Fluent Essays

Mini-case # 4 The Investment Detective is on page 239 of the textbook. You will find four questions in the text; answer each question. Include an excel document with the calculations of your quantitative rankings. Additional Notes: For question 2, include NPV, IRR, MIRR, Payback Period, Discount Payback Period, and Profitability Index. Page i Case Studies in Finance Managing for Corporate Value Creation Eighth Edition Robert F. Bruner Kenneth M. Eades Michael J. Schill Page ii CASE STUDIES IN FINANCE: MANAGING FOR CORPORATE VALUE CREATIONS, EIGHTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2018 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2014, 2002, and 1989. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 LCR 21 20 19 18 17 ISBN 978-1-259-27719-1 MHID 1-259-27719-4 Portfolio Manager: Tim Vertovec Senior Product Developer: Jennifer Upton Marketing Manager: Trina Maurer Content Project Managers: Melissa M. Leick, Karen Jozefowicz Buyer: Susan K. Culbertson Content Licensing Specialist: Beth Thole Compositor: Aptara , Inc. All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data ® Names: Bruner, Robert F., 1949-author. | Eades, Kenneth M., author. | Schill, Michael J., author. Title: Case studies in finance: managing for corporate value creation / Robert F. Bruner, Kenneth M. Eades,  Michael J. Schill. Description: Eighth Edition. | Dubuque, IA : McGraw-Hill Education, [2018] | Series: The McGraw-Hill/Irwin series in finance, insurance, and real estate | Revised edition of the authors’ Case studies in finance, [2014] Identifiers: LCCN 2017023496| ISBN 9781259277191 (alk. paper) | ISBN 1259277194 (alk. paper) Subjects: LCSH: Corporations—Finance—Case studies. | International business enterprises—  Finance—Case studies. Classification: LCC HG4015.5 .B78 2017 | DDC 658.15—dc23 LC record available  at https://lccn.loc.gov/2017023496 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw- Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites. mheducation.com/highered https://lccn.loc.gov/2017023496 http://mheducation.com/highered Page iii The McGraw-Hill Education Series in Finance, Insurance, and Real Estate FINANCIAL MANAGEMENT Block, Hirt, and Danielsen Foundations of Financial Management Sixteenth Edition Brealey, Myers, and Allen Principles of Corporate Finance Twelfth Edition Brealey, Myers, and Allen Principles of Corporate Finance, Concise Second Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Ninth Edition Brooks FinGame Online 5.0 Bruner, Eades, and Schill Case Studies in Finance: Managing for Corporate Value Creation Eighth Edition Cornett, Adair, and Nofsinger Finance: Applications and Theory Fourth Edition Cornett, Adair, and Nofsinger M: Finance Fourth Edition DeMello Cases in Finance Third Edition Grinblatt (editor) Stephen A. Ross, Mentor: Influence through Generations Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition Higgins Analysis for Financial Management Twelfth Edition Ross, Westerfield, Jaffe, and Jordan Corporate Finance Eleventh Edition Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Fifth Edition Ross, Westerfield, and Jordan Essentials of Corporate Finance Ninth Edition Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Twelfth Edition Shefrin Behavioral Corporate Finance: Decisions that Create Value Second Edition INVESTMENTS Bodie, Kane, and Marcus Page iv Essentials of Investments Tenth Edition Bodie, Kane, and Marcus Investments Eleventh Edition Hirt and Block Fundamentals of Investment Management Tenth Edition Jordan, Miller, and Dolvin Fundamentals of Investments: Valuation and Management Eighth Edition Stewart, Piros, and Heisler Running Money: Professional Portfolio Management First Edition Sundaram and Das Derivatives: Principles and Practice Second Edition Financial Institutions and Markets Rose and Hudgins Bank Management and Financial Services Ninth Edition Rose and Marquis Financial Institutions and Markets Eleventh Edition Saunders and Cornett Financial Institutions Management: A Risk Management Approach Ninth Edition Saunders and Cornett Financial Markets and Institutions Seventh Edition INTERNATIONAL FINANCE Eun and Resnick International Financial Management Eighth Edition REAL ESTATE Brueggeman and Fisher Real Estate Finance and Investments Sixteenth Edition Ling and Archer Real Estate Principles: A Value Approach Fifth Edition Financial Planning and Insurance Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches Tenth Edition Altfest Personal Financial Planning Second Edition Harrington and Niehaus Risk Management and Insurance Second Edition Kapoor, Dlabay, Hughes, and Hart Focus on Personal Finance: An active approach to help you achieve financial literacy Sixth Edition Kapoor, Dlabay, Hughes, and Hart Personal Finance Twelfth Edition Walker and Walker Personal Finance: Building Your Future Second Edition Page v Dedication In dedication to our wives Barbara M. Bruner Kathy N. Eades And to the memory of Mary Ann H. Schill and to our children Page vi About the Authors Robert F. Bruner is University Professor, Distinguished Professor of Business Administration and Charles C. Abbott Professor of Business Administration and Dean Emeritus of the Darden Graduate School of Business Administration at the University of Virginia. He has taught and written in various areas, including corporate finance, mergers and acquisitions, investing in emerging markets, innovation, and technology transfer. In addition to Case Studies in Finance, his books include Finance Interactive, multimedia tutorial software in Finance (Irwin/McGraw-Hill 1997), The Portable MBA (Wiley 2003), Applied Mergers and Acquisitions, (Wiley, 2004), Deals from Hell: M&A Lessons that Rise Above the Ashes (Wiley, 2005) and The Panic of 1907 (Wiley, 2007). He has been recognized in the United States and Europe for his teaching and case writing. BusinessWeek magazine cited him as one of the “masters of the MBA classroom.” He is the author or co-author of over 400 case studies and notes. His research has been published in journals such as Financial Management, Journal of Accounting and Economics, Journal of Applied Corporate Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, and Journal of Money, Credit, and Banking. Industrial corporations, financial institutions, and government agencies have retained him for counsel and training. He has been on the faculty of the Darden School since 1982, and has been a visiting professor at Harvard, Columbia, INSEAD, and IESE. Formerly he was a loan officer and investment analyst for First Chicago Corporation. He holds the B.A. degree from Yale University and the M.B.A. and D.B.A. degrees from Harvard University. Copies of his papers and essays may be obtained from his website, http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Robert-F-Bruner/ He may be reached via email at [email protected] Kenneth M. Eades is Professor of Business Administration and Area Coordinator of http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Robert-F-Bruner/ mailto:[email protected] Page vii the Finance Department of the Darden Graduate School of Business Administration at the University of Virginia. He has taught a variety of corporate finance topics including: capital structure, dividend policy, risk management, capital investments and firm valuation. His research interests are in the area of corporate finance where he has published articles in The Journal of Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, and Financial Management. In addition to Case Studies in Finance, his books include The Portable MBA (Wiley 2010) Finance Interactive, a multimedia tutorial software in Finance (Irwin/McGraw- Hill 1997) and Case Studies in Financial Decision Making (Dryden Press, 1994). He has authored or co-authored over 70 case studies as well as a web-based, interactive tutorial on the pricing of financial derivatives. He has received the Wachovia Award for Excellence in Teaching Materials and the Wachovia Award for Excellence in Research. Mr. Eades is active in executive education programs at the Darden School and has served as a consultant to a number of corporations and institutions; including many commercial banks and investment banks; Fortune 500 companies and the Internal Revenue Service. Prior to joining Darden in 1988, Professor Eades was a member of the faculties at The University of Michigan and the Kellogg School of Management at Northwestern University. He has a B.S. from the University of Kentucky and Ph.D. from Purdue University. His website is http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Kenneth-M-Eades/ and he may be reached via email at [email protected] Michael J. Schill is Professor of Business Administration of the Darden Graduate School of Business Administration at the University of Virginia where he teaches corporate finance and investments. His research spans empirical questions in corporate finance, investments, and international finance. He is the author of numerous articles that have been published in leading finance journals such as Journal of Business, Journal of Finance, Journal of Financial Economics, and Review of Financial Studies, and cited by major media outlets such as The Wall Street Journal. He has been on the faculty of the Darden School since 2001 and was previously with the University of California, Riverside, as well as a visiting professor http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Kenneth-M-Eades/ mailto:[email protected] at Cambridge and Melbourne. He is the current course head for Darden’s core MBA finance course. He is the author or co-author of over 40 cases and technical notes, as well as a financial market simulation entitled Bond Trader. Prior to his doctoral work, he was a consultant with Marakon Associates in Stamford and London. He received a B.S. degree from Brigham Young University, an M.B.A. from INSEAD, and a Ph.D. from University of Washington. More details are available from his website, http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Michael-J-Schill/ He may be reached via email at [email protected] http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Michael-J-Schill/ mailto:[email protected] Page viii Contents Dedication  v About the Authors  vi Contents  viii Foreword  xi Preface  xii Note to the Student: How To Study and Discuss Cases  xxiii Ethics in Finance  xxx 1  Setting Some Themes 1  Warren E. Buffett, 2015   To think like an investor   3 2  The Battle for Value, 2016: FedEx Corp. vs. United Parcel Service, Inc.   Valu e creation and economic profit   23 3  Larry Puglia and the T. Rowe Price Blue Chip Growth Fund   Market efficienc y   43 4  Genzyme and Relational Investors: Science and Business Collide?   Value cre ation, business strategy and activist investors   63 2  Financial Analysis and Forecasting 5  Business Performance Evaluation: Approaches for Thoughtful Forecasting   F inancial forecasting principles   89 6  The Financial Detective, 2016   Financial ratio analysis   107 7  Whole Foods Market: The Deutsche Bank Report   Financial performance for ecasting   113 8  Horniman Horticulture   Financial forecasting and bank financing   127 Page ix 9  Guna Fibres, Ltd.   Forecasting seasonal financing needs   133 3  Estimating the Cost of Capital 10  “Best Practices” in Estimating the Cost   Estimating the cost of capital   145 of Capital: An Update 11  Roche Holdings AG: Funding the Genentech Acquisition   Cost of debt capit al   173 12  H. J. Heinz: Estimating the Cost of Capital in Uncertain Times   Cost of capi tal for the firm   189 13  Royal Mail plc: Cost of Capital   Cost of capital for the firm   197 14  Chestnut Foods   Cost of capital for multi-division firm   207 4  Capital Budgeting and Resource Allocation 15  Target Corporation   Multifaceted capital investment decisions   219 16  The Investment Detective   Investment criteria and discounted cash flow    239 17  Centennial Pharmaceutical Corporation   Valuation of earnout plan   241 18  Worldwide Paper Company   Analysis of an expansion investment   249 19  Fonderia del Piemonte S.p.A.   Capital investment decision   253 20  Victoria Chemicals plc (A): The Merseyside Project   Relevant cash flows    257 21  Victoria Chemicals plc (B): Merseyside and Rotterdam Projects   Mutually e xclusive investment opportunities   265 22  The Procter & Gamble Company: Investment in Crest Whitestrips Advanced Se al   Scenario analysis in a project decision   273 23  Jacobs Division 2010   Strategic planning   285 24  University of Virginia Health System: The Long-Term Acute Care Hospital Proj ect   Analysis of an investment in a not-for-profit organization   293 25  Star River Electronics Ltd.   Capital project analysis and forecasting   30 3 5  Management of the Firm’s Equity: Dividends and R epurchases 26  Rockboro Machine Tools Corporation   Dividend payout decision   313 27  EMI Group PLC   Dividend policy   329 28  Autozone, Inc.   Dividend and stock buyback decisions   347 6  Management of the Corporate Capital Structure 29  An Introduction to Debt Policy and Value   Effects of debt tax shields   3 63 30  M&M Pizza   Capital structure in a frictionless market   369 31  Structuring Corporate Financial Policy: Diagnosis of Problems and Evaluation o f Strategies   Concepts in setting financial policy   373 32  California Pizza Kitchen   Optimal leverage   391 33  Dominion Resources: Cove Point   Project funding and capital structure    409 34  Nokia OYJ: Financing the WP Strategic Plan   Corporate funding alternativ es   425 35  Kelly Solar   Debt financing negotiation   449 36  J. C. Penney Company   Liquidity management   453 37  Horizon Lines, Inc.   Financial distress/restructuring/bankruptcy   467 7  Analysis of Financing Tactics: Leases, Options, an d Foreign Currency 38  Baker Adhesives   Hedging foreign currency cash flows   483 39  Vale SA   Debt financing across borders   489 40  J&L Railroad   Risk management and hedging commodity risk   501 Page x 41  WNG Capital, LLC   Economics of lease financing   513 42  MoGen, Inc.   Convertible bond valuation and financial engineering   52 5 8  Valuing the Enterprise: Acquisitions and Buyo uts 43  Methods of Valuation for Mergers and Acquisitions   Valuation principles    539 44  Medfield Pharmaceuticals   Valuing assets in place   559 45  American Greetings   Firm valuation in stock repurchase decision   571 46  Ferrari: The 2015 Initial Public Offering   Initial public offering valuation    583 47  Rosetta Stone: Pricing the 2009 IPO   Initial public offering valuation   6 03 48  Sun Microsystems   Valuing a takeover opportunity   623 49  Carter International   Acquisition valuation and financing   645 50  DuPont Corporation: Sale of Performance Coatings   Business Unit Divestitu re   657 51  OutReach Networks: First Venture Round   Valuation of early stage compan y   679 52  Sanofi-Aventis’s Tender Offer for Genzyme   Corporate acquisition   68 7 53  Delphi Corporation   Corporate bankruptcy   715 54  Flinder Valves and Controls Inc.   Acquisition negotiation   731 Page xi Foreword As I think about developing the next generation of leaders in business and finance, I naturally reflect on my own path. My career in business has taught some profound lessons—and so did my experience at the University of Virginia’s Darden School of Business. Both life experience and school learning are critical components in the development of any leader. For that reason, I have supported wholeheartedly higher education as the path toward a promising future. As the world keeps changing, higher education must continually adapt. Practices, processes, and business models that were once popular have faded. At the same time, the field of Finance has witnessed dramatic changes, including the advent of new valuation models, the rise of new markets and institutions, the invention of new financial instruments, the impact of new information technologies, and growing globalization. In this environment, we must think critically about the changing world, pay attention to new ideas, and adapt in sensible ways. Business schools play a critical role in the change process: theory suggests new approaches, empirical research tests them, and classroom teaching transfers knowledge. The development of new teaching materials is vital to that process. Case studies in Finance have evolved markedly over the past 40 years. This shift reflects the revolutionary changes in markets and organization, as well as the many significant advances in theory and empirical research. Because case studies are an invaluable teaching tool, it is critical that the body of cases grows with the practice of and scholarship in Finance. I am pleased to introduce the reader to the eighth edition of Case Studies in Finance, by Robert F. Bruner, Kenneth M. Eades, and Michael J. Schill. These professors exemplify the practice-oriented scholar who understands the economic foundations of Finance and the extensive varieties of its practice. They translate business phenomena into material that is accessible both to experienced practitioners and novices in Finance. This book is a valuable contribution to the teaching materials available in the field of Finance. First, these cases link managerial decisions to capital markets and investor expectations. At the core of most is a valuation task that requires students to look to financial markets to resolve the problem. Second, these cases feature a wide range of contemporary and relevant problems, including examples in real and financial options, agency conflicts, financial innovation, investing in emerging markets, and corporate control. They also cover classic topics in Finance, including dividend policy, the mix of debt and equity financing, the estimation of future financial requirements, and the choice between mutually exclusive investments. Finally, these cases invite students to harness technology they will use in the workplace to develop key insights. I am confident this collection will help students, scholars, and practitioners sharpen their decision-making ability, and advance the development of the next generation of leaders in Finance. John R. Strangfeld Chairman and Chief Executive Officer Prudential Financial, Inc. May 3, 2017 Newark, New Jersey Page xii Preface The inexplicable is all around us. So is the incomprehensible. So is the unintelligible. Interviewing Babe Ruth in 1928, I put it to him “People come and ask what’s your system for hitting home runs—that so?” “Yes,” said the Babe, “and all I can tell ‘em is I pick a good one and sock it. I get back to the dugout and they ask me what it was I hit and I tell `em I don’t know except it looked good.”   —Carl Sandburg Managers are not confronted with problems that are independent of each other, but with dynamic situations that consist of complex systems of changing problems that interact with each other. I call such situations messes . . . Managers do not solve problems: they manage messes.   —Russell Ackoff Orientation of the Book Practitioners tell us that much in finance is inexplicable, incomprehensible, and unintelligible. Like Babe Ruth, their explanations for their actions often amount to “I pick a good one and sock it.” Fortunately for a rising generation of practitioners, tools and concepts of Modern Finance provide a language and approach for excellent performance. The aim of this book is to illustrate and exercise the application of these tools and concepts in a messy world. Focus on Value The subtitle of this book is Managing for Corporate Value Creation. Economics teaches us that value creation should be an enduring focus of concern because value is the foundation of survival and prosperity of the enterprise. The focus on value also helps managers understand the impact of the firm on the world around it. These cases harness and exercise this economic view of the firm. It is the special province of finance to highlight value as a legitimate concern for managers. The cases in this book exercise valuation analysis over a wide range of assets, debt, equities, and options, 1 2 3 Page xiii and a wide range of perspectives, such as investor, creditor, and manager. Linkage to Capital Markets An important premise of these cases is that managers should take cues from the capital markets. The cases in this volume help the student learn to look at the capital markets in four ways. First, they illustrate important players in the capital markets such as individual exemplar Warren Buffett and institutions like investment banks, commercial banks, rating agencies, hedge funds, merger arbitrageurs, private equity firms, lessors of industrial equipment, and so on. Second, they exercise the students’ abilities to interpret capital market conditions across the economic cycle. Third, they explore the design of financial securities, and illuminate the use of exotic instruments in support of corporate policy. Finally, they help students understand the implications of transparency of the firm to investors, and the impact of news about the firm in an efficient market. Respect for the Administrative Point of View The real world is messy. Information is incomplete, arrives late, or is reported with error. The motivations of counterparties are ambiguous. Resources often fall short. These cases illustrate the immense practicality of finance theory in sorting out the issues facing managers, assessing alternatives, and illuminating the effects of any particular choice. A number of the cases in this book present practical ethical dilemmas or moral hazards facing managers—indeed, this edition features a chapter, “Ethics in Finance” right at the beginning, where ethics belongs. Most of the cases (and teaching plans in the associated instructor’s manual) call for action plans rather than mere analyses or descriptions of a problem. Contemporaneity and Diversity All of the cases in this book are set in the year 2006 or after and 25 percent are set in 2015 or later. A substantial proportion (57 percent) of the cases and technical notes are new, or significantly updated. The mix of cases reflects the global business environment: 52 percent of the cases in this book are set outside the United States, or have strong cross-border elements. Finally the blend of cases continues to reflect the growing role of women in managerial ranks: 31 percent of the cases present women as key protagonists and decision-makers. Generally, these cases reflect the increasingly diverse world of business participants. Plan of the Book The cases may be taught in many different combinations. The sequence indicated by the table of contents corresponds to course designs used at Darden. Each cluster of cases in the Table of Contents suggests a concept module, with a particular orientation. Page xiv 1. Setting Some Themes. These cases introduce basic concepts of value creation, assessment of performance against a capital market benchmark, and capital market efficiency that reappear throughout a case course. The numerical analysis required of the student is relatively light. The synthesis of case facts into an important framework or perspective is the main challenge. The case, “Warren E. Buffett, 2016,” sets the nearly universal theme of this volume: the need to think like an investor. The updated case entitled, “The Battle for Value, 2016: FedEx Corp. vs. United Parcel Service, Inc.” explores the definition of business success and its connections to themes of financial management. “Larry Puglia and the T. Rowe Price Blue Chip Growth Fund,” is an updated version of cases in prior editions that explores a basic question about performance measurement: what is the right benchmark against which to evaluate success? And finally, “Genzyme and Relational Investors: Science and Business Collide?”, is a case that poses the dilemma of managing a public company when the objectives of the shareholders are not always easily aligned with the long-term objectives of the company and an activist investor is pressuring the company for change. 2. Financial Analysis and Forecasting. In this section, students are introduced to the crucial skills of financial-statement analysis, break-even analysis, ratio analysis, and financial statement forecasting. The section starts with a note, “Business Performance Evaluation: Approaches for Thoughtful Forecasting”, that provides a helpful introduction to financial statement analysis and student guidance on generating rational financial forecasts. The case, “The Financial Detective 2016”, asks students to match financial ratios of companies with their underlying business and financial strategies. “Whole Foods Market: The Deutsche Bank Report” provides students with the opportunity to reassess the financial forecast of a research analyst in light of industry dynamics. This case can also be used an opportunity for students to hone firm valuation skills with the evaluation of the analyst’s “buy, hold, or sell” recommendation. “Horniman Horticulture” uses a financial model to build intuition for the relevancy of corporate cash flow and the financial effects of firm growth. The case, “Guna Fibres” asks the students to consider a variety of working capital decisions, including the impact of seasonal demand upon financing needs. Other cases address issues in the analysis of working-capital management, and credit analysis. 3. …