Washington University in St.

Louis
Olin Business School
FIN 534B Advanced Corporate Finance II: Financing
Meetings: Monday, Wednesday: Bauer Hall 230
Section 1: 11:30am 1:00pm
Section 2: 1:00 2:30pm

Professor Mark Leary

Office: 215 Simon Hall
Phone: 314-935 6394
E-mail: leary@wustl.edu

Office hours: Tuesday, Friday: 3:00 4:00 pm,

or by appointment

Teaching assistants:
Yun (Bella) Bai (ybai@wustl.edu
Rui Xu (rxu25@wustl.edu)

Course Objectives:
The purpose of this course is to provide an understanding of the financing decisions made by corporations.
While ACF I focuses on firms investment decisions, this course focuses on how firms fund those investments,
how they return capital to investors, and on the interaction between investing and financing decisions. By the
end of the course, you should be able to articulate how a variety of market frictions, such as taxes, financial
distress costs, asymmetric information and agency conflicts create costs for firms, and how managers can use
financial policy capital structure, debt structure, and payout policy to minimize these costs and create value
for the firm.

Course Material:

Course packet
The course packet includes copies of the case studies we will discuss in class, and should be available in
the book store.

Text book
I highly recommend using whichever Corporate Finance text you already own from Fin 5203 (finance
core) or equivalent. In the schedule below I have included the relevant chapters for each class session
from the following recommended texts:
Berk and DeMarzo (B&D): Corporate Finance (Pearson) (1st 2nd or 3rd Edition)
Brealey, Myers and Allen (BMA), Principles of Corporate Finance (McGraw-Hill) (10th or 11th Edition)

Lecture notes
At each class session I will hand out copies of lecture slides. Note that in order to facilitate engagement
in class, these notes will not contain answers to all the questions we will discuss or examples we will
work out in class. However, if you miss something, filled-in versions of the notes will be posted to
Blackboard following each class.

Evaluation:
Class Participation
Group Assignments (4)
Take-home quiz (Individual)
Final Exam

10%
30%
15%
45%

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How to prepare for class

We will rely on four primary learning tools:
Interactive lectures
Case discussions
Assignments and practice problems
Text book readings
These are designed to complement one another. While some students may wish to emphasize some tools more
than others, depending on your learning style, I would not recommend neglecting any of them.
It is important that you come to class prepared on case discussion days. The better prepared you are, the better
will be the classroom experience and the more we will all learn.
Lectures:
In our lectures, we will try to address three broad types of questions for each topic.
1. What does financial theory say about a given market friction?
Why is it costly to the firm? How can financial policy mitigate these costs?
2. Do firms actually behave this way?
Is there evidence from case examples, manager surveys or empirical studies that firms follow the
predictions of the theory?
3. How then should I manage my firm?
To which types of firms does the theory apply most? What are the relationships between firm
characteristics and optimal financial policy?
How to do well on the assignments
The assignments are designed to help reinforce the material, apply concepts weve learned to actual firm data,
and prepare for the exams. They will include a combination of analytical problems and questions pertaining to
the cases we will discuss in class.
For the assignments, you may work independently or in groups of two to three people.
Important assignment policies:
1. Each group should submit one hard copy of the assignment, with each group members name indicated.
2. The assignments are due at the beginning of class. If you are not able to attend class, you may submit your
assignment electronically. Late assignments will not be accepted without prior permission.
3. Any re-grade requests must be submitted in writing, with an explanation of the proposed discrepancy.
Requests must be submitted within 2-weeks after the assignment is returned.
How to do well on the exam
The exam will contain both qualitative and quantitative questions.
In order to do well on the qualitative portion, you need to understand the concepts. Think through the issues
we have studied and apply them to the questions.
For questions with calculations, it is the justifications, logic and interpretations which are important and not the
actual number. Bring a calculator but it need not be a fancy one. Show all your work.
The final exam will be closed books and closed notes, but you may bring a one-page cheat sheet.
The final exam covers the entire course.
How to do well on class participation
My evaluation of class participation is based on the quality as well as quantity of your participation.
Answering questions, asking thoughtful questions and contributing comments that enhance our class discussion
are all great ways to participate.

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Communication:
Please make use of the office hours or make an appointment to see me or one of the TAs. I am usually here and
more than happy to find some time to meet with you. Your feedback on what is interesting or difficult is
important. Finally, the course is short. If you find yourself lost, come see me as soon as possible. Do not wait for
the exam before coming for help.

Schedule:
A tentative schedule appears below. The chapter numbers listed are guidelines. Since this is a 6-week course, not
everything in each chapter will be covered in class.

Week

Date

Topic

16-Mar

Introduction and core concepts

Leverage and risk in perfect markets

18-Mar

Applications of M&M

23-Mar

Recapitalization and the tax benefits A New Financial Policy

of debt
at Swedish Match

25-Mar
30-Mar

Case Readings

Text Readings
B&D
BMA

Assignments
Due

14, 24

14, 24
17

15

18.1 - 18.2

Credit ratings and debt capacity

15.1 - 15.3

18.1, 23.3

Costs of debt and the

tax-bankruptcy tradeoff

16.1 - 16.4

18.3, 23

16.8

18.4

23

15

16.5 - 16.7

18.3

Take-home Quiz
(Individual)

28.6, 19.5

19(review)
32.1
25

Group Assign. 3

1-Apr

Information asymmetry and security

issuance

6-Apr

IPOs

8-Apr

Moral hazard, agency costs and

financial structure

13-Apr

LBOs & ABS financing

15-Apr

More on debt structure

20-Apr

Payout policy

22-Apr

Payout policy (applications)

29-Apr

Final Exam 9:00am - 12:00 pm

Bauer Hall, Room 240 (Section 1)
Bauer Hall, Room 230 (Section 2)

Google IPO

Hertz LBO

24.1, 24.4
25
17
Dividend Policy
at FPL Group

17

Group Assign. 1

Group Assign. 2

16
16

Group Assign. 4

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Academic Integrity:
The Olin Business School is a community of individuals with diverse backgrounds and interests who share
certain fundamental goals. Primary among these goals is the creation and maintenance of an atmosphere
conducive to learning and personal growth for everyone in the community. Becoming a member of the Olin
community is a privilege that brings certain responsibilities and expectations. The success of Olin in attaining its
goals and in maintaining its reputation of academic excellence depends on the willingness of its members, both
collectively and individually, to meet their responsibilities. All individuals associated with Olin should conduct
themselves with the utmost integrity in all aspects of their life, both on and off campus.
The MBA Code of Conduct outlines the following responsibilities for you, as the student, and me, as the instructor,
that we will follow in the context of this course:
Student Responsibilities
The Code of Professional Conduct (the Code) is meant to encourage and clarify appropriate classroom, interpersonal,
and extra-curricular etiquette that is expected of each individual by their peers, the faculty and the institution. It is also
intended to help describe the overall environment of excellence and professionalism that all members of the Olin
community seek to establish and to continually enhance. It is the responsibility of each member of the Olin community to
uphold the spirit, as well as the principles, of the Code.
Expectations Professional Standards of Conduct
In keeping with these shared expectations, Olin graduate students are expected to conduct themselves at all times
in a professional manner. Professional behavior includes, but is not limited to, the following:

In the Classroom
Attendance: Students are expected to attend each class session. Students who must miss a session for any reason
should make every effort to notify the instructor prior to the class meeting. Students should never register for
courses scheduled in conflict with one another.
Punctuality: Students are expected to arrive and be seated prior to the start of each class session. They should
display their name cards in all classes at all times.
Behavior: Classroom interaction will be conducted in a spirited manner, but always while displaying
professional courtesy and personal respect.
Preparation: Students are expected to complete the readings, case preparations and other assignments prior to
each class session and be prepared to actively participate in class discussion.
Distractions:
Exiting and Entering: Students are expected to remain in the classroom for the duration of the class
session unless an urgent need arises or prior arrangements have been made with the professor.
Laptop, PDA, and Other Electronic Device Usage: Students are expected to use laptops, PDAs and
other electronic devices only with the instructors consent and for activities directly related to the class
session. Accessing e-mail or the Internet during class is not permitted as they can be distracting for peers
and faculty.
Cellular Phone and Pager Usage: Students are expected to keep their mobile phones and pagers turned
off or have them set on silent/vibrate during class. Answering phones or pagers while class is in session
is not permitted.
Other distractions: Specifically identified by individual instructors, such as eating in the classroom.
Outside the Classroom:

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Students are expected to conduct themselves professionally when dealing with all members of the Olin and
Washington University communities as well as in the career search process, at club activities, networking events,
job interviews, and other functions where they are representing the Olin community.
Facilities: Students are expected to help maintain the appearance and the functionality of the building,
classrooms, and other facilities.

Should Violations of this Code Occur:

The matter may be referred to the Code of Professional Conduct Council for review and possible sanctions. The
Council will consist of one appointed member from each of these groups: the graduate student body, the faculty,
and the staff.

Faculty Responsibilities

Members of the faculty teaching in the graduate programs will consistently and fully support the Code of
Professional Conduct which includes a uniform policy concerning behavior both in and outside the classroom
environment.
All Graduate Faculty members agree to treat students with professional courtesy and personal respect.
All Graduate Faculty members affirm that it is proper and appropriate to use the entire range of the existing
grading system.
All Graduate classes will include a final exam and/or other method(s) of individual evaluation.
Most Graduate classes will use cold calling or similar techniques in the classroom and will, as appropriate,
place grading value on class participation.
All Graduate classes agree to employ a mid-course student feedback mechanism (for the exclusive benefit of the
faculty member).
Faculty members assigned to Graduate classes will return assignments in a timely fashion and provide an
appropriate level of feedback on graded coursework.

Disabilities
Reasonable accommodations will be made for students with verifiable disabilities. Students who qualify for
accommodations must register through Washington Universitys Center for Advanced Learning Disability
Resources (DR) in Cornerstone. Their staff members will assist me in arranging appropriate accommodations.

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Core Competencies
The following are the key concepts and skills that we will cover in each section of the course.
I. Intro to Capital Structure
a. Understand why firm value and WACC are unaffected by financial structure in perfect markets
b. Be able to show the effects of financial transactions on both book value and market value balance
sheets
c. Understand the effect of financial leverage on the risk and expected return of equity
II. Taxes and capital structure
a. Understand how debt financing reduces corporate tax payments
b. Understand the personal tax cost of debt financing
c. Be able to calculate the annual cash flow impact of interest tax shields with:
i. Corporate taxes only
ii. Corporate and personal taxes
d. Be able to calculate the capitalized present value of tax shields under different assumptions
i. Perpetual vs. finite maturity debt
ii. With and without personal tax penalty
iii. When to use rD or rU to discount future tax shields
iv. Adjusting for exhaustion of taxable income
e. Be able to calculate the effect of a change in capital structure on the after-tax WACC
f. Understand which types of firms should find interest tax shields most valuable
III. Swedish Match case discussion
a. Calculate the impact of a leverage increasing (or decreasing) recapitalization on share price in the
presence of corporate and personal taxes
b. Estimate the impact of a change in leverage on a firms credit rating
c. Estimate a firms appropriate debt level with various methods (Industry comparisons, target a
credit rating, cash flow versus debt service)
d. Understand the difference between expected yield and promised yield on risky debt and between
book value and market value of debt
e. Be able to approximate the cost of risky debt using debt betas or the adjusted yield-to-maturity
approach
IV. Tax-bankruptcy tradeoff
a. Understand the sources of financial distress costs
b. Calculate the net gain to leverage as PV of expected tax shield benefit minus expected financial
distress costs
c. Understand which types of firms should find financial distress most costly
V. Information asymmetry
a. Understand why asymmetric information makes outside equity financing costly for good quality
firms
b. Understand why internal funds and debt are less exposed to these information costs
c. Understand why rights offerings avoid the costs of information asymmetry
d. Calculate the impact of a rights offer on the number of shares outstanding, share price, value of a
right, and shareholder wealth.

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VI. IPOs
a. Understand the major benefits and costs of going public
b. Be able to calculate:
i. Effect of an IPO on the number of shares outstanding (understanding the difference
between primary and secondary shares offered)
ii. Net proceeds raised by the firm
iii. Total underwriter costs
iv. Money left on the table due to underpricing
c. Understand the common explanations for IPO underpricing
d. Understand the role of investment banks in the IPO process
VII.

Agency conflicts
a. Understand the two roles of high debt in mitigating manager-shareholder agency conflicts
i. Preserving incentives of original owners
ii. Disciplining managers by pre-committing free cash flow to lenders
b. Understand why high debt can lead equity holders to:
i. Pass up safe, positive NPV projects
ii. Invest in high risk projects, even if negative NPV
c. Understand how convertible debt and short-term debt can mitigate the risk-shifting problem
d. Understand how the monitoring role of banks can mitigate agency conflicts
e. Understand which types of firms are most exposed to manager-shareholder and debtholderequityholder agency costs

VIII.

Hertz LBO case

a. Understand the major sources of value associated with LBO transactions (refer back to sections
on tax shield value and agency conflicts)
b. Understand the benefits of asset-backed (ABS) financing in minimizing financial distress costs,
avoiding debt overhang problems, and enhancing access to public market debt.

IX. Leasing
a. Be able to adjust a firms leverage ratio for operating lease obligations
b. Be able to evaluate whether a lease is more/less attractive to purchasing the same asset with
leverage
X. Payout Policy
a. Understand why payout policy does not affect firm (or equity) value in a perfect capital market
setting
b. Payout levels; Understand:
i. When corporate taxes create an incentive to increase/decrease payout
ii. Why financial distress costs create an incentive to reduce payout
iii. Why mgr-shareholder agency conflicts create an incentive to increase payout
iv. How payout policy can influence a firms shareholder clientele
c. Dividends vs. Share repurchases; Understand:
i. The tax incentive for repurchases
ii. The financial flexibility advantage of repurchases