Foundations of Financial Management

Cover
Foundations of Financial Management
Meet the Authors
Dedication
Preface
Acknowledgements
Distinguishing Features
Supplements
Brief Contents
Contents
List of Selected Real-World Managerial Examples and Boxes
List of Selected Global Examples and Boxes
part 1: Introduction
1: The Goals and Activities of Financial Management
The Field of Finance
Investments vs. Corporate Finance
The Value of Studying Finance
Activities of Financial Management
Forms of Organization
Sole Proprietorship
Partnership
Corporation
Corporate Governance
The Time Value of Money
Goals of Financial Management
A Valuation Approach
Maximizing Shareholder Wealth
Management and Stockholder Wealth
Social Responsibility and Ethical Behavior
The Role of the Financial Markets
Structure and Functions of the Financial Markets
Allocation of Capital
Internationalization of the Financial Markets
Format of the Text
Parts
1. Introduction
2. Financial Analysis and Planning
3. Working Capital Management
4. The Capital Budgeting Process
5. Long-Term Financing
6. Expanding the Perspective of Corporate Finance
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Web Exercise
part 2: Financial Analysis and Planning
2: Review of Accounting
Income Statement
Return to Capital
Price-Earnings Ratios and Earnings per Share
Limitations of the Income Statement
Balance Sheet
Interpretation of Balance Sheet Items
Concept of Book Value
Limitations of the Balance Sheet
Statement of Cash Flows
Developing an Actual Statement
Determining Cash Flows from Operating Activities
Determining Cash Flows from Investing Activities
Determining Cash Flows from Financing Activities
Combining the Three Sections of the Statement
Depreciation and Funds Flow
Free Cash Flow
Income Tax Considerations
Corporate Tax Rates
Cost of a Tax-Deductible Expense
Depreciation as a Tax Shield
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Web Exercise
3: Financial Analysis
Ratio Analysis
Classification System
The Analysis
A. Profitability Ratios
B. Asset Utilization Ratios
C. Liquidity Ratios
D. Debt Utilization Ratios
Trend Analysis
Impact of Inflation on Financial Analysis
An Illustration
Disinflation Effect
Deflation
Other Elements of Distortion in Reported Income
Explanation of Discrepancies
Sales
Cost of Goods Sold
Net Income
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
4: Financial Forecasting
Constructing Pro Forma Statements
Pro Forma Income Statement
Establish a Sales Projection
Determine a Production Schedule and the Gross Profit
Cost of Goods Sold
Other Expense Items
Actual Pro Forma Income Statement
Cash Budget
Cash Receipts
Cash Payments
Actual Budget
Pro Forma Balance Sheet
Explanation of Pro Forma Balance Sheet
Analysis of Pro Forma Statement
Percent-of-Sales Method
Summary
List of Terms
Discussion Questions
Practice Problems And Solutions
Problems
Comprehensive Problems
Web Exercise
5: Operating and Financial Leverage
Leverage in a Business
Operating Leverage
Break-Even Analysis
A More Conservative Approach
The Risk Factor
Cash Break-Even Analysis
Degree of Operating Leverage
Leveraged Firm
Conservative Firm
Limitations of Analysis
Financial Leverage
Impact on Earnings
Degree of Financial Leverage
Plan A (Leveraged)
Plan B (Conservative)
Limitations to Use of Financial Leverage
Combining Operating and Financial Leverage
Degree of Combined Leverage
A Word of Caution
Summary
Review of Formulas
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
part 3: Working Capital Management
6: Working Capital and the Financing Decision
The Nature of Asset Growth
Controlling Assets„Matching Sales and Production
Temporary Assets under Level Production„an Example
Patterns of Financing
Alternative Plans
Long-Term Financing
Short-Term Financing (Opposite Approach)
The Financing Decision
Term Structure of Interest Rates
A Decision Process
Introducing Varying Conditions
Expected Value
Toward an Optimal Policy
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Web Exercise
7: Current Asset Management
Cash Management
Reasons for Holding Cash Balances
Cash Flow Cycle
Collections and Disbursements
Float
Improving Collections
Extending Disbursements
Cost-Benefit Analysis
Electronic Funds Transfer
International Cash Management
Marketable Securities
Management of Accounts Receivable
Accounts Receivable as an Investment
Credit Policy Administration
Credit Standards
Terms of Trade
Collection Policy
An Actual Credit Decision
Inventory Management
Level versus Seasonal Production
Inventory Policy in Inflation (and Deflation)
The Inventory Decision Model
Carrying Costs
Ordering Costs
Economic Ordering Quantity
Safety Stock and Stockouts
Just-in-Time Inventory Management
Cost Savings from Lower Inventory
Other Benefits
The Downside of JIT
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
8: Sources of Short-Term Financing
Trade Credit
Payment Period
Cash Discount Policy
Net Credit Position
Bank Credit
Prime Rate and LIBOR
Compensating Balances
Maturity Provisions
Cost of Commercial Bank Financing
Interest Costs with Compensating Balances
Rate on Installment Loans
Annual Percentage Rate
The Credit Crunch Phenomenon
Financing through Commercial Paper
Advantages of Commercial Paper
Limitations on the Issuance of Commercial Paper
Foreign Borrowing
Use of Collateral in Short-Term Financing
Accounts Receivable Financing
Pledging Accounts Receivable
Factoring Receivables
Asset-Backed Public Offerings of Receivables
Inventory Financing
Stages of Production
Nature of Lender Control
Blanket Inventory Liens
Trust Receipts
Warehousing
Appraisal of Inventory Control Devices
Hedging To Reduce Borrowing Risk
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Web Exercise
part 4: The Capital Budgeting Process
9: The Time Value of Money
Relationship to the Capital Outlay Decision
Future Value„Single Amount
Present Value„Single Amount
Interest Rate„Single Amount
Number of Periods„Single Amount
Future Value„Annuity
Present Value„Annuity
Alternative Calculations: Using TVM Tables
Graphical Presentation of Time Value Relationships
The Relationship between Present Value and Future Value
The Relationship between the Present Value of a Single Amount and the Present Value of an Annuity
Future Value Related to the Future Value of an Annuity
Determining the Annuity Value
Annuity Equaling a Future Value
Annuity Equaling a Present Value
Finding Annuity Payments with a Financial Calculator or Excel
Finding Interest Rates and the Number of Payments
Finding Annuity Interest Rates
Finding the Number of Annuity Payments
Compounding over Additional Periods
Patterns of Payment with a Deferred Annuity
Annuities Due
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
Appendix 9A Alternative Calculations: Using TVM Tables
Appendix 9B Yield and Payment Examples Using TVM Tables
Appendix 9C Using Calculators for Financial Analysis
10: Valuation and Rates ofæReturn
Valuation Concepts
Valuation of Bonds
Present Value of Interest Payments
Present Value of Principal Payment (Par Value) at Maturity
Bond Valuation Using a Financial Calculator
Using ExcelÍs PV Function to Calculate a Bond Price
Concept of Yield to Maturity
Changing the Yield to Maturity and the Impact on Bond Valuation
Increase in Inflation Premium
Decrease in Inflation Premium
Time to Maturity
Determining Yield to Maturity from the Bond Price
Semiannual Interest and Bond Prices
Valuation and Preferred Stock
Determining the Required Rate of Return (Yield) from the Market Price
Valuation of Common Stock
No Growth in Dividends
Constant Growth in Dividends
Stock Valuation Based on Future Stock Value
Determining the Required Rate of Return from the Market Price
The Price-Earnings Ratio Concept and Valuation
Variable Growth in Dividends
Summary and Review of Formulas
List of Terms
Discussion Questions
Practice Problems And Solutions
Problems
Comprehensive Problems
Web Exercise
Appendix 10A Valuation of a Supernormal Growth Firm
11: Cost of Capital
The Overall Concept
Cost of Debt
Cost of Preferred Stock
Cost of Common Equity
Valuation Approach
Required Return on Common Stock Using the Capital Asset Pricing Model
Cost of Retained Earnings
Cost of New Common Stock
Overview of Common Stock Costs
Optimum Capital Structure„Weighting Costs
Capital Acquisition and Investment Decision Making
Cost of Capital in the Capital Budgeting Decision
The Marginal Cost of Capital
Summary
Review of Formulas
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
Appendix 11 Cost of Capital and the Capital Asset Pricing Model
List of Terms
Discussion Questions
Problems
12: The Capital Budgeting Decision
Administrative Considerations
Accounting Flows versus Cash Flows
Methods of Ranking Investment Proposals
Payback Method
Net Present Value
Internal Rate of Return
Selection Strategy
Reinvestment Assumption
Modified Internal Rate of Return
Capital Rationing
Combining Cash Flow Analysis and Selection Strategy
The Rules of Depreciation
The Tax Rate
Actual Investment Decision
The Replacement Decision
Sale of Old Asset
Tax Benefit on the Sale of Old Asset
Incremental Depreciation
Elective Expensing
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
APPENDIX 12: New Present Value Profile
13: Risk and Capital Budgeting
Definition of Risk in Capital Budgeting
The Concept of Risk-Averse
Actual Measurement of Risk
Risk and the Capital Budgeting Process
Risk-Adjusted Discount Rate
Increasing Risk over Time
Qualitative Measures
Example„Risk-Adjusted Discount Rate
Simulation Models
Decision Trees
The Portfolio Effect
Portfolio Risk
Evaluation of Combinations
The Share Price Effect
Summary
Review of Formulas
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
part 5: Long-Term Financing
14: Capital Markets
International Capital Markets
Competition for Funds in the U.S. Capital Markets
Government Securities
U.S. Government Securities
Federally Sponsored Credit Agencies
State and Local Securities
Corporate Securities
Corporate Bonds
Preferred Stock
Common Stock
Internal versus External Sources of Funds
The Supply of Capital Funds
The Role of the Security Markets
The Organization of the Security Markets
Traditional Organized Exchanges
Listing Requirements for Firms
The Major Exchanges
ICE
Cboe Global Markets
The NASDAQ Market
Foreign Exchanges
Other Financial Exchanges
Electronic Communication Networks (ECNs)
Market Efficiency
The Efficient Market Hypothesis
Regulation of the Security Markets
The Securities Act of 1933
The Securities Exchange Act of 1934
The Securities Acts Amendments of 1975
The Sarbanes_Oxley Act of 2002
Summary
List of Terms
Discussion Questions
Web Exercise
15: Investment Banking
The Role of Investment Banking
Enumeration of Functions
Underwriter
Market Maker
Advisor
Agency Functions
The Distribution Process
The Spread
Pricing the Security
Debt versus Equity Offerings
Dilution
Market Stabilization
Aftermarket
Shelf Registration
The Gramm_Leach_Bliley Act Repeals the Glass_Steagall Act
Public versus Private Financing
Advantages of Being Public
Disadvantages of Being Public
Public Offerings
A Classic Example„Rosetta Stone Goes Public
Private Placement
Going Private and Leveraged Buyouts
International Investment Banking Deals
Privatization
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problem
Web Exercise
16: Long-Term Debt and Lease Financing
The Expanding Role of Debt
The Debt Contract
Par Value
Coupon Rate
Maturity Date
Security Provisions
Unsecured Debt
Methods of Repayment
Serial Payments
Sinking-Fund Provision
Conversion
Call Feature
An Example: Eli LillyÍs 6.77 Percent Bond
Bond Prices, Yields, and Ratings
Bond Yields
Nominal Yield (Coupon Rate)
Current Yield
Yield to Maturity
Bond Ratings
Examining Actual Bond Ratings
The Refunding Decision
A Capital Budgeting Problem
Step A„Identification of Cash Inflows and Outflows
Step B„Calculating Each Cash Flow
Aftertax Interest Savings
Aftertax Call Premium Cost
New Underwriting Costs and Tax Benefits of Amortization
Accelerated Tax Benefits from Unamortized Underwriting Cost on Original Bond
Loss of Amortization Tax Benefits from the Original Bond Underwriting
Step C„Net Present Value of Combined Cash Flows
Other Forms of Bond Financing
Advantages and Disadvantages of Debt
Benefits of Debt
Drawbacks of Debt
Eurobond Market
Leasing as a Form of Debt
Finance Lease versus Operating Lease
Income Statement Effect
Advantages of Leasing
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
Appendix 16A Financial Alternatives for Distressed Firms
17: Common and Preferred Stock Financing
Common StockholdersÍ Claim to Income
The Voting Right
Cumulative Voting
The Right to Purchase New Shares
The Use of Rights in Financing
Rights Required
Monetary Value of a Right
Effect of Rights on StockholderÍs Position
Desirable Features of Rights Offerings
Poison Pills
American Depository Receipts
Preferred Stock Financing
Justification for Preferred Stock
Investor Interest
Summary of Tax Considerations
Provisions Associated with Preferred Stock
1. Cumulative Dividends
2. Conversion Feature
3. Call Feature
4. Participation Provision
5. Floating Rate
6. Auction Rate Preferred Stock
7. Par Value
Comparing Features of Common and Preferred Stock and Debt
Summary
Review of Formulas
List of Terms
Discussion Questions
Practice Problems And Solutions
Problems
Comprehensive Problems
Web Exercise
18: Dividend Policy and Retained Earnings
The Marginal Principle of Retained Earnings
Life Cycle Growth and Dividends
Dividends as a Passive Variable
An Incomplete Theory
Arguments for the Relevance of Dividends
Dividend Stability
Other Factors Influencing Dividend Policy
Legal Rules
Cash Position of the Firm
Access to Capital Markets
Desire for Control
Tax Position of Shareholders
Dividend Payment Procedures
Stock Dividend
Accounting Considerations for a Stock Dividend
Value to the Investor
Possible Value of Stock Dividends
Use of Stock Dividends
Stock Splits
Reverse Stock Splits
Repurchase of Stock as an Alternative to Dividends
Other Reasons for Repurchase
Dividend Reinvestment Plans
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
19: Convertibles, Warrants, and Derivatives
Convertible Securities
Value of the Convertible Bond
Is This FoolÍs Gold?
Advantages and Disadvantages to the Corporation
Forcing Conversion
Accounting Considerations with Convertibles
Financing through Warrants
Valuation of Warrants
Use of Warrants in Corporate Finance
Accounting Considerations with Warrants
Derivative Securities
Options
Futures
Summary
Review of Formulas
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Comprehensive Problems
Web Exercise
PART 6: Expanding the Perspective of Corporate Finance
20: External Growth through Mergers
Motives for Business Combinations
Financial Motives
Portfolio Effect
Access to Financial Markets
Tax Inversions
Tax Loss Carryforward
Nonfinancial Motives
Motives of Selling Stockholders
Terms of Exchange
Cash Purchases
Stock-for-Stock Exchange
Portfolio Effect
Accounting Considerations in Mergers and Acquisitions
Negotiated versus Tendered Offers
Premium Offers and Stock Price Movements
Two-Step Buyout
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Web Exercise
21: International Financial Management
The Multinational Corporation: Nature and Environment
Exporter
Licensing Agreement
Joint Venture
Fully Owned Foreign Subsidiary
Foreign Exchange Rates
Factors Influencing Exchange Rates
Purchasing Power Parity
Interest Rates
Balance of Payments
Government Policies
Other Factors
Spot Rates and Forward Rates
Cross Rates
Managing Foreign Exchange Risk
Forward Exchange Market Hedge
Money Market Hedge
Currency Futures Market Hedge
Foreign Investment Decisions
Analysis of Political Risk
Financing International Business Operations
Funding of Transactions
Eximbank (Export-Import Bank)
Loans from the Parent Company or a Sister Affiliate
Eurodollar Loans
Eurobond Market
International Equity Markets
The International Finance Corporation
Some Unsettled Issues in International Finance
Summary
List of Terms
Discussion Questions
Practice Problems and Solutions
Problems
Web Exercise
Appendix 21 Cash Flow Analysis and the Foreign Investment Decision
Appendices
Appendix A Future Value of $1, FVIF
Appendix B Present Value of $1, PVIF
Appendix C Future Value of an Annuity of $1, FVIFA
Appendix D Present Value of an Annuity of $1, PVIFA
Appendix E Keystrokes for HP 12C and HP 10bii Calculators
Glossary
Indexes