IF2105 Corporate Finance and Valuation


MODULE LEADER

Anh L. Tran, Ph.D., Professor of Finance
Bayes Business School, City University London, Faculty of Finance
Office: Room 5029, 106 Bunhill Row, London EC1Y 8TZ
Phone: 0207 040 5109
Email: anh.tran [at] city.ac.uk or anh.tran.1 [at] city.ac.uk
Web: www.bayes.city.ac.uk/faculties-and-research/experts/anh-tran

EDUCATIONAL OBJECTIVES

This module offers a critical understanding and knowledge of modern corporate finance at an
intermediate level. The aim is to provide a good foundation in basic concepts of corporate
finance and a thorough understanding of the key factors affecting the valuation of a company,
the choice between various forms of short- and long-term financing, and other important
corporate finance decisions.

The course will make it possible for participants to:
 To acquire an understanding of corporate finance and the linkages between corporate
strategic and financial decisions, firm value, and equity value
 To understand different valuation and restructuring techniques used in corporate
strategic and financial decisions, and how to use them to enhance firm value
 To be able to apply for junior positions in the corporate finance area of different
companies, financial institutions, turnaround management, investment banking,
strategy consulting, and investment management

LEARNING OUTCOMES

The participants will be familiar with most concepts and tools used by practitioners in the
corporate finance area, which will make it easier for them to successfully apply for a wide
range of job positions. In particular, they will:
 Gain a good understanding of the core corporate finance decisions which are essential
for all businesses: how to finance their short and long-term activities, how to select
their investments, when and how to reward shareholders through payouts
 Gain a good understanding of how corporate finance activities increase firm value

MODULE ASSESSMENT

The module is assessed by an individual coursework exam and an individual final examination.
The coursework counts for 30% and the exam for 70% of the overall module mark. The exams
are based on lectures, readings, problem solving, and case study discussion. Its structure and
study guide will be discussed during the revision session and posted on Moodle. Sample
and/or previous exam papers will also be posted for students to be familiar with the instruction
and the types of questions.
TEACHING METHOD AND STRUCTURE

Each topic’s materials consist of lectures, problem solving, and, if applicable, case study
discussion. Students are expected to fully participate in the discussion and problem solving
around the issues raised in the lectures. The tutorials cover exam-style questions and Q&As.

Case studies are used extensively throughout the course. They play an important role in this
course to facilitate discussions and sharpen students’ analytical skills. Case studies also form
part of the final exam questions. Students are expected to fully prepare all cases and
participate in case discussions. The cases should be attempted after studying the lecture. See
“Notes on the case study method in this class”.

Students are expected to be on time, attentive, and prepared. They are expected to be actively
involved and not surfing the web, texting, checking email or otherwise multitasking.

READING LIST

Each session will require preparation, including a case study, readings from academic or
business journals, or independent research online. All students should read the daily financial
press because we expect to refer frequently in the class to current events related to the course
materials as they happen during the term.

Textbook:
 Hillier D., Ross S., Westerfield R., Jaffe J., and Jordan B. (2020) Corporate Finance:
4th European Edition, McGraw-Hill (ISBN: 9781526848093)
Additional references:
 Damodaran A. (2010) Applied Corporate Finance: A user’s manual, 3rd Edition, John
Wiley and Sons (ISBN: 978-0470384640)
 Berk, J., DeMarzo, P. (2016) Corporate Finance, 4th Edition, Pearson (ISBN: 978-
0134083278)
 Benninga, S. (2014) Financial Modelling, 4th Edition, MIT Press (covers a wide range
of topics with Excel and Visual Basic applications) (ISBN: 978-0262027281)
 Research papers and financial press (Financial Times, Wall Street Journal, The
Economist, etc.)

INSTRUCTOR BIOGRAPHY

Prof Anh L Tran is a Professor of Finance at the Bayes Business School of City University
London, the Academic Director of the Bayes M&A Research Centre, a Fellow of the Gupta
Governance Institute in Philadelphia, and a Fellow of the Higher Education Academy. Anh has
taught corporate finance classes at both master’s and undergraduate levels. His research
interests are in empirical corporate finance, including mergers and acquisitions, executive
compensation, institutional investors and corporate governance. His research on stock option
grants was cited in a front-page article of The Wall Street Journal. Anh's other research has
also been mentioned in various media outlets including Bloomberg, The New York Times, The
Times, Le Monde, Les Echos, the Financial Times, The Economist, etc. Anh has presented
his research at many international conferences and published all his research articles in
leading academic journals including Journal of Financial Economics, Journal of Accounting
and Economics, Journal of Financial and Quantitative Analysis, and Management Science.
He has received the City University Staff Prize for outstanding research and the Bayes
Business School Excellent Research Publication Awards.
TOPICS AND ASSIGNMENTS

This is a tentative list of topics covered in the course. All the readings, concept questions, and
practice problems are from the required textbook Hillier et al. (2020). All lecture notes,
solutions to textbook problems, and case study materials are posted on Moodle. Students do
not have to submit answers to the concept questions, tutorial problems, or case study
questions. Students should read the lecture notes before coming to the session. After studying
the session, students must read the cases and attempt the case questions before coming to
the following session, at the beginning of which the cases are then discussed.


Topic 1 Introduction to corporate finance and governance (Chapters 1, 2, 4)

Concept questions: Chapter 1: 1, 2, 12, 19-22, 25
Chapter 2: 4, 7-11, 16, 19-25, 28-30
Chapter 4: 1-5
Practice problems: Chapter 4: 6, 14, 18, 24, 25, 29, 33
Tutorial problems: Principles of finance tutorial problems 1-3

Topic 2 Cost of capital (Chapter 12)

Concept questions: Chapter 12: 1-5, 7, 9, 12-16
Practice problems: Chapter 12: 20-26, 28
Tutorial problems: Cost of capital tutorial problems 1-4

Case study “Nike Inc Cost of Capital”

Topic 3 Capital budgeting (Chapters 6-8)

Concept questions: Chapter 6: 1-8
Chapter 7: 1-3
Chapter 8: 1, 3, 4
Practice problems: Chapter 6: 9-14, 17, 18, 25
Chapter 7: 8, 9, 20, 21
Chapter 8: 9, 17, 18
Tutorial problems: Capital budgeting tutorial problems 1-2

Topic 4 Valuation (Chapters 5)

Concept questions: Chapter 5: 4-6, 8, 10
Practice problems: Chapter 5: 13, 19, 20, 24
Tutorial problems: Valuation tutorial problem 1

Case study “Warren E Buffett”

Topic 5 Raising capital (Chapters 15-16)

Concept questions: Chapter 15: 1-17
Practice problems: Chapter 15: 21, 24, 27
Tutorial problems: Raising capital tutorial problems 1-2

Case study “JetBlue Airways IPO”



Topic 6 Capital structure Part 1 (Chapter 18)

Concept questions: Chapter 18: 1-8
Practice problems: Chapter 18: 17, 18, 23, 24, 29, 30
Tutorial problems: Capital structure tutorial problems 1-2

Capital structure Part 2 (Chapter 19)

Concept questions: Chapter 19: 1-16, 26, 29, 30
Practice problems: Chapter 19: 21, 23
Tutorial problems: Capital structure tutorial problem 3

Case study “California Pizza Kitchen”

Topic 7 Payout policy (Chapter 21)

Concept questions: Chapter 21: 1-15
Practice problems: Chapter 21: 30-32, 34, 35
Tutorial problems: Payout tutorial problems 1-2

Topic 8 Mergers and acquisitions (Chapter 28)

Concept questions: Chapter 28: 1-18
Practice problems: Chapter 28: 26, 27, 31, 33, 34
Tutorial problems: M&A tutorial problems 1-3

Case study “General Electrics Proposed Acquisition of Honeywell”




ADDITIONAL READING FOR EACH TOPIC

This reading section (which lists articles from academic journals and the press that provide a
practical view on the topic) should be skim-read.

Topic 1 Introduction to corporate finance and governance

 Denis - Is Managerial Myopia a Persistent Governance Problem, Journal of
Applied Corporate Finance 1999, Vol. 31 No. 3
 Economist - What companies are for (24/8/2019)
 FT - Are companies right to abandon the shareholder-first mantra
(27/8/2019)
 FT - Five issues in UK’s corporate governance revamp (7/3/2018)
 FT - How paying chief executives less can help corporate performance
(13/2/2017)
 FT - Opportunist shareholders must embrace commitment (26/8/2014)
 FT - Shareholder primacy is central to modern governance woes (4/3/2018)
 FT - The backlash against shareholder value (4/3/2018)
 Goizueta - Why Shareowner Value, CEO Series Issue No. 13, February
1996, Center for the Study of American Business, Washington University
in St. Louis
 Kaplan - CEO Pay and Corporate Governance in the US, Journal of Applied
Corporate Finance 2013, Vol. 25 No. 2
 MARC - A study of corporate cash holdings and spending behavior, 2012
 Ramani and Ward - How Board Oversight Can Drive Climate and
Sustainability Performance, Journal of Applied Corporate Finance 2019,
Vol. 31 No. 2
 Times - Golden parachutes cost investors dear (13/1/2011)
 WSJ - Option grants during mergers (12/10/2009)
 Zenner - Are US Companies Really Holding That Much Cash, Journal of
Applied Corporate Finance 2016, Vol. 28 No. 1

Topic 2 Cost of capital

 Bruner - Best Practices in Estimating the Cost of Capital, Financial Practice
and Education 1998
 Cooper and Davydenko - Estimating the Cost of Risky Debt, Journal of
Applied Corporate Finance 2007, Vol. 19 No. 3
 Damodaran 2020 - Equity Risk Premiums Determinants Estimation and
Implications, SSRN
 Fernandez - Survey of Market Risk Premium and Risk-Free Rate used for
81 countries in 2020, SSRN
 Holthausen and Zmijewski - Pitfalls in Levering and Unlevering Beta and
Cost of Capital Estimates, Journal of Applied Corporate Finance 2012, Vol.
24 No. 3
 Jacobs and Shivdasani - Do You Know Your Cost of Capital, Harvard
Business Review 2012,
 Pettit - Corporate Capital Costs A Practitioners Guide, Journal of Applied
Corporate Finance 1999, Vol. 12 No. 1


Topic 3 Capital budgeting

 Amram - How Kimberly-Clark Uses Real Options, Journal of Applied
Corporate Finance 2006, Vol. 18 No. 2
 Graham and Harvey - How Do CFOs Make Capital Budgeting and Capital
Structure Decisions, Journal of Applied Corporate Finance 2002, Vol. 15
No. 1
 Ross - Uses, Abuses, and Alternatives to the Net-present-value Rule,
Financial Management 1995, Vol. 24 Issue 3
 Triantis and Borison - Real Options State of the Practice, Journal of Applied
Corporate Finance 2001, Vol. 14 No. 2

Topic 4 Valuation

 Bancel and Mittoo - The Gap between the Theory and Practice of Corporate
Valuation Survey of European Experts, Journal of Applied Corporate
Finance 2014, Vol. 26 No. 4
 Easton and Sommers - Two Different Ways of Treating Corporate Cash in
FCF Valuations and the Importance of Getting the Cost of Capital Right,
Journal of Applied Corporate Finance 2017, Vol. 29 No. 3
 Estridge and Lougee - Measuring Free Cash Flows for Equity Valuation
Pitfalls and Possible Solutions, Journal of Applied Corporate Finance 2007,
Vol. 19 No. 2
 Hoffmann - Discounted Cash Flow Valuation for Small Cap MA Integration,
Journal of Applied Corporate Finance 2013, Vol. 25 No. 2
 Holthausen and Zmijewski - Valuation with Market Multiples How to Avoid
Pitfalls When Identifying and Using Comparable Companies, Journal of
Applied Corporate Finance 2012, Vol. 24 No. 3
 Nissim and Penman - Ratio Analysis and Equity Valuation from Research
to Practice, Review of Accounting Studies 2001, Vol. 6
 Penman - Handling Valuation Models, Journal of Applied Corporate
Finance 2006, Vol. 18 No. 2

Topic 5 Raising capital

 Anshuman, Martin, and Titman - An Entrepreneur Guide to Understanding
the Cost of Venture Capital, Journal of Applied Corporate Finance 2012,
Vol. 24 No. 3
 Brau and Fawcett - Evidence on What CFOs Think About the IPO Process
Practice, Theory, and Managerial Implications, Journal of Applied
Corporate Finance 2006, Vol. 18 No. 3
 Brown and WIles - Unicorns - Private IPOs and the Changing Markets for
Private Equity Investments and Corporate Control, Journal of Applied
Corporate Finance 2015, Vol. 27 No. 3
 Datta, Gruskin, and Iskandar-Datta - What Happens During the Private
Period Evidence from Public-to-Private Reverse LBOs, Journal of Applied
Corporate Finance 2012, Vol. 24 No. 4
 Katti and Phani - Underpricing of IPOs A Literature Review, Universal
Journal of Accounting and Finance 2016, Vol. 4 No. 2
 King and Mittoo - What Companies Need to Know About International
Cross-Listing, Journal of Applied Corporate Finance 2007, Vol. 19 No. 4
 Kruse, Nohel and Todd - The Decision to Repurchase Debt, Journal of
Applied Corporate Finance 2014, Vol. 26 No. 2
 Wilhelm - Bookbuilding Auctions and the Future of the IPO Process, Journal
of Applied Corporate Finance 2005, Vol. 17 No. 1

Topic 6 Capital structure

 Barclays and Smith - The Capital Structure Puzzle Another Look at the
Evidence, Journal of Applied Corporate Finance 2020, Vol. 32 No. 1
 Cooper - Valuing the Debt Tax Shield, Journal of Applied Corporate
Finance 2007, Vol. 19 No. 2
 DeAngelo and Roll - Capital Structure Instability, Journal of Applied
Corporate Finance 2016, Vol. 28 No. 4
 Fridson - Bond Rating Agencies Conflicts and Competence, Journal of
Applied Corporate Finance 2010, Vol. 22 No. 3
 Graham, Leary, and Roberts - The Leveraging of Corporate America,
Journal of Applied Corporate Finance 2016, Vol. 28 No. 4
 Kisgen - The Influence of Credit Ratings on Corporate Capital Structure
Decisions, Journal of Applied Corporate Finance 2007, Vol. 19 No. 3
 Miller - Leverage, Journal of Applied Corporate Finance 2005, Vol. 17 No.
1
 Rajan and Zingales - Debt, Folklore, and Cross-Country Differences in
Financial Structure, Journal of Applied Corporate Finance 1998, Vol. 10 No.
4

Topic 7 Payout policy

 Abuaf - Excess Cash and Shareholder Payout Strategies, Journal of
Applied Corporate Finance 2012, Vol. 24 No. 3
 Baker and Powell - Determinants of corporate dividend policy survey of
NYSE firms, Financial Practice and Education 2000
 Julio and Ikenbery - Reappearing dividends, Journal of Applied Corporate
Finance 2004, Vol. 16 No. 4
 Michayluk, Walker and Neuhauser - Dividend Consistency Rewards,
Learning, and Expectations, Journal of Applied Corporate Finance 2019,
Vol. 31 No. 4

Topic 8 Mergers and acquisitions

 Bruner - Where MA Pays and Where It Strays A Survey of the Research,
Journal of Applied Corporate Finance 2004, Vol. 16 No. 4
 Gompers, Ishii and Metrick – Corporate Governance and Equity Prices,
Quarterly Journal of Economics 2003, Vol. 118 Issue 1
 Hazelkorn, Shivdasani and Zenner - Creating Value With Mergers and
Acquisitions, Journal of Applied Corporate Finance 2004, Vol. 16 No. 2-3
 Mamdani and Noah - Pathways to success in MA, Journal of Applied
Corporate Finance 2004, Vol. 16 No. 4
 MARC and Intralinks - Attractive targets MA report

TOPIC DESCRIPTION

This section offers an overview of each of the topics covered in this module.


Introduction to corporate finance and governance

Corporate finance deals with the decisions made by firms that have financial implications.
They can be grouped into three main areas: those relating to resource allocation (the
investment decision), those covering the financing of these investments (the capital structure
decision) and those determining how much cash gets reinvested and taken out of the business
(the dividend decision). This topic discusses the framework in which these decisions are
undertaken and introduces some principles of finance (such as time value of money) and
notions of corporate governance. Corporate governance is one of the most important issues
to face organizations of all kinds and their management and other stakeholders. It combines
management, ethics, laws and regulation, corporate social responsibility and stakeholder
theory. It helps to understand the challenges and opportunities that modern enterprises face
in their need to ensure effective management of their role and place in society.

Cost of capital

Companies obtain capital from different stakeholders to fund the assets for operation. These
stakeholders such as bondholders and stockholders demand a return on their investment in
the company, which is the cost of capital for the company. Given a number of alternative
investment opportunities, investors expect the company to put their capital to work in order to
maximize the return. There are different ways to estimate the cost of debt and the cost of
equity capital of the company depending on the company’s capital characteristics. The cost of
capital is important for both the company and investors since it’s the minimum return that
should be earned from the company operation.

Capital budgeting

One of the major decisions managers have to make is to undertake projects. This topic covers
the fundamentals of the investment decision rules and the different types of projects
companies can undertake. They include Net present value, Internal rate of return, Profitability
index, Payback period, Discounted payback period, and Average accounting return. How do
firms use these investment decision rules in practice? How do managers handle projects that
have different life spans? The topic also discusses various types of analyses associated with
capital budgeting including incremental cash flow, sensitivity and scenario analyses, and real
options.

Valuation

The principles underlying the investment decision will be extended to the valuation of the firm
as a whole. The session will define the free cash flows to the firm and the discounted cash
flow method of firm valuation. The underlying differences in valuations between dividends and
free cash flow methods are explored using practical examples and cases. Relative valuation
often supplements the discounted cash flow valuation method. In spite of some limitations,
banks and analysts use this method extensively to derive reasonable proxies for value. This
method includes price-to-earnings, price-to-book and enterprise-to-EBITDA ratios. The
differences and the suitability of different methods are assessed using real practical examples.

Raising capital

The undertaking of suitably identified investment projects often depends on the availability of
funding. Companies can raise capital from private and public sources. The need for financing
future expansion is one reason for going public. The flotation decision poses some critical
questions - pricing, method of issue, etc. for the managers, the existing shareholders and the
financial institutions involved. Publicly listed companies need additional funding for future
expansion. The institutional framework for raising additional equity capital varies across
countries. Seasoned equity offerings involve delicate decisions on pricing, underwriting and
effective distribution of the new shares. Companies can also raise debt capital in different
forms, maturities and repayment provisions.

Capital structure

One of the most controversial issues in corporate finance is the choice between debt and
equity. The question faced by financial managers is whether they can maximize the value of
their company by opting for a particular mix of debt and equity. The theory provides the factors
that can be considered by financial managers in setting their level of debt, including taxes,
bankruptcy costs, signalling and agency costs. How do companies set their capital structure
in practice? Do financial managers choose an optimal level of debt relative to equity as
predicted by some theories or is debt financing irrelevant? What are the financial
characteristics of companies that have high debt equity ratios? How important are taxes,
bankruptcy costs and agency costs in explaining firm’s debt-equity ratios in practice? Do
companies across industries or across countries set their capital structure in the same way?

Payout policy

Most public companies have to decide at least twice a year on the amount of cash flows to
distribute to their shareholders. Some companies are too generous and distribute a large
proportion of their cash flow to their shareholders while others retain their cash for
reinvestments. The corporate finance theory provides a framework for making such a decision
but does not predict the level of cash payment of firms and the question as to whether the
payment of dividend creates value is still controversial. How do companies set their dividends
in practice? What are the forms of dividend payments? Do share repurchases substitute for
cash dividend payments? The empirical evidence provided to date shows that companies
signal their future prospects when paying dividends. How important are other factors, such as
taxes and agency costs, in firms’ dividend policy in practice? Are these factors homogeneous
across countries of different cultures?

Mergers and acquisitions

M&A is among the largest investments that a firm ever will undertake. It is one of the most
important corporate events in the finance and business world in terms of both size and impact.
It also involves substantial re-allocations of resources both within and across industries, and
shape the corporate landscape. A good or bad acquisition can have substantial wealth effects
for the merging firms, managers, and shareholders. Companies have different reasons for
engaging in M&A such as synergy, managerial overconfidence, agency problem, etc. M&A
deal structure could be complicated ranging from the payment methods, advisor involvement,
deal valuation and negotiation, due diligence, and post-deal integration. Do M&A deals create
value? If so, in the short term or long term, and for which party? Merger arbitrage is one of the
strategies employed by hedge funds on M&A deals.