Volume 30 CONTENTS Winter 2004
#1 - The Required Growth Factor: How Large
is a Firm Expected to Become?
Morris G. Danielson
The required growth factor measures the amount of future (real) growth that will justify a firm's stock price. Is the company expected to become twice as large as it is today, three times as large, or more? The required growth factor is a concrete measure of growth an investor or student can compare to the size of a firm's potential markets. If the required amount of growth is larger than the firm's potential markets, the firm's stock price is too high. The required growth factor is illustrated for three firms—Microsoft, Wal-Mart, and K-Mart—using data from the 1989 to 2000 period.
#2 - An Empirical Analysis of a
Cumulative/Re-Work Testing Strategy:
Its Effect on Student Performance in Principles of Finance
Kam C. Chan and Connie Shum
This paper examines the effectiveness of a cumulative/rework testing strategy (CRTS) in principles of finance course. We find evidence suggesting that CRTS adversely affected student performance although students had a positive perception of CRTS. The empirical results are robust to different estimation methods and different performance measures. The findings of this study are in contrast with the literature in psychology and accounting. We conjecture that the mechanics of responding to CRTS may be different with respect to different disciplines or different student academic standings and students may not study as hard as they should since they know that they can rework the missed problems.
#3 - Using Excel to Solve the Unequal Lives, Unequal Cost of Capital Problem
Michael J. Barry
This paper provides an Excel model to solve the problem where managers must choose between two projects of unequal lives, each with a different cost of capital. The model computes each project’s NPV, equivalent annual cash flow and the present value of an unending series of these annual cash flows. Straight-line depreciation and MACRS depreciation are both modeled. This model can resolve the age-old dilemma of buying something inexpensive or paying extra for quality.
#4 - Using the U.S. Treasury Market to Teach Bond Valuation and Financial Engineering
Cheri Etling, Luis Garcia-Feijoo and Randy D. Jorgensen
The U.S. Treasury STRIPS program allows coupon-bearing Treasury securities to be stripped into zero-coupon bonds that then trade separately. Studying the mechanics of this process helps students understand the building block approach to valuation and the process of financial engineering. We make these topics accessible by discussing 1) bond valuation and stripping, 2) the Treasury STRIPS market and financial innovation, and 3) how to use Treasuries to create securities with unique maturity and coupon structures. This teaching note provides the related background and foundation material along with exercises based on Wall Street Journal bond quotes allowing professors to link bond valuation and financial engineering with reading the Journal.
#5 - Teaching Real Options in the Financial
A Pedagogical Note
John A. Halloran and Howard P. Lancer
The purpose of this paper is to share class notes designed to introduce real options to students in the financial management course. The notes present the fundamental ways in which real options create value that are not accounted for in standard NPV analysis. Because we stress the conceptual and fundamental framework of real options, we strive to avoid the mathematical complexities that can quickly envelope the discussion of real options. Consequently, we first value a real option situation through the use of a basic decision tree analysis. This type of analysis is most appropriate for inexperienced undergraduate students in a first course in financial management. We then introduce contingent claims analysis as an alternative valuation technique for real options. Given its additional financial sophistication, this technique might be most appropriate for graduate students or more experienced undergraduates in an intermediate level financial management course.
#6 - An Instructional Case on Real Optons
J. Barry Lin and Anthony F. Herbst
Businesses constantly make strategic changes in response to changes in business environment. Conventional NPV-based capital budgeting does not account for the value of such strategic flexibility, and thus leads to under-investment. This case applies real option theory of modern finance, and analyzes embedded real options within the framework of a fish farming-tourist/recreational operation. Numerical examples are given to illustrate the optimal exercise of strategic options, calculation of Strategic Net Present Value, and the valuation of several commonly observed Real Options. The analytical tools can be generalized to the evaluation of any project with embedded real options. The general conclusions and illustrations for optimal exercise are also easily applicable to similar strategic evaluations.
#7 - Case Study: KPMG Consulting's IPO
Eric W. Hayden
Rand Blazer, CEO of KPMG Consulting, Inc.,1 was facing one of the most important -and also one of the most difficult- decisions of his business career. It was mid-January 2001, and he and his management team were planning to take their firm public in the next few weeks. They had already postponed an initial public offering ("IPO") the previous spring due to a badly deteriorating stock market, and things had only gotten worse since then. As investors continued to shun stocks, especially IPOs, should the issue again be postponed?