Fundamentals of financial management

Preface

Part 1. Introduction to Financial Management

Chapter 1. An Overview of Financial Management

Striking the Right Balance

Putting Things in Perspective

1.1. Forms of Business Organization

1.2. Stock Prices and Shareholder Value

1.3. Intrinsic Values, Stock Prices, and Compensation Plans

1.4. Some Important Trends

Is Shareholder Wealth Maximization a Worldwide Goal?

1.5. Business Ethics

What Companies Are Doing

Consequences of Unethical Behavior

How Should Employees Deal with Unethical Behavior?

Protection for Whistle-Blowers

1.6. Conflicts between Managers and Stockholders

1.7. The Role of Finance in the Organization

Tying it All Together

Part 2. Fundamental Concepts in Financial Management

Chapter 2. Time Value of Money

Will You Be Able to Retire?

Putting Things in Perspective

2.1. Time Lines

2.2. Future Values

Simple versus Compound Interest

1. Step-by-Step Approach

2. Formula Approach

3. Financial Calculators

4. Spreadsheets

Hints on Using Financial Calculators

Graphic View of the Compounding Process

2.3. Present Values

Graphic View of the Discounting Process

2.4. Finding the Interest Rate, I

2.5. Finding the Number of Years, N

2.6. Annuities

2.7. Future Value of an Ordinary Annuity

2.8. Future Value of an Annuity Due

2.9. Present Value of an Ordinary Annuity

2.10. Finding Annuity Payments, Periods, and Interest Rates

Finding Annuity Payments, PMT

Finding the Number of Periods, N

Finding the Interest Rate, I

2.11. Perpetuities

2.12. Uneven Cash Flows

2.13. Future Value of an Uneven Cash Flow Stream

2.14. Solving for I with Uneven Cash Flows

2.15. Semiannual and Other Compounding Periods

2.16. Comparing Interest Rates

2.17. Fractional Time Periods

2.18. Amortized Loans

Tying it All Together

Integrated Case: First National Bank

Web Appendix 2A. Continuous Compounding and Discounting

Chapter 3. Financial Statements, Cash Flow, and Taxes

Doing Your Homework with Financial Statements

Putting Things in Perspective

3.1. A Brief History of Accounting and Financial Statements

3.2. Financial Statements and Reports

3.3. The Balance Sheet

3.4. The Income Statement

3.5. Net Cash Flow

3.6. Statement of Cash Flows

Massaging the Cash Flow Statement

3.7. Statement of Retained Earnings

3.8. Uses and Limitations of Financial Statements

Financial Analysis on the Internet

3.9. Modifying Accounting Data for Investor and Managerial Decisions

Operating Assets and Operating Capital

Operating Cash Flows

Free Cash Flow

3.10. MVA and EVA

3.11. The Federal Income Tax System

Corporate Taxes

Personal Taxes

Interest Paid

Interest Earned

Dividends Paid

Dividends Received

Tax Loss Carry-Back and Carry-Forward

Capital Gains

Depreciation

Small Businesses

Tying it All Together

Integrated Case: D'Leon Inc., Part I

Web Appendix 3A. The Federal Income Tax System

Chapter 4. Analysis of Financial Statements

Lessons Learned from Enron and WorldCom

Putting Things in Perspective

4.1. Ratio Analysis

4.2. Liquidity Ratios

Current Ratio

Quick, or Acid Test, Ratio

4.3. Asset Management Ratios

Inventory Turnover Ratio

Days Sales Outstanding

Fixed Assets Turnover Ratio

Total Assets Turnover Ratio

4.4. Debt Management Ratios

Total Debt to Total Assets

Times-Interest-Earned Ratio

EBITDA Coverage Ratio

4.5. Profitability Ratios

Profit Margin on Sales

Global Perspectives: Global Accounting Standards: Can One Size Fit All?

Return on Total Assets

Basic Earning Power (BEP) Ratio

Return on Common Equity

4.6. Market Value Ratios

Price/Earnings Ratio

Price/Cash Flow Ratio

Market/Book Ratio

4.7. Trend Analysis

4.8. Tying the Ratios Together: The Du Pont Equations

4.9. Comparative Ratios and "Benchmarking"

Looking for Warning Signs within the Financial Statements

4.10. Uses and Limitations of Ratio Analysis

4.11. Problems with ROE

EVA and ROE

4.12. Looking Beyond the Numbers

Tying it All Together

Integrated Case: D'Leon Inc., Part II

Chapter 5. Financial Markets and Institutions

A Strong Financial System Is Necessary for a Growing and Prosperous Economy

Putting Things in Perspective

5.1. An Overview of the Capital Allocation Process

5.2. Financial Markets

Types of Markets

Recent Trends

5.3. Financial Institutions

5.4. The Stock Market

Citigroup Built to Compete in a Changing Environment

The Physical Location Stock Exchanges

The NYSE and Nasdaq Combine Forces with the Leading Online Trading Systems

The Over-the-Counter and the Nasdaq Stock Markets

5.5. The Market for Common Stock

Types of Stock Market Transactions

5.6. Stock Markets and Returns

Stock Market Reporting

Stock Market Returns

5.7. Stock Market Efficiency

Levels of Market Efficiency

Measuring the Market

Implications of Market Efficiency

Is the Stock Market Efficient?

A Closer Look at Behavioral Finance Theory

Tying it All Together

Integrated Case: Smyth Barry & Company, Part I

Part 3. Financial Assets

Chapter 6. Interest Rates

Low Interest Rates Encourage Investment and Stimulate Consumer Spending

Putting Things in Perspective

6.1. The Cost of Money

6.2. Interest Rate Levels

6.3. The Determinants of Market Interest Rates

The Real Risk-Free Rate of Interest, r*

The Nominal, or Quoted, Risk-Free Rate of Interest, r[subscript RF]

Inflation Premium (IP)

Default Risk Premium (DRP)

An Almost Riskless Treasury Bond

Liquidity Premium (LP)

Maturity Risk Premium (MRP)

6.4. The Term Structure of Interest Rates

6.5. What Determines the Shape of the Yield Curve?

The Links between Expected Inflation and Interest Rates: A Closer Look

6.6. Using the Yield Curve to Estimate Future Interest Rates

6.7. Other Factors that Influence Interest Rate Levels

Federal Reserve Policy

Federal Budget Deficits or Surpluses

International Factors

Business Activity

Global Perspectives: Measuring Country Risk

6.8. Investing Overseas

6.9. Interest Rates and Business Decisions

Tying it All Together

Integrated Case: Smyth Barry & Company, Part II

Chapter 7. Bonds and Their Valuation

Sizing Up Risk in the Bond Market

Putting Things in Perspective

7.1. Who Issues Bonds?

7.2. Key Characteristics of Bonds

Par Value

Coupon Interest Rate

Maturity Date

Call Provisions

Sinking Funds

Other Features

7.3. Bond Valuation

7.4. Bond Yields

Yield to Maturity

Yield to Call

Current Yield

7.5. Changes in Bond Values over Time

7.6. Bonds with Semiannual Coupons

7.7. Assessing a Bond's Riskiness

Interest Rate Risk

Reinvestment Rate Risk

Comparing Interest Rate and Reinvestment Rate Risk

7.8. Default Risk

Various Types of Corporate Bonds

Bond Ratings

Bankruptcy and Reorganization

7.9. Bond Markets

Tying it All Together

Intergated Case: Western Money Management Inc.

Web Appendix 7A. Zero Coupon Bonds

Web Appendix 7B. Bankruptcy and Reorganization

Chapter 8. Risk and Rates of Return

No Pain No Gain

Putting Things in Perspective

8.1. Stand-Alone Risk

Probability Distributions

Expected Rate of Return

Measuring Stand-Alone Risk: The Standard Deviation

Using Historical Data to Measure Risk

Measuring Stand-Alone Risk: The Coefficient of Variation

Risk Aversion and Required Returns

The Trade-Off between Risk and Return

8.2. Risk in a Portfolio Context

Expected Portfolio Returns, r[subscript p]

Portfolio Risk

The Benefits of Diversification Are More Important Than Ever

Diversifiable Risk versus Market Risk

The Concept of Beta

Global Perspectives: The Benefits of Diversifying Overseas

8.3. The Relationship between Risk and Rates of Return

Estimating the Market Risk Premium

The Impact of Inflation

Changes in Risk Aversion

Changes in a Stock's Beta Coefficient

8.4. Some Concerns about Beta and the CAPM

8.5. Some Concluding Thoughts: Implications for Corporate Managers and Investors

Tying it All Together

Integrated Case: Merrill Finch Inc.

Web Appendix 8A. Calculating Beta Coefficients

Chapter 9. Stocks and Their Valuation

Searching for the Right Stock

Putting Things in Perspective

9.1. Legal Rights and Privileges of Common Stockholders

Control of the Firm

The Preemptive Right

9.2. Types of Common Stock

9.3. Common Stock Valuation

Definitions of Terms Used in Stock Valuation Models

Expected Dividends as the Basis for Stock Values

9.4. Constant Growth Stocks

Illustration of a Constant Growth Stock

Dividend and Earnings Growth

When Can the Constant Growth Model Be Used?

9.5. Expected Rate of Return on a Constant Growth Stock

9.6. Valuing Stocks Expected to Grow at a Nonconstant Rate

Evaluating Stocks That Don't Pay Dividends

9.7. Valuing the Entire Corporation

The Corporate Valuation Model

Other Approaches to Valuing Common Stocks

Comparing the Total Company and Dividend Growth Models

9.8. Stock Market Equilibrium

Changes in Equilibrium Stock Prices

9.9. Investing in International Stocks

9.10. Preferred Stock

Global Perspectives: Investing in Emerging Markets

Tying it All Together

Integrated Case: Mutual of Chicago Insurance Company

Part 4. Investing in Long-Term Assets: Capital Budgeting

Chapter 10. The Cost of Capital

Creating Value at GE

Putting Things in Perspective

10.1. An Overview of the Weighted Average Cost of Capital

10.2. Basic Definitions

10.3. Cost of Debt, r[subscript d](1 - T)

10.4. Cost of Preferred Stock, r[subscript p]

Funny-Named Preferred-Like Securities

10.5. Cost of Retained Earnings, r[subscript s]

The CAPM Approach

Dividend-Yield-plus-Growth-Rate, or Discounted Cash Flow (DCF), Approach

Bond-Yield-plus-Risk-Premium Approach

How Much Does It Cost to Raise External Capital?

10.6. Cost of New Common Stock, r[subscript e]

Add Flotation Costs to a Project's Cost

Increase the Cost of Capital

When Must External Equity Be Used?

10.7. Composite, or Weighted Average, Cost of Capital, WACC

10.8. Factors That Affect the WACC

Factors the Firm Cannot Control

Factors the Firm Can Control

Global Perspectives: Global Variations in the Cost of Capital

10.9. Adjusting the Cost of Capital for Risk

10.10. Some Other Problems with Cost of Capital Estimates

Tying it All Together

Integrated Case: Coleman Technologies Inc.

Web Appendix 10A. The Cost of New Common Stock and the WACC

Chapter 11. The Basics of Capital Budgeting

Competition in the Aircraft Industry

Putting Things in Perspective

11.1. Generating Ideas for Capital Projects

11.2. Project Classifications

11.3. The Net Present Value (NPV) Criterion

11.4. Internal Rate of Return (IRR)

11.5. Comparison of the NPV and IRR Methods

NPV Profiles

NPV Rankings Depend on the Cost of Capital

Independent Projects

Mutually Exclusive Projects

11.6. Multiple IRRs

11.7. Modified Internal Rate of Return (MIRR)

11.8. Payback Period

11.9. Conclusions on Capital Budgeting Methods

11.10. Decision Criteria Used in Practice

11.11. Using Capital Budgeting Techniques in Other Contexts

11.12. The Post-Audit

Tying it All Together

Integrated Case: Allied Components Company

Chapter 12. Cash Flow Estimation and Risk Analysis

Home Depot Keeps Growing

Putting Things in Perspective

12.1. Background on the Project

12.2. Project Analysis

Input Data, Part 1

Depreciation Schedule, Part 2

Salvage Value Calculations, Part 3

Projected Cash Flows, Part 4

Appraisal of the Proposed Project, Part 5

12.3. Other Points on Cash Flow Analysis

Cash Flow versus Accounting Income

Timing of Cash Flows

Incremental Cash Flows

Replacement Projects

Sunk Costs

Opportunity Costs

Externalities

12.4. Estimating Project Risk

12.5. Measuring Stand-Alone Risk

Sensitivity Analysis

Scenario Analysis

Monte Carlo Simulation

Global Perspectives: Capital Budgeting Practices in the Asian/Pacific Region

12.6. Different Capital Structures

12.7. Introduction to Real Options

12.8. Abandonment/Shutdown Options

12.9. The Optimal Capital Budget

Tying it All Together

Integrated Case: Allied Food Products

Appendix 12A. Tax Depreciation

Web Appendix 12B. Replacement Project Analysis

Web Appendix 12C. Refunding Operations

Web Appendix 12D. Using the CAPM to Estimate the Risk-Adjusted Cost of Capital

Web Appendix 12E. Techniques for Measuring Beta Risk

Web Appendix 12F. Comparing Mutually Exclusive Projects with Unequal Lives

Web Appendix 12G. Real Options: Investment Timing, Growth, and Flexibility

Part 5. Capital Structure and Dividend Policy

Chapter 13. Capital Structure and Leverage

Debt: Rocket Booster or Anchor?

Putting Things in Perspective

13.1. The Target Capital Structure

13.2. Business and Financial Risk

Business Risk

Operating Leverage

Financial Risk

13.3. Determining the Optimal Capital Structure

WACC and Capital Structure Changes

The Hamada Equation

The Optimal Capital Structure

13.4. Capital Structure Theory

Yogi Berra on the M&M Proposition

The Effect of Taxes

The Effect of Potential Bankruptcy

Trade-Off Theory

Signaling Theory

Using Debt Financing to Constrain Managers

13.5. Checklist for Capital Structure Decisions

Global Perspectives: Taking a Look at Global Capital Structures

13.6. Variations in Capital Structures

Tying it All Together

Integrated Case: Campus Deli Inc.

Web Appendix 13A. Degree of Leverage

Chapter 14. Distributions to Shareholders: Dividends and Share Repurchases

Microsoft Shifts Gears and Begins to Unload Part of Its Vast Cash Hoard

Putting Things in Perspective

14.1. Dividends versus Capital Gains: What Do Investors Prefer?

Dividend Irrelevance Theory

Reasons Some Investors Prefer Dividends

Reasons Some Investors May Prefer Capital Gains

14.2. Other Dividend Policy Issues

Information Content, or Signaling, Hypothesis

Clientele Effect

14.3. Establishing the Dividend Policy in Practice

Setting the Target Payout Ratio: The Residual Dividend Model

Global Perspectives: Dividend Yields Around the World

Earnings, Cash Flows, and Dividends

Payment Procedures

14.4. Dividend Reinvestment Plans

14.5. Summary of Factors Influencing Dividend Policy

Constraints

Investment Opportunities

Alternative Sources of Capital

Effects of Dividend Policy on r[subscript s]

14.6. Stock Dividends and Stock Splits

Stock Splits

Stock Dividends

Effect on Stock Prices

14.7. Stock Repurchases

The Effects of Stock Repurchases

Stock Repurchases Soar in 2004

Advantages of Repurchases

Disadvantages of Repurchases

Conclusions on Stock Repurchases

Tying it All Together

Integrated Case: Southeastern Steel Company

Web Appendix 14A. An Example: The Residual Dividend Model

Part 6. Working Capital Management, Forecasting, and Multinational Financial Management

Chapter 15. Working Capital Management

Best Buy Successfully Manages Its Working Capital

Putting Things in Perspective

15.1. Working Capital Terminology

15.2. The Cash Conversion Cycle

Calculating the Targeted CCC

Calculating the Actual CCC

Some Firms Operate with Negative Working Capital!

15.3. Alternative Current Asset Investment Policies

15.4. Alternative Current Asset Financing Policies

Maturity Matching, or "Self-Liquidating," Approach

Aggressive Approach

Conservative Approach

Choosing between the Approaches

15.5. The Cash Budget

15.6. Cash and Marketable Securities

Currency

Demand Deposits

Marketable Securities

15.7. Inventories

Supply Chain Management

15.8. Accounts Receivable

Credit Policy

Setting and Implementing the Credit Policy

Monitoring Accounts Receivable

15.9. Accounts Payable (Trade Credit)

15.10. Bank Loans

Promissory Note

Line of Credit

Revolving Credit Agreement

Costs of Bank Loans

15.11. Commercial Paper

15.12. Accruals (Accrued Liabilities)

15.13. Use of Security in Short-Term Financing

Tying it All Together

Integrated Case: Ski Equipment Inc.

Web Appendix 15A. Inventory Management

Web Appendix 15B. Short-Term Loans and Bank Financing

Chapter 16. Financial Planning and Forecasting

Forecasting Apple's Future

Putting Things in Perspective

16.1. Strategic Planning

16.2. The Sales Forecast

16.3. The AFN Equation

Key Determinants of External Funds Requirements

Excess Capacity Adjustments

16.4. Forecasted Financial Statements

Initial Forecast: "Business as Usual"

16.5. Using Regression to Improve Financial Forecasts

16.6. Using Individual Ratios in the Forecasting Process

Modifying Accounts Receivable

Modifying Inventories

Other "Special Studies"

Tying it All Together

Integrated Case: New World Chemicals Inc.

Web Appendix 16A. Forecasting Financial Requirements When Financial Ratios Change

Chapter 17. Multinational Financial Management

U.S. Firms Look Overseas to Enhance Shareholder Value

Putting Things in Perspective

17.1. Multinational or Global Corporations

17.2. Multinational versus Domestic Financial Management

17.3. The International Monetary System

International Monetary Terminology

Current Monetary Arrangements

17.4. Foreign Exchange Rate Quotations

Cross Rates

Interbank Foreign Currency Quotations

17.5. Trading in Foreign Exchange

Spot Rates and Forward Rates

17.6. Interest Rate Parity

17.7. Purchasing Power Parity

17.8. Inflation, Interest Rates, and Exchange Rates

Hungry for a Big Mac? Go to China!

Stock Market Indices Around the World

17.9. International Money and Capital Markets

International Credit Markets

International Stock Markets

17.10. International Capital Budgeting

17.11. International Capital Structures

17.12. Multinational Working Capital Management

Cash Management

Credit Management

Inventory Management

Tying it All Together

Integrated Case: Citrus Products Inc.

Appendixes

Appendix A. Solutions to Self-Test Questions and Problems

Appendix B. Answers to Selected End-of-Chapter Problems

Appendix C. Selected Equations and Data

Web Appendix C. Selected Equations and Data

Index

Cyberproblems

Cyberproblem CP1-1. Executive Compensation

Cyberproblem CP2-1. Online Financial Calculators

Cyberproblem CP3-1. Examining the Financial Report-3M

Cyberproblem CP4-1. Using Ratio Analysis as a Tool-Brady Corporation

Cyberproblem CP5-1. World Financial Markets

Cyberproblem CP6-1. Yield Curves and Interest Rates

Cyberproblem CP7-1. BondsOnline Educated Investor Center

Cyberproblem CP8-1. Evaluating Portfolio Risk and Return