Case Studies in Finance: Managing for Corporate Value Creation 7th Edition solution manual

Here, the discussion should shift to an analysis of Berkshire’s general record, its experience with MidAmerican, and its experiences buying equity positions in the Big Four. The general conclusion will be that Buffett has done very well as an investor and as the manager of Berkshire.
4.   Here are the major elements of Buffett’s philosophy. What do those elements mean? Do you agree with them?
On a sideboard, one could list the major topic headings given in the case. The aim here should be to discuss the intuition behind each point: why Buffett holds those views and what they imply for his work. If the students already have been exposed to the major underpinnings of modern finance, this segment of the discussion would take the form of a quick review. For novices, this segment would warrant slower development.
5.   Let’s return to the basic issue. Is the PacifiCorp acquisition a good or bad deal? Why?
This question returns the discussion to the opening and aims to rationalize some of the contradictions that will have emerged during class. The main contradiction is the full price and the positive market reaction to the announcement. As a value investor, Buffett would probably say that he sees something that others do not—the positive market reaction is just the market revising its expectations about the future profitability of PacifiCorp.
6.   Take a vote on whether the shareholders should endorse the acquisition. For those of you who believe that PacifiCorp will be a good purchase, what justifies your belief? For those of you who voted no, why did you oppose it?
Hearing from both sides will serve as a summary of the major themes in the case and will invite a discussion about the sustainability of Buffett’s record.
 
The instructor could close with a discussion of the core tenets of finance and then discuss how the class will return to those themes repeatedly during the course. The instructor could also augment the discussion of tenets with more reading of material about Buffett. Finally, students could be updated on Berkshire Hathaway’s performance since the date of the case. See the firm’s Web site, http://www.berkshirehathaway.com, for updated reports as well as a compilation of Buffett’s letters to shareholders.
 

Case Analysis
 
Investor reaction to the PacifiCorp announcement
 
The investor reaction suggests that the deal will not only create value for PacifiCorp’s acquirer, Berkshire Hathaway, but also for the seller, Scottish Power. In fact, as a relative matter, it would appear that the market sees more value accruing to Scottish Power because of its divestiture of PacifiCorp than to Berkshire, as a result of its acquisition of the company. Students could be encouraged to consider why this might be so (i.e., why Scottish Power would seem to gain more benefit from the deal than Berkshire Hathaway).
Discussion question 1

The $2.55 billion increase in Berkshire Hathaway’s market value indicates an expected benefit to Berkshire from the acquisition. Some students will measure the extent of this benefit as a gain of $2.55 billion in Berkshire’s market value of equity divided by PacifiCorp’s 312.18 million shares outstanding or $6.95 per PacifiCorp share more than Buffett is paying. Berkshire is offering $5.1 billion in cash for PacifiCorp’s equity, for a per-share price of $16.34; altogether, this would imply a per-share expected value for PacifiCorp’s shares of $23.29. Is this a fair estimate of PacifiCorp’s intrinsic value? Students must perform their own valuation of PacifiCorp in order to arrive at an independent judgment about this value.
 
Valuation of PacifiCorp
 
Discussion questions 2 and 3

Because PacifiCorp is a privately held company that does not pay a dividend, the case does not contain enough information to derive a valuation for PacifiCorp using market values or the dividend discount model. It is necessary, therefore, to rely on an implied valuation for the firm using multiples from comparable regulated utilities. Case Exhibit 9 provides financial data for the comparable firms, and case Exhibit 10 presents implied valuations for PacifiCorp using averages and medians of those firms’ multiples. Table 1 presents a summary of the range of valuations provided in the case:
 
Table 1. Summary of PacifiCorp valuation estimates.
 
Enterprise Value as Multiple of:
MV Equity as Multiple of:

Rev.
EBIT
EBITDA
Net Income
EPS
Book Value

 
 
 
 
 
 

6,252
8,775
9,023
7,596
4,277
5,904

6,584
9,289
9,076
7,553
4,308
5,678