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Examines a proposed investment in the capability to manufacture printed circuit boards (PCBs) in-house rather than buying them from third-party contract manufacturers. Stryker Corporation's Instruments business is considering the proposal in response to difficulties with existing suppliers. Requires students to formulate and execute basic quantitative capital budgeting analyses, specifically, to compute net present value (NPV) internal rate of return (IRR) and payback period.

Spreadsheet Supplement for case 295033

Provides a basic introduction to the use of market multiples for business valuation. Explains the method's reliance on the Law of One Price, sets forth the basic steps for using the method, and reviews some practical issues arising in its application.

In this article, Timothy A. Luehrman explores how option pricing can be used to improve decision making about the sequence and timing of a portfolio of strategic investments. In financial terms, a business strategy is much more like a series of options than like a single projected cash flow. Executing a strategy almost always involves making a sequence of major decisions. Some actions are taken immediately while others are deliberately deferred so that managers can optimize their choices as circumstances evolve. While executives readily grasp the analogy between strategy and real options, until recently the mechanics of option pricing were so complex that few companies found this method practical to use when formulating strategy. But advances in both computing power and our understanding of option pricing over the last 20 years now make it feasible to apply real-options thinking to strategic decision making. To analyze a strategy as a portfolio of related real options, this article exploits a framework presented by the author in "Investment Opportunities as Real Options: Getting Started on the Numbers" (HBR July/August 1998). That article explained how to get from discounted-cash-flow value to option value for a typical project; in other words, it was about reaching a number. This article extends that framework, exploring how, once you've worked out the numbers, you can use option pricing to improve decision making about the sequence and timing of a portfolio of strategic investments. The author shows executives how to plot their strategies in two-dimensional "option space," giving them a way to "draw" a strategy in terms that are neither wholly strategic nor wholly financial, but some of both. Such pictures inject financial discipline and new insight into how a company's future opportunities can be actively cultivated and harvested.

In this article, Timothy A. Luehrman presents a framework that can bridge the gap between the practicalities of real-world capital projects and the higher mathematics associated with formal option-pricing theory. His step-by-step approach maps out the exact relationship between a project's characteristics and the five variables that determine the value of a simple call option on a share of stock. By going through these steps, executives not regularly steeped in finance can discover value hidden in their projects that their standard discounted cash flow analysis would overlook. The analogy between financial options and corporate investments that create future opportunities is both intuitively appealing and increasingly well accepted. Executives readily see that today's investment in R&D, or in a new marketing program, or even in a multiphased capital expenditure can generate the possibility of new products or markets tomorrow. But for many, the leap from the puts and calls of financial options to actual investment decisions has been difficult and deeply frustrating. The calculations required to value real options have been dauntingly complex, and practical how-to advice on the subject has been scarce and mostly aimed at specialists, preferably with Ph.D.s in finance. Luehrman's methodology is designed to be used by general managers, not technical specialists. It deliberately sacrifices absolute precision in order to generate a number "good enough" to provide executives with valuable insight into their most important and complex investment decisions.

For the past 25 years, managers have been taught that the best practice for valuing assets--that is, an existing business, factory, product line, or market position--is to use a discounted-cash-flow (DCF) methodology. That is still true. But the particular version of DCF that has been accepted as the standard--using the weighted-average cost of capital (WACC)--is now obsolete. Today's better alternative, adjusted present value (APV), is especially versatile and reliable. It will likely replace WACC as the DCF methodology of choice among generalists. Like WACC, APV is used to value operations, or assets-in-place. Timothy Luehrman explains APV and walks readers through a case example designed to teach them how to use it.

Behind every major resource-allocation decision a company makes lies some calculation of what that move is worth. So it is not surprising that valuation is the financial analytical skill general managers want to learn more than any other. What do generalists need in an updated valuation tool kit? In the 1970s, discounted-cash-flow analysis (DCF) emerged as best practice for valuing corporate assets. And one version of DCF--using the weighted-average cost of capital (WACC)--became the standard. Over the years, WACC has been used by most companies as a one-size-fits-all valuation tool. Today the WACC standard is insufficient. Improvements in computers and new theoretical insights have given rise to tools that outperform WACC in the three basic types of valuation problems managers face. Timothy Luehrman presents an overview of the three tools, explaining how they work and when to use them.

Once the rage of Western capitalism, leveraged buyouts have lost their glamour and much of their respectability. Suggest an LBO as a healthy way to create value, and most people will assume you are just trying to stimulate lively conversation. Propose it as a means of improving operating performance by restoring strong, constructive relationships among owners, managers, and other corporate stakeholders, and you may be viewed as a refugee of the 1980s, deluded by the decade of greed. Although some LBOs may have deserved the criticism they have received, the overall perception about them is distorted, the authors contend. Their research at one LBO firm, Clayton, Dubilier & Rice (CD&R), reveals an approach to ownership and governance that challenges the dominant view. Instead of finding impersonal transactions in which buyers put a lid on investment, growth, and managerial autonomy, the authors found that chief executives had more freedom to exercise discretion under LBO ownership than they had had under corporate ownership. CD&R's experience over more than a decade offers insights into what constitutes best practice in the ownership and governance of corporate enterprises.

Spreadsheet Supplement for case 295135

Home Shopping Network invented the video home shopping industry. It had immediate success in both the product and capital markets, which quickly drew imitators. This case describes the situation as of January 1986, when the company must decide how to sustain successes in both markets. Students must discuss the proper valuation of the firm, proper financing strategy, possible future product lines, and how to deal with competition.

Spreadsheet Supplement for case 295045

Amoco Corp. is negotiating to sell a wholly-owned subsidiary, MW Petroleum, to Apache Corp. MW owns large reserves of oil and gas comprising many properties at different stages of engineering, development, and production. The proposed acquisition is a large one for Apache and poses several important financing and valuation problems. This case focuses on evaluation and execution of a creative financing structure that allows the buyer and seller to reallocate oil price risk.

Spreadsheet Supplement for case 295085

A technical note for advanced students on the topic of valuing highly-levered equity. Introduces the "equity cash flow" valuation methodology, shows how to use it, discusses the sources and signs of its built-in biases, and provides some guidance about when to use it.

Spreadsheet Supplement for case 295065

Introduces a framework for evaluating corporate investment projects as call options. Presumes readers are familiar with basic option pricing and basic capital budgeting rules. Explains the motivation for viewing projects as options; presents a mapping between a capital project and an option; shows how to price the option; and explores the managerial implications of this approach to capital budgeting. Concludes with a discussion of common practical, analytical questions that arise with this methodology.

Amoco Corp. is negotiating to sell a wholly-owned subsidiary, MW Petroleum, to Apache Corp. MW owns large reserves of oil and gas comprising many properties at different stages of engineering, development, and production. The proposed acquisition is a large one for Apache and poses several important financing and valuation problems. This case focuses primarily on valuation.

Goodyear's transition to radial tires from bias and bias-belted tires was difficult and expensive, but successful. Afterward, in 1983, the company embarked on a major diversification program. Three years later, after investments exceeding $1 billion in oil and gas pipelines and reserves, Goodyear was attacked by a corporate "raider" and is considering abandoning its diversification program in favor of a highly leveraged restructuring.

Spreadsheet Supplement for case 295033.