Fundamentals of Corporate Finance Standard Edition (Mcgraw-Hill/Irwin Series in Finance, Insurance, and Real Estate)

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The best-selling Fundamentals of Corporate Finance (FCF) has three basic themes that are the central focus of the book: 1) An emphasis on intuition?the authors separate and explain the principles at work on a common sense, intuitive level before launching into any specifics. 2) A unified valuation approach?net present value (NPV) is treated as the basic concept underlying corporate finance. 3) A managerial focus?the authors emphasize the role of the financial manager as decision maker, and they stress the need for managerial input and judgment. The Tenth Edition continues the tradition of excellence that has earned Fundamentals of Corporate Finance its status as market leader. Every chapter has been updated to provide the most current examples that reflect corporate finance in today?s world. The supplements package has been updated and improved, and with the enhanced Connect Finance and Excel Master, student and instructor support has never been stronger. Cover Page connect Half Title Page The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate Title Page Copyright Page Dedication About the Author Preface from the Authors Coverage In-Text Study Features Comprehensive Teaching and Learning Package Acknowledgments Brief Contents Table of Content In Their Own Words Boxes Part 1 Overview of Corporate Finance CHAPTER 1 INTRODUCTION TO CORPORATE FINANCE 1.1 Corporate Finance and the Financial Manager What Is Corporate Finance? The Financial Manager Financial Management Decisions Capital Budgeting Capital Structure Working Capital Management Conclusion 1.2 Forms of Business Organization Sole Proprietorship Partnership Corporation A Corporation by Another Name . . . 1.3 The Goal of Financial Management Possible Goals The Goal of Financial Management A More General Goal Sarbanes-Oxley 1.4 The Agency Problem and Control of the Corporation Agency Relationships Management Goals Do Managers Act in the Stockholders’ Interests? Managerial Compensation Control of the Firm Conclusion Stakeholders 1.5 Financial Markets and the Corporation Cash Flows to and from the Firm Primary versus Secondary Markets Primary Markets Secondary Markets Dealer versus Auction Markets Trading in Corporate Securities Listing 1.6 Summary and Conclusions CHAPTER 2 FINANCIAL STATEMENTS, TAXES, AND CASH FLOW 2.1 The Balance Sheet Assets: The Left Side Liabilities and Owners’ Equity: The Right Side Net Working Capital Liquidity Debt versus Equity Market Value versus Book Value 2.2 The Income Statement GAAP and the Income Statement Noncash Items Time and Costs 2.3 Taxes Corporate Tax Rates Average versus Marginal Tax Rates 2.4 Cash Flow Cash Flow from Assets Operating Cash Flow Capital Spending Change in Net Working Capital Conclusion A Note about “Free” Cash Flow Cash Flow to Creditors and Stockholders Cash Flow to Creditors Cash Flow to Stockholders An Example: Cash Flows for Dole Cola Operating Cash Flow Net Capital Spending Change in NWC and Cash Flow from Assets Cash Flow to Stockholders and Creditors 2.5 Summary and Conclusions PART 2 Financial Statements and Long-Term Financial Planning CHAPTER 3 WORKING WITH FINANCIAL STATEMENTS 3.1 Cash Flow and Financial Statements: A Closer Look Sources and Uses of Cash The Statement of Cash Flows 3.2 Standardized Financial Statements Common-Size Statements Common-Size Balance Sheets Common-Size Income Statements Common-Size Statements of Cash Flows Common–Base Year Financial Statements: Trend Analysis Combined Common-Size and Base Year Analysis 3.3 Ratio Analysis Short-Term Solvency, or Liquidity, Measures Current Ratio The Quick (or Acid-Test) Ratio Other Liquidity Ratios Long-Term Solvency Measures Total Debt Ratio A Brief Digression: Total Capitalization versus Total Assets Times Interest Earned Cash Coverage Asset Management, or Turnover, Measures Inventory Turnover and Days’ Sales in Inventory Receivables Turnover and Days’ Sales in Receivables Asset Turnover Ratios Profitability Measures Profit Margin Return on Assets Return on Equity Market Value Measures Price–Earnings Ratio Price–Sales Ratio Market-to-Book Ratio Enterprise Value–EBITDA Ratio Conclusion 3.4 The DuPont Identity A Closer Look at ROE An Expanded DuPont Analysis 3.5 Using Financial Statement Information Why Evaluate Financial Statements? Internal Uses External Uses Choosing a Benchmark Time Trend Analysis Peer Group Analysis Problems with Financial Statement Analysis 3.6 Summary and Conclusions CHAPTER 4 LONG-T ERM FINANCIAL PLANNING AND GROWTH 4.1 What Is Financial Planning? Growth as a Financial Management Goal Dimensions of Financial Planning What Can Planning Accomplish? Examining Interactions Exploring Options Avoiding Surprises Ensuring Feasibility and Internal Consistency Conclusion 4.2 Financial Planning Models: A First Look A Financial Planning Model: The Ingredients Sales Forecast Pro Forma Statements Asset Requirements Financial Requirements The Plug Economic Assumptions A Simple Financial Planning Model 4.3 The Percentage of Sales Approach The Income Statement The Balance Sheet A Particular Scenario An Alternative Scenario 4.4 External Financing and Growth EFN and Growth Financial Policy and Growth The Internal Growth Rate The Sustainable Growth Rate Determinants of Growth A Note about Sustainable Growth Rate Calculations 4.5 Some Caveats regarding Financial Planning Models 4.6 Summary and Conclusions PART 3 Valuation of Future Cash Flows CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY 5.1 Future Value and Compounding Investing for a Single Period Investing for More Than One Period A Note about Compound Growth 5.2 Present Value and Discounting The Single-Period Case Present Values for Multiple Periods 5.3 More about Present and Future Values Present versus Future Value Determining the Discount Rate Finding the Number of Periods 5.4 Summary and Conclusions CHAPTER 6 DISCOUNTED CASH FLOW VALUATION 6.1 Future and Present Values of Multiple Cash Flows Future Value with Multiple Cash Flows Present Value with Multiple Cash Flows A Note about Cash Flow Timing 6.2 Valuing Level Cash Flows: Annuities and Perpetuities Present Value for Annuity Cash Flows Annuity Tables Finding the Payment Finding the Rate Future Value for Annuities A Note about Annuities Due Perpetuities Growing Annuities and Perpetuities 6.3 Comparing Rates: The Effect of Compounding Effective Annual Rates and Compounding Calculating and Comparing Effective Annual Rates EARS and APRS Taking It to the Limit: A Note about Continuous Compounding 6.4 Loan Types and Loan Amortization Pure Discount Loans Interest-Only Loans Amortized Loans 6.5 Summary and Conclusions CHAPTER 7 INTEREST RATES AND BOND VALUATION 7.1 Bonds and Bond Valuation Bond Features and Prices Bond Values and Yields Interest Rate Risk Finding the Yield to Maturity: More Trial and Error 7.2 More about Bond Features Is It Debt or Equity? Long-Term Debt: The Basics The Indenture Terms of a Bond Security Seniority Repayment The Call Provision Protective Covenants 7.3 Bond Ratings 7.4 Some Different Types of Bonds Government Bonds Zero Coupon Bonds Floating-Rate Bonds Other Types of Bonds Sukuk 7.5 Bond Markets How Bonds Are Bought and Sold Bond Price Reporting A Note about Bond Price Quotes 7.6 Inflation and Interest Rates Real versus Nominal Rates The Fisher Effect Inflation and Present Values 7.7 Determinants of Bond Yields The Term Structure of Interest Rates Bond Yields and the Yield Curve: Putting It All Together Conclusion 7.8 Summary and Conclusions CHAPTER 8 STOCK VALUATION 8.1 Common Stock Valuation Cash Flows Some Special Cases Zero Growth Constant Growth Nonconstant Growth Two-Stage Growth Components of the Required Return Stock Valuation Using Multiples 8.2 Some Features of Common and Preferred Stocks Common Stock Features Shareholder Rights Proxy Voting Classes of Stock Other Rights Dividends Preferred Stock Features Stated Value Cumulative and Noncumulative Dividends Is Preferred Stock Really Debt? 8.3 The Stock Markets Dealers and Brokers Organization of the NYSE Members Operations Floor Activity NASDAQ Operations ECNs Stock Market Reporting 8.4 Summary and Conclusions PART 4 Capital Budgeting CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 9.1 Net Present Value The Basic Idea Estimating Net Present Value 9.2 The Payback Rule Defining the Rule Analyzing the Rule Redeeming Qualities of the Rule Summary of the Rule 9.3 The Discounted Payback 9.4 The Average Accounting Return 9.5 The Internal Rate of Return Problems with the IRR Nonconventional Cash Flows Mutually Exclusive Investments Investing or Financing? Redeeming Qualities of the IRR The Modified Internal Rate of Return (MIRR) Method #1: The Discounting Approach Method #2: The Reinvestment Approach Method #3: The Combination Approach MIRR or IRR: Which Is Better? 9.6 The Profitability Index 9.7 The Practice of Capital Budgeting 9.8 Summary and Conclusions CHAPTER 10 MAKING CAPITAL INVESTMENT DECISIONS 10.1 Project Cash Flows: A First Look Relevant Cash Flows The Stand-Alone Principle 10.2 Incremental Cash Flows Sunk Costs Opportunity Costs Side Effects Net Working Capital Financing Costs Other Issues 10.3 Pro Forma Financial Statements and Project Cash Flows Getting Started: Pro Forma Financial Statements Project Cash Flows Project Operating Cash Flow Project Net Working Capital and Capital Spending Projected Total Cash Flow and Value 10.4 More about Project Cash Flow A Closer Look at Net Working Capital Depreciation Modifi ed ACRS Depreciation (MACRS) Book Value versus Market Value An Example: The Majestic Mulch and Compost Company (MMCC) Operating Cash Flows Change in NWC Capital Spending Total Cash Flow and Value Conclusion 10.5 Alternative Definitions of Operating Cash Flow The Bottom-Up Approach The Top-Down Approach The Tax Shield Approach Conclusion 10.6 Some Special Cases of Discounted Cash Flow Analysis Evaluating Cost-Cutting Proposals Setting the Bid Price Evaluating Equipment Options with Different Lives 10.7 Summary and Conclusions CHAPTER 11 PROJECT ANALYSIS AND EVALUATION 11.1 Evaluating NPV Estimates The Basic Problem Projected versus Actual Cash Flows Forecasting Risk Sources of Value 11.2 Scenario and Other What-If Analyses Getting Started Scenario Analysis Sensitivity Analysis Simulation Analysis 11.3 Break-Even Analysis Fixed and Variable Costs Variable Costs Fixed Costs Total Costs Accounting Break-Even Accounting Break-Even: A Closer Look Uses for the Accounting Break-Even 11.4 Operating Cash Flow, Sales Volume, and Break-Even Accounting Break-Even and Cash Flow The Base Case Calculating the Break-Even Level Payback and Break-Even Sales Volume and Operating Cash Flow Cash Flow, Accounting, and Financial Break-Even Points Accounting Break-Even Revisited Cash Break-Even Financial Break-Even Conclusion 11.5 Operating Leverage The Basic Idea Implications of Operating Leverage Measuring Operating Leverage Operating Leverage and Break-Even 11.6 Capital Rationing Soft Rationing Hard Rationing 11.7 Summary and Conclusions PART 5 Risk and Return CHAPTER 12 SOME LESSONS FROM CAPITAL MARKET HISTORY 12.1 Returns Dollar Returns Percentage Returns 12.2 The Historical Record A First Look A Closer Look 12.3 Average Returns: The First Lesson Calculating Average Returns Average Returns: The Historical Record Risk Premiums The First Lesson 12.4 The Variability of Returns: The Second Lesson Frequency Distributions and Variability The Historical Variance and Standard Deviation The Historical Record Normal Distribution The Second Lesson 2008: The Bear Growled and Investors Howled Using Capital Market History More on the Stock Market Risk Premium 12.5 More about Average Returns Arithmetic versus Geometric Averages Calculating Geometric Average Returns Arithmetic Average Return or Geometric Average Return? 12.6 Capital Market Efficiency Price Behavior in an Efficient Market The Efficient Markets Hypothesis Some Common Misconceptions about the EMH The Forms of Market Efficiency 12.7 Summary and Conclusions CHAPTER 13 RETURN, RISK, AND THE SECURITY MARKET LINE 13.1 Expected Returns and Variances Expected Return Calculating the Variance 13.2 Portfolios Portfolio Weights Portfolio Expected Returns Portfolio Variance 13.3 Announcements, Surprises, and Expected Returns Expected and Unexpected Returns Announcements and News 13.4 Risk: Systematic and Unsystematic Systematic and Unsystematic Risk Systematic and Unsystematic Components of Return 13.5 Diversifi cation and Portfolio Risk The Effect of Diversification: Another Lesson from Market History The Principle of Diversification Diversification and Unsystematic Risk Diversification and Systematic Risk 13.6 Systematic Risk and Beta The Systematic Risk Principle Measuring Systematic Risk Portfolio Betas 13.7 The Security Market Line Beta and the Risk Premium The Reward-to-Risk Ratio The Basic Argument The Fundamental Result The Security Market Line Market Portfolios The Capital Asset Pricing Model 13.8 The SML and the Cost of Capital: A Preview The Basic Idea The Cost of Capital 13.9 Summary and Conclusions PART 6 Cost of Capital and Long-Term Financial Policy CHAPTER 14 COST OF CAPITAL 14.1 The Cost of Capital: Some Preliminaries Required Return versus Cost of Capital Financial Policy and Cost of Capital 14.2 The Cost of Equity The Dividend Growth Model Approach Implementing the Approach Estimating g Advantages and Disadvantages of the Approach The SML Approach Implementing the Approach Advantages and Disadvantages of the Approach 14.3 The Costs of Debt and Preferred Stock The Cost of Debt The Cost of Preferred Stock 14.4 The Weighted Average Cost of Capital The Capital Structure Weights Taxes and the Weighted Average Cost of Capital Calculating the WACC for Eastman Chemical Eastman’s Cost of Equity Eastman’s Cost of Debt Eastman’s WACC Solving the Warehouse Problem and Similar Capital Budgeting Problems Performance Evaluation: Another Use of the WACC 14.5 Divisional and Project Costs of Capital The SML and the WACC Divisional Cost of Capital The Pure Play Approach The Subjective Approach 14.6 Flotation Costs and the Weighted Average Cost of Capital The Basic Approach Flotation Costs and NPV Internal Equity and Flotation Costs 14.7 Summary and Conclusions CHAPTER 15 RAISING CAPITAL 15.1 The Financing Life Cycle of a Firm: Early-Stage Financing and Venture Capital Venture Capital Some Venture Capital Realities Choosing a Venture Capitalist Conclusion 15.2 Selling Securities to the Public: The Basic Procedure 15.3 Alternative Issue Methods 15.4 Underwriters Choosing an Underwriter Types of Underwriting Firm Commitment Underwriting Best Efforts Underwriting Dutch Auction Underwriting The Aftermarket The Green Shoe Provision Lockup Agreements The Quiet Period 15.5 IPOs and Underpricing IPO Underpricing: The 1999–2000 Experience Evidence on Underpricing Why Does Underpricing Exist? 15.6 New Equity Sales and the Value of the Firm 15.7 The Costs of Issuing Securities The Costs of Selling Stock to the Public The Costs of Going Public: A Case Study 15.8 Rights The Mechanics of a Rights Offering Number of Rights Needed to Purchase a Share The Value of a Right Ex Rights The Underwriting Arrangements Effects on Shareholders 15.9 Dilution Dilution of Proportionate Ownership Dilution of Value: Book versus Market Values A Misconception The Correct Arguments 15.10 Issuing Long-Term Debt 15.11 Shelf Registration 15.12 Summary and Conclusions CHAPTER 16 FINANCIAL LEVERAGE AND CAPITAL STRUCTURE POLICY 16.1 The Capital Structure Question Firm Value and Stock Value: An Example Capital Structure and the Cost of Capital 16.2 The Effect of Financial Leverage The Basics of Financial Leverage Financial Leverage, EPS, and ROE: An Example EPS versus EBIT Corporate Borrowing and Homemade Leverage 16.3 Capital Structure and the Cost of Equity Capital M&M Proposition I: The Pie Model The Cost of Equity and Financial Leverage: M&M Proposition II Business and Financial Risk 16.4 M&M Propositions I and II with Corporate Taxes The Interest Tax Shield Taxes and M&M Proposition I Taxes, the WACC, and Proposition II Conclusion 16.5 Bankruptcy Costs Direct Bankruptcy Costs Indirect Bankruptcy Costs 16.6 Optimal Capital Structure The Static Theory of Capital Structure Optimal Capital Structure and the Cost of Capital Optimal Capital Structure: A Recap Capital Structure: Some Managerial Recommendations Taxes Financial Distress 16.7 The Pie Again The Extended Pie Model Marketed Claims versus Nonmarketed Claims 16.8 The Pecking-Order Theory Internal Financing and the Pecking Order Implications of the Pecking Order 16.9 Observed Capital Structures 16.10 A Quick Look at the Bankruptcy Process Liquidation and Reorganization Bankruptcy Liquidation Bankruptcy Reorganization Financial Management and the Bankruptcy Process Agreements to Avoid Bankruptcy 16.11 Summary and Conclusions CHAPTER 17 DIVIDENDS AND PAYOUT POLICY 17.1 Cash Dividends and Dividend Payment Cash Dividends Standard Method of Cash Dividend Payment Dividend Payment: A Chronology More about the Ex-Dividend Date 17.2 Does Dividend Policy Matter? An Illustration of the Irrelevance of Dividend Policy Current Policy: Dividends Set Equal to Cash Flow Alternative Policy: Initial Dividend Greater Than Cash Flow Homemade Dividends A Test 17.3 Real-World Factors Favoring a Low Dividend Payout Taxes Flotation Costs Dividend Restrictions 17.4 Real-World Factors Favoring a High Dividend Payout Desire for Current Income Tax and Other Benefits from High Dividends Corporate Investors Tax-Exempt Investors Conclusion 17.5 A Resolution of Real-World Factors? Information Content of Dividends The Clientele Effect 17.6 Stock Repurchases: An Alternative to Cash Dividends Cash Dividends versus Repurchase Real-World Considerations in a Repurchase Share Repurchase and EPS 17.7 What We Know and Do Not Know about Dividend and Payout Policies Dividends and Dividend Payers Corporations Smooth Dividends Putting It All Together Some Survey Evidence on Dividends 17.8 Stock Dividends and Stock Splits Some Details about Stock Splits and Stock Dividends Example of a Small Stock Dividend Example of a Stock Split Example of a Large Stock Dividend Value of Stock Splits and Stock Dividends The Benchmark Case Popular Trading Range Reverse Splits 17.9 Summary and Conclusions PART 7 Short-Term Financial Planning and Management CHAPTER 18 SHORT-TERM FINANCE AND PLANNING 18.1 Tracing Cash and Net Working Capital 18.2 The Operating Cycle and the Cash Cycle Defining the Operating and Cash Cycles The Operating Cycle The Cash Cycle The Operating Cycle and the Firm’s Organizational Chart Calculating the Operating and Cash Cycles The Operating Cycle The Cash Cycle Interpreting the Cash Cycle 18.3 Some Aspects of Short-Term Financial Policy The Size of the Firm’s Investment in Current Assets Alternative Financing Policies for Current Assets An Ideal Case Different Policies for Financing Current Assets Which Financing Policy Is Best? Current Assets and Liabilities in Practice 18.4 The Cash Budget Sales And Cash Collections Cash Outflows The Cash Balance 18.5 Short-Term Borrowing Unsecured Loans Compensating Balances Cost of a Compensating Balance Letters of Credit Secured Loans Accounts Receivable Financing Inventory Loans Other Sources 18.6 A Short-Term Financial Plan 18.7 Summary and Conclusions CHAPTER 19 CASH AND LIQUIDITY MANAGEMENT 19.1 Reasons for Holding Cash The Speculative and Precautionary Motives The Transaction Motive Compensating Balances Costs of Holding Cash Cash Management versus Liquidity Management 19.2 Understanding Float Disbursement Float Collection Float and Net Float Float Management Measuring Float Some Details Cost of the Float Ethical and Legal Questions Electronic Data Interchange and Check 21: The End of Float? 19.3 Cash Collection and Concentration Components of Collection Time Cash Collection Lockboxes Cash Concentration Accelerating Collections: An Example 19.4 Managing Cash Disbursements Increasing Disbursement Float Controlling Disbursements Zero-Balance Accounts Controlled Disbursement Accounts 19.5 Investing Idle Cash Temporary Cash Surpluses Seasonal or Cyclical Activities Planned or Possible Expenditures Characteristics of Short-Term Securities Maturity Default Risk Marketability Taxes Some Different Types of Money Market Securities 19.6 Summary and Conclusions 19A Determining the Target Cash Balance The Basic Idea The BAT Model The Opportunity Costs The Trading Costs The Total Cost The Solution Conclusion The Miller–Orr Model: A More General Approach The Basic Idea Using the Model Implications of the BAT and Miller–Orr Models Other Factors Influencing the Target Cash Balance CHAPTER 20 CREDIT AND INVENTORY MANAGEMENT 20.1 Credit and Receivables Components of Credit Policy The Cash Flows from Granting Credit The Investment in Receivables 20.2 Terms of the Sale The Basic Form The Credit Period The Invoice Date Length of the Credit Period Cash Discounts Cost of the Credit Trade Discounts The Cash Discount and the ACP Credit Instruments 20.3 Analyzing Credit Policy Credit Policy Effects Evaluating a Proposed Credit Policy NPV of Switching Policies A Break-Even Application 20.4 Optimal Credit Policy The Total Credit Cost Curve Organizing the Credit Function 20.5 Credit Analysis When Should Credit Be Granted? A One-Time Sale Repeat Business Credit Information Credit Evaluation and Scoring 20.6 Collection Policy Monitoring Receivables Collection Effort 20.7 Inventory Management The Financial Manager and Inventory Policy Inventory Types Inventory Costs 20.8 Inventory Management Techniques The ABC Approach The Economic Order Quantity Model Inventory Depletion The Carrying Costs The Restocking Costs The Total Costs Extensions to the EOQ Model Safety Stocks Reorder Points Managing Derived-Demand Inventories Materials Requirements Planning Just-in-Time Inventory 20.9 Summary and Conclusions 20A More about Credit Policy Analysis Two Alternative Approaches The One-Shot Approach The Accounts Receivable Approach Discounts and Default Risk NPV of the Credit Decision A Break-Even Application PART 8 Topics in Corporate Finance CHAPTER 21 INTERNATIONAL CORPORATE FINANCE 21.1 Terminology 21.2 Foreign Exchange Markets and Exchange Rates Exchange Rates Exchange Rate Quotations Cross-Rates and Triangle Arbitrage Types of Transactions 21.3 Purchasing Power Parity Absolute Purchasing Power Parity Relative Purchasing Power Parity The Basic Idea The Result Currency Appreciation and Depreciation 21.4 Interest Rate Parity, Unbiased Forward Rates, and the International Fisher Effect Covered Interest Arbitrage Interest Rate Parity Forward Rates and Future Spot Rates Putting It All Together Uncovered Interest Parity The International Fisher Effect 21.5 International Capital Budgeting Method 1: The Home Currency Approach Method 2: The Foreign Currency Approach Unremitted Cash Flows 21.6 Exchange Rate Risk Short-Run Exposure Long-Run Exposure Translation Exposure Managing Exchange Rate Risk 21.7 Political Risk 21.8 Summary and Conclusions APPENDIX A MATHEMATICAL TABLES APPENDIX B KEY EQUATIONS APPENDIX C ANSWERS TO SELECTED END-OF-CHAPTER PROBLEMS APPENDIX D USING THE HP 10B AND TI BA II PLUS FINANCIAL CALCULATORS Index Pedagogical Use of Color Back Cover