Core Concepts - GBV · CHAPTER 8 ever seen in an introductory text. **.4; Alex Wilson, University...

Core Concepts

Detailed Contents

PartilFundamental Concepts and BasicTools of Finance 29

11.21.31.4

1.5

31

33

3840

Financial Management1.1 The Cycle of Money 32

Overview of Finance AreasFinancial Markets 34The Finance Manager and FinancialManagement 35Objective of the Finance Manager 36Profit Maximization 37Maximizing Current Stock Price 37Maximizing Equity Value 38

1.6 Internal and External Players1.7 The Legal Forms of Business

Proprietorship 40Partnership 40Corporations 41Hybrid Corporations 42Not-for-Profit Corporations 42

1.8 The Financial Management Setting:The Agency Model 42

1.9 Corporate Governance and Business Ethics 45FINANCE FOLLIES The Financial Meltdown

of 2008 471.10 Why Study Finance? 48

PUTTING FINANCE TO WORK Now Hiring 49

Key Terms 50Questions 50Prepping for Exams 51MINI-CASE Richards' Tree Farm

Grows Up 53

L Financial Statements 552.1 Financial Statements 56

The Balance Sheet 56The Income Statement 59Statement of Retained Earnings 61

2.2 Cash Flow Identity and the Statement ofCash Flows 62The First Component: Cash Flow from

Assets 62The Second Component: Cash Flow to

Creditors 64The Third Component: Cash Flow to

Owners 65Putting It All Together: The Cash Flow

Identity 65The Statement of Cash Flows 65Free Cash Flow 67

2.3 Financial Performance Reporting 68Regulation Fair Disclosure 68Notes to the Financial Statements 68

2.4 Financial Statements on the Internet 69PUTTING FINANCE TO WORK Look Before

You Leap 72

Key Terms 73Questions 73Prepping for Exams 73Problems 75Advanced Problems for Spreadsheet

Application 78MINI-CASE Hudson Valley Realty 80

3 The Time Value of Money (Parti) 833.1 Future Value and Compounding Interest 84

The Single-Period Scenario 84The Multiple-Period Scenario 84Methods of Solving Future Value Problems 85

3.2 Present Value and Discounting 89The Single-Period Scenario 89The Multiple-Period Scenario 90The Use of Time Lines 92

3.3 One Equation and Four Variables 923.4 Applications of the Time Value of Money

Equation 94PUTTING FINANCE TO WORK Sports

Agent 99

21

CHAPTERS 1-3 te

A very good job in making the concept of financeofTVM early in the text. The author has obviously i

The explanation of bond pricing and yield calcula

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3.5 Doubling of Money: The Rule of 72 100


Application 108MINI-CASE Richards' Tree Farm, Inc.:

The Continuing Saga 109

4 The Time Value of Money (Part 2) i l l

4.1 Future Value of Multiple PaymentStreams 112

4.2 Future Value of an Annuity Stream 113Future Value of an Annuity: An

Application 1154.3 Present Value of an Annuity 117

PUTTING FINANCE TO WORK Modelingthe Future with Actuarial Science 119

4.4 Annuity Due and Perpetuity 120Perpetuity 122

4.5 Three Loan Payment Methods 123Interest and Principal at the Maturity of Loan

(Discount Loan) 123Interest as You Go, Principal at Maturity of Loan

(Interest-Only Loan) 123Interest and Principal as You Go

(Amortized Loan) 1244.6 Amortization Schedules 1254.7 Waiting Time and Interest Rates for

Annuities 1274.8 Solving a Lottery Problem 1284.9 Ten Important Points about the TVM

Equation 131


Application 140MINI-CASE Fitchminster Injection Molding, Inc.:

Rose Climbs High 141

22

Interest Rates 1435.1 How Financial Institutions Quote Interest

Rates: Annual and Periodic Interest Rates 1445.2 Effect of Compounding Periods on the Time

Value of Money Equations 1465.3 Consumer Loans and Amortization

Schedules 1505.4 Nominal and Real Interest Rates 1555.5 Risk-Free Rate and Premiums 157

Maturity Premiums 159Yield Curves 160

5.6 A Brief History of Interest Rates and Inflationin the United States 162


Application 170MINI-CASE Sweetening the Deal: Povero

Construction Company 171

Valuing Stocks and Bonds andUnderstanding Risk andReturn 173

O Bonds and Bond Valuation 1756.1 Application of the Time Value of Money Tool:

Bond Pricing 176Key Components of a Bond 176Pricing a Bond in Steps 177

6.2 Semiannual Bonds and Zero-Coupon Bonds 181Pricing Bonds after Original Issue 183Zero-Coupon Bonds 184Amortization of a Zero-Coupon Bond 186

6.3 Yields and Coupon Rates 187The First Interest Rate: Yield to Maturity 187The "Other" Interest Rate: Coupon Rate 188

CHAPTER 8

ever seen in an introductory text. **.4; Alex Wilson, University of Arizona

,y sophisticated information very well. **iRobert Bartolacci, Carnegie Mellon University

Relationship of Yield to Maturity and CouponRate 189

6.4 Bond Ratings 1906.5 Some Bond History and More Bond

Features 193PUTTING FINANCE TO WORK Municipal

Manager 197

6.6 U.S. Government Bonds 197Pricing a U.S. Government Note or Bond 198Pricing a Treasury Bill 199


Application 206MINI-CASE Bay Path Cranberry

Products 207

/ Stocks and Stock Valuation 2097.1 Characteristics of Common Stock 210

Ownership 210Claim on Assets and Cash Flow (Residual

Claim) 210Vote (Voice in Management) 210No Maturity Date 211Dividends and Their Tax Effect 211Authorized, Issued, and Outstanding Shares 211Treasury Stock 212Preemptive Rights 212

7.2 Stock Markets 212Primary Markets 212Secondary Markets: How Stocks Trade 213Bull Markets and Bear Markets 214

7.3 Stock Valuation 215The Constant Dividend Model with an Infinite

Horizon 217The Constant Dividend Model with a Finite

Horizon 218The Constant Growth Dividend Model with an

Infinite Horizon 220

The Constant Growth Dividend Model with aFinite Horizon 222

Nonconstant Growth Dividends 223FINANCE FOLLIES Irrational Expectations:

Bulbs and Bubbles 2247.4 Dividend Model Shortcomings 2257.5 Preferred Stock 2297.6 Efficient Markets 230

Operational Efficiency 230Informational Efficiency 230

Key Terms 231Questions 232,Prepping for Exams 232Problems 234Advanced Problems for Spreadsheet

Application 238

MINI-CASE Lawrence's Legacy:Part 1 239

O Risk and Return 2418.1 Returns 242

Dollar Profits and Percentage Returns 242Converting Holding Period Returns to

Annual Returns 243Extrapolating Holding Period

Returns 2448.2 Risk (Certainty and Uncertainty) 245

FINANCE FOLLIES "Dangerous toYour Wealth": Is Investing JustGambling? 246 —

8.3 Historical Returns 2478.4 Variance and Standard Deviation as a

Measure of Risk 251Normal Distributions 253

8.5 Returns in an Uncertain World (Expectationsand Probabilities) 255FINANCE FOLLIES "Scam of the Century":

Bernie Madoff and the $50 BillionFraud 256

Determining the Probabilities of All PotentialOutcomes 251

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CHAPTER 9 •;:;•* m4

Capital budgeting: Just exactly what I like to cover in an tntrodtMoryMiiti

CHAPTER 10 ':/\ ::&%:m

8.6 The Risk-and-Return Trade-off 259Investment Rules 260

8.7 Diversification: Minimizing Risk orUncertainty 261When Diversification Works 262Adding More Stocks to the Portfolio: Systematic

and Unsystematic Risk 2658.8 Beta: The Measure of Risk in a

Well-Diversified Portfolio 2668.9 The Capital Asset Pricing Model and the

Security Market Line 267The Capital Asset Pricing Model •,

(CAPM) 268Application of the SML 270


Application 280MINI-CASE Lawrence's Legacy:

Part 2 281

Capital Budgeting 283

Capital Budgeting DecisionModels 285

9.1

9.2

9.3

Short-Term and Long-Term DecisionsFINANCE FOLLIES IBM Exits the

Consumer Software Market:Misreading Future Cash Flows 287

Payback Period 288Discounted Payback Period 290Net Present Value 291Mutually Exclusive versus Independent

Projects 293Unequal Lives of Projects 295Net Present Value Example: Equation and

Calculator Function 296

286

9.4 Internal Rate of Return 298Appropriate Discount Rate or Hurdle Rate 300Problems with the Internal Rate of Return 301PUTTING FINANCE TO WORK Marketing

and Sales: Your Product = YourCustomer's Capital BudgetingDecision 302

Multiple Internal Rates of Return 302Reinvestment and Crossover Rates 304Modified Internal Rate of Return 306

9.5 Profitability Index 3089.6 Overview of Six Decision Models 310

Capital Budgeting Using a Spreadsheet 310


Application 321MINI-CASE BioCom, Inc.: Part 1 322

1 U Cash Flow Estimation 32510.1 The Importance of Cash Flow 32610.2 Estimating Cash Flow for Projects:

Incremental Cash Flow 327Sunk Costs 328Opportunity Costs 328Erosion Costs 329Synergy Gains 331Working Capital 331FINANCE FOLLIES Boston's "Big Dig"

Gets Dug Under 33310.3 Capital Spending and Depreciation 334

Straight-Line Depreciation 334Modified Accelerated Cost Recovery

System 33510.4 Cash Flow and the Disposal of Capital

Equipment 33710.5 Projected Cash Flow for a New

Product 339

24

CHAPTER 11

Cathy Goldberg, University of San Francisco

CHAPTER 13

nts receivable managementWarren Palmer, Beloit College


Application 349

MINI-CASE BioCom, Inc.: Part 2,Evaluating a New Product Line 351

1 1 The Cost of Capital 35311.1 The Cost of Capital: A Starting Point 35411.2 Components of the Weighted Average Cost

of Capital 357Debt Component 357Preferred Stock Component 359Equity Component 359Retained Earnings 361

11.3 Weighting the Components: Book Value orMarket Value? 362Book Value 363Adjusted Weighted Average Cost of

Capital 364Market Value 364

11.4 Using the Weighted Average Cost of Capital ina Budgeting Decision 366Individual Weighted Average Cost of Capital for

Individual Projects 36711.5 Selecting Appropriate Betas for

Projects 36911.6 Constraints on Borrowing and Selecting

Projects for the Portfolio 370


Application 380

MINI-CASE BioCom, Inc.: Part 3,A Fresh Look at the WACC 381

Financial Planning and EvaluatingPerformance 383

Forecasting and Short-Term FinancialPlanning 385Sources and Uses of Cash 386Cash Budgeting and the Sales Forecast 388Cash Inflow from Sales 390Other Cash Receipts 391Cash Outflow from Production 392The Cash Forecast: Short-Term Deficits andShort-Term Surpluses 393Funding Cash Deficits 394Investing Cash Surpluses 395Planning with Pro Forma FinancialStatements 396Pro Forma Income Statement 396Pro Forma Balance Sheet 398PUTTING FINANCE TO WORK Information

Technology 402


Application 408

MINI-CASE Midwest Properties: QuarterlyForecasting 409 —

12.112.2

12.312.4

12.5

1 3 Working Capital Management 41313.1 The Cash Conversion Cycle 414

Average Production Cycle 416Average Collection Cycle 417Average Payment Cycle 418Putting It All Together: The Cash Conversion

Cycle 419

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CHAPTER 14

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13.2 Managing Accounts Receivable and SettingCredit Policy 419Collecting Accounts Receivable 420Credit: A Two-Sided Coin 421Qualifying for Credit 422Setting Payment Policy 424Collecting Overdue Debt 426

13.3 The Float 427Speeding Up the Collection (Shortening the

Lag Time) 428Slowing Down Payment (Lengthening the

Lag Time) 42913.4 Inventory Management: Carrying Costs and

Ordering Costs 430ABC Inventory Management 430Redundant Inventory Items 431Economic Order Quantity 432

13.5 The Effect of Working Capital on CapitalBudgeting 437PUTTING FINANCE TO WORK Operations

Management 438Inventories and Daily Operations 438


Application 447MINI-CASE Cranston Dispensers, Inc.:

Part 1 448

1 4 Financial Ratios and FirmPerformance 451

14.1 Financial Statements 452Benchmarking 453

14.2 Financial Ratios 456Short-Term Solvency: Liquidity

Ratios 457Long-Term Solvency: Solvency or Financial

Leverage Ratios 459Asset Management Ratios 460

Profitability Ratios 462Market Value Ratios 463DuPont Analysis 465

14.3 External Uses of Financial Statements andIndustry Averages 466Cola Wars 467Industry Ratios 469FINANCE FOLLIES Cooking the Books at

Enron and WorldCom 470


Application 47 9MINI-CASE Cranston Dispensers, Inc.:

Part 2 479

Other Selected Finance Topics 483

1 J Raising Capital 48515.1 The Business Life Cycle 48615.2 Borrowing for a Start-up and Growing

Business 486Personal Funds and Family Loans 486Commercial Bank Loans 487Commercial Bank Loans through the Small'

Business Administration 487Angel Financing and Venture Capital 488

15.3 Borrowing for a Stable and Mature Business:Bank Loans 492Straight Loans 492Discount Loans 493Letter of Credit or Line of Credit 494Compensating Balance 494

15.4 Borrowing for a Stable and Mature Business:Selling Bonds 495

26

* TJTJ

CHAPTER 16

John Banko, University of Central Florida

15.5 Borrowing for a Stable and Mature Business:Selling Stock 497Initial Public Offerings and Underwriting 498Registration, Prospectus, and Tombstone 500The Marketing Process: Road Show 500The Auction 502

The Aftermarket: Dealer in the Shares 502PUTTING FINANCE TO WORK Corporate

Law 50415.6 Other Borrowing Options for a Mature

Business 50515.7 The Final Phase: Closing the

Business 507Straight Liquidation: Chapter 7 507Reorganization: Chapter 11 508Key Terms 509Questions 509Prepping for Exams 509Problems 511Advanced Problems for Spreadsheet

Application 515MINI-CASEAKWebDevelopers.com 515

1 0 Capital Structure 519

52016.1 Capital Markets: A Quick Review16.2 Benefits of Debt 521

Earnings per Share as a Measure of the Benefits ofBorrowing 522

16.3 Break-Even Earnings for Different CapitalStructures 524

16.4 Pecking Order 527Firms Prefer Internal Financing First 527Firms Choose to Issue Cheapest Security First and

Use Equity as a Last Resort 52716.5 Modigliani and Miller on Optimal Capital

Structure 529Capital Structure in a World of No Taxes and

No Bankruptcy 530Capital Structure in a World of Corporate Taxes

and No Bankruptcy 533Debt and the Tax Shield 534

16.6 The Static Theory of CapitalStructure 536Bankruptcy 536Static Theory of Capital Structure 537FINANCE FOLLIES Hedge Funds: Some

Really Smart Guys Get intoBig Trouble 538


Application 545

MINI-CASE General Energy StorageSystems: How Much Debt and HowMuch Equity? 546

1 / Dividends, Dividend Policy, andStock Splits 549

17.1 Cash Dividends 550Buying and Selling Stock 550Declaring and Paying a Cash Dividend:

A Chronology 550Different Types of Dividends 552

17.2 Dividend Policy 554Dividend Clienteles 554Dividend Policy Irrelevance 555Reasons Favoring a Low- or No-Diyidend-

Payout Policy 558Reasons Favoring a High-Dividend-Payout

Policy 559Optimal Dividend Policy 559

17.3 Selecting a Dividend Policy 560Some Further Considerations in the Selection of a

Dividend Policy 56217.4 Stock Dividends, Stock Splits, and

Reverse Splits 563Reasons for Stock Splits 564Reverse Splits 565

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CHAPTER 18

The presentation on foreign exchange is excellent. ** Eric Hayden, University r

17.5 Specialized Dividend Plans 566 18.3Stock Repurchase 566Dividend Reinvestment Plans 568

Key Terms 570Questions 570 184Prepping for Exams 571Problems 572Advanced Problems for Spreadsheet

Application 575MINI-CASE East Coast Warehouse

Club 575

1 0 International FinancialManagement 579

18.1 Managing Multinational Operations 580Cultural Risk 580Business Risk 582Political Risk 583FINANCE FOLLIES Rino International 584

18.2 Foreign Exchange 585Purchasing Power Parity 586Currency Exchange Rates 587Cross Rates 589Arbitrage Opportunities 590Forward Rates 591Using Forward Rates 593

Transaction, Operating, and TranslationExposures 595Transaction Exposure 595Operating Exposure 596Translation Exposure 597Foreign Investment Decisions 597


Application 607MINI-CASE Scholastic Travel

Services, Inc. 608

Appendix 1Appendix 2Appendix 3

Appendix 4

Appendix 5

GlossaryIndexCredits

j Future Value Interest Factors 610Present Value Interest Factors 612Future Value Interest Factors of an

Annuity 614Present Value Interest Factors of an

Annuity 616Answers to Prepping for Exam

Questions 618627637 .645

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Core Concepts - GBV · CHAPTER 8 ever seen in an introductory text. **.4; Alex Wilson, University...

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Transcript of Core Concepts - GBV · CHAPTER 8 ever seen in an introductory text. **.4; Alex Wilson, University...