LAHORE UNIVERSITY OF MANAGEMENT

SCIENCES
Course Outline
for

APPLIED CORPORATE FINANCE

Instructors Name: Dr. Naim Sipra
Telephone Ext:
Office Hours for students:

Room No. 161

2161
Fridays

3-5 pm

________________________________________________________________________

Course Title

APPLIED CORPORATE FINANCE

Course Code

ACF 465

Introduction
The objective of this course is to reinforce and expand on the previous financial analysis
and corporate finance/intermediate finance courses. Many of the topics covered are the
same, but the emphasis is different. By using the case-method methodology the emphasis
shifts from learning financial techniques to applying them to make managerial decisions,
Textbook
Since the topics covered in this course are those that are contained in any standard text of
corporate finance, therefore, no text is assigned for this course. You may use your
Brigham and Gapenski text for review and reference.
Grading:

CP
Quizzes
Mid-term
Final

40 %
10 %
25 %
25 %

Session 1
Case:

Butler Lumber Company

Assignment Questions
1.

Why does Mr. Butler have to borrow so much money to support this profitable business?

2.

Do you agree with his estimate of the companys loan requirements? How much will he need to borrow to
finance his expected expansion in sales (assume a 1991sales volume of $3.6 million)?

3.

As Mr. Butlers financial adviser, would you urge him to go ahead with, or to reconsider, his anticipated
expansion and his plans for additional debt financing? As the banker, would you approve Mr. Butlers
loan request, and, if so, what conditions would you put on the loan?

Session 2
Case: Toy World, Inc.
Assignment Questions
1.

What factors could Mr. McClintock consider in deciding whether or not to adopt the level production plan?

2.

What savings would be involved?

3.

Estimate the amount of added funds required and the timing of the needs under level production. Prepare pro
forma income statements and balance sheets (rather than a cash budget) to make this estimate. Ignore interest
expense in making these estimates.

4.

Compare the liabilities patterns feasible under the alternative production plans. What implications do their
differences have for the risk assumed by the various parties?

Session 3
Case: Hampton Machine Tool Company
Suggested Questions
1.

Why cant a profitable firm like Hampton repay its loan on time and why does it need more bank
financing? What major developments between November 1978and August 1979 contributed to this
situation?

2.

Based on the information in the case, prepare a projected cash budget for the four months September
through December 1979, a projected income statement for the same period, and a pro forma balance sheet
as of December 31, 1979.

3.

Review the results of your forecast. Do the cash budgets and the pro forma financial statements yield the
same results? Why?

4.

Critically evaluate the assumptions on which your forecasts are based. What developments could alter
your results? Is Mr. Cowins correct in his belief that Hampton can repay the loan in December?

5.

What action should Mr. Eckwood take on Mr. Cowins loan request? What are the major risks associated
with the proposed loan? What other alternatives does Mr. Eckwood have, and what are their pros and
cons? What would you do?

6.

Why did Hampton repurchase a substantial fraction of its outstanding common stock? What is the impact
of this repurchase on Hamptons financial performance? Critically assess Hamptons dividend policy. Do
you agree with Mr. Cowins proposal to pay a substantial dividend in December?

Session 4
Case: Tree Values
Assignment Questions
1.

Assume that the appropriate cost of capital is 240 basis points (2.4%) above the ten-year government bond
rate. To calculate the cost of capital, should you add the 240 basis points to a ten-year Treasury Bond that
yielded 6.04% in June 2000 or a ten-year Treasury Inflation Protected Security (TIPS) that yielded 4.14%
in June 2000? How do you decide?

2.

When would you recommend cutting a 50 year old tree that is 10 DBH? Assume no grade changes and
that a hypothetical tree takes five years to grow one inch in DBH. What if it takes ten years to grow one
inch in DBH? If you would recommend different times to cut the tree, please explain why you reach
different conclusions.

3.

When would you recommend cutting a 50 year old tree that is 10 DBH, grows at the rate of one inch of
DBH each five years, and also increases one grade with each 2growth in DBH? Is the decision the same
if the tree is growing at the rate of 1 DBH over ten years? In the following questions, assume all the trees
in Mr. Smiths forest have to be cut at the same time.

4.

If Mr. Smith simply lets his trees grow, would they increase in value? When would you recommend
cutting the trees if they are simply left to grow? Assume the trees grow at a rate of 1of DBH over ten
years.

5.

If Mr. Smith decides to thin and manage his forest, how would this affect its value? Assume that half the
trees are thinned and that the remaining trees grow at the rate of 2in DBH every ten years. Also assume
that a foresters management costs are offset by the value of the thinned trees.

6.

What forest management strategy, if any, would you recommend to Mr. Smith?

Session 5
Case:

The Super Project

Assignment Questions
1.

What are the relevant cash flows for General Foods to use in evaluating the Super project? In particular, how
should management deal with issues such as
a.
b.
c.
d.

Test-market expenses?
Overhead expenses?
Erosion of Jell-O contribution margin?
Allocation of charges for the use of excess agglomerator capacity?

2.

How attractive is the investment as measured by various capital budgeting techniques (i.e., accounting rate of
return, payback period, internal rate of return, net present value)? How useful are each of these measures of
investment attractiveness?

3.

How attractive is the Super project in strategic and competitive terms? What potential risks and benefits does
General Foods incur by either accepting or rejecting the project?

4.

Should General Foods proceed with the Super project? Why, or why not?

Session 6

Case: Whirlpool Europe

Assignment Questions
1.

Are all of the benefits of the ERP investment reasonable? Are the costs reasonable?

2.

What are the after-tax cash flows for the proposed ERP investment from 1999 through 2007? What is the
present value of those cash flows?

3.

When valuing the proposed investment, should value be included for possible cash flows that occur
beyond 2007? What does it depend on?

4.

Would you recommend the ERP investment? What is your major concern?

Session 7
Case:

Radio One, Inc.

Assignment Questions
1.

Why does Radio One want to acquire the 12 urban stations from Clear Channel Communications in the top 50
markets along with the nine stations in Charlotte, NC, Augusta, GA, and Indianapolis, ID? What are the
benefits and risks?

2.

What price should Radio One offer based on a discounted cash flow analysis? Are the cash flow projections
reasonable?

3.

What price should Radio One offer based on a transaction and trading multiples analysis?

4.

Assuming that Radio Ones stock price is 30X BCF, can it offer as much as 30X BCF for the new stations?

5.

What should Radio One offer for the new stations?

Session 8
Case:

Interco

Assignment Questions
1.

Assess Intercos financial performance. Why is the company a target of a hostile takeover attempt?

2.

As a member of Intercos board are you persuaded by the premiums paid analysis (Exhibit 10) and the
comparable transactions analysis (Exhibit 11)? Why?

3.

Wasserstein, perella & Co. established a valuation range of $68-$80 per common share for Interco. Show
that this valuation range can follow from the assumptions described in the discounted cash flow analysis
section of Exhibit 12. As a member of Intercos board, which assumptions would you have questioned?
Why?

4.

How would you advise the Interco board on the $70 per share offer?

5.

How would you assess the actions of Intercos board up to August 8, 1988? Wasserstein, Perella & Co.s?
The Rales brothers? Drexel Burnhams?

Session 9
Case:

Netscape's Initial Public Offering

Assignment Questions
Suggested Assignment Questions
1.

Why has Netscape been so successful to date? What appears to be its strategy? What must be accomplished if
it is to be a highly successful going concern in the long run? How risky is its current competitive position?

2.

Does Netscape need to go public to satisfy its capital needs? What would you estimate might be the magnitude
of its capital needs over the next 3 to 5 years? What sources other than the public equity market could be
tapped to satisfy those needs?

3.

Why, in general, do companies go public? What are the advantages and disadvantages of public ownership?

4.

The case points out that the IPO market is sometimes characterized as a hot issue market, and that many
IPOs are viewed in retrospect as having been under priced. What might explain these phenomena? Should
the Netscape board be concerned about under pricing? Why or why not?

5.

Can the recommended offering price of $28 per share for Netscapes stock be justified? In valuing Netscape,
you might find it helpful to use the following assumptions:
Total cost of revenues remains at 10.4% of total revenues;
R&D remains at 36.8% of total revenues;
Other operating expenses decline on a straight-line basis from 80.9% of revenues in 1995 to 20.9% of
revenues in 2001 (this would give Netscape a ratio of operating income to revenues close to Microsofts,
which is about34%);
Capital expenditures decline from 45.8% of revenues in 1995 to 10.8% of revenues by 2001 (again, close
to Microsofts experience);
Depreciation is held constant at 5.5% of revenues;
Changes in net working capital of essentially zero;
Long-term steady-state growth of 4% annually after 2005; and
A long-term riskless interest rate of 6.71%

Given these assumptions, and starting from its current sales base of $16.625 million, how fast must Netscape grow
on an annual basis over the next ten years to justify a$28 share value?
6.

As an executive of Netscape, what would you recommend with respect to the proposed offering price? As an
investor in Netscape, what would you recommend? As the manager of an institutional fund who was willing to
buy and hold Netscapes stock at the originally proposed price of $14 per share, would you be willing to buy
and hold at an initial offering price of $28 per share?

Session 10
Case: John M. Case Company
Assignment Questions
1. What are the most important operating and financial characteristics of the Case Company?
2. Is the company worth Mr. Cases $20 million asking price?
3. Can the $20 million purchase be financed so that management can retain at least 51% ownership? What
sources should management tap? In what amounts? Is the return being sought by the venture capital firm
reasonable?
4. How compelling a buyout opportunity is this proposition for the four managers?

5. Would you, as a commercial banking lender, provide the loan needed to finance the seasonal buildup in
accounts receivable and inventory? On what terms?
1.

Would you, as the venture capital firm, provide the balance of the funds needed? If so, on what terms?

Note: Mr. Case is willing to take a note with a face value of $6 million and an interest rate of 4%. However,
the notes economic value, due to the low interest rate, is only$4 million; the $20 million sale price is based on
receiving the note plus $16 million in cash.

Session 11
Case:

The Loewen Group, Inc. (Abridged)

Assignment Questions
2.

How was the Loewen Group able to grow explosively for the first half of the 1990s?
advantages of debt financing enjoyed by the firm in this phase?

What were

3.

How did Loewen get to the position it found itself in 1999?

4.

(Optional) why do you think SCI was willing to offer Loewen such a substantial premium?
incremental cash flows might SCI expect that could explain this premium?

5.

Some might describe Loewen as financially distressed. Is this a fair description of its problem? What
are the manifestations and apparent costs of this so-called financial distress?

6.

What are Loewens alternatives? What would you recommend to John Lacey?

What

Session 12
Case:

American Home Products Corporation

Assignment Questions
1.

How much business risk does American Home Products face? How much financial risk would American
Home Products face at each of the proposed levels of debt shown in case Exhibit 3? How much potential
value, if any, can American Home Products create for its shareholders at each of the proposed levels of debt?

2.

What capital structure would you recommend as appropriate for American Home Products? What are the
advantages of leveraging this company? The disadvantages? How would leveraging up affect the companys
taxes? How would the capital markets react to a decision by the company to increase the use of debt in its
capital structure?

3.

How might American Home Products implement a more aggressive capital structure policy? What are the
alternative methods for leveraging up?

4.

In view of AHPs unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his
successor to adopt your recommendation?

Session 13
Case:

Debt Policy at UST Inc.

Assignment Questions
1.

What are the primary business risks associated with UST Inc.? What are the attributes of UST Inc.?
Evaluate from the viewpoint of a bondholder.

2.

Why is UST Inc. considering a leveraged recapitalization after such a long history of conservative debt
policy?

3.

Should UST Inc. undertake the $1 billion recapitalization? Calculate the marginal (or incremental) effect
on USTs value, assuming that the entire recapitalization is implemented immediately (January 1, 1999).

Assume a 38% tax rate.

Prepare a pro-forma income statement to analyze whether UST will be able to make

For the basic analysis, assume the $1 billion in new debt is constant and perpetual. Should UST alter the
new debt via a different level or a change in the amount of debt through time.

4.

UST Inc. has paid uninterrupted dividends since 1912. Will the recapitalization hamper future dividend
payments?

interest payments.

Session 14
Case: Stone Container Corporation (A)
Assignment Questions
1.

What was the basis of Stone Containers successful growth during its first fifty years? What was its
product market strategy? What was its financial strategy?

2.

How did Roger Stones management of the company compare to that of his predecessors? In general,
would you judge his leadership to have been successful? Why or why not?

3.

How sensitive are Stone Containers earnings and cash flow to the paper and linerboard pricing cycle?
Estimate the effect on earnings and cash flow of a $50 per ton industry-wide increase in prices. Assume
Stone Containers sales volume approximates its 1992 production level of 7.5 million tons per year, and
costs, other than interest expense, remain the same. Also assume a 35% tax rate.

4.

What would be the effect of a $100 per ton industry-wide increase under the same assumptions given
above?

5.

What would be the effect under both these pricing scenarios if production and sales volume increased to
full capacity of 8.3 million tons per year (for simplicity, assume costs per ton remain constant)?

6.

What should be Stone Containers financial priorities for 1993? What must be accomplished if Stone is to
relieve the financial pressures afflicting it?

7.

Of the various financing alternatives described at the end of the case, which would be in the best interest
of Stones shareholders? Which would be in the best interests of its high-yield debt (i.e., junk bond)
holders? Of its bank creditors?

8.

Which of the financing alternatives would you recommend Stone Container pursue in 1993? If you
recommend more than one, which do you view as most important and why? Which would you do first,
and which later?

Session 15
Case: MCI Communications Corporation (1983)
Assignment Questions

1. What is the likely level of MCIs external needs over the next several years? By how much could they
reasonably be expected to vary? Why?
2. Critique MCIs past financial strategy, giving attention to the types of securities on which it has relied. Why did
MCI finance itself in the manner it did?
3. Based upon your analysis of the outlook for MCI and the competitive and regulatory evolution of the industry,
recommend a capital structure policy for MCI and defend your proposal against plausible alternatives.
4. Assume that Mr. English, the MCI chief financial officer, has the following financial alternatives available to
him as of April 1983:
a)$500 million of 121/2, 20-year subordinated debentures.
b)$400 million of common stock.
c1)$600 million of 75/8, 20-year convertible subordinated debentures with conversion price of $54 per share (i.e.,
each $1,000 bond would be converted into 18.52 common shares).
c2)$1 billion of a unit package consisting of a $1,000 71/2, 10-year subordinated debenture and 18.18 warrants,
each entitling the holder to purchase one share of MCI common stock for $5
5. The warrants would be exercisable until1988 and are callable. The exercise price of the warrants would be
payable either in cash or by surrender of the debentures valued at their principal amount. Which, if any, of these
alternatives, would you recommend that Mr. English take? Why? In broad outline, what financing steps would you
recommend he take over the next several years?

Session 16
Case: Dividend Policy at FPL Group, Inc. (A) and (B)
Assignment Questions
1.

Why do firms pay dividends? What, in general, are the advantages and disadvantages of paying cash
dividends?

2.

What are the most important issues confronting the FPL Group in May 1994?

3.

From FPLs perspective, is the current payout ratio appropriate? Would a higher payout ratio be more
appropriate? a lower payout ratio?

4.

From an investors perspective, is FPLs payout ratio appropriate?

5.

As Kate Stark, what would you recommend regarding investment in FPLs stock buy, sell, or hold?

Session 17
Case: Pioneer Petroleum Corporation
Assignment Questions
1.

Does Pioneer estimate its overall corporate weighted average cost of capital correctly?

2.

Should Pioneer use a single corporate cost of capital or multiple divisional hurdle rates in evaluating
projects and allocating investment funds among divisions? If multiple rates are used, how should they be
determined?

3.

How should Pioneer set capital budgeting criteria for different projects within a given division? What
distinctions among projects might be captured in these criteria? How should these different standards be
determined?

Session 18
Case: Ford Motor Cos Value Enhancement Plan (A)
Assignment Questions
Come prepared to discuss the case in class