532 Week 8 Objectives
FBE 532 - Class Objectives and Problem Assignments
J. K. Dietrich
Week 8 – March 2, 2006
Goals and Objectives
(1) Discuss steps and describe carefully procedures used to estimate and calculate net present value (NPV)
and internal rate-of-return (IRR) for investment projects and list and critique possible pitfalls in
using a the IRR criteria and/or the firm’s weighted-average cost of capital (WACC) for analyzing
possible investments.
(2) List types of real options and describe the implications of real options on evaluation of investments in
contrast to relying exclusively on NPV analysis
(3) Identify departures from assumptions used in the financial theory of investment and financing and
describe how these departures can influence the amounts and types of financing of investments
(4) Describe how leasing can be useful for corporate investment, list factors that determine whether leases
are capital or operating leases, and why that matters, and discuss how synthetic leases are
structured
Suggested Review Reading for this Class
Review investment project analysis as discussed in RWJ, Chapters 6 to 8 and Chapter 21 with appendix
Important Vocabulary List from this Class
NET PRESENT VALUE RULE, INTERNAL RATE OF RETURN
REAL OPTIONS, MANAGEMENT OPTIONS, OPTION VALUE
GROWTH, TIMING, SWITCHING, EXPANSION/CONTRACTION, AND ABANDONMENT
OPTIONS
OPERATING LEASES, FINANCIAL LEASES, SYNTHETIC LEASES
TRANCHES, RECOURSE AND
NON-RECOURSE DEBT, OFF-CREDIT
SPECIAL PURPOSE ENTITIES (SPEs)
OFF-BALANCE SHEET FINANCING
Case Questions for Next Class on March 23, 2006 (Financing PPL Corporation’s Growth Strategy**)
The issue facing management concerns the advantages and disadvantages of financing $1 billion in
electricity generating plants with traditional or limited recourse synthetic lease structures and your team
should make a recommendation on the best choice. The following questions are provided as guidance in
developing your group’s position on this issue but should not be taken as an outline or suggestion for the
specifics of your one-page memo.
(1) What departures from Modigliani and Miller and efficient market theories result in the attractiveness of
synthetic leases to corporations, specifically PPL in this case (they are widely used by many corporations)?
How do these departures from finance theory explain the tradeoffs determining the desirability of different
forms of off-balance sheet financing?
(2) What parties are involved in the financing involved in a synthetic lease and what determines their
differing expected risks and returns? Can you calculate or estimate the costs of the two types of synthetic
leases from data provided in Exhibit 9 so that you can assess the net benefits of a limited recourse synthetic
532 Week 8 Objectives
lease? In any case, what are all the factors that will determine the relative attractiveness of different lease
structures for PPL?
(3) What business considerations are driving the rapid expansion in generating capacity and how do timing
issues interact with the financing decision? Why is timing a concern in arranging the synthetic lease
financing in the present case and how do the different lease structures relate to cost and timing issues?
Suggested Review Readings for next Class on March 23, 2006
Chapters 2 and 3
Case Questions for Following Class on March 30, 2006 (Clarkson Lumber*)
This is an individual case write-up. These questions are provided for guidance only.
(1) Why does Mr. Clarkson have to borrow so much to support this profitable business?
(2) Do you agree with his estimate of the company’s loan requirements? How much will he need to borrow
to finance his expected expansion in sales volume to $5.5 million in 1996?
(3) Should he plan on taking all trade discounts in his calculations?
(4) As Mr. Clarkson’s financial advisor, 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. Clarkson’s loan request, and if so, what conditions would you put on the loan?
Notes: You should use the figures given in the case to come up with a specific amount for the loan to
answer part (4) above.
Suggested Wall Street Journal (WSJ) or other Articles
Continuing Stories (Multiple articles)
Dubai’s Ports World effort to buy English port operator Peninsula & Oriental Steam Navigation for $6.8
billion has provoked massive political interest and press coverage, illustrating the non-financial
considerations raised by corporate investment strategies involving cross-border acquisitions
Mittal’s effort to acquire Arcelor Steel continues to unfold
Stories last week
February 21, 2006
“Boards Tie CEO Pay More Tightly to Performance” (A1) – Efforts to use compensation to align
management to shareholders’ interests, as discussed in first classes
“Stock Buyback Will Raise Debt Of Time Warner” (A3) – Changes in financing of firm discussed, in line
with our class discussion this semester
“Alinta Nears Australian Gas Bid After Purchasing 10% of Shares” (A8) – Complex example of a
combination of mergers and spin-offs involving synergies and takeovers in Australia
February 22, 2006
532 Week 8 Objectives
“GM’s Debt Downgraded Again” (A13) – Good example of the impact of changes in risk assessments on
the costs of debt and the limits of debt capacity as discussed in class
“Australian Firm Plans Eircom Bid” and “Blackstone Group To Buy MeriStar For $940 Million” (both C4)
– Examples of private- equity deals involving taking publicly traded assets private
February 23, 2006
“Fannie Mae Report On Accounting Shields Board” (A3) – Directors responsibilities discussed in context
of reported accounting irregularities in major firm largely based on derivatives trading as discussed
in last few classes
“Simply Put: Accounting-Rule Makers May Change How to Book Derivatives” (C1) – Story discusses
issues for management in reporting earnings when hedging price or interest-rate risks with
derivatives
February 24, 2006
“Intel to Build Vietnam Chip Plant Raising Nation’s High-Tech Profile” (A6) – Decision to make major
investment in emerging market reflects global strategy and raises some international finance issues
we discuss later in the semester
“E.On Opts for Power Play” (B2) – Cross-border merger representing restructuring of European energy
markets and political impacts
“Prada Sells Jil Sander to Private-Equity Firm” (B4) – More activity suggesting the role of private-equity
firm in corporate restructuring
“News Corp. Buys Turner South For $375 Million” (B4) – Another example of a corporate investment in
the form of an acquisition
“CME’s Parent Examines Routes Into Credit-Derivatives Market” (C3) – Organized exchange tries to
overcome obstacles to design standardized contract to trade in competition with the over-thecounter market