Finc 312 Spring 2003

How to Approach a Financial Management Case

Introduction

"Tell me and I forget. Teach me and I remember. Involve me and I learn." -

Benjamin Franklin

A case study is a description of a situation involving a decision to be made or a problem to

be solved. Most case studies are written in such a way that the reader takes the place of
the manager whose responsibility it is to make the decisions to help solve the problem or an
analyst making a recommendation to a manager. Using the case method, you learn how to
think in terms of the problems faced by a financial manager. In almost all case studies, a
decision must be made, although that decision might be to leave the situation as it is and do
nothing.1 However, the lessons most worth learning often come from taking a stand.

The main benefit of the case method is that it is much more effective than traditional lecture
format in developing critical thinking skills. Critical thinking is consciously observing,
analyzing, reasoning, and evaluating according to proven standards. The development of
critical thinking skills, which are highly sought after by potential employers, requires that
student be an active participant in the learning process. The case method is a student-
centered learning technique in which you learn by directly engaging real-world problems.
What is meant by direct engagement is that the instructor is not the intermediary, but the
guide. In contrast, in the pure-lecture format, the instructor delivers content that students
record in their notes. Later the students reiterate that material back to the instructor on an
exam. This is a very passive learning environment, and as a result, only a fraction of the
content is retained in the long run. In a course conducted using the case method, you, the
student, are the protagonist in the learning process.

"The answers worth getting are never in the back of the book." -Jeff Millman,
creative director at the Leo Burnett advertising agency

The types of problems encountered in a professional environment are often brand new.
Professionals are compensated for finding solutions for new problems or for finding better
solutions for existing ones. You are not going to be able to earn a very good living by
solving problems that have already been solved in the same way they were solved before!
Similarly, in a professional environment, you rarely begin with the framework, and then find
the problem; rather, you start with a question and then decide which is the best available
framework to use to solve it. Therefore, to have a successful career, you must have the
ability to teach yourself.

Students, who are new to the case method, naturally expect that every case has a definitive,
correct answer. They often ask for references to readings or to textbooks in the belief that
case solutions are to be found there or somewhere. However, the case method focuses on
developing problem-solving processes. There are no absolutely right answers, but there are
good arguments and bad arguments. The toolkit you leave a case course with contains a
set of processes to solve new problems, the ability to invent new processes as the need
arises, and the capability to discern between strong and weak arguments. This is excellent
training for professional life.

1
Even deciding not to decide, is to decide, as Napoleon once observed.

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While there is no one definitive "Case Method, there are some common steps that help you
tackle a case study. Different instructors might tell you to do things differently; this is part of
life and will also be part of working for others. This variety in approaches is beneficial
because it will show you different ways of approaching decision-making. Nevertheless, it
helps to have a system when sitting down to prepare a case study because the amount of
information to be dealt with and the number of issues to be resolved can initially seem quite
overwhelming. What follows are guidelines for preparing cases for this class.

Each team will have a specific responsibility for each case: presenting, discussing, or writing
a memorandum. However, the actual preparation of the case is virtually the same,
regardless of whether the team is presenting, discussing, or preparing a memo. In addition,
the analysis for most of your cases requires using spreadsheet modeling. You will also find
it efficient to use your financial calculator to do some quick calculations.

First Reading
The very first time you read any case, look for the forest not the trees. This requires that
your first reading be quick. Do not begin taking notes on the first round; instead, read the
case like a magazine article. The first few paragraphs of a well-constructed case usually
say something about the problem: read those paragraphs very carefully. Then quickly read
the rest of the case, seeking mainly a sense of the scope of the problems, and what
information the case contains to help resolve them. Leaf through the exhibits, looking for
what information they hold, rather than for any analytical insights. At the conclusion of the
first pass, read any supporting articles, review questions, or notes that may have been
recommended. You should then be able to answer the following questions:
Who must take action on the problem in this case? What is their position and what are
their responsibilities?
In what business is the company? What is the nature of its product? What is the nature
of demand for that product?
What appears to be the issue of concern, the problem, the challenge, or the opportunity?
What is its significance for the organization?
Second Reading
With the broad perspective you have gained from the first reading, a second and more
detailed reading will be more productive. The reason is that as you now encounter details,
your mind will be able to organize them in some useful fashion rather than inventorying them
randomly. Making linkages among case details is necessary in solving the case. You will
be most successful if you project yourself into the position of the decision-maker because
this perspective helps you link case details as well as develop a stand on the case problem.
The larger point of this phase of your case preparation is to broaden your awareness of
issues. Perhaps the most successful investor in history, Warren Buffett, said, "Any player
unaware of the fool in the market, probably is the fool in the market." Awareness is an
important attribute of successful managers.
After you finish your detailed reading, you should discuss and exchange ideas with your
other team members and be able to answer questions like:
What are the goals of the firm? What is the firm's strategy in pursuit of these goals?
(The goals and strategy might be explicitly stated, or they may be implicit in the way the
firm does business.)
What are the firm's apparent functional policies in finance (e.g., the use of debt
financing, payment of dividends)? Financial and business strategies can be inferred
from analysis of financial ratios and a sources and uses of funds statement.

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How well has the firm performed in pursuit of its goals? (The answer to this question
calls for simple analysis using financial ratios, such as the Dupont system; compound
growth rates, and measures of value creation.)
What appears to be the problem(s) here? Can you identify some of the symptoms and
causes of the problem(s)?

A common trap for many executives is to assume that the issue at hand is the real problem
most worthy of their time, rather than a symptom of some larger problem that really
deserves their time. For instance, a lender is often asked to advance funds to help tide a
firm over a cash shortfall. Careful study may reveal that the key problem is not a cash
shortfall, but rather it is product obsolescence, unexpected competition, or careless cost
management. Even in cases where the decision is fairly narrowly defined (such as in a
capital expenditure choice), the "problem" generally turns out to be the believability of
certain key assumptions.

Be careful not to focus too narrowly in defining problems. If your focus is too narrow, you
will often overlook the influence that the larger setting has on the problem. In doing this, you
develop narrow specialist habits, never achieving the general manager perspective.
Analyzing the case - Running the Numbers

"A merely well-informed man is the most useless bore on God's Earth. -Alfred North
Whitehead

Virtually all finance cases require numerical analysis. This is good because figure-work
lends rigor and structure to your thinking. However, the large quantity of available data, the
power of desktop computers, and the plethora of available technical tools make it very
tempting to produce vast amounts of useless numerical analysis. There are many financial
analysts who can present the minutest operating data about a company but yet not foresee
the company's bankruptcy, or suggest steps to avert it.

Economy of effort is desirable.2 If you have invested wisely in problem definition,

economical analysis tends to follow. Usually short cuts in analyzing a case end up costing
more time and worse, the time is not well spent. The results of a rushed analysis often miss
the main problem and do not yield effective recommendations. For example, lets say in the
interest of saving some time, you dont carefully read the case and skip answering the key
questions posed in the previous two sections, and, instead jump right into crunching the
numbers. You then might mistakenly assume that a particular case is meant to exercise
financial forecasting skills and consequently spend two or more hours preparing a detailed
forecast. If you had followed the more systematic approach, recommended in this guide,
you would have realized that a better strategy for would be to prepare a simpler forecast in
one hour and to conduct a sensitivity analysis based on key assumptions in the next hour.

An executive rarely thinks of a situation as having to do with a forecasting method or

discounting or any other technique, but rather thinks of it as a problem of judgment. Get to

2
Economy of effort is also important because some cases, reflecting reality, invite you to explore
blind alleys. Although sometimes frustrating, even these explorations will help you learn. Case
analysis is often iterative: an understanding of the big issues invites an analysis of details-then the
details may restructure the big issues and invite the analysis of other details. In some cases, getting
to the "heart of the matter" will mean just such iteration.

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the business issues quickly, and avoid lengthy churning through relatively unimportant
calculations.

Remember the following, when you doing numerical analysis for the case:

Look at the numbers given in the case study and make a judgment as to their
relevance to the problem identified. Not all numbers will be immediately useful or
relevant, but you need to be careful not to overlook anything. When deciding to analyze
numbers, keep in mind why you are doing it, and what you intend to do with the result.
Make sure you understand how the spreadsheet formulas relate to the models
shown in your text. Without this level of understanding you run the risk of applying the
models incorrectly, making ridiculous recommendations and then being embarrassed
when you are unable to answer question about your own analysis.
Be aware of any implicit or explicit assumptions you are making and the impact of
those assumptions on your results. Are the assumptions reasonable? Do you know
how sensitive your results are to your assumptions? If you made slightly different
assumptions, would you get very different results?
Perform sensitivity analysis on the least reliable estimates or those with the most
variability. For example, if your cost of capital estimate is very important to your results,
but you very uncertain as to what the cost of equity will be, find the maximum cost of
equity under which your results are valid
Do a common sense check. Are your results reasonable numbers in the context of the
case? Have you supplied the information the decision needs to formulated alternatives
and make recommendations?

Recommendations
Simply "crunching the numbers" is insufficient: one must learn to transform analysis into a
point of view, and the point of view into practical recommendations. You need to develop
another important attribute of a good professional, which is the ability to harness information
usefully. When identifying alternative courses of action, here are some things to remember:

Be realistic! While you might be able to find a dozen alternatives, keep in mind that they
should be realistic and fit within the constraints of the situation.

What are the constraints and opportunities implicit to this situation? It is very rare that
resources are not constrained, and allocations must be made on the assumption that not
enough will be available to please everyone.

What do the numbers tell you? Use common sense and comparisons to industry
standards when making judgments as to the meaning of your answers to avoid jumping to
conclusions.

Doing nothing, as in not changing your strategy can be a viable alternative, provided
it is being recommended for the correct reasons.

Not making a decision pending further investigation is not an acceptable decision for any
case study that you will analyze. A manager can always delay making a decision to gather
more information, which is not managing at all! The whole point to this exercise is to learn

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how to make good decisions, and having imperfect information is normal for most business
decisions, not the exception.

The following are a list of some criteria that are often used to evaluate recommendations in
financial management cases. However, do not let this list limit you, it is far from exhaustive.

What is the impact of the decision on stock price and/or earnings per share?3
How are sales and market share affected?
Is this recommendation consistent with our corporate mission or strategy?
Is this recommendation within acceptable risk parameters?
What is the ease and speed of implementation?
Will this recommendation retain or increase flexibility?
Is this recommendation related to the problem as we defined it? If you find that you are
talking about something else, that is a sign of a poorly defined problem.

3
Although not the sole criterion, the effect of the alternative on stock price is ALWAYS a
key consideration in financial decisions.