Need help for open book FINAL test for Financial Management class

397411863_
timer Asked: Sep 30th, 2015

Question Description

I have an open book FINAL test for Financial Management class, test is worth 45%, I need someone who will guarantee me an A grade in this test and will master the material for this subject please. 

To get an A on this test, knowing the rules and formulas in the book used for the class is necessary (below a copy of the book link). This test is for a graduate online class. 

This is the test requirements, Please read carefully!! Test Requirements.png  
This is a copy of my book: Financial+Management+Theory+&%3+Practice+14+edition.pdf  
This is the lecture notes: Lecture Notes.doc  
This is the weekly assignment: weekly assignments.png  

 If you don't have enough financial expertise, please don't take the job! My budget range can be discussed. 

Total is 30 questions in 1 hour. You can decide the exam time within the stipulated time.

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FREQUENTLY USED SYMBOLS ACP ADR APR AR b bL bU BEP BVPS CAPM CCC CF CFPS CR CV  Dps Dt DCF D/E DPS DRIP DRP DSO EAR EBIT EBITDA EPS EVA F Average collection period American Depository Receipt Annual percentage rate Accounts receivable Beta coefficient, a measure of an asset’s market risk Levered beta Unlevered beta Basic earning power Book value per share Capital Asset Pricing Model Cash conversion cycle Cash flow; CFt is the cash flow in Period t Cash flow per share Conversion ratio Coefficient of variation Difference or change (uppercase delta) Dividend of preferred stock Dividend in Period t Discounted cash flow Debt-to-equity ratio Dividends per share Dividend reinvestment plan Default risk premium Days sales outstanding Effective annual rate, EFF% Earnings before interest and taxes; net operating income Earnings before interest, taxes, depreciation, and amortization Earnings per share Economic Value Added (1) Fixed operating costs (2) Flotation cost FCF FVN FVAN g I I/YR INT IP IPO IRR LP M Free cash flow Future value for Year N Future value of an annuity for N years Growth rate in earnings, dividends, and stock prices Interest rate; also denoted by r Interest rate key on some calculators Interest payment in dollars Inflation premium Initial public offering Internal rate of return Liquidity premium M/B MIRR MRP MVA n N N(di) NOPAT NOWC NPV P Market-to-book ratio Modified Internal Rate of Return Maturity risk premium Market Value Added Number of shares outstanding Calculator key denoting number of periods Area under a standard normal distribution function Net operating profit after taxes Net operating working capital Net present value Pc (1) Maturity value of a bond (2) Margin (profit margin) (1) Price of a share of stock in Period t; P0 = price of the stock today (2) Sales price per unit of product sold Conversion price Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Pf Ph PN P/E PM PMT PPP PV PVAN Q QBE r −r ^r r* rd re rf rh ri rM rNOM rps rPER rRF rs r ROA ROE RP RPM RR S SML ∑ s s2 t T TVN TIE V VB VL Vop Vps VU VC w wd wps ws WACC X YTC YTM Price of good in foreign country Price of good in home country A stock’s horizon, or terminal, value Price/earnings ratio Profit margin Payment of an annuity Purchasing power parity Present value Present value of an annuity for N years Quantity produced or sold Breakeven quantity (1) A percentage discount rate, or cost of capital; also denoted by i (2) Nominal risk-adjusted required rate of return “r bar,” historic, or realized, rate of return “r hat,” an expected rate of return Real risk-free rate of return Before-tax cost of debt Cost of new common stock (outside equity) Interest rate in foreign country Interest rate in home country Required return for an individual firm or security Return for “the market” or for an “average” stock Nominal rate of interest; also denoted by iNOM (1) Cost of preferred stock (2) Portfolio’s return Periodic rate of return Rate of return on a risk-free security (1) Required return on common stock (2) Cost of current outstanding common stock Correlation coefficient (lowercase rho); also denoted by R when using historical data Return on assets Return on equity Risk premium Market risk premium Retention rate (1) Sales (2) Estimated standard deviation for sample data (3) Intrinsic value of stock (i.e., all common equity) Security Market Line Summation sign (uppercase sigma) Standard deviation (lowercase sigma) Variance Time period Marginal income tax rate A stock’s horizon, or terminal, value Times interest earned Variable cost per unit Bond value Total market value of a levered firm Value of operations Value of preferred stock Total market value of an unlevered firm Total variable costs Proportion or weight Weight of debt Weight of preferred stock Weight of common equity raised internally by retaining earnings Weighted average cost of capital Exercise price of option Yield to call Yield to maturity Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. financial management 14e theor y & practice E U G E N E F. B R I G H A M University of Florida MICHAEL C. EHRHARDT University of Tennessee Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. This is an electronic version of the print textbook. Due to electronic rights restrictions, some third party content may be suppressed. Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. The publisher reserves the right to remove content from this title at any time if subsequent rights restrictions require it. For valuable information on pricing, previous editions, changes to current editions, and alternate formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Financial Management: Theory and Practice, Fourteenth Edition Eugene F. Brigham and Michael C. Ehrhardt Editorial Director, Business & Economics: Erin Joyner Editor-in-Chief: Joe Sabatino Executive Editor: Mike Reynolds ª 2014, 2011 South-Western, Cengage Learning ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may be reproduced, transmitted, stored, or used in any form or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, web distribution, information networks, or information storage and retrieval systems, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the publisher. Developmental Editor: Kendra Brown Sr. Editorial Assistant: Adele Scholtz Sr. Content Project Manager: Holly Henjum Supervising Media Editor: Scott Fidler Manufacturing Planner: Kevin Kluck For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706 For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions Further permissions questions can be emailed to permissionrequest@cengage.com Sr. Art Director: Michelle Kunkler Brand Manager: Robin Lefevre Market Development Manager: John Carey Rights Acquisitions Specialist: Anne Sheroff Production Service/Compositor: Integra Software Services Pvt. Ltd. ExamView® is a registered trademark of eInstruction Corp. Windows is a registered trademark of the Microsoft Corporation used herein under license. Macintosh and Power Macintosh are registered trademarks of Apple Computer, Inc. used herein under license. Microsoft Excel displays are © 2012 Microsoft. Microsoft Excel ® is a registered trademark of Microsoft Corporation. Cover and Internal Designer: c miller design Library of Congress Control Number: 2012956039 Cover Image: © Fernando Bueno/Getty Images, Inc.; © Adalberto Rios Szalay/Sexto Sol/ Getty Images, Inc. Student Edition ISBN-13: 978-1-111-97221-9 Student Edition ISBN-10: 1-111-97221-4 South-Western 5191 Natorp Boulevard Mason, OH 45040 USA Cengage Learning is a leading provider of customized learning solutions with office locations around the globe, including Singapore, the United Kingdom, Australia, Mexico, Brazil, and Japan. Locate your local office at: www.cengage.com/global Cengage Learning products are represented in Canada by Nelson Education, Ltd. For your course and learning solutions, visit www.cengage.com Purchase any of our products at your local college store or at our preferred online store www.cengagebrain.com Printed in Canada 1 2 3 4 5 6 7 16 15 14 13 12 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. © lulu/fotolia.com Preface xviii PART 1 CHAPTER 1 Web Extensions CHAPTER 2 Web Extensions CHAPTER 3 PART 2 Brief Contents Web Extensions The Company and Its Environment 1 An Overview of Financial Management and the Financial Environment 3 1A: An Overview of Derivatives 1B: A Closer Look at the Stock Markets Financial Statements, Cash Flow, and Taxes 51 2A: The Federal Income Tax System for Individuals Analysis of Financial Statements 95 CHAPTER 7 Web Extensions CHAPTER 8 PART 4 9A: The Required Return Assuming Nonconstant Dividends and Stock Repurchases The Basics of Capital Budgeting: Evaluating Cash Flows 397 10A: The Accounting Rate of Return (ARR) CHAPTER 10 Web Extensions 4A: The Tabular Approach 4B: Derivation of Annuity Formulas Web Extensions 4C: Continuous Compounding CHAPTER 11 CHAPTER 5 Bond, Bond Valuation, and Interest Rates 187 Web Extensions Web Extensions 5A: A Closer Look at Zero Coupon Bonds 5B: A Closer Look at TIPS: Treasury Inflation-Protected Securities PART CHAPTER 6 Risk and Return 235 5 Cash Flow Estimation and Risk Analysis 437 11A: Certainty Equivalents and Risk-Adjusted Discount Rates Corporate Valuation and Governance 485 CHAPTER 12 Corporate Valuation and Financial Planning 487 CHAPTER 13 Agency Conflicts and Corporate Governance 523 PART Stocks and Options 233 Projects and Their Valuation 355 Web Extensions Time Value of Money 133 3 7A: Derivation of Valuation Equations Financial Options and Applications in Corporate Finance 325 The Cost of Capital 357 CHAPTER 4 PART 6B: Estimating Beta with a Financial Calculator Valuation of Stocks and Corporations 289 CHAPTER 9 Fixed Income Securities 131 5C: A Closer Look at Bond Risk: Duration 5D: The Pure Expectations Theory and Estimation of Forward Rates 6A: Continuous Probability Distributions 6 CHAPTER 14 Cash Distributions and Capital Structure 545 Distributions to Shareholders: Dividends and Repurchases 547 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. iii iv Brief Contents CHAPTER 15 Web Extensions Capital Structure Decisions 589 15A: Degree of Leverage CHAPTER 24 Web Extensions PART 7 CHAPTER 16 Web Extensions CHAPTER 17 PART 8 CHAPTER 18 Managing Global Operations 629 Supply Chains and Working Capital Management 631 16A: Secured Short-Term Financing Tactical Financial Decisions 727 Web Extensions CHAPTER 19 Lease Financing 771 Web Extensions 19A: Leasing Feedback 19B: Percentage Cost Analysis 19C: Leveraged Leases CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 799 PART 9 20A: Calling Convertible Issues Strategic Finance in a Dynamic Environment 827 CHAPTER 21 Dynamic Capital Structures 829 CHAPTER 22 Mergers and Corporate Control 867 22A: Projecting Consistent Debt and Interest Expenses Web Extensions CHAPTER 23 10 Enterprise Risk Management 909 Special Topics 975 CHAPTER 25 Portfolio Theory and Asset Pricing Models 977 CHAPTER 26 Real Options 1011 Web Extensions Multinational Financial Management 681 Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks 729 18A: Rights Offerings Web Extensions PART Bankruptcy, Reorganization, and Liquidation 943 24A: Multiple Discriminant Analysis 26A: The Abandonment Real Option 26B: Risk-Neutral Valuation ____________________________________ Appendixes APPENDIX A Solutions to Self-Test Problems 1035 APPENDIX B Answers to End-of-Chapter Problems 1067 APPENDIX C Selected Equations 1077 APPENDIX D Values of the Areas under the Standard Normal Distribution Function 1091 ____________________________________ Glossary 1093 ____________________________________ Name Index 1121 ____________________________________ Subject Index 1127 ____________________________________ Web Chapters: CHAPTER 27 Providing and Obtaining Credit CHAPTER 28 Advanced Issues in Cash Management and Inventory Control CHAPTER 29 Pension Plan Management CHAPTER 30 Financial Management in Not-forProfit Businesses Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents © lulu/fotolia.com Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviii PART 1 The Company and Its Environment 1 CHAPTER 1 An Overview of Financial Management and the Financial Environment 3 Box: The Global Economic Crisis 4 The Five-Minute MBA 4 The Corporate Life Cycle 5 Box: Columbus Was Wrong—the World Is Flat! And Hot! And Crowded! 6 The Primary Objective of the Corporation: Value Maximization 9 Box: Ethics for Individuals and Businesses 10 Box: Corporate Scandals and Maximizing Stock Price 12 An Overview of the Capital Allocation Process 13 Financial Securities 14 The Cost of Money 18 Financial Institutions 23 Financial Markets 27 Trading Procedures in Financial Markets 29 Box: Life in the Fast Lane: High-Frequency Trading! 30 Types of Stock Market Transactions 30 The Secondary Stock Markets 31 Box: Measuring the Market 33 Stock Market Returns 34 The Global Economic Crisis 36 Box: Anatomy of a Toxic Asset 43 The Big Picture 45 e-Resources 46 Summary 46 Web Extensions 1A: An Overview of Derivatives 1B: A Closer Look at the Stock Markets CHAPTER 2 Financial Statements, Cash Flow, and Taxes 51 Box: Intrinsic Value, Free Cash Flow, and Financial Statements 52 Financial Statements and Reports 52 The Balance Sheet 53 Box: The Global Economic Crisis 56 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. v vi Contents The Income Statement 56 Statement of Stockholders’ Equity 58 Statement of Cash Flows 59 Box: Financial Analysis on the Web 60 Box: Filling in the GAAP 63 Net Cash Flow 64 Free Cash Flow: The Cash Flow Available for Distribution to Investors 65 Box: Sarbanes-Oxley and Financial Fraud 70 Performance Evaluation 72 The Federal Income Tax System 76 Box: When It Comes to Taxes, History Repeats and Repeals Itself! 79 Summary 82 Web Extensions 2A: The Federal Income Tax System for Individuals CHAPTER 3 Analysis of Financial Statements 95 Box: Intrinsic Value and Analysis of Financial Statements 96 Financial Analysis 96 Liquidity Ratios 97 Asset Management Ratios 100 Box: The Global Economic Crisis 103 Debt Management Ratios 103 Profitability Ratios 107 Box: The World Might Be Flat, but Global Accounting Is Bumpy! The Case of IFRS versus FASB 108 Market Value Ratios 110 Trend Analysis, Common Size Analysis, and Percentage Change Analysis 113 Tying the Ratios Together: The DuPont Equation 115 Comparative Ratios and Benchmarking 117 Uses and Limitations of Ratio Analysis 118 Box: Ratio Analysis on the Web 119 Looking Beyond the Numbers 119 Summary 120 PART 2 Fixed Income Securities 131 CHAPTER 4 Time Value of Money 133 Box: Corporate Valuation and the Time Value of Money 134 Time Lines 135 Future Values 135 Box: Hints on Using Financial Calculators 139 Present Values 143 Box: It’s a Matter of Trust 144 Finding the Interest Rate, I 147 Finding the Number of Years, N 148 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents vii Perpetuities 149 Annuities 150 Future Value of an Ordinary Annuity 151 Box: The Power of Compound Interest 153 Future Value of an Annuity Due 154 Present Value of Ordinary Annuities and Annuities Due 154 Box: Variable Annuities: Good or Bad? 157 Finding Annuity Payments, Periods, and Interest Rates 158 Box: Using the Internet for Personal Financial Planning 160 Uneven, or Irregular, Cash Flows 160 Future Value of an Uneven Cash Flow Stream 163 Solving for I with Irregular Cash Flows 164 Semiannual and Other Compounding Periods 165 Box: Truth in Lending: What Loans Really Cost 168 Fractional Time Periods 169 Amortized Loans 170 Box: What You Know Is What You Get: Not in Payday Lending 171 Box: The Global Economic Crisis An Accident Waiting to Happen: Option Reset Adjustable Rate Mortgages 174 Summary 176 Web Extensions 4A: The Tabular Approach 4B: Derivation of Annuity Formulas 4C: Continuous Compounding CHAPTER 5 Bond, Bond Valuation, and Interest Rates 187 Box: Intrinsic Value and the Cost of Debt 188 Who Issues Bonds? 188 Box: The Global Economic Crisis 190 Key Characteristics of Bonds 190 Bond Valuation 194 Changes in Bond Values Over Time 199 Box: Drinking Your Coupons 202 Bonds with Semiannual Coupons 202 Bond Yields 203 The Pre-Tax Cost of Debt: Determinants of Market Interest Rates 206 The Real Risk-Free Rate of Interest, r* 207 The Inflation Premium (IP) 208 The Nominal, or Quoted, Risk-Free Rate of Interest, rRF 210 The Default Risk Premium (DRP) 211 Box: The Global Economic Crisis 212 Box: The Global Economic Crisis 215 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. viii Contents The Liquidity Premium (LP) 216 Box: The Few, the Proud, the… AAA-Rated Companies! 217 The Maturity Risk Premium (MRP) 217 Box: The Global Economic Crisis 218 The Term Structure of Interest Rates 221 Financing with Junk Bonds 222 Bankruptcy and Reorganization 223 Summary 224 Web Extensions 5A: A Closer Look at Zero Coupon Bonds 5B: A Closer Look at TIPS: Treasury Inflation-Protected Securities 5C: A Closer Look at Bond Risk: Duration 5D: The Pure Expectations Theory and Estimation of Forward Rates PART 3 Stocks and Options 233 CHAPTER 6 Risk and Return 235 Box: Intrinsic Value, Risk, and Return 236 Investment Returns and Risk 236 Measuring Risk for Discrete Distributions 238 Risk in a Continuous Distribution 241 Using Historical Data to Estimate Risk 242 Box: What Does Risk Really Mean? 243 Box: The Historic Trade-off between Risk and Return 246 Risk in a Portfolio Context 246 The Relevant Risk of a Stock: The Capital Asset Pricing Model (CAPM) 250 Box: The Benefits of Diversifying Overseas 256 The Relationship between Risk and Return in the Capital Asset Pricing Model 257 Box: Another Kind of Risk: The Bernie Madoff Story 265 The Efficient Markets Hypothesis 265 The Fama-French Three-Factor Model 270 Behavioral Finance 274 The CAPM and Market Efficiency: Implications for Corporate Managers and Investors 276 Summary 277 Web Extensions 6A: Continuous Probability Distributions 6B: Estimating Beta with a Financial Calculator CHAPTER 7 Valuation of Stocks and Corporations 289 Box: Corporate Valuation and Stock Prices 290 Legal Rights and Privileges of Common Stockholders 290 Types of Common Stock 291 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents Stock Market Reporting 292 Valuing Common Stocks 293 Valuing a Constant Growth Stock 296 Valuing Nonconstant Growth Stocks 301 The Free Cash Flow Valuation Model 304 Market Multiple Analysis 311 Preferred Stock 312 Summary 313 Web Extensions 7A: Derivation of Valuation Equations CHAPTER 8 Financial Options and Applications in Corporate Finance 325 Box: The Intrinsic Value of Stock Options 326 Overview of Financial Options 326 Box: Financial Reporting for Employee Stock Options 330 The Single-Period Binomial Option Pricing Approach 330 The Single-Period Binomial Option Pricing Formula 335 The Multi-Period Binomial Option Pricing Model 337 The Black-Scholes Option Pricing Model (OPM) 340 Box: Taxes and Stock Options 345 The Valuation of Put Options 346 Applications of Option Pricing in Corporate Finance 348 Summary 350 PART 4 Projects and Their Valuation 355 CHAPTER 9 The Cost of Capital 357 Box: Corporate Valuation and the Cost of Capital 358 The Weighted Average Cost of Capital 359 Choosing Weights for the Weighted Average Cost of Capital 360 After-Tax Cost of Debt: rd(1 − T) and rstd(1 − T) 361 Box: How Effective Is the Effective Corporate Tax Rate? 364 Cost of Preferred Stock, rps 366 Cost of Common Stock: The Market Risk Premium, RPM 367 Using the CAPM to Estimate the Cost of Common Stock, rs 370 Dividend-Yield-Plus-Growth-Rate, or Discounted Cash Flow (DCF), Approach 372 The Weighted Average Cost of Capital (WACC) 375 Box: Global Variations in the Cost of Capital 377 Adjusting the Cost of Equity for Flotation Costs 377 Privately Owned Firms and Small Businesses 379 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. ix x Contents Managerial Issues and the Cost of Capital 381 Four Mistakes to Avoid 385 Summary 386 Web Extensions 9A: The Required Return Assuming Nonconstant Dividends and Stock Repurchases CHAPTER 10 The Basics of Capital Budgeting: Evaluating Cash Flows 397 Box: Corporate Valuation and Capital Budgeting 398 An Overview of Capital Budgeting 398 The First Step in Project Analysis 400 Net Present Value (NPV) 401 Internal Rate of Return (IRR) 403 Modified Internal Rate of Return (MIRR) 410 Profitability Index (PI) 413 Payback Period 414 How to Use the Different Capital Budgeting Methods 416 Other Issues in Capital Budgeting 419 Summary 425 Web Extensions 10A: The Accounting Rate of Return (ARR) CHAPTER 11 Cash Flow Estimation and Risk Analysis 437 Box: Project Valuation, Cash Flows, and Risk Analysis 438 Identifying Relevant Cash Flows 438 Analysis of an Expansion Project 443 Risk Analysis in Capital Budgeting 450 Measuring Stand-Alone Risk 451 Sensitivity Analysis 451 Scenario Analysis 455 Monte Carlo Simulation 457 Project Risk Conclusions 460 Replacement Analysis 461 Real Options 463 Phased Decisions and Decision Trees 465 Summary 468 Appendix 11A Tax Depreciation 481 Web Extensions 11A: Certainty Equivalents and Risk-Adjusted Discount Rates Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents PART 5 Corporate Valuation and Governance 485 CHAPTER 12 Corporate Valuation and Financial Planning 487 Box: Corporate Valuation and Financial Planning 488 Overview of Financial Planning 489 Financial Planning at MicroDrive, Inc. 490 Forecasting Operations 491 Projecting MicroDrive’s Financial Statements 496 Analysis and Revision of the Preliminary Plan 500 Additional Funds Needed (AFN) Equation Method 504 Forecasting When the Ratios Change 507 Summary 511 CHAPTER 13 Agency Conflicts and Corporate Governance 523 Box: Corporate Governance and Corporate Valuation 524 Agency Conflicts 524 Corporate Governance 528 Box: The Global Economic Crisis 532 Box: The Dodd-Frank Act and “Say on Pay” 534 Box: The Sarbanes-Oxley Act of 2002 and Corporate Governance 535 Box: International Corporate Governance 538 Employee Stock Ownership Plans (ESOPs) 539 Summary 542 PART 6 Cash Distributions and Capital Structure 545 CHAPTER 14 Distributions to Shareholders: Dividends and Repurchases 547 Box: Uses of Free Cash Flow: Distributions to Shareholders 548 An Overview of Cash Distributions 548 Procedures for Cash Distributions 550 Cash Distributions and Firm Value 553 Clientele Effect 556 Information Content, or Signaling, Hypothesis 557 Implications for Dividend Stability 558 Box: The Global Economic Crisis: Will Dividends Ever Be the Same? 559 Setting the Target Distribution Level: The Residual Distribution Model 559 The Residual Distribution Model in Practice 561 A Tale of Two Cash Distributions: Dividends versus Stock Repurchases 562 The Pros and Cons of Dividends and Repurchases 571 Box: Dividend Yields around the World 573 Other Factors Influencing Distributions 573 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xi xii Contents Summarizing the Distribution Policy Decision 574 Stock Splits and Stock Dividends 576 Box: The Global Economic Crisis: Talk about a Split Personality! 577 Dividend Reinvestment Plans 579 Summary 580 CHAPTER 15 Capital Structure Decisions 589 Box: Corporate Valuation and Capital Structure 590 An Overview of Capital Structure 590 Business Risk and Financial Risk 592 Capital Structure Theory 596 Box: Yogi Berra on the MM Proposition 598 Capital Structure Evidence and Implications 604 Estimating the Optimal Capital Structure 608 Anatomy of a Recapitalization 614 Box: The Global Economic Crisis: Deleveraging 618 Summary 619 Web Extensions 15A: Degree of Leverage PART 7 Managing Global Operations 629 CHAPTER 16 Supply Chains and Working Capital Management 631 Box: Corporate Valuation and Working Capital Management 632 Overview of Working Capital Management 633 Using and Financing Operating Current Assets 634 The Cash Conversion Cycle 638 Box: Some Firms Operate with Negative Working Capital! 644 The Cash Budget 644 Cash Management and the Target Cash Balance 648 Cash Management Techniques 649 Box: Your Check Isn’t in the Mail 651 Inventory Management 652 Box: Supply Chain Management 653 Receivables Management 654 Box: Supply Chain Finance 656 Accruals and Accounts Payable (Trade Credit) 658 Box: A Wag of the Finger or Tip of the Hat? The Colbert Report and Small Business Payment Terms 659 Managing Short-Term Investments 662 Short-Term Financing 663 Short-Term Bank Loans 664 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents xiii Commercial Paper 668 Use of Security in Short-Term Financing 668 Summary 669 Web Extensions 16A: Secured Short-Term Financing CHAPTER 17 Multinational Financial Management 681 Box: Corporate Valuation in a Global Context 682 Multinational, or Global, Corporations 682 Multinational versus Domestic Financial Management 683 Exchange Rates 685 Exchange Rates and International Trade 690 The International Monetary System and Exchange Rate Policies 691 Trading in Foreign Exchange 697 Interest Rate Parity 698 Purchasing Power Parity 700 Inflation, Interest Rates, and Exchange Rates 701 Box: Hungry for a Big Mac? Go To Ukraine! 702 Box: Greasing the Wheels of International Business 703 International Money and Capital Markets 703 Box: Stock Market Indices Around the World 708 Multinational Capital Budgeting 708 Box: Consumer Finance in China 709 Box: Double Irish with a Dutch Twist 712 International Capital Structures 714 Multinational Working Capital Management 715 Summary 718 PART 8 Tactical Financial Decisions 727 CHAPTER 18 Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks 729 The Financial Life Cycle of a Start-Up Company 730 The Decision to Go Public 731 The Process of Going Public: An Initial Public Offering 733 Equity Carve-Outs: A Special Type of IPO 743 Other Ways to Raise Funds in the Capital Markets 744 Box: Where There’s Smoke There’s Fire 748 Investment Banking Activities and Their Role in the Global Economic Crisis 749 Box: The Global Economic Crisis: What Was the Role of Investment Banks? 751 The Decision to Go Private 752 Managing the Maturity Structure of Debt 754 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xiv Contents Refunding Operations 756 Box: TVA Ratchets Down Its Interest Expenses 760 Managing the Risk Structure of Debt with Project Financing 763 Summary 764 Web Extensions 18A: Rights Offerings CHAPTER 19 Lease Financing 771 Types of Leases 772 Tax Effects 775 Financial Statement Effects 776 Evaluation by the Lessee 778 Box: Off–Balance Sheet Financing: Is It Going to Disappear? 779 Evaluation by the Lessor 784 Other Issues in Lease Analysis 786 Box: What You Don’t Know Can Hurt You! 787 Box: Lease Securitization 789 Other Reasons for Leasing 790 Summary 792 Web Extensions 19A: Leasing Feedback 19B: Percentage Cost Analysis 19C: Leveraged Leases CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 799 Preferred Stock 800 Box: The Romance Had No Chemistry, But It Had a Lot of Preferred Stock! 801 Box: Hybrids Aren’t Only for Corporations 803 Warrants 805 Convertible Securities 810 A Final Comparison of Warrants and Convertibles 817 Reporting Earnings When Warrants or Convertibles Are Outstanding 818 Summary 819 Web Extensions 20A: Calling Convertible Issues PART 9 Strategic Finance in a Dynamic Environment 827 CHAPTER 21 Dynamic Capital Structures 829 Box: Corporate Valuation and Capital Structure Decisions 830 The Impact of Growth and Tax Shields on Value 830 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents The Modigliani and Miller Models and the Compressed Adjusted Present Value (APV) Model 833 Dynamic Capital Structures and the Adjusted Present Value (APV) Model 840 Risky Debt and Equity as an Option 844 Introducing Personal Taxes: The Miller Model 848 Capital Structure Theory: Arbitrage Proofs of the Modigliani-Miller Theorems 852 Summary 858 CHAPTER 22 Mergers and Corporate Control 867 Rationale for Mergers 868 Types of Mergers 871 Level of Merger Activity 871 Hostile versus Friendly Takeovers 872 Merger Regulation 874 Overview of Merger Analysis 875 The Free Cash Flow to Equity (FCFE) Approach 876 Illustration of the Three Valuation Approaches for a Constant Capital Structure 878 Setting the Bid Price 884 Analysis When There Is a Permanent Change in Capital Structure 886 Taxes and the Structure of the Takeover Bid 888 Box: Tempest in a Teapot? 889 Financial Reporting for Mergers 892 Analysis for a “True Consolidation” 894 The Role of Investment Bankers 895 Who Wins: The Empirical Evidence 896 Box: Merger Mistakes 897 Corporate Alliances 898 Divestitures 898 Holding Companies 899 Summary 901 Web Extensions 22A: Projecting Consistent Debt and Interest Expenses CHAPTER 23 Enterprise Risk Management 909 Box: Corporate Valuation and Risk Management 910 Reasons to Manage Risk 910 An Overview of Enterprise Risk Management 913 A Framework for Enterprise Risk Management 915 Categories of Risk Events 918 Foreign Exchange (FX) Risk 920 Commodity Price Risk 921 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xv xvi Contents Interest Rate Risk 925 Box: The Game of Truth or LIBOR 930 Project Selection Risks 933 Managing Credit Risks 936 Risk and Human Safety 938 Summary 939 CHAPTER 24 Bankruptcy, Reorganization, and Liquidation 943 Financial Distress and Its Consequences 944 Issues Facing a Firm in Financial Distress 946 Settlements without Going through Formal Bankruptcy 946 Federal Bankruptcy Law 949 Reorganization in Bankruptcy 950 Liquidation in Bankruptcy 959 Box: A Nation of Defaulters? 963 Anatomy of a Bankruptcy: Transforming the GM Corporation into the GM Company 963 Other Motivations for Bankruptcy 965 Some Criticisms of Bankruptcy Laws 966 Summary 967 Web Extensions 24A: Multiple Discriminant Analysis PART 10 Special Topics 975 CHAPTER 25 Portfolio Theory and Asset Pricing Models 977 Box: Intrinsic Value, Risk, and Return 978 Efficient Portfolios 978 Choosing the Optimal Portfolio 983 The Basic Assumptions of the Capital Asset Pricing Model 986 The Capital Market Line and the Security Market Line 987 Calculating Beta Coefficients 991 Box: Skill or Luck? 992 Empirical Tests of the CAPM 999 Arbitrage Pricing Theory 1002 Summary 1005 CHAPTER 26 Real Options 1011 Valuing Real Options 1012 The Investment Timing Option: An Illustration 1013 The Growth Option: An Illustration 1023 Concluding Thoughts on Real Options 1028 Summary 1030 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents xvii Web Extensions 26A: The Abandonment Real Option 26B: Risk-Neutral Valuation Appendix A Solutions to Self-Test Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . 1035 Appendix B Answers to End-of-Chapter Problems . . . . . . . . . . . . . . . . . . . . . . 1067 Appendix C Selected Equations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1077 Appendix D Values of the Areas under the Standard Normal Distribution Function Glossary . . . . . . . . . . . . . . . . . . . . . Name Index . . . . . . . . . . . . . . . . . . Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1091 . 1093 . 1121 . 1127 Web Chapters CHAPTER 27 Providing and Obtaining Credit CHAPTER 28 Advanced Issues in Cash Management and Inventory Control CHAPTER 29 Pension Plan Management CHAPTER 30 Financial Management in Not-for-Profit Businesses Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface © lulu/fotolia.com resource Students: Access the Financial Management: Theory and Practice (14th Edition) companion site and online student resources by visiting www.cengagebrain. com, searching for ISBN 9781111972202, and clicking “Access Now” under “Study Tools” to go to the student companion site. Instructors: Access the Financial Management: Theory and Practice (14th Edition) companion site and instructor resources by going to login.cengage.com, logging in with your faculty account username and password, and using ISBN 9781111972202 to reach the site through your account. When we wrote the first edition of Financial Management: Theory and Practice, we had four goals: (1) to create a text that would help students make better financial decisions; (2) to provide a book that could be used in the introductory MBA course, but one that was complete enough for use as a reference text in follow-on case courses and after graduation; (3) to motivate students by demonstrating that finance is both interesting and relevant; and (4) to make the book clear enough so that students could go through the material without wasting either their time or their professors’ time trying to figure out what we were saying. The collapse of the sub-prime mortgage market, the financial crisis, and the global economic crisis make it more important than ever for students and managers to understand the role that finance plays in a global economy, in their own companies, and in their own lives. So in addition to the four goals listed above, this edition has a fifth goal, to prepare students for a changed world. INTRINSIC VALUATION AS A UNIFYING THEME Our emphasis throughout the book is on the actions that a manager can and should take to increase the intrinsic value of the firm. Structuring the book around intrinsic valuation enhances continuity and helps students see how various topics are related to one another. As its title indicates, this book combines theory and practical applications. An understanding of finance theory is essential for anyone developing and/or implementing effective financial strategies. But theory alone isn’t sufficient, so we provide numerous examples in the book and the accompanying Excel spreadsheets to illustrate how theory is applied in practice. Indeed, we believe that the ability to analyze financial problems using Excel also is essential for a student’s successful job search and subsequent career. Therefore, many exhibits in the book come directly from the accompanying Excel spreadsheets. Many of the spreadsheets also provide brief “tutorials” by way of detailed comments on Excel features that we have found to be especially useful, such as Goal Seek, Tables, and many financial functions. The book begins with fundamental concepts, including background on the economic and financial environment, financial statements (with an emphasis on cash flows), the time value of money, bond valuation, risk analysis, and stock valuation. With this background, we go on to discuss how specific techniques and decision rules can be used to help maximize the value of the firm. This organization provides four important advantages: 1. Managers should try to maximize the intrinsic value of a firm, which is determined by cash flows as revealed in financial statements. Our early coverage of financial statements helps students see how particular financial decisions affect the various parts of the firm and the resulting cash flow. Also, financial statement analysis provides an excellent vehicle for illustrating the usefulness of spreadsheets. 2. Covering time value of money early helps students see how and why expected future cash flows determine the value of the firm. Also, it takes time for students to digest TVM concepts and to learn how to do the required calculations, so it is good to cover TVM concepts early and often. xviii Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xix 3. Most students—even those who do not plan to major in finance—are interested in investments. The ability to learn is a function of individual interest and motivation, so Financial Management’s early coverage of securities and security markets is pedagogically sound. 4. Once basic concepts have been established, it is easier for students to understand both how and why corporations make specific decisions in the areas of capital budgeting, raising capital, working capital management, mergers, and the like. INTENDED MARKET AND USE Financial Management is designed primarily for use in the introductory MBA finance course and as a reference text in follow-on case courses and after graduation. There is enough material for two terms, especially if the book is supplemented with cases and/or selected readings. The book can also be used as an undergraduate introductory text for exceptionally good students, or where the introductory course is taught over two terms. IMPROVEMENTS IN THE 14TH EDITION As in every revision, we updated and clarified materials throughout the text, reviewing the entire book for completeness, ease of exposition, and currency. We made hundreds of small changes to keep the text up to date, with particular emphasis on updating the realworld examples and including the latest changes in the financial environment and financial theory. In addition, we made a number of larger changes. Some affect all chapters, some involve reorganizing sections among chapters, and some modify material covered within specific chapters. Changes That Affect All Chapters Following are some of the changes that affect all chapters. THE GLOBAL ECONOMIC CRISIS. In every chapter we use real-world examples to show how the chapter’s topics are related to some aspect of the global economic crisis. In addition, many chapters have “Global Economic Crisis” boxes that focus on important issues related to the crisis. Last edition we began using the global economic crisis to illustrate important learning points, and we have continued that in this edition. ADDITIONAL INTEGRATION WITH EXCEL. We have continued to integrate the textbook and the accompanying Excel Tool Kit spreadsheet models for each chapter. Many figures in the textbook show the appropriate area from the chapter’s Excel Tool Kit model. This makes the analysis more transparent to the students and better enables them to follow the analysis in the Excel model. In addition, we have added the Mini Case data to a worksheet in the Excel Tool Kits in selected chapters, saving time for those students who do the Mini Cases. IMPROVEMENTS IN MICRODRIVE. As in previous editions, we use a hypothetical company, MicroDrive, as a running example to provide continuity and help students move up the learning curve more efficiently. However, we have made several changes to MicroDrive’s financial statements for this edition. First, the values are now all integers and in most cases end with zero, which simplifies many calculations. This seemingly minor change helps students learn the finance topics without being distracted by complicated calculations. Second, we have broken operating costs into costs of goods sold (excluding Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xx Preface depreciation), other operating costs, and depreciation. This allows more flexibility in defining ratios and in forecasting financial statements. Third, we have modified the values in the financial statements so that MicroDrive can be used as the illustrative company in more chapters and more topics than in the previous editions, especially in measuring systematic risk and estimating intrinsic value with the free cash flow model. Notable Changes within Selected Chapters We made too many small improvements within each chapter to mention them all, but some of the more notable ones are discussed below. CHAPTER 1: AN OVERVIEW OF FINANCIAL MANAGEMENT AND THE FINANCIAL ENVIRONMENT. We added a box on high-frequency trading, “Life in the Fast Lane: High-Frequency Trading!,” and a box on mortgage-backed securities, “Anatomy of a Toxic Asset.” We also increased our coverage of the global economic crisis to reflect changes in the past three years, including a section on the Dodd-Frank Act. CHAPTER 2: FINANCIAL STATEMENTS, CASH FLOW, AND TAXES. We reorganized and better integrated the sections on the statement of cash flows, operating cash flow, and free cash flow. We now have a single section focusing on the use of free cash flow and its components as performance measures. We added two new boxes. “Filling in the GAAP” describes the planned convergence of GAAP and IFRS; “When It Comes to Taxes, History Repeats and Repeals Itself!” discusses the actual taxes (or lack thereof) paid by many corporations. MicroDrive is the company used as a running example throughout the book. We changed its financial statements so that MicroDrive would provide additional learning points when we cover valuation and forecasting in Chapter 12. CHAPTER 3: ANALYSIS OF FINANCIAL STATEMENTS. We updated and revised the opening vignette to describe Macy’s earnings announcement and its stock price reaction. In previous editions, we defined the inventory turnover ratio using sales instead of COGS because some compilers of financial ratio statistics, such as Dun & Bradstreet, use the ratio of sales to inventories. However, most sources now report the turnover ratio using COGS, so we have changed our definition to conform to the majority of reporting organizations and now define the inventory turnover ratio as COGS/Inventories. Also, to be more consistent with many Web-based reporting organizations, we now define the debt ratio as total debt divided by total assets, the market debt ratio as total debt divided by total debt plus the market value of equity, and the debt-to-equity ratio as total debt divided by total common equity. MicroDrive is the company used as a running example throughout the book, and we changed its financial statements (which change its ratios) so that MicroDrive would offer additional learning points when we cover valuation and forecasting in Chapter 12. CHAPTER 4: TIME VALUE OF MONEY. We added a new box, “It’s a Matter of Trust,” that describes the future value of several multi-century trusts. Another new box, “What You Know Is What You Get: Not in Payday Lending,” which describes the effects of better disclosure on consumer borrowing decisions. We moved the section on perpetuities so that it now comes before the section on annuities, because perpetuities are simpler than annuities and because perpetuities are the “building blocks” of annuities. We also modified the example of consols to be denominated in pounds instead of dollars as part of our effort to add more international examples to each chapter. We added a discussion Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xxi of mortgage payments in Section 4.17, comparing the total interest paid on a 30-year mortgage to a 15-year mortgage. CHAPTER 5: BONDS, BOND VALUATION, AND INTEREST RATES. We refocused the opening vignette on the amount of debt held by corporations, noncorporate businesses, and households. We updated the box “Betting with or against the U.S. Government: The Case of Treasury Bond Credit Default Swaps” to reflect the debt-ceiling crisis of July 2011. We added another new box describing the handful of AAA rated companies, “The Few, the Proud, the… AAA-Rated Companies!” We revised another box, “Fear and Rationality,” to include the TED spread as well as the Hi-Yield bond spread. We also added a brief discussion of duration and its use as a measure of risk. MicroDrive is the company used as a running example throughout the book. We changed its example bond offering to be consistent with MicroDrive’s revised financial statements. CHAPTER 6: RISK AND RETURN. As a part of our effort to integrate the illustrative company MicroDrive throughout the book, we made significant changes in this chapter. We begin with a discussion of discrete probability distributions involving different market scenarios and then segue into continuous distributions and estimating means and standard deviations using historical data for MicroDrive. We discuss 2-stock portfolios and the impact of diversification by using data for MicroDrive and another company. This sets the stage for a discussion of market risk versus diversifiable risk and the appropriate measure of market risk, beta. We then describe the risk-return relationship defined by the CAPM and the basic concept of market equilibrium. This provides a natural transition into the efficient market hypothesis (previously in Chapter 7, the stock valuation chapter). We also added optional sections covering the Fama-French 3-factor model and behavioral finance. These optional sections can be omitted without loss of continuity, or they can be covered to provide more depth on the topic of market efficiency and asset pricing. This new organization consolidates our treatment of risk and return and also illustrates these concepts with MicroDrive, providing a more effective learning experience for students. CHAPTER 7: VALUATION OF STOCKS AND CORPORATIONS. We moved coverage of efficient markets into Chapter 6, where it is a natural extension of risk and return. This change permits Chapter 7 to focus on stock valuation. In addition to the dividend growth model, we moved coverage of the free cash flow valuation model from later in the book into Chapter 7; this chapter now provides comprehensive coverage of stock valuation via the dividend growth model and the free cash flow corporate valuation model. CHAPTER 9: THE COST OF CAPITAL. We have a new opening vignette focusing on the importance of the cost of capital to companies making equipment purchases. A new box, “How Effective Is the Effective Corporate Tax Rate?,” shows the differences between the statutory rate and the effective rate over time; it also compares the U.S. statutory and effective rate with those of other developed economies. For better integration, we now use the company in our running example, MicroDrive, to illustrate cost of capital estimation. We streamlined the chapter’s coverage of the forward-looking risk premium by moving the discussion of the relatively complex multistage model to a Web Extension. This allows the text’s coverage of the forward-looking premium focus on the concepts all MBA students need to understand, while at the same time letting the Web Extension address additional issues in more detail, such as the application of multistage models and the Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xxii Preface impact of stock repurchases. We now cover the over-own-bond-yield-plus-judgmentalrisk-premium approach in the section on privately held companies, because this approach is used more often for such companies. CHAPTER 10: THE BASICS OF CAPITAL BUDGETING: EVALUATING CASH FLOWS. The new opening vignette describes John Deere’s expansion plans and its commitment to disciplined capital budgeting. We improved the integration with Chapter 11 by revising the numerical example in Chapter 10 so that the cash flows for Project L are now the cash flows that we estimate in Chapter 11. We put all the material related to IRR (such as the possibility of multiple IRRs) in a single section to make our coverage of IRR more cohesive. CHAPTER 11: CASH FLOW ESTIMATION AND RISK ANALYSIS. A new opening vignette describes how several companies use risk analysis when making capital budgeting decisions. We revised the numerical example so that the cash flows we estimate in this chapter are the same cash flows we use in Chapter 10 for Project L. CHAPTER 12: CORPORATE VALUATION AND FINANCIAL PLANNING. We divided the financial planning process into two activities. First, we show how to forecast the operating portion of a financial plan, including free cash flows and estimates of intrinsic value. Second, we show how to take the operating forecast and combine it with a preliminary financial policy to forecast the complete financial statements. This structure makes it easier for students to grasp and gives instructors a choice of covering just the operating forecast or covering the complete projection of financial statements. CHAPTER 13: AGENCY CONFLICTS AND CORPORATE GOVERNANCE. We moved the valuation material from the previous edition to the stock valuation chapter (Chapter 7) and to the financial forecasting chapter (Chapter 13). In addition to better integrating the topics in those chapters, the move allows us to focus on agency conflicts and corporate governance in this chapter. We added a new opening vignette describing the shareholder rejection of Citigroup’s proposed compensation plan at the 2012 annual meetings. CHAPTER 14: DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES. We added a new opening vignette describing Apple’s dividend initiation. We added a new Self-Test Problem addressing the impact of dividends versus repurchases. CHAPTER 15: CAPITAL STRUCTURE DECISIONS. While updating Section 15-4 to include results from the latest empirical tests, we also reorganized the material and added subheadings to make it easier to for students to synthesize. We moved the current valuation of Strausburg, the illustrative company, so that it immediately precedes Strausburg’s recapitalization, which provides a better segue into the valuation effects of recapitalizations. CHAPTER 16: SUPPLY CHAINS AND WORKING CAPITAL MANAGEMENT. We added two new boxes, “Your Check Isn’t in the Mail,” and “A Wag of the Finger or Tip of the Hat? The Colbert Report and Small Business Payment Terms.” We rewrote the first section in the chapter to better distinguish between cash (including cash equivalents and marketable securities) used to support current operations and short-term investments (including marketable securities) held for possible future uses. We continued this distinction throughout the chapter in our discussions of cash management and managing shortterm investments. Recall that in Chapter 3 we updated our definition of inventory turnover ratio to COGS/Inventories to be consistent with the majority of reporting, so we followed through with that definition in Chapter 16. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xxiii CHAPTER 17: MULTINATIONAL FINANCIAL MANAGEMENT. A new opening vignette describes the interconnectedness of global financial markets and begins a discussion of the Eurozone crisis that we continue throughout the chapter. We added a section on foreign exchange notation to ensure that all readers will better understand the relative values of currencies as reported by the financial press. We added a new figure showing the growth in employment by U.S. multinational corporations, including the mix of domestic and international employment. We added a new figure showing the value of the dollar index relative to major currencies to show how demand for the dollar and its relative value has changed over time. We added a new section on sovereign debt, including a brief discussion of the current Greek debt crisis. CHAPTER 18: PUBLIC AND PRIVATE FINANCING: INITIAL OFFERINGS, SEASONED OFFERINGS, AND INVESTMENT BANKS. The new opening vignette describes Facebook’s IPO and the events of the month that followed. We added a section describing how the offer price is set in an IPO. 19: LEASE FINANCING. We changed the definition of the net advantage of leasing (NAL) to: NAL = Present value of leasing – Present value of owning. Both present values are negative, so a positive NAL means that leasing should be preferred. The results from using this definition of NAL are unchanged from previous editions, but our students find this definition more intuitive. CHAPTER 20: HYBRID FINANCING: PREFERRED STOCK, WARRANTS, AND CONVERTIBLES. We added a new box describing the deductibility of preferred dividends by Section 521 cooperatives entitled “Hybrids Aren’t Only for Corporations.” CHAPTER 21: DYNAMIC CAPITAL STRUCTURES. We added a new opening vignette describing changes in Hewlett-Packard’s capital structure. We rewrote the chapter and organized it around the fundamental concept that a levered firm’s value is equal to its unlevered value plus any side effects due to leverage. From this general concept, we examine special cases, including the MM models and the compressed adjusted present value (APV) model. In addition to the static case of a constant capital structure and constant growth, we apply the APV model to situations with dynamic capital structures that vary from year to year before becoming constant. We retained the MM proofs and put them in a separate section, which provides flexibility to instructors in selecting topics to cover. CHAPTER 23: ENTERPRISE RISK MANAGEMENT. We rewrote much of the chapter, changing it from a chapter about derivatives with applications in risk management to a chapter about enterprise risk management with applications of derivatives as one of several tools in managing risk. We adapted the general enterprise risk management framework of the Treadway Commission’s Committee of Sponsoring Organizations (COSO) because it satisfies the requirements of the Sarbanes-Oxley Act and the Foreign Corrupt Practices Act (FCPA). We now include the use of Monte Carlo simulation as a technique for identifying risk. We use the results of a simulation example to illustrate VaR and the expected shortfall (ES) measures that is recommended by Basel III. CHAPTER 24: BANKRUPTCY, REORGANIZATION, AND LIQUIDATION. We added a new section describing the events leading to GM’s government bailout, bankruptcy, and IPO. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xxiv Preface LEARNING TOOLS AVAILABLE AND INSTRUCTORS TO STUDENTS Financial Management includes a broad range of ancillary materials designed to enhance students’ learning and to make it easier for instructors to prepare for and conduct classes. All resources available to students are also available to instructors; in addition, instructors have access to the course management tools. In addition to these resources and the items noted previously, many other resources are available on the Web at Financial Management’s Web site. These ancillaries include the following: Excel Tool Kits Proficiency with spreadsheets is an absolute necessity for all MBA students. With that in mind, for each chapter we created Excel spreadsheets, called Tool Kits, to show how the calculations used in the chapter were done. The Tool Kit models include explanations that show students how to use many of the features and functions of Excel, enabling the Tool Kits to serve as self-taught tutorials. Web Extensions Many chapters have Adobe PDF “appendices” that provide more detailed coverage of topics that were addressed in the chapter End-of-Chapter Spreadsheet Problems Each chapter has a Build a Model problem, where students start with a spreadsheet that contains financial data plus general instructions about solving a specific problem. The model is partially completed, with headings but no formulas, so the student must literally build a model. This structure guides the student through the problem, minimizes unnecessary typing and data entry, and also makes it easy to grade the work, because all students’ answers are in the same locations on the spreadsheet. The partial spreadsheets for the Build a Model problems are available to students on the book’s Web site; the completed models are in files on the Instructor’s portion of the Web site. THOMSON ONE—BUSINESS SCHOOL EDITION Thomson ONE–Business School Edition (TO:BSE) is an online database that draws from the world-acclaimed Thomson Reuters data sources. This product includes Thomson ONE Investment Banking assets which deliver world class content and powerful analytical tools via a web interface. TO:BSE enables students to gain insight into the financial markets by accessing data and analysis used by the deal-making community globally, such as investment bankers and consultancies. This product provides access to market news and comprehensive reference data to monitor changing market conditions and to gain insight into a company, industry or event. It consists of a foundation solution for market awareness and company insight. TO:BSE provides one-click download of financial statements to Excel, data from domestic and international companies, one-click Peer Set analysis, as well as other valuable tools useful in learning finance. Many chapters contain problems based on the data that is available in TO:BSE. Some of the key information that is available in the database includes: Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xxv I/B/E/S Consensus Estimates Find consensus estimates–averages, means, and medians; analyst-by-analyst earnings coverage; analysts’ forecasts based on 15 industry standard measures; current and historic coverage for the selected 500 companies. Current coverage is five years forward plus historic data from 1976 for U.S. companies and from 1987 for international companies, with current data updated daily and historic data updated monthly. Financials View current and historical financial information covering 99% of global market capitalization. You can access financial statements, key ratios and summary financial information for more than 70,000 active and inactive companies and click through to the underlying source. View financials in the format you prefer with both standardized and as-reported formats available. Company and Financial Information Find data for over one million private companies globally plus private company profiles including business descriptions, private equity investors and fund names, key executives and investment round details. Streaming Reuters News and Quotes Constantly monitor changing market conditions and breaking news in real time with Reuters News and other third-party news services. Reuters News includes market moving stories and comprehensive analysis on companies, industries, market trends, and more. It is the leading source of breaking news with the broadest coverage across sectors, geographies and markets from 2,700 journalists across 200 bureaus worldwide. Market Awareness Summary pages provide quick access to world indices, currencies and key exchange metrics like new highs and new lows, LIBOR, Benchmark bond yields and Treasury rates. View the latest key indicators through Thomson Reuters Datastream economics and a comprehensive calendar of upcoming indicators so you are always on top of the factors affecting market sentiment. Filings Access the largest database of international filings with 19 million documents that 60,000 companies filed with stock exchanges and regulatory agencies such as the LSE and the SEC, dating back to the late 1960s. COURSE MANAGEMENT TOOLS AVAILABLE ONLY TO INSTRUCTORS Instructors have access to all of the materials listed above in addition to course management tools. These tools are available at Financial Management’s Instructor companion Web site and on the Instructor’s Resource CD. These materials include the following resources. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xxvi Preface Solutions Manual This comprehensive manual contains worked-out solutions to all end-of-chapter materials. It is available in both printed and electronic formats. PowerPoint Slides For each chapter, we provide a set of PowerPoint slides that present graphs, tables, lists, and calculations for use in lectures. Although the slides correspond to the Mini Cases at the end of the chapter, the slides are completely self-contained in the sense that they can be used for lectures regardless of whether students have read the Mini Cases. In fact, we often don’t assign the Mini Case but we do use the PowerPoint slides. Copies of these files are on the Instructor’s Web site and the CengageNOW site. Instructors can easily customize the slides and convert them quickly into any PowerPoint Design Template.1 If you add some of your own slides or modify the existing slides to better illustrate important concepts, please share your changes with us—many of our best learning points have come from instructors and we appreciate all suggestions for ways to improve learning experiences for students. In addition to the slides, there is a Mini Case at the end of each chapter. We assign the Mini Cases only for specific chapters, but some professors assign the Mini Cases for most chapters. These cases cover all the essential issues presented in the chapter, and they provide the structure for our class lectures even if we don’t assign the Mini Case. Mini Case Spreadsheets In addition to the PowerPoint slides, we also provide Excel spreadsheets that perform the calculations required in the Mini Cases. These spreadsheets are similar to the Tool Kits except (a) the numbers correspond to the Mini Cases rather than the chapter examples, and (b) we added some features that enable “what if” analysis on a real-time basis in class. We usually begin our lectures with the PowerPoint presentation, but after we have explained a basic concept we “toggle” to the Mini Case Excel file and show how the analysis can be done in Excel.2 For example, when teaching bond pricing, we begin with the PowerPoint show and cover the basic concepts and calculations. Then we toggle to Excel and use a sensitivity-based graph to show how bond prices change as interest rates and time to maturity vary. More and more students are bringing their laptops to class— they can follow along and do the “what if” analysis for themselves. Solutions to End-of-Chapter Spreadsheet Problems The partial spreadsheets for the Build a Model problems are available to students, and the completed models are in files on the Instructor’s Web site. Solutions to Thomson ONE—BSE Problem Sets The Thomson ONE—BSE problem sets require students to use real-world data. Although the solutions change daily as the data change, we provide instructors with “representative” answers. 1 To convert into PowerPoint for Office 2010, select Design, Theme, and choose a theme. To convert into PowerPoint for Office 2007, select Format, Apply Design Template, and then pick any template. Always doublecheck the conversion; some templates use fonts of different sizes, which can cause some slide titles to run over their allotted space. 2 To toggle between two open programs, such as Excel and PowerPoint, hold the Alt key down and hit the Tab key until you have selected the program you want to show. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xxvii Test Bank The Test Bank contains more than 1,200 class-tested questions and problems. Information regarding the topic and degree of difficulty, along with the complete solution for all numerical problems, is provided with each question. The Test Bank is available in three forms: (1) in a printed book, (2) in Microsoft Word files, and (3) in a computerized test bank software package, ExamView, which has many features that make test preparation, scoring, and grade recording easy—including the ability to generate different versions of the same problem. With ExamView, instructors can easily export questions into Blackboard and WebCT. Optional Materials for Your Students We developed a printed Study Guide for this textbook, which includes an overview and outline of the chapter with brief explanations of key concepts. The Study Guide also has practice questions and problems for the students, along with the worked-out solutions. Students who have good math skills or who have taken a previous course in finance probably don’t need the Study Guide, but many students who don’t have that background have told us that our Study Guide is very helpful. Therefore, when ordering books for our course, we order this Study Guide as an optional book, not a required book. It is also possible for an instructor to order the Solutions Manual as an optional book for students. ADDITIONAL COURSE TOOLS CengageNOWTM for Financial Management: Theory and Practice. Designed by instructors for instructors, CengageNOWTM mirrors your natural workflow and provides time-saving, performance-enhancing tools for you and your students–all in one program! CengageNOWTM takes the best of current technology tools including online homework management and fully customizable algorithmic end-of-chapter problems and test bank to support your course goals and save you significant preparation and grading time! • Plan student assignments with an easy online homework management component • Manage your grade book with ease • Teach today’s student using valuable course support materials • Reinforce student comprehension with Personalized Study • Test with customizable algorithmic end-of-chapter problems that provide students with immediate feedback upon answer submission • Grade automatically for seamless, immediate results ApliaTM Finance Aplia™ Finance, an interactive learning system, engages students in course concepts, ensures they practice on a regular basis, and helps them prepare to learn finance through a series of problems and tutorials. Created by an instructor to help students excel, bookspecific problem sets have instant grades and detailed feedback, ensuring students have the opportunity to learn from and improve with every question. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xxviii Preface Chapter assignments use the same language and tone of the course textbook, giving students a seamless experience in and out of the classroom. Problems are automatically graded and offer detailed explanations, helping students learn from every question. Aplia™ Finance offers: • Problem Sets: Chapter-specific problem sets ensure that students are completing finance assignments on a regular basis. • Preparing for Finance Tutorials: Hands-on tutorials solve math, statistics, economics, and accounting roadblocks before they become a problem in the course, and financial calculator tutorials help students learn to use the tools needed in a finance course. • Finance in Action: Exploratory modules help students understand how financial theories are applied in the real world, and how finance professionals synthesize, use, and apply financial information. • Course Management System • MindTap Reader: Aplia now features Cengage’s premier ebook format. MindTap Reader is highly interactive, allows for inline note-taking and highlighting, and features a variety of apps to further assist students. For more information, visit www.aplia.com/finance. CengageCompose Cases More than 100 cases written by Eugene F. Brigham, Linda Klein, and Chris Buzzard are available via CengageCompose, an online case library. Cases are organized in a database that allows instructors to select individual cases or to create customized casebooks. Most cases have optional spreadsheet models that reduce number crunching, which allows more time for students to consider conceptual issues. The models also show students how computers can be used to make better financial decisions. Cases that we have found particularly useful for the different chapters are listed in the end-of-chapter references. The cases, case solutions, and spreadsheet models can be previewed and ordered by professors at compose.cengage.com. Cengage Learning Custom Solutions Whether you need print, digital, or hybrid course materials, Cengage Learning Custom Solutions can help you create your perfect learning solution. Draw from Cengage Learning’s extensive library of texts and collections, add or create your own original work, and create customized media and technology to match your learning and course objectives. Our editorial team will work with you through each step, allowing you to concentrate on the most important thing—your students. Learn more about all of our custom services at www.cengage.com/custom. The Cengage Global Economic Watch (GEW) Resource Center This is your source for turning today’s challenges into tomorrow’s solutions. This online portal houses the most up-to-date content concerning the economic crisis. Organized by discipline, the GEW Resource Center offers the solutions instructors and students need in an easy-to-use format. Included are an overview and timeline of the historical events leading up to the crisis, links to the latest news and resources, discussion Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xxix and testing content, an instructor feedback forum, and a Global Issues Database. Visit www.cengage.com/thewatch for more information. ACKNOWLEDGMENTS This book reflects the efforts of a great many people over a number of years. First, we would like to thank the following reviewers of the Thirteenth Edition for their suggestions: Loreto Peter Alonzi Michael H. Anderson T. Homer Bonitsis Alka Bramhandkar Bill Brunsen Deanne Butchey Manfen W. Chen Ting-Heng Chu Simona S. Citron Robert M. Donchez Anne Drougas David A. Dumpe Ibrahim Elsaif Suzanne Erickson Gary Engle Eliezer Fich Jane Finley Stuart L. Gillan Axel Grossmann James D. Harriss Mary Hartman Rodrigo Hernandez Amy Ho Biqing Huang Robert Irons Ashok Kapoor Brian Kluger Karen Eilers Lahey Angeline M. Lavin K. Sunny Liston Raymond H. Lopez Neil Mathur M. Imtiaz Mazumder Michael McBain Ronald W. Melicher Terrilyn Morgan Edward Morris Mark Pate Bruce C. Payne Armand Picou Gerard Ras William C. Sarsfield Amy K.S. Scott Arnav Sheth James L. Slaydon Steven Slezak Gordon Smith Richard D.C. Trainer Tim Khiem Tran Gary P. Tripp Kudret Topyan Irena Vodenska Elizabeth J. Wark Alex Wilson In addition, we appreciate the many helpful comments and suggestions from other instructors, including Greg Faulk, Anthony Gu, Andrew Mose, Chee Ng, and John Stieven. We are especially grateful to Serge Wind, who provided many hints and tips for improving the learning points in our textbook. Many professors and professionals who are experts on specific topics reviewed earlier versions of individual chapters or groups of chapters, and we are grateful for their insights; in addition, we would like to thank those whose reviews and comments on earlier editions and companion books have contributed to this edition: Mike Adler, Syed Ahmad, Sadhana M. Alangar, Ed Altman, Mary Schary Amram, Anne Anderson, Bruce Anderson, Ron Anderson, Bob Angell, Vince Apilado, Henry Arnold, Nasser Arshadi, Bob Aubey, Abdul Aziz, Gil Babcock, Peter Bacon, Kent Baker, Tom Bankston, Les Barenbaum, Charles Barngrover, Michael Barry, Bill Beedles, Moshe Ben-Horim, Omar M. Benkato, Bill Beranek, Tom Berry, Bill Bertin, Roger Bey, Dalton Bigbee, John Bildersee, Rahul Bishnoi, Eric Blazer, Russ Boisjoly, Keith Boles, Gordon R. Bonner, Geof Booth, Kenneth Boudreaux, Helen Bowers, Oswald Bowlin, Don Boyd, G. Michael Boyd, Pat Boyer, Ben S. Branch, Joe Brandt, Elizabeth Brannigan, Greg Brauer, Mary Broske, Dave Brown, Kate Brown, Bill Brueggeman, Kirt Butler, Robert Button, Chris Buzzard, Bill Campsey, Bob Carleson, Severin Carlson, David Cary, Steve Celec, Don Chance, Antony Chang, Susan Chaplinsky, Jay Choi, S. K. Choudhury, Lal Chugh, Jonathan Clarke, Maclyn Clouse, Margaret Considine, Phil Cooley, Joe Copeland, David Cordell, John Cotner, Charles Cox, David Crary, John Crockett, Roy Crum, Brent Dalrymple, Bill Damon, Joel Dauten, Steve Dawson, Sankar De, Miles Delano, Fred Dellva, Anand Desai, Bernard Dill, Greg Dimkoff, Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xxx Preface Les Dlabay, Mark Dorfman, Gene Drycimski, Dean Dudley, David Durst, Ed Dyl, Dick Edelman, Charles Edwards, John Ellis, Dave Ewert, John Ezzell, Richard Fendler, Michael Ferri, Jim Filkins, John Finnerty, Susan Fischer, Mark Flannery, Steven Flint, Russ Fogler, E. Bruce Frederickson, Dan French, Tina Galloway, Partha Gangopadhyay, Phil Gardial, Michael Garlington, Sharon H. Garrison, Jim Garvin, Adam Gehr, Jim Gentry, Stuart Gillan, Philip Glasgo, Rudyard Goode, Myron Gordon, Walt Goulet, Bernie Grablowsky, Theoharry Grammatikos, Ed Grossnickle, John Groth, Alan Grunewald, Manak Gupta, Sam Hadaway, Don Hakala, Janet Hamilton, Sally Hamilton, Gerald Hamsmith, William Hardin, John Harris, Paul Hastings, Patty Hatfield, Bob Haugen, Steve Hawke, Del Hawley, Hal Heaton, Robert Hehre, John Helmuth, George Hettenhouse, Hans Heymann, Kendall Hill, Roger Hill, Tom Hindelang, Linda Hittle, Ralph Hocking, J. Ronald Hoffmeister, Jim Horrigan, John Houston, John Howe, Keith Howe, Hugh Hunter, Steve Isberg, Jim Jackson, Vahan Janjigian, Kurt Jesswein, Kose John, Craig Johnson, Keith Johnson, Steve Johnson, Ramon Johnson, Ray Jones, Manuel Jose, Gus Kalogeras, Mike Keenan, Bill Kennedy, Joe Kiernan, Robert Kieschnick, Rick Kish, Linda Klein, Don Knight, Dorothy Koehl, Theodor Kohers, Jaroslaw Komarynsky, Duncan Kretovich, Harold Krogh, Charles Kroncke, Lynn Phillips Kugele, Joan Lamm, P. Lange, Howard Lanser, Martin Laurence, Ed Lawrence, Richard LeCompte, Wayne Lee, Jim LePage, Ilene Levin, Jules Levine, John Lewis, James T. Lindley, Chuck Linke, Bill Lloyd, Susan Long, Judy Maese, Bob Magee, Ileen Malitz, Phil Malone, Terry Maness, Chris Manning, Terry Martell, D. J. Masson, John Mathys, John McAlhany, Andy McCollough, Tom McCue, Bill McDaniel, Robin McLaughlin, Jamshid Mehran, Ilhan Meric, Larry Merville, Rick Meyer, Stuart E. Michelson, Jim Millar, Ed Miller, John Mitchell, Carol Moerdyk, Bob Moore, Hassan Moussawi, Barry Morris, Gene Morris, Fred Morrissey, Chris Muscarella, Stu Myers, David Nachman, Tim Nantell, Don Nast, Bill Nelson, Bob Nelson, Bob Niendorf, Tom O’Brien, Dennis O’Connor, John O’Donnell, Jim Olsen, Robert Olsen, Frank O’Meara, David Overbye, R. Daniel Pace, Coleen Pantalone, Jim Pappas, Stephen Parrish, Pam Peterson, Glenn Petry, Jim Pettijohn, Rich Pettit, Dick Pettway, Hugo Phillips, John Pinkerton, Gerald Pogue, Ralph A. Pope, R. Potter, Franklin Potts, R. Powell, Chris Prestopino, Jerry Prock, Howard Puckett, Herbert Quigley, George Racette, Bob Radcliffe, Allen Rappaport, Bill Rentz, Ken Riener, Charles Rini, John Ritchie, Jay Ritter, Pietra Rivoli, Fiona Robertson, Antonio Rodriguez, E. M. Roussakis, Dexter Rowell, Mike Ryngaert, Jim Sachlis, Abdul Sadik, A. Jon Saxon, Thomas Scampini, Kevin Scanlon, Frederick Schadler, James Schallheim, Mary Jane Scheuer, Carl Schweser, John Settle, Alan Severn, Sol Shalit, Elizabeth Shields, Frederic Shipley, Dilip Shome, Ron Shrieves, Neil Sicherman, J. B. Silvers, Clay Singleton, Joe Sinkey, Stacy Sirmans, Jaye Smith, Steve Smith, Don Sorenson, David Speairs, Ken Stanly, John Stansfield, Ed Stendardi, Alan Stephens, Don Stevens, Jerry Stevens, G. Bennett Stewart, Mark Stohs, Glen Strasburg, Robert Strong, Philip Swensen, Ernie Swift, Paul Swink, Eugene Swinnerton, Robert Taggart, Gary Tallman, Dennis Tanner, Craig Tapley, Russ Taussig, Richard Teweles, Ted Teweles, Andrew Thompson, Jonathan Tiemann, Sheridan Titman, George Trivoli, George Tsetsekos, Alan L. Tucker, Mel Tysseland, David Upton, Howard Van Auken, Pretorious Van den Dool, Pieter Vanderburg, Paul Vanderheiden, David Vang, Jim Verbrugge, Patrick Vincent, Steve Vinson, Susan Visscher, Joseph Vu, John Wachowicz, Mark D. Walker, Mike Walker, Sam Weaver, Kuo Chiang Wei, Bill Welch, Gary R. Wells, Fred Weston, Norm Williams, Tony Wingler, Ed Wolfe, Larry Wolken, Don Woods, Thomas Wright, Michael Yonan, Zhong-guo Zhou, David Ziebart, Dennis Zocco, and Kent Zumwalt. Special thanks are due to Dana Clark, Susan Whitman, Amelia Bell, and Kirsten Benson, who provided invaluable editorial support; to Joel Houston and Phillip Daves, whose work with us on other books is reflected in this text; and to Lou Gapenski, our past co-author, for his many contributions. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface xxxi Our colleagues and our students at the Universities of Florida and Tennessee gave us many useful suggestions, and the Cengage/South-Western staff—especially Kendra Brown, Scott Fidler, Holly Henjum, and Mike Reynolds—helped greatly with all phases of text development, production, and marketing. ERRORS IN THE TEXT At this point, authors generally say something like this: “We appreciate all the help we received from the people listed above, but any remaining errors are, of course, our own responsibility.” And in many books, there are plenty of remaining errors. Having experienced difficulties with errors ourselves, both as students and as instructors, we resolved to avoid this problem in Financial Management. As a result of our error-detection procedures, we are convinced that the book is relatively free of mistakes. Partly because of our confidence that few such errors remain, but primarily because we want to detect any errors in the textbook that may have slipped by so we can correct them in subsequent printings, we decided to offer a reward of $10 per error to the first person who reports a textbook error to us. For purposes of this reward, errors in the textbook are defined as misspelled words, nonrounding numerical errors, incorrect statements, and any other error that inhibits comprehension. Typesetting problems such as irregular spacing and differences in opinion regarding grammatical or punctuation conventions do not qualify for this reward. Also, given the ever-changing nature of the Internet, changes in Web addresses do not qualify as errors, although we would appreciate reports of changed Web addresses. Finally, any qualifying error that has follow-through effects is counted as two errors only. Please report any errors to Michael C. Ehrhardt at the e-mail address given below. CONCLUSION Finance is, in a real sense, the cornerstone of the free enterprise system. Good financial management is therefore vitally important to the economic health of business firms, hence to the nation and the world. Because of its importance, corporate finance should be thoroughly understood. However, this is easier said than done—the field is relatively complex, and it is undergoing constant change in response to shifts in economic conditions. All of this makes corporate finance stimulating and exciting, but also challenging and sometimes perplexing. We sincerely hope that Financial Management: Theory and Practice will help readers understand and solve the financial problems businesses face today. Michael C. Ehrhardt University of Tennessee Ehrhardt@utk.edu Eugene F. Brigham University of Florida Gene.Brigham@cba.ufl.edu December 2012 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 1 The Company and Its Environment PART © lulu/fotolia.com CHAPTER 1 An Overview of Financial Management and the Financial Environment 3 CHAPTER 2 Financial Statements, Cash Flow, and Taxes CHAPTER 51 3 Analysis of Financial Statements 95 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. CHAPTER An Overview of Financial Management and the Financial Environment © Adalberto Rios Szalay/Sexto Sol/Getty Images WWW See money.cnn.com/ magazines/fortune for updates on the ranking. 1 I n a global beauty contest for companies, the winner is . . . Apple Computer. Or at least Apple is the most admired company in the world, according to Fortune magazine’s annual survey. The others in the global top ten are Google, Berkshire Hathaway, Southwest Airlines, Procter & Gamble, Coca-Cola, Amazon.com, FedEx, Microsoft, and McDonald’s. What do these companies have that separates them from the rest of the pack? According to a survey of executives, directors, and security analysts, these companies have very high average scores across nine attributes: (1) innovativeness, (2) quality of management, (3) long-term investment value, (4) social responsibility, (5) employee talent, (6) quality of products and services, (7) financial soundness, (8) use of corporate assets, and (9) effectiveness in doing business globally. After culling weaker companies, the final rankings are then determined by over 3,700 experts from a wide variety of industries. What do these companies have in common? First, they have an incredible focus on using technology to understand their customers, reduce costs, reduce inventory, and speed up product delivery. Second, they continually innovate and invest in ways to differentiate their products. Some are known for game-changing products, such as Apple’s iPad. Others continually introduce small improvements, such as Southwest Airlines’s streamlined boarding procedures. In addition to their acumen with technology and customers, they are also on the leading edge when it comes to training employees and providing a workplace in which people can thrive. Prior to the global economic crisis, these companies maintained reasonable debt levels and avoided overpaying for acquisitions. This allowed them to weather the crisis and position themselves for stronger subsequent performance than many of their competitors. In a nutshell, these companies reduce costs by having innovative production processes, they create value for customers by providing high-quality products and services, and they create value for employees by training and fostering an environment that allows employees to utilize all of their skills and talents. As you will see throughout this book, the resulting cash flow and superior return on capital also create value for investors. 3 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 4 Pa r t 1 The Company and Its Environment GLOBALECONOMICCRISIS © uniquely india/Getty Images The Global Economic Crisis The global economic crisis is like a guest at a party who has one drink and is very interesting and entertaining but who then has many more drinks, gets sick, and lingers on after everyone else has left. At the risk of oversimplification, this is what happened during the past decade: Many of the world’s individuals, financial institutions, and governments borrowed too much money and used those borrowed funds to make speculative investments. Those investments turned out to be worth less than the amounts owed by the borrowers, forcing widespread bankruptcies, buyouts, and restructurings for both borrowers and lenders. This in turn reduced the supply of available funds that resource The textbook’s Web site has tools for teaching, learning, and conducting financial research. financial institutions normally lent to creditworthy individuals, manufacturers, and retailers. Without access to credit, consumers bought less, manufacturers produced less, and retailers sold less—all of which led to layoffs. According to the National Bureau of Economic Research, the resulting recession lasted from December 2007 through June 2009. But as we write this chapter in 2012, the U.S. economy is still not growing very quickly. As we progress through this chapter and the rest of the book, we will discuss different aspects of the crisis. For real-time updates, go to the Global Economic Watch (GEW) Resource Center at www.cengage.com/thewatch. This chapter should give you an idea of what financial management is all about, including an overview of the financial markets in which corporations operate. Before going into details, let’s look at the big picture. You’re probably in school because you want an interesting, challenging, and rewarding career. To see where finance fits in, here’s a five-minute MBA. 1-1 The Five-Minute MBA Okay, we realize you can’t get an MBA in five minutes. But just as an artist quickly sketches the outline of a picture before filling in the details, we can sketch the key elements of an MBA education. The primary objective of an MBA program is to provide managers with the knowledge and skills they need to run successful companies, so we start our sketch with some common characteristics of successful companies. In particular, all successful companies are able to accomplish two main goals: 1. All successful companies identify, create, and deliver products or services that are highly valued by customers—so highly valued that customers choose to purchase from them rather than from their competitors. 2. All successful companies sell their products/services at prices that are high enough to c...
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