Solution Manual for Strategic Management: A Competitive Advantage Approach, Concepts and Cas

Solution Manual for Strategic Management: A

Competitive Advantage Approach, Concepts and
Cases, 17th Edition, Fred R. David

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Chapter 8 - Implementing Strategies: Finance and
Accounting Issues
Overview
Chapter 8 explains how to implement strategies effectively using key finance and
accounting tools such as EPS-EBIT analysis to determine the appropriate mix of debt vs.
equity to obtain capital, corporate valuation to determine the appropriate price for an
acquisition, and projected financial statements to determine the expected impact of a
proposed set of strategies to be implemented (called recommendations).

Learning Objectives
The Chapter 8 Learning Objectives as stated in the textbook are given below:

8-1. Determine an appropriate capital structure for the firm by performing EPS/EBIT
analysis to compare the relative attractiveness of debt versus stock as a source of
capital to implement strategies.
8-2. Develop projected financial statements to reveal the impact of recommendations
with associated costs.
8-3. Determine the cash value of the firm, or a division of the firm, using four
corporate evaluation methods.
8-4. Discuss financial ratios, initial public offerings (IPOs), and issuing bonds as
strategic decisions.

Teaching Tips
1. This is a very important chapter in the book because it focuses on finance and
accounting aspects of implementing strategies. We usually spend four class days on
Chapter 8 because, for whatever reasons, many students come to the capstone course
weakest in finance. Yet, value of the firm analysis, and EPS-EBIT analysis, and projected
financial statement analysis, are essential for inclusion in a strategic-planning case
analysis. This chapter is very important because students must demonstrate for the class
that their proposed strategic plan is doable/feasible financially.

2. Ask all finance majors in the class to raise their hand and identify those students as
experts in determining the effective use of debt versus equity in obtaining capital to
finance strategic actions. Point out to students that in Chapter 8 a full, actual example for
P&G is developed for all analyses in Chapter 8 in order to help students grasp the
material.

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3. Ask all accounting majors in the class to raise their hand and identify them as experts
in developing projected financial statements.

4. In class, go to the www.strategyclub.com website and review the videos and materials
related to Chapter 8. Be sure to go over the free Excel template again because the
EPS/EBIT analysis is included there, as well as projected financial statement analysis.
Notice in all the 17th edition cases we used an author-determined standard format for
companies’ financial statements, instead of asking company permission to include actual
statements in the textbook; that standard format for an income statement and balance
sheet will be provided in the Excel template on the author website, so that students can
now more easily show the expected financial impact of the recommendations for the firm.

5. Go over EPS-EBIT analysis that is essential for students to include in their case
analysis, because any set of recommendations costs money, and students needs to show
the class where the firm should get the money – stock or debt or some combination. So,
go over the EPS-EBIT material slow and easy, and utilize class exercises, perhaps the
end-of-chapter review questions and assurance of learning exercises. Any quantitative
tools such as this sometimes give students trouble, but this one is easy, and important –
because raising capital is an important strategic issue for all for-profit firms.

6. Going over projected financial statement analysis is an essential strategy

implementation tool for students to learn, so go slow and easy over this material. Many
professors require students, as part of their case analysis, to provide three-year projected
financial statements, so the class will know what impact their recommendations would
likely have on the firm. Students will want to simply use an average historical percentage
change approach for these statements, but emphasize that the projected statements must
be based on their recommendations for the firm, which may be dramatically different
than the historical percentage increase or decrease. For example, the team might
recommend their case company acquire a rival firm that would nearly double their firm’s
revenues, rather than go up the 6% historical average.

7. Regarding projected financial statements, tell students to enter into the template the
firm’s existing financial statements, into the template format, to facilitate students then
developing projected financial statements using the template. This is a wonderful feature
of the template and a huge time saver for students.

8. Go over the section “Corporate Evaluation” that is important because a strategic plan
often includes acquiring another firm, so the question arises as to how much the firm is
worth. And, it is just good business to know the cash value of your firm, in case a
prospective buyer emerges. So, use several class exercises to go over this topic. We
oftentimes have students prepare this analysis, and others in this chapter, in class for their
assigned case company. This works really well. Many class days in our class are strategic
planning workshops, where instead of just one teacher (me), everyone in class becomes a
teacher helping others. This is a great pedagogical practice that AACSB recommends.

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9. At the end of Chapter 8, direct student attention to the new “Implications for
Strategists” and the new “Implications for Students” because these sections are important
information as the team prepares and ultimately delivers their oral case analysis
presentation later in the course.

10. Regarding the end-of-chapter review questions, consider assigning one half of them
one day in class giving each student a question, and letting them tell the class the answer,
with you commenting on their answers. Do the other half another day. We have found
this to be a fun day in class and it goes pretty quickly.

11. Several of the end-of-chapter Assurance of Learning Exercises can be used as

excellent homework or classwork assignments to be completed as an individual or as a
group of students. Several exercises focus on the Coca-Cola Cohesion Case, and several
focus on your college/university. We usually utilize at least one from each of the new
“four exercise venues.”

Answers to the End-of-Chapter 8 Review Questions

* 8-1. Acquisition premiums the last few years have averaged 25 to 40 percent, but
sometimes exceed 100 percent; prior research suggests that high premiums
generally have negative impacts on acquisition performance. Explain.

Answer: Scholars have long been interested in the decision-making process regarding
when firms pay premiums versus discounts for acquired firms. Paying high acquisition
premiums inflate a firm’s goodwill, and has often been criticized in research. Acquisition
premiums the last few years have averaged 25 to 40 percent, but sometimes exceed 100
percent. Prior research suggests that high premiums generally have negative impacts on
acquisition performance. Scholars have explored the how and why of excessive premium
decisions to determine if overconfidence or hubris on the part of chief executive officers
(CEOs) is the culprit. Specifically, Zhu recently reported that board members’ influence
on premium versus discount decisions may not always be beneficial. In particular, Zhu
reports a tendency for directors to support low premiums when their average prior
premium was low, but directors tend to support paying high premiums when their
average prior premium was relatively high. Due to this “group bias,” Zhu questions the
extent (or whether) members of a firm’s board of directors should be involved with
acquisition purchase decisions.

* 8-2. Explain why increasing Treasury Stock will increase EPS in any
corporation.

Answer: When a company buys back its own stock, that procedure reduces the number
of shares outstanding, which reduces the denominator in the EPS calculation. Anytime
you reduce the denominator you increase the ratio, so the EPS ratio will increase
whenever a firm increases its Treasury Stock.

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8-3. Some analysts say that huge New York Stock Exchange IPOs from companies
such as Alibaba, headquartered in China, should be illegal in the USA, since under
communist governments there are not sufficient safeguards in place for financial
transactions. Do you agree or disagree? Why?

Answer: The authors disagree with the thinking being that any investors purchasing
stock of new companies must know the risks involved, including additional risks if the
firm is headquartered in another country. To deny companies’ from other countries listing
of equity on US exchanges would send the wrong signal to people globally.

* 8-4. In the USA, no federal laws prevent businesses from using GPS devices to
monitor employees, nor does federal law require businesses to disclose to employees
whether they are using such techniques. What are the implications for employees
and companies?

Answer: Employees need to know what types of devices employers are using for monitoring.
Mutual respect is essential between employees and employers. Effectiveness and efficiency
hinge on employees understanding why such devices are needed for higher organizational
performance.

8-5. To raise capital, what are the pros and cons of selling bonds, compared to issuing
stock or borrowing money from a bank in terms of raising capital?

Answer: A popular way for a company to raise capital is to issue corporate bonds, which is
analogous to going to the bank and borrowing money, except that with bonds the company
obtains the funds from investors rather than banks. Pros could be that 1) issuing bonds avoids
dilution of ownership of the firm since shares of stock are not issued and 2) if the firm has a
good credit rating bonds may enable the firm to acquire more funds than a bank would offer.
Cons could be that 1) investors are receiving a higher rate of interest on their investment than a
bank would receive, and 2) there is a fixed, long-term obligation to pay the funds back to
investors, unlike issuance of stock, which carries no fixed obligation.

8-6. Many companies are aggressively buying their own stock. What are situations when
this practice is recommended or especially beneficial? What are the pros and cons of
increasing Treasury Stock on the balance sheet?

Answer: A firm would want to buy back its own stock, called Treasury Stock, whenever it 1)
believes its own corporate ROI and ROE will exceed alternative ways to invest that money,
and/or whenever it 2) desires to protect itself from a hostile takeover, and/or 3) whenever the
price of its own stock is arguably very inexpensive given the outlook for the firm. Also, 4)
increasing Treasury Stock reduces the company’s number of shares outstanding which increases
its EPS (since the denominator is # of shares outstanding). A drawback of increasing Treasury
Stock is that the firm could perhaps utilize those monies to grow the company.

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8-7. HP has more $goodwill than the $book value of the firm. Explain what this means,
how it could occur, and what can be done about this situation.

Answer: If a firm, such as HP, has historically paid a premium for one or more acquired firms,
then the sum of those premiums (called goodwill) could easily exceed the $book value of the
firm, defined as # of shares outstanding x the firm’s stock price. The best thing to do in this
situation is to do some excellent strategic planning and strive to increase the firm’s stock price
and performance through superior strategy formulation and implementation.

8-8. Give a hypothetical example where Company A buys Company B for a 15.0%
premium.

Answer: If the purchase price is more than the stock price times number of shares outstanding,
the additional dollars are called a premium. The premium is a per-share dollar amount that a
person or firm is willing to pay beyond the book value of the firm to control (acquire) the other
company. Thus, if a firm acquires another firm for $1.15B when the stock price times # shares
out = $1.0 B, then that would be a 15% premium.

8-9. Give a hypothetical example where Company A buys Company B for a 15.0%
discount.

Answer: If the purchase price is less than the stock price times # of shares outstanding, that
difference is called a discount. Thus, if a firm acquires another firm for $0.85 B when the stock
price times # shares out = $1.0 B, then that would be a 15% discount.

8-10. What is Treasury Stock? When should a company purchase Treasury Stock?

Answer: Treasury stock refers to shares of a firm that were once a part of shares outstanding but
were subsequently repurchased by the company and decommissioned. Treasury stock shares do
not have voting rights and do not pay any dividend distributions. A company can decide to hold
onto treasury stocks indefinitely, add to its treasury stock, reissue those shares to the public, or
even cancel them. A firm would want to buy back its own stock whenever it 1) believes its own
corporate ROI and ROE will exceed alternative ways to invest that money, and/or whenever it
2) desires to protect itself from a hostile takeover, and/or 3) whenever the price of its own stock
is arguably very inexpensive given the outlook for the firm.

8-11. What is an initial public offering (IPO)? When is an IPO good for a company? Why
did Facebook recently utilize an IPO? Was that a wise strategic move? Why?

Answer: An initial public offering (IPOs) occurs when a company moves from being private to
being public. Going public means selling off a percentage of your company to others in order to
raise capital; consequently, it dilutes the owners’ control of the firm. The most likely reason for
Facebook going public was to raise additional capital. The need to raise capital to finance
growth is a good time to issue an IPO.

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8-12. Generally speaking, how large does a firm normally need to be to justify having an
IPO? Explain the IPO process.

Answer: Going public means selling off a percentage of a company to others to raise
capital; consequently, it dilutes the owners’ control of the firm. Going public is not
recommended for companies with less than $10 million in sales because the initial costs
can be too high for the firm to generate sufficient cash flow to make going public
worthwhile. One dollar in four is the average total cost paid to lawyers, accountants, and
underwriters when an initial stock issuance is under $1 million; $1 in $20 will go to cover
these costs for issuances over $20 million. In addition to initial costs involved with a
stock offering, there are costs and obligations associated with reporting and management
in a publicly held firm. For firms with more than $10 million in sales, going public can
provide major advantages. It can allow the firm to raise capital to develop new products,
build plants, expand, grow, and market products and services more effectively.

8-13. How could/would dividends affect an EPS/EBIT analysis? Would it be correct to refer to
“earnings after taxes, interest, and dividends” as retained earnings for a given year?

Answer: Using equity to raise capital oftentimes carries an additional expense of paying dividends.
For dividend-paying firms, this could make equity a bit less attractive vs. debt. Considering dividends
in the EPS/EBIT analysis would make the analysis more robust. To consider dividends in an
EPS/EBIT analysis, a row should be inserted for “Dividends” below the “EAT” row, and then an
“Earnings after taxes and dividends” should be inserted below this. Yes, it would be correct to refer
to “earnings after taxes, interest, and dividends” as retained earnings in a given year.

8-14. In performing an EPS/EBIT analysis, where does the first row of (EBIT) numbers come
from?

Answer: In an EPS/EBIT analysis, the first row (EBIT) numbers come from earnings before interest
and taxes off the existing income statement. The first row is an estimate for EBIT next year, based on
what the EBIT was the prior year, and given what the firm’s strategies entail.

8-15. In performing an EPS/EBIT analysis, where does the tax rate percentage come from?

Answer: Tax rates for companies vary considerably and should be computed from the respective
income statements by dividing taxes paid by income before taxes. Then utilize this percentage in
performing EPS/EBIT analysis.

8-16. Show algebraically that the price earnings ratio formula is identical to the number of
shares outstanding times stock price formula. Why are the values obtained from these two
methods sometimes different?

Answer:
Formula 1: The price earnings ratio is calculated by dividing the market price of the firm’s common
stock (S) by the annual earnings per share (EPS) and multiplying this number by the firm’s average
net income for the past five years (or the most recent net income) (NI).

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Formula 2: Number of shares outstanding (#SO) x common stock price (SP).

SP NI #SO X SP
--- X ---- = ---- ----
EPS 1 1 1

Since EPS = NI / #SO, algebraically these two formulas are identical. Sometimes there are slight
differences between the two formulas since #SO is sometimes a year-end figure and sometimes and
average figure for the year.

8-17. In accounting terms, distinguish between intangibles and goodwill on a balance sheet.
Why do these two items generally stay the same on projected financial statements?

Answer: Whereas intangibles include copyrights, patents, and trademarks, goodwill arises only if a
firm acquires another firm and pays more than the book value for that firm. Oftentimes these two
items stay the same on projected balance sheets, unless strategies to be implemented impact those
two rows.

8-18. Explain four methods often used to calculate the total worth of a business.

Answer: There are four methods described in the chapter. The first approach in evaluating the worth
of a business is determining its net worth or stockholders’ equity. This number can be extracted from
the balance sheet as Total Equity or Owner’s Equity (less goodwill).
The second approach to measuring the value of a firm grows out of the belief that the worth of
any business should be based largely on the future benefits its owners may derive through net profits.
A rough rule of thumb is 5 times the 5-year annual net income.
The third approach is to let the market determine a business’s worth. First, base the firm’s
worth on the selling price of a similar company. Second, calculate a price-earnings ratio. To use this
method, divide the market price of the firm’s common stock by the annual earnings per share and
multiply this number by the firm’s average net income for the past five years.
The fourth approach can be called the outstanding share method. To use this method, simply
multiply the number of shares outstanding by the market price per share and add a premium.
Algebraically, method 3 and 4 are conceptually the same, and will yield the same answer if the
corresponding values are used for # of shares outstanding and earnings.
A recommended procedure is to determine the firm’s value using all approaches. Then decide
which amount is most reasonable or use an average of the computed amounts.

8-19. Explain how and why top executives can and do on occasion legally manipulate financial
statements to inflate or deflate expected results.

Answer:
Investors, shareholders, and others need to know that top executives can legally
manipulate financial statements to inflate or deflate expected results – and they
oftentimes do. Firms may inflate or present an overly rosy picture of projected financial
statements in order to garner support from a wide range of constituencies for a variety of

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reasons. But you may wonder why executives would present a deflated or unfavorable
picture of the future. Reasons to deflate include 1) to discourage potential acquirers, or 2)
to load bad financial information into a particular accounting period so that periods
beyond will look better. In the famous book Financial Shenanigans (2002) by Dr.
Howard Schilit, five ways are discussed in which top executives manipulate financial
statements, as follows:

1. Record revenue prematurely

2. Record fictitious revenue
3. Increase net income with one-time gains
4. Shift current expenses to an earlier or later period
5. Failure to record certain liabilities

The Securities and Exchange Commission (SEC) has taken steps to curtail projected
financial statement manipulation, but this remains an ethical issue in corporate America
(and globally).

Source: https://www.investopedia.com/articles/fundamental-analysis/financial-statement-
manipulation.asp, Also,
http://www.understand-
accounting.net/TheReliabilityandAccuracyoffinancialstatements.html

8-20. Explain why EPS/EBIT analysis is a central strategy-implementation technique.

Answer: EPS/EBIT analysis is a key strategy-implementation technique because additional capital is

often needed to implement strategies. EPS/EBIT analysis provides information regarding whether (1)
stock should be issued, (2) funds should be borrowed, or (3) a combination of stock and debt is the
best method to raise the capital.

8-21. Identify and discuss the limitations of EPS/EBIT analysis.

Answer: An EPS/EBIT analysis is the most widely used technique for determining whether debt,
stock, or a combination of debt and stock is the best alternative for raising capital to implement
strategies. Several limitations of this analysis include the following. The firm may be highly
leveraged and the analysis does not reveal this. Dilution of ownership may be a problem and the
analysis does not reveal this. Interest rates and/or stock prices may be rising or falling, and the
analysis does not reveal this. Basically the analysis is a snapshot in time. The analysis oftentimes
does not consider whether dividends are being paid, which could make the equity option a bit less
attractive. In addition, a limitation is that the stock price, tax rate, and interest rate are considered to
stay the same over varied economic conditions that impact EBIT.

8-22. True or False. “Retained earnings on the balance sheet are not monies available to
finance strategy implementation.”

Answer: This is a true statement. Retained earnings on the balance sheet represent historical earnings
that have been reinvested in the firm in the form of plants, equipment, inventory, and the like.

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8-23. Explain why projected financial statement analysis is considered both a strategy-
formulation and a strategy-implementation tool.

Answer: Projected analysis is a strategy-formulation tool in the sense that it enables the financial
impact of alternative strategies to be forecasted and scrutinized. This information can be instrumental
in selecting from among feasible alternative strategies. In addition, the analysis allows various
approaches for implementing strategies to be examined/scrutinized, as well as to forecast the
financial impact of strategies selected for implementation.

8-24. Complete the following EPS/EBIT analysis for a company whose stock price is $20,
interest rate on funds is 5%, tax rate is 20%, # of shares outstanding is 500 million, and EBIT
range is $100 to $300 million. The firm needs to raise $200 million in capital.

100% Stock 100% Debt 20% Debt / 80% Stock

Low High Low High Low High
EBIT $100 $300 $100 $300 $100 300
Interest (5%) 0 0 10 10 2 2
EBT $100 $300 $90 $290 $98 $298
Taxes (20%) $20 $60 $18 $58 $19.6 $59.6
EAT $80 $240 $72 $232 $78.4 $238.4
# Shares 510 510 500 500 508 508
EPS .157 .470 .144 .464 .154 .469
Answer: The all stock option is best since the EPS values are highest.

8-25. Under what conditions would Retained Earnings on the Balance Sheet decrease from
one year to the next?

Answer: The only way for RE to decrease from one year to the next on the balance sheet is 1) if the
firm incurred an earnings loss that year or 2) the firm has positive (or zero) net income for the year
but paid out dividends more than the net income.

8-26. In your own words, list all the steps in developing projected financial statements.

Answer: The six steps required to perform a projected financial analysis:

 Prepare the projected income statement before the balance sheet. Start by forecasting sales as
accurately as possible.
 Use the percentage of sales method to project the cost of goods sold (CGS) and the expense
items in the income statement. For example, if CGS is 70 percent of sales in the prior year (as it is in
Table 8-6) then use that same percentage to calculate CGS in the future year. Items such as interest,
dividends, and taxes must be treated independently and cannot be forecasted using the percentage-of-
sales method.
 Calculate the projected net income.
 Subtract from the net income any dividends to be paid for that year. This remaining net
income is Retained Earnings. Reflect the Retained Earnings total on both the income statement and

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balance sheet because this item is the key link between the two projected statements. Bring this
retained earnings amount for that year (NI-DIV = RE) over to the balance sheet by adding it to the
prior year’s RE shown on the balance sheet. The RE on the balance sheet is a cumulative number
rather than money available for strategy implementation.
 Project the balance sheet items, beginning with retained earnings and then forecasting
stockholder’s equity, long-term liabilities, current liabilities, total liabilities, total assets, fixed assets,
and current assets (in that order). Use the cash account as the plug figure; that is, use the cash account
to make the assets total the liabilities and net worth. Then, make appropriate adjustments.
 List comments on the projected statements. Any time a significant change is made in an item
from a prior year to the projected year, a remark should be provided.

8-27. Based on the financial statements provided for Coca-Cola in the Cohesion Case, how
much dividends in dollars did Coke pay in 2016? In 2017?

Answer:
2015 2016 2017
NI 7,366 6,527 1,248
RE 65,018 65,502 60,430
RE Change +484 -72
Dividends 6,527 - 484 = 6,043 1,248 + 72 = 1,320

Note: In 2017, Coke borrowed money to pay dividends. Whenever RE declines from one year to the
next on a corporate balance sheet as it did in 2017 for Coke, the firm paid more in dividends than it
made in net income. It is not good financial practice to pay such high dividends but sometimes a firm
such as Coke that has a history of paying a lot of dividends to shareholders will borrow money to
keep dividend payouts at a high level.

8-28. Why should you be careful not to use historical percentages blindly in developing
projected financial statements?

Answer: One must be aware of what the firm did to achieve past sales increases, which may not be
appropriate for the future unless the firm pursues the same or similar strategies. Similarly, for
manufacturing firms, if the firm is already operating at 100% capacity in all three 8-hour shifts, then
new manufacturing facilities would presumably be necessary to increase sales further.

MyLab Management

8-29. In developing projected financial statements, what should you do if the $ amount you
must put in the cash account (to make the statement balance) is far more (or less) than
desired?

Answer: If the cash needed to balance the statements is too small or too large, make appropriate,
offsetting changes on the balance sheet. For example, borrow more (or less) money than originally
planned, or pay off some long-term debt. The cash account is like a checking account that draws little
to no interest, so firms should not leave an excessive amount in cash.

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8-30. Explain how you would estimate the total worth of a business.

Answer: There are four methods discussed in Chapter 8.

Method 1 – Net Worth Method = Total Shareholders’ Equity minus (Goodwill + Intangibles)
Method 2 – Net Income Method = Net Income times Five
Method 3 – Price Earnings Ratio Method = (Stock Price divided by EPS) times NI
Method 4 – Outstanding Shares Method = # Shares Outstanding times Stock Price

Answers to the End-of-Chapter 8 Assurance of

Learning Exercises
Set 1: Strategic Planning for Coca-Cola

Exercise 8A
Perform an EPS/EBIT Analysis for Coca-Cola Company

Purpose

An EPS/EBIT analysis is one of the most widely used techniques for determining the
extent that debt or stock should be used to finance strategies to be implemented. This
exercise can give you practice performing EPS/EBIT analysis.

Instructions

Amount Coca-Cola needs: $5,000 million to build four new manufacturing plants
outside the USA
Interest rate: 5%
Tax rate: 21%
Stock price: $45.54 as of January 2, 2018
Number of shares outstanding: 4,255 million
EBIT: Pessimistic: $7,000 million, Realistic: $9,000 million, Optimistic: $11,000
million

Steps

1. Prepare an EPS/EBIT analysis for Coca-Cola. Determine whether the company

should use all debt, all stock, or a 50-50 combination of debt and stock to finance
this market-development strategy.

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2. Develop an EPS/EBIT chart after completing the EPS/EBIT table.

3. Next, give a 3-sentence recommendation for Coca-Cola’s CFO.

Coke should finance through 100% common stock if it wishes to maximize EPS
assuming both a pessimistic and realistic outlook and through 100% debt with an
optimistic outlook. New shares outstanding will only increase 2.6 percent under
100% common stock financing so dilution of ownership is not a major concern, but
combination financing could be used if desired to mitigate this possibility.

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Exercise 8B
Prepare Projected Financial Statements for Coca-Cola Company

Purpose

This exercise is designed to give you experience preparing projected financial statements.
This analysis is a strategic finance/accounting issue because it allows managers to
anticipate and evaluate the expected results of various strategy-implementation
approaches.

Instructions

Step 1 Work with a classmate. Develop a projected income statement and balance
sheet for Coca-Cola. Use the template if possible. Assume that Coca-Cola
needs to raise $5,000 million to increase its market share, and plans to obtain
50 percent financing from a bank and 50 percent financing from a stock
issuance. Make other assumptions as needed, and state them clearly in written
form.
Step 2 Bring your projected statements to class and discuss any problems or
questions you encountered.
Step 3 Compare your projected statements to the statements of other students. What
major differences exist between your analysis and the work of other students?

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ALL MAJOR TRANSACTIONS WERE PERFOMRED IN PROJECTED
YEAR 2018.

1. PAID IN CAPITAL INCREASED $2,500 M FROM 2017 TO

REFLECT 50% OF THE $5,000 M FINANCED THROUGH COMMON
STOCK.
2. DIVIDENDS PAID INCREASED SLIGHTLY IN 2018 TO REFLECT
THE SALE OF ADDITIONAL STOCK.
3. LONG-TERM DEBT INCREASED $2,500 M IN 2018 TO REFLECT
50% OF THE $5,000 M FINANCED THROUGH DEBT.
4. REVENUES INCREASED AT A RATE OF 5, 8 AND 10% AFTER
DECLINING 15% IN 2017. THIS REFLECTS THE BUILDING OF 4
PLANTS.

Exercise 8C

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Determine the Cash Value of Coca-Cola Company

Purpose

It is simply good business to continually know the cash value (corporate valuation) of
your company. This exercise gives you practice in determining the total worth of a
company using several methods. To perform this analysis, use Coca-Cola’s financial
statements as given in the Cohesion Case.

Instructions

Step 1 Calculate the financial worth of Coca-Cola based on four approaches: (1) the
net worth method, (2) the net income method, (3) the price-earnings ratio
method, and (4) the outstanding shares method.
Step 2 Get an average of the four methods. In a dollar amount, how much is Coca-
Cola worth?
Step 3 Compare your analyses and conclusions with those of other students.

EXERCISE 8D
Develop Actual and Projected Financial Ratios for Coca-Cola

Purpose

Financial ratios are vastly more than just an exercise for students to perform. If any firm’s
financial ratios get out of line with industry average or decline over time, investors can
withdraw support literally overnight. Projected financial ratios are an excellent means for
anticipating financial results so as to avoid overnight calamities. The template will
generate projected financial ratios after you convert your firm’s financial statements to
the template format and then develop projected financial statements based on
recommended strategies.

Step 1 Review the results of your EXERCISE 8B

Step 2 Compute Coca-Cola’s projected current ratio, debt-to-equity ratio, and return-
on-investment ratio. How do your projected ratios compare to prior year
ratios? Why is it important to make this comparison?

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Set 2: Strategic Planning for My University

EXERCISE 8E
Determine the Cash Value of My University

Answer: Answers will vary by student, but the same process for developing corporate
valuation works equally well for all types of for-profit and not-for-profit organizations
and, yes, even for individuals too.

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Set 3: Strategic Planning to Enhance My Employability

EXERCISE 8F
Developing Personal Financial Statements

Answer: Answers will vary by student, but the same process for developing projected
financial statements works equally well for all types of for-profit and not-for-profit
organizations and, yes, for individuals too.

EXERCISE 8G
A Template Competency Test

1. Why is it important to take the time to enter your financial statements into the
template format rather than simply copy and pasting financial statements off line
with respect to the template?

Answer: It is important to enter your financial statements into the template in order to
facilitate the construction of the projected statements. When the existing statements are
entered, the projected statements can be created and then easily manipulated by adjusting
one line item at a time. It is common practice when developing projected financial
statements to have multiple revisions and the template facilitates this process accurately
and quickly. By entering in the existing statements, historical financial ratios are
calculated. Students routinely compare the historical ratios to the projected ratios
(produced once students enter projected financial statements into the template) to
determine how feasible or where problem areas may lie in their projected financial
statements. For example, if projected year 1’s current ratio increased 400% from the
previous year, students know an adjustment may need to be made to a current asset or
current liability area on the projected statements. This adjustment can be made by simply
changing one number, enabling the template to then generate new projected statements
and projected ratios that can be reevaluated.

2. Does Chapter 8 focus on Part I or Part II of the template?

Answer: Chapter 8 focuses on Part II of the template which is devoted to financial

information, including financial statements, projected financial statements, ratios,
corporate valuation, and EPS/EBIT analysis.

3. If the EPS ranges for equity and debt for a given level of EBIT are identical, what
change in the analysis would likely provide the most variance: 1) Adjusting the
amount of capital needed by 25%, 2) Increasing the interest rate by 1% (100 basis
points), or 3) increasing the tax rate by 5% (500 basis points)? Why?

Answer: The correct answer depends on the amount of capital being raised.

4. Which of the following methods will never maximize EPS? 1) 100% equity
financing, 2) 100% debt financing, or 3) combination financing? Why?

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Answer: Combination financing will never maximize EPS because it is a weighted
average of the two 100% financing options.

5. Explain how analyzing projected financial ratios generated by the template can be
helpful in making adjustments to your projected financial statement estimates.

Answer: Answered in #1 above.

6. Do you physically have to calculate any number on the projected statements when
using the template?

Answer: No numbers anywhere on the template need to be physically calculated.

Students are prompted to enter in their expected change to that line item whether that be
additional dollars invested in plant property and equipment or simply what percent of
revenues they believe a line item such as accounts receivable should be. In the last
example, the template indicates the historical percent of revenues to accounts receivable
accounted for and many students simply use this same number unless they have
justification to change based on their recommendations.

7. Is it true or false that the template assures your projected balance sheets are in
balance every time by using what line item to achieve the balancing?

Answer: Yes. The template uses the cash line item to ensure the statements balance. As
students populate their projected statements or make subtle changes, the cash line item
will change to keep their projected balance sheet in balance.

8. If you notice your current ratio went from a historical 1.0 to a projected 5.0, what
are some steps you should consider taking?

Answer: Somewhat answered above, but a current ratio increasing from 1 to 5 indicates
one of two problems: 1) current assets are likely over estimated or 2) current liabilities
are likely under estimated. Students are 1) encouraged to check for any typos or data
entry errors first, 2) reevaluate projected revenue on the projected income statement as
often students over estimate potential revenues, and revenues filter down the income
statement into net income and from there to the projected balance sheet into retained
earnings and ultimately into inflating the cash figure, which will help explain the large
jump in a current ratio. 3) If students are happy with their estimated revenues, and have
ensured no typos or data entry errors on both the projected income statement and balance
sheet, then they should examine closely the remaining current asset and current liability
line items and make changes as deemed necessary. This process should not be thought of
as “gaming the system” or “changing the data until I am happy;” instead, this process
should be thought of as a warning that there are major flaws in your assumptions
assuming there are no typos present. This is another excellent reason to use the template,
as students can simply make one change and all numbers are recalculated for them
without having to manually recalculate new projected income and balance sheets.

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 9. When entering treasury stock on the template, why do you enter a negative
number?

Answer: Treasury stock is commonly entered in as a negative number on corporate

balance sheets because treasury stock is purchased with cash or debt. Considering the
equation Assets = Liabilities + Owners’ Equity, if the treasury stock is purchased through
cash, then treasury stock must be a negative number to keep the balance sheet balanced as
the cash account will be reduced and if debt is used to purchase the treasury stock, debt
increases. Then again, treasury stock must be a negative number to maintain balance in
the statements.

10. If you desire to quit paying dividends in projected years, what entry is needed for
the template to make this calculation?

Answer: Simply enter in $0 on Part II of the template in the space provided for dividends
if you wish to quit paying dividends.

11. If current plant, property, and equipment were $500 million and you wish to
increase plant, property, and equipment by $50 million in the first fiscal year,
what number would you enter into Part II of the template by plant, property, and
equipment under the first projected fiscal year?

Answer: You would simply enter in $50 if your data was entered in millions on Part II of
the template where it asks for plant, property, and equipment. The template remembers
existing plant, property, and equipment from previous years and will add (or subtract)
from the existing balance sheet entry any number entered into the template.

12. If you sold $100 million of common stock, what line item on the projected
balance sheet on Part II of the template would you make this entry?

Answer: You would need to enter in $100 if your data was entered in millions under
paid-in capital and other on Part II of the template. The template remembers the existing
paid-in capital and other balance sheet entries from previous years.

13. Just to the right of each line item on PART II of the projected income statement
and projected balance sheet, the template provides what type of hint?

Answer: The template provides what is referred to as a “Historical Note” to the right of
each line item in Part II of the template that instructs students on how to enter data. For
example, it may ask for the information to be entered in a dollar amount or as a percent.
Students are strongly encouraged to read the one sentence note to ensure their data is
entered correctly.

14. Why should a student enter into the template their existing and projected
financial data from oldest year to most current even though the template will

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 allow students to enter in dates in any sequence desired and even though many
published statements may enter the data in reverse order?

Answer: It is important to enter in all data from oldest to newest moving left to right; for
example, data should be entered for the existing statements as 2017 and then 2018 (even
if the corporation reveals their statements as 2018 then 2017) and for the projected
statements as 2019, 2020, and 2021 as the template is assuming this left to right sequence
for the calculation of percent changes and all ratios both existing and projected. Keep
data entry oldest to newest going left to right using the template, even though the Form
10K may go the other way.

Set 4: Individual vs. Group Strategic Planning

EXERCISE 8H
How Severe Are The Seven Limitations to EPS/EBIT Analysis?

Answer: The Expert Ranking

EPS/EBIT Limitations Authors’ Ranking

(1= most severe to 7 = least severe)

1. Flexibility 1
2. Control 5
3. Timing 3
4. Extent leveraged 4
5. Continuity 2
6. EBIT ranges 6
7. Dividends 7

Rationale: The expert rankings are based on the authors’ extensive experience, rather than on
findings from empirical research. The authors have performed several hundred EPS/EBIT
analyses for more than a hundred case companies. Their view is that the most severe limitation
is flexibility (1), followed by continuity (2). The third most severe limitation is timing (3),
followed by the extent leveraged (4). The fifth most severe limitation is control (5). The least
severe limitations are EBIT ranges (6) and dividends (7) respectively. The dividends limitation
is least severe because most companies do not pay dividends and more importantly dividends
are paid after EPS is calculated, i.e. after earnings are earned.

Answers to the End-of-Chapter 8 Mini-Case Questions

MINI-CASE ON HASBRO, INC.
Nerf Wants to Take over Barbie Doll – The Case of Hasbro, Inc.

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Based in Pawtucket, Rhode Island, the largest American toymaker Hasbro Inc. is engaged
in a hostile takeover attempt of the second largest toymaker Mattel Inc., based in El
Segundo, California. Mattel is the maker of Barbie dolls, American Girl dolls, Fisher-
Price and Hot Wheels toys. But Mattel has been losing money and its market value has
dropped to below $5 billion, whereas Hasbro is valued at about $11 billion. Hasbro has
brands such as Nerf, Transformers, and My Little Pony.
Hasbro’s stock has gained 18 percent on the year to $92 while Mattel’s stock has
declined 47 percent on the year to $14. Hasbro owns no toy factories but Mattel does own
its factories. Hasbro has forged close ties to Hollywood by producing movies and
creating toys tied to movies, even having toys now tied to Disney’s Star Wars and
Princess characters. Part of the problem for toy makers is that Toys “R” Us is operating
under Chapter 11 bankruptcy and Lego AS just cut 8 percent of its global staff. A few
years ago Mattel was trying to buy Hasbro but the firm’s fortunes have changed place.
Even if Hasbro and Mattel merge, the combined company would control about 35
percent of the U.S. market and 22 percent of global toy sales. In some categories
however, such as model vehicles, which includes Mattel’s Hot Wheels, the combined
firm would control 62 percent of the U.S. market. Mattel recently suspended its dividend
payments to shareholders in order to stay financially solvent; credit rating firms are
downgrading Mattel even as the firm tries to secure more debt financing.

Questions

1. How much is Hasbro worth today compared to the $11 billion figure in late 2017?
2. How much is Mattel worth today compared to the $5 billion figure in late 2017?
3. What would be the advantages and disadvantages of these two firms combining?
4. Assess the extent that antitrust regulators would approve a combination of the
industry’s two biggest players.

Answer:

Input Data as of 6-1-18

Hasbro Mattel

Shareholders’ Equity 1,829M 1,257M

Net Income 396M -1.053M
Stock Price 88 15
EPS 3.12 -3.07
# Shares Outstanding 125M 344M
Goodwill 573M 1,396M
Intangibles 217M 0

Four Valuation Methods for Hasbro

SE – (Goodwill + Intangibles) = 1,829 – (573 + 217) = 1,039M
NI x 5 = 396 x 5 = 1,980M
Stock Price/EPS x NI = 88/3.12 x 396 = 11,169M

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Solution Manual for Strategic Management: A Competitive Advantage Approach, Concepts and Cas

# Shares Outstanding x Stock Price 125 x 88 = 11,000M

Average 6,297M

Four Valuation Methods for Mattel

SE – (Goodwill + Intangibles) = 1,257 – (1,396 + 0) = NA
NI x 5 = -1.053 x 5 = NA
Stock Price/EPS x NI = 15 /-30.7 x -1,053 = NA
# Shares Outstanding x Stock Price = 344 x 15 = 5,160M
Average 5,160/4 = 1,290M

Conclusion: Mattel at best is worth $1.29B on 6-1-18, which is not much for such a huge
firm, but remember, whenever you acquire a firm, you then become responsible for that
firm’s debts and liabilities so theoretically a firm could be worth zero or even a negative
number, which theoretically would imply that firm would pay you to acquire them.
Antitrust regulators likely would let this merger occur because Mattel is really struggling
and not worth that much. The advantages offset the disadvantages of this merger
happening, for both firms, since Hasbro gets a lot of assets at a low price, and Mattel
otherwise may have to liquidate in the near future.

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