432 Week 11 Objectives
FBE 432 - Class Objectives and Problem Assignments
J. K. Dietrich
Week 11 – November 4 and 6, 2002
Goals and Objectives
(1) Calculate the value of and interpret the sustainable growth rate for a firm
(2) Trace the implications on financial policy of growth rates higher and lower than the sustainable growth
rate for a firm
(3) Discuss the importance of financial flexibility and critically assess the trade-offs from use of various
financial options in implementing a firm’s strategy
Suggested Review Reading for next Class
RWJ, Chapter 18
Questions for Next Case (November 18, 2002*, Avon Products)
* Note change in date in response to student preferences
(1) Evaluate Avon’s investment and financing decisions in the late 1980’s. Why was Avon restructuring
its business in 1988? Did the changes make sense?
(2) Evaluate Avon’s financial condition in mid-1988. Why was Avon reducing its dividend?
(3) What was the purpose of the exchange offer?
(4) What payoffs does an Avon PERCS provide as a function of the future stock price? What specifically
is motivating this design? I marketability an issue?
(5) As in institutional investor holding Avon stock, how would you evaluate the tradeoff between accepting
the new preferred and keeping the common stock? Should you just sell the common stock and ignore
the offer altogether?
Notes: the Avon case is an example of creative security design involving embedded options. Further, the
case provides new insights into dividend policy and its role in a corporation’s overall business strategy.
The case description of PERCA is not completely clear and requires more explanation: The exchange offer
invites investors to tender up to 25% of common stock. PERCs pay $2 dividends per year, paid in quarterly
installments of $ .50, for 13 quarters beginning September 1, 1988, and ending September 1, 1991. The
common stock pays $1 dividends per year, also in 13 quarterly payments. The redemption value of PERCs
is the price of Avon’s common stock on September 1, 1991, if this price is below $31.50 and $31.50
otherwise.
Case Questions for Following Week’s Class (November 25, 2002 *, Huaneng Power International)
* Note change in date in response to student preferences
(1) What are Huaneng Power’s strengths and weaknesses?
(2) Is this the right time for Huaneng Power International (HPI) to raise capital overseas? What are the
benefits to HPI of listing on a U.S. exchange? Are there other financing alternatives the HPI
should have considered?
432 Week 11 Objectives
(4) Was the chosen issue price for HPI reasonable? What is a reasonable value for 25% of HPI?
(5) Will foreign investors be interested in buying stock in this company? Should HPI proceed with this
issue?
(6) Given the economic, political, and social environment in the PRC, would you recommend that U.S.
institutional investors buy stock in HPI?
Note: HPI will issue 1,250,000,000 new B shares to bring the total number of shares outstanding to 5
billion. Each ADR represents 40 B class shares. To get cash flows, you need to estimate the firm’s capital
expenditures. This can be done using the data in Exhibit 10, noting that capital expenditures in year t
equals net assets in year t+1 minus net assets in year t + depreciation in year t. Regarding the data in
Exhibit 14, keep in mind that the projected EPS of $1.45 is for an ADR, not an ordinary share.
Important Vocabulary List from Class
SUSTAINABLE GROWTH
OPTIMAL GROWTH
ACTUAL GROWTH
DEBT POLICY, DIVIDEND POLICY
FINANCIAL FLEXIBILITY
Suggested Wall Street Journal (WSJ) or other Articles
October 28, 2002
“The Investors” (R3) – Discussion of role of venture capital in a real-life case very much like Clarkson
Lumber; many of you might be interested in the rest of this special section on “Small Business”
that deals with a range of small business problems
October 29, 2002
“GE Taps 2 Outside Directors In Move to Boost Governance” (A8) – Good example of firm’s worried
about perception of poor corporate governance and background to end-of-semester discussion on
that issue
“Growth Needs a Plan or Only Losses May Build” (B9) – Article on a firm is real-life counterpart to smallfirm cases discussed this year, including Clarkson Lumber
October 30, 2002
“Uncooking the Books: How Three Unlikely Sleuths Discovered Fraud at WorldCom” (A1) – Fascinating
account of who and how misleading accounting numbers were created at major firm and how
junior people uncovered and dealt with the deceptions
“Well-Baked: With Its Business So Slow, Wall Street Shows Hunger for Any Deal” (C1) – Background
piece on factors affecting jobs in investment banking
October 31, 2002
“IPO Shows China Is Bent on Selling State Enterprises” (A17) – IPO of major Chinese company recalls the
Huaneng Power case discussed later this semester