Unformatted Attachment Preview
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).
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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
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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
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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
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Cover and Internal Designer: c miller design
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Student Edition ISBN-13: 978-1-111-97221-9
Student Edition ISBN-10: 1-111-97221-4
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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
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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
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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
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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
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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
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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
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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
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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
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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 . . . . . . . . . . . . . . . . .
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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
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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
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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
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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
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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
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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.
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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
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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
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4
Pa r t 1
The Company and Its Environment
GLOBALECONOMICCRISIS
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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...