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Case Studies in Finance Case Studies in Finance

Case Studies in Case Studies in Finance Finance Table of Contents Table of Contents Case 1: Insider Case 1: Insider Trading Trading Case 2: The Case 2: The Tobacco Industry Tobacco Industry Case 3: Connect Case 3: Connect Cable Contractors Cable Contractors Case 4: IBP Case 4: IBP Case 5: Chrysler Case 5: Chrysler Case 6: Moog Case 6: Moog

Case 7: Kate Myers Case 7: Kate Myers Case 8: Quilici Case 8: Quilici Family Family Case 9: Wal-Mart Case 9: Wal-Mart Case 10: Intel Case 10: Intel Case 11: Amber Case 11: Amber Plank Plank Case 12: Fruit of Case 12: Fruit of the Loom the Loom Case 13: Nations Case 13: Nations Bank Bank Case 14: AMR Case 14: AMR -American Airlines American Airlines Case 15: Mirage Case 15: Mirage Resorts Resorts Case 16: eBay Case 16: eBay Case 17: Aether Case 17: Aether Systems Systems Case 18: NetJ.com Case 18: NetJ.com Case 19: OTCBB Case 19: OTCBB Home

Home>> Case Studies in FinanceCase Studies in Finance>> Table of ContentsTable of Contents >>

Case Studies in Finance

Written by Written by Dr. Michael J. Seiler Dr. Michael J. Seiler

Associate Professor of Finance Associate Professor of Finance

Hawaii Pacific University Hawaii Pacific University

Chapter 1: Chapter 1:

Case 1: Insider Trading

Case 2. The Tobacco Industry

Case 3. Connect Cable Contractors

Chapter 2: Chapter 2: Case 4. IBP Case 4. IBP Case 5. Chrysler Case 5. Chrysler Chapter 3: Chapter 3: Case 6. Moog Case 6. Moog Chapter 4: Chapter 4:

Case 7. Kate Myers

Case 8. Quilici Family

Chapter 5: Chapter 5: Case 9. Wal-Mart Case 9. Wal-Mart Case 10. Intel Case 10. Intel Chapter 6: Chapter 6:

Case 11. Amber Plank

Case 12. Fruit of the Loom

Case 13. Nations Bank

Case 14. AMR - American Airlines

Case 15. Mirage Resorts

Case 23. Southwest Airlines

Case 24. Acclaim Entertainment

Case 25. Philip Morris

Case 26. Computerized Business Systems

Chapter 12: Chapter 12: Case 27. McLeodUSA Case 27. McLeodUSA Chapter 13: Chapter 13:

Case 28. Lancaster Colony

Chapter 14: Chapter 14: Case 29.

Case 29. Anheuser-BuschAnheuser-Busch

Case 30. Pepsi

Case 31. Inn-Room Safe

Case 32. Home Depot

Chapter 16: Chapter 16: Case 33. Hasbro Case 33. Hasbro Case 34. Microsoft Case 34. Microsoft Case 35. REITs Case 35. REITs http://wps.

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Case 20: Pittston Case 20: Pittston Case 21: Vanguard Case 21: Vanguard Case 22: Florida Case 22: Florida Power & Light Power & Light Case 23: Case 23: Southwest Airlines Southwest Airlines Case 24: Acclaim Case 24: Acclaim Entertainment Entertainment Case 25: Philip Case 25: Philip Morris Morris Case 26: Case 26: Computerized Computerized Business Systems Business Systems Case 27: Case 27: McLeodUSA McLeodUSA Case 28: Lancaster Case 28: Lancaster Colony Colony Case 29: Case 29: Anheuser-Busch Busch Case 30: Pepsi Case 30: Pepsi Case 31: Inn-Room Case 31: Inn-Room Safe Safe Case 32: Home Case 32: Home Depot Depot Case 33: Hasbro Case 33: Hasbro Case 34: Microsoft Case 34: Microsoft Case 35: REITs Case 35: REITs Case 36: HOLDRs Case 36: HOLDRs Case 37: Reynolds Case 37: Reynolds Case 38: Adaptec Case 38: Adaptec Case 39: Roxio Case 39: Roxio Case 40: Tyco Case 40: Tyco Case 16. eBay Case 16. eBay

Case 17. Aether Systems

Case 18. NetJ.com Case 18. NetJ.com Case 19. OTCBB Case 19. OTCBB Case 20. Pittston Case 20. Pittston Case 21. Vanguard Case 21. Vanguard Chapter 8: Chapter 8:

Case 22. Florida Power & Light

Case 36. HOLDRs Case 36. HOLDRs Chapter 17: Chapter 17: Case 37. Reynolds Case 37. Reynolds Case 38. Adaptec Case 38. Adaptec Case 39. Roxio Case 39. Roxio Chapter 18: Chapter 18: Case 40. Tyco Case 40. Tyco Copyright © 1995-2003 by

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Home > Case Studies in Finance > Table of Contents >

Case 1: Insider Trading

Ethics: Insider Trading over the Internet

You don't have to be a member of the Board of Directors to engage in illegal insider trading. John J. Freeman, a part-time temporary word processor at two investment houses, learned all he needed to know from the desks of co-workers, garbage cans, and from making copies of documents that discussed impending mergers and acquisitions. Even though the documents referred to the companies involved by code, Freeman was able to learn their true identity by piecing together their industry, historical stock prices, names of officers, and geographic location.

Once Freeman knew who and when, he disseminated the information to friends, family, and anyone who would listen via an Internet chat room under the name "TheBren." What

Freeman did not know is that among his many listeners were members of the Securities and Exchange Commission (SEC), the FBI, and federal prosecutors. In fact, at any given time, 100 specially trained SEC employees are surfing the Net, visiting chat rooms, and reading message boards looking for illegal inside traders. When they identify a red flag, they forward the information to the Office of Internet Enforcement, a special division of the SEC who helps build cases to pursue criminal charges and/or civil lawsuits.

The SEC is not the only surveillance group out in cyberspace. The exchanges monitor trading activity as well. In fact, the American Stock Exchange was the organization who originally identified a problem when they noticed unusual trading patterns prior to the public

announcement of these mergers and acquisitions. Once the SEC was notified, it was only a matter of time.

Freeman directly told at least 10 people, but as with any valuable secret, the information spread like wildfire. A friend of Freeman's, a waiter at a New York restaurant, made over $285,000. He told a patron who profited by at least $445,000, which was certainly more than he earned in his former career as a school teacher.

While his friends made millions of dollars, Freeman was more conservative and profited by only $70,000-$110,000, plus various non-pecuniary benefits such as cases of wine. This seems to be a small gain given the hefty fines and prison time that is certain to follow.

It seems the Internet is affecting the stock market in all sorts of ways, both good and bad. It remains to be seen if the perceived anonymity of the Internet acts as a breeding ground for the conveying of private corporate information. One thing is for certain, however, the SEC is readying themselves by continual efforts and manpower devoted to policing cyberspace.

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aw_gitman_pmf_10|Case Studies in Finance|Case 1: Insider Trading

Questions

1.

What is the definition of non-public, or private, information?

2.

Who can come into contact with private, or inside, information?

3.

When does private corporate information turn into illegal insider trading?

4.

Why is the Internet such a high potential breeding ground for inside information?

5.

What should you do if you learn of inside information?

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aw_gitman_pmf_10|Case Studies in Finance|Case 2: The Tobacco Industry

Home > Case Studies in Finance > Case 2: The Tobacco Industry >

Case 2: The Tobacco Industry

Special Management Topics: Ethics

Cigarettes have long been known to cause cancer, lung diseases, and other related illnesses, but until recently, only minor steps have been taken to prevent this pernicious habit from

reaching those who do not smoke. The government is strongly considering a ban on smoking in the work place. Offices, restaurants, sporting events, casinos, bars, and even construction sites are included in this definition of "work place."

It has been argued that placing a ban on smoking in the work place will result in millions of dollars in savings by businesses through a lower rate of absenteeism, higher productivity, and an overall healthier work force. For those businesses that insist on providing on-site smoking facilities, smoking rooms would have to be established with ventilation systems separate from the rest of the building.

Small firms have already complained that this would be detrimental to them due to the costs involved with installing such systems. Smokers argue that the necessity for smoking rooms would be so costly to businesses that they would find it too expensive to hire smokers. Thus, discrimination is also a key issue.

The Food and Drug Administration (FDA) has also voiced complaints against the tobacco industry. Specifically, they accused the tobacco industry of increasing the amount of nicotine, a highly addictive narcotic, in its cigarettes. By increasing nicotine levels, tobacco firms are able to keep existing smokers addicted, while increasing their chances of hooking first time smokers.

The tobacco industry has retaliated by stating they have not altered natural nicotine levels. Further, although the removal of nicotine is scientifically possible, just as caffeine can be removed from coffee, the industry refuses to reduce levels because nicotine gives cigarettes its flavor and feel.

The FDA refuses to believe that tobacco companies do not boost nicotine levels. They cite three disturbing facts that support this contention. First, the tobacco industry has known through research conducted by its own scientists that nicotine causes cancer. This fact provides the tobacco industry's motive. Second, the tobacco industry holds several U.S. patents on technology that controls the amount of nicotine in cigarettes. Why would the tobacco industry spend millions of research and development dollars to develop technology that it did not intend to use? Finally, even the cigarettes that the industry claims are low in nicotine are still at levels that can induce addiction in the majority of smokers.

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aw_gitman_pmf_10|Case Studies in Finance|Case 2: The Tobacco Industry

It's only a matter of time before we find out which party is telling the truth. Meanwhile, the smoking ban becomes more and more realistic and within the next few years many experts feel that it will be in effect across the entire country.

Questions

1.

The Surgeon General has long since declared that cigarettes are hazardous to people's health. Since this is common knowledge, is it unethical for the tobacco industry to increase the level of nicotine in their cigarettes without informing consumers?

2.

Is it unethical for the tobacco industry to increase the level of nicotine in their cigarettes if they do inform consumers?

3.

If the tobacco industry decided voluntarily or otherwise to convey to consumers that nicotine levels are higher in a particular brand of cigarette, how should the message be conveyed? That is, is a fine print warning on the side of a pack of cigarettes ample warning?

4.

Do you feel that the ban on smoking in all work places, such as those listed in the case, violates the civil rights of smokers? Does smoking in the work place violate the civil rights of non-smokers?

5.

What can the government do to protect or help defray the costs of establishing smoke rooms in the work place for small businesses that cannot afford to install ventilation systems?

6.

It can be argued that if the ban is implemented, businesses will find the costs

associated with hiring smokers (due to having to establish smoke rooms) outweigh the benefits. What can the government do to prevent or mitigate the discrimination law suits that might result from a firm's hesitation to hire a smoker after the ban is

implemented?

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aw_gitman_pmf_10|Case Studies in Finance|Case 3: Connect Cable Contractors

Home > Case Studies in Finance > Case 3: Connect Cable Contractors >

Case 3: Connect Cable Contractors

Entrepreneurial Decision Making

Caldwell Cable Company is responsible for providing and maintaining cable services to

Lexington County in South Carolina. To reduce expenses and remove the burden of providing insurance and company vehicles, Caldwell Cable hires outside contractors to perform

installations and initial connection of cable service. Every three years the cable contract expires and anyone can submit a closed-bid in an attempt to get the contract.

Until recently, P&R Cable, owned by Bob Martin, held the contract. Five years ago, Bob promoted an installer from within the company, named Steve Seiler, to run the business. Since then, Steve has taken on full responsibilities at P&R. On March 15, the contract came up for bid again. Over-burdened by the additional responsibilities and displeased with Bob's unwillingness to share in the profits of P&R, Steve decided to submit a closed bid under the company name "Connect Cable Contractors." Connect Cable underbid P&R by 2% (This figure was discovered later when all the bids became public record after the contract was awarded). This, coupled with Caldwell Cable's preference for working with Steve, caused Caldwell to award the contract to Connect Cable.

Steve now faced several new obstacles. In the course of complying with industry regulations, Steve found that Bob's treatment of worker's compensation was not in compliance with IRS regulations. Under the previous contract, Bob had passed on worker's compensation

premiums to his three sub-contractors by deducting 12% from their gross weekly paycheck. By law, Bob should have paid a fixed amount of approximately $6,000 a year. This amount is the responsibility of P&R, not of each sub-contractor.

Steve now has to pay the $6,000 at the beginning of the year and cannot pass on the charges to his sub-contractors. Each sub-contractor is paid on a per job basis and Steve is given an override on each job. Exhibit 1 lists the various jobs that can be performed and the amount both Steve and his sub-contractors earned under the previous contract.

Exhibit 1

Various jobs that can be performed and the price Bob paid for each under the previous contract

Type of job Bob's price

Overhead Install $14.50 Underground Install $14.50

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aw_gitman_pmf_10|Case Studies in Finance|Case 3: Connect Cable Contractors A/O(unwired-w/) $5.50 A/O( wired-w/) $5.50 VCR (w/ install) $1.50 Long Drop $10.00 Replace Drop $14.50 Relocate; A/O Only:

Wired $10.00 Unwired $10.00 Reconnect $10.50 VCR (w/ reconnect) $1.50 VCR Hook-Up Only $6.50 Upgrades $6.50 Trip Charge $5.00

With the removal of the 12% charge, the current amounts that are paid to sub-contractors per job are too high. Therefore, Steve must decide on a new level of prices to pay each person

per job. His goal is to pay the sub-contractors more, in real terms, but less in nominal terms. For example, if Steve reduces the pay on a job by exactly 12%, this would be a decrease of 12% in nominal terms, but no change in pay in real terms because the 12% decrease is offset by the sub-contractors not having to pay 12% for worker's compensation. Steve would prefer to give them a raise of between 7%-8%, in real terms.

Furthermore, Bob's old prices are not commensurate with the level of difficulty each job entails. For example, "replacing a drop" is much easier than completely installing cable in a house for the first time, yet both jobs pay the same amount. This disparity in prices relative to the amount of time required to complete a job causes low morale and overall dissatisfaction. Steve, therefore, must revamp the pricing structure to reflect the level of time each job

requires and include an increase in real pay of approximately 7%-8%.

The previous prices are consistent relative to each other with the following exceptions. First, overhead and underground installations are priced the same as replacing a drop. Because understanding the differences between the three requires a great familiarity with the cable industry, the analysis will be simplified by informing the reader that overhead installations require the most time, followed by underground installations, then finally replacing the drop. For this reason, Steve would like to pay a higher price for overhead installations, a lower price for underground installations, and an even lower price for replacing a drop. These prices

should be altered only slightly as all three are still more time consuming than a basic reconnect.

Second, the previous price structure paid the same amount for installing an additional cable outlet whether or not the outlet was already wired (Exhibit 1, lines 3 and 4. Also lines 8a and 8b.). From a sub-contractor's standpoint, installing cable wire for an additional outlet is not worth the small amount of revenue received, whereas activating an existing line is very quick

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and easy. Since both jobs paid the same amount, many sub-contractors avoided installing unwired outlets. This caused Bob to lose revenue. Steve knew that something had to be done to entice sub-contractors to promote the installation of additional outlets. After deciding on the new prices, Steve wishes to demonstrate to his employees that in real terms, they will be better off.

To show the resulting increases in real income, Steve asked each sub-contractor for a copy of their invoices since the "time window" system was initiated in January of this year. Steve felt that using records prior to January would be misleading since the time windows have caused a permanent decrease in everyone's income. Due to constraints, such as

incompletely kept records and Bob's unwillingness to provide official records, Steve was able to gather only five weeks of records for one contractor named Burt. A second

sub-contractor, Chris, provided Steve with nineteen weeks of financial records; Steve kept all twenty weeks worth of records on himself. From this data, Steve calculated a weekly average of the number of each job performed by each sub-contractor, including himself. These weekly averages are shown in Exhibit 2.

Exhibit 2

Weekly averages of the number and type of job performed by each sub-contractor from January 1995 to the first week in March 1995

Type of job Steve's Average number of each job per week

Burt's Average number of each job per week

Chris' Average number of each job per week

Overhead Install 5.5 11.8 8.1 Underground Install 6.9 1.6 7.6 A/O(unwired-w/) 17.8 17.6 18.5 A/O( wired-w/) 20.3 11.6 9.9 VCR (w/ install) 9.2 11.6 11.9 Long Drop 2.1 4.6 3.7 Replace Drop 3.0 2.8 0.9

Relocate; A/O Only:

Wired 2.0 0.4 0.8 Unwired 7.8 3.4 8.4 Reconnect 9.9 6.8 7.2 VCR (w/ reconnect) 9.9 2.8 3.8 VCR Hook-Up Only 0.0 0.0 0.0 Upgrades 1.0 1.0 1.0 Trip Charge 0.5 1.2 2.4

Put yourself in Steve's position. What are the new prices you will pay to make the amount of time that each job requires commensurate with the amount of money the sub-contractors receive, and at the same time provide the sub-contractors with an increase in real income of

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approximately 7%-8%? As you perform the analysis and answer the following questions, remember that Steve's employees will surely ask you to explain the assumptions you have made and where the calculations came from. Keep in mind that the purpose of the new pricing structure is to benefit the employees as well as Steve and to allow for a smooth transition in the transfer of the contract from Bob to Steve.

Questions

1.

Complete the following table. Be sure to reflect both adjustments for the time required to do different jobs and a 7%-8% increase in REAL pay for each sub-contractor.

Table 1

Calculations Worksheet for New Prices

Type of job (1) Bob's price (2) Steve's price (3) = {[(2)-(1)(1-.12)]/ (1)(1-.12)}*100 Percentage increase in pay

Overhead Install Underground Install A/O(unwired-w/) A/O( wired-w/) VCR (w/ install) Long Drop Replace Drop

Relocate; A/O Only: Wired Unwired Reconnect VCR (w/ reconnect) VCR Hook-Up Only Upgrades Trip Charge

2.

How much did Chris and Burt earn under Bob's old pricing per week?

3.

How much more will they earn per week under Steve's new system?

Table 2

Calculations Worksheet for Increases in Weekly Earnings Under the New Pricing System for Chris

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Type of job

Average number of each job per week

Dollar increase in pay per job

Total dollar increase In pay per type of job

Relocate; A/O Only: Wired Unwired Reconnect VCR (w/ reconnect) VCR Hook-Up Only Upgrades Trip Charge Table 3

Calculations Worksheet for Increases in Weekly Earnings Under the New Pricing System for Burt

Type of job

Average number of each job per week

Dollar increase in pay per job

Total dollar increase In pay per type of job

Relocate; A/O Only: Wired

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aw_gitman_pmf_10|Case Studies in Finance|Case 3: Connect Cable Contractors Unwired Reconnect VCR (w/ reconnect) VCR Hook-Up Only Upgrades Trip Charge

4.

How much MORE will EACH sub-contractor earn under the new pricing structure per year?

5.

In question 3, you assumed that they will work the same number of each job in each of the 52 weeks throughout the year. How valid of an assumption is this? Is the

assumption just as valid for each sub-contractor? Explain.

6.

Based on your results from Question 2, can Steve hire another sub-contractor to help cope with the new time windows without cutting into the existing contractor's income too much? Explain.

7.

The entire analysis is based on using data that dates back only to January of this

year. What are the advantages and disadvantages of using such a period in the case?

8.

In addition to the steps suggested in the case, what else can Steve do to increase his chances of renewing the contract three years from now? This may be the most

important question in the case!

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aw_gitman_pmf_10|Case Studies in Finance|Case 4: IBP

Home > Case Studies in Finance > Case 4: IBP >

Case 4: IBP

Financial Statement Construction: The Balance Sheet

IBP, Inc., now a division of Tyson Foods and a worldwide provider of various food products, had achieved record fourth quarter earnings. The company felt the results were due primarily to IBP's focus on the "home-meal replacement" market segment. For years the traditional family unit has undergone tremendous change. The "typical" American household no longer consists of a working father and a stay-at-home housewife mother who prepares four course meals for the family (which includes 2.4 children).

Today, there is no one definition of a "family" or "household." Phrases used to describe life today include, duel family incomes, fast-food takeout, microwave cooking, etc. People just don't seem to have the time or are not willing to make the time to cook at home the way they used to. Forbes Magazine reports that a decade ago 70% of all purchases from the grocery store were for ingredients used to make meals in the home. Today, only 47 cents out of every dollar are spent on ingredients. What then are people spending their money on at the grocery store? They're buying meals that are prepared someplace else and only need to be heated up. The food industry refers to this as ready-to-cook or ready-to-eat meals. Examples include frozen pizzas, deli sandwiches, canned soup, frozen dinners, chicken pot pies, frozen

sausage biscuits, and the list goes on and on. Industry experts predict this trend will continue for the foreseeable future. In fact, they say that within the next ten years, this market segment will represent over two-thirds of all grocery store purchases.

Even in these exciting times of record earnings, IBP must be sure to keep track of their accounting. Below is a list of all the items found on their Balance Sheet. Reconstruct IBP's Balance Sheet by arranging the items in their correct order.

An Alphabetical Listing of IBP's Balance Sheet Items

1. Accounts payable and accrued expenses $ 565,517

2. Accounts receivable 599,999

3. Accumulated depreciation and amortization (843,937) 903,837

4. Additional paid-in capital 405,278

5. Assets

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6. Buildings and stockyards 544,711

7. Cash and cash equivalents $ 27,254

8. Commitments and Contingencies Stockholders' Equity

9. Common stock, $.05 par value per share 4,750

10. Construction in progress 168,256

11. Current Assets

12. Current Liabilities

13. Deferred credits and other liabilities

deferred income taxes 17,037

other 148,811

Total deferred credits and other liabilities 165,848

14. Deferred income tax benefits 51,781

15. Deferred income taxes 1,818

16. Equipment 1,096,571

1,747,774

17. Federal and State income taxes 152,122

18. Inventories 405,418

19. Land and improvements 106,492

20. Liabilities and Stockholder's Equity

21. Marketable securities 1,400

22. Net Property, plant, and equipment 1,072,093

23. Notes payable to banks 140,967

24. Other 5,388

Total current liabilities 865,812

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Treasury stock (60,383)

Total Stockholder's Equity 1,400,914

26. Other assets

Goodwill 724,089

Other 115,099

Total other assets 839,096

27. Preferred stock 0

28. Prepaid expenses 10,983

29. Property, plant, and equipment

30. Retained earnings 1,067,725

31. Total Assets $3,008,096

32. Total Current Assets 1,096,815

33. Total Liabilities and

Stockholder's Equity $3,008,096

34. Total Long-term Obligations 575,522

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aw_gitman_pmf_10|Case Studies in Finance|Case 5: Chrysler

Home > Case Studies in Finance > Case 5: Chrysler >

Case 5: Chrysler

Ratio Analysis

Before Chysler merged to become DaimlerChrysler AG, they were presented with a takeover bid of $55 per share by MGM billionaire Kirk Kerkorian and former Chrysler chairman Lee Iacocca. Kirk Kerkorian was a stockholder in Chrysler and an experienced takeover financier who apparently found Chrysler to be a good buy. Chrysler rejected the offer, however, stating that the firm was not for sale. Further, many Wall Street experts felt that Kerkorian could not come up with the $20 billion necessary to complete the deal.

After Chrysler rejected Kirk Kerkorian's bid of $55 per share, Kerkorian decided to have his people repeat the analysis of the firm's financial performance over the two most recent years to determine if he should increase his bid in this friendly takeover attempt. To measure the financial performance of Chrysler over the past two years, key financial ratios will have to be computed and compared with industry averages. To help in this endeavor, Chrysler's financial statements are found on the following pages.

Chrysler Corporation's Balance Sheet for the year ending December 31 (in millions)

This Last

year year

Assets

Current Assets

Cash and cash equivalents $ 5,543 $ 5,145

Marketable securities $ 2,582 $ 3,226

Accounts receivable $ 2,003 $ 1,695

Inventories $ 4,448 $ 3,356

Prepaid taxes $ 985 $ 1,330

Finance receivables $13,623 $12,433

Total Current Assets $29,184 $27,185

Property & equipment $20,468 $18,281

Less: Accumulated Depreciation $ 7,873 $ 7,208

Net Plant & Equipment $12,595 $11,073

Other Assets

Special tools $ 3,566 $ 3,643

Intangible assets $ 2,082 $ 2,162

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aw_gitman_pmf_10|Case Studies in Finance|Case 5: Chrysler Other assets $ 5,839 $ 5,081 Total Assets $53,756 $49,539 Liabilities Current Liabilities Accounts payable $ 8,290 $ 7,826 Short-term debt $ 2,674 $ 4,645 Accrued liabilities $ 7,032 $ 5,582 Other payments $ 1,661 $ 811

Total Current Liabilities $19,657 $18,864

Long-term Liabilities

Long-term debt $ 9,858 $ 7,650

Accrued employee benefits $ 9,217 $ 8,595

Other non-current liabilities $ 4,065 $ 3,736

Total Long-term Liabilities $23,140 $19,981

Total Liabilities $42,797 $38,845

Stockholder's Equity

Preferred stock $ 0 $ 2

Common stock (at $1 par) $ 408 $ 364

Additional paid-in capital $ 5,506 $ 5,536

Retained earnings $ 6,280 $ 5,006

Treasury stock ($1,235) ($ 214)

Total Shareholder's Equity $10,959 $10,694

Total Liabilities and Share. Equity $53,756 $49,539

Chrysler Corporation's Income Statement for the year ending December 31, (in millions)

This Last

year year

Sales revenue $53,195 $52,235

Less: Cost of goods sold $41,304 $38,032

Gross profits $11,891 $14,203

Less: Operating expenses

Selling & admin. $4,064 $3,933

Pension $ 405 $ 714

Nonpension post ret. $ 758 $ 834

Depreciation $1,100 $ 994

Amort. of tools $1,120 $ 961

Total operating expenses $ 7,447 $ 7,436

Operating profits $ 4,444 $ 6,767

Less: Interest expenses $ 995 $ 937

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Net profit before taxes $ 3,449 $ 5,830

Less: Taxes (40%) $ 1,380 $ 2,332

Net profit after taxes $ 2,069 $ 3,498

Industry Average Financial ratios this year and last year

This Last

year year

Liquidity

Net Working Capital $5,056 $4,892

Current Ratio 1.78 1.69

Quick Ratio (Acid Test) 1.55 1.51

Activity

Inventory Turnover 7.41 7.58

Average Age of Inventory .021 .021

Average Collection Period 22.8 23.4

Fixed Asset Turnover 1.54 1.62

Total Asset Turnover .89 .91

Debt

Debt 75% 77%

Times Interest Earned 6.4 7.0

Profitability

Gross Profit Margin 24% 28%

Net Profit Margin 4.7% 4.9%

Return on Total Assets 4.6% 4.7%

Return on Equity 20.7% 33.8%

Questions

1.

Compute Chrysler's financial ratios for the past two years.

2.

Compare these ratios to the industry's average. Comment on Chrysler's strengths and weaknesses by ratio category.

3.

Should Kerkorian have pursued the purchase of Chrysler?

4.

If Kerkorian did not want to takeover Chrysler, what other reasons might he have had for trying to convince other people that Chrysler was a takeover candidate?

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aw_gitman_pmf_10|Case Studies in Finance|Case 6: Moog

Home > Case Studies in Finance > Case 6: Moog >

Case 6: Moog

Financial Statement Construction: Consolidated Statement of Earnings

The future of military warfare is being defined by innovations and advancements in

technology. For example, Moog, Inc., has recently seen their flight control device installed in the V-22 Osprey, a wing-folding aircraft that is effectively both a helicopter and a fighter plane.

But this is just the tip of the iceberg. Moog is in the process of creating technology that will allow unmanned vehicles and airplanes to be operated by remote control. Sound like futuristic science fiction? It really is not that far away. Think about the advantages of flying from a

remote location. Today, it costs millions of dollars to train a single fighter pilot. When the pilot is lost in a war, a new pilot must be trained in his place. However, if the pilot is flying the plane from a remote, safe location, even when the plane is lost in a battle, the pilot will survive to flying again.

Advancements are taking place in artillery as well. You may have heard of the expression, "I've got a bullet with your name on it." Well, this may be more true than you realize. Smart bullets are being developed that use the same technology as a guided missile. Instead of locking on a stationary target many miles away, this bullet will receive continually updated target location information that will enable it to follow a moving target even if that target goes around corners.

No matter how good Moog's technology, they still need to construct their Consolidated

Statement of Earnings to continue to be a successful company. Below is an alphabetical list of the items that appear on their Consolidated Statement of Earnings. Using these items, reconstruct the statement by putting all of the items in the correct order. Double check your answer to make sure the numbers add up.

Items on the Consolidated Statement of Earnings

Cost of Sales $493,235 Earnings Before Income Taxes $42,013 Income Taxes $14,075 Interest $32,054 Gross Profit $211,143 Net Earnings $27,938

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aw_gitman_pmf_10|Case Studies in Finance|Case 6: Moog

Net Earnings Per Share

Basic $2.13

Diluted $2.11

Net Sales $704,378

Other ($64)

Research and Development $26,461 Selling, general and administrative $110,679

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aw_gitman_pmf_10|Case Studies in Finance|Case 7: Kate Myers

Home > Case Studies in Finance > Case 7: Kate Myers >

Case 7: Kate Myers

Basic Concepts: The Time Value of Money

After graduating from Ohio State University with a degree in Finance, Kate Myers took a position as a stock broker with Merrill Lynch in Cleveland. Although she had several college loans to make payments on, her goal was to set aside funds for the next eight years in order to make a down payment on a house. After considering the various suburbs of Cleveland, Kate chose Lakewood as her desired future residency. Based on median house price data, she learned that a three-bedroom, two-bath house currently costs $98,000. To avoid paying Private Mortgage Insurance (PMI), Kate wanted to make a down payment of 20%.

Because it will be eight years before Kate buys a house, the $98,000 price will surely not be the same in the future. To estimate the rate at which the median house price will increase, she considered the historical price appreciation in Lakewood. In the past, homes appreciated by nearly 4% per annum. Kate was satisfied with this estimation.

Merrill Lynch provides several opportunities for Kate to invest the funds that will be devoted to the purchase of her future home. She feels that a balanced account containing stocks, bonds, and government securities would realistically achieve an annual rate of return of 8%.

Questions

1.

Taking into consideration the fact that the $98,000 home price will grow at 4% per year, what will be the future median home selling price in Lakewood in eight years? What amount will Kate Myers have to accumulate as a down payment if she does decide to buy a house in Lakewood?

2.

Based on your answer from number 1, how much will have to be deposited into the Merrill Lynch account (which earns 8% per year) at the end of each month to

accumulate the required down payment?

3.

If Kate decides to make end-of-the-year deposits into the Merrill Lynch account, how much would these deposits be? Why is this amount greater than twelve times the monthly payment amount?

4.

If homes in Lakewood appreciate by 6% per annum over the next eight years instead of the assumed 4%, how much would Kate have to deposit at the end of each month to make the down payment? What if the appreciation is only 2% per year?

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aw_gitman_pmf_10|Case Studies in Finance|Case 7: Kate Myers

5.

If Kate decided to deposit her down payment funds in less risky certificates of deposit (CDs) earning only 4%, how much would she have to deposit at the end of each

month to make the down payment? What if she pursued a more risky investment of growth stocks that have an expected return of 12%?

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aw_gitman_pmf_10|Case Studies in Finance|Case 8: Quilici Family

Home > Case Studies in Finance > Case 8: Quilici Family >

Case 8: Quilici Family

Basic Concepts: The Time Value of Money

Greg and Debra Quilici own a four bedroom home in an affluent neighborhood just north of San Francisco, California. Greg is a partner in the family owned commercial painting

business. Debra now stays home with their child, Brady, who is age 5. Until recently, the Quilicis have felt very comfortable with their financial position.

After visiting Lawrence Krause, a family financial planner, the couple became concerned that they were spending too much and not putting enough funds aside for both their child's future education needs and their own retirement. Greg earns $85,000 per year, but with the rising costs of education, their past contribution efforts have left them short of their financial goals. To estimate the amount of money the Quilicis need to begin putting away for future security some general information was obtained by their financial planner. The couple felt that the amount of money they currently contribute to their Koegh plan would be sufficient for their retirement needs. What they had not accounted for was Brady's education.

Greg is an alumni of Stanford University, a private school with an extremely high tuition of approximately $20,000 per year. Debra graduated from the University of North Carolina at Chapel Hill. The tuition expense there is only $2,500 per year. When Brady turns 18, the couple wishes to send him to either of these exceptional universities. They have a slight preference for the much more local Stanford University. The problem, however, is that with the rate at which tuition is increasing the Quilicis are not sure they can raise enough money. To assist in the calculations, assume the tuition at both universities will increase at an annual rate of 5%. Living expenses are currently estimated at $6,000 per year at both schools. This expense is expected to grow at only 3% per year. Further assume the Quilicis can deposit their money into a growth oriented mutual fund at Neuberger & Berman Management, Inc., which has historically earned a 12% return per annum (1% per month).

The couple wishes to have a pre-determined monthly amount automatically drafted from their checking account. When Brady starts college they will slowly liquidate the account by making an annual payment to Brady to cover tuition and living expenses at the beginning of each year for the four years he will be in college.

Questions

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aw_gitman_pmf_10|Case Studies in Finance|Case 8: Quilici Family

attend? Give an answer for each university.

2.

Once Brady starts college what will his total expenses be in each of his four years? Again, give an answer for each university.

3.

How much money will Greg and Debra have to deposit per month to allow Brady to attend Stanford University? How much money will have to be deposited per month to allow Brady to attend the University of North Carolina? (HINT: To answer this question you need to consider the costs of ALL four years.)

4.

What if the Quilicis feel the Neuberger & Berman mutual fund will only yield 10%. How much will have to be deposited per month in order for Brady to attend each college?

5.

What is the relationship between the amount that must be deposited monthly by the parents and the future increases in both tuition and living expenses?

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aw_gitman_pmf_10|Case Studies in Finance|Case 9: Wal-Mart

Home > Case Studies in Finance > Case 9: Wal-Mart >

Case 9: Wal-Mart

Basic Concepts: Risk and Return Analysis

Marvin Brown is a savvy investor who is always looking for a sound company to include in his portfolio of stocks and bonds. Being somewhat risk-averse, his main objective is to buy stock in firms that are mature and well-established in their respective industries. Wal-Mart is one of the stocks Marv is currently considering for inclusion in his portfolio.

Wal-Mart has four major areas of business: traditional Wal-Mart discount stores,

Supercenters, Sam's Clubs, and international operations. Although Wal-Mart was established over 50 years ago, it continues to achieve growth through expansion.

The Supercenter concept, which combines groceries and general merchandise, is extreme success as 75 new Supercenters were opened last year alone. Another 95 will be opening over the next two years.

Sam's clubs have also seen success as 99 Pace stores (Pace is one of Sam's former Competitors) were converted to Sam's stores in 1995. In addition to taking over competitor stores, Sam's also opened 22 new stores of its own.

Internationally, the picture is equally as rosy. In Canada, 122 former Woolco stores were converted to Wal-Mart discount stores. Expansion has reached Mexico and Hong Kong as well, as 24 Clubs and Supercenters and 3 "Value Clubs" were established, respectively. Wal-Mart plans to continue its reign as the world's largest retailer through expansion by developing the previously discussed 95 Wal-Mart discount stores, 12 new Supercenters and 9 new Sam's Clubs. Internationally, 20 to 25 new stores will be built in Hong Kong, China, Argentina, Brazil and Canada.

In order to determine if Wal-Mart is a "good buy," Marv has to perform several analyses. First, he must calculate the returns on Wal-Mart's common stock over the past eight quarters as an indicator of how the stock might perform over the next year. He must then calculate the

standard deviation of the stock as a proxy for its risk. To aid in his calculation, Marv has gathered the following stock price and dividend data.

Table 1

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Quarter Closing Stock Price June 2002 $55.01 March 2002 $61.22 December 2001 $57.41 September 2001 $49.32 June 2001 $48.54 March 2001 $50.16 December 2000 $52.69 September 2000 $47.67 Table 2

Quarterly Dividend Payments

Date Dividend Payment June 19, 2002 $0.08 March 20, 2002 $0.08 December 19, 2001 $0.07 September 19, 2001 $0.07 June 20, 2001 $0.07 March 21, 2001 $0.07 December 20, 2000 $0.06 September 13, 2000 $0.06 Questions

1.

Calculate the returns for each of the seven quarters.

2.

Calculate the standard deviation of the returns from question 1.

3.

Assume that Wal-Mart has a Beta of 1.2, the risk-free rate of interest (i.e. as proxied by the return on a 3-month treasury bill) is 5.25%, and the return on the market is 12.2% annually (as proxied by the return on the Standard & Poor's 500). Based on CAPM, what is the required rate of return on Wal-Mart's stock?

4.

Using your answer from question 3, if Wal-Mart had an expected return of 14%, would Marv be well advised to purchase the stock? At what minimum expected rate of return would Marv be encouraged to buy the stock?

5.

Marv has based his buy decision on quarterly data from the past two years. If the same analysis was performed five years ago or five years from now, do you think

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Marv might have come to a different conclusion? Discuss the effect that choosing this particular time period might have on Marv's results.

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aw_gitman_pmf_10|Case Studies in Finance|Case 10: In tel

Home > Case Studies in Finance > Case 10: Intel >

Case 10: Intel

Basic Concepts: Portfolio Risk and Return Analysis

Michael Frank is an individual investor who is currently considering the purchase of $4,000 worth of Intel's common stock. Mike already has a significant amount invested in the

computer industry, but he feels Intel will be one of the leading companies in the future. One of the reasons for this perceived future success is the Research and Development being done in the area of parallel supercomputers.

Justin Rattner, Intel's former scientist of the year, is a leading researcher in parallel

supercomputing. Parallel supercomputing breaks down a complex problem into many, easier to manage components. Further, all of these components can be manipulated

simultaneously. It is analogous to Tom Sawyer getting all his friends to paint the fence. The speed of parallel computers is much faster than their larger and supposedly faster computers competitors. Computer chip manufacturers are concerned primarily with speed and the size of the components necessary to generate the speed. With Intel leading the way in this emerging area, Mike feels he should own their stock.

One concern Mike has is how the inclusion of Intel's common stock will affect the overall return and risk of the computer stocks he currently owns. Presently, Mike holds $2,000 worth of IBM, $3,500 in Compaq, and $4,500 in Apple.

To determine the impact of the purchase of $4,000 worth of Intel, Mike has calculated the expected annual returns over the next eight years for each of the four stocks. The expected returns for each are shown in the table below.

Years into the future

Expected Return for each Company (%) IBM Compaq Apple Intel 1 6.2 0.1 -4.2 4.8 2 7.8 2.8 6.6 10.2 3 6.9 -1.9 12.2 11.3 4 -4.1 2.9 7.8 18.1 5 8.9 7.7 4.3 6.6 6 10.2 15.1 -2.1 -1.8 7 15.3 19.3 8.4 2.7 http://wps.aw.com/aw_gitman_pmf_10/0,6047,347193-,00.html (1 of 2) [11/27/2002 12:20:02 AM]

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aw_gitman_pmf_10|Case Studies in Finance|Case 10: In tel

8 9.2 14.2 10.2 10.9

The beta of Intel is projected to be 1.1 over the next eight years. The betas of IBM, Compaq, and Apple assumed to be 0.7, 1.6, and 1.0, respectively. Mike wants to see what affect the purchase of Intel will have on the beta of his overall portfolio. He is assuming the beta of each firm will remain constant over the eight year period.

Questions

1.

Calculate the expected return for each of the next eight years without the inclusion of Intel.

2.

Calculate the expected return for each of the next eight years with the inclusion of Intel.

3.

Calculate the standard deviation for each of the next eight years without the inclusion of Intel.

4.

Calculate the standard deviation for each of the next eight years with the inclusion of Intel.

5.

Calculate the beta of the portfolio both with and without Intel.

6.

We have assumed that beta will be constant over the next eight years. How realistic is this assumption. That is, does beta tend to remain constant over time?

7.

Which measure of risk is more appropriate when considering Intel's inclusion into Mike Frank's portfolio, standard deviation or beta?

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aw_gitman_pmf_10|Case Studies in Finance|Case 11: Amber Plank

Home > Case Studies in Finance > Case 11: Amber Plank >

Case 11: Amber Plank

Term Structure of Interest Rates

Amber Plank is a high school senior who plans to attend college next year and major in

Astronomy. Her first choice is to attend the University of Charleston, which is highly regarded in her intended field. However, to do so she will have to take out a substantial amount of loans as this is a private university with high tuition costs. While loan rates today are not high by historical standards, Amber will be charged the one-year rate that exists at the time she takes out the loans. That is, each year when she borrows to pay for her tuition, she will be assessed interest at a rate consistent with the short-term rate that exists in the future.

Amber's second collegiate choice is to attend the University of Florida. The benefit of doing so is that she will receive a full scholarship and thus will not have to borrow in order to attend this institution. The drawback is that while this is a fine university, it does not specialize in her major.

Selecting which university to attend is an extremely important decision to make. In order to perform a complete cost comparison between the two universities, Amber must determine the future one-year interest rates that are likely to exist. Since they are the rates at which she will have to borrow in the future, accuracy is extremely important as these interest costs will

eventually be used in a cost-benefit analysis.

Table 1 lists today's rates that exist for U.S. Treasury securities of various maturities. Table 1

Time To Maturity Yield to Maturity 1 year 7.0% 2 years 7.5% 3 years 8.0% 4 years 8.5% 5 years 8.6% Questions

1.

What are the four most important variables that determine a bond's yield to maturity?

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aw_gitman_pmf_10|Case Studies in Finance|Case 11: Amber Plank

2.

Define a Yield Curve.

3.

Explain the Expectations Hypothesis and use the theory to try to predict what the one-year interest rates will be over the next five one-years.

4.

Explain the Liquidity Preference Hypothesis and use the theory to try to predict what the one-year interest rates will be over the next five years.

5.

Explain the Market Segmentation Hypothesis and use the theory to try to predict what the one-year interest rates will be over the next five years.

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aw_gitman_pmf_10|Case Studies in Finance|Case 12: Fruit of the Loom

Home > Case Studies in Finance > Case 12: Fruit of the Loom >

Case 12: Fruit of the Loom

Bond Ratings

On August 5, 1999, the Standard & Poor's CreditWire reported that Fruit of the Loom's 8.875% senior notes, which mature in 2006, were downgraded from BB- to B. This downgrade came after the company recently amended its credit agreement on all other outstanding issues which effectively made the 8.875% notes subordinate to existing claims. Since this represented a mere shuffling of priority claims, Fruit of the Loom's overall corporate credit rating remained at BB- as did the rating of all but one other claim (an $850 million

senior unsecured debt shelf filing was downgraded to B as well). The corporate BB- rating was justified by Standard & Poor's because while Fruit of the Loom still has strong brand name recognition and holds significant market share in underwear, imprinted T-shirt and fleece markets, they are having performance and operational difficulties.

Below is a qualitative description of each of Standard & Poor's bond rating categories. Table 1

Standard & Poor's Bond Rating Scale

AAA - An obligor rated 'AAA' has EXTREMELY STRONG capacity to meet its financial commitments.

AA - An obligor rated 'AA' has VERY STRONG capacity to meet its financial commitments. It differs from the highest rated obligors only in small degree.

A - An obligor rated 'A' has STRONG capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher•rated categories.

BBB - An obligor rated 'BBB' has ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.

BB - An obligor rated 'BB' is LESS VULNERABLE in the near term than other lower•rated obligors. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions which could lead to the obligor's inadequate capacity to meet its financial commitments.

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B - An obligor rated 'B' is MORE VULNERABLE than the obligors rated 'BB', but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments.

CCC - An obligor rated 'CCC' is CURRENTLY VULNERABLE, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments. CC - An obligor rated 'CC' is CURRENTLY HIGHLY VULNERABLE.

R - An obligor rated 'R' is under regulatory supervision owing to its financial condition. During the pendency of the regulatory supervision the regulators may have the power to favor one class of obligations over others or pay some obligations and not others. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of regulatory

supervision on specific issues or classes of obligations.

SD and D - An obligor rated 'SD' (Selective Default) or 'D' has failed to pay one or more of its financial obligations (rated or unrated) when it came due. A 'D' rating is assigned when

Standard & Poor's believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they come due. An 'SD' rating is assigned when Standard & Poor's believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of a default on specific issues or classes of obligations.

Note: Obligors rated 'BB', 'B', 'CCC', and 'CC' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'CC' the highest. While such obligors will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.

Plus (+) or minus (•): Ratings from 'AA' to 'CCC' may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.

Source: Standard & Poors

Questions

1.

Define what is meant by "a Pecking Order".

2.

Why is it, specifically, that the 8.875% bond received a downgrading from BB- to B?

3.

Should the stock price react to this bond's down rating? Why or why not?

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same Earnings Per Share (EPS), but still have a different bond rating?

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aw_gitman_pmf_10|Case Studies in Finance|Case 13: Nations Bank

Home > Case Studies in Finance > Case 13: Nations Bank >

Case 13: Nations Bank

Valuation: Stock Valuation - the Gordon Growth model

Before Nations Bank was bought by Bank of America, Tina Brown was considering the purchase of Nations Bank's common stock. Given Nations Bank's recent merger with the Southeastern powerhouse, Bank South, and talks of penetration into the Florida market via a takeover of Barnett Bank, Tina felt Nations Bank would be a solid "buy and hold" as it

continued to increase its market share through aggressive growth by acquisition.

While Tina was convinced she wanted to own Nations Bank, with all the price volatility surrounding the recent speculations, she was not sure if the price was above or below the stock's intrinsic value. She decided to derive the price of Nations Bank's common stock by using the Gordon Growth Model (Constant Growth Model).

To use the Gordon Growth Model, Tina had to first calculate Nations Bank's required rate of return on their common stock. The risk free rate, as proxied by the yield on a three month Treasury Bill, was 6%. The return on the market, as proxied by the return on the Standard and Poor's 500 (S&P 500), was 10%. Nations Bank had a beta of 1.75.

Past dividend payments also had to be known. Tina was not sure how far back into the future she should go to retrieve the dividend payment information, so she arbitrarily stopped in

1987. Between 1987 and 1990, Nations Bank seemed to have very different payout amounts. Not fully understanding the reasons behind these differences, Tina decided to consider two periods for analysis: from 1987-1995 and from 1990-1995. The dividend information that Tina recovered is shown below in Table 1.

Table 1 Year Dividends 1995 $2.00 ($1.00 through June 1995) 1994 $1.88 1993 $1.64 1992 $1.51 1991 $1.48 1990 $1.42 1989 $1.10

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aw_gitman_pmf_10|Case Studies in Finance|Case 13: Nations Bank

1988 $0.94 1987 $0.86

Questions

1.

Using the Capital Asset Pricing Model (CAPM), what was Nations Bank's required rate of return on common stock?

2.

Consider the first time period from 1987-1995. Use the Gordon Growth Model to determine the price of Nations Bank's common stock.

3.

Consider the second time period from 1990-1995. Use the Gordon Growth Model to determine the price of Nations Bank's common stock.

4.

The answers for questions 2 and 3 are very different. What does this indicate, in general, about the Gordon Growth Model? (Hint--The observed market price of Nations Bank's common stock is $70.25.)

5.

What effect does the stock's required rate of return have on the calculation of its stock price when using the Gordon Growth Model?

6.

If you felt that Nations Bank's last year dividend of $2.00 was going to be paid in that constant amount throughout the remainder of the company's life (i.e. zero growth), what would be the value of the stock today?

7.

Based on your response to question 6, what is the relationship between the present value of a dividend paid one year from now, a dividend paid ten years from now and a dividend paid one hundred years from now?

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aw_gitman_pmf_10|Case Studies in Finance|Case 14: AMR - American Airlines

Home > Case Studies in Finance > Case 14: AMR - American Airlines >

Case 14: AMR - American Airlines

Valuation: Valuing a Corporate Bond Issue

AMR is the parent company of American Airlines. In addition to its primary subsidiary, AMR also operates several airline support companies such as the SABRE group (reservations), the Management Services Group, and American Eagle (a regional carrier).

American Airlines is currently considering the issuance of a series of $1,000 par bonds. The coupon rate offered, based on current market interest rates and the Standard & Poor's based AMR bond rating, will be 10%. The current interest rate is coincidentally 10% as well. Interest on the bonds will be paid semi-annually. However, American cannot decide on the maturity of the new issue. The life of the bonds will be 10, 20, or 30 years.

Questions

1.

Ignoring floatation costs, what will the bonds sell for today if American decides to

issue the bonds with a maturity of 10 years? What will the price be if the bonds have a maturity of 20 years? 30 years?

2.

If the bonds are issued with 10 years to maturity and the day after they are issued, the market interest rates increase to 12%, what will be the price of American Airline's bonds? What if interest rates drop to 8%?

3.

4.

5.

Based on your answers to questions 2 through 4, what is the relationship between time to maturity and the price of the bond?

6.

Based on your answer to question 1, what is the relationship between current interest rates, the coupon rate, and time to maturity?

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aw_gitman_pmf_10|Case Studies in Finance|Case 14: AMR - American Airlines

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aw_gitman_pmf_10|Case Studies in Finance|Case 15: Mirage Resorts

Home > Case Studies in Finance > Case 15: Mirage Resorts >

Case 15: Mirage Resorts

Refunding a Bond Issue

Las Vegas is the fastest growing and arguably the most exciting city in the United States. In fact, Las Vegas now has more visitors than Orlando or the entire state of Hawaii. The

difference is, when people visit Orlando and Hawaii, they come to see theme parks and beaches and coincidentally stay in hotels. But, when people come to Las Vegas, they come to see its hotels.

Mirage Resorts owns several hotels along the Las Vegas strip: The Mirage, Golden Las Vegas, and Treasure Island. Other hotels, not in Vegas include the Golden Nugget-Laughlin and Casino Iguaza. When the Mirage hotel was first built, Mirage Resorts financed the project with 11% notes from the GNS Finance Corporation. These 20-year, $1,000 par, callable bonds had a face value of $40,000,000 and were issued in March of 1988. When they actually sold, they went at a discount at $970 each. The call price of each bond is

$1,110. Further, when the bonds were originally issued, the floatation costs totaled $200,000. The unamortized debt discount is $39,065,000.

Today, interest rates have dropped substantially. Mirage Resorts is considering the possibility that it might be able to refund the old bond issue and replace it with a new issue that has a much lower coupon rate. After meeting with several investment bankers, Mirage learned they could get new bonds at a much lower coupon rate.

The new bonds are expected to sell at their par value of $1,000, have only an 8 1/2 coupon rate, and a 13-year maturity. Mirage estimates that there will be a two month overlapping period while it retires the old bond issue.

Goldman Sachs was chosen to underwrite the issue because of their reputation and relatively low floatation costs. The deal held that Goldman Sachs would receive a fixed amount of

$120,000 to cover administration expenses plus a variable amount equal to .4% of the par value of the offering. The selling group would receive another .3% of the par value upon the offering.

Mirage Resorts has an after-tax cost of debt equal to 6% and their corporate tax rate is 35%. Questions

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aw_gitman_pmf_10|Case Studies in Finance|Case 15: Mirage Resorts

2.

What is the initial investment required to issue the new debt?

3.

What is the annual cash flow from the old bond issue?

4.

What is the annual cash flow from the new bond issue?

5.

Calculate the annual cash flow savings associated with the new bond issue.

6.

What is the present value of the annual cash flow savings associated with the new bond issue? (Hint: these saving will occur every year until the bond issue matures.)

7.

Should Mirage refund the bond issue?

8.

Mirage issued the debt only seven years ago. Why is it that they are able to get such a lower interest rate today? Do you think Mirage Resorts should have waited until interest rates had decreased in the first place before building the Mirage hotel?

9.

What factor(s) do you think were most responsible for the decision you made? That is, of all the factors that affect the refunding decision, which ones do you feel tend to have the greatest impact?

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aw_gitman_pmf_10|Case Studies in Finance|Case 23: Sou thwest Airlines

Home > Case Studies in Finance > Case 23: Southwest Airlines >

Case 23: Southwest Airlines

Capital Budgeting: One Project - Accept/Reject Decision

The airline industry is extremely cyclical. That is, when the economy does well, so too do airlines. In recent years, the airline industry has found itself with too many seats and too few passengers. Some experts point to the past deregulation of the industry while others argue that technological advances such as teleconferencing are responsible. Several airlines such as Continental, America West, Eastern, and Trans World Airlines, have filed for Chapter 11 Bankruptcy. Some have fully recovered, while others have been forced to liquidate (Chapter 7). Narrowing profit margins have prompted airlines to develop creative survival tactics. Southwest Airlines has successfully found its niche in the industry by providing direct flight service to less traveled routes such as those to and from smaller cities. Since these routes do not generate nearly as much revenue as major city routes, Southwest has found ways to reduce its costs. Costs are reduced by following a no frills policy that the travelers refer to as "peanut flights." This means that instead of serving costly meals (the quality of which

passengers have historically complained about anyway), Southwest serves just a bag of peanuts and a soft drink. With the recent success of short, direct flights, Southwest is considering the purchase of one such additional route.

Before an airline applies to the federal government for a new route, a lengthy analysis is performed to determine the feasibility of the route. Expenses to consider include airport costs such as gate and landing fees and labor costs such as local baggage handlers and

maintenance workers. Many times the airline will provide its own employees to load and

unload luggage or to provide upkeep for their planes, but in the case of Southwest, they have so many small cities to service that the outsourcing of these jobs is not uncommon.

Table 1 provides a summary of the after-tax cash flows associated with the acquiring of an additional small route. All costs and revenues are reflected by the following numbers.

Table 1

Projected Net Cash flows (in Millions of Dollars)

Year Net Cash flow 0 -$20.8 1 $4.5 2 $6.3 3 $5.2