Case: Ski Right

After retiring as a physician, Bob Guthrie became an avid downhill skier on the steep slopes of the Utah Rocky Mountains. As an amateur inventor, Bob was always looking for something new. With the recent deaths of several celebrity skiers, Bob knew he could use his creative mind to make skiing safer and his bank account larger. He knew that many deaths on the slopes were caused by head injuries. Although ski helmets have been on the market for some time, most skiers considered them boring and basically ugly. As a physician, Bob knew that some type of new ski helmet was the answer.

Bob’s biggest challenge was to invent a helmet that was attractive, safe, and fun to wear. Multiple colors, using the latest fashion designs would be a must. After years of skiing, Bob knew that many skiers believed that how you looked on the slopes was more important than how you skied. His helmets would have to look good and fit in with current fashion trends. But attractive helmets were not enough. Bob had to make the helmets fun and useful. The name of the new ski helmet, Ski Right, was sure to be a winner. If Bob could come up with a good idea, he believed that there was a 20% chance that the market for the Ski Right Helmet would be excellent. The chance of a good market should be 40%. Bob also knew that the market for his helmet could be only average (30% chance) or even poor (10% chance).

The idea of how to make ski helmets fun and useful came to Bob on a gondola ride to the top of a mountain. A busy executive on the gondola ride was on his cell phone trying to complete a complicated merger. When the executive got off of the gondola, he dropped the phone and it was crushed by the gondola mechanism. Bob decided that his new ski helmet would have a built-in cell phone and an AM/FM Stereo radio. All of the electronics could be operated by a control pad worn on a skier’s arm or leg.

Bob decided to try a small pilot project for Ski Right. He enjoyed being retired and didn’t want a failure to cause him to go back to work. After some research, Bob found Progressive Products (PP). The company was willing to be a partner in developing the Ski Right and sharing any profits. If the market were excellent, Bob would net $5,000. With a good market, Bob would net $2,000. An average market would result in a loss of $2,000, and a poor market would mean Bob would be out $5,000.

Another option for Bob was to have Leadville Barts (LB) make the helmet. The company had extensive experience in making bicycle helmets. Progressive would then take the helmets made by Leadville Barts and do the rest. Bob had a greater risk. He estimated that he could lose $10,000 in a poor market or $4,000 in an average market. A good market for Ski Right would result in a $6,000 profit for Bob, while an excellent market would mean a $12,000 profit. A third option for Bob was to use TalRad TR, a radio company in Tallahassee, Florida. TalRad had extensive experience in making military radios. Leadville Barts could make the helmets, and Progressive Products could do the rest. Again, Bob would be taking on greater risk. A poor market would mean a $15,000 loss, while an average market would mean a $10,000 loss. A good market would result in a net profit of $7,000 for Bob. An excellent market would return $13,000.

Bob could also have Celestial Cellular (CC) develop the cell phones. Thus, another option was to have Celestial make the phones and have Progressive do the rest of the production and distribution. Because the cell phone was the most expensive component of the helmet, Bob could lose $30,000 in a poor market. He could lose $20,000 in an average market. If the market were good or excellent, Bob would see a net profit of $10,000 or $30,000, respectively.

Bob’s final option was to forget about Progressive Products entirely. He could use Leadville Barts to make the helmets, Celestial Cellular to make the phones, and TalRad to make the AM/FM stereo radios. Bob could then hire some friends to assemble everything and market the finished Ski Right helmets. With this final alternative, Bob could realize a net profit of $55,000 in an excellent market. Even if the market were just good, Bob would net $20,000. An average market, however, would mean a loss of $35,000. If the market were poor, Bob would lose $60,000.

Answer the following questions.

1. Based on the analysis what do you recommend?
2. What is the opportunity loss for this problem?
3. Compute the expected value of perfect information.
4. Was Bob completely logical in how he approached this decision problem?

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Case:Akron Zoological Park

Akron Zoological Park

During the late 1980s, the decline in Akron’s tire industry, inflation, and changes in governmental priorities almost resulted in the permanent closing of the Akron Children’s Zoo. Lagging attendance and a low level of memberships did not help matters. Faced with uncertain prospects of continuing, the city of Akron opted out of the zoo business. In response, the Akron Zoological Park was organized as a corporation to contract with the city to operate the zoo.

The Akron Zoological Park is an independent organization that manages the Akron Children’s Zoo for the city. To be successful, the zoo must maintain its image as a high-quality place for its visitors to spend their time. Its animal exhibits are clean and neat. The animals, birds, and reptiles look well cared for. As resources become available for construction and continuing operations, the zoo keeps adding new exhibits and activities. Efforts seem to be working, because attendance increased from 53,353 in 1989 to an all-time record of 133,762 in 1994.

Due to its northern climate, the zoo conducts its open season from mid-April until mid-October. It reopens for 1 week at Halloween and for the month of December. Zoo attendance depends largely on the weather. For example, attendance was down during the month of December 1995, which established many local records for the coldest temperature and the most snow. Variations in weather also affect crop yields and prices of fresh animal foods, thereby influencing the costs of animal maintenance.

In normal circumstances, the zoo may be able to achieve its target goal and attract an annual attendance equal to 40% of its community. Akron has not grown appreciably during the past decade. But the zoo became known as an innovative community resource, and as indicated in the table, annual paid attendance has doubled. Approximately 35% of all visitors are adults. Children accounted for one-half of the paid attendance. Group admissions remain a constant 15% of zoo attendance.

The zoo does not have an advertising budget. To gain exposure in its market, then, the zoo depends on public service announcements, the zoo’s public television series, and local press coverage of its activities and social happenings. Many of these activities are but a few years old. They are a strong reason that annual zoo attendance has increased. Although the zoo is a nonprofit organization, it must ensure that its sources of income equal or exceed its operating and physical plant costs. Its continued existence remains totally dependent on its ability to generate revenues and to reduce its expenses.

Source: Professor F. Bruce Simmons III, University of Akron.

YEAR	ATTENDANCE	ADMISSION FEE ($)
		ADULT	CHILD	GROUP
1998	117,874	4.00	2.50	1.50
1997	125,363	3.00	2.00	1.00
1996	126,853	3.00	2.00	1.50
1995	108,363	2.50	1.50	1.00
1994	133,762	2.50	1.50	1.00
1993	95,504	2.00	1.00	0.50
1992	63,034	1.50	0.75	0.50
1991	63,853	1.50	0.75	0.50
1990	61,417	1.50	0.75	0.50
1989	53,353	1.50	0.75	0.50

1.  The president of the Akron Zoo asked you to calculate the expected gate admittance figures and revenues for both 1999 and 2000. You can use at least three forecasting methods to estimate the forecast values and compare the results. Recommend the best method to the president of Akron Zoo.
2. What factors other than admission price influence annual attendance and thus should be considered in the forecast?
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Case: Assessing the Goal of Sports Products, Inc.

Managerial Finance-

Case: Assessing the Goal of Sports Products, Inc.

Loren Seguara and Dale Johnson both work for Sports Products, Inc., a major producer of boating equipment and accessories. Loren works as a clerical assistant in the Accounting Department, and Dale works as a packager in the Shipping Department. During their lunch break one day, they began talking about the company. Dale complained that he had always worked hard trying not to waste packing materials and efficiently and cost-effectively performing his job. In spite of his efforts and those of his co-workers in the department, the firm’s stock price had declined nearly $2 per share over the past 9 months. Loren indicated that she shared Dale’s frustration, particularly because the firm’s profits had been rising. Neither could understand why the firm’s stock price was falling as profits rose. Loren indicated that she had seen documents describing the firm’s profit sharing plan under which all managers were partially compensated on the basis of the firm’s profits. She suggested that maybe it was profit that was important to management, because it directly affected their pay. Dale said, “That doesn’t make sense, because the stockholders own the firm. Shouldn’t management do what’s best for stockholders? Something’s wrong!” Loren responded, “Well, maybe that explains why the company hasn’t concerned itself with the stock price. Look, the only profits that stockholders receive are in the form of cash dividends, and this firm has never paid dividends during its 20-year history. We as stockholders therefore don’t directly benefit from profits. The only way we benefit is for the stock price to rise.” Dale chimed in, “That probably explains why the firm is being sued by state and federal environmental officials for dumping pollutants in the adjacent stream. Why spend money for pollution control? It increases costs, lowers profits, and therefore lowers management’s earnings!”

Loren and Dale realized that the lunch break had ended and they must quickly return to work. Before leaving, they decided to meet the next day to continue their discussion.

Questions:

a. What should the management of Sports Products Inc. pursue as its overriding goal? Why?

b. Does the firm appear to have an agency problem? Explain.

c. Evaluate the firm’s approach to pollution control. Does it seem to be ethical? Why might incurring the expense to control pollution be in the best interests of the firm’s owners despite its negative effect on profits?

d. Does the firm appear to have an effective corporate governance structure? Explain any shortcomings.

e. On the basis of the information provided, what specific recommendations would you offer the firm?

Answers:

a. What should the management of Sports Products Inc. pursue as its overriding goal? Why?

Current theory asserts that the firms’ proper goal is to maximize shareholders’ wealth, as measured by the market price of the firm’s stock. A firm’s stock price reflects the timing, size and risk of the cash flow that investors expect a firm to generate over time. So financial managers should undertake only those actions that they expect will increase the value of the firm’s future cash flow. Theorical and empirical arguments support the assertion that managers should focus on maximization shareholder wealth. Shareholders of a firm are sometimes called residual claimants, meaning that they have claims only on any of the firm’s cash flows that remain after employees, suppliers, creditors, governments and other stakeholders are paid in full. As you see, shareholders stand at the end of this line so if the firm cannot pay the stakeholders first, shareholders receive nothing! Shareholders also bear most of the risk of running the firm. So if firms did not manage to maximize shareholders wealth, investors would have little incentive to accept the risks necessary for a business to succeed.

b. Does the firm appear to have an agency problem? Explain.

Yes. In this case,” the firm’s stock price had declined nearly $2 per share over the past 9 months” and at the same time “the firm’s profits had been rising”. What the shareholders receive are in the form of cash dividends, and this firm has never paid dividends during its 20-year history. Based on what I wrote before, shareholders wealth is reducing during this period and it shows that there is an agency problem.

In addition, management’s actions in case of pollution controls show a profit maximization try, which means they are trying to maximize their salary, rather than an attempt to maximize shareholders’ wealth(stock price).

c. Evaluate the firm’s approach to pollution control. Does it seem to be ethical? Why might incurring the expense to control pollution be in the best interests of the firm’s owners despite its negative effect on profits?

It possibly has two sides! We don’t know whether their acts were planned or accidental. It is clear that they are violating the law with dumping pollutants in the adjacent stream and damaging the environment. Clearly, Sports Products has not only done against the law but also established poor standards of conduct and moral judgment. So at both situations, the company’s manner does not seem to be ethical. Incurring the expense to control pollution be in the best interests of the firm’s owners because guarantees the firm’s long term profits in case of social responsibility.

d. Does the firm appear to have an effective corporate governance structure? Explain any shortcomings.

It seems not! The most important shortcoming is the management team who don’t make good decisions for maximizing shareholders’ wealth.

e. On the basis of the information provided, what specific recommendations would you offer the firm?

• Comply with all laws as well as accepted standards of conduct or moral judgment.
• Establish a corporate ethics policy, to be read and signed by all employees
• Designing a payment system that ties management team and employees’ salary to share price or a performance based scale.