective for this Individual Essay #2 is to let each
student extend his/her alternative ideas to enhance maximized firm value from what each student has recommended
a company to create its maximum firm value.
Each student is allowed to utilize data, information, and assumptions from what were used in Individual Essay #1
with additional hypothetical data and assumptions. This Essay is worth 10% of the student’s performance.
Instructions
Based on the additional library-research and/or Internet-survey works from the Thomson-Reuters online database,
you are required to perform the following individual learning tasks:
1. Identify and describe the company’s value enhancers from its operating, investing, financing, governing,
security-design, strategic, and short-term activities in terms of their improved strengths and weaknesses as well
as their secured opportunities and averted challenges. You can combine your quantitative analysis of the firm’s
value information with your qualitative assessment of the firm’s strategic implications.
2. Choose only one aspect or scope of the company’s value enhancers that you believe is the most compelling,
distinctive, and sustainable on which to expand your alternative ideas of firm-value enhancement. You can
approach the analysis of your chosen value enhancer from various competitive strategic positions to see how any
opportunity to value enhancement can be effectively maximized.
3. Critically synthesize your stepwise recommendations on how the company should pursue and proceed in order
to achieve its targeted or desired value-enhancing outcomes. You can reconcile diverging ideas from different
competitive strategic positions in order to come up with a unified approach to firm-value enhancement
specifically applicable to your chosen company.
4. Write your individual report outlining, detailing, analyzing, and synthesizing the above items in their sequential
order. Please ascertain that you are the only person who authors your report and not somebody else. Your
report will be evaluated based on the following assessment criteria:
(a) Demonstration of learned theories and relevant concepts (40%)
(b) Completeness of explanations, examples, and citations (30%)
(c) Accuracy of definitions, arguments, and calculations (20%)
(d) Timeliness of report submission (10%)
5. There is no minimum number of pages in your report, but its upper limit is NOT to exceed 10 pages using a 12-
point Times New Roman font and a 1.5 line spacing, excluding tables, charts, appendices, citations, or references.
Collaboration
You are allowed to collaborate with one or more students in your class in terms of library-research and/or Internet-
survey works prior to writing your own individual report. This is to help you save your information-search time while
enhancing your analytical and critical thinking processes to concisely derive strategic conclusions and
recommendations. However, plagiarism is prohibited. Please make sure you inspect and clear your report through
Turn-it-in plagiarism detection software before you submit it.
Submission
The deadline for you to submit your Individual Essay #2 is Wednesday May 27, 2015. You must hand in your
report directly to the lecturer for acknowledgement on or before that deadline date. Failure to do so shall result in
your zero mark on this Essay. Your inquiry should be made directly to the lecturer of this module.

ACF401 Advanced Corporate Finance A Student s Handbook.pdf

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