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Contents
The Lotto Case (or Hitting the Jackpot)
Allen B. Atkins, Roxanne Stell, & Larry Watkins 3 – 5
American Apparel, Inc. – Saved from Bankruptcy but can it sustain?
Dr Anupam Mehta 6 – 20
A Model for Running an Undergraduate Business-Focused Case Competition
Jill M. Bale, Jimmy Senteza, & Toby A. White 21 – 36
Midwest Bancshares, Inc.
Heather Muehling, & Edward C. Lawrence 37 – 53
Creating Equity Indices: A Case Exercise
Judson W. Russell, & Christopher Brockman 54 – 66
Netflix: DVD-by-Mail or Online Streaming?
Rick Long, Inchul Suh, & Toby White 67 – 82
Strategic Approach of Business Valuation
Dr. Rishma Vedd, & Nataliya Yassinski 83 – 95
Did Right Case Take a Wrong Turn?
Janet E. Mosebach, & Diana R. Franz 96 – 100
Quandary at National Health Company
N. Ahadiat, & D. Rice 101 – 107
Interest Charge Domestic International Sales Corporations – The remaining ex-
porter tax benefit
Matthew Yost, & Chris Bjornson 108 – 122
Generating Financial Statements using QuickBooks: A Group Project in Financial
Accounting
Christopher Aquino, & Lei Han 123 – 133
Investing in a Brewpub: A Capital Budgeting Analysis
Elizabeth Webb Cooper 134 – 137
New Mexico National Bank, a bank with growth in mind (A)
Dr. James F. Cotter 138 – 154
A Case Study: Ethical Implications of friendly takeovers: A Financial Manager’s
Story
Barbara Tarasovich 155 – 165
Drug Revolution/Grace Pharmaceuticals Joint Venture
Karen M. Hogan, & Gerard T. Olson 166 – 170
From Jail Time to Swagger, Romance and Machoism: Changing the Image of the
Minivan
Mary Catherine Colley 171 – 185
3
The Lotto Case (Hitting the Jackpot)
Allen B. Atkins, Roxanne Stell, & Larry Watkins
Bob, Chad and Dylan had been dream-
ing of this day for the past six years; ever
since they first met in an introductory
economics course in college. For several
years they had been pooling their money
and buying Arizona Lottery tickets
dreaming that one day they would win
big. They realized that the lottery was
considered by many to be a voluntary
tax on the statistically challenged. But
miraculously they now sat at their favor-
ite local “watering hole” holding the
winning ticket that meant they would
split “The Pick” jackpot of $6 million.
What a great feeling! Now they just
needed to decide if they wanted to take
their winnings as a lump sum now or to
be paid over the next twenty in install-
ments.
Bob had been a political science major in
college but things hadn’t worked out as
he anticipated when he was a student.
He had entered the job market at what
looked now to be the bottom of the eco-
nomic downturn following the housing
crisis in the U.S. Bob believes he did not
start his job search soon enough and
found suitable openings virtually nonex-
istent. He was currently working part-
time at an organic farm and still living at
home which cramped his style consider-
ably. He has $150,000 in college related
loans (7% interest rate) which he cannot
service based on his annual taxable in-
come of $15,000. His share of the jackpot
would allow him to be debt free and
change his life for the better without
doubt.
Chad had been more fortunate than Bob.
He had applied himself in college and
earned a master of accounting degree
with an emphasis in taxation. After
graduation he immediately went to
work for one of the international ac-
counting firms and was now earning a
taxable income of $100,000 in spite of the
economic issues facing his friend Bob
and the country as a whole. He too had
debt but not from student loans. Chad
had purchased a very nice home in An-
them, Arizona for approximately 50% of
what it had sold for three years earlier
when built. He had a $250,000 mortgage
on the home, at a 4% interest rate, which
he saw little reason to pay off since he
anticipated significant inflation in the
near future.
Of the three friends Dylan was by far the
most successful. Dylan had majored in
finance and had excelled. When he
graduated, although he had several at-
tractive offers in the financial services
industry, he decided to go into the fami-
ly business. The company which his fa-
ther and uncle had started nearly 50
years ago had done amazingly well in
the downturn and since he was the only
child/nephew they were rewarding him
handsomely. He had been reluctant to
tell Bob but he was on track to receive to-
tal compensation (including bonuses)
that yielded a taxable income of $300,000
this year. Unlike his friend Bob, Dylan
was frugal and had taken on zero debt.
He was pleased with the trio’s good for-
tune but he didn’t think the windfall
would change his life all that much.
A few days later when the euphoria of
winning was subsiding the three friends
met again at the same establishment. All
4
were obviously in good spirits and were
looking forward to presenting their win-
ning ticket to Arizona Lottery officials.
Chad started the conversation by telling
Bob and Dylan that he had taken the ini-
tiative of doing some basic research on
how “The Pick” worked and what the
payout options were. Bob, proud of his
forethought, produced an article he had
saved years earlier from the Arizona Dai-
ly Star with the headline “Lump-sum
Lotto Payout is Best, Experts Say.” Bob
excitedly told his buddies that the ex-
perts were local CPAs and that clearly
the lump-sum payout was “the way to
go.” Dylan said he wanted to hear what
Chad had found out since he had gone
to the effort of looking into the specifics.
Chad (being a tax accountant) had pre-
pared a summary of his research which
follows:
A percentage of the proceeds from the sale of
Lotto tickets are allocated to a prize pool.
The size of the Jackpot that is prominently
advertised, six million dollars in this in-
stance, is actually only an estimate. The ad-
vertised amount is the sum of the estimated
annuity1 payments, without consideration of
the time value of money, which Lotto officials
believe can be purchased from the prize pool.
If the winner chooses the annuity payout
multiple insurance companies submit bids.
Officials award the bid to the insurance
company that offers the largest annual pay-
ments in return for the prize pool amount.
The insurance company with the best bid
typically offers a rate that is near the long-
1 The term annuity is actually a misnomer. Since
the payments are made by the insurance compa-
ny at the beginning of each of twenty periods it
is an annuity due.
term U.S. Treasury Bonds rate (currently
3%). If the winner chooses the Lump Sum
payout they simply receive the prize pool
amount; the amount that would have been
used to buy the annuity.
After reading the summary Bob said he
didn’t see how this related to the deci-
sion that had to be made since he didn’t
see anything that changed the preferred
option being that the lump-sum payout
is best. Chad acknowledged that Bob
was probably correct but he still wanted
to “run the numbers” and suggested that
Bob and Dylan should do the same.
Chad reminded them that they needed
to consider the tax consequences of the
payout schema and then provided the
following schedule of federal income tax
rates and reminded them that the state
tax rate was an additional 5%.
Bob rolled his eyes but said he would get
right on it. Dylan thanked Chad for the
information and they agreed to meet
again tomorrow to decide on the best
course of action.
Questions:
1. Is there necessarily one best deci-
sion for the group regarding the
payout options? If so what is it
and why?
2. What might be the reason(s) that
Chad does not want to pay off his
debt? Do you concur?
3. Prepare a personal analysis of the
payout options for Bob, Chad and
Dylan. Designate the preferred
option for each individual and
explain why.
4. What non-financial factors might
enter into the decision for the
winners?
5
References
Atkins, Allen B. and Edward A. Dyl,
“The LOTTO Jackpot: Should You Take
the Lump Sum or the Annuity?” Finan-
cial Practice and Education, Vol. 5, No. 2,
Fall/Winter, 1995, 107-111.
Authors
Allen B. Atkins, Ph.D., Professor of Fi-
nance, Northern Arizona University, al-
len.atkins@nau.edu
Roxanne Stell, Ph.D., Professor of Mar-
keting, Northern Arizona University,
roxanne.stell@nau.edu
Larry Watkins, Ph.D., CPA, Professor of
Accounting, Northern Arizona Universi-
ty, larry.watkins@nau.edu
Taxable Income Bracket* Federal Tax Rate
$0 to 8,500$ 10%
8,500 to 34,500 15%
34,500 to 83,600 25%
83,600 to 174,400 28%
174,400 to 379,150 33%
379,150 to and over 35%
* Assumes individual filing status
6
American Apparel, Inc. – Saved from Bankruptcy but can it sustain? Dr Anupam Mehta
Abstract
American Apparel, Inc, which was once the fastest growing retailer of America, is
now striving to save its bleeding bottom line. With the possible bankruptcy looming
on the American Apparel heads and huge pile of loans to pay, it is battling to get on
the operating profits necessary for its very existence. The present case depicts the
struggle of founder and CEO Dov Charney to revive the company with his recovery
mechanism, inventory management, strengthening online & offline sales and crush-
ing operating expenses to fight against the quarter by quarter losses, negative EPS
and decreasing margins. This case gives an opportunity to the students to analyze
and evaluate the financially troubled company’s performance along with applying
the Altman’s Z score. At the end of the case students need to decide: whether the
CEO Dov Charney’s recovery plan is able to improve the financial performance of
the company? What are the trends of growth and earnings? Does the company have
sufficient liquidity and profitability to meet the requirements of massive debt and
gather refinance options? Does the company survive bankruptcy?
Keywords: American Apparel, Bankruptcy, Z score, Profitability, Retails sector, fi-
nancial performance, Ratio analysis
Introduction
With a cumulative loss of $41 million for
the first three quarters in 2012, Ameri-
can Apparel, once the “Label of the Year:
American Apparel”, “The fashion sensa-
tion of 2008” (The Guardian, 2008) is
struggling to stay afloat, after going into
deep financial troubles in 2009 and was
on the verge of bankruptcy in 2011. The
company’s net profit slipped to $1 mil-
lion in 2009 from $15 million in 2007 and
down to annual net losses of $86 million
& $39 millions in 2010 and 2011 respec-
tively. Dov Charney, the CEO and
Founder of American Apparel, who built
the company from a small retailer to a
massive vertically integrated manufac-
turer, distributor and retailer, is now
burdened with massive debt load, falling
share prices and decreasing margins. Till
now, Dov Charney’s efforts have been
able to sustain the company in spite of
losses and pull up the investors for its
sinking company, while enhancing the
sales from $533 million in 2010 to $547
million in 2011 and further building up
to $444 million (first three quarters in
2012) with effective inventory manage-
ment and expansion plans. But, continu-
ous losses pressurized him to improve
the profitability and deliver the financial
results or it will run out of options soon.
7
Figure 1 Stock Performance for 2006-2011
(Source: American Apparel, Inc., 2011)
Company background
As of July 31, 2012, American Apparel
had approximately 10,000 employees
and operated 251 retail stores in 20 coun-
tries, including the United States, Cana-
da, Mexico, Brazil, United Kingdom, Ire-
land, Austria, Belgium, France,
Germany, Italy, Netherlands, Spain,
Sweden, Switzerland, Australia, Japan,
South Korea and China. American Ap-
parel operates a global e-commerce site
that serves over 60 countries worldwide
at http://www.americanapparel.net. In
addition, American Apparel also oper-
ates a leading wholesale business that
supplies high quality T-shirts and other
casual wear to distributors and screen
printers. It is also one of the few clothing
companies exporting “Made in the USA”
goods. The American Apparel is head-
quartered in Downtown, Los Angeles,
where, from a single building they con-
trol the dyeing, finishing, designing,
sewing, cutting, marketing and distribu-
tion of the company’s product. CEO Dov
is very passionate about the company,
and involved in every stage of manufac-
turing. He is known for the sexual con-
troversies and various sexual lawsuits.
The CEO Dov is also, famous for his use
of provocative models for advertise-
ments. Apart from these controversies,
Dov is having a very strong fashion
sense. In 2004, he was named Ernst &
Young’s Entrepreneur of the Year and
Apparel Magazine’s Man of the Year
(www.americanapparel.net, 1997).
American Apparel’s Mission statement
Company’s Long-term goal: to become
the #1 destination for basics – be the first
name that fashion-conscious consumers
think of for t-shirts, sweatpants, under-
wear, socks, and other basic apparel.
(www.americanapparel.net., n.d.)
The rise of American Apparel
The CEO Dov Charney with his vertical
integration business model converted
the company to America’s fastest retailer
in 2008. During the year, the company
made wide spread expansion and
launched stores across the globe with
new launches in Australia, Belgium,
Brazil, China, and Spain. The company
expanded 78 net store openings and 3
store moves. The company got strong
comparable store sales results: 22%,
8
Achieved EBITDA of $70.1 million and
EPS of $0.33 by significantly expanding
the manufacturing operations. The com-
pany was basking on the glory of signifi-
cant store growth and strong compara-
ble store sales performance. By the end
of 2008, the company has 260 stores in 19
countries, nearly 10,000 employees and
$545 million in revenues and a five year
compound annual growth rate of 46%
(American Apparel, Inc., 2008). The
company has a biggest competitive ad-
vantage of bringing the fashion changes
quickly, as the entire process is governed
in one building right from, cloth, cutting,
and delivery of final product. By the end
of 2008, the company was able to build a
unique brand which was fashionable
and low on prices.
Major setback to the profitability
In 2009, despite the company’s ability to
build a unique brand and having built a
wide network of stores across the globe,
the company started struggling to sus-
tain. Although, year 2008 was good in
terms of revenues and over all expan-
sion, beginning 2009, the company faced
several difficulties. The long run probe
into the employment of illegal immi-
grants, and forced termination of bulk of
its employees, brutally affected the per-
formance of the company. Immigration
crackdown forced American Apparel to
fire 1,800 workers, most of whom are La-
tino immigrants (Daily 49ER, 2009). As a
result, the company’s profits reduced
from $14 million in 2008 to $1 million in
2009, with EPS reduced from 0.33$ to
0.02$ in just one year and the operating
margins decreased from 6.6% to 4.4%.
The forced terminations of several em-
ployees impacted the performance of
2010 as well.
“We suffered the after-effects of a major
labor disruption resulting from an im-
migration intervention in 2009. The dis-
ruption of our 2010 production schedule
resulted in significantly higher produc-
tion costs per unit and late deliveries of
products to our stores and to our whole-
sale clients,” said acting president Tom
Casey. “In addition, we encountered ex-
traordinarily challenging world-wide
economic conditions. We also experi-
enced higher yarn and fabric costs in the
second half of 2010″ (American Apparel,
Inc., 2011).
Liquidity crisis and production losses
A significant decrease in the net cash
flow from operating activities, was ob-
served from December 31, 2009 ($45.2
million) to December 31, 2010 (- $32 mil-
lion). Meanwhile, the revenue during the
period fell nearly 5% as compared to
previous year, with total retail sales fell
just over 10%, wholesales sales dropped
6%, while online consumer sales shrunk
by 4.4% (Proactive investors, 2009). In
2011 things became worse, when the
company, with a long term mission of
becoming the number one destination
for garments, started to feel the difficulty
even to stay afloat. In its annual report
company specified that its operations are
at risk and raised substantial doubt that
the company may able to continue as a
going concern. As the crisis grew, the
company desperately looked for new in-
vestors.
“If the company is not able to timely,
successfully or efficiently implement the
strategies that the company is pursuing
to improve its operating performance
and financial position, obtain alternative
sources of capital or otherwise meet its
liquidity needs, the company may need
9
to voluntarily seek protection under
Chapter 11 of the U.S. Bankruptcy
Code,” DealBook (2011).
Recovery plan
On the blink of bankruptcy, the CEO
Dov Charney secured $14.9 million in
additional financing and gave life line to
the company. Dov, in his upbeat spirits,
made an extensive plan for the recovery
of the company through improving the
operating performance, over hauling of
the entire process of inventory manage-
ment and severely trying to crush the
cost while focusing on getting the re-
quired EBIT quarter by quarter in order
to meet the requirements of heavy debt
that it has taken.
According to Dov Charney, “We contin-
ue to make meaningful progress in im-
proving inventory efficiency lower car-
rying costs and reduce working capital
requirements over the long-term. These
efforts, together with other operating
performance improvements will assist in
our near-term refinancing efforts” (Inves-
tors.americanapparel.net, 2012).
The expansion and renewed focus on
sales enhancements resulted into total
net sales increase by 15% to $56.3 million
in December 2011. For the same period,
comparable store sales increased 12%
and wholesale net sales increased 25%.
The Gross operating margin as well im-
proved.
“Our sales exceeded plan in all channels
and we saw good progress in our whole-
sale channel across a broad spectrum of
customers. Our retail sales increases
were also broad based with notably
large increases in the US, in all Asian
markets, and in Australia. Our product
is resonating well with our customers
both in stores and online. During the
quarter we opened three new stores in
the UK, including one in Westfield, Lon-
don and two store-in-store locations at
the venerable Selfridges department
store chain. We are excited about our
progress in 2011 and expect to build on
our recent successes in the coming year”
said Dov Charney (American Apparel,
Inc., 2012).
The strategy of building both online and
offline stores was continued in 2012 as
well. In April 2012, it launched a new
online store,
www.store.americanapparel.com.hk,
serving Hong Kong, while continued to
build brand offline and online.
Figure 2: Recent Stock Performance
(Source: Yahoo Finance, 2012)
10
Figure 3: Quarterly results
(Source: Google Finance, 2012)
Burdened under Debt
In spite of some improvements, the
overall financial figures were still nega-
tive, making CEO Dov Charney to fur-
ther increase debt or refinance, else it
would go bankrupt. This time again Dov
was able to arrange the investors and
managed to get the major loans extend-
ed/refinanced till 2015 During July 2012,
the company announced it has replaced
its existing $75 million senior credit facil-
ity that was due to expire in July 2012
with a three year $80 million Senior
Credit Facility also extended the maturi-
ty date of the Second Lien Loan by two
years to December 31, 2015
(Americanapparel.net.,2012).
“I’ve never seen a company get so many
lifelines. Dov must be very charming,”
said the retail analyst. (Retailgeeks.com,
2012)
The growing liabilities, the high interest
rates and inability to generate profits
and once again resorting to the lenders
for further loan, resulted into a total lia-
bilities increasing to $ 319 million at the
end of the third quarter of 2012 as com-
pared to $13,877 in equity. But it seems
Dov, is unshattered with the loans, all he
wants to somehow keep the company
floating. He believes that once the com-
pany is able to hit the numbers, the in-
terest payment can be made easily.
Concern and challenges
“There’s obviously a level of sexiness
and excitement that (Charney) portrays,
and passion for the brand” retail con-
sultant said. “If the numbers aren’t that
positive, as they’re not, investors are
probably buying a vision and a promise
that, things will get better”
(Retailgeeks.com, 2012). Although the ef-
forts of Dov Charney have managed to
get investors till now, some analysts be-
lieve that the company has done noth-
ing, except buying some time from its
latest financing. With huge liabilities, the
company has to show the results in
numbers otherwise it may have to face
the bankruptcy. No wonder, the compa-
ny is having tough time to save its bleed-
ing bottom line. With the sword of liabil-
ities dangling on Dov Charney’s head,
he fears, whether the recovery plan will
able to enhance the profitability of the
company? What are the key financial in-
dicators that need to be further empha-
sized, in order to pay back the liabilities,
and generate further refinance, if re-
quired? Having survived on the blink of
bankruptcy, would American Apparel
be able to pass through the crisis or is it a
sure short candidate of business failure?
11
Specific Assignment Questions
1. Has the recovery plan of Dov
Charney able to improve the financial
performance of the company?
2. Do you think company can sur-
vive? Apply the Atman Z –score to fur-
ther strengthen your conclusions.
3. How good are the operating mar-
gins and EBIT of the company?
Notes: 1 Altman’s Z score
“Z” Score Component Definitions
1. X1=Working capital/ total Assets
2. X2=Retained earnings / Total As-
sets
3. X3=EBIT/Total Assets
4. X4=Equity value/ total book debt
5. X5=Sales/Total Assets
Z score is calculated to find out the fu-
ture viability and chances of bankruptcy
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
Altman defined a “problematic area”
which is between 1.81 and 2.99. Firms,
with z-scores within this range, are con-
sidered uncertain about credit risk and
considered marginal cases to be watched
with attention. Firms with Z scores be-
low 1.81 indicate failed firms. Although,
the cut-off point was set at 2.675, Altman
advocates using the lower bound of the
zone-of-ignorance (1.81) as a more realis-
tic cutoff Z-Score. So if Z < 1.81, then the
company has a high probability of de-
fault. Altman, E., (1968)
When using this model Altman conclud-
ed:
Z-score < 1.81 = high probability of bank-
ruptcy.
Z-score > 3.0 = low probability of bank-
ruptcy.
Z-score 1.81- 3.0 = indeterminate. (Al-
Rawi, K. et al., 2008)
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Altman, E., (1968) Financial Ratios, Dis-
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http://www.wwd.com/retail-
news/financial/american-apparel-
losses-narrow-
5795784/print…(Accessed:12th July
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Yahoo Finance (2012) American Apparel
Inc Common Stock (NYSE MKT). (im-
age online) Available at:
http://finance.yahoo.com/q/bc?s=APP
&t=1y&l=on&z=l&q=l&c= (Accessed:
11th Dec 2012)
14
Exhibit 1: Annual Cash Flow statement for year ending 2011
(Source: American Apparel, Inc. (2011) annual report on form 10-k for the year ended December 31, 2011)
American Apparel, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Amounts in Thousands)
2011 2010 2009
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers 542,930$ 532,601$ 559,089$
Cash paid to suppliers, employees and others (534,497) (559,386) (488,858)
Income taxes (paid) refunded (866) 698 (16,901)
Interest paid (5,535) (6,456) (8,609)
Other 273 173 482
Net cash provided by (used in) operating activities 2,305 (32,370) 45,203
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (11,070) (15,701) (20,889)
Proceeds from sale of fixed assets 311 39 –
Net cash used in investing activities (10,759) (15,662) (20,889)
CASH FLOWS FROM FINANCIN
