Mci case study capital structure

Case Studies in Finance links managerial decisions to capital markets and the expectations of investors. At the core of almost all of the cases is a valuation task that requires students to look to financial 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.

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.

Bruner Eades S chi l l

Case Studies in Finance

managing for corporate value creation

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Bruner Eades Schil l

Case Studies in Finance managing for corporate value creation

seventh edition

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Case Studies in Finance

Managing for Corporate Value Creation

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Case Studies in Finance

Managing for Corporate Value Creation

Seventh Edition

Robert F. Bruner Kenneth M. Eades Michael J. Schill

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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 broad- cast 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.

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ISBN 978-0-07-786171-1 MHID 0-07-786171-X

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Library of Congress Cataloging-in-Publication Data

Bruner, Robert F., 1949- Case studies in finance : 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.

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The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate

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FINANCIAL MANAGEMENT

Block, Hirt, and Danielsen Foundations of Financial Management Fourteenth Edition

Brealey, Myers, and Allen Principles of Corporate Finance Eleventh Edition

Brealey, Myers, and Allen Principles of Corporate Finance, Concise Second Edition

Brealey, Myers, and Marcus Fundamentals of Corporate Finance Seventh Edition

Brooks FinGame Online 5.0

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

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Grinblatt (editor) Stephen A. Ross, Mentor: Influence through Generations

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Shefrin Behavioral Corporate Finance: Decisions that Create Value First Edition

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INVESTMENTS

INTERNATIONAL FINANCE

Bodie, Kane, and Marcus Essentials of Investments Ninth Edition

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Kapoor, Dlabay, and Hughes Personal Finance Tenth Edition

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In dedication to our wives

Barbara M. Bruner Kathy N. Eades

Mary Ann H. Schill

and to our children

Dedication

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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 finance, mergers and acquisitions, investing in emerg- ing 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 Man- agement, 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 various schools including 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 brunerr@virginia.edu.

About the Authors

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 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 (Dry- den Press, 1994). He has written numerous 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

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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 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 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. Some of his recent research projects investigate the market pricing of firm 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 consult- ing 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.vir- ginia.edu/web/Faculty-Research/Directory/Full-time/ Michael-J-Schill/. He may be reached via email at schill@virginia.edu.

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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

Setting Some Themes 1. Warren E. Buffett, 2005 To think like an investor 3 2. Bill Miller and Value Trust Market efficiency 23 3. Ben & Jerry’s Homemade Value creation and governance 39 4. The Battle for Value, 2004: FedEx Corp. vs. Value creation and economic profit 53

United Parcel Service, Inc. 5. Genzyme and Relational Investors: Science Value creation, business strategy and activist investors 75

and Business Collide?

Financial Analysis and Forecasting 6. The Thoughtful Forecaster Forecasting principles 101 7. The Financial Detective, 2005 Ratio analysis 119 8. Krispy Kreme Doughnuts, Inc. Financial statement analysis 125 9. The Body Shop International PLC 2001: Introduction to forecasting 143

An Introduction to Financial Modeling 10. Value Line Publishing: October 2002 Financial ratios and forecasting 161 11. Horniman Horticulture Analysis of growth and bank financing 175 12. Guna Fibres, Ltd. Forecasting seasonal financing needs 181

Estimating the Cost of Capital 13. “Best Practices” in Estimating the Cost Estimating the cost of capital 193

of Capital: Survey and Synthesis” 14. Roche Holdings AG: Funding the Genentech Cost of debt capital 219

Acquisition 15. Nike, Inc.: Cost of Capital Cost of capital for the firm 235 16. Teletech Corporation, 2005 Business segments and risk-return tradeoffs 243 17. The Boeing 7E7 Project specific risk-return 257

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Capital Budgeting and Resource Allocation 18. The Investment Detective Investment criteria and discounted cash flow 283 19. Worldwide Paper Company Analysis of an expansion investment 285 20. Target Corporation Multifaceted capital investment decisions 289 21 Aurora Textile Company Analysis of an investment in a declining industry 311 22. Compass Records Analysis of working capital investment 323 23 The Procter and Gamble Company: Scenario analysis in a project decision 337

Investment in Crest Whitestrips Advanced Seal

24. Victoria Chemicals plc (A): Relevant cash flows 349 The Merseyside Project

25 Victoria Chemicals plc (B): The Merseyside Mutually exclusive investment opportunities 357 and Rotterdam Projects

26. Star River Electronics Ltd. Capital project analysis and forecasting 365 27. The Jacobs Division 2010 Strategic planning 373 28. University of Virginia Health System: Analysis of an investment in a not-for-profit 381

The Long-Term Acute Care Hospital organization Project

Management of the Firm’s Equity: Dividends and Repurchases 29. Gainesboro Machine Tools Corporation Dividend payout decision 393 30. AutoZone, Inc. Dividend and stock buyback decisions 409

Management of the Corporate Capital Structure 31. An Introduction to Debt Policy and Value Effects of debt tax shields 425 32. Structuring Corporate Financial Policy: Concepts in setting financial policy 431

Diagnosis of Problems and Evaluation of Strategies

33. California Pizza Kitchen Optimal leverage 449 34. The Wm. Wrigley Jr. Company: Capital Leveraged restructuring 467

Structure, Valuation, and Cost of Capital 35. Deluxe Corporation Financial flexibility 479 36. Horizon Lines, Inc. Bankruptcy/restructuring 497

Analysis of Financing Tactics: Leases, Options, and Foreign Currency 37. Carrefour S.A. Currency risk management 513 38. Baker Adhesives Hedging foreign currency cash flows 523 39. J&L Railroad Risk management and hedging commodity risk 529 40. Primus Automation Division, 2002 Economics of lease financing 541 41. MoGen, Inc. Convertible bond valuation and financial engineering 553

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8Valuing the Enterprise: Acquisitions and Buyouts42. Methods of Valuation for Mergers Valuation principles 569and Acquisitions43. American Greetings Firm valuation in stock repurchase decision 589 44. Arcadian Microarray Technologies, Inc. Evaluating terminal values 599 45. JetBlue Airways IPO Valuation Initial public offering valuation 617 46. Rosetta Stone: Pricing the 2009 IPO Initial public offering valuation 635 47. The Timken Company Financing an acquisition 655 48. Sun Microsystems Valuing a takeover opportunity 671 49. Hershey Foods Corporation: Bitter Corporate governance influence 693

Times in a Sweet Place 50. Flinder Valves and Controls Inc. Valuing the enterprise for sale 715 51. Palamon Capital Partners/TeamSystem Valuing a private equity investment 727

S.p.A. 52. Purinex, Inc. Financing the early-stage firm 745 53. Medfield Pharmaceuticals Valuing strategic alternatives 755

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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 offing, given the unresolved issues stemming from the global financial 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 con- sequences of financial illiteracy. At few other times in financial history have we seen so strong an affir- mation of Derek Bok’s famous argument, “If you think education is expensive, try ignorance.” The actions and behavior of consumers, investors, financial intermediaries, and regulators suggest ignorance (naïve or otherwise) of such basic financial concepts as time value of money, risk-adjusted returns, cost of capital, capital adequacy, solvency, optionality, capital market efficiency, and so on. If ignorance is bliss, teachers of finance face a delirious world.

Now more than ever, the case method of teaching corporate finance 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 finance are the necessary foun- dation 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 con- cepts to a contextual setting for analysis. Such real-world linkage is an important advantage of case studies over textbook problem sets.