Fundamentals of Corporate Finance Alternate Edition / Edition 10 available in Hardcover
Fundamentals of Corporate Finance Alternate Edition / Edition 10
- ISBN-10:
- 0077479459
- ISBN-13:
- 9780077479459
- Pub. Date:
- 01/20/2012
- Publisher:
- McGraw-Hill Higher Education
- ISBN-10:
- 0077479459
- ISBN-13:
- 9780077479459
- Pub. Date:
- 01/20/2012
- Publisher:
- McGraw-Hill Higher Education
Fundamentals of Corporate Finance Alternate Edition / Edition 10
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Overview
The best-selling Fundamentals of Corporate Finance (FCF) has three basic themes that are the central focus of the book:
1) An emphasis on intuitionthe authors separate and explain the principles at work on a common sense, intuitive level before launching into any specifics.
2) A unified valuation approachnet present value (NPV) is treated as the basic concept underlying corporate finance.
3) A managerial focusthe authors emphasize the role of the financial manager as decision maker, and they stress the need for managerial input and judgment.
The Tenth Edition continues the tradition of excellence that has earned Fundamentals of Corporate Finance its status as market leader. Every chapter has been updated to provide the most current examples that reflect corporate finance in today’s world. The supplements package has been updated and improved, and with the enhanced Connect Finance and Excel Master, student and instructor support has never been stronger.
Connect is the only integrated learning system that empowers students by continuously adapting to deliver precisely what they need, when they need it, and how they need it, so that your class time is more engaging and effective.
Product Details
ISBN-13: | 9780077479459 |
---|---|
Publisher: | McGraw-Hill Higher Education |
Publication date: | 01/20/2012 |
Pages: | 992 |
Product dimensions: | 8.30(w) x 10.10(h) x 1.50(d) |
About the Author
Bradford D. Jordan is Professor of Finance and holder of the Richard W. and Janis H. Furst Endowed Chair in Finance at the University of Kentucky. He has a longstanding interest in both applied and theoretical issues in corporate finance and has extensive experience teaching all levels of corporate finance and financial management policy.
Randolph W.Westerfield is Dean Emeritus of the University of Southern California's Marshall School of Business and is the Charles B. Thornton Professor of Finance. He came to USC from the Wharton School, University of Pennsylvania, where he was the chairman of the finance department and a member of the finance faculty for 20 years.
Stephen Ross is presently the Franco Modigliani Professor of Finance and Economics at the Sloan School of Management, Massachusetts Institute of Technology. One of the most widely published authors in finance and economics, Professor Ross is recognized for his work in developing the Arbitrage Pricing Theory and his substantial contributions to the discipline through his research in signaling, agency theory, option pricing, and the theory of the term structure of interest rates, among other topics. A past president of the American Finance Association, he currently serves as an associate editor of several academic and practitioner journals. He is a trustee of CalTech, a director of the College Retirement Equity Fund (CREF), and Freddie Mac. He is also the co-chairman of Roll and Ross Asset Management Corporation.
Table of Contents
Overview of Corporate Finance
Introduction to Corporate Finance 1
Corporate Finance and the Financial Manager 2
What Is Corporate Finance? 2
The Financial Manager 2
Financial Management Decisions 2
Capital Budgeting 2
Capital Structure 3
Working Capital Management 4
Conclusion 4
Forms of Business Organization 4
Sole Proprietorship 5
Partnership 5
Corporation 6
A Corporation by Another Name... 7
The Goal of Financial Management 8
Possible Goals 8
The Goal of Financial Management 9
A More General Goal 9
The Agency Problem and Control of the Corporation 10
Agency Relationships 10
Management Goals 10
Do Managers Act in the Stockholders' Interests? 12
Managerial Compensation 12
Control of the Firm 13
Conclusion 14
Stakeholders 14
Financial Markets and the Corporation 14
Cash Flows to and from the Firm 14
Primary versus Secondary Markets 15
Primary Markets 15
Secondary Markets 16
Summary and Conclusions 17
Financial Statements, Taxes, and Cash Flow 20
The Balance Sheet 21
Assets: The Left-Hand Side 21
Liabilities and Owners' Equity: The Right-Hand Side 21
Net Working Capital 22
Liquidity 23
Debt versus Equity 24
Market Value versus Book Value 24
The Income Statement 25
GAAP and the Income Statement 26
Noncash Items 27
Time and Costs 27
Taxes 29
Corporate Tax Rates 29
Average versus Marginal Tax Rates 29
Cash Flow 31
Cash Flow from Assets 32
Operating Cash Flow 32
Capital Spending 33
Change in Net Working Capital 33
Conclusion 34
A Note on "Free" Cash Flow 34
Cash Flow to Creditors and Stockholders 34
Cash Flow to Creditors 34
Cash Flow to Stockholders 35
An Example: Cash Flows for Dole Cola 36
Operating Cash Flow 36
Net Capital Spending 31
Change in NWC and Cash Flow from Assets 37
Cash Flow to Stockholders and Creditors 38
Summary and Conclusions 39
Financial Statements and Long-Term Financial Planning
Working with Financial Statements 48
Cash Flow and Financial Statements: A Closer Look 49
Sources and Uses of Cash 49
The Statement of Cash Flows 51
Standardized Financial Statements 53
Common-Size Statements 53
Common-Size Balance Sheets 54
Common-Size Income Statements 54
Common-Size Statements of Cash Flows 55
Common-Base Year Financial Statements: Trend Analysis 55
Combined Common-Size and Base-Year Analysis 56
Ratio Analysis 56
Short-Term Solvency, or Liquidity, Measures 57
Current Ratio 58
The Quick (or Acid-Test) Ratio 59
Other Liquidity Ratios 59
Long-Term Solvency Measures 60
Total Debt Ratio 60
A Brief Digression: Total Capitalization versus Total Assets 61
Times Interest Earned 61
Cash Coverage 61
Asset Management, or Turnover, Measures 62
Inventory Turnover and Days' Sales in Inventory 62
Receivables Turnover and Days' Sales in Receivables 63
Asset Turnover Ratios 64
Profitability Measures 64
Profit Margin 65
Return on Assets 65
Return on Equity 65
Market Value Measures 66
Price-Earnings Ratio 66
Market-to-Book Ratio 61
Conclusion 68
The Du Pont Identity 68
A Closer Look at ROE 68
An Expanded Du Pont Analysis 70
Using Financial Statement Information 71
Why Evaluate Financial Statements? 72
Internal Uses 72
External Uses 12
Choosing a Benchmark 72
Time-Trend Analysis 72
Peer Group Analysis 73
Problems with Financial Statement Analysis 77
Summary and Conclusions 78
Long-Term Financial Planning and Growth 90
What Is Financial Planning? 91
Growth as a Financial Management Goal 91
Dimensions of Financial Planning 92
What Can Planning Acccomplish? 93
Examining Interactions 93
Exploring Options 93
Avoiding Surprises 93
Ensuring Feasibility and Internal Consistency 93
Conclusion 94
Financial Planning Models: A First Look 94
A Financial Planning Model: The Ingredients 94
Sales Forecast 94
Pro Forma Statements 94
Asset Requirements 95
Financial Requirements 95
The Plug 95
Economic Assumptions 95
A Simple Financial Planning Model 95
The Percentage of Sales Approach 97
The Income Statement 97
The Balance Sheet 98
A Particular Scenario 99
An Alternative Scenario 100
External Financing and Growth 102
EFN and Growth 104
Financial Policy and Growth 106
The Internal Growth Rate 106
The Sustainable Growth Rate 107
Determinants of Growth 108
A Note on Sustainable Growth Rate Calculations 109
Some Caveats Regarding Financial Planning Models 111
Summary and Conclusions 111
Valuation of Future Cash Flows
Introduction to Valuation: The Time Value of Money 124
Future Value and Compounding 125
Investing for a Single Period 125
Investing for More Than One Period 125
A Note on Compound Growth 131
Present Value and Discounting 132
The Single-Period Case 132
Present Values for Multiple Periods 133
More on Present and Future Values 136
Present versus Future Value 136
Determining the Discount Rate 137
Finding the Number of Periods 141
Summary and Conclusions 144
Discounted Cash Flow Valuation 149
Future and Present Values of Multiple Cash Flows 150
Future Value with Multiple Cash Flows 150
Present Value with Multiple Cash Flows 153
A Note on Cash Flow Timing 156
Valuing Level Cash Flows: Annuities and Perpetuities 157
Present Value for Annuity Cash Flows 157
Annuity Tables 159
Finding the Payment 160
Finding the Rate 162
Future Value for Annuities 163
A Note on Annuities Due 164
Perpetuities 165
Comparing Rates: The Effect of Compounding 167
Effective Annual Rates and Compounding 167
Calculating and Comparing Effective Annual Rates 168
EARs and APRs 170
Taking It to the Limit: A Note on Continuous Compounding 171
Loan Types and Loan Amortization 172
Pure Discount Loans 172
Interest-Only Loans 173
Amortized Loans 173
Summary and Conclusions 178
Interest Rates and Bond Valuation 192
Bonds and Bond Valuation 193
Bond Features and Prices 193
Bond Values and Yields 193
Interest Rate Risk 197
Finding the Yield to Maturity: More Trial and Error 198
More on Bond Features 203
Is It Debt or Equity? 203
Long-Term Debt: The Basics 203
The Indenture 205
Terms of a Bond 205
Security 206
Seniority 206
Repayment 206
The Call Provision 207
Protective Covenants 207
Bond Ratings 208
Some Different Types of Bonds 209
Government Bonds 209
Zero Coupon Bonds 210
Floating-Rate Bonds 211
Other Types of Bonds 212
Bond Markets 214
How Bonds Are Bought and Sold 214
Bond Price Reporting 216
A Note on Bond Price Quotes 219
Inflation and Interest Rates 219
Real versus Nominal Rates 219
The Fisher Effect 220
Determinants of Bond Yields 221
The Term Structure of Interest Rates 221
Bond Yields and the Yield Curve: Putting It All Together 223
Conclusion 225
Summary and Conclusions 226
Stock Valuation 233
Common Stock Valuation 234
Cash Flows 234
Some Special Cases 236
Zero Growth 236
Constant Growth 236
Nonconstant Growth 239
Components of the Required Return 241
Some Features of Common and Preferred Stocks 243
Common Stock Features 243
Shareholder Rights 243
Proxy Voting 244
Classes of Stock 245
Other Rights 245
Dividends 245
Preferred Stock Features 246
Stated Value 246
Cumulative and Noncumulative Dividends 246
Is Preferred Stock Really Debt? 241
The Stock Markets 247
Dealers and Brokers 247
Organization of the NYSE 248
Members 248
Operations 249
Floor Activity 249
NASDAQ Operations 250
NASDAQ Participants 251
Stock Market Reporting 252
Summary and Conclusions 254
Capital Budgeting
Net Present Value and Other Investment Criteria 261
Net Present Value 262
The Basic Idea 262
Estimating Net Present Value 263
The Payback Rule 266
Defining the Rule 266
Analyzing the Rule 267
Redeeming Qualities of the Rule 268
Summary of the Rule 269
The Discounted Payback 269
The Average Accounting Return 272
The Internal Rate of Return 274
Problems with the IRR 278
Nonconventional Cash Flows 278
Mutually Exclusive Investments 280
Redeeming Qualities of the IRR 282
The Profitability Index 283
The Practice of Capital Budgeting 284
Summary and Conclusions 286
Making Capital Investment Decisions 295
Project Cash Flows: A First Look 296
Relevant Cash Flows 296
The Stand-Alone Principle 296
Incremental Cash Flows 296
Sunk Costs 297
Opportunity Costs 297
Side Effects 298
Net Working Capital 298
Financing Costs 298
Other Issues 299
Pro Forma Financial Statements and Project Cash Flows 299
Getting Started: Pro Forma Financial Statements 299
Project Cash Flows 300
Project Operating Cash Flow 301
Project Net Working Capital and Capital Spending 301
Projected Total Cash Flow and Value 301
More on Project Cash Flow 302
A Closer Look at Net Working Capital 302
Depreciation 305
Modified ACRS Depreciation (MACRS) 305
Book Value versus Market Value 307
An Example: The Majestic Mulch and Compost Company (MMCC) 308
Operating Cash Flows 309
Change in NWC 309
Capital Spending 310
Total Cash Flow and Value 310
Conclusion 312
Alternative Definitions of Operating Cash Flow 312
The Bottom-Up Approach 313
The Top-Down Approach 313
The Tax Shield Approach 314
Conclusion 314
Some Special Cases of Discounted Cash Flow Analysis 314
Evaluating Cost-Cutting Proposals 315
Setting the Bid Price 316
Evaluating Equipment Options with Different Lives 319
Summary and Conclusions 321
Project Analysis and Evaluation 330
Evaluating NPV Estimates 331
The Basic Problem 331
Projected versus Actual Cash Flows 331
Forecasting Risk 331
Sources of Value 332
Scenario and Other What-If Analyses 333
Getting Started 333
Scenario Analysis 334
Sensitivity Analysis 336
Simulation Analysis 337
Break-Even Analysis 337
Fixed and Variable Costs 338
Variable Costs 338
Fixed Costs 339
Total Costs 339
Accounting Break-Even 341
Accounting Break-Even: A Closer Look 342
Uses for the Accounting Break-Even 343
Operating Cash Flow, Sales Volume, and Break-Even 344
Accounting Break-Even and Cash Flow 344
The Base Case 344
Calculating the Break-Even Level 344
Payback and Break-Even 345
Sales Volume and Operating Cash Flow 345
Cash Flow, Accounting, and Financial Break-Even Points 346
Accounting Break-Even Revisited 346
Cash Break-Even 346
Financial Break-Even 341
Conclusion 347
Operating Leverage 349
The Basic Idea 349
Implications of Operating Leverage 349
Measuring Operating Leverage 349
Operating Leverage and Break-Even 351
Capital Rationing 352
Soft Rationing 352
Hard Rationing 352
Summary and Conclusions 353
Risk and Return
Some Lessons from Capital Market History 361
Returns 362
Dollar Returns 362
Percentage Returns 364
The Historical Record 366
A First Look 367
A Closer Look 368
Average Returns: The First Lesson 372
Calculating Average Returns 372
Average Returns: The Historical Record 372
Risk Premiums 373
The First Lesson 373
The Variability of Returns: The Second Lesson 374
Frequency Distributions and Variability 374
The Historical Variance and Standard Deviation 375
The Historical Record 377
Normal Distribution 377
The Second Lesson 379
Using Capital Market History 379
More on Average Returns 380
Arithmetic versus Geometric Averages 380
Calculating Geometric Average Returns 381
Arithmetic Average Return or Geometric Average Return? 382
Capital Market Efficiency 383
Price Behavior in an Efficient Market 383
The Efficient Markets Hypothesis 385
Some Common Misconceptions about the EMH 385
The Forms of Market Efficiency 387
Summary and Conclusions 388
Return, Risk, and the Security Market Line 394
Expected Returns and Variances 395
Expected Return 395
Calculating the Variance 397
Portfolios 398
Portfolio Weights 399
Portfolio Expected Returns 399
Portfolio Variance 400
Announcements, Surprises, and Expected Returns 402
Expected and Unexpected Returns 402
Announcements and News 403
Risk: Systematic and Unsystematic 404
Systematic and Unsystematic Risk 404
Systematic and Unsystematic Components of Return 405
Diversification and Portfolio Risk 406
The Effect of Diversification: Another Lesson from Market History 406
The Principle of Diversification 407
Diversificaton and Unsystematic Risk 408
Diversification and Systematic Risk 408
Systematic Risk and Beta 409
The Systematic Risk Principle 409
Measuring Systematic Risk 410
Portfolio Betas 411
The Security Market Line 412
Beta and the Risk Premium 412
The Reward-to-Risk Ratio 413
The Basic Argument 414
The Fundamental Result 416
The Security Market Line 417
Market Portfolios 417
The Capital Asset Pricing Model 418
The SML and the Cost of Capital: A Preview 420
The Basic Idea 420
The Cost of Capital 420
Summary and Conclusions 421
Options and Corporate Finance 430
Options: The Basics 431
Puts and Calls 431
Stock Option Quotations 431
Option Payoffs 433
Fundamentals of Option Valuation 436
Value of a Call Option at Expiration 436
The Upper and Lower Bounds on a Call Option's Value 437
The Upper Bound 437
The Lower Bound 437
A Simple Model: Part I 438
The Basic Approach 439
A More Complicated Case 439
Four Factors Determining Option Values 440
Valuing a Call Option 441
A Simple Model: Part II 441
The Fifth Factor 442
A Closer Look 443
Employee Stock Options 444
ESO Features 444
ESO Repricing 445
Equity as a Call Option on the Firm's Assets 445
The Debt Is Risk-Free 446
The Debt Is Risky 446
Options and Capital Budgeting 448
The Investment Timing Decision 448
Managerial Options 450
Contingency Planning 451
Options in Capital Budgeting: An Example 452
Strategic Options 453
Conclusion 453
Options and Corporate Securities 454
Warrants 454
The Difference between Warrants and Call Options 454
Earnings Dilution 455
Convertible Bonds 455
Features of a Convertible Bond 455
Value of a Convertible Bond 455
Other Options 457
The Call Provision on a Bond 457
Put Bonds 458
Insurance and Loan Guarantees 458
Summary and Conclusions 459
Cost of Capital and Long-Term Financial Policy
Cost of Capital 468
The Cost of Capital: Some Preliminaries 469
Required Return versus Cost of Capital 469
Financial Policy and Cost of Capital 469
The Cost of Equity 470
The Dividend Growth Model Approach 470
Implementing the Approach 470
Estimating g 471
Advantages and Disadvantages of the Approach 472
The SML Approach 472
Implementing the Approach 473
Advantages and Disadvantages of the Approach 473
The Costs of Debt and Preferred Stock 474
The Cost of Debt 474
The Cost of Preferred Stock 475
The Weighted Average Cost of Capital 476
The Capital Structure Weights 476
Taxes and the Weighted Average Cost of Capital 477
Calculating the WACC for Eastman Chemical 478
Eastman's Cost of Equity 478
Eastman's Cost of Debt 480
Eastman's WACC 481
Solving the Warehouse Problem and Similar Capital Budgeting Problems 483
Performance Evaluation: Another Use of the WACC 485
Divisional and Project Costs of Capital 485
The SML and the WACC 485
Divisional Cost of Capital 486
The Pure Play Approach 487
The Subjective Approach 488
Flotation Costs and the Weighted Average Cost of Capital 489
The Basic Approach 489
Flotation Costs and NPV 490
Summary and Conclusions 492
Raising Capital 499
The Financing Life Cycle of a Firm: Early-Stage Financing and Venture Capital 500
Venture Capital 500
Some Venture Capital Realities 501
Choosing a Venture Capitalist 501
Conclusion 502
Selling Securities to the Public: The Basic Procedure 502
Alternative Issue Methods 503
Underwriters 505
Choosing an Underwriter 506
Types of Underwriting 506
Firm Commitment Underwriting 506
Best Efforts Underwriting 506
Dutch Auction Underwriting 507
The Aftermarket 507
The Green Shoe Provision 508
Lockup Agreements 508
The Quiet Period 508
IPOs and Underpricing 509
IPO Underpricing: The 1999-2000 Experience 509
Evidence on Underpricing 510
Why Does Underpricing Exist? 512
New Equity Sales and the Value of the Firm 515
The Costs of Issuing Securities 516
The Costs of Selling Stock to the Public 516
The Costs of Going Public: The Case of Symbion 518
Rights 520
The Mechanics of a Rights Offering 520
Number of Rights Needed to Purchase a Share 521
The Value of a Right 522
Ex Rights 524
The Underwriting Arrangements 524
Effects on Shareholders 525
Dilution 526
Dilution of Proportionate Ownership 526
Dilution of Value: Book versus Market Values 526
A Misconception 527
The Correct Arguments 528
Issuing Long-Term Debt 528
Shelf Registration 529
Summary and Conclusions 530
Financial Leverage and Capital Structure Policy 536
The Capital Structure Question 537
Firm Value and Stock Value: An Example 537
Capital Structure and the Cost of Capital 538
The Effect of Financial Leverage 538
The Basics of Financial Leverage 539
Financial Leverage, EPS, and ROE: An Example 539
EPS versus EBIT 540
Corporate Borrowing and Homemade Leverage 542
Capital Structure and the Cost of Equity Capital 543
M&M Proposition I: The Pie Model 544
The Cost of Equity and Financial Leverage: M&M Proposal II 544
Business and Financial Risk 546
M&M Propositions I and II with Corporate Taxes 547
The Interest Tax Shield 547
Taxes and M&M Proposition I 548
Taxes, the WACC, and Proposition II 549
Conclusion 550
Bankruptcy Costs 552
Direct Bankruptcy Costs 553
Indirect Bankruptcy Costs 553
Optimal Capital Structure 554
The Static Theory of Capital Structure 554
Optimal Capital Structure and the Cost of Capital 555
Optimal Capital Structure: A Recap 556
Capital Structure: Some Managerial Recommendations 558
Taxes 558
Financial Distress 558
The Pie Again 558
The Extended Pie Model 559
Marketed Claims versus Nonmarketed Claims 560
Observed Capital Structures 560
A Quick Look at the Bankruptcy Process 562
Liquidation and Reorganization 562
Bankruptcy Liquidation 562
Bankruptcy Reorganization 563
Financial Management and the Bankruptcy Process 564
Agreements to Avoid Bankruptcy 565
Summary and Conclusions 565
Dividends and Dividend Policy 572
Cash Dividends and Dividend Payment 573
Cash Dividends 573
Standard Method of Cash Dividend Payment 574
Dividend Payment: A Chronology 574
More on the Ex-Dividend Date 575
Does Dividend Policy Matter? 576
An Illustration of the Irrelevance of Dividend Policy 576
Current Policy: Dividends Set Equal to Cash Flow 576
Alternative Policy: Initial Dividend Greater than Cash Flow 577
Homemade Dividends 577
A Test 578
Real-World Factors Favoring a Low Payout 578
Taxes 578
Expected Return, Dividends, and Personal Taxes 580
Flotation Costs 580
Dividend Restrictions 580
Real-World Factors Favoring a High Payout 581
Desire for Current Income 581
Uncertainty Resolution 582
Tax and Legal Benefits from High Dividends 582
Corporate Investors 582
Tax-Exempt Investors 582
Conclusion 583
A Resolution of Real-World Factors? 583
Information Content of Dividends 583
The Clientele Effect 584
Establishing a Dividend Policy 585
Residual Dividend Approach 585
Dividend Stability 587
A Compromise Dividend Policy 587
Some Survey Evidence on Dividends 589
Stock Repurchase: An Alternative to Cash Dividends 590
Cash Dividends versus Repurchase 591
Real-World Considerations in a Repurchase 592
Share Repurchase and EPS 593
Stock Dividends and Stock Splits 593
Some Details on Stock Splits and Stock Dividends 593
Example of a Small Stock Dividend 594
Example of a Stock Split 594
Example of a Large Stock Dividend 595
Value of Stock Splits and Stock Dividends 595
The Benchmark Case 595
Popular Trading Range 595
Reverse Splits 596
Summary and Conclusions 597
Short-Term Financial Planning and Management
Short-Term Finance and Planning 605
Tracing Cash and Net Working Capital 606
The Operating Cycle and the Cash Cycle 607
Defining the Operating and Cash Cycles 608
The Operating Cycle 608
The Cash Cycle 608
The Operating Cycle and the Firm's Organizational Chart 610
Calculating the Operating and Cash Cycles 610
The Operating Cycle 611
The Cash Cycle 612
Interpreting the Cash Cycle 613
Some Aspects of Short-Term Financial Policy 613
The Size of the Firm's Investment in Current Assets 614
Alternative Financing Policies for Current Assets 615
An Ideal Case 615
Different Policies for Financing Current Assets 615
Which Financing Policy Is Best? 618
Current Assets and Liabilities in Practice 619
The Cash Budget 619
Sales and Cash Collections 620
Cash Outflows 621
The Cash Balance 621
Short-Term Borrowing 622
Unsecured Loans 623
Compensating Balances 623
Cost of a Compensating Balance 623
Letters of Credit 624
Secured Loans 624
Accounts Receivable Financing 624
Inventory Loans 625
Other Sources 625
A Short-Term Financial Plan 626
Summary and Conclusions 627
Cash and Liquidity Management 637
Reasons for Holding Cash 638
The Speculative and Precautionary Motives 638
The Transaction Motive 638
Compensating Balances 638
Costs of Holding Cash 638
Cash Management versus Liquidity Management 639
Understanding Float 639
Disbursement Float 639
Collection Float and Net Float 640
Float Management 641
Measuring Float 641
Some Details 642
Cost of the Float 643
Ethical and Legal Questions 645
Electronic Data Interchange: The End of Float? 645
Cash Collection and Concentration 646
Components of Collection Time 646
Cash Collection 646
Lockboxes 647
Cash Concentration 648
Accelerating Collections: An Example 648
Managing Cash Disbursements 651
Increasing Disbursement Float 651
Controlling Disbursements 651
Zero-Balance Accounts 651
Controlled Disbursement Accounts 652
Investing Idle Cash 652
Temporary Cash Surpluses 653
Seasonal or Cyclical Activities 653
Planned or Possible Expenditures 653
Characteristics of Short-Term Securities 654
Maturity 654
Default Risk 654
Marketability 654
Taxes 654
Some Different Types of Money Market Securities 654
Summary and Conclusions 655
Determining the Target Cash Balance 660
The Basic Idea 660
The BAT Model 660
The Opportunity Costs 662
The Trading Costs 662
The Total Cost 663
The Solution 663
Conclusion 665
The Miller-Orr Model: A More General Approach 665
The Basic Idea 665
Using the Model 665
Implications of the BAT and Miller-Orr Models 666
Other Factors Influencing the Target Cash Balance 667
Credit and Inventory Management 670
Credit and Receivables 671
Components of Credit Policy 671
The Cash Flows from Granting Credit 671
The Investment in Receivables 672
Terms of the Sale 672
The Basic Form 672
The Credit Period 673
The Invoice Dote 673
Length of the Credit Period 673
Cash Discounts 674
Cost of the Credit 675
Trade Discounts 675
The Cash Discount and the ACP 675
Credit Instruments 676
Analyzing Credit Policy 676
Credit Policy Effects 676
Evaluating a Proposed Credit Policy 677
NPV of Switching Policies 677
A Break-Even Application 679
Optimal Credit Policy 679
The Total Credit Cost Curve 679
Organizing the Credit Function 680
Credit Analysis 681
When Should Credit Be Granted? 681
A One-Time Sale 681
Repeat Business 682
Credit Information 683
Credit Evaluation and Scoring 683
Collection Policy 684
Monitoring Receivables 684
Collection Effort 685
Inventory Management 685
The Financial Manager and Inventory Policy 686
Inventory Types 686
Inventory Costs 686
Inventory Management Techniques 687
The ABC Approach 687
The Economic Order Quantity Model 688
Inventory Depletion 688
The Carrying Costs 689
The Shortage Costs 690
The Total Costs 690
Extensions to the EOQ Model 692
Safety Stocks 692
Reorder Points 692
Managing Derived-Demand Inventories 694
Materials Requirements Planning 694
Just-in-Time Inventory 694
Summary and Conclusions 695
More on Credit Policy Analysis 700
Two Alternative Approaches 700
The One-Shot Approach 700
The Accounts Receivable Approach 701
Discounts and Default Risk 702
NPV of the Credit Decision 703
A Break-Even Application 703
Topics in Corporate Finance
International Corporate Finance 709
Terminology 710
Foreign Exchange Markets and Exchange Rates 711
Exchange Rates 712
Exchange Rate Quotations 712
Cross-Rates and Triangle Arbitrage 713
Types of Transactions 715
Purchasing Power Parity 716
Absolute Purchasing Power Parity 716
Relative Purchasing Power Parity 717
The Basic Idea 718
The Result 718
Currency Appreciation and Depreciation 719
Interest Rate Parity, Unbiased Forward Rates, and the International Fisher Effect 719
Covered Interest Arbitrage 720
Interest Rate Parity 721
Forward Rates and Future Spot Rates 722
Putting It All Together 722
Uncovered Interest Parity 722
The International Fisher Effect 722
International Capital Budgeting 723
The Home Currency Approach 724
The Foreign Currency Approach 725
Unremitted Cash Flows 725
Exchange Rate Risk 726
Short-Run Exposure 726
Long-Run Exposure 726
Translation Exposure 727
Managing Exchange Rate Risk 728
Political Risk 729
Summary and Conclusions 729
Risk Management: An Introduction to Financial Engineering 736
Hedging and Price Volatility 737
Price Volatility: A Historical Perspective 737
Interest Rate Volatility 738
Exchange Rate Volatility 738
Commodity Price Volatility 739
The Impact of Financial Risk: The U.S. Savings and Loan Industry 739
Managing Financial Risk 740
The Risk Profile 742
Reducing Risk Exposure 742
Hedging Short-Run Exposure 743
Cash Flow Hedging: A Cautionary Note 744
Hedging Long-Term Exposure 744
Conclusion 745
Hedging with Forward Contracts 745
Forward Contracts: The Basics 745
The Payoff Profile 746
Hedging with Forwards 746
A Caveat 747
Credit Risk 748
Forward Contracts in Practice 748
Hedging with Futures Contracts 748
Trading in Futures 748
Futures Exchanges 749
Hedging with Futures 749
Hedging with Swap Contracts 751
Currency Swaps 751
Interest Rate Swaps 752
Commodity Swaps 752
The Swap Dealer 752
Interest Rate Swaps: An Example 753
Hedging with Option Contracts 754
Option Terminology 754
Options versus Forwards 754
Option Payoff Profiles 755
Option Hedging 755
Hedging Commodity Price Risk with Options 756
Hedging Exchange Rate Risk with Options 757
Hedging Interest Rate Risk with Options 757
A Preliminary Note 758
Interest Rate Caps 758
Other Interest Rate Options 758
Summary and Conclusions 759
Option Valuation 764
Put-Call Parity 765
Protective Puts 765
An Alternative Strategy 765
The Result 765
Continuous Compounding: A Refresher Course 767
The Black-Scholes Option Pricing Model 770
The Call Option Pricing Formula 770
Put Option Valuation 773
A Cautionary Note 774
More on Black-Scholes 775
Varying the Stock Price 776
Varying the Time to Expiration 778
Varying the Standard Deviation 780
Varying the Risk-Free Rate 780
Implied Standard Deviations 781
Valuation of Equity and Debt in a Leveraged Firm 783
Valuing the Equity in a Leveraged Firm 783
Options and the Valuation of Risky Bonds 784
Options and Corporate Decisions: Some Applications 786
Mergers and Diversification 786
Options and Capital Budgeting 787
Summary and Conclusions 789
Mergers and Acquisitions 797
The Legal Forms of Acquisitions 798
Merger or Consolidation 798
Acquisition of Stock 799
Acquisition of Assets 800
Acquisition Classifications 800
A Note on Takeovers 800
Alternatives to Merger 801
Taxes and Acquisitions 801
Determinants of Tax Status 802
Taxable versus Tax-Free Acquisitions 802
Accounting for Acquisitions 802
The Purchase Method 803
Pooling of Interests 803
More on Goodwill 803
Gains from Acquisition 804
Synergy 804
Revenue Enhancement 806
Marketing Gains 806
Strategic Benefits 806
Market Power 806
Cost Reductions 807
Economies of Scale 807
Economies of Vertical Integration 807
Complementary Resources 807
Lower Taxes 808
Net Operating Losses 808
Unused Debt Capacity 808
Surplus Funds 808
Asset Write-Ups 809
Reductions in Capital Needs 809
Avoiding Mistakes 809
A Note on Inefficient Management 810
Some Financial Side Effects of Acquisitions 810
EPS Growth 810
Diversification 811
The Cost of an Acquisition 812
Cash Acquisition 813
Stock Acquisition 813
Cash versus Common Stock 814
Defensive Tactics 814
The Corporate Charter 815
Repurchase and Standstill Agreements 815
Poison Pills and Share Rights Plans 815
Going Private and Leveraged Buyouts 816
Other Devices and Jargon of Corporate Takeovers 816
Some Evidence on Acquisitions: Does M&A Pay? 818
Divestitures and Restructurings 818
Summary and Conclusions 819
Leasing 826
Leases and Lease Types 827
Leasing versus Buying 827
Operating Leases 828
Financial Leases 828
Tax-Oriented Leases 829
Leveraged Leases 829
Sale and Leaseback Agreements 829
Accounting and Leasing 829
Taxes, the IRS, and Leases 832
The Cash Flows from Leasing 832
The Incremental Cash Flows 833
A Note on Taxes 834
Lease or Buy? 834
A Preliminary Analysis 834
Three Potential Pitfalls 835
NPV Analysis 835
A Misconception 835
A Leasing Paradox 837
Reasons for Leasing 838
Good Reasons for Leasing 838
Tax Advantages 839
A Reduction of Uncertainty 840
Lower Transactions Costs 840
Fewer Restrictions and Security Requirements 840
Dubious Reasons for Leasing 840
Leasing and Accounting Income 840
100 Percent Financing 841
Low Cost 841
Other Reasons for Leasing 841
Summary and Conclusions 841
Mathematical Tables A-1
Key Equations B-1
Answers to Selected End-of-Chapter Problems C
Index I-1