In March 2013, Apple Computer has a very large cash balance, and is under pressure to return cash to shareholders. Hedge fund manager David Einhorn thinks Apple can "unlock value" by issuing perpetual preferred stock, dubbed iPrefs. Henry Blodget, CEO of Business Insider, disagrees, saying "you can't just wave your magic wand and make something of nothing." This short case is designed to support a discussion of "perfect" markets and the Modigliani-Miller capital structure irrelevance propositions. The case focuses on two questions: (1) From a shareholder's perspective, how is Apple's cash different from cash in a bank or money market account? (2) Can Apple create significant value for shareholders by splitting each common share into an iPref plus a common share?
In early 2017, HCA Holdings, an investor-owned hospital management company, faced a strategically important capital allocation decision. After the exit of its private equity sponsors in 2016, HCA had to determine how best to allocate its substantial annual free cash flows among several competing alternatives. Equity analysts and some mutual fund investors were clamoring for the company to initiate regular quarterly dividends, while some other hedge fund investors were eager to see more share repurchases. Other choices being advocated by various parties included reducing leverage to improve HCA's credit rating to investment grade, spurring growth by initiating a major acquisition program or reinvesting heavily in existing markets to enhance HCA's strong competitive position. These choices had to be made in the face of uncertainty about the future of healthcare regulation and tax policy following the 2016 U.S. presidential election, and in the context of its closest publicly traded peers struggling with heavy debt burdens. HCA's capital allocation choices would be crucial to its ability to provide high quality health care to patients, implement its corporate strategy and deliver value to shareholders.
This case is designed to provide an elementary introduction to options and option pricing for beginning finance students. Analysis of the case requires students to compare the prices of put and call options with various exercise prices and maturity dates on two equities (JPMorgan Chase and Facebook) that had identical closing stock prices on January 14, 2014 but very different volatilities. These common features and differences enable students to do a series of static comparisons that reveal the impact of a change in one determinant of an option's price while holding other factors constant. The business setting involves a mutual fund board considering the initiation of an option trading strategy to enhance the risk-adjusted performance of the fund and, through covered call writing, to increase earned income that can be used to support cash dividend distributions. Although the administrative situation is fictional, the data contained in the case are real. The case is best positioned at the beginning of a course module on derivatives and risk management.
Classic Fixtures & Hardware Company is a nationally-known manufacturer and distributor of kitchen and bathroom fixtures and trim, as well as lock sets and hardware for doors and windows. The company is privately held and has limited access to capital markets, so it depends on a loan facility with Southwest National Bank to finance its seasonal working capital needs. Level production and seasonal sales result in higher inventory levels and loan balances in the first half of the year and declining inventory and loan balances in the second half of the year. In 2008, Classic's loan balances have grown beyond forecasted amounts, and its CFO believes that Classic will likely be unable to pay off the loan balance before the end of the year. The CFO and a senior loan officer from Southwest have scheduled a meeting in order to determine both the reasons for this problem and what Classic might do to turn itself around.
In 2008, EADS, the European aerospace group that owns Airbus, was faced with the decision of how best to hedge a large and growing mismatch between its dollar revenues and its euro manufacturing costs. Specifically, the company needed to decide if it would continue hedging primarily with forward contracts, but in much higher volumes and at increasingly unfavorable rates, or to break with past practice and begin using foreign exchange option contracts. The decision would have consequences for EADS' profitability, cash flow, and its ability to fund strategic investment programs crucial to its ability to remain competitive with Boeing. Students must address questions concerning the proper way to measure foreign exchange exposures, the objectives of a rational risk management policy and program for a company like EADS competing in a duopoly with Boeing, the differences between hedging with FX options versus FX futures, counterparty risk, and hedge accounting, among other considerations.
A small, publicly traded company specializing in non-hazardous waste management considers a major acquisition in the Midwestern U.S. The acquisition can provide entry into the region, help the firm compete in a competitive industry, and improve its cost position. The company has a long-standing policy to avoid long term debt and until now has made a series of small acquisitions using only internal financing. The chief financial officer wants the board of directors to reconsider the policy and suggests funding the acquisition through a bond issue. Several company directors disagree and prefer that the firm issue common stock. Students must analyze the costs of issuing either a bond or common stock before making a final recommendation for financing the acquisition.
Hill Country Snack Foods, located in Austin, Texas, manufactures, markets, and distributes snack foods and frozen treats. The CEO is passionate about maximizing shareholder value and believes in keeping tight control over costs and operating the business as efficiently as possible. The company invests in additional capacity and new products only when attractive, low-risk opportunities are identified and can be funded internally. The firm's culture of risk aversion extends to financing decisions with a clear preference for equity finance over debt finance. The CEO believes a strong balance sheet with large cash balances provides the company with maximum safety and flexibility. Sales growth has been steady but unspectacular. As the CEO approaches retirement, investors and analysts speculate that the company will change to a more aggressive capital structure. Students must analyze the firm's current capital structure, explore three alternatives using debt finance, and determine the optimal debt-to-capital ratio.
Polar Sports, Inc. is a fashion skiwear manufacturing company in Littleton, Colorado. The company has a unique design for skiwear using a special synthetic material that improves insulation and durability. The ski apparel industry is highly competitive and the best way for companies to gain market share is by developing new fabrics and using innovative patterns. The firm generates over 80% of sales between September and January and relies on seasonal production to respond promptly to customer orders. During those months, the plant must rapidly increase production by hiring and training additional workers, often paying them overtime. The vice president of operations is concerned about the costs associated with seasonal production and presents a proposal to switch to level production. The change can reduce costs and improve efficiency but can also affect other aspects of company finance. Students must analyze potential cost savings and understand the financial risks involved before making a final recommendation. This case can be used in first-year MBA-level courses in finance or in advanced undergraduate finance courses.