Group case questions: General Dynamics - Case is in Harvard electronic packet

There is no need to gather additional information for this case.(Just use the information provided in the case and in the case questions.)Also, answer the questions as posed - no need to put this into a memo format.Any numbers or tables can be referenced in your answers.Below is some additional information

Many analysts use crude stock screens to ascertain if a stock "looks cheap."

One measure is price to earnings ratios.A low price relative to earnings might indicate that a stock is a bargain.On the other hand, there may be reasons why a stock trades at a low P/E ratio that are consistent with the circumstances of the company and not necessarily investment attractiveness.Analysts often purge out unusual items from earnings when calculating this ratio.

A second crude valuation tool used by analysts is to look at the value of the firm's stock as a multiple of shareholder operating cash flow, where shareholder operating cash flow (for our purposes) is defined as net earnings from ongoing operations (excluding extraordinary one-time items and special charges) plus depreciation and amortization.This cash flow is available to shareholders to invest back in the firm, pay dividends, pay off debts, buyback stock, build up working capital, do acquisitions, invest in new equipment and/or replace old equipment.

A third measure is the market value of equity to book value of equity ratio.This is simply market value of equity divided by book value of equity.A low ratio might indicate that the firm is trading at a low valuation relative to its hard net assets.Of course, it may also mean that the assets are overstated, liabilities are understated or that assets are being utilized in a way that will result in low returns on capital (lower than the cost of capital).

Below I show market value of stock divided by book value of stock (M/B), price to adjusted earnings (P/E), Price to operating cash flow per share (P/OCF), and I also show the ROE (accounting return on equity for General Dynamics for the last 4 years (in the case).The OCF and E are from the prior year.ROE* is the return on equity if we adjust for the special charge the company had.

1990198919881987

ROE-27%15%18% 32%

ROE *14%15%18%32%

M/B.70.881.101.28

P/E3.476.397.255.14(takes out A-12 charge for 1990

P/OCF1.562.853.492.82

Note: P/OCF is price divided by shareholder operating cash flow per share as defined earlier in the question.There are many definitions of operating cash flow.This is just one.This operating cash flow is after interest expense and taxes and the cash flow can be used for capital expenditures, investment in working capital, acquisitions, pay dividends, buyback shares, repayment of debt, etc.....

3. What factors might make some think that Anders was just pumping up short term cash flow and earnings to artificially boost share price with no sound strategy for the long term?Briefly explain.

4. What were the weaknesses of the "gain sharing" plan (if any) as implemented by GD?Or to put it another way, how was the plan potentially counterproductive in helping to achieve shareholder wealth maximization?

5. Overall, do you think that the various compensation plans (taken as a group of plans) at General Dynamics as instituted by Anders were beneficial in incentivizing managers of General Dynamics toward the goal of maximizing long run shareholder?

Note: Incentive Compensation plans are effective if they i) tie pay to appropriate performance measures and ii) decision makers have some control over the performance measures.This might include long run and short run measures of performance. That said, this case is really more about the wisdom of the decisions made by GD management.