Corporate Finance

TENTH EDITION

Stephen A. RossSloan School of Management

Massachusetts Institute ofTechnology

Randolph W. WesterfieldMarshall School of Business

University of Southern California

Jeffrey JaffeWharton School of Business

University of Pennsylvania

McGraw-HillIrwin

Contents

CHAPTER I

Introduction to Corporate Finance

I . I W h a t Is Corporate Finance?The Balance Sheet Model of the FirmThe Financial Manager

1.2 The Corporate FirmThe Sole ProprietorshipThe PartnershipThe CorporationA Corporation by Another Name ...

1.3 The Importance of Cash Flows1.4 The Goal of Financial Management

Possible GoalsThe Goal of Financial ManagementA More General Goal

1.5 The Agency Problem and Controlof the CorporationAgency RelationshipsManagement GoalsDo Managers Act in the Stockholders' Interests?Stakeholders

1.6 RegulationThe Securities Act of 1933 and the SecuritiesExchange Act of 1934Sarbanes-OxleySummary and ConclusionsConcept Questions

- CHAPTER 2

Financial Statements and Cash Flow

2.1 The Balance SheetLiquidityDebt versus EquityValue versus Cost

2.2 The Income StatementGenerally Accepted Accounting PrinciplesNoncash ItemsTime and Costs

2.3 TaxesCorporate Tax RatesAverage versus Marginal Tax Rates

II3444578

III I1212

2.4 Ne twork ing Capital 282.5 Financial Cash Flow 292.6 The Accounting Statement of Cash Flows 32

Cash Flow from Operating Activities 32Cash Flow from Investing Activities 33Cash Flow from Financing Activities 33

2.7 Cash Flow Management 34Summary and Conclusions 35Concept Questions 36Questions and Problems 36Excel Master It! 41Mini Case: Cash Flows at Warf Computers, Inc. 42

CHAPTER 3

Financial Statements Analysis andFinancial Models 44

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3.1

3.2

3.3

3.4

3.5

3.6

Financial Statements AnalysisStandardizing StatementsCommon-Size Balance SheetsCommon-Size Income StatementsRatio AnalysisShort-Term Solvency or Liquidity MeasuresLong-Term Solvency MeasuresAsset Management orTurnover MeasuresProfitability MeasuresMarket Value MeasuresThe DuPont IdentityA Closer Look at ROEProblems with Financial Statement AnalysisFinancial ModelsA Simple Financial Planning ModelThe Percentage of Sales ApproachExternal Financing and GrowthEFN and GrowthFinancial Policy and GrowthA Note about Sustainable Growth Rate CalculationsSome Caveats Regarding FinancialPlanning ModelsSummary and ConclusionsConcept QuestionsQuestions and ProblemsExcel Master It!Mini Case: Ratios and Financial Planning atEast Coast Yachts

4444454648495052545558586061616367687074

7576767883

84

XXVI

PART II Valuation andCapital BudgetingCHAPTER 4

Discounted Cash Flow Valuation 87

4.1 Valuation: The One-Period Case 874.2 The Multiperiod Case 91

Future Value and Compounding 91The Power of Compounding: A Digression 94Present Value and Discounting 95Finding the Number of Periods 98The Algebraic Formula 101

4.3 Compounding Periods 102Distinction between Stated Annual InterestRate and Effective Annual Rate 103Compounding over Many Years 104Continuous Compounding 104

4.4 Simplifications 106Perpetuity 106Growing Perpetuity 108Annuity 109Growing Annuity I 15

4.5 Loan Amortization 1164.6 What Is a Firm Worth? . 120

Summary and Conclusions , 122Concept Questions , 123Questions and Problems 123Excel Master It! 133Mini Case:The MBA Decision 134

Appendix 4A: Net Present Value: FirstPrinciples of Finance 134

Appendix 4B: Using Financial Calculators 134

CHAPTER 5

Net Present Value and OtherInvestment Rules 135

5.15.2

5.35.45.5

Why Use Net Present Value?The Payback Period MethodDefining the RuleProblems with the Payback MethodManagerial PerspectiveSummary of PaybackThe Discounted Payback Period MethodThe Internal Rate of ReturnProblems with the IRR ApproachDefinition of Independent and MutuallyExclusive ProjectsTwo General Problems Affecting BothIndependent and Mutually Exclusive Projects

135138138139140141

141141145

145

145

Problems Specific to Mutually ExclusiveProjects 149Redeeming Qualities of IRR 154A Test 154

5.6 The Profitability Index 155Calculation of Profitability Index 155

5.7 The Practice of Capital Budgeting 157Summary and Conclusions 159Concept Questions ' 160Questions and Problems 162Excel Master It! 169Mini Case: Bullock Gold Mining 170

CHAPTER 6

Making Capital Investment Decisions 171

6.1 Incremental Cash Flows: The Keyto Capital Budgeting 171Cash Flows—Not AccountingIncome 171Sunk Costs 172Opportunity Costs - 172Side Effects 173Allocated Costs 173

6.2 The Baldwin Company: An Example 174An Analysis of the Project 176Which Set of Books? 179A Note about Net Working Capital 179A Note about Depreciation 180Interest Expense 181

6.3 Inflation and Capital Budgeting 181Interest Rates and Inflation 181Cash Flow and Inflation 183Discounting: Nominal or Real? 184

6.4 Alternative Definitions of OperatingCash Flow 186The Top-Down Approach 187The Bottom-Up Approach 187The Tax Shield Approach 188Conclusion ' 189

6.5 Some Special Cases of DiscountedCash Flow Analysis 189Evaluating Cost-Cutting Proposals ' 189Setting the Bid Price 191Investments of Unequal Lives: The Equivalent .Annual Cost Method 193Summary and Conclusions 195Concept Questions 195Questions and Problems 197Excel Master It! 205Mini Cases: Bethesda Mining Company 206

GoodweekTires, Inc. 206

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CHAPTER 7

Risk Analysis, Real Options, and CapitalBudgeting 208

7.1 Sensitivity Analysis, Scenario Analysis,and Break-Even Analysis 208Sensitivity Analysis and Scenario Analysis 208Break-Even Analysis 212

7.2 Monte Carlo Simulation 216Step I: Specify the Basic Model 216Step 2: Specify a Distribution for Each Variablein the Model 216Step 3:The Computer Draws One Outcome 219Step 4: Repeat the Procedure 219Step 5: Calculate NPV 220

7.3 Real Options 220The Option to Expand 221The Option to Abandon 222Timing Options 224

7.4 Decision Trees 225Summary and Conclusions 227Concept Questions 228Questions and Problems 228Excel Master It! 235Mini Case: Bunyan Lumber; LLC 236

CHAPTER 8

Interest Rates and Bond Valuation 238

8.1 Bonds and Bond Valuation 238Bond Features and Prices 238Bond Values and Yields 239Interest Rate Risk 242Finding the Yield to Maturity: More Trial and Error 244Zero Coupon Bonds 246

8.2 Government and Corporate Bonds 248Government Bonds 248Corporate Bonds 249Bond Ratings 251

8.3 Bond Markets 252How Bonds Are Bought and Sold 252Bond Price Reporting 253A Note on Bond Price Quotes 256

8.4 Inflation and Interest Rates 257Real versus Nominal Rates 257Inflation Risk and Inflation-Linked Bonds 258The Fisher Effect 259

8.5 Determinants of Bond Yields 261The Term Structure of Interest Rates 261

. Bond Yields and the Yield Curve:Putting It All Together 264Conclusion 265Summary and Conclusions 265

Concept QuestionsQuestions and ProblemsExcel Master It!Mini Case: Financing East Coast Yachts'sExpansion Plans with a Bond Issue

265267270

271

CHAPTER 9

Stock Valuation

9.1

9.2

9.3

9.4

9.59.6

The Present Value of Common StocksDividends versus Capital GainsValuation of Different Types of StocksEstimates of Parameters in the DividendDiscount ModelWhere Does g Come From?Where Does R Come From?A Healthy Sense of SkepticismDividends or Earnings: Which to Discount?The No-Dividend FirmGrowth OpportunitiesNPVGOs of Real-World CompaniesGrowth in Earnings and Dividends •versus Growth OpportunitiesComparablesPrice-to-Earnings RatioEnterprise Value RatiosValuing the Entire FirmThe Stock MarketsDealers and BrokersOrganization of the NYSENASDAQ OperationsStock Market ReportingSummary and ConclusionsConcept QuestionsQuestions and ProblemsExcel Master It!Mini Case: Stock Valuation atRagan Engines

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304

CHAPTER 10

Risk and Return: Lessons fromMarket History

10.1 ReturnsDollar ReturnsPercentage Returns

10.2 Holding Period Returns10.3 Return Statistics10.4 Average Stock Returns and

Risk-Free Returns

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317

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10.5 Risk StatisticsVariance

Normal Distribution and Its Implicationsfor Standard Deviation

10.6 More on Average ReturnsArithmetic versus Geometric AveragesCalculating Geometric Average ReturnsArithmetic Average Return or GeometricAverage Return?

10.7 The U.S. Equity Risk Premium: Historicaland International Perspectives

10.8 2008: A Year of Financial CrisisSummary and ConclusionsConcept Questions

Questions and ProblemsExcel Master It!

Mini Case: A Job at East Coast Yachts

CHAPTER 11

Return and Risk: The Capital Asset

Pricing Model (CAPM)

I I.I Individual Securities11.2 Expected Return,Variance, and

CovarianceExpected Return and VarianceCovariance and Correlation

11.3 The Return and Risk for PortfoliosThe Expected Return on a PortfolioVariance and Standard Deviation of a Portfolio

11.4 The Efficient Set for Two Assets11.5 The Efficient Set for Many Securities

Variance and Standard Deviation in aPortfolio of Many Assets

11.6 Diversification

The Anticipated and UnanticipatedComponents of NewsRisk: Systematic and UnsystematicThe Essence of Diversification

11.7 Riskless Borrowing and LendingThe Optimal Portfolio

11.8 Market EquilibriumDefinition of the Market EquilibriumPortfolio

Definition of Risk When InvestorsHold the Market PortfolioThe Formula for BetaA Test

11.9 Relationship between Risk andExpected Return (CAPM)Expected Return on MarketExpected Return on Individual SecuritySummary and Conclusions

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Concept QuestionsQuestions and ProblemsExcel Master It!Mini Case: A Job at East Coast Yachts, Part 2

Appendix 11 A: Is Beta Dead?

C H A P T E R 12

An Alternative View of Risk and Return:

The Arbitrage Pricing Theory

12.112.212.3

12.4

12.5

12.6

CHAPTER 13

Risk, Cost of Capital, and Valuation

13.1 The Cost of Capital13.2 Estimating the Cost of Equity

353 Capital with the CAPM

353 The Risk-Free Rate354 Market Risk Premium356 13.3 Estimation of Beta358 Real-World Betas359 Stability of Beta

Using an Industry Beta359 13.4 Determinants of Beta

Cyclically of RevenuesOperating LeverageFinancial Leverage and Beta

368

369

375

376

377

378

IntroductionSystematic Risk and BetasPortfolios and Factor ModelsPortfolios and DiversificationBetas,Arbitrage, and Expected ReturnsThe Linear Relationship

The Market Portfolio and the Single FactorThe Capital Asset Pricing Model and theArbitrage Pricing TheoryDifferences in PedagogyDifferences in ApplicationEmpirical Approaches to Asset PricingEmpirical ModelsStyle Portfolios

Summary and Conclusions •Concept QuestionsQuestions and ProblemsExcel Master It!Mini Case:The Fama-French Multifactor Model

and Mutual Fund Returns

378378381383386386387

388388388390390391393393394

398

399

13.5 The Dividend Discount Model ApproachComparison of DDM and CAPM

363 13.6 Cost of Capital for Divisions and Projects363 13.7 Cost of Fixed Income Securities364 Cost of Debt367 Cost of Preferred Stock

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XXIX

13.8 The Weighted Average Cost of Capital 41713.9 Valuation with RWACC 418

Project Evaluation and the RWACC 418

Firm Valuation with the RWACC 419

13.10 Estimating Eastman Chemical'sCost of Capital 422

13.11 Flotation Costs and the WeightedAverage Cost of Capital 424The Basic Approach 424Flotation Costs and NPV 425Internal Equity and Flotation Costs 426Summary and Conclusions 426Concept Questions 427Questions and Problems 428Mini Case:The Cost of Capital forGoff Computer, Inc. 433

Appendix 13 A: Economic Value Added and theMeasurement of Financial Performance 334

CHAPTER 14

Efficient Capital Markets andBehavioral Challenges /

14.1 Can Financing Decisions Create Value?14.2 A Description of Efficient Capital Markets

Foundations of Market Efficiency14.3 The Different Types of Efficiency

The Weak FormThe Semistrong and Strong FormsSome Common Misconceptions about theEfficient Market Hypothesis

14.4 The Evidence• The Weak Form

The Semistrong FormThe Strong Form

14.5 The Behavioral Challenge toMarket Efficiency

14.6 Empirical Challenges to Market Efficiency14.7 Reviewing the Differences14.8 Implications for Corporate Finance

I. Accounting Choices, Financial Choices,and Market Efficiency2,The Timing Decision3. Speculation and Efficient Markets4. Information in Market PricesSummary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case: Your 401 (k) Account at East Coast Yachts

CHAPTER 15

Long-Term Financing: An Introduction 474

15.1 Some Features of Commonand Preferred Stocks 474Common Stock Features 474Preferred Stock Features 477

15.2 Corporate Long-Term Debt 478Is It Debt or Equity? 479Long-Term Debt:The Basics 479The Indenture 481

15.3 Some Different Types of Bonds 484Floating-Rate Bonds 484Other Types of Bonds 484

15.4 Bank Loans 48515.5 International Bonds 48615.6 Patterns of Financing 48615.7 Recent Trends in Capital Structure 488

Which Are Best: Book or Market Values? 489Summary and Conclusions 490Concept Questions 490Questions and Problems 491

CHAPTER 16

Capital Structure: Basic Concepts 494

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16.1

16.2

16.3

16.4

16.5

The Capital Structure Questionand the Pie TheoryMaximizing Firm Value versusMaximizing Stockholder InterestsFinancial Leverage and Firm Value:An ExampleLeverage and Returns to ShareholdersThe Choice between Debt and EquityA Key AssumptionModigliani and Miller: Proposition II(No Taxes)Risk to Equityholders Rises with LeverageProposition II: Required Return toEquityholders Rises with LeverageMM: An InterpretationTaxesThe Basic InsightPresent Value of the Tax ShieldValue of the Levered FirmExpected Return and Leverage underCorporate TaxesThe Weighted Average Cost of Capital, RVJN-C

and Corporate TaxesStock Price and Leverage under Corporate TaxesSummary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case: Stephenson Real Estate Recapitalization

494

495

497497499501

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CHAPTER 17

Capital Structure: Limits to the Useof Debt 526

17.1 Costs of Financial Distress 526Bankruptcy Risk or Bankruptcy Cost? 526

17.2 Description of Financial Distress Costs 528Direct Costs of Financial Distress: Legal andAdministrative Costs of Liquidation orReorganization 528Indirect Costs of Financial Distress 530Agency Costs 531

17.3 Can Costs of Debt Be Reduced? 534Protective Covenants 534Consolidation of Debt 535

17.4 Integration of Tax Effects andFinancial Distress Costs 536Pie Again 537

17.5 Signaling 53817.6 Shirking, Perquisites, and Bad Investments:

A Note on Agency Cost of Equity 540 19.3Effect of Agency Costs of Equity onDebt-Equity Financing 542Free Cash Flow 542

17.7 The Pecking-Order Theory 543Rules of the Pecking Order 544Implications 545

17.8 Personal Taxes ' 546The Basics of Personal Taxes 546The Effect of Personal Taxes on Capital Structure 546

17.9 How Firms Establish Capital Structure 548Summary and Conclusions - 553Concept Questions 553Questions and Problems 554Mini Case: McKenzie Corporation's Capital Budgeting 557

Appendix 17A: Some Useful Formulas ofFinancial Structure 558

Appendix l7B:The Miller Model and theGraduated Income Tax 558

CHAPTER 18

Valuation and Capital Budgeting for theLevered Firm 559

18.1 Adjusted Present Value Approach 55918.2 Flow to Equity Approach 561

Step I: Calculating Levered Cash Flow (LCF) 561Step 2: Calculating Rs 562Step 3:Valuation 562

18.3 Weighted Average Cost of Capital Method 56218.4 A Comparison of the APV, FTE,

and WACC Approaches 563A Suggested Guideline 564

18.5 Valuation When the Discount RateMust Be Estimated 566

18.6 APV Example 56818.7 Beta and Leverage 571

The Project Is Not Scale Enhancing 573Summary and Conclusions 574Concept Questions 574Questions and Problems 575Mini Case:The Leveraged Buyout ofCheek Products, Inc. 579

Appendix 18A: The Adjusted Present Value Approachto Valuing Leveraged Buyouts 580

CHAPTER 19

Dividends and Other Payouts

19.119.2

581

Different Types of Payouts 581Standard Method of CashDividend Payment 581The Benchmark Case: An Illustrationof the Irrelevance of Dividend Policy 584Current Policy: Dividends" Set Equal to Cash Flow 584Alternative Policy: Initial Dividend Is GreaterThan Cash Flow 584The Indifference Proposition- 585Homemade Dividends 585A Test 586Dividends and Investment Policy 587

19.4 Repurchase of Stock 587Dividend versus Repurchase: Conceptual Example 589Dividends versus Repurchases: Real-WorldConsiderations 590

19.5 Personal Taxes, Dividends, andStock Repurchases 591Firms without Sufficient Cash to Pay a Dividend 591Firms with Sufficient Cash to Pay a Dividend 592Summary of Personal Taxes 595

19.6 Real-World Factors Favoringa High-Dividend Policy 595Desire for Current Income 595Behavioral Finance 596Agency Costs 597Information Content of Dividends andDividend Signaling 598

19.7 The Clientele Effect: A Resolutionof Real-World Factors? 600

19.8 What W e Know and Do Not Knowabout Dividend Policy 602Corporate Dividends Are Substantial 602Fewer Companies Pay Dividends 603Corporations Smooth Dividends 604Some Survey Evidence about Dividends 605

19.9 Putting It All Together 607

xxxi

19.10 Stock Dividends and Stock SplitsSome Details about Stock Splits andStock DividendsValue of Stock Splits and Stock DividendsReverse SplitsSummary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case: Electronic Timing, Inc.

609

60961 I612613613615619

CHAPTER 20

Raising Capital

20.1 Early-Stage Financing and Venture CapitalVenture CapitalStages of FinancingSome Venture Capital RealitiesVenture Capital Investments andEconomic Conditions

20.2 The Public Issue20.3 Alternative Issue Methods20.4 The Cash Offer

Investment BanksThe Offering PriceUnderpricing: A Possible Explanation

20.5 The Announcement of New Equityand the Value of the Firm

20.6 The Cost of New IssuesThe Costs of Going Public: A Case Study

20.7 RightsThe Mechanics of a Rights OfferingSubscription PriceNumber of Rights Needed to Purchase a ShareEffect of Rights Offering on Price of StockEffects on ShareholdersThe Underwriting Arrangements

20.8 The Rights Puzzle20.9 Dilution

Dilution of Proportionate OwnershipStock Price DilutionBookValueEarnings Per ShareConclusion

20.10 Shelf Registration20.11 Issuing Long-Term Debt

Summary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case: East Coast Yachts Goes Public

621

CHAPTER 21

Leasing 656

21.1 Types of Leases 656The Basics 656Operating Leases 656Financial Leases 657

21.2 Accounting and Leasing 65821.3 Taxes, the IRS, and Leases 66021.4 The Cash Flows of Leasing 66121.5 A Detour for Discounting and Debt

Capacity with Corporate Taxes 663Present Value of Riskless Cash Flows 663Optimal Debt Level and Riskless Cash Flows 664

21.6 NPV Analysis of the Lease-versus-BuyDecision 665

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21.7

21.821.9

21.10

The Discount RateDebt Displacement and Lease ValuationThe Basic Concept of Debt DisplacementOptimal Debt Level in the Xomox ExampleDoes Leasing Ever Pay? The Base CaseReasons for LeasingGood Reasons for LeasingBad Reasons for Leasing

i Some Unanswered QuestionsAre the Uses of Leases and Debt Complementary?Why Are Leases Offered by Both Manufacturersand Third-Party Lessors?Why Are Some Assets Leased More Than Others?Summary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case:The Decision to Lease orBuy at Warf Computers

Appendix 21 A: APV Approach to Leasing

PAIam

RT ¥1 Options, Futures,i Corporate Finance

CHAPTER 22

Options and Corporate Finance

22.122.2

22.3

22.422.522.6

OptionsCall OptionsThe Value of a Call Option at ExpirationPut OptionsThe Value of a Put Option at ExpirationSelling OptionsOption QuotesCombinations of Options

665666666667669670670673674674

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22.7 Valuing OptionsBounding the Value of a CallThe Factors Determining Call Option ValuesA Quick Discussion of Factors DeterminingPut Option Values

22.8 An Option Pricing FormulaA Two-State Option ModelThe Black-Scholes Model

22.9 Stocks and Bonds as OptionsThe Firm Expressed in Terms of Call OptionsThe Firm Expressed in Terms of Put OptionsA Resolution of the Two ViewsA Note about Loan Guarantees

22.10 Options and Corporate Decisions:Some ApplicationsMergers and DiversificationOptions and Capital Budgeting

22.11 Investment in Real Projects and OptionsSummary and ConclusionsConcept QuestionsQuestions and ProblemsExcel Master It!Mini Case: Clissold Industries Options

690690692

695695696698703704705706707

708708710712715715716723724

24.424.5

24.6

24.7

24.8

Convertible BondsThe Value of Convertible BondsStraight Bond ValueConversion ValueOption ValueReasons for Issuing Warrants andConvertiblesConvertible Debt versus Straight DebtConvertible Debt versus Common StockThe "Free Lunch" StoryThe "Expensive Lunch" StoryA ReconciliationWhy Are Warrants and ConvertiblesIssued?Matching Cash FlowsRisk SynergyAgency CostsBackdoor EquityConversion PolicySummary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case: S&S Air's Convertible Bond

757758758758759

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764764764765765765767767768770

CHAPTER 23 :

Options and Corporate Finance:Extensions and Applications < 726

23.1 Executive Stock Options 726Why Options? 726Valuing Executive Compensation 727

23.2 Valuing a Start-Up 73023.3 More about the Binomial Model 733

Heating Oil 73423.4 Shutdown and Reopening Decisions 740

Valuing a Gold Mine 740The Abandonment and Opening Decisions 741Valuing the Simple Gold Mine 742Summary and Conclusions 747Concept Questions 747Questions and Problems 748Mini Case: Exotic Cuisines' Employee Stock Options 750

CHAPTER 24

Warrants and Convertibles

24.124.2

24.3

WarrantsThe Difference between Warrantsand Call OptionsHow the Firm Can Hurt Warrant HoldersWarrant Pricing and theBlack-Scholes Model

751

751

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CHAPTER 25

Derivatives and Hedging Risk 772

25.1 Derivatives, Hedging, and Risk 77225.2 Forward Contracts 77325.3 Futures Contracts 77425.4 Hedging 77825.5 Interest Rate Futures Contracts 780

Pricing ofTreasury Bonds 780Pricing of Forward Contracts 781Futures Contracts 782Hedging in Interest Rate Futures 783

25.6 Duration Hedging 787The Case of Zero Coupon Bonds 787The Case ofTwo Bonds with the Same Maturitybut with Different Coupons 788Duration 789Matching Liabilities with Assets 791

25.7 Swaps Contracts . 793Interest Rate Swaps 794Currency Swaps 795Credit Default Swaps (CDS) 796Exotics 796

25.8 Actual Use of Derivatives 797Summary and Conclusions 799Concept Questions 799Questions and Problems 801Mini Case:Williamson Mortgage, Inc. 803

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CHAPTER 26

Short-Term Finance and Planning 804

26.1 Tracing Cash and Networking Capital 80526.2 The Operating Cycle and the Cash Cycle 806

Defining the Operating and Cash Cycles 807The Operating Cycle and the Firm'sOrganization Chart 809Calculating the Operating and Cash Cycles 809Interpreting the Cash Cycle 812A Look at Operating and Cash Cycles 812

26.3 Some Aspects of Short-TermFinancial Policy 813The Size of the Firm's Investment in Current Assets 814Alternative Financing Policies for Current Assets 815Which Is Best? 818

26.4 Cash Budgeting 819Cash Outflow 820The Cash Balance 821

26.5 The Short-Term Financial Plan 821Unsecured Loans 821Secured Loans 822Other Sources . 822Summary and Conclusions 823Concept Questions 823Questions and Problems ' 824Excel Master It! 832Mini Case: Keafer Manufacturing Working

Capital Management 833

C H A P T E R 27

Cash Management 834

27.1 Reasons for Holding Cash 834• The Speculative and Precautionary Motives 834

The Transaction Motive 835Compensating Balances 835Costs of Holding Cash 835Cash Management versus Liquidity Management 835

27.2 Understanding Float 836Disbursement Float 836Collection Float and Net Float 837Float Management - 838Electronic Data Interchange and Check 21:

- The End of Float? 84127.3 Cash Collection and Concentration 842

Components of Collection Time • 842Cash Collection 843Lockboxes 843Cash Concentration 844Accelerating Collections: An Example 845

27.4 Managing Cash Disbursements 847Increasing Disbursement Float 847Controlling Disbursements 848

27.5 Investing Idle Cash 849Temporary Cash Surpluses 849Characteristics of Short-Term Securities 850Some Different Types of Money Market Securities 850Summary and Conclusions 851Concept Questions 852Questions and Problems 853Mini Case: Cash Management at RichmondCorporation 855

Appendix 27A: Determining the TargetCash Balance 855

Appendix 27B: Adjustable Rate PreferredStock, Auction Rate PreferredStock, and Floating-RateCertificates of Deposit. 855

CHAPTER 28

Credit and Inventory Management 856

28.1 Credit and Receivables 856Components of Credit Policy 856The Cash Flows from Granting Credit 857The Investment in Receivables 857

28.2 Terms of the Sale 858The Basic Form 858The Credit Period 858Cash Discounts 860Credit Instruments 861

28.3 Analyzing Credit Policy 862Credit Policy Effects 862Evaluating a Proposed Credit Policy 862

28.4 Optimal Credit Policy 864The Total Credit Cost Curve 865Organizing the Credit Function 866

28.5 Credit Analysis 866When Should Credit Be Granted? 867Credit Information 868Credit Evaluation and Scoring 869

28.6 Collection Policy 869Monitoring Receivables 869Collection Effort 870

28.7 Inventory Management 871The Financial Manager and Inventory Policy 871Inventory Types 871Inventory Costs 872

28.8 Inventory Management Techniques 872The ABC Approach 872The Economic Order Quantity Model 873Extensions to the EOQ Model 877Managing Derived-Demand Inventories 879

XXXIV

Summary and ConclusionsConcept QuestionsQuestions and ProblemsMini Case: Credit Policy At Braam Industries

Appendix 28A: More about Credit Policy Analysis

PART VIII Special TopicsCHAPTER 29

Mergers,Acquisitions, and Divestitures

29.1 The Basic Forms of AcquisitionsMerger or ConsolidationAcquisition of StockAcquisition of AssetsA Classification SchemeA Note about Takeovers

29.2 Synergy29.3 Sources of Synergy

Revenue EnhancementCost ReductionTax GainsReduced Capital Requirements

29.4 Two Financial Side Effects of AcquisitionsEarnings GrowthDiversification

29.5 A Cost to Stockholders from Reductionin RiskThe Base CaseBoth Firms Have DebtHow Can Shareholders Reduce Their Lossesfrom the Coinsurance Effect?

29.6 The NPV of a MergerCashCommon StockCash versus Common Stock

29.7 Friendly versus Hostile Takeovers29.8 Defensive Tactics

Deterring Takeovers before Being in PlayDeterring aTakeover after the Company Is in Play

29.9 Do Mergers Add Value?Returns to BiddersTarget CompaniesThe Managers versus the Stockholders .

29.10 The Tax Forms of Acquisitions29.11 Accounting for Acquisitions29.12 Going Private and Leveraged Buyouts29.13 Divestitures

SaleSpin-OffCarve-OutTracking StocksSummary and Conclusions

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Concept QuestionsQuestions and ProblemsMini Case: The Birdie Golf—Hybrid Golf Merger

CHAPTER 30

Financial Distress

30.130.230.3

30.4

30.530.6

W h a t Is Financial Distress?W h a t Happens in Financial Distress?Bankruptcy Liquidation andReorganizationBankruptcy LiquidationBankruptcy ReorganizationPrivate Workout or Bankruptcy:Which Is Best?The Marginal FirmHoldoutsComplexityLack of InformationPrepackaged BankruptcyPredicting Corporate Bankruptcy:The Z-Score ModelSummary and ConclusionsConcept QuestionsQuestions and Problems

CHAPTER 31

International Corporate Finance

31.131.2

31.3

31.4

31.5

31.6

TerminologyForeign Exchange Marketsand Exchange RatesExchange Rates

Purchasing Power ParityAbsolute Purchasing Power ParityRelative Purchasing Power ParityInterest Rate Parity, Unbiased ForwardRates, and the International Fisher EffectCovered Interest ArbitrageInterest Rate ParityForward Rates and Future Spot RatesPutting It All TogetherInternational Capital BudgetingMethod 1 :The Home Currency ApproachMethod 2:The Foreign Currency ApproachUnremitted Cash FlowsThe Cost of Capital for International FirmsExchange Rate RiskShort-Term ExposureLong-Term ExposureTranslation ExposureManaging Exchange Rate Risk

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31.7 Political Risk 965 Appendix B: Solutions to SelectedSummary and Conclusions 966 End-of-Chapter Problems 982Concept Questions 967 Appendix C: Using the HP I OB and Tl BA II PlusQuestions and Problems 968 Financial Calculators 985Excel Master It! 971 Glossary 989Mini Case: East Coast Yachts Goes International 971 Name Index 1007

Subject Index 1009Appendix A: Mathematical Tables 9 73

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