The inexplicable is all around us. So is the incomprehensible. So is the unintelligible. Interviewing Babe Ruth₁ in 1928, I put it to him “People come and ask what’s your system for hitting home runs—that so?” “Yes,” said the Babe, “and all I can tell ‘em is I pick a good one and sock it. I get back to the dugout and they ask me what it was I hit and I tell `em I don’t know except it looked good.”

—Carl Sandburg₂

Managers are not confronted with problems that are independent of each other, but with dy­namic situations that consist of complex systems of changing problems that interact with each other. I call such situations messes . . . Managers do not solve problems: they manage messes.

—Russell Ackoff₃

Orientation of the Book

Practitioners tell us that much in finance is inexplicable, incomprehensible, and unintel­ligible. Like Babe Ruth, their explanations for their actions often amount to “I pick a good one and sock it.” Fortunately for a rising generation of practitioners, tools and concepts of Modern Finance provide a language and approach for excellent perfor­mance. The aim of this book is to illustrate and exercise the application of these tools and concepts in a messy world.

Focus on Value

The subtitle of this book is Managing for Corporate Value Creation. Economics teaches us that value creation should be an enduring focus of concern because value is the foun­dation of survival and prosperity of the enterprise. The focus on value also helps manag­ers understand the impact of the firm on the world around it. These cases harness and exercise this economic view of the firm. It is the special province of finance to highlight value as a legitimate concern for managers. The cases in this book exercise valuation analysis over a wide range of assets, debt, equities, and options, and a wide range of perspectives, such as investor, creditor, and manager.

Linkage to Capital Markets

An important premise of these cases is that managers should take cues from the capital markets. The cases in this volume help the student learn to look at the capital markets in four ways. First, they illustrate important players in the capital markets such as individual exemplar Warren Buffett and institutions like investment banks, commercial banks, rating agencies, hedge funds, merger arbitrageurs, private equity firms, lessors of industrial equipment, and so on. Second, they exercise the students’ abilities to interpret capital market conditions across the economic cycle. Third, they explore the design of financial securities, and illuminate the use of exotic instruments in support of corporate policy. Finally, they help students understand the implications of transparency of the firm to investors, and the impact of news about the firm in an efficient market.

Respect for the Administrative Point of View

The real world is messy. Information is incomplete, arrives late, or is reported with error. The motivations of counterparties are ambiguous. Resources often fall short. These cases illustrate the immense practicality of finance theory in sorting out the issues facing managers, assessing alternatives, and illuminating the effects of any particular choice. A number of the cases in this book present practical ethical dilemmas or moral hazards facing managers—indeed, this edition features a chapter, “Ethics in Finance” right at the beginning, where ethics belongs. Most of the cases (and teaching plans in the associated instructor’s manual) call for action plans rather than mere analyses or descriptions of a problem.

Contemporaneity and Diversity

All of the cases in this book are set in the year 2006 or after and 25 percent are set in 2015 or later. A substantial proportion (57 percent) of the cases and technical notes are new, or significantly updated. The mix of cases reflects the global business environ­ment: 52 percent of the cases in this book are set outside the United States, or have strong cross-border elements. Finally the blend of cases continues to reflect the growing role of women in managerial ranks: 31 percent of the cases present women as key pro­tagonists and decision-makers. Generally, these cases reflect the increasingly diverse world of business participants.

Plan of the Book

The cases may be taught in many different combinations. The sequence indicated by the table of contents corresponds to course designs used at Darden. Each cluster of cases in the Table of Contents suggests a concept module, with a particular orientation.

1. Setting Some Themes. These cases introduce basic concepts of value creation, assessment of performance against a capital market benchmark, and capital mar­ket efficiency that reappear throughout a case course. The numerical analysis required of the student is relatively light. The synthesis of case facts into an important framework or perspective is the main challenge. The case, “Warren E. Buffett, 2016,” sets the nearly universal theme of this volume: the need to think like an investor. The updated case entitled, “The Battle for Value, 2016: FedEx Corp. vs. United Parcel Service, Inc.” explores the definition of business success and its connections to themes of financial management. “Larry Puglia and the T. Rowe Price Blue Chip Growth Fund,” is an updated version of cases in prior

editions that explores a basic question about performance measurement: what is the right benchmark against which to evaluate success? And finally, “Genzyme and Relational Investors: Science and Business Collide?”, is a case that poses the dilemma of managing a public company when the objectives of the shareholders are not always easily aligned with the long-term objectives of the company and an activist investor is pressuring the company for change.

2. Financial Analysis and Forecasting. In this section, students are introduced to the crucial skills of financial-statement analysis, break-even analysis, ratio analy­sis, and financial statement forecasting. The section starts with a note, “Business Performance Evaluation: Approaches for Thoughtful Forecasting”, that provides a helpful introduction to financial statement analysis and student guidance on gener­ating rational financial forecasts. The case, “The Financial Detective 2016”, asks students to match financial ratios of companies with their underlying business and financial strategies. “Whole Foods Market: The Deutsche Bank Report” provides students with the opportunity to reassess the financial forecast of a research ana­lyst in light of industry dynamics. This case can also be used an opportunity for students to hone firm valuation skills with the evaluation of the analyst’s “buy, hold, or sell” recommendation. “Horniman Horticulture” uses a financial model to build intuition for the relevancy of corporate cash flow and the financial effects of firm growth. The case, “Guna Fibres” asks the students to consider a variety of working capital decisions, including the impact of seasonal demand upon financ­ing needs. Other cases address issues in the analysis of working-capital manage­ment, and credit analysis.

3. Estimating the Cost of Capital. This module begins with an article that is a survey of “best practices” among leading firms for estimating the cost of capital during the low interest rate regime following the 2007–08 financial crisis. The cases following the survey article expose students to the skills in estimating the cost of capital for firms and their business segments. The cases aim to exercise and solidify students’ mastery of the capital asset pricing model, the dividend-growth model, and the weighted average cost of capital formula. “Roche Holdings AG: Funding the Genentech Acquisition” is a case that invites students to esti­mate the appropriate cost of debt for a massive debt offering. The case provides an introduction to the concept of estimating required returns. Two new cases ask the student to estimate the cost of capital for the firm. “H.J. Heinz: Estimating the Cost of Capital in Uncertain Times” gives students the opportunity to reas­sess the cost of capital following share price decline. “Royal Mail plc:Cost of Capital” affords students the challenge of critiquing a cost of capital estimate for recently privatized British postal service. The case “Chestnut Foods” requires students to consider arguments for and against risk-adjusted hurdle rates in a multi-divisional firm, as well as techniques for estimating divisional-specific cost of capital.

4. Capital Budgeting and Resource Allocation. The focus of these cases is the evaluation of individual investment opportunities as well as the assessment of corporate capital budgets. The analytical challenges range from setting the entire

capital budget for a resource-constrained firm (“Target Corporation”) to basic time value of money problems (“The Investment Detective”). Key issues in this module include the estimation of Free Cash Flows, the comparison of various in­vestment criteria (NPV, IRR, payback, and equivalent annuities), the treatment of issues in mutually exclusive investments, and capital budgeting under rationing. This module features several new cases. The first is “Centennial Pharmaceutical Corporation” provides an introduction to discounted cash flow principles by asking the student to compare values of two earnout plans. “Worldwide Paper Company” is an updated case that serves as an introduction to estimating cash flows and calculating the NPV of an investment opportunity. “Fonderia del Piemonte S.p.A.” is a new addition to the book. Fonderia is an Italian company considering a capital investment in machinery that replaces existing equipment. The student must assess the incremental value to the company of investing in the new equip­ment. The Victoria Chemical cases give students cash flow estimates for a large capital investment opportunity (“Victoria Chemical plc (A): The Merseyside Project”) as asks the student to provide a careful critique of the DCF analysis. The sequel case, (“Victoria Chemical plc (B): Merseyside and Rotterdam Projects”, deepens the analysis by adding a competing and mutually exclusive investment opportunity. “The Procter and Gamble Company: Crest Whitestrips Advanced Seal” is a case that asks the student to value a new product launch but then con­sider the financial implications of a variety of alternative launch scenarios The case, “Jacobs Division”, presents students an opportunity to consider the implica­tions of strategic planning processes. “UVa Hospital System: The Long-term Acute Care Hospital Project”, is an analysis of an investment decision within a not-for-profit environment. In addition to forecasting and valuing the project’s cash flows, students must assess whether NPV and IRR are appropriate metrics for an organization that does not have stockholders. “Star River Electronics Ltd” has been updated for this edition and presents the student will a range of issues that the new CEO of the company must address, including the determination of the company’s cost of capital and whether to invest in new machinery. We have used this case as an exam for the first half of the finance principles course in the MBA program.

5. Management of the Firm’s Equity: Dividends and Repurchases. This module seeks to develop practical principles about dividend policy and share repurchases by drawing on concepts about dividend irrelevance, signaling, investor clienteles, bonding, and agency costs. The first case, “Rockboro Machine Tools Corporation”, is set in 2015 and concerns a company that is changing its business strategy and considering a change in its dividend policy. The case serves as a comprehensive introduction to corporate financial policy and themes in managing the right side of the balance sheet. The second case, “EMI Group PLC”, is new to this edition and features a struggling music producer in the U.K. confronted with whether it should continue to pay a dividend despite the profit pressures it is facing. And finally, “AutoZone, Inc.” is a leading auto parts retailer that has been repurchas­ing shares over many years. The case serves as an excellent example of how share

repurchases impact the balance sheet and presents the student with the challenge of assessing the impact upon the company’s stock price.

6. Management of the Corporate Capital Structure. The problem of setting capi­tal structure targets is introduced in this module. Prominent issues are the use and creation of debt tax shields, the role of industry economics and technology, the influence of corporate competitive strategy, the tradeoffs between debt pol­icy, dividend policy, and investment goals, and the avoidance of costs of distress. Following a technical note, “An Introduction to Debt Policy and Value”, is a new case, “M&M Pizza”, which explores the debt-equity choice within a perfect capi­tal market environment—a capital market with full information and no costs of trading. This case provides an engaging environment for students to confront fundamental financial policy theory. “California Pizza Kitchen”, is a real world analog to “M&M Pizza” as it addresses the classic dilemma entailed in optimizing the use of debt tax shields and providing financial flexibility for a national res­taurant chain. The next four cases are all new to the book. “Dominion Resources: Cove Point” presents the student with the challenge of financing a large new project without creating substantial disruption to the firm’s capital structure polices. The “Nokia OYJ: Financing the WP Strategic Plan” presents a similar theme as management has taken a new strategic direction and must make financ­ing decisions that are cost effective, but also preserve financial flexibility going forward. “Kelly Solar” concerns a start-up that needs new funds for investment, but already has a significant amount of debt on the books that needs to be rene­gotiated before new investors will find their investment to be attractive. The case, “JC Penney Company”, presents a large retail chain that is facing widespread performance challenges and needs to raise funds to offset the steadily declining cash balance that will eventually create a liquidity crisis for the company. The last case is “Horizon Lines, Inc.” The case is about a company facing default on a debt covenant that will prompt the need for either Chapter 11 protection or a voluntary financial restructuring.

7. Analysis of Financing Tactics: Leases, Options, and Foreign Currency. While the preceding module is concerned with setting debt targets, this module ad­dresses a range of tactics a firm might use to pursue those targets, hedge risk, and exploit market opportunities. Included are domestic and international debt offer­ings, leases, currency hedges, warrants, and convertibles. With these cases, students will exercise techniques in securities valuation, including the use of option-pricing theory. For example, the first case, “Baker Adhesives” explores the concept of exchange-rate risk and the management of that risk with a forward-contract hedge and a money-market hedge. “Vale SA” is new to this edition and is a Brazilian mining company that must choose between debt financing denomi­nated in U.S. dollars, euros or British pounds. The case “J&L Railroad” presents a commodity risk problem for which students are asked to propose a specific hedging strategy using financial contracts offered on the open market or from a commercial bank. “WNG Capital, LLC” is a new case about a company that owns older aircraft that it leases to airlines as an alternative to the airline buying new aircraft. “MoGen, Inc” presents the pricing challenges associated with a

convertible bond as well as a complex hedging strategy to change the conversion price of the convertible through the purchase of options and issuance of warrants.

8. Valuing the Enterprise: Acquisitions and Buyouts. This module begins with an extensive introduction to firm valuation in the note “Methods of Valuation: Merg­ers and Acquisitions.” The focus of the note includes valuation using DCF and multiples. This edition features six new cases in this module and five cases from the previous edition. The “Medfield Pharmaceuticals” introduces students to firm valuation with the reality of considering the difference between the value of firm assets in place and the value of firm growth opportunities in the context of a take­over offer for a pharmaceutical company. The case also includes important ethical considerations. “American Greetings” was in the prior edition and provides a straightforward firm valuation in the context of a repurchase decision and is de­signed to be an introduction to firm valuation. The new case “Ferrari: The 2015 Initial Public Offering”, presents students the opportunity to value the legendary automotive company, and consider how to determine appropriate company com­parables for a firm that is both an auto manufacturer and a luxury brand. The case, “Rosetta Stone: Pricing the 2009 IPO”, provides an alternative IPO valuation case with additional focus on valuation with market multiples. “Sun Microsystems” is also returning from the previous edition and presents a traditional takeover valua­tion case with opportunities to evaluate merger synergies and cost of capital impli­cations. The next five cases are all new to this edition. “Carter International” involves assessing the correct price to offer to acquire another hotel company. “DuPont Corporation: Sale of Performance Coatings” asks the student to assess the economics of divesting a business unit that is not meeting the strategic objectives of the firm. “Sanofi-Aventis’s Tender Offer for Genzyme” is a sequel to the “Genzyme and Relational Investors: Science and Business Collide?” in which Genzyme’s CEO must decide whether to accept a tender offer to acquire Genzyme. “Delphi Corpora­tion” features a large auto parts company that has been in Chapter 11 bankruptcy for two years. The student must decide in the role of a non-secured lender whether to vote to approve the Plan of Reorganization to emerge from Chapter 11.

And finally, the module features a merger negotiation exercise (“Flinder Valves and Controls Inc.”) that provides an engaging venue for investigating the distribu­tion of value in a merger negotiation. The comprehensive nature of cases in this module makes them excellent vehicles for end-of-course classes, student term pa­pers, and/or presentations by teams of students.

This edition offers a number of cases that give insights about investing or financing decisions in emerging markets. These include “Guna Fibres Ltd.,” “Star River Electron­ics Ltd.,” and “Baker Adhesives.”

₁George Herman “Babe” Ruth (1895–1948) was one of the most famous players in the history of American baseball, leading the league in home runs for 10 straight seasons, setting a record of 60 home runs in one season, and hitting 714 home runs in his career. Ruth was also known as the “Sultan of Swat.”

₂Carl Sandburg, “Notes for Preface,” in Harvest Poems (New York: Harcourt Brace Jovanovich, 1960), p.11.

₃Russell Ackoff, “The Future of Operational Research is Past,” Journal of Operational Research Society, 30, 1 (Pergamon Press, Ltd., 1979): 93–104.