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Bruner Eades Schill Visit the Online Learning Center at www.mhhe.com/bruner7e to see a complete list of changes to the Seventh Edition and to access study and teaching tools. seventh edition Eades S chill Case Studies in Finance managing for corporate value creation seventh edition MD DALIM #1218056 12/10/12 CYAN MAG YELO BLK managing for corporate value creation investors. At the core of almost all of the cases is a valuation task that requires students to look to nancial markets for guidance in resolving the case problem. These cases also invite students to apply modern information technology to the analysis of managerial decisions. In the Seventh Edition, 25% of the cases are new with many dating from 2011-2012, ensuring that your students are learning from the most relevant and current sources. Case Studies in Finance Case Studies in Finance links managerial decisions to capital markets and the expectations of Bruner bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page i Case Studies in Finance Managing for Corporate Value Creation bru6171X_fm_i-l.qxd ii ii 12/11/12 Part One Part Title 3:01 PM Page ii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page iii Case Studies in Finance Managing for Corporate Value Creation Seventh Edition Robert F. Bruner Kenneth M. Eades Michael J. Schill bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page iv CASE STUDIES IN FINANCE: MANAGING FOR CORPORATE VALUE CREATION, SEVENTH EDITION Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved. Printed in the United States of America. Previous editions 2002, 1989, and 1975. 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 The McGraw-Hill Companies, Inc., 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 0 DOC/DOC 1 0 9 8 7 6 5 4 3 ISBN 978-0-07-786171-1 MHID 0-07-786171-X Senior Vice President, Products & Markets: Kurt L. Strand Vice President, Content Production & Technology Services: Kimberly Meriwether David Managing Director: Douglas Reiner Executive Brand Manager: Charles Synovec Developmental Editor II: Jennifer Lohn Executive Marketing Manager: Melissa Caughlin Editorial Coordinator: Casey Rasch Director, Content Production: Terri Schiesl Senior Project Manager: Lisa A. Bruodt Buyer: Nichole Birkenholz Media Project Manager: Prashanthi Nadipalli Cover Design: Studio Montage, St. Louis, MO Cover Image: Alija/Getty Images Typeface: 10/12 Times Compositor: Cenveo Publisher Services Printer: R. R. Donnelley Library of Congress Cataloging-in-Publication Data Bruner, Robert F., 1949Case studies in nance : managing for corporate value creation / Robert F. Bruner, Kenneth M. Eades, Michael J. Scholl.--Seventh Edition. pages cm Includes index. ISBN-13: 978-0-07-786171-1 (alk. paper) ISBN-10: 0-07-786171-X (alk. paper) 1. Corporations--Finance--Case studies. 2. International business enterprises--Finance--Case studies. I. Eades, Ken M. II. Schill, Michael J. III. Title. HG4015.5.B78 2013 658.15--dc23 2012046392 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, and McGraw-Hill does not guarantee the accuracy of the information presented at these sites. www.mhhe.com bru6171X_fm_i-l.qxd 12/18/12 5:52 PM Page v The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate Stephen A. Ross Franco Modigliani Professor of Finance and Economics Sloan School of Management Massachusetts Institute of Technology Consulting Editor FINANCIAL MANAGEMENT Block, Hirt, and Danielsen Foundations of Financial Management Fourteenth Edition Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition Brealey, Myers, and Allen Principles of Corporate Finance Eleventh Edition Higgins Analysis for Financial Management Tenth Edition Brealey, Myers, and Allen Principles of Corporate Finance, Concise Second Edition Kellison Theory of Interest Third Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Seventh Edition Ross, Westereld, and Jaffe Corporate Finance Tenth Edition Brooks FinGame Online 5.0 Ross, Westereld, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Third Edition Bruner, Eades, and Schill Case Studies in Finance: Managing for Corporate Value Creation Seventh Edition Cornett, Adair, and Nofsinger Finance: Applications and Theory Second Edition Cornett, Adair, and Nofsinger M: Finance Second Edition DeMello Cases in Finance Second Edition Grinblatt (editor) Stephen A. Ross, Mentor: Inuence through Generations Ross, Westereld, and Jordan Essentials of Corporate Finance Eighth Edition Ross, Westereld, and Jordan Fundamentals of Corporate Finance Tenth Edition Shefrin Behavioral Corporate Finance: Decisions that Create Value First Edition White Financial Analysis with an Electronic Calculator Sixth Edition bru6171X_fm_i-l.qxd 12/18/12 5:52 PM Page vi INVESTMENTS Bodie, Kane, and Marcus Essentials of Investments Ninth Edition Bodie, Kane, and Marcus Investments Ninth Edition Hirt and Block Fundamentals of Investment Management Tenth Edition Jordan, Miller, and Dolvin Fundamentals of Investments: Valuation and Management Sixth Edition Stewart, Piros, and Heisler Running Money: Professional Portfolio Management First Edition Sundaram and Das Derivatives: Principles and Practice First Edition FINANCIAL INSTITUTIONS AND MARKETS Rose and Hudgins Bank Management and Financial Services Ninth Edition Saunders and Cornett Financial Institutions Management: A Risk Management Approach Seventh Edition Rose and Marquis Financial Institutions and Markets Eleventh Edition Saunders and Cornett Financial Markets and Institutions Fifth Edition INTERNATIONAL FINANCE Eun and Resnick International Financial Management Sixth Edition REAL ESTATE Brueggeman and Fisher Real Estate Finance and Investments Fourteenth Edition Ling and Archer Real Estate Principles: A Value Approach Fourth 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 First Edition Harrington and Niehaus Risk Management and Insurance Second Edition Kapoor, Dlabay, and Hughes Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills Fourth Edition Kapoor, Dlabay, and Hughes Personal Finance Tenth Edition Walker and Walker Personal Finance: Building Your Future First Edition bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page vii Dedication In dedication to our wives Barbara M. Bruner Kathy N. Eades Mary Ann H. Schill and to our children vii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page viii About the Authors Robert F. Bruner is Dean of the Darden Graduate School of Business Administration, Distinguished Professor of Business Administration and Charles C. Abbott Professor of Business Administration at the University of Virginia. He has taught and written in various areas, including corporate nance, 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, nancial 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 various schools including Columbia, INSEAD, and IESE. Formerly he was a loan ofcer 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 brunerr@virginia.edu. Kenneth M. Eades is Professor of Business Administration and Area Coordinator of the Finance Department of the Darden Graduate School of Business Administration at the University of Virginia. He has taught a variety of corporate nance topics including: capital structure, dividend policy, risk management, capital investments and rm valuation. His research interests are in the area of corporate nance 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 written numerous case studies as well as a web-based, interactive tutorial on the pricing of nancial 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 viii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page ix About the Authors ix 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-MEades/ and he may be reached via email at eades@virginia.edu. Michael J. Schill is Associate Professor of Business Administration of the Darden Graduate School of Business Administration at the University of Virginia where he teaches corporate nance and investments. His research spans empirical questions in corporate nance, investments, and international nance. He is the author of numerous articles that have been published in leading nance 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. Some of his recent research projects investigate the market pricing of rm growth and the corporate gains to foreign stock exchange listing or foreign currency borrowing. 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 at Cambridge and Melbourne. Prior to his doctoral work, he was a management consultant with Marakon Associates in Stamford and London. He continues to be active in consulting and executive education for major corporations. 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 schill@virginia.edu. ix bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page x Contents Dedication vii About the Authors viii Contents x Foreword xiii Preface xiv Note to the Student: How To Study and Discuss Cases xxv Ethics in Finance xxxii 1 Setting Some Themes 1. 2. 3. 4. 5. Warren E. Buffett, 2005 Bill Miller and Value Trust Ben & Jerry's Homemade The Battle for Value, 2004: FedEx Corp. vs. United Parcel Service, Inc. Genzyme and Relational Investors: Science and Business Collide? 2 To think like an investor Market efciency Value creation and governance Value creation and economic prot 3 23 39 53 Value creation, business strategy and activist investors 75 Financial Analysis and Forecasting 6. 7. 8. 9. 10. 11. 12. The Thoughtful Forecaster The Financial Detective, 2005 Krispy Kreme Doughnuts, Inc. The Body Shop International PLC 2001: An Introduction to Financial Modeling Value Line Publishing: October 2002 Horniman Horticulture Guna Fibres, Ltd. 3 Forecasting principles Ratio analysis Financial statement analysis Introduction to forecasting 101 119 125 143 Financial ratios and forecasting Analysis of growth and bank nancing Forecasting seasonal nancing needs 161 175 181 Estimating the cost of capital 193 Cost of debt capital 219 Cost of capital for the rm Business segments and risk-return tradeoffs Project specic risk-return 235 243 257 Estimating the Cost of Capital 13. 14. 15. 16. 17. x \"Best Practices\" in Estimating the Cost of Capital: Survey and Synthesis\" Roche Holdings AG: Funding the Genentech Acquisition Nike, Inc.: Cost of Capital Teletech Corporation, 2005 The Boeing 7E7 bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page xi Contents 4 xi Capital Budgeting and Resource Allocation 18. 19. 20. 21 22. 23 24. 25 26. 27. 28. The Investment Detective Worldwide Paper Company Target Corporation Aurora Textile Company Compass Records The Procter and Gamble Company: Investment in Crest Whitestrips Advanced Seal Victoria Chemicals plc (A): The Merseyside Project Victoria Chemicals plc (B): The Merseyside and Rotterdam Projects Star River Electronics Ltd. The Jacobs Division 2010 University of Virginia Health System: The Long-Term Acute Care Hospital Project 5 6 Investment criteria and discounted cash ow Analysis of an expansion investment Multifaceted capital investment decisions Analysis of an investment in a declining industry Analysis of working capital investment Scenario analysis in a project decision 283 285 289 311 323 337 Relevant cash ows 349 Mutually exclusive investment opportunities 357 Capital project analysis and forecasting Strategic planning Analysis of an investment in a not-for-prot organization 365 373 381 Management of the Firm's Equity: Dividends and Repurchases 29. 30. Gainesboro Machine Tools Corporation AutoZone, Inc. Dividend payout decision Dividend and stock buyback decisions 393 409 Management of the Corporate Capital Structure 31. 32. 33. 34. 35. 36. An Introduction to Debt Policy and Value Structuring Corporate Financial Policy: Diagnosis of Problems and Evaluation of Strategies California Pizza Kitchen The Wm. Wrigley Jr. Company: Capital Structure, Valuation, and Cost of Capital Deluxe Corporation Horizon Lines, Inc. 7 Effects of debt tax shields Concepts in setting nancial policy 425 431 Optimal leverage Leveraged restructuring 449 467 Financial exibility Bankruptcy/restructuring 479 497 Analysis of Financing Tactics: Leases, Options, and Foreign Currency 37. 38. 39. 40. 41. Carrefour S.A. Baker Adhesives J&L Railroad Primus Automation Division, 2002 MoGen, Inc. Currency risk management Hedging foreign currency cash ows Risk management and hedging commodity risk Economics of lease nancing Convertible bond valuation and nancial engineering 513 523 529 541 553 bru6171X_fm_i-l.qxd xii 12/11/12 3:01 PM Page xii Contents 8 Valuing the Enterprise: Acquisitions and Buyouts 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. Methods of Valuation for Mergers and Acquisitions American Greetings Arcadian Microarray Technologies, Inc. JetBlue Airways IPO Valuation Rosetta Stone: Pricing the 2009 IPO The Timken Company Sun Microsystems Hershey Foods Corporation: Bitter Times in a Sweet Place Flinder Valves and Controls Inc. Palamon Capital Partners/TeamSystem S.p.A. Purinex, Inc. Medeld Pharmaceuticals Valuation principles 569 Firm valuation in stock repurchase decision Evaluating terminal values Initial public offering valuation Initial public offering valuation Financing an acquisition Valuing a takeover opportunity Corporate governance inuence 589 599 617 635 655 671 693 Valuing the enterprise for sale Valuing a private equity investment 715 727 Financing the early-stage rm Valuing strategic alternatives 745 755 bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page xiii Foreword The half-decade from 2008 to 2013 forced a series of \"teachable moments\" into the consciousness of leaders in both business and government. More such moments may be in the ofng, given the unresolved issues stemming from the global nancial crisis. What lessons shall we draw from these moments? And how shall we teach the lessons so that the next generation of leaders can implement wiser policies? One theme implicit in most critiques and policy recommendations of this period entails the consequences of nancial illiteracy. At few other times in nancial history have we seen so strong an afrmation of Derek Bok's famous argument, \"If you think education is expensive, try ignorance.\" The actions and behavior of consumers, investors, nancial intermediaries, and regulators suggest ignorance (nave or otherwise) of such basic nancial concepts as time value of money, risk-adjusted returns, cost of capital, capital adequacy, solvency, optionality, capital market efciency, and so on. If ignorance is bliss, teachers of nance face a delirious world. Now more than ever, the case method of teaching corporate nance is critical to meeting the diverse educational challenges of our day. The cases presented in this volume address the richness of the problems that practitioners face and help to develop the student in three critical areas: Knowledge. The conceptual and computational building blocks of nance are the necessary foundation for professional competence. The cases in this volume afford solid practice with the breadth and depth of this foundational knowledge. And they link the practical application of tools and concepts to a contextual setting for analysis. Such real-world linkage is an important advantage of case studies over textbook problem sets. Skills. Case studies demand decisions and recommendations. Too many analysts are content to calculate or estimate without helping a decision-maker fully understand the implications of the analysis. By placing the student in the position of the decision-maker, the case study promotes condence and competence in making decisions. Furthermore, class discussions of cases promote skills in communication, selling and defending ideas, giving feedback, negotiating, and getting results through teamworkthese are social skills that are best learned in face-to-face engagement. Attributes of character. Popular outrage over the crisis focused on shady ethics. The duty of agents, diligence in the execution of professional responsibilities, breaches of trust, the temptations of selfdealing, and outright fraud intrude into retrospective assessments of what might otherwise be dry and technical analyses of the last decade. It is no longer possible or desirable to teach nance as a purely technical subject devoid of ethical considerations. Ultimately, teaching is a moral act: by choosing worthy problems, modeling behavior, and challenging the thinking of students, the teacher strengthens students in ways that are vitally important for the future of society. The case method builds attributes of character such as work ethic and persistence; empathy for classmates and decision-makers; social awareness of the consequences of decisions and the challenging context for decision-makers; and accountability for one's work. When students are challenged orally to explain their work, the ensuing discussion reveals the moral dilemmas that confront the decision maker. At the core of transformational teaching with cases is growth in integrity. As Aristotle said, \"Character is destiny,\" a truism readily apparent in the ruinous aftermath of the global nancial crisis. As with the sixth edition of this book, I must commend my colleagues, Kenneth Eades and Michael Schill, who brought this seventh edition to the public. They are accomplished scholars in Finance and masterful teachersabove all, they are devoted to the quality of the learning experience for students. Their efforts in preparing this volume will enrich the learning for countless students and help teachers world-wide to rise to the various challenges of the post-crisis world. Robert F. Bruner Dean and Charles C. Abbott Professor of Business Administration Distinguished Professor of Business Administration Darden Graduate School of Business Administration University of Virginia Charlottesville, Virginia October 8, 2012 xiii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page xiv 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 runsthat 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 nance 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 rm on the world around it. These cases harness and exercise this economic view of the rm. It is the special province of nance 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, 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 exemplars like Warren Buffett and Bill Miller and institutions like *George Herman \"Babe\" Ruth (1895-1948) was one of the most famous players in the history of American baseball, leading the league in home runs for 10 straight seasons, setting a record of 60 home runs in one season, and hitting 714 home runs in his career. Ruth was also known as the \"Sultan of Swat.\" Carl Sandburg, \"Notes for Preface,\" in Harvest Poems (New York: Harcourt Brace Jovanovich, 1960), p.11. Russell Ackoff, \"The Future of Operational Research is Past,\" Journal of Operational Research Society, 30, 1 (Pergamon Press, Ltd., 1979): 93-104. xiv bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page xv Preface xv investment banks, commercial banks, rating agencies, hedge funds, merger arbitrageurs, private equity rms, 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 nancial securities, and illuminate the use of exotic instruments in support of corporate policy. Finally, they help students understand the implications of transparency of the rm to investors, and the impact of news about the rm in an efcient 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 nance 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 managersindeed, 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 All of the cases in this book are set in the year 2000 or after and 40 percent are set in 2006 or later. A substantial proportion (25 percent) of these cases and technical notes are new, or signicantly updated. The mix of cases reects the global business environment: 45 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 reect the growing role of women in managerial ranks: 28 percent of the cases present women as key protagonists and decision-makers. Generally, these cases reect 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. 1. Setting Some Themes. These cases introduce basic concepts of value creation, assessment of performance against a capital market benchmark, and capital market efciency 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, 2005,\" sets the nearly universal theme of this volume: the need to think like an investor. \"Bill Miller and Value Trust,\" explores a basic question about performance measurement: what is the right benchmark against which to evaluate success? \"Ben & Jerry's Homemade, Inc.\" invites a consideration of \"value\" and the ways to measure it. The case entitled, \"The Battle for Value, 2004: FedEx Corp. vs. United Parcel Service, Inc.\" uses bru6171X_fm_i-l.qxd xvi 12/11/12 3:01 PM Page xvi Preface \"economic prot\" (or EVA) to explore the origins of value creation and destruction, and its competitive implications for the future. A new case, \"Genzyme and Relational Investors: Science and Business Collide?\