Session 9
FINANCE AND ECONOMICS TRACK
Track Chair
and Session Chair: Jonathan B. Welch, Northeastern University
CASES:
Peter M. Bergevin and W. Kent Moore, Valdosta State University
Bell Financial Software, Inc.
Steven R. Kursh, Northeastern University
Hugh Grove and Tom Cook, University of Denver
Hugh Grove and Tom Cook, University of Denver
Jon Goodwin, International Capital Strategies, LLC
Alva Wright Butcher, University of Puget Sound
Eldon Gardner, The University of Lethbridge
Armand Gilinsky, Jr., Sonoma State University
Raymond H. Lopez, Pace University
APPLE COMPUTER: WHAT TOOK THE BITE OUT OF THE DIVIDENDS?
Peter M. Bergevin, Valdosta State University
W. Kent Moore, Valdosta State University
Case Objectives and Use:
This case provides
a vehicle for developing and interpreting financial statements and measures in
the context of the personal computer industry.
As a background for the case, students are asked to describe
characteristics of the PC industry in the 1990s, to provide a brief history of
Apple Computer, Inc., and to evaluate the financial health of Apple Computer in
the 1990s. The primary objectives of
the case are:
1.
To develop an understanding of how cash flow statements can be
misinterpreted.
2.
To reconcile the seeming contradictions between net income and cash flows.
3.
To calculate and interpret cash receipts and cash payments data.
4. To analyze inventory, accounts
receivable, and accounts payable amounts by calculating various financial
measures.
5.
To assess a company’s ability to pay dividends.
The case is
designed primarily for a first Financial Statement Analysis course, or other
finance courses with varying titles such as Financial Management or Financial
Decision Making. It could also be used
in an Intermediate Financial Accounting course. All of these courses are generally taught at the junior level.
Case Synopsis:
Because of
declining profits, Apple Computer suspended payment of its quarterly dividend
payments in December, 1995. During the
five years prior to that time, the company had consistently paid a $0.12 per
share dividend each quarter. For
awhile, Donald Rogers accepted the lack of dividends. However, by 1998, Rogers was both frustrated and perplexed. Apple was reporting profits again and their
operating cash flows were good; surely they had money available for
dividends. After he read a proxy notice
soliciting proposals for the upcoming annual stockholders’ meeting, he wondered
if it was time to take action by submitting a proposal with regard to future
dividends.
This case demonstrates
that cash flow statements can be misleading.
Apple’s cash flow statements presented an overly favorable view of the
company. Its relatively large cash
flows from operations resulted primarily from decreases in inventory and
accounts receivable, not from income earned from product sales. The apparent paradox between operating cash
flows and net income is the key to solving the case.
Contact Person: W. Kent Moore, College of Business Administration, Valdosta State University, Valdosta, GA 31698. Phone: 912/333-5991, FAX: 912/245-6498, e-mail: kmoore@valdosta.edu
BELL FINANCIAL SOFTWARE, INC.
The primary objective of this case is to have students apply financial analysis to value a closely-held computer software company for an acquisition. The case requires students to identify and to value the key components of a company’s business and to consider several other factors including the effect of federal taxes, the risk of technological changes on a company, and non-financial factors that may impact a merger or acquisition. Students also gain some perspective about the dynamics involved in the acquisition of a small company and learn the importance of considering both tangible and non-tangible assets in the valuation of an information technology business.
The case is
typically used in upper level undergraduate and graduate level finance courses,
particularly units within courses in entrepreneurial finance, financial
strategy, or business valuation. We
usually assign an accompanying note, entitled, Note on Valuing Computer Software Companies, with the case if the
students have not had prior work in valuation of companies that are not
publicly traded, particularly information technology companies. This note describes the three basic
valuation approaches (income, market, and asset). It also provides some general information about how to apply these
three approaches to valuing software companies.
Bell
Financial Software, a provider of software used by attorneys and accountants to
prepare federal and state estate tax returns, is considering an acquisition
proposal from Thomson Professional Publishing, a division of one of the world’s
largest publishers. The founder and
principal owner of company, Steven Bell, needs to determine the value of his
company. He also needs to have
financial data to support the valuation for the negotiations with Thomson. Although his company has been successful,
Bell is concerned about changes in technology and the future. These concerns effect the negotiations and
the structure of the transaction.
_____________________
Contact Person: Steven R. Kursh, College of Business Administration, 413 Hayden Hall, Northeastern University, Boston, MA 02115
Voice: (617)
373-2197; FAX (617) 373-8798; e-mail: kursh@mediaone.net
CYGNUS ACQUISITION CASE
Hugh Grove and Tom Cook, University of Denver
Case Objectives and Use
The students are challenged to make a recommendation
concerning the acquisition of a company that enhances a core competency of the
acquiring company. This acquisition
recommendation must include both a business valuation of the company and a
negotiating strategy to close the deal.
The students take the role of the CFO who is in charge of making this
recommendation to the CEO who wants to close the deal quickly. Yet the acquiring company is under severe
pressure to make the quarterly earnings projections of the financial analysts,
especially since the company recently went public with an IPO and has had huge
swings in its stock price.
This case is intended for graduate and senior level courses
in finance and managerial accounting.
The case topics include the price-earnings and free cash flow methods of
business valuation of a company, comparable financial benchmarks, purchase and
pooling accounting methods for a deal structure, and negotiating strategies for
an acquisition.
Case Synopsis
Jason McCracken, Chief Executive Officer of CST, a public
United States customer service company, wants to buy Cygnus Computer
Associates, a private Canadian firm that produces a variety of systems
integration tools or “middleware” that links together existing software
programs, such as databases to web servers.
CST currently hires Cygnus to provide such middleware as needed by CST’s
existing customers, especially for e-commerce applications. The two firms are in the initial stage of
negotiations and have differing views about key aspects of the merger. First, concerning the business valuation,
the parties have a sharp disagreement over price. CST thinks that the value of Cygnus is about 30% lower than does
Cygnus’ owner. Second, concerning the
deal structure, CST has been using stock-only deals in its recent
acquisitions. CST has been missing its
earnings projections lately and Jason does not want the acquisitions to dilute
earnings, either because of choice of accounting method or because of purchase
price. However, CST’s stock price has
been falling steadily and a stock-only deal is risky for the sellers. The merger seems beneficial to both parties
if a fair price and deal structure can be worked out.
The major decision problem is to make a recommendation for
an acquisition price for Cygnus and to support it with a negotiating strategy
to close the deal. The CFO of CST is
under pressure from the CEO and the departments of sales and information
technology to make the acquisition.
Complicating the business valuation of Cygnus are the lack of directly
comparable financial information from other companies, the very optimistic
growth projections provided by Cygnus, and the fact that 90% of its current
total sales came from one customer, Bell Canada. Complicating the deal structure and negotiating strategy are
potential financing deals from joint venture capitalists, the unavailability of
earn-outs or contingent payments if pooling is used, and the lack of any
cushion for CST to make the quarterly earnings projections of the financial analysts. Thus, the use of either purchase or pooling
accounting is an important consideration for its impact on CST’s earnings and
the deal structure negotiations.
________________________
Contact
Person: Hugh Grove, University of Denver, Denver, CO 80208
Mail:
School of Accountancy, Daniels College of Business,
2101 S. University Blvd., Denver, CO
80208 USA
Voice:
303-871-2026; FAX: 303-871-2016; email: hgrove@du.edu
HERMES CORPORATION
JOINT VENTURE FINANCING CASE
Hugh Grove and Tom Cook, University of Denver
Jon Goodwin, International Capital Strategies, LLC
Case Objectives and Use
The students take the role of the
investment banker who has to make the joint venture decision. This case is integrative is providing
students with an opportunity to apply concepts from finance and accounting to a
proposed joint venture deal. This case is intended for advanced finance courses
in undergraduate, MBA and MS-finance and managerial accounting courses. There are several major objectives for
student learning opportunities: 1) to understand a complex joint venture
agreement by following the cash flows and by discovering the ownership
percentage changes from the financial securities, 2) to understand complex
financial accounting issues, concerning revenue recognition and equity
investments, in a joint venture deal, and 3) to integrate and summarize
financing and accounting issues in making a final recommendation on whether to
do a joint venture or not.
Case Synopsis
This is a decision-based case written from the view of the
actual investment banker that was hired by Hermes for a $125,000 fee to make a
recommendation on whether Hermes should participate in a joint venture with
Circe. Also, Hermes has only two weeks
to decide whether to sign the Letter of Intent created by Circe for the
proposed joint venture with Hermes. The
major task is to understand this complex Letter of Intent, especially all the
cash flows and ownership percentage changes between Circe, Hermes, and the new
joint venture company. The following
information is what the students must determine from the case. There are complex financing arrangements,
involving convertible preferred stock and two convertible debts, all issued by
Hermes to Circe and all convertible by Circe into Hermes common stock. All such funding by Circe would cover Hermes
required cash contribution for an initial 80% ownership in the joint
venture. Alternatively, the preferred
stock may be exchanged for enough common stock in the joint venture to give
Circe a majority interest in the joint venture. Hermes also has to issue common stock warrants to Circe. The joint venture would pay Circe an initial
$10 million license fee. There are also
complex financial accounting issues in this proposed joint venture, primarily
for revenue recognition and equity investments. If the students can follow all the cash flows and ownership
percentage changes between the two companies and the joint venture entity, they
will determine that the proposed joint venture is really a hostile takeover of
Hermes by Circe. Also, the proposed
deal enables Circe to bill the joint venture and recognize its own revenues
that are really self-funded. One
challenge for the students is to see through Circe’s enticement to fully fund
Hermes’s initial 80% joint venture ownership and recommend against the proposed
deal as the investment banker did.
Conversely, the students may recommend to accept the deal in agreement
with Hermes’ CEO and CFO who signed the deal to take advantage of the funding
opportunity to help develop its biotechnology products.
_____________________
Contact
Person: Hugh Grove, University of Denver, Denver, CO 80208
Mail:
School of Accountancy, Daniels College of Business,
2101 S. University Blvd., Denver, CO
80208 USA
Voice:
303-871-2026; FAX: 303-871-2016; email: hgrove@du.edu
JENESA
International
Alva Wright Butcher
University of Puget Sound
Case Objectives and Use
The case can be used effectively as an early case in
an introductory undergraduate finance course.
After students have read material on the basic structure of capital
markets, and the features of debt and equity, it can be used as a platform for
discussion as to how small firms raise capital. What sources of capital are available? The instructor can provide some background on venture capital,
and ask students whether that might be another source of financing. Would it be feasible for this firm to do an
initial public offering? It provides an
example of a slightly different form of debt, i.e. debt with warrants. Why might investors be interested in this
type of financial security? It can also
be used to review the Income Statement and Statement of Cash Flows, and to
discuss the difference between income and cash flow.
It
could then be used again later in the course after students have studied the
time value of money, or in an advanced finance course. Students can be asked to calculate the debt
payments, prepare a Statement of Cash Flows, and prepare pro-forma Income
Statements
Case Synopsis
Hansan Ozbekhan, President and Chief Executive
Officer of JENESA International, has just been informed that containers of
hazelnuts from Turkey were contaminated.
After five years of hard work, his sales were finally increasing. If he could not fill these orders, he was
afraid that he would lose his customer base.
The containers represented $360,000 in inventory. This was an enormous amount of capital for a
small firm. He had no capital available
to obtain inventory from other suppliers.
The case then provides background information on
this family business and the strategy for market entry. It emphasizes the degree to which family and
friends are often involved in establishing a small business, and illustrates
the difficulties faced by such a small business in obtaining financing. The case illustrates how Ozbekhan used
vendor financing to reduce his need for funds.
The firm relied primarily on debt financing. The case discusses the role
of the Small Business Administration to facilitate financing for small
businesses. Additional financing was
obtained at a lower interest rate by using warrants as a sweetener. Financial Statements and information on
sales, profit margins and interest rates are provided.
The case ends with the question of what Ozbekhan
should do now. He has a tremendous
sense of responsibility to his family and friends because of their past
support. What other sources of
financing might be available?
The case provides students with some background on
the sources of financing that are available to a small business. It can also be used to discuss the effect of
capital structure on cash flows, and the ability to raise additional capital.
Contact Person:
Alva
Butcher, University of Puget Sound, 1500 North Warner, Tacoma, WA 98416
Voice:
(253)-879-3349; FAX: (253)-879-3156; Email: butcher@ups.edu
MAKE-ME-BUY MULTI-MEDIA CONSULTANTS
Eldon
Gardner, The University of Lethbridge
Synopsis
This case is the story of a multi-media
consulting firm, Make Me Buy Multi-Media Consultants (MMBMMC), a fictional name
for a real company, which went from a successful, small business to a bankrupt
company in only a few months. The two
principals of the firm, Henry Yu and Penny Chow (disguised names), had turned
their mutual interest in computers into a small, thriving media consulting
firm. After obtaining a loan from Apex
Bank (disguised name), the firm tried to enter the CD-ROM publishing
business. In developing the new
product, the owners neglected the old ones, saw their cash flow disappear, and
were forced into bankruptcy before the new product hit the market. The bankruptcy trustee, Sean Carter
(disguised name), and the bank discovered, after the fact, that the accounting
records were misleading and were prepared in a format that was not in keeping
with Generally Accepted Accounting Principles (GAAP). Now the bank was wondering how it had allowed itself to be misled
so completely, and the bankruptcy trustee was wondering whether the accountant
involved should be subject to disciplinary action by the accounting profession.
This case is intended to provide finance and accounting students with the
opportunity to examine a case where there is evidence of fraudulent accounting
records. It allows analysis of issues
of financial record keeping, financial decision-making, lending decision
making, and insolvency examination. There is no clear-cut epilogue, since the
case was never heard by a judge, and no public record of any charges against
the company accountants exists. It
really has no right answer. There are,
of course, ethical issues involved in such a case, but exactly how they should
be handled is not easy to decide. Students
must consider not only the right and wrong of the actions of the various
parties, but also the ability to punish the wrongdoers in an appropriate
manner.
This case provides finance and accounting
students with the opportunity to see a real company that had prepared its
financial statements in such a way that they were grossly misleading to lenders
and to outsiders in general. The
accounts are relatively simple, and the lending decision is straightforward. Thus, students at the end of a first accounting
course, or students in a first course in financial institutions, long-term
finance or capital markets, could be provided with this case for analysis
without causing them undue hardship.
Contact Person: Eldon Gardner, Faculty of
Management, The University of Lethbridge, 4401 University Drive, Lethbridge,
Alberta, T1K 3M4, Canada
Telephone: 403-329-2726; fax 403-329-2038;
e-mail: gardner@uleth.ca
Stone Creek
Vineyards 2000
Armand Gilinsky, Jr., Sonoma
State University
Raymond H. Lopez, Pace
University
Case Objectives and Use
Stone Creek Vineyards may be
used as an introductory case in the areas of financial analysis and
policy. Due to the nature of the
business, the case strengthens a student’s estimation and understanding of the
dichotomy between accounting income and cash requirements of operations. It also highlights the policy of balancing
short-term assets with short-term liabilities, working capital management, with
the unique characteristics of the inventory position of a wine business. When the characteristics and significance of
this aspect of operations are understood and appreciated, a short term
financing solution may not be in the best interests of the firm. Intermediate and/or longer term financing
sources may in fact be a component of an optimum financing strategy.
The teaching note was prepared for graduate students
in an MBA program. It is best used
early in a capstone course, after students have been exposed to a broad range
of financial subject matter from their previous classwork.
Case Synopsis
Stone Creek Vineyards has
been expanding rapidly for several years.
The firm has experienced this performance by targeting an expanding
segment of a slow growing industry, as consumers’ tastes and preferences for
premium table wine have increased at the expense of lower priced products. They have been exceptionally successful,
through skillful applications of market segmentation strategies and using
increasingly diverse channels of distribution to reach an ever growing segment
of wine consumers.
The owners of Stone Creek
are two sisters who inherited the business from their parents. Since they have taken over operational
control, the business has required ever growing capital expenditures to
maintain and enhance its competitive position in the industry. Working capital requirements have outrun the
capacity of the company to generate funds from internal sources. In addition to funding expanding and
changing operations, the sisters have had to repay a personal loan from their
uncle, adding pressures to their financial challenge. While capital expansion of vineyards, crushing, processing, and
storage facilities has been funded with primarily cash flow and mortgage debt,
the firm has had to constantly renegotiate its credit lines with a variety of
commercial banks.
As the firm has expanded its
production of premium table wines, it has been faced with rapidly growing
inventory of wine, both bulk in barrels and bottled in cases. The Stone sisters have recently come to the
realization that this “liquid asset” is really not a liquid asset. The average length of time these products
stay on the balance sheet is now well over two years. Yet, it is being financed with primarily a short-term bank
loan. This loan is growing even faster
than sales for each of the last four years and now must be secured.
The Stone sisters must now
decide whether or not to continue to expand operations at the rates of the last
few years and, if so, how to obtain the necessary funds. They are also considering a new distribution
channel – direct customer sales through the firm’s recently created web site
and how these incremental sales are likely to affect financial management. While Nancy Stone is supporting these new
initiatives her sister Sally is seriously questioning the costs of further,
rapid expansion.
A new loan proposal has been
made to the sisters by a much larger bank.
This bank, Wells Fargo, must forecast the financing needs of Stone Creek
for at least the next two years, to evaluate its proposal accurately. What is the cash generating potential of
this business, a schedule for repayment and the nature and degree of risks to
be incurred if this loan is accepted?
Both parties to the loan agreement must be completely informed of the
implications of its details.
Contact Person: Raymond
H. Lopez, Pace University Telephone:
914-422-4165
Lubin
School of Business Fax:
914-422-4311/4184
1
Martine Avenue E-Mail:
rlopez@pace.edu
White
Plains, NY 10606