Finance 551

Problems in Business Finance

Autumn 2021

Professor Jennifer L. Koski

Dempsey 303D, (206) 543-7975
jkoski@uw.edu
Office Hours: Mondays 3:00-4:00 p.m. and by appt.
Course materials available on Canvas

DESCRIPTION:

This class is a case course examining the corporate financing and investment decisions and related
issues in financial strategy. The course is organized into four sections:

1. Short-Term Financial Management

2. Capital Structure
3. Capital Budgeting
4. Firm Valuation and Corporate Restructuring

In the first two sections of the course, we deal with two important problems relating to raising capital:
managing the cash flowing through the business and financing company operations. In the last two
sections, we turn our attention to evaluating investment opportunities, estimating discount rates,
valuing firms, and analyzing bankruptcy, corporate restructuring, and mergers.

When you complete this course, you should be able to:

• Analyze a company’s financial statements and draw inferences about the firm’s strengths
and weaknesses.
• Use a computer spreadsheet to create pro forma financial forecasts.
• Evaluate the appropriate balance between debt and equity capital.
• Identify an investment’s relevant costs and benefits to calculate free cash flows.
• Estimate a company's weighted-average cost of capital and understand its role in investment
decision making.
• Use a variety of valuation techniques to evaluate capital expenditures and to value firms.
• Use valuation models to analyze strategic business alternatives.
• Enhance group collaboration skills by working together to analyze corporate financial
decisions.
PREPARATION:

Most of our class time will be devoted to discussion of assigned cases. To get the most out of class
you must prepare conscientiously and participate actively in study group and class discussions.
Failure to participate robs others of your perspective and increases the chances that the discussion
will not be relevant to your interests and abilities. Please participate actively.

So, what is conscientious case preparation? Read the case thoroughly; identify principal issues to be
addressed in the case; attempt to analyze these issues using your common sense and any appropriate
tools or techniques and note any action recommendations implied by your analysis. Alternatively, if
you find yourself hitting a roadblock, try to articulate what the problem is. Oftentimes, identifying
roadblocks is as valuable as a complete analysis. You should expect to spend between two and three
hours preparing each case for class discussion.

For each case assigned you will note below that I have posed one or more preparation questions.
The questions play several roles depending on the case. Usually the questions are simply guidelines
to help you get started on your analysis. In some instances, I may give you additional information in
the questions, or I may ask you to perform specific calculations. You should not assume that
answering all of the preparation questions necessarily constitutes a complete analysis. My general
advice is always to read the preparation questions, but do not feel overly constrained by them.

Do not be surprised if after conscientious preparation you still feel there are some loose ends in the
case about which you are uncertain. Your test of whether you are learning the material and
progressing adequately should be how you feel after the class discussion, not before. You are doing
fine if after a class discussion you believe you could adequately handle a similar situation in the
future.

COURSE RESPONSIBILITIES:

Your grade will be based on the following:

Participation 30%
Group Assignments (3) 30%
Individual Assignments (4) 40%

Participation. Your participation grade will be based on your presence in class, my assessment of
the extent to which you helped make the class a productive learning experience, and my assessment
of the depth of your command of the material.

I will be forming students into subsets which I’ll call Panels. The Panels will be different from your
Groups for group assignments. For each class session, one Panel will be “on call.” I will cold call
primarily from the list of students on assigned Panel that day. I may also cold call students who are
not on the Panel that day for shorter, non-quantitative comments such as a final recommendation.
All students are expected to be prepared for each class session, and everyone is encouraged to join
in the discussion. Lists of students on each Panel for each class session will be posted on Canvas.

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Supplemental resources including the course textbook and online video tutorials are available to help
you review some of the technical skills required to support your case analyses. We will be applying
these skills to a range of corporate financial issues. However, there is no substitute for the in-class
case discussion to learn how to use these skills to evaluate alternatives, draw inferences, and make
recommendations. You will not be able to master the material if you are not in class to engage in
case discussions.

Assignments. The assignments are as follows:

Assignment Due Date

I. Ceres Gardening (Individual) Monday, Oct. 11

II. National Gypsum Products (Group) Monday, Oct. 18
III. Latam Airlines (Group) Wednesday, Oct. 27
IV. Intel WACC (Individual) Monday, Nov. 8
V. Current Event Valuation (Individual) Wednesday, Nov. 17
VI. RJR Nabisco (Group) Monday, Nov. 29
VII. Dow’s Bid for Rohm and Haas (Individual) Monday, Dec. 6

Please note that the specific deliverable for each case may differ from the study questions (provided
as a basis for class discussion) also included in the syllabus. Assignments for the graded deliverables
are outlined in boxes in the syllabus.

All assignments are due at 10:00 a.m. on the day we will be discussing the case. Assignments should
be submitted electronically on Canvas. If you submit an Excel file, all of your work should be in one
worksheet which is clearly labeled as containing your solutions. Please spend time formatting your
assignments; you will be evaluated on the clarity of your work.

There are two types of written assignments, Group and Individual:

Group Assignments. During the quarter, you will be responsible for completing three group
assignments. Each group should consist of from 3-5 students, and you should retain the same group
for each group assignment. Please email me a list of names of students in your group. Please also let
me know if you would like my assistance with group formation.

Individual Assignments. You are also responsible for completing four individual written
assignments. Although you are allowed to discuss the individual assignments with others as
described below, you must each prepare and turn in your own work.

You are encouraged to discuss any of the written assignments with other students in the class or with
me. You are also welcome to use the internet or any other written resources to research background
on the case, although (except as otherwise noted) I don’t anticipate that you will need to do any
outside research. Please DO NOT use sample solutions or notes from the internet, from students in
prior years, or from any other source for any of the case assignments.

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Final Exam. There is no final exam for this class. You will have completed your course
responsibilities by the end of the last class session on Wednesday, Dec. 8.

MATERIALS:

The following materials are required for this course:

• A required packet of cases is available to purchase for electronic download or hard copy from
the HBS website.

• Robert C. Higgins, Jennifer L. Koski, and Todd Mitton, Analysis for Financial
Management, (Twelfth Edition), Irwin/McGraw-Hill, 2019. (Older editions of this textbook
will work fine.)

TECHNOLOGY POLICY:

I encourage the use of laptops in class for class-related purposes such as note taking and accessing
your financial models. Learning how to prepare financial models in Excel is an important objective
of the class. However, I support the School’s policy against accessing email, surfing the Internet,
etc. during class. Please constrain the use of your laptop during class to class-related purposes.

MBA HONOR CODE:

I employ the policies and procedures espoused by the Foster School of Business Honor Code to
maintain academic integrity in the course.

ACCOMMODATIONS:

If you have already established accommodations with Disability Resources for Students (DRS),
please communicate your approved accommodations to me at your earliest convenience. To request
academic accommodations due to disability (including accommodations related to COVID-19),
please contact Disability Resources for Students (DRS), uwdrs@uw.edu or (206) 543-8924.

Washington state law requires that UW develop a policy for accommodation of student absences or
significant hardship due to reasons of faith or conscience, or for organized religious activities. The
UW’s policy, including more information about how to request an accommodation, is available at
Religious Accommodations Request.

Any student seeking reasonable accommodations must provide written notice to the Office of the
University Registrar of the specific dates of absence due to religious accommodation, within the
first two weeks of the beginning of the course.

Students who have requested and been denied a religious accommodation and wish to file a
complaint should contact the University Complaint Investigation and Resolution Office (UCIRO).

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UCIRO is responsible for investigating complaints that a University employee has violated the
University’s nondiscrimination and/or non-retaliation policies, including a failure to accommodate
a student under this policy.

COVID PROTOCOLS:

Please remember that the current Washington State indoor mask mandate, which took effect Aug.
23, requires everyone to wear a mask indoors. The University of Washington requires students and
UW personnel to attest to their vaccination status. The University also has COVID-testing
requirements for students who receive an exemption from the UW’s vaccination mandate. Please
note that these standards are continually evolving and subject to change.

If you are sick, please stay home. If I am sick but still able to teach, I will hold class on Zoom. If
I am sick and unable to teach, I will either cancel class or arrange for a substitute instructor. I will
post an announcement on Zoom if there are any changes to our in-person class meeting schedule.

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Course Schedule
SHORT-TERM FINANCIAL MANAGEMENT

Class 1 (Wednesday, Sept. 29): Determinants of Financial Structure

Prepare (in class): Financial Ratios Exercise (Case Available on Canvas)

Read: Higgins, Chapter 2.

a.) Match company financial data to differing industries. (There will be time during the
class session to work together on this exercise.)

Class 2 (Monday, Oct. 4): Assessing the Financial Health of the Firm

Prepare: J.C. Penney Company

Read: Higgins, Chapter 2.

a.) Evaluate JCP’s strategy. What are the company’s strengths?

b.) What went wrong? Is JCP’s current position primarily the result of operating decisions,
financial decisions, or bad luck?
c.) Evaluate JCP’s historical operating performance. What ratios will help you with this
evaluation? What is JCP’s ROE?
d.) How has JCP managed its working capital in the recent past? Is there an opportunity to
squeeze more cash from any of these accounts?
e.) How serious is the situation? What are JCP’s alternatives, and what should they do?

Class 3 (Wednesday, Oct. 6): Financial Forecasting and Cash Budgeting

Prepare: NanoLabs (Case Available on Canvas)

Read: Higgins, Chapter 3

a.) How has NanoLabs performed so far? What are the company’s main strengths and
weaknesses?
b.) Why has NanoLabs borrowed increasing amounts despite its consistent profitability?
c.) How much money will NanoLabs need? For how long, a few months or longer?
d.) As a banker, would you approve NanoLabs’ request for a larger loan? If so, what
conditions would you put on the loan?

Class 4 (Monday, Oct. 11): Managing Working Capital

Prepare: Ceres Gardening Company: Funding Growth in Organic Products

Read: Higgins, Chapter 4

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 a.) Evaluate Ceres’ historical operating performance and marketing efforts. What are the
company’s strengths?
b.) How has the company grown? What is its basic marketing strategy, and how has this
strategy evolved? What is GetCeres?
c.) Prepare a financial forecast for 2007. What do you learn from this forecast?
d.) Should the GetCeres program be expanded? Why or why not?

Graded Assignment I (Individual Assignment)

Please submit a spreadsheet with your 2007 forecast for Ceres. Clearly note any assumptions,
either on your spreadsheet or in an attached memo. How much additional external debt funding (if
any) do they need?

Class 5 (Wednesday, Oct. 13): Financing Seasonal Operations

Prepare: Polar Sports, Inc.

a.) What factors should Weir consider in deciding whether or not to adopt the level
production plan?
b.) What effect will shifting to level production have on the company’s need for a bank
loan? Prepare a financial forecast to estimate the company’s funding needs with level
production.
c.) As the banker, would you be willing to extend the line of credit to finance level
production? Why or why not? What other sources could substitute in part for bank
lending if the lender is not willing to extend the present line of credit? Do you think it is
feasible for Polar Sports to switch to level production?
d.) What are Weir’s options, and what should he do?

CAPITAL STRUCTURE

Class 6 (Monday, Oct. 18): Long-Term Financing Alternatives

Prepare: National Gypsum Products Corp. (Case Available on Canvas)

Read: Higgins, pp. 199-206

a.) What are the advantages and disadvantages of the three methods NGP might use to
raise the needed external capital?
b.) Estimate NGP’s pro forma book value leverage ratio (D/D+E) in early 2021 and their
fiscal year 2021 coverage ratio and EPS under the three alternatives. Prepare a financial
model to illustrate these effects.
c.) Which of the financing methods do you recommend? Why?

Graded Assignment II (Group Assignment)

Please submit written responses to the three study questions, above. In your response to question
(b), clearly state any assumptions and show your work

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Class 7 (Wednesday, Oct. 20): Optimal Capital Structure- Interest Tax Shields

Prepare: California Pizza Kitchen

Read: Higgins, Chapter 6 Appendix (pp. 223-226)

a.) Evaluate CPK’s strategy and operating performance. How would you characterize
CPK’s business risk? Why is CPK considering this transaction now?
b.) For each scenario in Exhibit 9, calculate the present value of the interest tax shield
assuming the new debt is permanent. How will the interest tax shield affect the value
of the firm? Clearly state any additional assumptions you need to make.
c.) Calculate the coverage, EPS, and market value leverage ratios for the three scenarios in
Exhibit 9. How many shares can they repurchase in each scenario, and at what price?
d.) Is their line of credit a reasonable source of funding for this transaction? Why or why
not?
e.) What should CPK do, and why? Be specific

Class 8 (Monday, Oct. 25): Optimal Capital Structure- Tradeoff Theory

Prepare: Diageo plc

Read: Higgins, pp. 206-218

a.) How has Diageo historically managed its capital structure? Is their target capital
structure reasonable?
b.) How would you apply the tradeoff theory of capital structure to Diageo’s business?
Is the present value of the interest tax shield likely to be large or small for Diageo?
What about distress costs?
c.) Based on the results of the model, what recommendation would you make for
Diageo’s future capital structure? Why doesn’t Diageo have more debt? What are the
disadvantages of more debt for them?
d.) Should Diageo change its target capital structure?

Class 9 (Wednesday, Oct. 27): Optimal Capital Structure- Financial Distress and Bankruptcy

Prepare: Latam Airlines and COVID-19: Seeking Bankruptcy Protection in the United States

a.) What is Latam’s strategy? What is Latam doing well?

b.) How did Latam get into this situation? Is their distress primarily the result of poor
operating decisions, poor financial decisions, or bad luck?
c.) How levered is Latam? Does this amount of leverage make sense for them? Why or why
not?
d.) How serious is the situation? Why?

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 e.) What are Latam’s alternatives, and what are the advantages and disadvantages of these
alternatives?
f.) What should should Latam do?

Graded Assignment III (Group Assignment)

Please submit written responses to the six study questions, above.

Class 10 (Monday, Nov. 1): Payout Policy

Prepare: Payout Policy at Alphabet (case available on Canvas)

a.) What are Alphabet’s funding needs? Will it need the $40 billion in cash to finance its
operations?
b.) Why do firms pay dividends? What are the disadvantages of paying dividends? How do
these considerations change if the payout is a share repurchase?
c.) If Alphabet were to pay $40 billion as a special dividend, what would be the effect on market
value? On the share price? On net income? On earnings per share? What if Alphabet used
this money to repurchase shares instead? Assume a 1% rate of interest on any cash and
short-term investments, and a 3% interest rate on the debt. Also assume that the deal takes
place in early 2021. Estimate the impact on the Jan. 1, 2021, capitalization, and the 2021
income statement. (Solve this problem in the Modigliani-Miller setting.)
d.) If you relax the assumptions from Modigliani-Miller to incorporate frictions from the real
world, how might your estimates in question (c) change? Address this question qualitatively
(there is no need to recalculate your pro forma).
e.) Should Porat recommend a dividend to Alphabet’s board?

CAPITAL BUDGETING

Class 11 (Wednesday, Nov. 3): Lecture (Capital Budgeting and Valuation)

Read: Higgins Chapter 7 Appendix (pp. 269-276), pp. 337-351, and Chapter 8 Appendix (pp.
321-326)

Class 12 (Monday, Nov. 8): Cost of Capital

Prepare: Intel Build vs Buy: Weighted Average Cost of Capital (Case Available on Canvas)
Read: Higgins, pp. 294-306

a.) How did Andrews calculate the WACC? Do you agree with the assumptions?
b.) Calculate the cost of equity using at least three different techniques.
c.) What is your estimate of the WACC for Intel?

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Graded Assignment IV (Individual Assignment)
Please submit a 1-2 page memo with your estimate of the cost of capital for Intel. In your memo,
please explain your assumptions and provide a specific value for the WACC.

Class 13 (Wednesday, Nov. 10): Incremental Free Cash Flows

Prepare: Intel Build vs Buy: Incremental Cash Flows (Case Available on Canvas)
Read: Higgins, pp. 258-269

a.) How would you define the “project”?

b.) What are the incremental cash flows for the project?
c.) Is the WACC for Intel appropriate to use as a discount rate for this decision? Why or
why not?
d.) What is the NPV of the project? Should Intel undertake this project?

Class 14 (Monday, Nov. 15): Incremental Cash Flows – Replacement Problem

Prepare: Fonderia del Piedmonte S.p.A.

a.) What are the incremental cash flows associated with acquiring the machine?
b.) What is the appropriate discount rate? Why? What is the NPV of the project at this
discount rate?
c.) Are you especially uncertain about any of the assumptions? What does a sensitivity
analysis of these assumptions reveal?
d.) What other factors might influence your recommendation? Are there any qualitative
factors that you did not incorporate into the NPV? What would be the impact of an
inflation rate of 2%?
e.) Should Martina Bellucci proceed with the project?

FIRM VALUATION AND CORPORATE RESTRUCTURING

Class 15 (Wednesday, Nov. 17): Current Event NPV Firm Valuation

Prepare: Current Event Valuation Case (Case and Study Questions Available on Canvas)

a.) What is the NPV of the company?

b.) How does this NPV translate into a stock price per share?
c.) As of what date have you valued the company?

Graded Assignment V (Individual Assignment)

Please submit a spreadsheet with your NPV valuation of the company. Clearly note any
assumptions either on your spreadsheet or in an attached memo. How does your NPV translate into
a stock price per share? As of what date have you valued the company?

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Class 16 (Monday, Nov. 22): APV Valuation/Bankruptcy Restructuring

Prepare: Infinity Carpets, Inc.

Read: Higgins, pp. 340-341
a.) Why did Infinity Carpets get into financial difficulty? Was it bad luck, bad operating
decisions, or bad financial decisions?
b.) How pressing is the situation? Can Infinity get by without restructuring?
c.) What do you think Infinity would fetch in liquidation? How would these proceeds be
divided among the claimants?
d.) What is a reasonable estimate of Infinity’s firm value? Use the APV method to value
the company.
e.) As Benson, recommend an action plan to Infinity’s controlling stockholder, SLP.

Wednesday, Nov. 24: Optional Class Session (TBD)

Class 17 (Monday, Nov. 29): Leveraged Buyouts

Prepare: RJR Nabisco

Read: Higgins, pp. 356-365
a.) What is the value of RJR Nabisco under
i. The pre-bid operating strategy?
ii. The Management Group’s operating strategy?
iii. KKR’s operating strategy?
b.) What accounts for any difference in the value among the three operating plans?
c.) Evaluate the Special Committee’s use of an auction of RJR Nabisco.
d.) Which bid should the Special Committee select, if any? What other actions should the
Special Committee take?

Graded Assignment VI (Group Assignment)

Please submit your responses to questions (a.i) and (b) above. For question (a), use the APV
method to value RJR Nabisco. You only need to submit your valuation under the pre-bid scenario;
please submit your spreadsheet for this valuation, along with a brief discussion of your
assumptions. Express your valuation as a stock price per share. Your response to question (b)
should be one or two paragraphs and should be based on the case discussion and the cash flow
projections provided in the case. Please see Canvas for some additional assumptions to help you
with your analysis.

Class 18 (Wednesday, Dec. 1): Mergers and Acquisitions

Prepare: Flinder Valves and Controls Inc.

Read: Appendix for Flinder Case (on Canvas)

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 a.) Using the case and the supplementary information in the Appendix (posted on Canvas),
what are the strengths and weaknesses of Flinder and RSE? Why should the two
companies want to merge?
b.) What is Flinder worth as a stand-alone company? Value Flinder using NPV and
comparable trades.
c.) What is the value of synergies that would potentially be created through a merger with
RSE?
d.) What opening price do you think Flinder should offer to sell the company to RSE? At
what price should he walk away from the negotiation? How did you estimate these
values?

Class 19 (Monday, Dec. 6): Mergers and Acquisitions

Prepare: Dow’s Bid for Rohm and Haas

a.) Why does Dow want to buy Rohm and Haas?

b.) How much is Rohm worth per share on a standalone basis? How much is Rohm worth
to Dow? Was the $78 per share bid reasonable?
c.) What are the major deal risks inherent in this merger transaction? How and to whom
does the merger agreement allocate these key risks? (Hint: Analyze some of the
provisions in case Exhibit 4. What risk does each provision address and which party
ultimately bears the risk?)
d.) As of early February 2009, what should Liveris do, and what should Gupta do?

Graded Assignment VII (Individual Assignment)

Please submit written responses to all four study questions, above. In responding to question (b),
you should estimate the value of Rohm both when Dow originally announced the deal (July 2008)
and based on the revised expectations as of early February 2009 (so you will have four valuations
total: standalone and as an acquisition target, in July 2008 and February 2009). Please include the
spreadsheet with these valuations in your response. Be sure to discuss clearly your main
assumptions. On page 4, the case discusses the $800 million in annual cost synergies, which can
be achieved with a one-time cost of $1.3 billion. Assume that both the $800 million and the $1.3
billion figures are pre-tax.

Class 20 (Wednesday, Dec. 8): Summary and Course Overview

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