Case studies

This case asks the student to decide whether Aurora Textile Company can create value by upgrading its spinning machine to produce higher-quality yarn that sells for a higher margin. Cost information allows the student to produce cash-flow projections for both the existing spinning machine and the new machine. The cash flows have many different cost components, including depreciation, the number of days of cotton inventory, and the liability costs associated with returns from retailers. The cost of capital is specified in order to simplify the analysis. The analysis has added complexity, however, owing to the troubled financial condition of both the company and the U.S. textile industry, which is in decline as manufacturers migrate to Asia to benefit from lower manufacturing costs. This begs the question whether management should invest in a declining business or harvest the company by paying out all profits as a dividend to the owners. The case is suitable for students just beginning to learn finance principles, but is also rich enough to use with experienced students and executives. The primary learning points are as follows:

• The basics of incremental-cash-flow analysis: identifying the cash flows relevant to a capital-investment decision

• The construction of a side-by-side discounted-cash-flow analysis for a replacement decision

• How to adapt the NPV decision rule to a troubled or dying industry

• The effect of financial distress on the NPV calculation

• The importance of sensitivity analysis to a capital-investment decision

The basics of incremental-cash-flow analysis: identifying the cash flows relevant to a capital-investment decision

The construction of a side-by-side discounted-cash-flow analysis for a replacement decision

How to adapt the NPV decision rule to a troubled or dying industry

The effect of financial distress on the NPV calculation

The importance of sensitivity analysis to a capital-investment decision

The case can be taught in an introductory corporate finance course or to more experienced students or executives to spur a discussion about share repurchases and corporate financial strategies in general. If used in an introductory course, the case is most effective if preceded by a traditional dividend class. It follows a portfolio manager of Johnson & Associates, Mark Johnson, who is reviewing his holdings, including his position in AutoZone in early 2012. A prominent shareholder, Edward Lampert, had begun liquidating his position in AutoZone, and Johnson is concerned that Lampert's reduced position could lead the company to stop using share repurchases as a method of distributing cash flows to shareholders. The case lists a number of alternative uses for the cash flows and asks students to assume Johnson's role as an analyst and assess the likely impact of those alternatives on AutoZone's stock price.

A small adhesives company faces exchange rate risks as it makes its first foray into international sales. The receipt of payment from an unhedged foreign-currency-denominated past sale illustrates potential currency risks while a potential follow-on order provides a context to discuss potential hedges. Sufficient detailed information is provided for the students to construct and analyze both a forward and money market hedge. A teaching note and instructor and student Excel spreadsheets are available.

A new director of this small brewery must prepare to vote on three issues coming before the board of directors the next day: (1) approval of the financial plan for 1993, (2) quarterly dividend declaration, and (3) incentive-compensation plan for the marketing manager. The tasks for the student are to evaluate the past and prospective financial performance of the company and to assess the extremely liberal credit and inventory terms the company is extending to its distributors. The objective of the case is to introduce and exercise tools and concepts of financial-statement analysis. Perhaps the biggest insight gained by students concerns the link between incentives and financial performance: in this case, the marketing manager is motivated to build sales volume, which he accomplishes by a dramatic buildup in receivables and inventory.

The case has been used in a first-year required course called Global Economies and Markets in a module on monetary policy. On October 24, 2005, President Bush nominated Ben S. Bernanke to be chairman of the board of governors of the Federal Reserve System for a term of four years along with a 14-year term on the board of governors. With the U.S. Senate confirmation widely anticipated, Bernanke was expected to take over stewardship of the U.S. monetary policy from Chairman Alan Greenspan when he retired in January 2006. While the U.S. economy was in good shape at the end of 2005, Bernanke had to prepare to deal with two challenges when charting a course for managing U.S. monetary policy. First, the sharp rise in energy prices that began in 2002 had the potential to bring back the specter of inflation and dampen desired consumer and business spending. Second, the housing boom could turn into a housing bust, throwing the mortgage industry into turmoil and weakening consumer business confidence. There was also the possibility that the housing bust could affect broader financial markets. Bernanke had to consider his options for dealing with contingencies in the not-so-distant future.

This case pertains to one of the most important topics in financial accounting and reporting: revenue recognition. It is intended for use in a required MBA financial accounting course or in an MBA elective course in Financial Reporting and Analysis. The company, Better Buy, Inc., is an electronics retailer selling TVs and other electronic products. The company is a bit unique, however, in that it not only sells major brand TVs, but it also sells TVs under its own brand that carry a one-year warranty for which the retailer—not the manufacturer—is responsible. The company also offers an additional two-year warranty on its TVs that also is the sole responsibility of the retailer. The case asks students to address a number of revenue recognition situations along with the associated expenses. These situations include a product sale where the sales price also includes a warranty provision, a “bundle” of a product sale and an extended warranty sale, and a bundle of a product sale and an extended warranty sale where the company has an agreement to outsource the servicing of its extended warranty service

This case has been significantly revised to update its currency and to be more concise. In early 2015, two partners in an Oklahoma medical practice must reconcile their booming urology business with declines in practice cash flow. The case highlights the difference between cash flow and accounting profits, as well as the common negative effects of growth on cash flow. It provides a straightforward introduction to simple financial-statement modeling and an opportunity to develop intuition on the importance of cash flow to business owners. The case is tailored to an audience with a professional business-practice perspective.

Lee High, the newly hired cost accountant at Blackheath Manufacturing Company, computes the variable cost and the fixed cost per unit on a weekly volume of 500 units of the Great Heath. He uses this information to develop some pricing guidelines. His boss, Charlton Blackheath, endorses the guidelines and adds a feature: a higher commission on sales at a higher price. While both High and Blackheath are away, the file clerk, Adelaide Ladywell, accepts an order below the guidelines and is fired. Students are asked to develop an appropriate set of decision rules for pricing Great Heath and to evaluate Ladywell's decision. See also “Blackheath Manufacturing Company—Revisited” (UVA-C-2198).

It's panic time at Blackheath Manufacturing. Profits have been declining, so the owner's son comes to the rescue to run the company. He asks a consultant to determine what's wrong. And the consultant has specific answers: The company's pricing guidelines are all wrong, there needs to be a budgeting system to reverse the downward slide in profits, and a former employee should be rehired. This case provides students with the data for constructing a production and raw-materials budget, flexible-expense budget, income statement, balance sheet, and cash budget. See also “Blackheath Manufacturing Company” (UVA-C-2197).

In May 1999, the CEO of this company (the largest brewer in Brazil) is contemplating a bid for Antarctica, the second-largest brewer in Brazil. The primary motives are to exploit economies of scale and other synergies and to prevent other competitors (mainly foreign multinationals) from acquiring the firm. The tasks for the student are to value the target and buyer, propose an exchange ratio of shares, and generally design the terms of the transaction.