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Contents PART 1 | INTRODUCTION 1 The Goals and Functions of Financial Management 4 The Field of Finance 5 Evolution of the Field of Finance 5 Recent Issues in Finance 6 The Impact of the Internet 6 Functions of Financial Management 7 Forms of Organization 8 Sole Proprietorship 8 Partnership 8 Corporation 9 Corporate Governance 10 Sarbanes-Oxley Act 11 Goals of Financial Management 11 A Valuation Approach 12 Maximizing Shareholder Wealth 12 Management and Stockholder Wealth 13 Social Responsibility and Ethical Behavior 13 The Role of the Financial Markets 15 Structure and Functions of the Financial Markets 15 Allocation of Capital 16 Institutional Pressure on Public Companies to Restructure 17 Internationalization of the Financial Markets 17 The Internet and Changes in the Capital Markets 18 Format of the Text 18 Parts 19 1. Introduction 19 2. Financial Analysis and Planning 19 3. Working Capital Management 19 4. The Capital Budgeting Process 19 5. Long-Term Financing 19 6. Expanding the Perspective of Corporate Finance 20 List of Terms 20 Discussion Questions 20 Web Exercise 21 PART 2 | FINANCIAL ANALYSIS AND PLANNING 2 Review of Accounting 24 Income Statement 25 Return to Capital 26 Price-Earnings Ratio Applied to Earnings per Share 26 Limitations of the Income Statement 27 Balance Sheet 28 Interpretation of Balance Sheet Items 28 Concept of Net Worth 30 Limitations of the Balance Sheet 30 Statement of Cash Flows 31 Developing an Actual Statement 32 Determining Cash Flows from Operating Activities 32 Determining Cash Flows from Investing Activities 34 Determining Cash Flows from Financing Activities 34 Combining the Three Sections of the Statement 36 Depreciation and Funds Flow 37 Free Cash Flow 37 Income Tax Considerations 38 Corporate Tax Rates 40 Cost of a Tax-Deductible Expense 40 Depreciation as a Tax Shield 40 Summary 42 List of Terms 42 Discussion Questions 43 Practice Problems and Solutions 43 Problems 44 Web Exercise 51 S&P Problems 52 3 Financial Analysis 53 Ratio Analysis 54 Classi?cation System 54 The Analysis 56 A. Pro? tability Ratios 56 B. Asset Utilization Ratios 59 C. Liquidity Ratios 60 D. Debt Utilization Ratios 60 Trend Analysis 61 Impact of In?ation on Financial Analysis 65 An Illustration 65 Disin?ation Effect 66 De? ation 67 Other Elements of Distortion in Reported Income 67 Explanation of Discrepancies 67 Sales 68 Cost of Goods Sold 68 Extraordinary Gains/Losses 68 Net Income 69 Summary 70 List of Terms 70 Discussion Questions 70 Practice Problems and Solutions 71 Problems 74 Comprehensive Problems 85 Web Exercise 90 S&P Problems 90 4 Financial Forecasting 92 Constructing Pro Forma Statements 93 Pro Forma Income Statement 93 Establish a Sales Projection 94 Determine a Production Schedule and the Gross Pro?t 94 Cost of Goods Sold 96 Other Expense Items 97 Actual Pro Forma Income Statement 97 Cash Budget 97 Cash Receipts 98 Cash Payments 98 Actual Budget 100 Pro Forma Balance Sheet 101 Explanation of Pro Forma Balance Sheet 101 Analysis of Pro Forma Statement 104 Percent-of-Sales Method 104 Summary 106 List of Terms 106 Discussion Questions 107 Practice Problems and Solutions 107 Problems 108 Comprehensive Problems 116 Web Exercise 118 5 Operating and Financial Leverage 119 Leverage in a Business 120 Operating Leverage 120 Break-Even Analysis 120 A More Conservative Approach 122 The Risk Factor 123 Cash Break-Even Analysis 124 Degree of Operating Leverage 124 Leveraged Firm 125 Conservative Firm 125 Limitations of Analysis 126 Financial Leverage 127 Impact on Earnings 128 Degree of Financial Leverage 128 Plan A (Leveraged) 130 Plan B (Conservative) 130 Limitations to Use of Financial Leverage 131 Combining Operating and Financial Leverage 131 Degree of Combined Leverage 133 A Word of Caution 135 Summary 135 Review of Formulas 135 List of Terms 136 Discussion Questions 136 Practice Problems and Solutions 137 Problems 138 Comprehensive Problem 147 Web Exercise 148 S&P Problems 149 PART 3 | WORKING CAPITAL MANAGEMENT 6 Working Capital and the Financing Decision 152 The Nature of Asset Growth 154 Controlling Assets?Matching Sales and Production 154 Temporary Assets under Level Production?An Example 158 Patterns of Financing 163 Alternative Plans 164 Long-Term Financing 164 Short-Term Financing (Opposite Approach) 165 The Financing Decision 165 Term Structure of Interest Rates 167 A Decision Process 170 Introducing Varying Conditions 171 Expected Value 171 Shifts in Asset Structure 172 Toward an Optimal Policy 173 Summary 175 List of Terms 175 Discussion Questions 175 Practice Problems and Solutions 176 Problems 183 Web Exercise 183 S&P Problems 183 7 Current Asset Management 185 Cash Management 186 Reasons for Holding Cash Balances 186 Cash Flow Cycle 186 Collections and Disbursements 189 Float 190 Improving Collections 191 Extending Disbursements 192 Cost-Bene?t Analysis 192 Electronic Funds Transfer 193 International Cash Management 196 Marketable Securities 196 Management of Accounts Receivable 201 Accounts Receivable as an Investment 201 Credit Policy Administration 201 Credit Standards 201 Terms of Trade 205 Collection Policy 205 An Actual Credit Decision 206 Inventory Management 207 Level versus Seasonal Production 207 Inventory Policy in In?ation (and De?ation) 208 The Inventory Decision Model 208 Carrying Costs 208 Ordering Costs 209 Economic Ordering Quantity 209 Safety Stock and Stock Outs 211 Just-in-Time Inventory Management 211 Cost Savings from Lower Inventory 212 Other Bene? ts 212 The Downside of JIT 212 Summary 214 List of Terms 214 Discussion Questions 215 Practice Problems and Solutions 215 Problems 216 Comprehensive Problem 221 Web Exercise 222 8 Sources of Short-Term Financing 223 Trade Credit 224 Payment Period 224 Cash Discount Policy 224 Net Credit Position 225 Bank Credit 225 Prime Rate and LIBOR 226 Compensating Balances 227 Maturity Provisions 228 Cost of Commercial Bank Financing 229 Interest Costs with Compensating Balances 229 Rate on Installment Loans 230 Annual Percentage Rate 230 The Credit Crunch Phenomenon 231 Financing through Commercial Paper 231 Advantages of Commercial Paper 233 Limitations on the Issuance of Commercial Paper 234 Foreign Borrowing 234 Use of Collateral in Short-Term Financing 235 Accounts Receivable Financing 235 Pledging Accounts Receivable 235 Factoring Receivables 236 Asset-Backed Public Offerings 236 Inventory Financing 238 Stages of Production 239 Nature of Lender Control 239 Blanket Inventory Liens 239 Trust Receipts 239 Warehousing 239 Appraisal of Inventory Control Devices 239 Hedging to Reduce Borrowing Risk 240 Summary 241 List of Terms 242 Discussion Questions 242 Practice Problems and Solutions 243 Problems 244 Web Exercise 248 PART 4 | THE CAPITAL BUDGETING PROCESS 9 The Time Value of Money 253 Relationship to the Capital Outlay Decision 254 Future Value?Single Amount 254 Present Value?Single Amount 255 Future Value?Annuity 256 Present Value?Annuity 258 Graphical Presentation of Time Value Relationships 260 The Relationship between Present Value and Future Value 260 The Relationship between the Present Value of a Single Amount and the Present Value of an Annuity 263 Future Value Related to the Future Value of an Annuity 265 Determining the Annuity Value 266 Annuity Equaling a Future Value 266 Annuity Equaling a Present Value 266 Determining the Yield on an Investment 268 Yield?Present Value of a Single Amount 268 Yield?Present Value of an Annuity 269 Special Considerations in Time Value Analysis 270 Patterns of Payment 270 Special Review of the Chapter 272 List of Terms 274 Discussion Questions 274 Practice Problems and Solutions 275 Problems 276 Comprehensive Problem 281 10 Valuation and Rates of Return 282 Valuation Concepts 283 Valuation of Bonds 283 Present Value of Interest Payments 284 Present Value of Principal Payment (Par Value) at Maturity 284 Concept of Yield to Maturity 285 Changing the Yield to Maturity and the Impact on Bond Valuation 286 Increase in In? ation Premium 287 Decrease in In? ation Premium 287 Time to Maturity 289 Determining Yield to Maturity from the Bond Price 289 A 13 Percent Discount Rate 290 A 12 Percent Discount Rate 291 Formula for Bond Yield 291 Semiannual Interest and Bond Prices 292 Valuation and Preferred Stock 293 Determining the Required Rate of Return (Yield) from the Market Price 294 Valuation of Common Stock 295 No Growth in Dividends 295 Constant Growth in Dividends 296 Stock Valuation Based on Future Stock Value 298 Determining the Required Rate of Return from the Market Price 298 The Price-Earnings Ratio Concept and Valuation 299 Variable Growth in Dividends 300 Summary and Review of Formulas 302 Bonds 303 Preferred Stock 303 Common Stock 304 List of Terms 304 Discussion Questions 304 Practice Problems and Solutions 305 Problems 306 Comprehensive Problem 312 Web Exercise 313 Appendix 10A The Bond Yield to Maturity Using Interpolation 314 Appendix 10B Using Calculators for Financial Analysis 315 Appendix 10C Valuation of a Supernormal Growth Firm 324 11 Cost of Capital 327 The Overall Concept 328 Cost of Debt 328 Costs of Preferred Stock 331 Cost of Common Equity 331 Valuation Approach 332 Required Return on Common Stock Using the Capital Asset Pricing Model 332 Cost of Retained Earnings 333 Cost of New Common Stock 335 Overview of Common Stock Costs 335 Optimal Capital Structure?Weighting Costs 336 Capital Acquisition and Investment Decision Making 338 Cost of Capital in the Capital Budgeting Decision 338 The Marginal Cost of Capital 340 Summary 345 Review of Formulas 345 List of Terms 346 Discussion Questions 346 Practice Problems and Solutions 347 Problems 349 Comprehensive Problems 356 Web Exercise 358 S&P Problems 358 Appendix 11A Cost of Capital and the Capital Asset Pricing Model (Optional) 359 12 The Capital Budgeting Decision 367 Administrative Considerations 368 Accounting Flows versus Cash Flows 368 Methods of Ranking Investment Proposals 371 Payback Method 371 Internal Rate of Return 372 Net Present Value 374 Selection Strategy 375 Reinvestment Assumption 376 Modi? ed Internal Rate of Return 377 Capital Rationing 378 Net Present Value Pro?le 379 Characteristics of Investment C 380 Combining Cash Flow Analysis and Selection Strategy 382 The Rules of Depreciation 382 The Tax Rate 384 Actual Investment Decision 384 The Replacement Decision 385 Sale of Old Asset 386 Incremental Depreciation 387 Cost Savings 388 Elective Expensing 390 Summary 390 List of Terms 390 Discussion Questions 390 Practice Problems and Solutions 391 Problems 392 Comprehensive Problem 400 Web Exercise 401 S&P Problems 401 13 Risk and Capital Budgeting 403 De?nition of Risk in Capital Budgeting 404 Simulation Models 412 Decision Trees 413 The Portfolio Effect 415 Portfolio Risk 415 Evaluation of Combinations 418 The Share Price Effect 419 Summary 419 Review of Formulas 419 List of Terms 420 Discussion Questions 420 Practice Problems and Solutions 420 Problems 422 Comprehensive Problems 431 Web Exercise 433 PART 5 | LONG-TERM FINANCING 14 Capital Markets 436 International Capital Markets 437 Competition for Funds in the U.S. Capital Markets 439 Government Securities 439 U.S. Government Securities 439 Federally Sponsored Credit Agencies 440 State and Local Securities 440 Corporate Securities 440 Corporate Bonds 440 Preferred Stock 440 Common Stock 440 Internal versus External Sources of Funds 441 The Supply of Capital Funds 442 The Role of the Security Markets 444 The Organization of the Security Markets 445 The New York Stock Exchange 445 Size and Liquidity 445 Listing Requirements 447 Decimalization 447 Electronic Trading 447 International Merger 447 The NASDAQ Market 448 The National Market and Small-Cap Market 448 The American Stock Exchange 448 Regional Stock Exchanges 448 Foreign Exchanges 449 The Concept of Risk-Averse 405 Actual Measurement of Risk 405 Risk and the Capital Budgeting Process 408 Risk-Adjusted Discount Rate 409 Increasing Risk over Time 410 Qualitative Measures 411 Example?Risk-Adjusted Discount Rate 411 Electronic Communication Networks (ECNs) 449 National Association of Securities Dealers (NASD) 450 Market Ef?ciency 450 The Ef?cient Market Hypothesis 450 Regulation of the Security Markets 451 Securities Act of 1933 451 Securities Exchange Act of 1934 452 Securities Acts Amendments of 1975 452 Sarbanes-Oxley Act of 2002 453 Summary 454 List of Terms 454 Discussion Questions 455 Web Exercise 455 S&P Problems 456 15 Investment Banking: Public and Private Placement 457 The Role of Investment Banking 458 Concentration of Capital 458 The Gramm-Leach-Bliley Act Repeals the Glass- Steagal Act 460 Investment Banking Competitors 461 Enumeration of Functions 461 Underwriter 461 Market Maker 461 Advisor 461 Agency Functions 462 The Distribution Process 462 The Spread 462 Pricing the Security 465 Dilution 465 Market Stabilization 465 Aftermarket 466 Shelf Registration 466 Public versus Private Financing 467 Advantages of Being Public 467 Disadvantages of Being Public 468 Public Offerings 468 A Classic Example of Instant Wealth? EDS Goes Public 468 Internet Capital Group?A Second Example 469 Private Placement 473 Going Private and Leveraged Buyouts 473 International Investment Banking Deals 474 Privatization 474 Summary 477 List of Terms 477 Discussion Questions 477 Practice Problems and Solutions 478 Problems 479 Comprehensive Problem 484 Web Exercise 486 S&P Problems 486 16 Long-Term Debt and Lease Financing 488 The Expanding Role of Debt 489 The Debt Contract 489 Par Value 489 Coupon Rate 490 Maturity Date 490 Security Provisions 490 Unsecured Debt 490 Methods of Repayment 491 Serial Payments 491 Sinking-Fund Provision 492 Conversion 492 Call Feature 492 An Example: Dillard?s 7.875 Percent Bond 492 Bond Prices, Yields, and Ratings 492 Bond Yields 495 Coupon Rate (Nominal Yield) 495 Current Yield 496 Yield to Maturity 496 Bond Ratings 496 Examining Actual Bond Ratings 497 The Refunding Decision 498 A Capital Budgeting Problem 498 Step A?Out?ow Considerations 499 Step B?In?ow Considerations 500 Step C?Net Present Value 501 Other Forms of Bond Financing 502 Advantages and Disadvantages of Debt 503 Bene?ts of Debt 504 Drawbacks of Debt 504 Eurobond Market 504 Leasing as a Form of Debt 505 Capital Lease versus Operating Lease 506 Income Statement Effect 507 Advantages of Leasing 507 Summary 508 List of Terms 508 Discussion Questions 508 Practice Problems and Solutions 509 Problems 512 Comprehensive Problem 516 Web Exercise 517 S&P Problems 517 Appendix 16A Financial Alternatives for Distressed Firms 518 Out-of-Court Settlement 518 In-Court Settlements?Formal Bankruptcy 519 Reorganization 519 Liquidation 519 List of Terms 522 Discussion Questions 523 Problem 523 Appendix 16B Lease versus Purchase Decision 524 17 Common and Preferred Stock Financing 527 Common Stockholders? Claim to Income 528 The Voting Right 529 Cumulative Voting 530 The Right to Purchase New Shares 532 The Use of Rights in Financing 533 Rights Required 533 Monetary Value of a Right 533 Effect of Rights on Stockholder?s Position 535 Desirable Features of Rights Offerings 536 Poison Pills 536 American Depository Receipts 537 Preferred Stock Financing 538 Justi?cation for Preferred Stock 539 Investor Interest 539 Summary of Tax Considerations 540 Provisions Associated with Preferred Stock 540 1. Cumulative Dividends 540 2. Conversion Feature 540 3. Call Feature 541 4. Participation Provision 541 5. Floating Rate 541 6. Dutch Auction Preferred Stock 541 7. Par Value 541 Comparing Features of Common and Preferred Stock and Debt 542 Summary 543 Review of Formulas 544 List of Terms 544 Discussion Questions 545 Practice Problems and Solutions 546 Problems 547 Comprehensive Problems 551 Web Exercise 553 18 Dividend Policy and Retained Earnings 554 The Marginal Principle of Retained Earnings 555 Life Cycle Growth and Dividends 555 Dividends as a Passive Variable 556 An Incomplete Theory 556 Arguments for the Relevance of Dividends 557 Dividend Stability 558 Other Factors In?uencing Dividend Policy 558 Legal Rules 558 Cash Position of the Firm 560 Access to Capital Markets 560 Desire for Control 561 Tax Position of Shareholders 561 Dividend Payment Procedures 561 Stock Dividend 563 Accounting Considerations for a Stock Dividend 563 Value to the Investor 563 Possible Value of Stock Dividends 564 Use of Stock Dividends 565 Stock Splits 565 Reverse Stock Splits 566 Repurchase of Stock as an Alternative to Dividends 566 Other Reasons for Repurchase 568 Dividend Reinvestment Plans 568 Summary 569 List of Terms 569 Discussion Questions 569 Practice Problems and Solutions 570 Problems 571 Comprehensive Problem 578 Web Exercise 578 S&P Problems 579 19 Convertibles, Warrants, and Derivatives 580 Convertible Securities 581 Value of the Convertible Bond 581 Is This Fool?s Gold? 584 Advantages and Disadvantages to the Corporation 584 Forcing Conversion 586 Accounting Considerations with Convertibles 587 Financing through Warrants 589 Valuation of Warrants 590 Use of Warrants in Corporate Finance 592 Accounting Considerations with Warrants 592 Derivative Securities 593 Options 593 Futures 594 Summary 595 Review of Formulas 595 List of Terms 596 Discussion Questions 596 Practice Problems and Solutions 597 Problems 598 Comprehensive Problems 602 Web Exercise 603 PART 6 | EXPANDING THE PERSPECTIVE OF CORPORATE FINANCE 20 External Growth through Mergers 606 Motives for Business Combinations 607 Financial Motives 608 Non?nancial Motives 609 Motives of Selling Stockholders 609 Terms of Exchange 611 Cash Purchases 611 Stock-for-Stock Exchange 612 Portfolio Effect 613 Accounting Considerations in Mergers and Acquisitions 614 Negotiated versus Tendered Offers 615 Premium Offers and Stock Price Movements 617 Two-Step Buyout 618 Summary 619 List of Terms 619 Discussion Questions 619 Practice Problems and Solutions 620 Problems 621 Web Exercise 625 S&P Problems 626 21 International Financial Management 627 The Multinational Corporation: Nature and Environment 630 Exporter 630 Licensing Agreement 630 Joint Venture 630 Fully Owned Foreign Subsidiary 630 Foreign Exchange Rates 631 Factors In?uencing Exchange Rates 632 In? ation 633 Interest Rates 633 Balance of Payments 633 Government Policies 634 Other Factors 634 Spot Rates and Forward Rates 634 Cross Rates 636 Managing Foreign Exchange Risk 636 Forward Exchange Market Hedge 637 Money Market Hedge 638 Currency Futures Market Hedge 639 Foreign Investment Decisions 639 Analysis of Political Risk 641 Financing International Business Operations 643 Funding of Transactions 643 Eximbank (Export-Import Bank) 643 Loans from the Parent Company or a Sister Af? liate 643 Eurodollar Loans 645 Eurobond Market 646 International Equity Markets 646 The International Finance Corporation 648 Some Unsettled Issues in International Finance 649 Summary 649 List of Terms 650 Discussion Questions 651 Practice Problems and Solutions 651 Problems 652 Web Exercise 654 S&P Problems 654 Appendix 21A Cash Flow Analysis and the Foreign Investment Decision 655 Appendixes A-1 Appendix A Future Value of $1, FV IF A-2 Appendix B Present Value of $1, PV IF A-4 Appendix C Future Value of an Annuity of $1, FV IFA A-6 Appendix D Present Value of an Annuity of $1, PV IFA A-8 Selected References R Glossary G Indexes I-1

Library of Congress Subject Headings for this publication:

Corporations -- Finance.