Economics 314S Finance

Class Meeting: Office Hours: Office (Phone): Email:

Dr. David Martin Fall 2011

9:30-10:20 MWF in Chambers B027 TTh 2-4, F 11-12, and use Outlook Calendar to schedule an appointment (see below) Chambers 2253 (x2264) DaMartin@davidson.edu

The purpose of this course is to examine some fundamental aspects of financial theory through economic theory and application. I treat this course as a senior-level seminar with an emphasis on class discussion and group analysis, and I expect you to be prepared to contribute to our learning every day. Prerequisites: Economics 105 (Statistics), Economics 202 (Intermediate Microeconomic Theory), and Economics 211 (Introduction to Accounting). You will use Excel extensively and prepare PowerPoint presentations regularly. Grading Unit 1: Net Present Value Theory CS 1 (Monday, Sep. 12): Mercury Athletic Unit 2: Option and CAPM Pricing Models CS 2 (Friday, Oct. 14): Eskimo Pie Unit 3: Market Efficiency or Not Unit 4: A Firms Capital Structure CS 3 (Monday, Nov. 17): Restructuring Nova Unit 5: Risk Management Unit 6: Corporate Restructuring CS 4 (Friday, Dec. 9): Hybritech and Lilly Homework: Homework ...................................... 20% 18 Discussions ................................ 40% Preparation ................. 50% Leading ....................... 25% Participation ............... 25% Case Studies 1-3 ............................ 30% Preparation ................. 50% Leading ....................... 25% Participation ............... 25% Case Study 4 .................................. 10%

The purpose of the homework grade is to encourage you to exploit the superb textbook by reading it (as well as the other materials) in a timely way. Reading the textbook is defined to include working the end-of-the-chapter problems for which the answers are given in the appendix (usually the odd-numbered Basic problems). The grading scale is relatively simple, for each individual chapter or article: 10 ...... I read the material (and worked the relevant problems) before the start of class on the due date (10=100%, 9=90%, etc.). 5 ...... I read the material by the class after the due date (5=100%, 4=80%, etc.). 0 ...... Anything else. You will prepare discussions in small groups that I assign, and each group will work independently of the other groups. A typical discussion preparation might involve a two-page paper and a supporting spreadsheet analysis. The discussion leaders will likely use PowerPoint to make their initial points.

18 Discussions:

Case Studies 1-3: You will work these assignments independently. Some students will present their decisions with PowerPoint before the floor opens for the class to reach a consensus. Case Study 4: Attendance: One set of groups will represent Hybritech and the other set Eli Lilly. Your firms mission will be to conduct merger negotiations with (against?) the other firm. If you are absent for four or more meetings of this class for any reason then you will earn a grade of F for the course regardless of other work done for it.

Network File Space: The network folder P:\Economics\Eco 314 (Finance) has three subfolders. o P:\Economics\Eco 314 (Finance)\Completed Assignments: You will turn your completed spreadsheets and presentation materials into this folders subfolder. You are honor-bound to access only your groups materials. o P:\Economics\Eco 314 (Finance)\Homework: The homework grade recording sheet will be available in this folder as will odds and ends related to the homework. You are honor-bound not to alter another students grades (and, in fact, I encourage you to ignore them as much as is possible). If you do alter another students grades then you will earn a grade of F for the course regardless of other work done for it. o P:\Economics\Eco 314 (Finance)\Readings and Materials: I will place reading materials, some spreadsheets, and other materials in here for your use. While you may use the spreadsheets as the starting point for your work (including viewing and printing them), you are honor-bound to follow the copyright provisions so you may not distribute any of these files in any way. If you do so then you will earn a grade of F for the course regardless of other work done for it. Outlook Calendar (regular Outlook or web-Outlook): 1. Click on the calendar option 2. Scroll to the correct day (don't worry, you can change it easily later) 3. Click on the New Meeting icon or the arrow next to the "New Items" icon, and select "Meeting". 4. There are two key tabs, "Appointment" and "Scheduling Assistant" ... begin with "Appointment". 5. Fill out the subject and place as well as any other notes you want to add in the notes field. 6. Select the "Scheduling Assistant" tab. 7. You can either click on the Add Attendees button (which gives you the standard campus list of people) or simply type my username (damartin) in the list of attendees. 8. Look at the resulting calendar to see when I am busy and when I am free. 9. Select a meeting time and date when I am free by moving the green line (starting time) and brown line (ending time) or by changing the date/time information at the bottom of the tab. 10. Click on Send. 11. It is not official until I accept the appointment, which happens via email.

The Honor Code is a critical component of life at Davidson. Lets keep it that way!
Reading Materials Principles of Corporate Finance, Tenth Edition can be purchased at the bookstore. I have not ordered The Big Short on the theory that you can get it most cheaply over the internet. Student-rate subscriptions to the WSJ will be available during the first couple of days of class. BMA .............................. Brealey, Richard A., Stewart C. Myers, and Franklin Allen 2011. Principles of Corporate Finance, Tenth Edition. New York: McGraw-Hill. ISBN: 9780077356385. Big Short ....................... Lewis, Michael. 2011. The Big Short: Inside the Doomsday Machine. New York: W.W. Norton. ISBN (paperback): 9780393338829. The discussion of it is on November 21. WSJ ............................... The Wall Street Journal. Read it regularly so that we can bring current topics into the classroom. Ive listed the following readings in the order that they appear in the syllabus. They will be available at a cost that reflects the cost of copyright permissions*; in 2010, the copyright permissions cost $56.

One time permissions to reproduce the case study materials has been purchased from Harvard Business School and Darden Graduate Business School. Other materials (freely) fall under Davidson Colleges Annual Copyright License from the Copyright Clearance Center or may be (freely) downloaded from one of Davidson Colleges internet resources or other web sites.

Howland LTO Fund .... Perold, Andr F., and David S. Scharfstein. April 11, 2008. The Howland Long-Term Opportunity Fund. Harvard Business School. 9-207-066. Mercury Footwear ..... Luehrman, Timothy A., and Joel L. Heilprin. September 18, 2009. Mercury Athletic Footwear: Valuing the Opportunity. Harvard Business School. 4050. Butterflies/Condors .... The Economist. Of Butterflies and Condors. 16 February 1991. 318(7694):58-59. Arundel Sequels ......... Luehrman, Timothy A., and William A. Teichner. June 1992. Arundel Partners: The Sequel Project. Harvard Business School. 9-292-140. Citic Tower .................. Ho, Mary, and Frederik Pretorius, Frederik. July 16, 2002. CITIC Tower II: The Real Option. Centre for Asian Business Cases, School Business, The University of Hong Kong. HKU199. Ameritrade CoC ......... Mitchell, Mark L., and Erik Stafford. 2001. Cost of Capital at Ameritrade. Harvard Business School. 9-201-046. Nike, Inc. ...................... Chan, Jessica. 2001. Nike, Inc.: Cost of Capital. Darden Business Publishing, University of Virginia. UVA-F-1353. Eskimo Pie .................... Ruback, Richard S. December 2003. Eskimo Pie Corporation (Abridged). Harvard Business School. 9-202-037. Interstellar Trade ......... Krugman, Paul. October 2010. The Theory of Interstellar Trade. Economic Inquiry. 48(4):1119-1123. Intel (2).......................... Cornell, Bradford. Spring 2001. Is the Response of Analysts to Information Consistent with Fundamental Valuation? The Case of Intel. Financial Management. 30(1):113-136. ............ McLean, Bethany, and Peter Elkind. 2003. The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. New York: Penguin. 230-235. De Bondt, et al. .......... De Bondt, Werner, Gulnur Muradoglu, Hersh Shefrin, and Sotiris K. Staikouras. Fall/Winter 2008. Behavioral Finance: Quo Vadis? Journal of Applied Finance. 18(2):7-21. Please download it at: https://ezproxy.lib.davidson.edu/login?url=http://search.ebscohost.com/login.as px?direct=true&db=ecn&AN=1043745&site=ehost-live. Economist articles ...... What went wrong with economics and how the discipline should change to avoid the mistakes of the past (11-12), The other-worldly philosophers (65-67), Efficiency and beyond (68-69). The Economist. 18 July 2009, 392(8640). Momentum in financial markets: Why Newton was wrong. The Economist. 8 January 2011, 398(8715):69-70. T. Rowe Price .............. Case, Edward R. 1993. T. Rowe Price Associates. Darden Business Publishing, University of Virginia. UVA-QA-0295. RJR Nabisco (2) .......... Dammon, Robert M., Kenneth B. Dunn, and Chester S. Spatt. December 1993. The Relative Pricing of High-Yield Debt: The Case of RJR Nabisco Holdings Capital Corporation. The American Economic Review. 83(3):1090-1111. Please download it at: https://ezproxy.lib.davidson.edu/login?url=http://search.ebscohost.com/login.as px?direct=true&db=buh&AN=9405110085&site=ehost-live. ........... Tufano, Peter. June 1995. RJR Nabisco Holding Capital Corporation 1991. Harvard Business School. 9-292-129. Blaine Kitchenware .... Luehrman, Timothy A., and Joel L. Heilprin. October 8, 2009. Blaine Kitchenware, Inc.: Capital Structure. Harvard Business School. 4040. Midland Energy .......... Luehrman, Timothy A., and Joel L. Heilprin. June 19, 2009. Midland Energy Resources, Inc.: Cost of Capital. Harvard Business School. 4040. Restructuring Nova .... Mason, Scott, and Stuart C. Gilson. February 8, 2008. Restructuring at Nova Chemical Corporation. Harvard Business School. 9-208-107. Enron ............................ Bhatnagar, Sanjay, and Peter Tufano. September 1995. Enron Gas Services. Harvard Business School. 9-294-076. 1st American Bank....... Chacko, George, and Eli Peter Strick. July 17, 2002. First American Bank: Credit Default Swaps. Harvard Business School. 9-203-033.

Structured Finance .... Coval, Joshua, Jakub Jurek, and Erik Stafford. Winter 2009. The Economics of Structured Finance. The Journal of Economic Perspectives. 23(1):3-25. Please download it at: https://ezproxy.lib.davidson.edu/login?url=http://search.ebscohost.com/login.as px?direct=true&db=buh&AN=36434809&site=ehost-live. Jensen Monks ............. Michael Jensen, Robert Monks, and Ralph Walkling. Spring/Summer 2008. U.S. Corporate Governance: Accomplishments and Failings. Journal of Applied Finance. 18(1):133-147. Please download at: https://ezproxy.lib.davidson.edu/login?url=http://search.ebscohost.com/login.as px?direct=true&db=ecn&AN=1016368&site=ehost-live. Barbarians (6) .............. Ticer, Scott. 5 December 1988. RJR Tobacco: More Smoke than Fire. Business Week. (3082):27. Full text file retrieved 28 December 2005 from Lexis/Nexis Academic. Davidson College. ............. Greenwald, John, Richard Hornick, William McWhirter, and Frederick Ungeheuer. 5 December 1988. Wheres the Limit? The biggest takeover battle in history raises questions about greed, debt and the well-being of American industry. Time. 132(23):66-71. Full text file retrieved 28 December 2005 from InfoTrac OneFile. Thomson Gale. Davidson College. Please download at: http://www.time.com/time/magazine/article/0,9171,956435,00.html. ............. Greenwald, John, Raji Samghabadi, and Frederick Ungeheuer. December 12, 1988. $25,000,000,000: buyout barons KKR outfox Ross Johnsons group and walk off with RJR Nabisco, but the price comes with a colossal debt load. Time. 132(24):56-57. Full text file retrieved 28 December 2005 from InfoTrac OneFile. Thomson Gale. Davidson College. Please download at: http://www.time.com/time/magazine/article/0,9171,956470,00.html. ............. Lewis, Michael. January 1990. Barbarians at the Trough. New Republic. Version from Money Culture, 1991, New York: WW Norton, 75-78. ............. Lewis, Michael. 21 November 1988. Ski Lift Tiff. Manhattan, Inc. Version from Money Culture, 1991, New York: WW Norton, 81-86. ............. HBO Studios. Barbarians at the Gate (starring James Garner, et al.). Theatrical Release 1992. Rated R. Hope Enterprises ......... Harris, Robert S. June 24, 1998. Hope Enterprises. Darden Graduate Business School. UVA-F-1219. The following readings will be distributed in class as part of Case Study 4. Bruner, Robert F., and Casey S. Opitz. September 1990. Hybritech Incorporated (A). Darden Graduate Business School. UVA-F-0792. Bruner, Robert F., and Casey S. Opitz. September 1990. Eli Lilly and Company. Darden Graduate Business School. UVA-F-0794. Bruner, Robert F., and Casey S. Opitz. July 1989. Hybritech Incorporated (B). Darden Graduate Business School. UVA-F-0793.

Day

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By next class

Unit 1: Net Present Value Theory 1 2 3 4 5 6 7 8 9 10 M W F M W F M W F M W 8/22 8/24 8/26 8/29 8/31 9/2 9/5 9/7 9/9 9/12 9/14 Introduction to the course and the Fisher Separation Theorem Basic net present value NPV continued Investment using net present value Project analysis Valuing economic rents and stocks Bring laptops, Vegetrons CFO (BMA 6), and Howland LTO Fund case study Discussion 1: New Economy Tport (BMA 6) Discussion 2: Waldo County (BMA 10) Discussion 3: Reeby Sports (BMA 4) Discussion 4: Ecsy-Cola (BMA 11) Case Study 1: Mercury Athletic case study No class: Ill be attending a meeting all day. Read BMA 1 and 28 Read BMA 2 Read BMA 5 Read BMA 6 Read BMA 10.1,2,4 Read BMA 11 and 4 Prepare Discussions 1 and 2 Prepare Discussions 3 and 4 Prepare Case Study 1

Read BMA 20

Unit 2: Two Pricing Models: Option Pricing and Capital Asset Pricing Model 11 12 13 14 15 16 17 18 19 20 21 22 F M W F M W F M W F 9/16 9/19 9/21 9/23 9/26 9/28 9/30 10/3 10/5 10/7 Introduction to options (Butterflies/Condors) Binomial option valuation Black-Scholes option valuation Discussion 5: Arundel Sequels case study Real options Discussion 6: Citic Tower case study Risk, return, and the opp. cost of capital The capital asset pricing model More on the opp. cost of capital Discussion 7: Ameritrade CoC case study Fall Break Bring laptops, Jones Family cases (BMA 8 & 9), and Nike, Inc. Case Study 2: Eskimo Pie case study Read BMA 21.1-2 Read BMA 21.3-6 Prepare Discussion 5 Read BMA 22 Prepare Discussion 6 Read BMA 7 Read BMA 8.1-3 Read BMA 9 Prepare Discussion 7 Enjoy your break! Prepare Case Study 2 Read BMA 13.1-3,5 and Interstellar Trade

M 10/10 W 10/12 F 10/14

Unit 3: Market Efficiency or Not 23 24 25 M 10/17 W 10/19 F 10/21 Efficient markets Discussion 8: Intel (2) Behavioral finance Prepare Discussion 8 Read BMA 13.4, De Bondt, et al., and Economist articles Read BMA 14 and 3

Day

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Unit 4: A Firms Capital Structure 26 27 28 29 30 31 32 M 10/24 W 10/26 F 10/28 Valuing Debt Discussion 9: T. Rowe Price case study Discussion 10: RJR Nabisco (2) Debt versus equity (MM I & II) Discussion 11: Blaine Kitchenware case study Financing and valuation Discussion 12: Midland Energy case study Case Study 3: Restructuring Nova case study Prepare Discussions 9 and 10 Read BMA 17 and 18 Prepare Discussion 11 Read BMA 19 Prepare Discussion 12 Prepare Case Study 3 Read BMA 26

M 10/31 W 11/2 F 11/4 M 11/7

Unit 5: Risk Management 33 34 35 36 37 38 W 11/9 F 11/11 M 11/14 W 11/16 F 11/18 M 11/21 W 11/23 F 11/25 Managing Risk Discussion 13: Enron case study Credit Risk Discussion 14: 1st American Bank case study Discussion 15: Structured Finance Discussion 16: The Big Short Thanksgiving Break Thanksgiving Break Prepare Discussion 13 Read BMA 23 Prepare Discussion 14 Prepare Discussion 15 Prepare Discussion 16 Enjoy your break!

Unit 6: Corporate Restructuring 39 40 41 42 43 M 11/28 W 11/30 F M W Th F 12/2 12/5 12/7 12/8 12/9 Agency and Mergers Corporate Restructuring Discussion 17: Barbarians (6) Discussion 18: Hope Enterprises case study and distribute Case Study 4 materials No class meet with each group Reading Day Read BMA 12.1, 31, and Jensen Monks Read BMA 32 Prepare Discussion 17 Prepare Discussion 18

Read Hybritech (A) or Lilly and Each group map out strategy Finalize negotiation strategy Conduct merger negotiations Read Hybritech (B) and BMA 34 In lieu of a final exam: Discuss Case Study 4 and BMA 34 (10-11:30, Place TBA)

We will meet outside of the normal class time to view and to discuss the movie Barbarians at the Gate (running time 107 minutes).