Jeffrey F.

Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 1

Spring 2016
Corporate Finance FNCE 100
Wharton School of Business

Syllabus

Course Description:
This course provides an introduction to the theory, the methods, and the concerns of corporate finance. It forms the foundation for all subsequent courses such as speculative
markets, investments and corporate finance. The purpose of this course is to develop a
framework for analyzing a firms investment and financing decisions. Since the emphasis
is on the fundamental concepts underlying modern corporate finance, the approach will
be analytical and rigorous, and some familiarity with accounting, mathematical, and statistical tools is necessary. The topics covered in the course include (1) discounted cash
flow (time value of money), (2) capital budgeting, (3) valuation of stocks, (4) valuation
of bonds, (5) security market efficiency, (6) corporate financing and optimal capital structure, (7) portfolio analysis and the Capital Asset Pricing Model (CAPM), and (8) options.

Grading:
There are two midterms, each counting 30%, and a final exam, counting 40%. The midterms are scheduled for Monday, February 22 and Monday, April 4. Both midterms will
be given from 6:15 8:15 PM.

Attendance:
Students are responsible for all material presented in class. You must attend the section
in which you are enrolled.

Required Reading:
The textbook is Corporate Finance by Ross, Westerfield, Jaffe, and Jordan, 11th edition, customized for FNCE 100.

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 2

Readings:
a) Value and Capital Budgeting
Firms and individuals invest in a large variety of assets. The objective of these investments is to maximize the value of the investment. In this part, we will develop tools that
can be used to determine the best investment from several alternatives.
Ch. 4
Ch. 5
Ch. 6
Ch. 8
Ch. 9

Discounted Cash Flow Valuation

Net Present Value and Other Investment Rules
Making Capital Investment Decisions
Interest Rates and Bond Valuation
Stock Valuation

b) Capital Structure
As with capital-budgeting decisions, firms seek to create value with their financing decisions. Therefore, firms must find positive NPV financing arrangements. However, to
maximize NPV in financial markets, firms must consider taxes, bankruptcy costs, and
agency costs. In this part, we will develop the methodology to maximize the value of the
financing decision.
Ch. 14 Efficient Capital Markets and Behavioral Challenges
Ch. 16 Capital Structure: Basic Concepts
Ch. 17 Capital Structure: Limited Use of Debt
Ch. 18 Valuation and Capital Budgeting for the Levered Firm

c) Risk and Portfolio Analysis

In this part, we will investigate the relationship between expected return and risk for portfolios and individual assets. This relationship determines the shareholders required (expected) return and the firms cost of equity capital. The capital-asset-pricing model is
used to measure risk and expected return.
Ch. 10 Risk and Return: Lessons from Market History
Ch. 11 Return and Risk: The Capital-Asset-Pricing Model (CAPM)
Ch. 13 Risk, Cost of Capital, and Valuation
d) Options
In this part, we study both the principles and uses of options.
Ch. 22 Options and Corporate Finance

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 3

DETAILED DESCRIPTION OF TOPICS

The first four topics deal with the time value of money and its application to capital
budgeting:
TOPIC I FUTURE AND PRESENT VALUE
This topic examines one of the most important concepts in all of corporate finance, the
relationship between $1 today and $1 in the future.
Chapter 4
Compounding the one period case
Assignment 1
Discounting the one period case
Compounding beyond one year
Discounting beyond one year
Compounding more rapidly than once a year
Annual percentage rate vs. effective annual yield
Continuous compounding
Multiperiod valuation
Short cuts for multiperiod valuation:
Perpetuity
Growing perpetuity
Annuity
Growing annuity
Examples
Pension fund and Mortgage

TOPIC II THE RULES OF CAPITAL BUDGETING

This topic examines alternative approaches to capital budgeting.
Chapter 5
Definition of capital budgeting
(Excl. Sect. 5.6)
The justification for net present value
Independent vs. mutual exclusive projects
Simple net present value example
Payback example
Problems with payback
Internal rate of return (IRR)
Problems of IRR with independent projects
Borrowing vs. lending
Multiple rates of return
No internal rates of return
Problems of IRR with mutually exclusive returns
Timing
Scale
Replacement chains

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 4

TOPIC III THE PRACTICE OF CAPITAL BUDGETING

This topic considers the practical application of capital budgeting techniques. Most of the
emphasis here is on the determination of cash flows.
Chapter 6
Brief review of capital budgeting
Relation between cash flow and accounting income
Important considerations in determining cash flows
Incremental cash flows
Opportunity costs
Taxes
Stockholders vs. tax books
Working capital and capital budgeting
Inflation and capital budgeting
Interest rates and inflation
Cash flow and inflation
Discounting: nominal vs. real
Direct cash flow effects of purchase and sale of capital assets
Initial outlay
Depreciation
Resale of used asset
TOPIC IV VALUATION OF STOCKS AND BONDS
This topic uses earlier techniques (present value and future value) to value stocks and
bonds.
Chapter 9
Stocks
(Excl. Sect. 9.5)
Brief discussion of discount rate
Relationship between short-term investor and long-term investor
Assignment 2
Dividends vs. capital gains
Estimating growth
Difference between income and growth stocks
Growth opportunities
Price-Earnings ratio
Pitfalls in applying dividend discount model and related approaches

Chapter 8,
including appendix

Assignment 3

Bonds
Pure discount bonds
Coupon bonds
Interest rates and bond prices
Coupon vs. yield to maturity
Term structure of interest rates
Spot rates and yield to maturity

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 5
Forward rates
Explanation of term structure
Corporate Debt

The next five topics deal with capital structure decisions.

TOPIC V EFFICIENT CAPITAL MARKETS AND CAPITAL STRUCTURE
This topic defines efficient capital markets, presents empirical evidence, and shows why
timing decisions on capital structure are suspect.
Chapter 14
Definition of efficient capital markets
Types of market efficiency
Empirical evidence
Implications for corporate managers

TOPICS VI AND VII CAPITAL STRUCTURE WITHOUT TAXES AND WITH

TAXES
Topic VI examines the basic issues of capital structure, finishing with the ModiglianiMiller relationship without taxes. Topic VII extends the Modigliani-Miller relationship to
the world of corporate taxes.
Chapter 16
The goal of the manager: Maximizing the value of the firm
(pp. 490 - 506)
The relationship between firm value and stock price
Assignment 4
How to maximize value: The traditionalists approach
A counter-example to traditionalist approach
The effect of leverage on value: Modigliani-Miller (MM) Proposition I
The effect of leverage on required equity return: ModiglianiMiller (MM) Proposition II
Justification for equality between personal and corporate borrowing rate
Example when inequality between rates occurs
The concept of market value balance sheets
(pp. 506 515)
Assignment 5

The basic paradigm: The pie chart

Why the IRS treats interest more favorable than dividends
The value of the tax shield
The value of the levered firm: MM Proposition I
The effect of leverage on required equity return: MM Proposition II
Market value balance sheets
Effect of leverage on stock prices

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 6

TOPIC VIII ADJUSTED PRESENT VALUE, WEIGHTED AVERAGE COST OF

CAPITAL AND FLOWS TO EQUITY
This topic shows how the earlier material on capital structure can be used to perform capital budgeting on levered firms.
Chapter 18
Adjusted Present Value (APV)
(Excluding 18.7)
The base case: Review of capital budgeting
Tax shield
Market Value Balance Sheets
Weighted average cost of capital (WACC)
The cost of equity
The cost of debt
Calculating WACC
Flows to Equity
Determining cash flows
Determining discount rate
EPS and shareholder risk
Comparison of WACC and APV
The scale enhancing project
The known debt level case
A suggested guideline
Recapitalization
LBO Example
TOPIC IX COSTS OF DEBT AND OPTIMAL CAPITAL STRUCTURE
Topic IX shows why firms must balance the tax benefits of debt with agency costs of
debt when considering capital structure.
Chapter 17
Relationship between MM theory with taxes and real world behavior
(Excluding 17.7 and The search for costs of debt: Bankruptcy
17.8)
Direct costs of financial distress
Indirect costs of financial distress
Who bears costs of financial distress
Taxes vs. bankruptcy costs: The tradeoff
The three determinants of debt level
Decision-Making in the real world
Agency costs of equity
Application to LBOs
Bonding the managers
How LBOs reduce agency costs
The future of LBOs

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 7

The next three topics deal with the relationship between risk and returns in its application
to the determination of the discount rate in capital budgeting.
TOPIC X STATISTICAL CONCEPTS AND AN OVERVIEW OF CAPITAL MARKETS
Chapter 10

Preview of the next three topics

Review of definition of return
Risk statistics for an isolated stock
Variance
Standard deviation
Risk statistics for a diversified investor
Covariance
Correlation
An historical perspective to risk and return

TOPIC XI RETURN AND RISK

The topic develops the relationship between the expected return on a stock and its risk.
Chapter 11
Statistical parameters for a portfolio
Expected return on a portfolio
Variance and standard deviation of a portfolio
The efficient frontier
Efficient set for 2 assets
Efficient set for many assets
Efficient set and diversification
Efficient frontier and riskless borrowing and lending
The relationship between risk and return
Beta: The measure of risk for individual security in context of a
large portfolio
Expected return as compensation for beta
The capital asset pricing model (CAPM)
Empirical evidence on CAPM
Determining beta in the real world
Formula for calculating beta

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 8

TOPIC XII THE CAPM AND CAPITAL BUDGETING

This topic shows how discount rates for projects can be determined from the relationship
between risk and return.
Chapter 13
Review of rationale for choosing a discount rate
(Excl. Sect. 13.11)
Relationship between beta of a stock and beta of a project
Determinants of beta of a project
Practical application of CAPM to capital budgeting
TOPIC XIII OPTIONS
This topic discusses both the principles and uses of options.
Chapter 22
Definition of calls and puts
(Excl. 22.8 22.11) Combinations of options
Covered calls
Put-call parity
Other option strategies

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 9

RECOMMENDED END-OF-CHAPTER PROBLEMS (Not to be handed in)

While attending class and reading the textbook are obviously necessary for learning the
FNCE 100 material, doing end-of-chapter problems is also an extremely important way
to understand and reinforce the material. Students should work through the following
end-of-chapter problems. While I strongly urge all students to attempt both the suggested
and additional problems, students should, at the very least, tackle the suggested ones.
Chapter 4
Suggested:
Basic: # 3, 4, 6, 12, 13, 14, 15, 16
Intermediate: # 21, 24, 25, 26, 27, 28, 30, 34, 38, 40, 41, 45, 46, 49
Challenge: # 52, 54, 56, 57, 65, 66, 67, 68, 69, and 70
Chapter 5
Suggested:
Basic: # 1, 5
Intermediate: # 11, 13
Challenge: # 23, 28
Additional Practice Problems:
Basic: # 6
Intermediate: # 14, 17
Chapter 6
Suggested:
Basic: # 1, 3, 4, 5, 9
Intermediate: # 14, 15, 23, 25
Challenge: # 30, 31, 33, 34
Additional Practice Problems:
Intermediate: # 19
Challenge: # 38a

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 10

Chapter 9
Suggested:
Basic: # 1, 4, 9
Intermediate: # 13, 14, 15, 16, 18, 21, 23
Challenge: # 30, 33, 34
Additional Practice Problems:
Intermediate: # 17, 24, 25
Challenge: # 31
Note:
#25 the P/E ratio that you are asked to calculate is the trailing P/E ratio.
Chapter 8
Suggested:
Basic: # 3, 4
Intermediate: # 17, 18, 19, 20, 21
Challenge: #31
and # 1 6 in Appendix to Bond Chapter
Additional Practice Problems:
Intermediate: # 24, 26
Chapter 14
Suggested:
Concept Questions: # 2, 3, 5, 6, 7
Basic: # 2, 3, 4
Additional Practice Problems:
Concept Questions: # 11

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 11

Chapter 16
Suggested:
Basic: # 1, 2, 12, 13, 14, 15, 16
Intermediate: # 17, 18, 19, 23, 24, 25
Challenge: #26
Note:
#26 while this is a theoretical question, the rudiments of this question will be discussed
in class.
Chapter 18 (excluding the CAPM questions which will not be on the second midterm)
Suggested:
Basic: # 1, 3
Intermediate: # 10, 11, 12
Challenge: # 15, 16, 17
Chapter 17
Suggested:
Concept Questions: # 1, 2, 4
Intermediate: #8
Chapter 10
Suggested:
Basic: # 1, 2, 12, 17
Intermediate: #23
Additional Practice Problems:
Basic: # 4, 6
Chapter 11
Suggested:
Basic: # 1, 2, 3, 5, 10, 12, 16
Intermediate: # 26, 28, 29, 30, 31
Challenge: # 34, 36, 37, 38

Jeffrey F. Jaffe
Corporate Finance FNCE 100

Spring Semester 2016

Syllabus, page 12

Note:
#37 the sentence Assume the CAPM holds should be ignored.
#38 uses calculus which will not be on exam.
Additional Practice Problems:
Basic: # 6, 9
Intermediate: # 22
Chapter 13
Suggested:
Basic: # 1, 3, 5, 10, 11, 12, 13
Intermediate: # 16, 19, 21
Challenge: #24 (ignore part e and flotation cost)
Note:
#24 this is a good problem to go over but ignore calculations of flotation cost, which
you will not be responsible for on the final
Chapter 18 (CAPM questions which can be on the final exam but not on the second midterm)
Suggested:
Basic: #4
Intermediate: #13
Chapter 22
Suggested:
Concept Questions: # 1, 2, 3, 4, 5, 6, 7, 11, 12, 13
Basic: #2, 3