The Lee Kong Chian School of Business Academic Year 2012/13 Term 1

The Lee Kong Chian School of Business Academic Year 2012/13 Term 1 FNCE101 FINANCE Instructor Name : Daniel A Stone Title : Adjunct Tel : Email Office : TBD : dstone@smu.edu.sg COURSE DESCRIPTION This course serves as an introduction to managerial finance. The aim is to provide students with a strong foundation in finance. Students will be exposed to key financial concepts and tools commonly used by managers in making sound financial decisions, which include time value of money, risk-return analysis, asset pricing and cost of capital. The course focuses on basic financial activities undertaken by a firm to create value for its shareholders. These activities include financial planning and management, investing and financing. LEARNING OBJECTIVES By the end of this course, students will be able to: Describe important financial management decisions and forms of business organizations; explain the goal of financial management; explain agency problems; and describe the characteristics of a well-functioning securities market; Interpret balance sheets, income statements; compare and contrast cash flows from operating, investing, and financing activities; and conduct ratio analyses to analyse various aspects of a company s financial health; Calculate and interpret annual percentage rate and effective annual rate; solve time value of money problems for both single cash flow and multiple cash flow problems (Ordinary annuity, annuity due, growing annuity, and perpetuity); and understand the calculation of fixed-payment amortization; Calculate and interpret results using each of the following methods to evaluate capital projects: payback period, discounted payback period, net present value (NPV), internal rate of return (IRR) (and the potential problems with IRR), and profitability index; identify various types of costs, such as sunk costs, opportunity costs, and side effects; and forecast future cash flows with Pro Forma financial statements; State various forms of investment returns; calculate and interpret the difference of arithmetic average and geometric average returns; calculate sample and population mean and standard deviation of returns on a single asset; explain risk-return tradeoffs across asset classes based on historical evidence; Calculate mean and standard deviation of returns on portfolios; understand the correlation between assets and diversification benefit; differentiate systematic vs. unsystematic risk; explain the capital asset pricing model (CAMP), security market line (SML), and asset beta, and the effects on asset expected returns and risk tradeoff; estimate asset beta using tools such as Excel spreadsheet; explain various forms of efficient market hypotheses and their practical implications; Estimate the values of common stocks and preferred stocks, using the discount dividend models (DDM), free cash flow valuation models, and market ratio models; Contrast the theoretical irrelevance of dividend policy with how it is often relevant in practice, including high, low, and residual dividend policies; explain the basic properties stock repurchase and its relation with cash dividend; Explain contractual properties of bonds, special bond features, and bond quotations; calculate and interpret various bond yields (current yield, yield-to-maturity, and realized return); explain the steps in the bond valuation process; explain the difference between nominal and real rate and the effect of inflation; explain factors driving the bond yields; and explain the interest rate risk and the term structure of interest rate, and the effects on bond valuation; 1

Calculate and interpret the cost of equity, cost of debt, and the weighted average cost of capital (WACC) of a company; explain the effect of tax subsidy on cost of debt and WACC; calculate and interpret flotation costs; explain the pure play approach of estimating WACC for multi-sector companies; Explain the basic processes for venture capital investment, IPO, SEO, and rights offerings; explain Modigliani and Miller (MM) theory of optimal capital structure choice under various tax and bankruptcy costs scenarios; solve problems of firm valuation and cost of capital with and without corporate taxes; explain the basic concepts of the peck-order theory of capital structure choice; Define European option, American option, and moneyness, and compute and interpret option payoffs; explain the upper and lower bounds of option prices; value options in a one-period model; explain how factors such as underlying asset price, strike prices, volatility, time to maturity, interest rate affect option prices; explain the put-call parity and calculate call (put) prices applying the put-call parity formula; view the equity portion of the company as a call option of its total assets. PRE-REQUISITE/ CO-REQUISITE/ MUTUALLY EXCLUSIVE COURSE(S) Please refer to the Course Catalogue on OASIS for the most updated list of pre-requisites / co-requisites for this particular course. Do note that if this course has a co-requisite, it means that the course has to be taken together with another course. Dropping one course during BOSS bidding would result in both courses being dropped at the same time. Assessment Method Class Participation: 10% Project: 20% Quizzes: 10% Midterm exam: 20% Final Exam: 40% Academic Integrity All acts of academic dishonesty (including, but not limited to, plagiarism, cheating, fabrication, facilitation of acts of academic dishonesty by others, unauthorized possession of exam questions, or tampering with the academic work of other students) are serious offences. All work presented in class must be the student s own work. Any student caught violating this policy may result in the student receiving zero marks for the component assessment or a fail grade for the course. This policy applies to all works (whether oral or written) submitted for purposes of assessment. Where in doubt, students are encouraged to consult the instructors of the course. Details on the SMU Code of Academic Integrity may be accessed at http://www.smuscd.org/resources.html. INSTRUCTIONAL METHODS AND EXPECTATIONS Class Participation Participation is a central part of the learning process for you and your classmates. Your participation mark reflects your contribution to your classmates learning. You are expected to attend weekly class meetings, prepare for reading materials and other assignments before class, and actively participate in class discussion. Group Project: There will be a group project on a firm s financial health analysis, emphasizing risk-return tradeoffs and valuation. The project will be executed in groups of about 5 students each. Group project will be graded based on a written final report. Details will be provided in class. 2

Quizzes: There will be in-class mini quizzes (each about 20 minutes) aimed to help you better understand the class materials and prepare for the exams. The quizzes will be open-book unless otherwise mentioned. Examinations: There will be a midterm exam and a final exam. Both are 2-hour, closed-book exams (financial calculators will be allowed). The final exam will be cumulative of all content covered in this course. No make-up exams will be allowed without prior permission. FINANCIAL CALCULATOR A financial calculator is needed for various materials covered in class and for the exams. I ll give a brief instruction on the operations of Texas Instruments BA II Plus in class. I encourage you to buy or borrow the same model (many of your seniors have this model). You can use other brands/models, provided that you know how to use them appropriately. RECOMMENDED TEXT AND READINGS Required: Corporate Finance Fundamentals by Stephen A. Ross, Randolph Westerfield, Bradford D. Jordan, Joseph Lim, and Ruth Tan, Asia Global Edition, McGraw-Hill, 2012. Recommended: Additional readings will be assigned. Students are expected to keep abreast of current developments in the Asia-Pacific region by reading leading business dailies/weeklies like the Asian Wall Street Journal, Far Eastern Economic Review, The Economist, Business Times and Business Week. WEEKLY LESSON PLAN (Subject to change) Week Topic Readings Other Readings 1 24Aug Intro to the course and financial management 2 30Aug Cash and Cash flow Financial Statement Analysis Financial Management decision Forms of Business Organization The Goal of Financial Management The Agency Problem Financial Markets Balance Sheet Income Statement Taxes Sources and Uses of Cash The Cashflow Statement Calculating CF from assets (CF to equity holders/debt holders) Liquidity Solvency Profitability Leverage Chapter 1 Chapter 2 2.1-2.3 only Chapter 2 2.4 Mini-case Sunset Boards Chapter 3 3.1, 3.3 P. 82 Question 17 (To Browse only) Chapter 3 3.2 3

3 6Sep Time Value of Money - Calculations 4 13Sep Time Value of Money Applications Simple Interest Compound interest Expressing Rates (e.g. PA, EIR) Present and Future Values (Single Cash flow) PV and FVs on Multiple Cashflows (Annuity, Annuity due, Perpetuity Amortization Financial calculator Payback rule NPV IRR Problems with IRR Mutually exclusive projects Un-even Cash flows CF estimates Issues about costs (Sunk cost, opportunity cost, side effect) Pro Forma financial statement Project analysis and evaluation Scenario, sensitivity, simulation (intro only) Break-even analysis (Accounting, Cash, and Financial breakeven) Chapter 5 All Sections Page 151 Self-test questions 5.1-5.4 Chapter 6 All Sections Page 202-3 Self-test Questions 6.1, 6.2, 6.4-6.6 to class. Any kind, but ideally Texas Instruments BA II. Chapter 9 & 10 Page 321 9.1-9.3 Page 358 10.3 Group Project Assignments Chapter 11 5 & 6 20Sep & 27Sep Risk and Return 1 st Open-book Quiz Dollar & pctg return Capital gain vs dividend yield Arithmetic average vs Geometric average (Blume s formula) Sample average and sample volatility calculation Historical evidence on Chapter 12 & 13 Assgts TBA 4

7 4Oct average return/volatility across asset classes Population mean and variance calculation Normal distribution Portfolio mean and variance calculation Correlation Illustration of diversification benefit Systematic risk vs unsystematic risk Introduction of beta estimate Security Market Line and CAPM Efficient Markets Hypothesis 2 nd Open-book Quiz Mid-term Exam Covering Content through 21Sep 8 11 Oct Mid-term Break 9 18Oct Financial Asset Valuation Basic properties of bonds Bond valuation Bond yield (yield-tomaturity, current yield, realized return) Bond Pricing Interest rate risk and its determinants Term structure of interest rate Nominal vs real rate, inflation Chapter 7 Common stock valuation Discount dividend model (DDM) Constant dividend, constant growth, multi-stage growth Estimate of growth Chapter 8 5

rate P/E and DDM Free cash flow model Preferred stock valuation 10 25Oct Capital Cost and Budgeting Cost of equity DDM approach SML approach Cost of debt Cost of preferred stock WACC Tax and WACC Flotation cost Pure Play and MNCs Chapter 14 11 1Nov Capital Structure 3rd Open-book Quiz Long-term financing choice VC, IPO, SEO MM capital structure theoriesi No tax Tax subsidy of debt financing Bankruptcy costs Pecking Order Theory Chapter 15-16 12 8Nov Dividend Decision Irrelevance of dividend policy High/low payout in practice Residual dividend policy Stock repurchases Chapter 17 13 15Nov Options Contract Features Strategy Pay-offs and Premium Valuation boundaries and formula Inputs of option value Put-call Parity Chapter 14 and 24 14 19-23 Nov Revision Week 4 th Open-book Quiz Group Project Assignments Submitted 6

15 27 Nov Final Exam Final Exam Common to all sessions of FNCE 101 7