Case Study Analysis

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GuidetoCaseAnalysis.pdf

A Guide to

Case Analysis

I keep six honest serving men

(They taught me all I knew);

Their names are What and Why and When;

And How and Where and Who.

Rudyard Kipling

STRATEGY: Core Concepts and Analytical Approaches

Why Use Cases to Practice Strategic Management?

A student of business with tact

Absorbed many answers he lacked.

But acquiring a job,

He said with a sob,

“How does one fit answer to fact?”

Objectives of Case Analysis

I

A Guide to Case Analysis

Preparing a Case for Class Discussion

1. Skim the case rather quickly to get an overview of the situation it presents.

2. Read the case thoroughly to digest the facts and circumstances.

STRATEGY: Core Concepts and Analytical Approaches

3. Carefully review all the information presented in the exhibits.

4. Decide what the strategic issues are.

5. Start your analysis of the issues with some number crunching.

6. Apply the concepts and techniques of strategic analysis you have been studying.

7. Check out conflicting opinions and make some judgments about the validity of

all the data and information provided.

8. Support your diagnosis and opinions with reasons and evidence.

9. Develop an appropriate action plan and set of recommendations.

A Guide to Case Analysis

Table 1 Key Financial Ratios: How to Calculate Them and What They Mean

Ratio How Calculated What It Shows

Profitability ratios

1. Gross profit margin Sales revenues – Cost of goods sold

Sales revenues

Shows the percentage of revenues available to cover operating expenses and yield a profit. Higher is better and the trend should be upward.

2. Operating profit margin (or return on sales)

Sales revenues – Operating expenses Sales

or Operating income Sales revenues

Shows the profitability of current operations without regard to interest charges and income taxes. Higher is better and the trend should be upward.

3. Net profit margin (or net return on sales)

Profits after taxes Sales revenues

Shows after tax profits per dollar of sales. Higher is better and the trend should be upward.

4. Return on total assets Profits after taxes + interest Total assets

A measure of the return on total assets earned by both lenders and stockholders. Interest is added to after tax profits to form the numerator since total assets are financed by the lenders of borrowed funds as well as by stockholders. Higher is better, and the trend should be upward.

5. Net return on total assets

Profits after taxes Total assets

A measure of the return earned by stockholders on the firm’s total assets. Higher is better, and the trend should be upward.

6. Return on invested capital (ROIC)

Profits after taxes Long term debt + Total stockholders’ equity

Shows the return that both stockholders and the providers of long-term loans are earning on the capital that has been invested in the company. A higher ROIC reflects greater bottom-line effectiveness in the use of long-term capital, and the trend in ROIC should be upward.

7. Return on stockholders’ equity (ROE)

Profits after taxes Total stockholders’ equity

Shows the return stockholders are earning on their investment in the enterprise. A return in the 12% to 15% range is “average,” and the trend should be upward.

8. Earnings per share (EPS) Profits after taxes Number of shares of common

stock outstanding

Shows the earnings for each share of common stock outstanding. The trend in EPS should be upward, and the bigger the annual percentage gains, the better.

Liquidity Ratios

1. Current ratio Current assets Current liabilities

Shows a firm’s ability to pay current liabilities using assets that can be converted to cash in the near term. Ratio should definitely be higher than 1.0; ratios of 2 or higher are better still.

2. Working capital Current assets – Current liabilities Bigger amounts are better because the company has more internal funds available to (1) pay its current liabilities on a timely basis and (2) finance inventory expansion, additional accounts receivable, and a larger base of operations without resorting to borrowing or raising more equity capital.

Leverage Ratios

1. Total debt-to-assets ratio Total debt Total assets

Measures the extent to which borrowed funds (both short-term loans and long-term debt) have been used to finance the firm’s operations. A low fraction or ratio is better—a high fraction indicates overuse of debt and greater risk of bankruptcy.

STRATEGY: Core Concepts and Analytical Approaches

Ratio How Calculated What It Shows

Leverage Ratios

2. Long-term debt-to-capital ratio

Long-term debt Long-term debt +

total stockholders’ equity

An important measure of creditworthiness and balance sheet strength. It indicates the percentage of capital investment in the enterprise that has been financed by both long-term lenders and stockholders. A ratio below 0.25 is usually preferable since monies invested by stockholders account for 75% or more of the company’s total capital. The lower the ratio, the greater the capacity to borrow additional funds. A debt-to capital ratio above 0.50 and certainly above 0.75 indicates a heavy and perhaps excessive reliance on long-term borrowing, lower creditworthiness, and weak balance sheet strength.

3. Debt-to-equity ratio Total debt Total stockholders’ equity

Shows the balance between debt (funds borrowed both short-term and long-term) and the amount that stockholders have invested in the enterprise. A low ratio indicates greater capacity to borrow additional funds if needed.

4. Times-interest-earned (or coverage) ratio

Operating income Interest expenses

Measures the ability to pay annual interest charges. Lenders usually insist on a minimum ratio of 2.0, but ratios above 3.0 signal better creditworthiness.

Activity Ratios

1. Days of inventory Inventory Cost of goods sold ÷ 365

Measures inventory management efficiency. Fewer days of inventory are usually better.

2. Inventory turnover Cost of goods sold Inventory

Measures the number of inventory turns per year. Higher is better.

3. Average collection period Accounts receivable Total sales revenues ÷ 365

or Accounts receivable Average daily sales

Indicates the average length of time the firm must wait after making a sale to receive cash payment. A shorter collection time is better.

Other Important Measures of Financial Performance

1. Dividend yield on common stock

Annual dividends per share

Current market price per share

A measure of the return that shareholders receive in the form of dividends. A “typical” dividend yield is 2-3%. The dividend yield for fast-growth companies is often below 1% (maybe even 0); the dividend yield for slow- growth companies can run 4-5%.

2. Price-earnings ratio Current market price per share Earnings per share

P-e ratios above 20 indicate strong investor confidence in a firm’s outlook and earnings growth; firms whose future earnings are at risk or likely to grow slowly typically have ratios below 12.

3. Dividend payout ratio Annual dividends per share Earnings per share

Indicates the percentage of after-tax profits paid out as dividends.

4. Internal cash flow After tax profits + Depreciation A quick and rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, and taxes. Such amounts can be used for dividend payments or funding capital expenditures.

5. Free cash flow After tax profits + Depreciation – Capital Expenditures – Dividends

A quick and rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, taxes, dividends, and desirable reinvestments in the business. The larger a company’s free cash flow, the greater is its ability to internally fund new strategic initiatives, repay debt, make new acquisitions, repurchase shares of stock, or increase dividend payments.

Table 1

A Guide to Case Analysis

Participating in Class Discussion of a Case

STRATEGY: Core Concepts and Analytical Approaches

Preparing a Written Case Analysis

A Guide to Case Analysis

STRATEGY: Core Concepts and Analytical Approaches

Preparing an Oral Presentation

A Guide to Case Analysis

Researching Companies and Industries

via the Internet and Online Data Services

Online Data Services

Public and Subscription Websites with Good Information

STRATEGY: Core Concepts and Analytical Approaches

A Guide to Case Analysis

The Ten Commandments of Case Analysis

Table 2 The Ten Commandments of Case Analysis

STRATEGY: Core Concepts and Analytical Approaches

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