Kanthals College Essay Example

until the uncertainty of proxy variables is explored.

Pedagogical Objectives The primary objective of this case is to explore the application of the CAPM. You must calculate a beta based on comparable companies and lever betas to adjust for capital structure. You are also asked to determine the appropriate riskless rate and market risk premium. You are encouraged to focus on the choice of time period to estimate expected returns and the differences between the geometric and arithmetic average as a measure of expected returns. In addition to the cost of capital issues, the case presents an integrated financial system that relies on the CAPM and modern financial economics. Marriott(s financial strategy emphasizes share repurchases, hotel syndications, and the aggressive use of debt financing. Each of these strategic components is consistent so that the strategy can be pursued coherently.

Suggested Questions 1. Are the four components of Marriott(s financial strategy consistent with its growth objective? 2. How does Marriott use its estimate of its cost of capital? Does this make sense? 3. What is the WACC for Marriott Corporation?

a. What risk-free rate and risk premium did you use to calculate ke? b. How did you measure Marriott(s cost of debt? c. Did you use arithmetic or geometric averages to measure rates of return? Why? 4. What type of investments would you value using Marriott(s WACC? 5. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? 6. What is the cost of capital for the lodging and restaurant divisions of Marriott? a. What risk-free rate and risk premium did you

use in calculating the cost of equity for for each division? Why did you choose these numbers? b. How did you measure the cost of debt for each division? Should the debt cost differ across divisions? Why? 1. What is the cost of capital for Marriott(s contract services division? How can you estimate its equity costs without publicly traded comparable companies?

Globalizing the Cost of Capital and Capital Budgeting at AES Substantive Issues This case examines a global power company with operations in 30 countries and on five continents. The company operates in multiple business segments and is subject to the economic state of each company as well as the global economy. Does the CFO estimate a different WACC for each economy and for each business segment?

Pedagogical Objectives AES is faced with a problem common to every company that invests beyond its home borders: how to assess and incorporate the various risks of its myriad international investments into its capital budgeting process. This case allows for each group to: • explore the problems faced by managers who have to evaluate different types of projects across countries with different political and economic characteristics; • evaluate the approach to capital budgeting used by a global firm; • calculate the cost of capital for 15 projects around the world using a methodology that incorporates country risk and other types of risks that arise in international investments into each project’s cost of capital; • determine how the adjusted cost of capital derived from the new methodology affects the value of a particular project; • assess the broader implications of using sovereign spreads and idiosyncratic risk factor to evaluate international projects.

Suggested

Questions 1. How would you evaluate the capital budgeting method used historically by AES? What’s good or bad about it? 2. If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world? 3. Does this make sense as a way to do capital budgeting? 4. What is the value of the Pakistan project using the cost of capital derived from the new methodology? If this project was located in the U.S., what would its value be?

5. How does the adjusted cost of capital for the Pakistan project reflect the probabilities of real events? What does the discount rate adjustment imply about expectations for the project because it is located in Pakistan and not the U.S.? As part of the overall analysis incorporate the following into the group presentation: (a) what is AES’s business and its historic approach to capital budgeting, (b) describe the new methodology for determining project discount rates, (c) evaluate the proposed methodology.

Whirlpool Europe Substantive Issues Whirlpool Europe manufactures appliances in 11 plants and sells its products throughout Europe. The case focuses on the company(s decision to invest in its information system to improve its inventory management. The enterprise resource planning (ERP) system is anticipated to reduce the amount of inventory, provide increased sales through improved product availability, and improve margins. The costs of the new system include capital expenditures and implementation costs. The case presents the information required to evaluate the proposed investment using a discounted cash flow approach.

Pedagogical Objectives The case highlights a DCF approach to evaluating an investment in an ERP system to improve inventory management. The case allows you

to use the mechanics of working capital analysis to estimate cash flows from the reduction in inventory. You also analyze the impact of additional unit sales and margin improvements on cash flows, and the interaction between the three sources of cash flow improvements. The inventory reduction, additional sales, and margin increase differ in their taxability and their persistence through time. You are required to analyze those differences to forecast the cash flows. The system, and thus its benefits, is phased in across four groups of markets and three years for each group.

Suggested Questions 1. Are all of the benefits of the ERP investment reasonable? Are the costs reasonable? 2. What are the after-tax cash flows for the proposed ERP investment from 1999 through 2007? What is the present value of those cash flows? 3. When valuing the proposed investment, should value be included for possible cash flows that occur beyond 2007? On what does it depend? 4. Would you recommend the ERP investment? What is your major concern?

United Parcel Service(s IPO Substantive Issues In 1999, UPS announced an IPO of 109 million shares. The transaction was expected to be the largest US IPO in history. UPS had a long track record for excellent customer and financial performance in the package delivery business. The case provides you with an opportunity to apply all of the tools you have learned in financial accounting, corporate finance, economics and strategy.

Pedagogical Issues This case provides an opportunity to apply a variety of valuation techniques to a well known and well understood company. Information on UPS(s business model and competitors is provided. The difficulty is deciding what valuation technique to use

and how to forecast financial performance is a very dynamic industry.

Suggested Questions 1. What are the key success factors and risks for UPS given its business strategy? 2. How is UPS performing? What factors are driving this performance? Is the current performance likely to be sustained? Why or why not? 3. How is FedEx performing? How, if at all, does its performance and plans affect your assessment of the sustainability of UPS(s current performance? 4. Given your assessment of the company(s strategy and the sustainability of its performance, forecast the key factors for UPS(s stock value. 5. What is your estimate of UPS(s value and its multiples?

6. How do your estimates of UPS(s PE and PB multiples compare with those for FedEx? How do they compare with those for the (best in breed( companies multiples?

Jones Electrical Distribution

Substantive Issues Jones Electrical Distribution has been expanding rapidly for the past several years. Increases working capital requirements have significantly outrun the capacity of the company to generate funds from internal sources. The company has been forced to forgo taking discounts on accounts payable and to borrow in increasing amounts from its bank to maintain its expansion. Nelson Jones must decide whether to continue to expand and, if so how to finance the growth.

Pedagogical Objectives • Highlight the difference between income statement profit and cash flow by determining why the company is so short of funds despite its history of profitable operations. • Use financial ratios to understand a business situation • Explore the attractiveness of expanding a profitable business in light of the cash flow profile and resulting capital requirements, including the constraints which come with accepting outside

debt and/or equity financing. • Understand the relationship between sustainable growth rate (i.e., growth which can be financed proportionally from retained earnings) capital intensity and profitability.

Suggested Questions. 1. How well is Jones Electrical performing? What must Jones do well to succeed? 2. Why does a business that has profit of $30,000 per year need a bank loan? 3. What drove the increase in Jones’s accounts receivable and inventory balances in 2005 and 2006? 4. Is Nelson Jones’s estimate that $350,000 line of credit is sufficient for 2007 reasonable? 5. When will Jones be able to repay the line of credit?

6. What could Jones do to reduce the size of the line of credit he needs? 7. What are the implications for Jones’s lifestyle of accepting a new, larger line of credit?

Toy World, Inc. Substantive Issues This case provides the opportunity to explore changes in operating economies through adoption of a level production schedule. This forces a company with seasonal sales to consider the problems of financing an off-season inventory buildup. The amount of funds needed for the projected inventory accumulation exceeds known short-term sources. Questions of liquidity and risk arise as the proportion of debt financing for an inventory subject to price and fad risks climbs sharply in the off season.

Pedagogical Objectives This case provides an introduction to considering the pattern of inventory accumulation and cash flow in a company with a very seasonal inventory and cash cycle. It also provides an elementary exercise in estimation of funds requirements and construction of pro forma statements. The case also provides an exercise in the preparation of cash budgets and how they interlock with the pro forma

financial statements. I like the case because it provides a vary clear example of evaluating the trade-off between profitability versus risk and liquidity in the choice between level and seasonal production.

Suggested Questions 1. What are the market, competitive, and operating characteristics of Toy World? 2. What are the characteristics of Toy World(s need for external financing? What are the timing, magnitude, and duration of its borrowing needs? How certain are the forecasts? 3. What will happen to Toy World(s borrowing needs if it adopts level production? Conceptually what will happen? 4. Would you provide the loan that Toy World will need if it adopts level production? How attractive a piece of business is it for a bank? 5. What are the cost savings and are the cost savings sufficient to warrant adoption of level production? 6. What factors could Mr. McClintock consider in deciding whether or not to adopt the level production plan? 7. Estimate the amount of added funds required and the timing of the needs under level production. Prepare pro forma income statements and balance sheets to make this estimate.

Netflix – Going Public Substantive Issues NetFlix.com delivers movies in DVD format to subscribers using the internet and the U.S. Mail. During its first three years of operation, the company has been successful and plans an initial public offering in July 2000. Because of large sales and marketing expenses associated with acquiring new subscribers, the company has never shown a profit. Following the collapse of the NASDAQ market in Spring 2000, the CEO is forced to consider withdrawing the company(s planned IPO. Barry McCarthy, the NetFlix CFO, is asked to reevaluate the company(s projected

cash flow requirements and to suggest modifications to the existing business model that would improve the company(s projected cash flows. McCarthy must strike a delicate balance between generating positive cash flow in the near-term and sustaining the high rate of growth necessary for the company to achieve its objectives in the long-term.

Pedagogical Objectives This case is intended to provide background on the decision to go public. There are many facets to the decision including dealing with regulatory authorities (SEC), managers of the process (underwriters), and stakeholders (founders, employees, venture capital providers, etc.).

Suggested Questions. What are the internal and external factors that impact a company’s decision to pursue a public offering? What do you think are the most important criteria for selecting a lead underwriter? What leverage does the company have towards ensuring that the underwriter, once selected, follow through on the company’s expectations? Who is the audience?

What legal and ethical concerns might Netflix and Merrill Lynch have related to the issuance of direct shares? How would you decide the number of direct shares elative to the remainder of the offering? How would you decide who would receive them?

You are Reed Hastings: what do you do once you get off the phone with David Hyman after the ‘popcorn incident’ discussion? Evaluate and rank your options; consider your actions in light of the upcoming pricing discussion. To what extent are the company’s and the underwriter’s incentives aligned when it comes to pricing the offering? What influence does a manager have over the pricing decision?