Case studies

Teuer Furniture is a privately owned, moderately sized chain of upscale home furnishing showrooms in the United States. By the end of 2012, it had regained its financial footing and a number of long-term investors, including several of Teuer’s original non-management investors, now want to sell their shares. At the request of the board, Jennifer Jerabek, the chief financial officer of the company, and her team put together an extensive valuation of Teuer based on a discounted cash flow analysis. When the model was presented to investors, a number of them disagreed with the results. Some investors considered the value too high; others considered it too low. Not surprisingly, some of the differences of opinion were correlated with whether or not the investors wanted to sell their shares of Teuer. Jerabek was instructed to build a valuation of Teuer using a multiples approach instead.

After reading and analyzing the case, students will be able to:

• Estimate the value of a firm using a multiples approach

• Select an appropriate group of comparable firms and defend the logic behind the selection

• Select a correct set of valuation ratios and defend the logic behind the selection

• Compare the valuations produced by a multiples and DCF approach and if the valuations do not match, explain why the two methods yield different valuations

Estimate the value of a firm using a multiples approach

Select an appropriate group of comparable firms and defend the logic behind the selection

Select a correct set of valuation ratios and defend the logic behind the selection

Compare the valuations produced by a multiples and DCF approach and if the valuations do not match, explain why the two methods yield different valuations

Zoe Greenwood, vice president at Foundation Investment Advisors, was glancing through the offering memorandum for a new commercial mortgage-backed securities (CMBS) deal on April 1, 2010, a time when the opportunities for commercial mortgage investors had been bleak to the point of comical. This new CMBS deal represented the first opportunity to buy CMBS backed by loans to multiple borrowers since credit markets had shut the securitization pipeline in June 2008.

The offering gave Greenwood a new investment opportunity to suggest to her firm's latest client. She had planned to recommend an expansion in her client's traditional commercial mortgage business, but these new bonds looked intriguing. Could the new CMBS offer her client a superior risk-return tradeoff compared with making individual mortgage loans?

After students have analyzed the case they will be able to:

• –Learn how to construct promised cash flows from both commercial mortgages and commercial mortgage-backed securities

• –Understand the benefits and costs of direct lending versus indirect lending (purchase of mortgage-backed bonds)

• –Underwrite commercial mortgage loans issued by others to identify potentially hidden risks

• –Evaluate at what price a mortgage-bond investment makes financial sense

–Learn how to construct promised cash flows from both commercial mortgages and commercial mortgage-backed securities

–Understand the benefits and costs of direct lending versus indirect lending (purchase of mortgage-backed bonds)

–Underwrite commercial mortgage loans issued by others to identify potentially hidden risks

–Evaluate at what price a mortgage-bond investment makes financial sense

In April 2012 Bill Nichols, a financial analyst at the real estate investment firm Koenig Capital, was about to enter a unique lease renegotiation. One of Koenig's tenants, Hasperat Inc., had sixteen years left on its long-term lease of the Kelley Building, a 165,000-square-foot office building in downtown Cleveland. The lease contained a clause giving Hasperat the option to buy the Kelley Building from Koenig. When Nichols tried to place a mortgage on the property to take advantage of low interest rates, he learned that the existence of this option in the lease contract prevented lenders from offering Koenig their lowest rates. As a result, Nichols had been tasked with renegotiating the lease to remove the option clause. This unexpected event offered Nichols the opportunity to use his financial skills. He needed to calculate the fair value of the purchase option to be able to justify to his superiors by how much they should compensate Hasperat. Students will step into the role of Bill Nichols and apply real options modeling techniques to value the purchase option in Hasperat's lease.

After reading and analyzing the case, students will be able to:

• Apply real options theory to the valuation of a purchase option in a commercial real estate lease

• Identify the common mistakes in applying traditional discounted cash flow (DCF) analysis to financial problems with option components

Apply real options theory to the valuation of a purchase option in a commercial real estate lease

Identify the common mistakes in applying traditional discounted cash flow (DCF) analysis to financial problems with option components

In the summer of 2013, Whitney DeSoto had just been hired as managing director for real assets at the Overton Pension Fund (OPF). Her task was to provide recommendations to the board of trustees to introduce real estate into the fund's portfolio, which to date had been invested solely in stocks and bonds. Combining her knowledge of modern portfolio theory with her institutional expertise in real estate, DeSoto needed to decide what fraction of the fund should optimally be invested in real assets. She then faced the task of deciding whether to invest in public or private real estate. If she thought private real estate belonged in the portfolio, she would need to identify the best investment strategy, the best vehicle, and ultimately the specific investments to recommend.

• Apply modern portfolio theory to the investment decision of an institutional investor allocating its assets between stocks, bonds, and real estate

• Understand the limits of portfolio theory in a real estate context

• Analyze the benefits/costs of investments in both public and private real estate

• Understand the various vehicles in which one can invest in private real estate

• Argue for a set of investments that offer individual benefits/costs relative to a theoretically ideal investment

Apply modern portfolio theory to the investment decision of an institutional investor allocating its assets between stocks, bonds, and real estate

Understand the limits of portfolio theory in a real estate context

Analyze the benefits/costs of investments in both public and private real estate

Understand the various vehicles in which one can invest in private real estate

Argue for a set of investments that offer individual benefits/costs relative to a theoretically ideal investment

The case simulates the experience of a private equity investor evaluating a potential investment, requiring the student to: (1) determine the risks and merits of an investment in Toys “R” Us, (2) evaluate the spectrum of returns using multiple operating model scenarios, and (3) identify strategic actions that might be undertaken to improve the risk/return profile of the investment. The case also discusses trends and participants in the private equity industry.

To understand how private equity firms analyze investment opportunities through application of an LBO model (provided in the case) that summarizes returns and risks. Also, to review private equity participation in club deals, large (and early) dividends, and IPOs.

Although the federal gasoline tax played multiple roles in financing surface transportation infrastructure in the United States, experts did not agree on the tax's purpose. Some argued that it was essentially a fee for users of the nation's federally supported highways. Others suggested that it should play a more prominent role in environmental, energy, and transportation policy by correcting for driving-related externalities. Still others suggested that it should be used to reduce the federal budget deficit. Finally, the tax itself had remained at the same level since 1993, and with the Highway Trust Fund virtually insolvent, many experts believed it was time for an increase. The case presents a background on the U.S. federal gasoline tax, an overview of the market for gasoline in the United States, and survey of gasoline taxes in U.S. states as well as several other countries around the world.

The case can be used to discuss the incidence of the gasoline tax, as well as its role as a Pigouvian tax to deal with negative externalities related to gasoline consumption and driving. There is sufficient data in the case to enable students to analyze the incidence of the federal gasoline tax and to determine the socially efficient level of the tax in light of externalities related to gasoline consumption and driving.

This case asks the student to take a stance on whether an portfolio manager should take a long or short position in the equity of Universal Display Corporation (PANL). The stock is polarizing, in that reasonable arguments could be made for both long and short positions. The case suggests a number of steps that an analyst might follow when valuing a company

Discounted cash flow valuation, comparables valuation, short selling. After students have analyzed the case they will be able to value the equity of a publicly traded company and take a position on whether a portfolio manager should buy or sell the stock.

Ever since he had heard her speak at a private equity conference, Babatunde Omotoba had wanted to work for Venita Fields, co-founder and senior managing director of private equity firm Smith Whiley & Company. He wrote and asked her for an informational interview, and was excited to receive her invitation to meet with her at the firm's regional office in Evanston, Illinois. After the interview, however, Omotoba came to the grim realization that despite all his preparations—researching private equity firms, studying the types of deals they make, and evaluating the analytical tools used to perform due diligence on companies and make investment decisions—he did not have a full grasp on the actual day-to-day work private equity professionals perform. He spent time reviewing materials from the career management office about private equity, and he meets two Kellogg alumni for informational interviews. He also reviews the investment process. The case ends with Omotoba having a broader perspective on the human aspect of private equity, beyond the analytical and financial aspects, as he anticipates meeting Fields again, hopefully to get the job offer.

Students learn the “tools of the trade” in private equity: managing portfolio company executives, meeting with limited partners to raise funds, managing the fund, selecting investments, and managing their time. Students learn the interpersonal nature of the business, including persuasion and negotiation, and how that is as important as financial skills. Students learn the process of preparing to interview with a private equity professional.

Wildcat Capital Investors is a small real estate private equity company. Its MBA intern, Jessica Zaski, is asked to develop a financial model for the purchase of Financial Commons, a 90,000 square foot office building in suburban Chicago. By simple metrics, the property seems to be a good value, but with credit conditions tight, Jessica must consider whether outside investors would be comfortable with the risks of investing in the midst of a severe commercial real estate downturn. Wildcat is designed to give students exposure to both the quantitative and qualitative aspects of investing in commercial real estate through a private equity structure. Beyond the numbers, the case allows for a discussion of the process of finding suitable real estate investments. The importance of the simultaneous negotiations that Wildcat must have with the seller, the lender, and the outside investor can be emphasized.

By working through the financial models, students will take a given set of assumptions and analyze the cash flows expected to be received by the equity partners of Financial Commons. With a given deal structure, the students can then model the cash flow to both outside equity investors and Wildcat, learning the mechanics of private equity. The model will allow students to investigate how the variations in the underlying assumptions affect returns to the property and to the investors.

In 2010 Drive Property Solutions, a special servicing firm in Chicago, had partnered with Spiner Capital to win an FDIC auction of distressed debt. Included in that auction was the defaulted mortgage note on Northwinds Community Crossing, a retail strip mall in suburban Savannah, Georgia, which had been in default since November 2009. Sam Schey, an asset manager at Drive, needed to decide how to maximize recoveries from the nonperforming loan.