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CASES IN CORPORATE FINANCE

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CASES IN CORPORATE FINANCE

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     CASES IN FINANCIAL MANAGEMENT

    SYLLABUS

FIN 522 Professor James A. Gentry

    Cases In Financial Management 343M Wohlers Hall

    Spring Semester 2009 333-7995

    2043 BIF j-gentry@uiuc.edu

     Office Hours: 10:30 a.m. to 11:45 a.m.

     on Mon. and Wed/. or by Appointment

I. Teaching Objectives

Financial decision making cases are used to…

    ? Create a highly interactive learning environment;

    ? Learn about the application of financial management and credit analysis concepts;

    ? Discover what you do not know about the practice of financial management;

    ? Show what you have learned;

    ? Highlight the relationships between strategic goals and the creation of firm value;

    ? Develop techniques for interpreting a firm’s financial data and strategic plans;

    ? Enhance your critical thinking and problem solving skills;

    ? Expand your understanding of financial theory and its application;

    ? Improve your listening and cooperative learning skills.

II. Learning Promises

At the end of this course your will be able to…

    ? Think like a financial manager;

    ? Interpret a company’s financial health by evaluating the performance of its cash

    flow components and financial ratios;

    ? Create financial forecasts with different scenarios;

    ? Justify the acceptance or rejection of a loan based on credit analysis:

    ? Learn to interpret loan covenants and the underlying collateral;

    ? Discover the metrics that Moody’s uses to identify credit risk changes;

    ? Explain how management establishes a firm’s target capital structure;

    ? Learn to measure a firm’s cost of capital components; to use Credit Risk

    Spreads to adjust the interest rate on debt when the D/V [Wd] makes changes

    up or down; and learn ROIC is a cost of capital proxy;

    ? Discover issues that cause changes in a firm’s target capital structure;

    ? Estimate the intrinsic value of a stock and the enterprise value of a firm and

    explain the strengths and shortcomings of your analyses.

    ? Learn best practices and invaluable insights from Visiting Executives.

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    III. Cases and Readings

A. Cases:

    ? Cases in Financial Management by TIS, January 2009;

    ? Text for the Caterpillar Case [Exhibit 25 WEB], Caterpillar Case [Exhibit 27

    WEB];

     B. Readings:

    ? Selected Readings for Cases in Financial Management, by James A. Gentry,

    Champaign, IL: Stipes Publishing, 2009.

    ? Cash Flow Story, January 2007, by James A. Gentry [WEB]

    ? Analysis for Financial Management, 8th Edition, by Robert C. Higgins, McGraw-

    Hill/Irwin, 2007.

    ? Estimating The Intrinsic Value of a Real Company With An Integrated Financial

    System: A Live Case, January 2009, by James A. Gentry and Frank K. Reilly.

    [Exhibit 25 WEB];

    IV. SYLLABUS FOR FIN 522 Spring 2009

     A. Exhibits related to assignments:

? Exhibit 1. Cash Flow Statement

    ? Exhibit 2. The Cash Flow Cycle

    ? Exhibit 3. The Cash Conversion Cycle

    ? Exhibit 4. Dupont System

    ? Exhibit 5 Gentry’s Key Financial Ratios

    ? Exhibit 6 Moody’s User’s Guide

    ? Exhibit 7 Moody’s Key Ratios for Comparison ? Exhibit 8 Porter’s Five Competitive Forces ? Exhibit 9. Micro-Drive Balance Sheet

    ? Exhibit 10. Micro-Drive Income Statement

    ? Exhibit 11. Micro-Drive Summary Sheet

    ? Exhibit 12. AFN-Financial Forecast

    ? Exhibit 13. Cash Budget

    ? Exhibit 14. Dell’s Pro-forma Balance Sheet

    ? Exhibit 15. Dell’s Pro-forma Income Statement

    ? Exhibit 16 Credit Risk Premiums

    ? Exhibit 17 Equity Premiums

    ? Exhibit 18. DuPont’s Bond Rating: Is it optimal? ? Exhibit 19. Moody’s Corporate Default and Recovery Rates 1920-2008 ? Exhibit 20. Estimating the Probability of Default

    ? Exhibit 21. Moody’s Speculative Grade Liquidity Ratings Sept. 2002

    ? Exhibit 22. Moody’s Market Implied Ratings Description… ? Exhibit 23. Financial Structure

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    ? Exhibit 24 Polaroid Financial Flexibility

    ? Exhibit 25. Integrated Valuation System (text)

    ? Exhibit 26. Integrated Valuation System (Exhibits)

    ? Exhibit 27. Caterpillar Case

    ? Exhibit 28. Caterpillar Case, xls (Exhibits).

    ? Exhibit 29. Scorecard for Exhibit 3 results

    ? Exhibit 30. MCI Capital Structure 1974-1983

    ? Exhibit 31. Analysis of MCI Convertible Bond Financing

    ? Exhibit 32. Valuation of Gannett’s Cable Properties

    ? Exhibit 33. Cox: Short- and Long-Term Funding

    ? Exhibit 34. Instructions for estimating the value of Interco

    B. Exhibits Related To Valuation

    ? Exhibit 1. Generalized Cash Flow Valuation Model

    ? Exhibit 2. Dividend Valuation Model

    ? Exhibit 3. Capital Investment Valuation Model

    ? Exhibit 4. Dividend Valuation of a Stock

    ? Exhibit 5. Valuation of a StockFCFE Approach

    ? Exhibit 6. Valuation of a FirmFCFF Approach

     C. Case Exams: You will purchase a package of two tickets at the TIS Bookstore,

    one for each case. The tickets will be used to pick up each case at the Business and

    Economics Library (BEL) for the designated time period. Do not purchase tickets until

    February 16, 2009. Note the Business and Economics Library is currently scheduled to

    be open during the following times:

     Monday Thursday -- 8:30 a.m. 10 p.m.

     Friday -- 8:30 a.m. 5:00 p.m.

     Saturday -- 1:00 p.m. 5:00 p.m.

     Sunday -- 1:00 p.m. 10:00 p.m.

D. Grading Policies:

There are three components to your grade. First, each student will complete two

    written case examinations during the semester. The second component is a group

    valuation analysis of Caterpillar Inc. Each case exam and the valuation project

    represent 20 percent of your total grade, for a total of 60 percent. Third,

    participation in case discussions will contribute 40 percent of each student’s total

    grade. There are two ways to earn participation points. They are: (1) contributions

    to class discussions and/or (2) submitting case briefs, an optional approach, that are

    discussed below. Team Peer Evaluations will be distributed for the Caterpillar

    valuation project. The peer evaluation points will be added to your class

    contribution points.

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    The examination cases will be made available in the Business and Economics Library at appropriate times during the semester. A completed case analysis shall be no more than

    five double- spaced typewritten pages. Exhibits are not included in the five-page limit.

    You will have nine (9) hours to complete the case analysis. The clock starts running when

    you pick up the exam in the Business and Economics Library (BEL) and ends when you

    submit your completed case exam.

     Upon completing the case exam, you will print the following pledge on the back of your case analysis, “On my honor as a University of Illinois graduate student I have

    neither given nor received unauthorized aid on this exam, and I have limited the time

    spent on this case to eight hours”. Please carefully sign your name below the pledge, date the pledge and print your name below the pledge. Your name should NOT appear

    elsewhere on the paper. Please do not miss other classes when you are writing the exam.

Intrinsic Valuation of Caterpillar Inc. (CAT). The assignment is to prepare a

    financial forecast and then estimate and interpret the intrinsic value of Caterpillar Inc.

    Each valuation team will consist of two or three Fin 522 students. On April 1 Mike

    DeWalt, Director of Investor Relations (IR), ad Brad Halverson, Controller at Caterpillar

    will present background information on Caterpillar that will be valuable in preparing the

    financial forecast. On May 4 two case groups will present their valuation of Caterpillar

    and Mike DeWalt (IR) and Kevin Colgan, Treasurer at Caterpillar, will listen and

    comment on your assumptions, analysis and interpretations of Caterpillar’s intrinsic

    valuation. The highlight of this special class should be the natural learning that

    occurs in the exchange of ideas between the Finance 522 students and the Financial

    Executives from Caterpillar.

    Participation grades. A maximum of 40 percent of your course grade is based on participation in class discussions. The quality of your class participation will be graded

    each day on a scale of zero to three points. The participation points will be based on the

    following criterion:

    ? 0 points No participation or observations

    ? ? point Contributes relevant information and/or facts, asks critical questions

    concerning the discussion in class and/or the reading assignments, and responses

    to comments made by your classmates.

    ? 1 point Provides an interpretation of relevant information and/or facts that are

    based on analysis and, in turn, advances the discussion to other related topics;

    ? 2 points Develops a well supported interpretation of relevant information that is

    associated with good financial practices in financial management; or provides

    contributions that lead a discussion to a significantly higher level of thought.

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    ? 3 points Presents a superior analysis and interpretation of the relevant

    information that results in a solution to the case.

You are encouraged to work independently in the initial preparation of the case. After

    you have completed your initial analysis, you should meet with your study group in order

    to challenge your ideas and thereby improve your analysis and interpretation. Finally,

    discussions within your study group will help you to be prepared to more effectively

    participate in the class discussion.

Case Briefs (optional)

Case briefs are optional. When a brief is submitted to Professor Gentry by 2 p.m. on a

    class day, it can contribute between ? to 2 points to your daily participation grade. The

    quality of the brief determines the number of points. Professor Gentry will read the case

    briefs before class and return the graded briefs the next class period.

The text of the case briefs should be no longer than two double-spaced pages and

    address the following: (1) what is the primary problem(s) in the case; (2) what is

    your interpretation of your attached exhibits, and (3) what is your recommendation to management. If Exhibits are attached, please cite them in the text of the brief. Each

    brief must reflect your work and judgment. The case briefs will greatly help you be a

    more effective participant in class discussions. Answering the questions for each case

    that are presented in the syllabus is not considered as part of the case brief. The

    case questions are designed for discussions purposes.

    SCHEDULE OF CLASSES

    C= Cases in Strategic Financial Management

    R = Selected Readings for Case Problems in Finance by Gentry

    H = Analysis for Financial Management, 8

    th edition by Higgins

    I. Extending Bank Credit vis-à-vis Measuring Credit Risk

Jan. 21 Organization Day--Analyzing Business Problems: The Case Method (R);

     Students Guidelines: Preparing a Case (R). Reading: Assessing a Company’s

     Future Financial Health (C); Case of Unidentified Industries (C); Other

     Readings: Dupont Analysis in Readings (R) and Exhibit 4 on WEB.

     Optional Readings in Chap. 2 in (H).

     Jan. 26 Butler Lumber Company (C); Cash Flow Story” (WEB); Exhibits for

     assignments are in the Fin.522 WEB--Cash Flow Statement (Exhibit 1),

     Cash Flow Cycle in( R) & (Exhibit 2), Cash Conversion Cycle in (R) &

     Exhibit 3, DuPont Analysis in (R) & Exhibit 4. Also refer to Exhibit 5 for

     Key Ratios and Exhibits 6 & 7 Moody’s User’s Guide and Key Ratios for

     Comparison. Organize Case Study Groups.

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     Suggested Analysis

    ? Prepare Butler Lumber cash flow statements for 1989 and 1990, using

    Exhibit in (WEB).

    ? Assess Butler’s market position. Use Porter’s Five Competitive Forces in

    Exhibit 8 on WEB.

Jan. 28 Butler Lumber Company (C) (continued); Readings: Financial Statement

     Forecasting: The Percent of Sales Method (H), 84-97 and Sustainable

     Growth(H), 119-133. Optional Reading: Solving the Interest Dilemma (R);

     Note on Bank Loans (C);

     Suggested Analysis

    ? Prepare a proforma income statement and balance sheet for

     1991 using information cited above. Another option on how to prepare

     profoma statements in Exhibits 9-12.

    ? Interpret the proforma statement results.

Feb. 2 SureCut Shears Inc. (C)

     Questions for management

    ? What critical assumptions did Mr. Fischer make when he prepared the forecasts

    shown in case Exhibits 1 and 2? Were these assumptions reasonable?

    ? Why was SureCut Shears, Inc. unable to repay its bank loan by March 31, 1996,

    as originally forecast?

    ? Has SureCut’s financial condition worsened sufficiently to cause Mr. Stewart any

    great concern?

    Suggested Analysis

    ? Prepare two separate cash flow statements for the 8 month period, where the

    beginning date is June 30, 1995 and the ending is March 31, 1996 for (1) the

    financial forecast in Case Exhibit 1 and 2 and (2) the actual financial statements

    in Case Exhibits 3 and 4.

    ? In addition to the cash flow analysis, use cash conversion cycle (CCC) ratios to

    help you answer questions 2 and 3 above.

    ? Interpret for the SureCut management the analytical insights derived from the

    two cash flow statements and the CCC ratio.

Feb. 4 Hampton Machine Company (C); Note on Bank Loans (C).

    ? Why can’t a profitable firm like Hampton repay its loan on time and why does it

    need more bank financing?

    Suggested Analysis

    ? Prepare a cash flow statement for the period 11/30/78 to 8/31/79. Interpret the

    results. See next page.

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    ? Based on the information in the case, prepare monthly cash budgets for

    September through December 1979, Higgins (H), pp. 101-103 , a monthly pro

    forma income statement and a year end balance sheet. See Exhibit 13 WEB.

    ? Evaluate the assumptions underlying your forecasts. What developments could

    alter your results?

    ? Should the bank approve Mr. Cowin’s loan request? ? What is the effect of the share repurchase on Hampton’s financial performance?

    Feb.9 Dell’s Working Capital (C)

? How was Dell’s working capital policy a competitive advantage?

    ? How did Dell fund its 52 percent growth in 1996?

    ? Assuming Dell sales grow 50 percent in 1997, how might the company fund this

    growth internally?

    ? How would your answers to the preceding question change, if Dell also

    repurchased $500 million of common stock in 1997 and repaid its long-term debt?

Suggested Analysis

    ? Prepare proforma income statements and balance sheets for January 1997

     based on 50 percent growth in sales. See Exhibits 14 and 15 WEB.

    ? Prepare cash flow statements for January 1996 (actual) and January 1997

    (proforma) and interpret the results.

    Feb. 11 Padgett Paper Products Company (C)

    ? What is the problem in the Padgett Paper Products Case? ? Why does Padgett need a loan? How fast can it repay the loan? ? What would you propose as terms for the new loan structure?

     Suggested Analysis

    ? Prepare annual cash flow statements for 1994 and 1996 and interpret your

    findings.

    ? What does an analysis of case Exhibits 3 and 4 reveal about the financial health

    of Padgett Paper?

    ? Interpret the proforma financial statements in case Exhibit 6.

Feb. 16 U.S. Bank of Washington (C)

    ? Does the Redhook loan “fit” U. S. Bank of Washington? Why? ? Each Case Group will be assigned to play a specific role. The roles are presented

    below. The first three groups will make formal presentations to the Loan

    Committee of the Bank. The Loan Committee will ask questions of each case

    group and make the final judgment as to accept or reject the proposal. Each

    group will present their support or objections for the project and be and be

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    prepared to defend their position to questions from the loan committee. The four

    roles are:

    > CEO and CFO of Redhook Ale

    > Credit Analysts Staff at U.S. Bank Washington

    > European Brewery being approached for $5 million equity investment

    > Loan Committee at the U. S. Bank of Washington

    Feb. 17-22 Case Examination 1 begins on Feb. 17 and ends Feb 22.

    Cases and instructions for Examination 1 may be picked up at the Business and

    Economics Library commencing Tuesday, Feb.17 at 8 a.m. and must be returned

    to the Commerce Library no later than nine (9) hours after picking up the case

    exam and instructions. Please arrange for adequate time to complete the case

    analysis before the Library closes. All case analyses must be returned by 11:59

    p.m. Sunday, February 22.. Library Hours Schedule is attached.

    Feb. 22 Case Examination 1 ends.

    II. The Linkages between Capital Structure and Credit Risk

    Feb. 23 Reading (1): Note on the Theory Of Optimal Capital Structure” (R)

    ? What are the important assumptions used in creating Case Exhibit 1?

    ? What is the significance of lines 9, 10, and 13 in Case Exhibit 1?

    ? What is the significance of lines 20 and 27 in Case Exhibit 1?

    ? Why does line 13 equal line 27 in Case Exhibit 1? Why is this possible?

    Reading (2) : “Credit Risk Premiums by Jim Gentry, Exhibit 16 WEB.

    ? How do you measure Credit Risk Premiums (CRP)?

    ? How stable are the credit risk premiums (CRP)?

    ? What causes changes in the CRPs , i.e., credit risk spreads?

    Reading (3): ―The Equity Premium in 100 Textbooks” by Pablo Fernandez,

    Exhibit 17 WEB.

    ? How do you measure the equity premium or market risk premium (MRP)?

    ? How stable is the equity premium over time?

    ? What are the four equity premium concepts?

    ? What are the most important conclusions associated with equity

    premiums?

    ? Is there any relationship between credit risk premiums and equity

    premiums?

    Introduction to DuPont Case

    Feb. 25 Case Assignment for the day: E. I. du Pont de Nemours and Company (1983)

    (C);

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    ? Why should a company have a target debt ratio?

    ? Why did Du Pont abandon its AAA debt-rating policy? What were the

    consequences? What is the role of bond ratings?

    ? What bond rating would Du Pont receive under each alternative in Case

    Exhibit 8 for 1987? How would Du Pont’s financial performance,

    financing needs, access to capital and financial risk differ under the two

    alternative debt policies?

    ? What capital structure policy should Du Pont adopt? What are the key

    issues?

    ? How should a company determine its appropriate capital structure?

    a. What impact does leverage have on a firm’s prospects and

    performance?

    b. What problems arise from employing too much debt? too little

    debt?

    c. What indications does a firma have that its leverage is too high?

    too low?

    d. What competitive strategy issues arise in establishing capital

    structure policy?

    e. Do industry differences affect capital structure policy?

     Suggested Analysis

    ? DuPont’s Bond Ratings: Is it Optimal? (Exhibit 18 WEB)

    Mar 2-9 Readings from Moody’s Credit Risk Research

    Mar 2. ―Moody’s Corporate Default and Recovery Rates, 1920-2008Exhibit 19 WEB.

    ? Introduction pp.1-6

    ? Rating Accuracy Metrics pp. 6-7 Interpret Moody’s Exhibits 6-7

    ? Estimating Probability of Default Exhibit 20 WEB [Assignment]

    ? Corporate Default and Recovery Rates Moody’s pp. 8-14,

    Interpret Moody’s Exhibit 14 and compare results to Moody’s

    Exhibits 15 and 16

    ? Moody’s Exhibit 24 Annual Issuer-Weighted Default Rates 1920 -

    2008 Interpret the resultsinsights in Great Depression Years

    (1929-1939)

    ―Moody’s Speculative Grade Liquidity Rating‖ Exhibit 21 WEB

    ? What are SGL Ratings?

    ? Interpret the equation on page 3

    ? Interpret SGL 1-SGL 4 on page 4

    Mar. 4. Readings based on Moody’s Credit Risk Research

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    ―Moody’s Market Implied Ratings Description, Methodology. And Analytical

    Applications. Exhibit 22 WEB

    ? What are Implied Ratings?

    ? What are the key components used in estimating Implied

    Ratings?

    ? Assignment: Answer ―Frequently Asked Questions‖ on page 37.

    TM Key Ratios By Ratings and Industry Exhibit 7 WEB ―Moody’s Financial Metrics

    Mar. 9 Presentation by Executive from Moody’s

    ? Prepare questions from Readings in Exhibits 19-22

    Mar. 11 Financial Structure

    ? Structuring Corporate Financial Policy: Diagnosis of Problems and

    Evaluation of Strategies by Robert F. Bruner (C)

    ? What are the components of financial structure? Why are they important?

    ? Using Bruner’s methods for diagnosing a firm’s financial policy, what are

    critical insights concerning Caterpillar’s (CAT) financial structure? CAT

    financial structure is presented in 2008 Form 10K in the CAT website.

    Exhibit 23 WEB provides a framework for analyzing CAT’s financial

    structure. Also use Bruner’s FRICT model to analyze CAT’s financial

    structure. See Exhibit 7 WEB for Moody’s key industry ratios for

    comparative data; http://finance.yahoo.com and other available sources.

    ? Professor Gentry will provide additional information on CAT.

    Mar. 16 Polaroid Corporation 1996

    1. What are the main objectives of the debt policy that Ralph Norwood must

    recommend to Polaroid’s board of directors?

    2. What financing requirements do you foresee for the firm in the coming

    years? What are the risks associated with Polaroid’s business and strategy?

    In your view, what firms are Polaroid’s peer firms?

    3. Drawing on the case’s financial ratios in Exhibit 9, how much debt could

    Polaroid borrow at each rating level? What EBIT coverage ratios would

    result from the borrowings implied in each rating category?

    4. Using Hudson Guaranty’s estimates of the costs of debt and equity in case

    Exhibit 11, which rating category has the lowest overall cost of funds?

    Do you agree with Hudson Guaranty’s view that equity investors are

    indifferent to the increases in financial risk across that investment grade

    debt categories?

    5. Is Polaroid’s current maturity structure of debt appropriate? Why?

    6. What should Ralph Norwood recommend regarding:

    ? The target bond rating? (Exhibit 24)

    ? The level of flexibility or reserves? (Exhibit 24)

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