• Use the Financial Calculator to solve math problems right in MyFinanceLab! The Financial Calculator is available as a smartphone application as well as on a computer and includes important functions such as future and present value Fifteen helpful tutorials show instructors and students the many ways to use the Financial Calculator in MyFinanceLab Tutorials include lessons on calculator functions such as IRR and bond valuation Select end-of-chapter problems are now available in MyFinanceLab as simulated Excel problems Each problem has algorithmically generated values and allows students to solve the problem as they would in Excel Each problem is autograded and has both Excel and problem-specific Learning Aids Did your textbook come with a MyFinanceLab Student Access Kit? If so, go to www.pearsonmylab.com to register using the code If not, you can purchase access to MyFinanceLab online at www.pearsonmylab.com This page is intentionally left blank Principles of Managerial Finance Fourteenth Edition Lawrence J Gitman San Diego State University Chad J Zutter University of Pittsburgh Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Dedicated to the memory of my mother, Dr Edith Gitman, who instilled in me the importance of education and hard work LJG Dedicated to my wonderful children, Logan, Henry, Evelyn, and Oliver, who provide me with constant commotion, fun, and affection CJZ This page is intentionally left blank Our Proven Teaching and Learning System U sers of Principles of Managerial Finance have praised the effectiveness of the book’s Teaching and Learning System, which they hail as one of its hallmarks The system, driven by a set of carefully developed learning goals, has been retained and polished in this fourteenth edition The “walkthrough” on the pages that follow illustrates and describes the key elements of the Teaching and Learning System We encourage both students and instructors to acquaint themselves at the start of the semester with the many useful features the book offers The Role of Managerial Finance Learning Goals Why This Chapter Matters to You LG Define finance and the managerial finance function In your professional life LG Describe the legal forms of business organization LG Describe the goal of the firm, and explain why maximizing the value of the firm is an appropriate goal for a business LG Describe how the managerial finance function is related to economics and accounting Accounting You need to understand the relationships between the accounting and finance functions within the firm, how decision makers rely on the financial statements you prepare, why maximizing a firm’s value is not the same as maximizing its profits, and the ethical duty you have when reporting financial results to investors and other stakeholders informAtion SYStemS You need to understand why financial information is important to managers in all functional areas, the documentation that firms must produce to comply with various regulations, and how manipulating information for personal gain can get managers into serious trouble mAnAgement You need to understand the various legal forms of a business organization, how to communicate the goal of the firm to employees and other stakeholders, the advantages and disadvantages of the agency relationship between a firm’s managers and its owners, and how compensation systems can align or misalign the interests of managers and investors LG identify the primary activities of the financial manager mArketing You need to understand why increasing a firm’s revenues or market share is not always a good thing, how financial managers evaluate aspects of customer relations such as cash and credit management policies, and why a firm’s brands are an important part of its value to investors LG Describe the nature of the principal–agent relationship between the owners and managers of a corporation, and explain how various corporate governance mechanisms attempt to manage agency problems operAtionS You need to understand the financial benefits of increasing a firm’s production efficiency, why maximizing profit by cutting costs may not increase the firm’s value, and how managers act on behalf of investors when operating a corporation many of the principles of managerial finance In your life also apply to your personal life Learning a few simple financial principles can help you manage your own money more effectively personal Six Learning Goals at the start of the chapter highlight the most important concepts and techniques in the chapter Students are reminded to think about the learning goals while working through the chapter by strategically placed learning goal icons Every chapter opens with a feature, titled Why This Chapter Matters to You, that helps motivate student interest by highlighting both professional and personal benefits from achieving the chapter learning goals Its first part, In Your Professional Life, discusses the intersection of the finance topics covered in the chapter with the concerns of other major business disciplines It encourages students majoring in accounting, information systems, management, marketing, and operations to appreciate how financial acumen will help them achieve their professional goals The second part, In Your Personal Life, identifies topics in the chapter that will have particular application to personal finance This feature also helps students appreciate the tasks performed in a business setting by pointing out that the tasks are not necessarily different from those that are relevant in their personal lives Each chapter begins with a short opening vignette that describes a recent real-company event related to the chapter topic These stories raise interest in the chapter by demonstrating its relevance in the business world Tesla Motors Going Green to Find Value O ne of the most “hotly” debated topics of our day has been the issue of global warming and the benefits and costs of lower emissions Many companies are investing in radical new technologies with the hope of capitalizing on the going green movement On June 29, 2010, Tesla Motors raised $226 million in its initial public offering (IPO) of common stock Tesla, whose shares trade on the Nasdaq stock exchange, was the first automaker to use lithium ion batteries to produce an all-electric vehicle with a range of more than 200 miles Even though Tesla racked up losses of $279 million from 2006 to 2009 and had never been profitable, investors were enthusiastic about the IPO, and Tesla’s stock price rose from $17 to $24 on its first day of trading Excitement about Tesla’s prospects was fueled in part by its mission to reduce carbon emissions and in part by its charismatic cofounder, Elon Musk, who had previously started several successful companies, including PayPal It also helped that the federal government offered a tax subsidy of $7,500 to anyone who purchased an electric vehicle, and some states offered additional tax incentives In its first years as a public company, Tesla continued to struggle to become profitable, but its stock price gradually trended upward In 2013, Tesla reported its first quarterly profit as well as its first quarter of positive cash flow Just days after that news hit the markets, Consumer Reports announced that Tesla’s sedan, the Model S, was the best car it had ever tested, receiving the highest score in the magazine’s history, a 99 out of 100 From May to May 13, the company’s stock rose 57 percent! In the long run, Tesla’s stock price will depend on its ability to generate positive cash flows, without the help of government subsidies, and convince the market of its ability to so into the future • Owner receives all profits (and • Can raise more funds than sole • Low organizational costs • Income included and taxed on • Borrowing power enhanced by • Owners have • Can achieve large size via sale of • More available brain power and • Independence • Secrecy • Ease of dissolution • Income included and taxed on • Owner has • Owners have • Ownership (stock) is readily • Long life of firm • Can hire professional 271 • Has better access to financing Learning goal icons tie chapter content to the learning goals and appear next to related text sections and again in the chapter-end summary, end-of-chapter homework materials, and supplements such as the Study Guide, Test Item File, and MyFinanceLab For help in study and review, boldfaced key terms and their definitions appear in the margin where they are first introduced These terms are also boldfaced in the book’s index and appear in the endof-book glossary Matter of Fact boxes provide interesting empirical facts that add background and depth to the material covered in the chapter LG • Taxes are generally higher be 6.2 Corporate Bonds LG • Limited fund-raising power MyFinancelab Video • Partnership is dissolved when a A corporate bond is a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future • Proprietor must be jack-of-all• Difficult to liquidate or transfer • More expensive to organize than corporate bond under clearly defined terms Most bonds are issued with maturities of 10 to A long-term debt instrument 30 years and with a par value, or face value, of $1,000 The coupon interest rate indicating a corporation • that Difficult to give employees long• Subject to greater government on a bond represents the percentage of the bond’s par value that will be paid anhas borrowed a certain amount of money and promises nually, typically in two equal semiannual payments, as interest The bondholders, • payments Lacks secrecy because regula Lacks continuity when propri who are the lenders, are promised the semiannual interest and, at mato repay• it in the future under turity, repayment of the principal amount clearly defined terms Corporations corporation A corporation is an entity created by law A corporation has the legal powers of an individual in that it can sue and be sued, make and be party to contracts, and acquire property in its own name Although only about 20 percent of all U.S stockholders businesses are incorporated, the largest businesses nearly always are; corporaThe owners of a corporation, tions account for roughly 80 percent of total business revenues Although corpowhose ownership, or equity, takes the form of common stock rations engage in all types of businesses, manufacturing firms account for the largest portion of corporate business receipts and net profits Table 1.1 lists the or, less frequently, preferred key strengths and weaknesses of corporations stock The owners of a corporation are its stockholders, whose ownership, or eqAn entity created by law Matter of fact Bond Yields Hit Record Lows O n July 25, 2012, the 10-year Treasury note and 30-year Treasury bond yields reached all-time lows of 1.43% and 2.46% That was good news for the housing market Many mortgage rates are linked to rates on Treasury securities For example, the traditional 30-year mortgage rate is typically linked to the yield on 10-year Treasury notes With mortgage rates reaching new lows, potential buyers found that they could afford more expensive homes, and existing homeowners were able to refinance their existing loans, lowering their monthly mortgage payments and leaving them with more money to spend on other things This kind of activity is precisely what the Federal Reserve hoped to stimulate by keeping interest rates low during the economic recovery 5.10 IRF Example ▶ In Example 5.8 of Braden Company, we found the present value of Braden’s $700, 5-year ordinary annuity discounted at 8% to be $2,794.90 If we now assume that Braden’s $700 annual cash flow occurs at the start of each year and is thereby an annuity due This situation is depicted on the following time line Time line for present value of an annuity due ($700 beginning-of-year cash flows, discounted at 8%, over years) $700 $700 Beginning of Year $700 $700 $700 $ 700 648.15 600.14 555.68 514.52 Present Value $3,018.49 We can calculate its present value using a calculator or a spreadsheet MyFinancelab financial calculator Note: Switch calculator to BEGIN mode Input 700 Function PMT N I Calculator use Before using your calculator to find the present value of an annuity due, you must either switch it to BEGIN mode or use the DUE key, depending on the specifics of your calculator Then, using the inputs shown at the left, you will find the present value of the annuity due to be $3,018.49 (Note: Because we nearly always assume end-of-period cash flows, be sure to switch your calculator back to END mode when you have completed your annuity-due calculations.) Spreadsheet use The present value of the annuity due also can be calculated as shown on the following Excel spreadsheet CPT A PV Solution 23,018.49 B PRESENT VALUE OF AN ANNUITY DUE $700 8% –$3,018.49 Annual annuity payment Annual rate of interest Number of years Present value Entry in Cell B5 is =PV(B3,B4,B2,0,1) The minus sign appears before the $3,018.49 in B5 because the annuity’s present value is a cost and therefore a cash outflow Fran Abrams wishes to determine how much money she will have at the end of years if she chooses annuity A, the ordinary annuity She will deposit $1,000 annually, at the end of each of the next years, into a savings account paying 7% annual interest This situation is depicted on the following time line IRF Personal Finance Example 5.7 ▶ Time line for future value of an ordinary annuity ($1,000 end-of-year deposit, earning 7%, at the end of years) $1,310.80 1,225.04 1,144.90 1,070.00 1,000.00 $5,750.74 Future Value $1,000 $1,000 $1,000 $1,000 $1,000 Examples are an important component of the book’s learning system Numbered and clearly set off from the text, they provide an immediate and concrete demonstration of how to apply financial concepts, tools, and techniques Some examples demonstrate time-valueof-money techniques These examples often show the use of time lines, equations, financial calculators, and spreadsheets (with cell formulas) New! An IRF icon, which appears with some examples, indicates that the example can be solved using the interest rate factors The reader can access the Interest Rate Factor Supplement at MyFinanceLab The Interest Rate Factor Supplement is a self-contained supplement that explains how the reader should use the interest rate factors and documents how the in-chapter examples can be solved by using them MyFinanceLab contains additional resources to demonstrate the examples New! The MyFinanceLab Financial Calculator reference indicates that the reader can use the finance calculator tool in MyFinanceLab to find the solution for an example by inputting the keystrokes shown in the calculator screenshot New! The MyFinanceLab Solution Video reference indicates that the reader can watch a video in MyFinanceLab of the author discussing or solving the example New! The MyFinanceLab Video reference indicates that the reader can watch a video on related core topical areas Personal Finance Examples demonstrate how students can apply managerial finance concepts, tools, and techniques to their personal financial decisions End of Year As the figure shows, at the end of year 5, Fran will have $5,750.74 in her account Note that because the deposits are made at the end of the year, the first Key Equations appear in blue boxes throughout the text to help readers identify the most important mathematical relationships The variables used in these equations are, for convenience, printed on the front endpapers of the book PV = CF , r Review Questions appear at the end of each major text section These questions challenge readers to stop and test their understanding of key concepts, tools, techniques, and practices before moving on to the next section ➔ REVIEW QuESTIONS 5-10 What is the difference between an ordinary annuity and an annuity due? Which is more valuable? Why? 5-11 What are the most efficient ways to calculate the present value of an ordinary annuity? 5-12 How can the formula for the future value of an annuity be modified to find the future value of an annuity due? 5-13 How can the formula for the present value of an ordinary annuity be modified to find the present value of an annuity due? 5-14 What is a perpetuity? Why is the present value of a perpetuity equal to the annual cash payment divided by the interest rate? New! Excel Review Questions ask readers to complete problems using a simulated Excel spreadsheet in MyFinanceLab that resemble the examples demonstrated in the corresponding section These problems allow students to gain experience building Excel spreadsheet solutions and developing valuable business skill In Practice boxes offer insights into important topics in managerial finance through the experiences of real companies, both large and small There are three categories of In Practice boxes: (5.7) ➔ ExCEL REVIEW QuESTIONS MyFinancelab 5-15 Since tax time comes around every year you smartly decide to make equal contributions to your IRA at the end of every year Based on the information provided at MFL, calculate the future value of annual IRA contributions grown until retirement 5-16 You have just graduated from college, begun your new career, and now it is time to buy your first home Based on the information provided at MFL, determine how much you can spend for your new dream home 5-17 Rather than making contributions to an IRA at the end of each year, you decide to make equal contributions at the beginning of each year Based on the information provided at MFL, solve for the future value of beginning-of-year annual IRA contributions grown until retirement focus on EThICS If It Seems Too Good to Be True, It Probably Is reported in these statements However, a Over the years, suspicions were in practice For many years, invesraised about Madoff He generated high court ruling only permits claims up to the tors around the world difference between the amount an invesreturns year after year, seemingly with clamored to invest with Bernard tor deposited with Madoff and the very little risk Madoff credited his comMadoff Those fortunate enough to amount the investor withdrew The judge plex trading strategy for his investment invest with “Bernie” might not have also ruled that investors who managed to performance, but other investors understood his secret trading system, withdraw at least their initial investment employed similar strategies with much but they were happy with the doublebefore the fraud was uncovered are not different results than Madoff reported digit returns that they earned Madoff Harry Markopolos went as far as to sub- eligible to recover additional funds was well connected, having been the Total out-of-pocket cash losses mit a report to the SEC years prior to chairman of the board of directors of Madoff’s arrest, titled “The World’s Larg- as a result of Madoff’s fraud were the NASDAQ Stock Market and a estimated be $17.5 billion In early Fund Is a Fraud,” that founding member of the consultancy in Barrington, Illinois “The to metric tough economicest Hedge for evaluating IT projects—even in practice In International 2013, Investor than Protecdetailed his concerns Securities Clearing Corporation His times, the standard for simplicity of computing payback may the Securities more important discounted cash tionthe Corporation thatIRR)—because more 29, 2009, after a lengthy credentials seemed to beisimpeccable encourage sloppiness, especially a payback period often reduced On June flow reported (NPV and it spotthan 53 percent of the funds had However, as the old saying goes, if trial and eventual conviction, Madoff Chief information officers (CIOs) are apt failure to include all costs associated lights the risks inherent in lengthy IT projeither been returned or were in the something sounds too good to be true, it was sentenced to 150 years in prison an investment, suchtoas training, to reject projectsinvestors with payback ects returned “It should a hard-and-fast rule to process of being to be Madoff’s Madoff’swith investors are still working probably is Madoff’s learned periods maintenance, and hardware upgrade more years “We never take an IT project with a payback defrauded customers recover what they can Fraudulent this of lesson thethan hard2way when, on start with says senior vice period greater than years, unless it’s payback says Fijalkowski, account costs,” statements sentDouglas just priorEmond, to December 11,period,” 2008, the U.S.Ron Securities ▶ What are some hazards of and chief technology officer at Strategic Distribution, an infrastructure project you can’t Madoff’spresident arrest indicated that investors’ andCIO Exchange Commission (SEC) Inc., in allowing investors to pursue claims $64 bilcharged MadoffPennsylvania with securities fraud atcontained Eastern more Bankthan in Lynn, Massachusetts without,” Campbell says Bensalem, “For sure, accounts if based on their most recent account lion, in aggregate Many pur- may be Madoff’s hedge fund, Ascotis Partners, For example, heinvestors says, “you the payback period over 36 months, Whatever the weaknesses of the paystatements? sued claims basedin onathe turned be a giant Ponzi scheme But our bringing hotbalance new technology, but it’s out nottogoing to get approved back period method of evaluating capital focus on PRACTICE Focus on Ethics boxes in every chapter help readers understand and appreciate important ethical issues and problems related to managerial finance Focus on Practice boxes take a corporate focus that relates a business event or situation to a specific financial concept or technique Global Focus boxes look specifically at the managerial finance experiences of international companies All three types of In Practice boxes end with one or more critical thinking questions to help readers broaden the lesson from the content of the box Limits on Payback Analysis a rule of thumb is we’d like to see 24 uh-oh, after implementation you realize projects, the simplicity of the method does allow it to be used in conjunction with and you don’t have one.” other, more sophisticated measures It But the payback method’s emphasis can be used to screen potential projects on the short term has a special appeal and winnow them down to the few that for IT managers “That’s because the merit more careful scrutiny with, for examhistory of IT projects that take longer ple, net present value (NPV) than years is disastrous,” says Gard▶ In your view, if the payback period ner Indeed, Ian Campbell, chief remethod is used in conjunction with search officer at Nucleus Research, Inc., the NPV method, should it be used in Wellesley, Massachusetts, says paybefore or after the NPV evaluation? back period is an absolutely essential www.sec.gov/news/studies/2009/oig-509/exhibit-0293.pdf months And if it’s close to 12, it’s prob- that you need a Net guru in-house, ably a no-brainer.” Although easy to compute and easy to understand, the payback period’s simplicity brings with it some drawbacks “Payback gives you an answer that tells you a bit about the beginning stage of a project, but it doesn’t tell you much about the full lifetime of the projGLOBAL focus ect,” says Chris Gardner, a cofounder of iValue LLC, an IT valuation An International Flavor to Risk Reduction Source: Gary Anthes, “ROI Guide: Payback Period,” Computerworld.com (February 17, 2003), in practice Earlier in this chapter Staunton calculated the historical www.computerworld.com/s/article/78529/ROI_Guide_Payback_Period?taxono returns on a portfolio that included U.S (see Table 8.5 on page 324), we learned that from 1900 through 2011, the U.S stock market produced an average annual nominal return of 9.3 percent, but that return was associated with a relatively high standard deviation: 20.2 percent per year Could U.S investors have done better by diversifying globally? The answer is a qualified yes Elroy Dimson, Paul Marsh, and Mike stocks as well as stocks from 18 other countries This diversified portfolio produced returns that were not quite as high as the U.S average, just 8.5 percent per year However, the globally diversified portfolio was also less volatile, with an annual standard deviation of 17.7 percent Dividing the standard deviation by the annual return produces a coefficient of variation for the globally diversified portfolio of 2.08, slightly lower than the 2.17 coefficient of variation reported for U.S stocks in Table 8.5 International mutual funds not include any domestic assets, whereas global mutual funds include both foreign and domestic assets How might this difference affect their correlation with U.S equity mutual funds? ▶ Source: Elroy Dimson, Paul Marsh, Mike Staunton, Paul McGinnie, and Jonathan Wilmot, Credit Suisse Global Investment Returns Yearbook 2012 10 www.downloadslide.net Index Note: Boldface page numbers indicate pages where terms are defined A AAFM See American Academy of Financial Management Abandonment option, 536 ABC inventory system, 663 Abnormal returns, 331 Accounting cash flow and, 63–65 decision making and, 65 example, 63–65 exposure, 826 liquidation final, 798–799 Accounts payable management, 697 See also Stretching accounts payable cash conversion cycle and, 697–698 credit term analysis and, 698–701 stretching accounts payable and, 701–702 Accounts receivable factoring, 714 management, 669–678 pledge of, 713–714 secured short-term loans and, 713–715, 718 Accruals, 702–703, 718 basis, 63 ethics, 702 ACH See Automated clearinghouse transfer Acquiring company, 770 Adjustable rate mortgage (ARM), 242 Adobe Systems, 567 ADRs See American depositary receipts ADSs See American depositary shares Agency, 66–69 capital structure and lender imposed costs of, 584–585 costs, 68 problems, 68, 584–585 Aggressive funding strategy, 660–661 Aging schedule, 676–677 Air New Zealand, 812 Alcoa, Inc., 409, 426, 452 All-current-rate method, 820 American Academy of Financial Management (AAFM), 51 American depositary receipts (ADRs), 323 American depositary shares (ADSs), 323 American Taxpayer Relief Act of 2012, 622, 623 Angel capitalists, 325 Annualized net present value (ANPV), 534, 541 calculator for, 534 spreadsheet for, 534–535 Annual percentage rate (APR), 237 Annual percentage yield (APY), 237 Annuity, 213, 220–228 future value of, 221–222 ordinary, 220, 221–224 present value of, 222–224 types, 220–221 Annuity due, 220 future value of, 224–225 present value of, 225–227 ANPV See Annualized net present value Apple, Inc., 653 APR See Annual percentage rate APY See Annual percentage yield Argentina, 578 ARM See Adjustable rate mortgage Ascot Partners, 362 ASEAN, 814 Ask price, 84 Assets See also Capital Asset Pricing Model; Net current asset investment; Net fixed asset investment; Return on total assets acquisitions of, 778–779 after-tax proceeds from sale of old, 485–488, 500 bankruptcy and dividing, 318 changes in current, 655–656 cost of new, 485 current, 110 installed cost of new, 485 proceeds from sale of, 495 risk of single, 365–373, 391 stockholders’ claims on, 318–319 total turnover, 123–124 Assignment, 794 Asymmetric information, 585–586 Automated clearinghouse transfer (ACH), 681 Average collection period, 122 credit monitoring, 676 Average payment period, 123 B Balance sheet, 110 See also Excess cash balance example, 111–112 pro forma, 188–190, 192 Banking consolidation, 79 Bank loans, 703–708 Bankruptcy, 792 asset division during, 318 capital structure and, 579–584 largest, 795 legislation, 795, 801 in liquidation, 798–799 probability of, 579–584 reorganization in, 796–798 straight, 797 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), 797 Bankruptcy Reform Act of 1978, 795 BAPCPA See Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Bar chart, 367 Bear Stearns, 89 Behavioral finance, 86, 331, 332 risk and, 518–522 Berkshire Hathaway, 83 Bid price, 84 Bill of materials, 667 Bird-in-the-hand argument, 627 Black swan, 366 Board of directors, 54 Bond, 81, 271 See also specific types call feature, 286 call premium, 286 call price, 286 collateral trust, 289 conversion feature, 286 corporate, 81, 283–290, 303 cost of money and, 285 cost to issuer, 285 current yield, 286 debentures, 289 discount, 296 equipment trust certificates, 289 extendible notes, 290 features of, 285–286 floating-rate, 290 foreign, 85, 290, 833 I-1 www.downloadslide.net I-2 Index Bond (continued) fundamentals, 293–294 income, 289 international, 289–290 junk, 290 legal aspects of, 284–285, 303 maturity, 81, 285 mortgage, 289 offering size, 285 premium, 296 prices, 286–287 putable, 290 rating, 287–288 risk, 285 secured, 289 subordinated debentures, 289 types of, 288–289 unsecured, 289 zero-coupon, 290 Bond indenture, 284 restrictive covenants, 284 sinking-fund requirement, 284 standard debt provisions, 284 subordination, 284 trustee, 285 Bond values, 81, 293–302 basic, 294–295 behavior, 295–299 calculators for, 295, 296 inputs, 303 required returns and, 295–297 semiannual interest and, 300–301 spreadsheets for, 295, 296 time to maturity and, 297–299 yield to maturity and, 299–300 Book value, 110, 346, 486 per share, 339 weights, 424 BP See British Petroleum Breakeven analysis, 561–565, 597 See also Financial breakeven point; Operating breakeven point algebraic approach to, 561–562 graphical approach, 563 operating leverage and, 565 Breakup value, 777 British Petroleum (BP), 527 Broker market, 82, 83–84 Buffett, Warren, 83, 107 Buybacks See Share repurchase C CAFTA See Central American Free Trade Agreement Calculators, 211–212 for annualized net present value, 534 for bond values, 295, 296 for compounding, 234, 235 for future value, 215–216, 222, 224, 229 for growth rates, 242–243 for interest rates, 242–243 for internal rate of return, 454–455 keys, 212 loan amortization and, 240 for net present value, 450 for present value, 218, 223, 226, 231 for risk-adjusted discount rates, 528 for yield to maturity, 299 Campbell, Ian, 447 Capital See also Net working capital debt, 575 equity, 575 expenditure, 442 gains, 95 long-term, 412 sources of, 412, 425–426 types, 575–576, 597 working, 655, 658 Capital Asset Pricing Model (CAPM), 359, 381, 382–392, 419 beta coefficient, 382–385 constant-growth model compared with, 419–420 equation, 385–386 historical risk and, 385–386 market return, 382 risk-adjusted discount rates and, 525–526 risk and, 385–386, 525–526 Capital budgeting, 412, 442 accept-reject approach, 443 cash flows, 439 cash flow timing, 460 conflicting rankings, 458–461 ethics, 463 independent projects, 443 initial investment magnitude, 460–461 international, 483, 499 key elements of, 464 mutually exclusive, 443 overview, 442–445 process, 442–443 ranking approach, 443 refinements, 532–539 reinvestment assumption, 458–459 risk in, 517, 540 techniques, 439, 444–445 terminology, 443 uncertainty, 522 unequal lives and, 532–535, 541 unlimited funds, 443 Capital cost, 410 See also Weighted average cost of capital basics, 411–412 divisional, 531 ethics and, 527 functions, 597 marginal, 426 overview of, 410–412 Capital market, 80, 81 international, 84–85, 831 money market differentiated from, 96 role of, 85–86 Capital rationing, 443, 537, 541 internal rate of return approach, 537–538 net present value approach, 538–539 Capital structure, 560, 575–596 agency costs imposed by lenders and, 584–585 alternative, 598 with alternative debt ratios, 581 bankruptcy and, 579–584 cash flow and, 595 choosing, 592–596 comparing alternative, 591–592 contractual obligations and, 595 control and, 596 cost functions, 587 country factors, 832–833 debt cost and, 587 earnings per share approach to, 589–592 equity cost and, 587 external assessment of, 576–577, 596, 597 graphical view of, 587–588 linkage and, 592–593 management preferences and, 595 multinational companies and, 831–833, 843–844 of non-U.S firms, 577–578 optimal, 587–588, 597 revenue stability and, 595 risk and, 579–584 target, 588 tax benefits and, 579 theory, 578–587, 597 timing and, 596 total risk and, 580–584 value estimations and, 593–594 weighted average cost of capital, 587 CAPM See Capital Asset Pricing Model www.downloadslide.net Index Captive finance companies, 716 Carrying costs, 663 Casa de Diseño, 727–728 Cash basis, 63 bonuses, 68 concentration, 681–682 ending, 180 excess balance, 180 planning, 173, 176–184, 191 procedures for dividends, 619–620 total disbursements, 178–180 total receipts, 177–178 Cash budgets, 176–184, 191–192 evaluations, 181–182 format, 177 personal, 181–182 preparing, 177–181 scenario analysis, 182–183 simulation, 183 uncertainty in, 182–183 Cash conversion cycle (CCC), 657, 685 accounts payable management and, 697–698 calculating, 657–658 funding requirements, 658–661 management strategies, 661–662 time line, 659 Cash discount, 673–674 analysis, 675 changes, 686 cost of giving up, 698–701 decision making and, 700–701 period, 675 taking, 698 Cash flow, 191 See also Annuity; Cash inflows; Cash outflows; Free cash flow; Mixed stream; Operating cash flow; Single amounts accounting and, 63–65 analysis, 164–173 capital budgeting, 439 capital budgeting and timing of, 460 capital structure and, 595 Cisco Systems, 173 components, 480–481, 499 discounting, 217 ethics, 480 European Aeronautic Defense and Space Co., 163 expansion versus replacement decisions, 481–482, 499 from financing activities, 167 incremental, 480, 493–495 from investment activities, 167 within month, 183 multinational companies and, 830–831 net, 180 from operating activities, 167 patterns, 212–213, 246 profit and, 58 relevant, 480–484, 497–499 signs, 212 terminal, 481, 495–497, 500 valuation and, 291 Cash flow statement, 113 developing, 166–171 interpreting, 169–171 preparing, 168–169 Cash inflows, 167–168, 211 breakeven, 518 intermediate, 458–459 operating, 481 risk and, 518–519 sources, 167 Cash outflows, 167–168, 211 sources, 167 Catering theory, 630 CBOE See Chicago Board Options Exchange CCC See Cash conversion cycle Central American Free Trade Agreement (CAFTA), 814 CEO See Chief executive officer Certified Financial Planner (CFP), 51 Certified Treasury Professional (CTP), 51 CFA See Chartered Financial Analyst CFP See Certified Financial Planner Chapter 53 Bankruptcy Reform Act of 1978, 795 Chapter 57 Bankruptcy Reform Act of 1978, 795 Chartered Financial Analyst (CFA), 51 Check Into Cash, 238 Chevron Corp., 516 Chicago Board Options Exchange (CBOE), 753 Chicago Mercantile Exchange (CME), 755 Chief executive officer (CEO), 54 Chipotle Mexican Grill, 463 Chiquita, 829 Cincinnati, 209 Cisco Systems, 173 Clientele effect, 626 CME See Chicago Mercantile Exchange Coefficient of variation (CV), 371–372 Collateral trust bonds, 289 Commercial banks, 79 I-3 Commercial finance companies, 713 Commercial paper, 709, 718 ebb and flow of, 709 interest on, 709–710 Common stock, 53, 81, 82, 319–323 authorized shares, 321 closely owned, 320 cost of, 417–421, 426 cost of new issue of, 420–421, 426 decision making and, 342–344 dilution of earnings, 320 dilution of ownership, 320 dividend changes and, 342–343 dividends, 322 features of, 345 international, 323–324 issued shares, 321 issuing, 325–328, 345 nonvoting, 322 outstanding shares, 321 par value, 320 preemptive rights, 320–321 privately owned, 320 proxy battle, 322 proxy statement, 321–322 publicly owned, 320 rights, 320–321 risk changes and, 343 supervoting shares, 322 treasury stock, 321 underpriced, 420 valuation, 329–342 valuation equation, 331–332 voting rights, 321–322 widely owned, 320 Composition, 794 Compounding, 211 calculators for, 234, 235 computational tools for, 234 continuous, 234–235 equation, 233 frequency of, 231–238 interest, 214, 231–238 quarterly, 232–233 semiannual, 232 spreadsheets for, 234, 235 Confidence crisis, 89 Conservative funding strategy, 660–661 Consolidation, 770 banking, 79 of international financial statements, 113–114 Constant-growth model, 333–334, 345, 418–419 capital asset pricing model compared with, 419–420 www.downloadslide.net I-4 Index Constant-payout-ratio, 630 Consumer Price Index for All Urban Consumers (CPI-U), 277 Contingent securities, 743 Controlled disbursing, 680 Controller, 62 Conversion feature, 741 bond, 286 preferred stock, 325 Convertible bonds, 731, 741 value of, 745–747, 758 Convertible securities, 741–747 conversion price, 742 conversion ratio, 742 earnings per share and, 743 features of, 742–743, 757 financing with, 743–744, 757 stock purchase warrants compared to, 748 types of, 741, 757 value of, 742 Cooke, Robert A., 60 Corporate bonds, 81, 283–290, 303 Corporate governance, 66 Corporate restructuring, 770 Corporations, 53 See also specific corporations organization of, 54 publicly owned, 106 strengths and weaknesses of, 53 Correlation, 391–392 See also Uncorrelated coefficient, 375 negative, 375 perfectly negative, 375 perfectly positive, 375 portfolio, 375 positive, 375 Cost of goods sold, 108 Coupon interest rate, 81, 284–285 CPI-U See Consumer Price Index for All Urban Consumers Credit See also Line of credit; Revolving credit agreements five C’s, 669 letter of, 711 multinational companies management of, 840 period, 675–676 scoring, 670 selection, 686 Credit monitoring, 676, 686 aging schedule, 676–677 average collection period, 676 collection techniques, 677–678 Creditor control, 794 secured, 798 unsecured, 798 Credit standards, 669–673 changing, 670–673, 686 international, 672 profit and, 670 Credit terms, 673–676 accounts payable management and, 698–701 analyzing, 698–701 CTP See Certified Treasury Professional Currency swaps, 834 Current liabilities, 110 changes in, 657 Current rate (translation) method, 114 CV See Coefficient of variation d Dealer market, 82, 84 Debentures, 289 Debt, 110, 318 See also Degree of indebtedness ability to service, 125 acceptable, 576 after-tax cost of, 415–416, 426 before-tax cost of, 413–415 bond indenture provisions, 284 capital, 575 capital structure and, 587 equity differentiated from, 318– 319, 345 federal, 273 long-term, 110, 833–834 long-term cost of, 413–416, 426 multinational companies and, 833–834 position, 124 risk premium and, 283 taxes and, 319, 413–416, 426 Debtor in possession (DIP), 796 role of, 797–798 Debt ratios, 124–127, 126, 133, 140 capital structure with alternative, 581 earnings per share and, 582 Debt-to-equity ratios, 126 Decision making accounting and, 65 cash flow, 481–482, 499 common stock and, 342–344 cost of giving up cash discount and, 700–701 internal rate of return, 453–454 lease-versus-purchase, 735–739, 757 net present value and, 449–450 payback period and, 445–446 yield curves and, 279 Deepwater Horizon accident, 527 Deflation, 277 Degree of financial leverage (DFL), 570 measuring, 570–571 Degree of indebtedness, 125 Degree of operating leverage (DOL), 566–567 Degree of total leverage (DTL), 573 Dell, 769 Dell, Michael, 769 Depository transfer check (DTC), 681 Depreciation, 164, 191 for financial reporting, 165 methods, 165–166 recaptured, 486–487 for tax purposes, 165 Derivative security, 732 hybrid security differentiated from, 757 DFL See Degree of financial leverage Diamond Comic Distributors, 479, 500–501 Diebold, Inc., 702 DIP See Debtor in possession Disbursements management, 678–684, 686 Discounting, 211 See also Riskadjusted discount rates bond, 296 cash, 673–675, 686, 698–701 cash flows, 217 loan, 704 Diversification, 375, 392 international, 379–380, 813, 831 mergers for, 772 multinational companies and, 379–380, 813, 831 portfolio, 375–376 return from international, 379 risk, 381 risk of international, 380 Divestitures, 776, 800 spin-off, 777 Dividend reinvestment plans (DRIPs), 623–624, 636 Dividends, 53 aggregate, 617 cash procedures, 619–620 common stock, 322 common stock and changes in, 342–343 constant-payout-ratio, 630 contractual constraints, 629–630 date of record, 619 www.downloadslide.net Index ex, 619 extra, 632 growth prospects, 629 income, 94 increasing, 613 industrial firms, 619 informational content of, 627 irrelevance theory, 625–626, 636 legal constraints, 628–629 low-regular-and-extra, 632 market considerations, 630 owner considerations, 629–630 payment date, 619 payment time line, 620 payout ratio, 630 policy, 628–632, 637 policy types, 630–632, 637 preferred stock, 416–417 Procter & Gamble, 616 regular, 631–632 relevance theory, 626–628, 637 residual theory of, 625 S&P 546, 615 stock, 633–634, 637 target payout ratio, 632 tax cuts and, 323 taxes and, 622–623 trends in, 614–618 valuation, 332–336 Dividends per share (DPS), 109 Dobson, John, 463 Dodd-Frank Wall Street Reform and Consumer Protection Act, 91 Domanico, Ron, 423 Donaldson, William, 340 DPS See Dividends per share DRIPs See Dividend reinvestment plans Drucker, Peter, 410 DTC See Depository transfer check DuPont system, 132, 136–141 application of, 138–139 formula, 136, 138 modified formula, 138 return on equity and, 138 return on total assets and, 136 E EADS See European Aeronautic Defense and Space Co Earnings available for common stockholders, 109 common stock and dilution of, 320 cost of retained, 420 excess accumulation tax, 629 retained, 112 retained statement, 112–113 trends in, 614–616 Earnings before interest and taxes (EBIT), 108, 561 earnings per share for levels of, 569 sale levels and, 566 risk in, 591–592 shortcomings of, 592 Earnings per share (EPS), 107, 109, 130, 561 basic, 743 capital structure approach, 589–592 coefficient of variation, 584 convertible securities and, 743 debt ratios and, 582 diluted, 743 earnings before interest and taxes and, 569 example, 57 expected, 584 maximizing, 595 mergers and, 781–784 probability distributions, 583 S&P 546, 615 stock swap transactions and, 800–801 EBIT See Earnings before interest and taxes EBIT–EPS approach, 589–592, 597–598 Economic exposure, 826 Economic order quantity model (EOQ), 663–666 mathematical development of, 664 Economics, 62–63 finance function, 71 pure profit, 452 Economic value added (EVA) calculating, 464 evaluating, 464 interpreting, 464 net present value and, 452–453 Eco Plastics Company, 437–438 Efficient market, 85 Efficient market hypothesis (EMH), 86, 330–331 Encore International, 356–357 Ending cash, 180 Enron Corporation, 792 Enterprise resource planning (ERP), 668 EOQ See Economic order quantity model EPS See Earnings per share Equipment trust certificates, 289 Equity, 110, 318 See also Return on equity capital, 575 I-5 capital structure and cost of, 587 debt differentiated from, 318–319, 345 external, 318 internal, 318 international market, 85 multinational companies and, 834–835 permanence of, 319 ratios, 126 stockholders statement, 112 ERP See Enterprise resource planning Ethics, 59 accruals and, 702 capital budgeting, 463 capital cost and, 527 cash flow, 480 Chiquita and, 829 failure and, 793 Google Glass and, 61 insider trading and, 86 Lehman Brothers and, 574 payday loan and, 238 profit, 410 Repo 151, 574 share price and, 60 share repurchase, 617 stretching accounts payable and, 701 EU See European Union Euro, 814 Eurobond, 289, 833 market, 84–85 Eurocurrency market, 81, 836, 844 Euromarket, 818 growth of, 818–819 European Aeronautic Defense and Space Co (EADS), 163 European Open Market, 814 European Union (EU), 814 EVA See Economic value added Excess cash balance, 180 Excess earnings accumulation tax, 629 Exchange rate, 822–824 changes in, 824–825 fixed relationship, 822 floating relationship, 822 forward, 822 hedging tools, 838 impact of fluctuations in, 825–827 spot, 822 Exchange rate risk, 523, 822–827 multinational companies and, 843 Expectations theory, 280–281 Extendable notes, 290 Extension, 794 of secured short-term loans, 713 www.downloadslide.net I-6 Index F Facebook, 49 Failure causes of, 792–793, 801 ethics and, 793 fundamentals, 791–794 types, 792, 801 Fama, Eugene, 86 FASB See Financial Accounting Standards Board Fastow, Andrew, 792 FastPay, 696 FCF See Free cash flow FDI See Foreign direct investment FDIC See Federal Deposit Insurance Corporation Federal debt, 273 Federal Deposit Insurance Corporation (FDIC), 91, 96 Fettig, Jeff, 613, 614 Fijalkowski, Ron, 447 Finance, 50–55 behavioral, 86, 331, 332, 518–522 captive companies, 716 career opportunities in, 50–51, 55 commercial companies, 713 managerial, 50–51 Finance function, 61–62, 70 economics and, 71 Financial Accounting Standards Board (FASB), 106 Standard No 98, 114, 820 Financial breakeven point, 590 Financial crisis, 87–90 confidence crisis and, 89 delinquent mortgages and, 88–89 gross domestic product and, 90 housing values and, 77, 88–89 root causes of, 96 spillover effects, 90 Financial institutions, 78, 79–87 See also specific institutions customers of, 78 financial markets relationship with, 80–81, 96 flow of funds, 80 major, 78 net demanders of, 78 net suppliers of, 78 regulations, 91, 96–97 role of, 95 Financial leverage, 124, 560, 561, 568–571, 597 See also Degree of financial leverage Financial leverage multiplier (FLM), 138 Financial manager, 50 primary activities of, 65, 71 Financial markets, 78, 80 See also specific financial markets financial institutions’ relationship with, 80–81, 96 flow of funds, 80 international, 818–819 primary, 80 regulations, 91–92, 96–97 role of, 95, 96 secondary, 80 Financial planning process, 173–176 graphical presentation of, 589–590 long-term (strategic), 174, 191 short-term (operating), 174–175, 191 Financial services, 50 See also specific services Financial statements, 140 See also specific financial statements audited, 118 consolidating international, 113–114 key, 107–113 multinational companies and, 819–821, 843 notes to, 113 preceding years, 184 Fiscal year, 108 Fitch Ratings, 287–288 Fixed costs, 572 operating leverage and, 568 Fixed-rate loan, 704 Flexibility option, 536 FLM See Financial leverage multiplier Float, 678, 686 clearing, 679 costs, 413 exchange rate, 822 mail, 679 processing, 679 Floating inventory lien, 716 Floating-rate bonds, 290 Floating-rate loan, 704 Foreign bonds, 85, 290, 833 Foreign currency hedging with options, 755–756, 758 rate, 822 Foreign direct investment (FDI), 483, 829–830 See also Multinational companies in China, 484 multinational companies and, 843–844 openness to, 841–842 Foreign exchange manager, 62 Free cash flow (FCF), 171–172, 191 valuation model, 336–339, 337, 346 Funding strategy aggressive, 660–661 cash conversion cycle requirements, 658–661 conservative, 660–661 permanent, 659 seasonal, 659 Fund raising call options in, 753–754 mergers and, 772 put options in, 753–754 Future sum deposit determination, 239 Future value, 214 of annuity due, 224–225 calculator for, 215–216, 222, 224, 229 equation, 214–215 graphical views, 216–217 of mixed stream, 228–230, 246 of ordinary annuity, 221–222 present value versus, 210–211, 246 relationships, 217 single amounts, 213–217 spreadsheet for, 216, 222, 225, 229 G GAAP See Generally accepted accounting principles Gardner, Chris, 447 Gateway Computers, 463 GATT See General Agreement on Tariffs and Trade GD See General Dynamics GDP See Gross domestic product Geithner, Timothy, 79 General Agreement on Tariffs and Trade (GATT), 815 General Dynamics (GD), 105 Generally accepted accounting principles (GAAP), 106 General Motors (GM), 793 Glass-Steagall Act, 79, 91, 96–97 GM See General Motors Going concerns, 779–780 Gold, 441 Golden parachutes, 787 Gong, Guojin, 617 Google, 60 Google Glass, 61 Gordon, Myron J., 626–627 Gordon growth model, 333–334, 418–419 Governance, 66–69 corporate, 66 Government regulation, 67 www.downloadslide.net Index Gramm-Leach-Bliley Act, 91, 96–97 Greenmail, 787 Gross domestic product (GDP), 90 Gross profit, 108 margin, 128 Growth option, 536 Growth rates calculator for, 242–243 spreadsheet for, 243 Gurtcheff, Glenn, 480 h Hedging, 755 exchange rate tools, 838 foreign-currency exposures with options, 755–756, 758 multinational companies, 834, 837–839 strategies, 837–839 Herding, 332 High-frequency trading, 82 Holding company, 770, 801 advantages of, 787–789 disadvantages of, 789 international, 842 Home Depot, 175 Housing crisis, 77, 88–89 Hull, Robert, 559 Hybrid security, 732 derivative security differentiated from, 757 I I-bond, 277 Icahn, Carl, 322, 769 IFRS See International Financial Reporting Standards Incentive plans, 68 Income bonds, 289 dividends, 94 interest, 94 ordinary, 92–93 stockholders’ claims on, 318 Income statement, 107 common-size, 128 examples, 108–110 pro forma, 186–188, 192 Individual investors, 66 institutional investors versus, 66–67 Inflation, 118, 274 See also Deflation expected, 277 I-bond and, 277 security market line and, 387–388 Treasury bills and, 278 Inflation premium (IP), 275, 277 Initial investment, 481, 484–490 basic format, 485 calculating, 489–490, 499–500 Initial public offering (IPO), 326–327 Facebook, 49 Insider trading, 86 Insolvency, 655, 792 Installation costs, 485 Institutional investors, 66 individual investors versus, 66–67 Integrative cases Casa de Diseño, 727–728 Eco Plastics Company, 437–438 Encore International, 356–357 Lasting Impressions Company, 555–556 Merit Enterprise Corp., 101 O’Grady Apparel Company, 648–650 Organic Solutions, 849–850 Track Software, Inc., 267–270 Interest See also Semiannual interest on commercial paper, 709–710 effective (true) annual rate, 235–237 expense, 108–109 income, 94 nominal (stated) annual rate, 235–237, 275–277 ratios time earned, 126–127 Interest compounding, 214 frequency of, 231–238 Interest rates, 271, 274–283, 718 calculator for, 242–243 coupon, 81, 284–285 effective, 836 fundamentals, 274–277, 302–303 line of credit, 707 nominal, 836 prime, 703–704 real, 274–275 risk, 298 spreadsheet for, 243 swaps, 834 term structure, 278–281, 302–303 term structure theories, 280–281 Internal rate of return (IRR), 453 calculating, 454–456, 465 calculator for, 454–455 capital rationing and, 537–538 decision criteria, 453–454 evaluating, 465 interpreting, 465 multiple, 462 net present value compared with, 456–463, 465 spreadsheets for, 455–456 Internal Revenue Code (IRS), 164 I-7 International See also Multinational companies bond, 833 common stock, 323–324 consolidation of financial statements, 113–114 credit standards, 672 diversification, 379–380, 813, 831 equity market, 85 financial markets, 818–819 holding company, 842 inventory management, 668 joint venture, 844 loans, 710–712 share repurchase, 618 stock market, 834 trade financing, 711 International Financial Reporting Standards (IFRS), 106 International transactions, 710–711 between subsidiaries, 711 Inventory, 110, 121 average age of, 122 as collateral for secured short-term loans, 715–717 floating lien, 716 total cost, 664 trust receipt loan, 716 turnover, 121–122 Inventory management, 685–686 computerized systems for, 667–668 differing viewpoints on, 662–663 international, 668 of multinational companies, 840 techniques, 663–668 Investment banker, 328, 345, 785 mergers and, 785–786 Investment banks, 79 Investment opportunities schedule (IOS), 537 IP See Inflation premium IPO See Initial public offering IRR See Internal rate of return IRS See Internal Revenue Code J Japan, 842 JIT See Just-in-time system Jobs and Growth Tax Relief Reconciliation Act of 2003, 322, 323, 622, 623 Joint venture, 815 international, 844 Japan and, 842 multinational companies and, 835, 841–842 www.downloadslide.net I-8 Index JPMorgan Chase, 89 Junk bonds, 290 Just-in-time system (JIT), 666–667 K Kahneman, Daniel, 331 Khuzami, Robert, 702 L Lasting Impressions Company, 555–556 LBO See Leveraged buyout Lea, Teresa, 727–728 Leads and lags, 839 Lease, 732–741 advantages and disadvantages of, 740, 757 arrangements, 733–734, 757 capitalized, 739 direct, 733 financial, 733 future financing and, 739–740, 757 leveraged, 733–734 maintenance clauses, 734 operating, 732–733 purchase options, 734 renewal options, 734 sale-leaseback arrangement, 733 types, 732–733, 757 Lease-versus-purchase decision, 735–739, 757 Legg Mason Value Trust, 361 Lehman Brothers, 89 ethics and, 574 Lending limits, 710 Lessee, 732 Lessor, 732 Leverage, 560–575, 597 See also Financial leverage; Operating leverage; Total leverage in Argentina, 578 lease, 733–734 recapitalization, 787 relationships, 574 types, 560 Leveraged buyout (LBO), 775–776 objectives, 800 procedures, 800 Liability changes in current, 657 current, 110 limited, 53 spontaneous, 697–703 unlimited, 52 Lichtenstein, 842 Lien, 714 floating inventory, 716 Limited liability, 53 Line of credit, 706 annual cleanup, 708 compensating balances, 707 interest rates, 707 operating-change restrictions, 707 Lintner, John, 627 Liquidation, 119 in bankruptcy, 798–799 final accounting, 798–799 mergers and increased ownership, 774 preference theory, 274, 281 priority of claims, 798, 799 procedures, 798 ratios, 119–121, 133, 140 risk, 653 summary, 133 value per share, 339–340, 346 voluntary settlement resulting in, 794 Loan amortization, 240 calculators and, 240 schedule, 240–241 spreadsheets and, 240 Loans See specific loans Lock box system, 679–680 London, Scott, 86 Long-term funds, 81 Louis, Henock, 617 Lowes, 559 M M&A See Mergers and acquisitions MACRS See Modified accelerated cost recovery system Madoff, Bernard, 362 Management compensation plans, 68 Managerial finance, 50–51 career opportunities in, 55 Manufacturing resource planning II (MRP II), 668 Marginal cost-benefit analysis, 62 Market efficiency, 330, 345–346 makers, 82 premium, 746 segmentation theory, 281 value weights, 424 Marketability, 715 Marketable securities, 81 features of, 683–684 investing in, 683 Market/book ratio (M/B), 132 Markopolos, Harry, 362 Materials requirement planning (MRP), 667–668 M/B See Market/book ratio McLemore, Samantha, 361 Measurable milestones, 326 Mental accounts, 332 Merck, 410 Mercosur, 814 Mergers, 770 analyzing, 777–790 congeneric, 774 conglomerate, 774 for diversification, 772 earnings per share and, 781–784 financial, 771 friendly, 770–771 fundamentals of, 800 fund raising and, 772 growth and, 772 horizontal, 774 hostile, 770–771 increased ownership liquidity and, 774 initial effect, 781 international, 789–791, 801, 844 investment bankers and, 785–786 long-run effect of, 783 management negotiations, 786 motives for, 772–774, 800 multinational companies and, 841–842 negotiating, 777–790, 801 strategic, 771 synergy of, 772 takeover threats and, 770–771, 774 taxes and, 772–773 two-tier offer, 786 types of, 774, 800 vertical, 774 Western European changes and, 789–790 Mergers and acquisitions (M&A), 841 Merit Enterprise Corp., 101 Miller, Bill, 361 Miller, Merton H., 578–579, 626, 627 Mixed stream, 213, 228 future value of, 228–230, 246 present value of, 230–231, 246 MNCs See Multinational companies Modified accelerated cost recovery system (MACRS), 164 property classes, 165, 166 recovery period, 165 Modigliani, Franco, 578–579, 626, 627 Monetary union, 814 Money market, 80, 81 www.downloadslide.net Index capital market differentiated from, 96 Monte Carlo method, 522 Moody’s Investors Service, 287–288 Mortgage-based securities, 87 Mortgage bonds, 289 Mortgage delinquency, 88–89 MRP See Materials requirement planning MRP II See Manufacturing resource planning II Multinational companies (MNCs), 522–523, 813–819 capital structure, 831–833, 843–844 cash flows and, 830–831 cash management, 837–840 credit management, 840 diversification and, 379–380, 813, 831 equity capital and, 834–835 exchange rate risk and, 843 financial statements, 819–821, 843 foreign direct investment and, 843–844 functional currency, 820 hedging, 834, 837–839 individual account translation, 820–821 influences on, 813, 843 inventory management, 840 joint ventures and, 835, 841–842 long-term debt and, 833–834 mergers and, 841–842 political risk and, 827–828, 843 risk and, 821–828 short-term financial decisions and, 835–837 subsidiary characterization, 820 taxes and, 816–818 Munger, Charlie, 83 Murdoch, Rupert, 791 Musk, Elon, 317 N NAFTA See North American Free Trade Agreement Nardelli, Robert L., 175 Nasdaq market, 82, 84 National entry control systems, 828 NCAI See Net current asset investment Net current asset investment (NCAI), 172 Net fixed asset investment (NFAI), 171 Net operating profits after taxes (NOPAT), 170–171 Net present value (NPV), 449 See also Annualized net present value calculating, 464 calculators for, 450 capital rationing and, 538–539 decision criteria, 449–450 economic value added and, 452–453 equation, 524 evaluating, 464 highest overall, 537 internal rate of return compared with, 456–463, 465 interpreting, 464 profiles, 456–458 profitability index and, 451–452 simulation, 521 spreadsheets for, 450–451 Net proceeds, 413 Net profit after taxes, 109 before taxes, 109 margin, 129–130 Net working capital, 488 change in, 488–489, 496 News Corp, 791 NFAI See Net fixed asset investment Nokia Corporation, 731 Noncash charge, 168 NOPAT See Net operating profits after taxes Normal probability distribution, 370–371 North American Free Trade Agreement (NAFTA), 813 NYSE Euronext, 83–84 O OC See Operating cycle OCF See Operating cash flow Offshore centers, 818 O’Grady Apparel Company, 648–650 Operating breakeven point, 561, 597 changing costs and, 563–564 Operating cash flow (OCF), 170–171, 191, 490–495, 500 calculating, 491–492 Operating cycle (OC), 657–658 Operating expenditure, 108, 442 Operating leverage, 560, 561, 565–568, 597 See also Degree of operating leverage Adobe Systems, 567 breakeven analysis and, 565 fixed costs and, 568 I-9 Operating profits, 108, 561 See also Net operating profits after taxes margin, 128–129 Operating unit, 776–777 Opportunity costs, 482, 499 Options, 752 See also specific options backdating, 755 call, 752, 753–754, 758 in fund raising, 753–754 hedging foreign-currency exposures with, 755–756, 758 market, 752–753, 758 put, 752, 753–754, 758 trading, 753–754, 758 Order costs, 663 Organic Solutions (OS), 849–850 Organization, 51–55, 70 See also Reorganization of corporations, 54 international, 815–816 legal forms of, 815–816 venture capital, 325–326 OS See Organic Solutions Overhanging issue, 744 Overseas assignments, 832 Over-the-counter market, 82, 84 P Paid-in capital in excess of par, 110 Panama, 842 Partnerships, 52 articles of, 52 strengths and weaknesses of, 53 Par value, 320, 324 Payback analysis in Europe, 446 limits on, 447 pros and cons of, 446–448 Payback period, 445–449 calculating, 464 decision criteria, 445–446 evaluating, 464 interpreting, 464 Payday loan, 238 Payout policy, 614 basics, 614–618 elements of, 614 mechanics, 618–624 relevance of, 625–628 stock price reactions to, 624 taxes and, 636 Payout ratio, 630 constant, 630 target, 632 PCAOB See Public Company Accounting Oversight Board www.downloadslide.net I-10 Index P/E See Price/earnings ratio Pecking Order Theory, 585–586 Performance plans, 68 Performance shares, 68 Permanent funding requirements, 659 Perpetuity, 227–228 Philadelphia Stock Exchange (PHLX), 755 PI See Profitability index Poison pill, 786–787 Political risk, 380, 483, 523, 827, 843 coping with, 828 macro, 827 micro, 827 multinational companies and, 827–828, 843 Portfolio, 362, 391–392 correlation, 375 diversification, 375–376 return, 373–374 risk, 373–380 risk-adjusted discount rates and, 530, 541 standard deviation, 373–374 Preferred stock, 81, 82, 319, 323–325 basic rights and, 324 callable feature, 324 conversion feature, 325 convertible, 741 cost of, 416–417, 426 cumulative, 324 dividends, 416–417 features, 324–325, 345 noncumulative, 324 non-par, 324 par-value, 324 restrictive covenants, 324 straight, 741 valuation, 333 Present value, 217 See also Net present value of annuity due, 225–227 calculator for, 218, 223, 226, 231 equation, 218 future value versus, 210–211, 246 graphical view of, 219 of mixed stream, 230–231, 246 of ordinary annuity, 222–224 of perpetuity, 227–228 relationships, 219 of single amount, 217–220 spreadsheet for, 218, 223, 226, 231 President, 54 Price/earnings (P/E) ratio, 131 multiple approach, 340–341, 346 problems with, 341 Prime rate of interest, 703–704 Principle, 214 Principle-agent relationship, 67, 71 Private placement, 78, 80 Probability, 366 of bankruptcy, 579–584 Probability distributions continuous, 367 earnings per share, 583 normal, 370–371 risk, 366–367 Procter & Gamble, 616 Profit, 655 See also Net profit; Operating profits cash flow and, 58 credit standards and, 670 ethics, 410 gross, 108, 128 maximizing, 57–59 pure economic, 452 ratios, 128–131, 133, 136, 140 risk and, 58–59, 655–657, 685 timing, 58 Profitability index (PI), 451–452 Profit planning, 173, 184–185 sales forecast and, 184 Pro forma balance sheet, 192 external financing required, 189 judgmental approach, 188–190 plug figure, 189 Pro forma income statements, 192 percent-of-sales method, 186 preparing, 186–188 Pro forma statements, 184–185, 192 evaluation of, 190 Prospect theory, 332 Prospectus, 327 Proxy battle, 322 Proxy statement, 321–322 Public Company Accounting Oversight Board (PCAOB), 106 Public offering, 80 Putable bonds, 290 Pyramiding, 788 Q Quasi factoring, 715 R RADR See Risk-adjusted discount rates Ratios, 105 See also specific ratios activity, 121–124, 133, 140 analysis, 115, 140 benchmarking, 115 cautions, 118 combined analysis, 117 comparison types, 115–117 complete analysis, 132–139 coverage, 125 cross-sectional analysis, 115–117 current, 119 debt, 124–127, 126, 133, 140, 581, 582 debt-to-equity, 126 fixed-payment coverage, 127 liquidity, 119–121, 133, 140 market, 131–132, 136 profitability, 128–131, 133, 136, 140 quick (acid-test), 120 summary, 133–136 time-series analysis, 117 times interest earned, 126–127 Ratios of exchange, 780–781 in market price, 784 Real options, 535–537, 541 types, 536 Recapitalization, 797 leveraged, 787 Receipt management, 678–684, 686 Red herring, 327 Regret theory, 332 Reorder point, 665 Reorganization in bankruptcy, 796–798 involuntary, 796 procedures, 796–797 voluntary, 796 wage earner plan, 797 Repo 151, 574 Repsol S A., 516 Required returns, 274–283 bond values and, 295–297 changing, 298–299 constant, 297 valuation and, 292 Required total financing, 180 Residual theory of dividends, 625 Retained earnings, 112 cost of, 420 statement, 112–113 Return See also specific returns abnormal, 331 expected value of, 368 fundamentals, 362–365, 391 historical, 364 from international diversification, 379 measurements of, 391–392 portfolio, 373–374 Return on equity (ROE), 130–131 DuPont system and, 138 Return on total assets (ROA), 130 DuPont system and, 136 Return rate, 363–364 See also Internal rate of return www.downloadslide.net Index risk free, 385 Revenue stability, 595 Revolving credit agreements, 708 RFID, 667 Risk, 58, 362, 518, 655 See also specific risks above-average, 531 assessment, 365–367 average, 531 behavioral approaches to, 518–522 below-average, 531 bond, 285 business, 579–580 capital asset pricing model and, 385–386, 525–526 capital budgeting and, 517, 540 capital structure and, 579–584 cash inflows and, 518–519 classes, 530–531 common stock and changes in, 343 diversifiable, 381 in EBIT–EPS approach, 591–592 exchange rate, 523, 822–827, 843 free return rate, 385 fundamentals, 362–365, 391 high, 531 historical, 370, 385–386 interest rate, 298 international, 522–523, 540 of international diversification, 380 liquidity, 653 measurement, 367–372 multinational companies and, 821–828 neutral, 364 nondiversifiable, 381–382 political, 380, 483, 523, 827–828, 843 portfolio, 373–380 preferences, 364–365, 391 probability distributions, 366–367 profit and, 58–59, 655–657, 685 reduction, 381 seeking, 364–365 of single asset, 365–373, 391 synthetic, 381–382 total, 381, 527, 580–584 types, 381–382, 392 valuation and, 292 Risk-adjusted discount rates (RADR), 524–532, 540 application of, 527–530 calculator for, 528 capital asset pricing model and, 525–526 determining, 524–526 portfolio and, 530, 541 in practice, 530–531 spreadsheets for, 528–529 Risk aversion, 59, 364 security market line and, 388–390 Risk premium (RP), 276, 302–303 debt and, 283 issuer components, 282–283 issue-related components, 282–283 ROA See Return on total assets ROE See Return on equity RP See Risk premium S Safety stock, 666 Sales forecast, 176 external, 176 internal, 176 profit planning and, 184 Sales revenue, 108 Salvage value, 495 Sarbanes-Oxley Act (SOX), 60, 67, 106 Scenario analysis, 365, 519–520, 540 cash budgets, 182–183 range, 365–366 Seafield Resources, 441 Seasonal funding requirements, 659 Seasonality, 118 SEC See Securities and Exchange Commission Secured creditor, 798 Secured short-term loans, 712 accounts receivable as collateral for, 713–715, 718 characteristics of, 712–713 collateral, 712–713 extending, 713 factoring accounts receivable, 714 inventory as collateral for, 715–717, 718 nonnotification basis, 714 nonrecourse basis, 714–715 notification basis, 714 percentage advance, 713 pledge of accounts receivable, 713–714 security agreement, 712 terms, 712–713 Securities Act of 1933, 91, 97 Securities Act of 1934, 91–92 Securities and Exchange Commission (SEC), 92, 97, 106 Securities exchanges, 82 Securitization, 87 Security market line (SML), 386, 392, 526 I-11 inflation and, 387–388 risk aversion and, 388–390 shifts in, 387–390 Selling group, 328 Semiannual interest, 232, 303–304 bond values and, 300–301 Shadow banking system, 79 Share price ethics, 60 Share repurchase, 616–618 Dutch auction, 621 ethics, 617 international, 618 open-market, 620–621 procedures, 620–622 taxes and, 622–623 tender offer, 621 U.S.-listed companies, 617 Shark repellents, 787 Shaw, Bryan, 86 Short-term funds, 81 Short term self-liquidating loans, 703 Signaling theory, 586 Simulation, 520, 540 cash budgets, 183 net present value, 521 Single amounts, 212, 246 future value of, 213–217 present value of, 217–220 Single-payment notes, 705–706 SML See Security market line Sole proprietorships, 52 strengths and weaknesses of, 53 SOX See Sarbanes-Oxley Act Spontaneous liabilities, 697–703 Spreadsheets for annualized net present value, 534–535 for bond values, 295, 296 for compounding, 234 for future value, 216, 222, 225, 229 for growth rates, 243 for interest rates, 243 for internal rate of return, 455–456 loan amortization and, 240 for net present value, 450–451 for present value, 218, 223, 226, 231 for risk-adjusted discount rates, 528–529 time value, 212 for yield to maturity, 299–300 Stakeholders, 59 Standard deviation, 368–370, 391–392 portfolio, 373–374 Standard & Poor’s, 287–288, 615 Stimulus package, 90 www.downloadslide.net I-12 Index Stock dividends, 633 company viewpoint on, 634, 637 small (ordinary), 633 stockholder viewpoint of, 634, 637 Stockholders, 53 claims on assets, 318–319 claims on income, 318 earnings available for, 109 equity statement, 112 letter to, 106–107 report, 106–115, 140 stock dividends and, 634, 637 Stock options, 68 Stock purchase warrants, 286, 747 characteristics of, 747–748, 758 convertible securities compared to, 748 exercise prices, 747–748 implied price of, 748–749, 758 market value of, 750 premium, 749, 750–751 theoretical value of, 750 trading, 748 value of, 758 Stock split, 634–636 motivation for, 637–638 reverse, 635 Stock swap transactions, 780–785 earnings per share and, 800–801 Straight bond, 741 value, 745, 758 Strategic options, 535–537 Stretching accounts payable, 680, 718 accounts payable management and, 701–702 ethics and, 701 Strike price, 752 Subordinated debentures, 289 Subprime mortgages, 242 Subsidiaries, 770 international transactions between, 711 multinational companies characterization of, 820 Sun, Amy, 617 Sunk costs, 482, 499 Supervoting, 322 T Takeover defenses, 786 Takeover threats, 69 fighting, 786–787 hostile, 322 mergers and, 770–771, 774 of U.S companies, 790 Taleb, Nassim Nicholas, 366 Target company, 770 valuing, 778–780, 800 Taxes, 92–95, 97 See also specific taxes and tax laws average rate, 93 capital structure and, 579 corporate rate schedule, 93 debt and, 319 debt cost after, 415–416, 426 debt cost before, 413–415 deductible expenses, 94–95 depreciation methods for, 165 dividends and, 622–623 dividends and cuts in, 323 double, 94 marginal rate, 93 mergers and, 772–773 multinational companies and, 816–818 net profit before and after, 109 payout policy and, 636 on sale of old asset, 485–488, 500 share repurchase and, 622–623 shield, 579 Tax loss carryforward, 772–773 Temporal method, 821 Tender offers, 621, 786 Tesla Motors, 317, 346 Time deposits, 81 Time line, 210–211 cash conversion cycle, 659 dividends payment, 620 Time value, 210–213, 246 See also Future value; Present value computational tools, 211–212 future versus present, 210–211 special applications of, 238–245 spreadsheets, 212 valuation and, 291 Timing capital budgeting, 460 capital structure and, 596 cash flow, 460 option, 536 profit, 58 Total leverage, 561, 572–574, 597 See also Degree of total leverage Track Software, Inc., 267–270 Transfer prices, 523 Treasurer, 62 Treasury bills, 274, 276, 385 inflation and, 278 yield curves, 279 Trust receipt inventory loan, 716 Two-bin method, 663 u Uncertainty capital budgeting, 522 in cash budgets, 182–183 weighted average cost of capital and, 423 Uncorrelated, 376 Underwriting, 328 Underwriting syndicate, 328 United States Postal Service, 679 Unlimited liability, 52 Unsecured creditor, 798 Unsecured short-term financing, 697 Unsecured short-term loans, 703–712, 718 V Valuation, 291 cash flows and, 291 common stock, 329–342 dividends, 332–336 free cash flow, 336–339, 337, 346 fundamentals, 291–293 inputs, 291–292, 303 maximizing, 595 model, 292–293 preferred stock, 333 required returns and, 292 risk and, 292 time and, 291 Variable-growth model, 334–336, 345 VCs See Venture capitalists Venture capital, 325, 345 deal structure, 326 organization, 325–326 Venture capitalists (VCs), 325 Voluntary settlements, 793–794, 801 liquidation from, 794 to sustain firm, 794 Voting rights, 321–322 W WACC See Weighted average cost of capital Wal-Mart Stores, Inc., 667 Walt Disney Company, 734 Warehouse receipt loans, 716–717 Weighted average cost of capital (WACC), 359, 422 book value weights, 424 calculating, 422–423, 426 capital structure and, 587 historical weights, 424 market value weights, 424 www.downloadslide.net Index minimum, 588 target weights, 424 uncertainty and, 423 weighting schemes, 424–425, 426 Welch, Jack, 175 Whirlpool Corporation, 613 White knight, 786 Wilson, Charlie, 793 Wire transfer, 681 Working capital, 655 speed and, 658 Working capital management, 654, 685 World Trade Organization (WTO), 815 Y Yield curve, 278 decisions based on, 279 flat, 279 inverted, 278 normal, 278–279 Treasury bills, 279 Yield to maturity (YTM), 278, 303–304 I-13 bond values and, 299–300 calculator for, 299 spreadsheets for, 299–300 YPF, 516, 541 YTM See Yield to maturity Z Zero-balance accounts (ZBAs), 682–683 Zero-coupon bonds, 290 Zero-growth model, 332–333, 345, 597 www.downloadslide.net FREQUENTLY USED SYMBOLS AND ABBREVIATIONS AAI Average Age of Inventory EOQ ACH Automated Clearinghouse EPS Earnings per Share ACP Average Collection Period ERP Enterprise Resource Planning AFj Amount of Funds Available from Financing Source j at a Given Cost EU European Union EVA Economic Value Added ANPV Annualized Net Present Value FC Fixed Operating Cost A/P Accounts Payable FCF Free Cash Flow APP Average Payment Period FDI Foreign Direct Investment APR Annual Percentage Rate FLM Financial Leverage Multiplier APY Annual Percentage Yield FV Future Value A/R Accounts Receivable GAAP Generally accepted accounting principles bj Beta Coefficient or Index of Nondiversifiable Risk for Asset j GATT General Agreement on Tariffs and Trade bp Portfolio Beta g Growth Rate B0 Value of a Bond I Interest Payment C Carrying Cost per Unit per Period IP Inflation Premium CAPM Capital Asset Pricing Model IPO Initial Public Offering CCC Cash Conversion Cycle IRR Internal Rate of Return CD Stated Cash Discount in Percentage Terms CF0 Initial Investment CFt Cash Inflow in Period t Economic Order Quantity JIT Just-In-Time System LBO Leveraged Buyout m Number of times per year interest is compounded CV Coefficient of Variation M Bond’s Par Value Dp Preferred Stock Dividend M/B Market/Book Ratio D t • Per-Share Dividend Expected at the End of Year t MACRS Modified Accelerated Cost Recovery System • Depreciation Expense in Year t MNC Multinational Company DFL Degree of Financial Leverage MP Market Price per Share DIP Debtor in Possession MPR Market Price Ratio of Exchange DOL Degree of Operating Leverage MRP Materials Requirement Planning DPS Dividends per Share n • Number of Outcomes Considered DTC Depository Transfer Check • Number of Periods—Typically, Years DTL Degree of Total Leverage • Years to Maturity e Exponential Function 2.7183 N • Number of Days Payment Can Be Delayed by Giving up the Cash Discount E Exercise Price of the Warrant EAR Effective Annual Rate • Number of Shares of Common Stock Obtainable With One Warrant EBIT Earnings Before Interest and Taxes Nd Net Proceeds from the Sale of Debt (Bond) EOM End of the Month www.downloadslide.net FREQUENTLY USED SYMBOLS AND ABBREVIATIONS (CONTINUED) Nn Net Proceeds from the Sale of New Common Stock rr Cost of Retained Earnings r s • Required Return on Common Stock Np Net Proceeds from the Sale of Preferred Stock • Cost of Common Stock Equity NAFTA North American Free Trade Agreement RF Risk-Free Rate of Interest NCAI Net Current Asset Investment RADR Risk-Adjusted Discount Rate NFAI Net Fixed Asset Investment RE Ratio of Exchange NOPAT Net operating profits after taxes ROA Return on Total Assets NPV Net Present Value ROE Return on Common Equity O Order Cost Per Order S • Usage in Units per Period OC Operating Cycle • Sales in Dollars OCF Operating Cash Flow SML Security Market Line P Price (value) of asset t Time P0 Value of Common Stock T Firm’s Marginal Tax Rate PBDTt Profits Before Depreciation and Taxes in year t TVW Theoretical Value of a Warrant PD Preferred Stock Dividend V • Value of an Asset or Firm P/E Price/Earnings Ratio • Venture Capital PI Profitability Index VC Value of Entire Company PMT Amount of Payment VD Value of All Debt Pr Probability VP Value of Preferred Stock PV Present Value • Order Quantity in Units VS Value of Common Stock Q • Sales Quantity in Units • Actual, Expected (r–), or Required Rate of r Return VC Variable Operating Cost per Unit wj • Proportion of the Portfolio’s Total Dollar Value Represented by Asset j • Proportion of a Specific Source of Financing j in the Firm’s Capital Structure • Annual Rate of Interest • Cost of Capital WACC Weighted Average Cost of Capital r* Real Rate of Interest WTO World Trade Organization Weighted Average Cost of Capital YTM Yield to Maturity rd • Required Return on Bond ZBA Zero Balance Account • Before-Tax Cost of Debt s Standard Deviation ri After-Tax Cost of Debt ∑ Summation Sign rj Required Return on Asset j r m • Market Return • Return on the Market Portfolio of Assets rp • Cost of Preferred Stock • Portfolio Return ... U sers of Principles of Managerial Finance have praised the effectiveness of the book’s Teaching and Learning System, which they hail as one of its hallmarks The system, driven by a set of carefully... maximizing profit by cutting costs may not increase the firm’s value, and how managers act on behalf of investors when operating a corporation many of the principles of managerial finance In your... to Managerial Finance  47 1.1 Finance and Business  50 The Role of Managerial Finance What is finance?   50 page 48 Legal forms of Business organization  51 career opportunities in finance  50 in