Case Studies in Finance

Case Studies in Finance Managing for Corporate Value Creation, 8e Robert Bruner, Kenneth Eades, Michael Schill

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UVA-F-1769TN

Rev. Nov. 8, 2017

This teaching note was prepared by Robert F. Bruner, University Professor, Distinguished Professor of Business Administration, and Dean Emeritus.The author is grateful to Stuart Gillan and Constance Lutolf-Carroll for helpful comments. Any errors that may remain are the author’s alone.Copyright © 2017 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to [email protected].

Warren E. Buffett, 2015

Teaching Note

Synopsis and Objectives Set in August 2015, this case invites students to assess Berkshire Hathaway’s bid for Precision Castparts Corporation (PCP). The task for students is to perform a simple valuation of PCP and to consider the reasonableness of Berkshire Hathaway’s offer. Student analysis readily extends to the investment philosophy and the remarkable record of Berkshire Hathaway’s chair and CEO, Warren E. Buffett.The case affords an introduction to a finance course or a module on capital markets. The analytical tasks are straightforward and intended to provide a springboard into discussion

of the main tenets of modern finance. Thus the case would be useful for:

• Setting themes at the beginning of a finance course, including risk and return, economic reality (not accounting reality), the time value of money, and the benefits of alignment of agents and owners.• Linking valuation to the behavior of investors in the capital market.• Modeling good practice in management and investment using Buffett as an example by returning to the image of him repeatedly during a finance course to ask students what Buffett would likely do in a situation.• Characterizing intrinsic value as equaling the present value of future equity cash flows.• Exercising simple equity-valuation skills by focusing on Buffett’s investment philosophy, basic principles of value creation, and multiples-valuation information provided in the case.• Exercising more advanced equity-valuation skills by estimating capital costs, a terminal value, and the discounted cash flow value from information in the case and teaching note. Used in this fashion, the case could be positioned later in the course as a basic introduction to methods of valuing a firm. This

1 Kenneth M. Eades and Dorothy Kelly, “Larry Puglia and the T. Rowe Price Blue Chip Growth Fund,” UVA-F-1772 (Charlottesville, VA: Darden Business Publishing, 2017).Suggested complementary case about investment managers

and superior performance:

“Larry Puglia and the T. Rowe Price Blue Chip Growth Fund”

(UVA-F-1772).

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could be accomplished by distributing this note along with focused assignment questions (discussed below).Suggested Questions for Advance Assignment Where this case is to be used in an introductory class, the instructor could assign these questions for

advance preparation by the students:

• Who is Warren E. Buffett? How would you describe the business of Berkshire Hathaway?
• How well has Berkshire Hathaway performed? Over the long term? Recently?
• What is your assessment of Berkshire Hathaway’s investments in Buffett’s largest equity positions

shown in case Exhibit 5? Has he been uniformly successful in making major investments?

• Prepare to describe the elements of Buffett’s investment philosophy. How might this philosophy differ

from that of other investment styles, such as a very active day trader, a chart watcher, or someone who passively invests in index funds?

• From Buffett’s perspective, what is intrinsic value? Why is it accorded such importance? How is it

estimated? What are the alternatives to intrinsic value? Why does Buffett reject them?

• Critically assess Buffett’s investment philosophy. Be prepared to identify points where you agree and

disagree with him.

• What is the possible meaning of the changes in stock price for Berkshire Hathaway on the day of the

acquisition announcement? Specifically, what does the $4 billion loss in Berkshire Hathaway’s market value of equity imply about the intrinsic value of Precision Castparts (PCP)?

• Should Berkshire Hathaway’s shareholders endorse the acquisition of PCP?

If the instructor chooses to engage the students in a valuation exercise regarding PCP, the following questions could be distributed in advance along with the supplemental information given in Exhibit TN1. Also, spreadsheet models for the student (UVA-F-1769X) and instructor (UVA-F-1769TNX) support the DCF valuation work.

• Based on the multiples for comparable companies, what is the range of possible values for PCP? What

questions might you have about this range?

• Please forecast and discount the free cash flows to estimate the value of PCP. To do this, you should

estimate PCP’s weighted-average cost of capital (WACC).

• Assess the bid for PCP. How does it compare with the firm’s intrinsic value?

Suggested Supplemental Readings As the case indicates, there is a growing library of books and articles about Buffett and his investment style.The instructor may choose to assign readings from one or more of the publications listed in Exhibit TN2.Alternatively, it may be appropriate simply to share the list of books with students to illustrate the breadth of scholarship and reportage about the Sage of Omaha, Warren Buffett.

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