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Chapter 5
Risk Analysis
5-27
in whole or in part.
II. Approach to Teaching the Case
A. Begin by placing the segment data in Note 3 to the financial statements on an
overhead transparency. Ask students to describe the likely rationale for
FBN’s involvement in the five businesses indicated by the segment data for
B. Next, raise the question as to why FBN likely discontinued its Transport and
Training segments. These operations were not very profitable in Year 10.
Each would require management’s attention to return the operations to
profitability, yet they relate only tangentially to FBN’s main flight operations
contract work.
C. Finally, ask why FBN likely sold its Aircraft Sales and Leasing segment. FBN
derived a substantial portion of its operating profit from this segment in Year
10 and Year 11. One possible explanation is that FBN had only a limited
this segment to a company owned by Douglas Mather, CEO and majority
shareholder of FBN. FBN sold additional aircraft in Year 14 to a company
owned by Douglas Mather. These transactions and others in the case raise
questions regarding the role and power of a CEO/majority shareholder in a
members did not effectively assume their responsibilities in this regard until
late Year 14. We try to delay student discussion of the ethical issues until after
addressing other issues in the case.
Chapter 5
Risk Analysis
5-28
in whole or in part.
III. Responses to Questions
A. Signals of Cash Flow Problems
Year 13 followed by only a 50% increase in sales in Year 14 led to sig-
Year 10 Year 11 Year 12 Year 13 Year 14
Sales ............................... 100.0% 100.0% 100.0% 100.0% 100.0%
Variable Expenses .......... (82.0) (62.7) (77.1) (79.4) (80.1)
its aircraft and obtained an attractive price for the fleet. Perhaps FBN
anticipated new government contract work and wanted to gear up its
capacity accordingly.
14. The cost of services in Year 12 and Year 13 increased faster than
sales. Perhaps FBN hired the pilots for its new aircraft in anticipation of
aircraft.
these items to conserve cash.
4. During Year 12 to Year 14, FBN assumed increasing amounts of varia-
any increasing interest cost.
Chapter 5
Risk Analysis
5-29
in whole or in part.
5. The transactions between Mather and FBN suggest a pattern whereby
Mather “shared” economic profits from various transactions between
FBN and himself personally. Several of these transactions occurred in
Year 13 and Year 14. One wonders how much potential cash flow (and
profits) Mather redirected from FBN to himself during this period. We
get students to address the ethical issues by focusing on only one of the
issues described in the case. We usually address the sale of the Eastwind
September, Year 14.
We begin by acknowledging that Mather should have obtained
approval for the sale from the board of Directors. We ask students to
assume that he had obtained such approval and then ask whether Mather
did anything wrong if he obtained such approval. Approximately half the
students argue that Mather did nothing legally wrong and therefore they
do not have a problem with his ethics. He obtained the required
operations to help FBN deal with an overcapacity problem. Although a
few more students now accept the ethics of the transaction, some still
argue that any transaction between a firm and its CEO has the
appearance of unethical behavior, even if none is actually present, and
Chapter 5
Risk Analysis
5-30
B. Can FBN Avoid Bankruptcy in Year 15?
Positive Factors:
2. The board has fired Mather.
4. The banks have not yet demanded payment of their notes, despite viola-
tion of loan covenants.
7. The company has a reasonably clear strategic focus.
Negative Factors:
1. All assets are already collateralized. The company has zero unused debt
capacity.
3. Altman’s Z-score (see Exhibit 5.A) suggests a high probability of bank-
man’s Z score).
5. Risk ratios are at very low levels. There is very little margin for safety.
Sales must increase 43% in Year 15 just to break even.
IV. Epilogue
U.S. Navy in 1993. It filed for bankruptcy in February 1994 in a prearranged deal in
which creditors exchanged debt for a majority of the common stock. The firm
Chapter 5
Risk Analysis
5-31
in whole or in part.
Exhibit 5.A
Z-Score Analysis for FBN
(Case 5.3)
Z 1.2 1.4 3.3 0.6 1.0
Assets Assets Assets B.V. Liab. Assets
⎛⎞
−
⎛ ⎞⎛ ⎞⎛⎞ ⎛⎞
=+ +++
⎜⎟
⎜ ⎟⎜ ⎟⎜⎟ ⎜⎟
−
⎝ ⎠⎝ ⎠⎝⎠ ⎝⎠
⎝⎠
Year 10
$6,963 $2,149 $2, 750 $6,500 $31,992
Year 11
$1, 083 $2, 469 $4,392 $6,000 $19, 266
Year 12
$336 $3, 208 $3, 044 $6,809 $20, 758
1.2 1.4 3.3 0.6 1.0
$23,976 $23,976 $23,976 $16,178 $23,976
−
⎛⎞⎛⎞⎛⎞⎛⎞⎛⎞
++++
Year 13
$10,552 $3,802 $3,983 $13,893 $36,597
Year 14
$66,810 $29 $1,111 $31,896 $54,988
Chapter 5
Risk Analysis
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in whole or in part.
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