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Contents PART 1 INTRODUCTION C HA PT ER

1

The Financial Manager and the Firm

1

1.1 THE ROLE OF THE FINANCIAL MANAGER 2 Stakeholders 2 It’s All about Cash Flows 2 Building Intuition: Cash Flows Matter Most to Investors 4 Three Fundamental Decisions in Financial Management 4 Building Intuition: Sound Investments are Those Where the Value of the Benefits Exceeds Their Cost 5 Building Intuition: Financing Decisions Affect the Value of the Firm 5

1.2 FORMS OF BUSINESS ORGANIZATION 6 Sole Proprietorships 6 Partnerships 7 Corporations 7 Hybrid Forms of Business Organization 8

1.3 MANAGING THE FINANCIAL FUNCTION 9 Organizational Structure 9 Positions Reporting to the CFO 10 External Auditors 10 The Audit Committee 10 The Compliance and Ethics Director 10

1.4 THE GOAL OF THE FIRM 11 What Should Management Maximize? 11 Why Not Maximize Profits? 11

Building Intuition: The Timing of Cash Flows Affects Their Value 11 Building Intuition: The Riskiness of Cash Flows Affects Their Value 12 Maximize the Value of the Firm’s Stock 12 Building Intuition: The Financial Manager’s Goal Is to Maximize the Value of the Firm’s Stock 12 Can Management Decisions Affect Stock Prices? 12

1.5 AGENCY CONFLICTS: SEPARATION OF OWNERSHIP AND CONTROL 13 Ownership and Control 14 Agency Relationships 14 Do Managers Really Want to Maximize Stock Price? 14 Aligning the Interests of Management and Stockholders 14 Sarbanes-Oxley and Other Regulatory Reforms 16

1.6 THE IMPORTANCE OF ETHICS IN BUSINESS 18 Business Ethics 18 Are Business Ethics Different from Everyday Ethics? 18 Types of Ethical Conflicts in Business 19 The Importance of an Ethical Business Culture 20 Serious Consequences 20 Summary of Learning Objectives • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

PART 2 FOUNDATIONS C HA PT ER

2.2 DIRECT FINANCING 27

2

The Financial System and the Level of Interest Rates 24 2.1 THE FINANCIAL SYSTEM 25 The Financial System at Work 26 through the Financial System 26

How Funds Flow

A Direct Market Transaction 28 and Direct Financing 28

Investment Banks

2.3 TYPES OF FINANCIAL MARKETS 30 Primary and Secondary Markets 30 Exchanges and Over-the-Counter Markets 31 Money and Capital Markets 31


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LibraryPirate CONTENTS Public and Private Markets 31 Markets 32

Futures and Options

Corporate Income Tax Rates 72 Average versus Marginal Tax Rates 72 Unequal Treatment of Dividends and Interest Payments 73

2.4 MARKET EFFICIENCY 33 Efficient Market Hypotheses 33

2.5 FINANCIAL INSTITUTIONS AND INDIRECT FINANCING 34 Indirect Market Transactions 35 Financial Institutions and Their Services 35 Corporations and the Financial System 36

2.6 THE DETERMINANTS OF INTEREST RATE LEVELS 38

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

3

Financial Statements, Cash Flows, and Taxes 48

3.1 FINANCIAL STATEMENTS AND ACCOUNTING PRINCIPLES 49 The Annual Report 49 Generally Accepted Accounting Principles 50 Fundamental Accounting Principles 50 International GAAP 51 Illustrative Company: Diaz Manufacturing 51

3.2 THE BALANCE SHEET 52 Current Assets and Liabilities 53 and Liabilities 54 Equity 55

Long-Term Assets

3.3 MARKET VALUE VERSUS BOOK VALUE 57 A More Informative Balance Sheet 57 Value Balance Sheet 58

A Market-

3.4 THE INCOME STATEMENT AND THE STATEMENT OF RETAINED EARNINGS 60 The Income Statement 60 Retained Earnings 63

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

CH AP TE R

The Real Rate of Interest 38 Loan Contracts and Inflation 40 The Fisher Equation and Inflation 40 Cyclical and Long-Term Trends in Interest Rates 42

CHAP T ER

3.8 FEDERAL INCOME TAX 71

The Statement of

3.5 THE STATEMENT OF CASH FLOWS 63

4

Analyzing Financial Statements

81

4.1 BACKGROUND FOR FINANCIAL STATEMENT ANALYSIS 82 Perspectives on Financial Statement Analysis 82 Guidelines for Financial Statement Analysis 83

4.2 COMMON-SIZE FINANCIAL STATEMENTS 84 Common-Size Balance Sheets 84 Income Statements 85

Common-Size

4.3 FINANCIAL RATIOS AND FIRM PERFORMANCE 86 Why Ratios Are Better Measures 86 Short-Term Liquidity Ratios 87 Efficiency Ratios 89 Leverage Ratios 93 Profitability Ratios 97 Market-Value Indicators 100 Concluding Comments on Ratios 101

4.4 THE DUPONT SYSTEM: A DIAGNOSTIC TOOL 101 An Overview of the DuPont System 101 The ROA Equation 101 The ROE Equation 103 The DuPont Equation 103 Applying the DuPont System 104 Is Maximizing ROE an Appropriate Goal? 104

4.5 SELECTING A BENCHMARK 106 Trend Analysis 106 Group Analysis 106

Industry Analysis 106

4.6 USING FINANCIAL RATIOS 108 Performance Analysis of Diaz Manufacturing 108 Limitations of Financial Statement Analysis 111

Sources and Uses of Cash 63

3.6 TYING THE FINANCIAL STATEMENTS TOGETHER 66

3.7 CASH FLOWS TO INVESTORS 67 Net Income versus the Cash Flow to Investors 67 Cash Flow To Investors: Putting It All Together 70

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

E T H I C S C A S E : A S a d Ta le : T h e De mi s e o f Arthur Andersen 122

Peer


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PART 3 VALUATION OF FUTURE CASH FLOWS AND RISK C HA PT ER

6.4 THE EFFECTIVE ANNUAL INTEREST RATE 185

5

The Time Value of Money

124

5.1 THE TIME VALUE OF MONEY 125 Consuming Today or Tomorrow 125 Building Intuition: The Value of Money Changes with Time 126 Time Lines as Aids to Problem Solving 126 Financial Calculator 127

5.2 FUTURE VALUE AND COMPOUNDING 127 Single-Period Investment 127 Two-Period Investment 128 The Future Value Equation 129 The Future Value Factor 131 Applying the Future Value Formula 132 Building Intuition: Compounding Drives Much of the Earnings on Long-Term Investments 134 Calculator Tips for Future Value Problems 137

5.3 PRESENT VALUE AND DISCOUNTING 140 Single-Period Investment 140 Multiple-Period Investment 141 The Present Value Equation 142 Future and Present Value Equations Are the Same 142 Applying the Present Value Formula 142 The Relations among Time, the Discount Rate, and Present Value 144 Calculator Tips for Present Value Problems 145 Future Value versus Present Value 146

5.4 ADDITIONAL CONCEPTS AND APPLICATIONS 147

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

6

Discounted Cash Flows and Valuation

A P P E N D I X : Deriving the Formula for the Present Value of an Ordinar y Annuity 196 P ro ble m 1 9 7 E T H I C S C A S E : Buy It on Credit and Be True to Your School 198 CH AP TE R

7

Risk and Return

200

7.1 RISK AND RETURN 201 Building Intuition: More Risk Means a Higher Expected Return 202

7.2 QUANTITATIVE MEASURES OF RETURN 202

Present

6.2 LEVEL CASH FLOWS: ANNUITIES AND PERPETUITIES 167 Present Value of an Annuity 167 Future Value of an Annuity 177 Perpetuities 179 Annuities Due 181

6.3 CASH FLOWS THAT GROW AT A CONSTANT RATE 183

Expected Returns 203

7.3 THE VARIANCE AND STANDARD DEVIATION AS MEASURES OF RISK 207 Calculating the Variance and Standard Deviation 207 Interpreting the Variance and Standard Deviation 208 Historical Market Performance 211

7.4 RISK AND DIVERSIFICATION 214 Single-Asset Portfolios 215 Portfolios with More Than One Asset 217 Building Intuition: Diversified Portfolios are Less Risky 223 The Limits of Diversification 223

7.5 SYSTEMATIC RISK 224 159

6.1 MULTIPLE CASH FLOWS 160 Future Value of Multiple Cash Flows 160 Value of Multiple Cash Flows 163

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

Holding Period Returns 202

Finding the Interest Rate 148 Finding How Many Periods It Takes an Investment to Grow a Certain Amount 149 The Rule of 72 150 Compound Growth Rates 150 Concluding Comments 152

CHA PT ER

Why the Confusion? 185 Calculating the Effective Annual Interest Rate 185 Comparing Interest Rates 186 Consumer Protection Acts and Interest Rate Disclosure 187 The Appropriate Interest Rate Factor 188

Why Systematic Risk Is All That Matters 224 Building Intuition: Systematic Risk Is the Risk That Matters 224 Measuring Systematic Risk 225

7.6 COMPENSATION FOR BEARING SYSTEMATIC RISK 227 7.7 THE CAPITAL ASSET PRICING MODEL 228 The Security Market Line 228 The Capital Asset Pricing Model andPortfolio Returns 230 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and


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CONTENTS

CH AP T ER

8

CH AP TE R

Bond Valuation and the Structure of nterest Rates 238

8.1 CORPORATE BONDS 239 Market for Corporate Bonds 239 Bond Price Information 240 Types of Corporate Bonds 240

8.2 BOND VALUATION 241 The Bond Valuation Formula 242 Calculator Tip: Bond Valuation Problems 243 Par, Premium, and Discount Bonds 244 Semiannual Compounding 246 Zero Coupon Bonds 246

8.3 BOND YIELDS 248 Yield to Maturity 249 Realized Yield 252

Effective Annual Yield 250

8.4 INTEREST RATE RISK 252 Bond Theorems 253 Applications 255

Bond Theorem

8.5 THE STRUCTURE OF INTEREST RATES 255 Marketability 255 Call Provision 256 Default Risk 256 The Term Structure of Interest Rates 258

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

E T H I C S C A S E : The Subprime Mortgage Market Me lt dow n: How Did It H ap pen? 267

9

Stock Valuation

270

9.1 THE MARKET FOR STOCKS 271 Secondary Markets 271 Secondary Markets and Their Efficiency 272 Stock Market Indexes 274 Reading the Stock Market Listings 274 Common and Preferred Stock 275 Preferred Stock: Debt or Equity? 276

9.2 COMMON STOCK VALUATION 276 A One-Period Model 277 A Perpetuity Model 278 The General Dividend Valuation Model 279 The Growth Stock Pricing Paradox 280

9.3 STOCK VALUATION: SOME SIMPLIFYING ASSUMPTIONS 281 Zero-Growth Dividend Model 281 Constant-Growth Dividend Model 281 Computing Future Stock Prices 284 The Relationship between R and g 286 Mixed (Supernormal) Growth Dividend Model 286

9.4 VALUING PREFERRED STOCK 290 Preferred Stock with a Fixed Maturity 290 Preferred Stock with No Maturity 291 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

E T H I C S C A S E : Insider Trading: Have I Got a S to ck Ti p for You ! 2 9 9

PART 4 CAPITAL BUDGETING DECISIONS

CH AP T ER

10

The Fundamentals of Capital Budgeting 301

10.1 AN INTRODUCTION TO CAPITAL BUDGETING 302 The Importance of Capital Budgeting 302 The Capital Budgeting Process 303 Sources of Information 304 Classification of Investment Projects 304 Basic Capital Budgeting Terms 305 Building Intuition: Investment Decisions Have Opportunity Costs 305

10.2 NET PRESENT VALUE 306 Valuation of Real Assets 306 NPV—The Basic Concept 306 NPV and Value Creation 307 Framework for Calculating NPV 307 Net Present Value Techniques 309 Concluding Comments on

10.3 THE PAYBACK PERIOD 313 Computing the Payback Period 313 How the Payback Period Performs 315 Discounted Payback Period 316 Evaluating the Payback Rule 317

10.4 THE ACCOUNTING RATE OF RETURN 318 10.5 INTERNAL RATE OF RETURN 318 Calculating the IRR 319 When the IRR and NPV Methods Agree 321 When the NPV and IRR Methods Disagree 322 Modified Internal Rate of Return (MIRR) 325 IRR versus NPV: A Final Comment 327

10.6 CAPITAL BUDGETING IN PRACTICE 328 Practitioners’ Methods of Choice 329 Ongoing Reviews 329

Postaudit and

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and


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LibraryPirate CONTENTS C HA PT ER

Building Intuition: Revenue Changes Drive Profit Volatility Through Operating Leverage 390

11

Cash Flows and Capital Budgeting

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341

11.1 CALCULATING PROJECT CASH FLOWS 342 Building Intuition: Capital Budgeting is Forward Looking 342 Incremental After-Tax Free Cash Flows 343 The FCF Calculation 343 Building Intuition: Incremental After-Tax Free Cash Flows Are What Stockholders Care About in Capital Budgeting 344 Cash Flows from Operations 345 Cash Flows Associated with Capital Expenditures and Net Working Capital 345 The FCF Calculation: An Example 346 FCF versus Accounting Earnings 349

12.3 BREAK-EVEN ANALYSIS 391 Pretax Operating Cash Flow Break-Even 391 Accounting Break-Even 393

12.4 RISK ANALYSIS 395 Sensitivity Analysis 395 Simulation Analysis 397

Scenario Analysis 396

12.5 INVESTMENT DECISIONS WITH CAPITAL RATIONING 398 Capital Rationing in a Single Period 399 Capital Rationing across Multiple Periods 401

11.2 ESTIMATING CASH FLOWS IN PRACTICE 350 Five General Rules for Incremental After-Tax Free Cash Flow Calculations 350 Nominal versus Real Cash Flows 353 Tax Rates and Depreciation 355 Computing the Terminal-Year FCF 359 Expected Cash Flows 362 Building Intuition: We Discount Expected Cash Flows in an NPV Analysis 362

11.3 FORECASTING FREE CASH FLOWS 363 Cash Flows from Operations 363 Cash Flows Associated with Capital Expenditures and Net Working Capital 364

11.4 SPECIAL CASES (OPTIONAL) 365 Projects with Different Lives 365 When to Harvest an Asset 367 When to Replace an Existing Asset 368 The Cost of Using an Existing Asset 369 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

E T H I C S C A S E : U n i l e ve r ’s S u s t a i n a bl e L i vi ng P l an 3 7 8

C HA PT ER

12

Evaluating Project Economics and Capital Rationing 380 12.1 VARIABLE COSTS, FIXED COSTS, AND PROJECT RISK 381 Cost Structure and Sensitivity of EBITDA to Revenue Changes 382 Cost Structure and Sensitivity of EBIT to Revenue Changes 385 Building Intuition: High Fixed Costs Mean Larger Fluctuations in Cash Flows and Profits 385

12.2 CALCULATING OPERATING LEVERAGE 388 Degree of Pretax Cash Flow Operating Leverage 389

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

CH AP TE R

13

The Cost of Capital

409

13.1 THE FIRM’S OVERALL COST OF CAPITAL 410 The Finance Balance Sheet 411 Building Intuition: The Market Value of a Firm’s Assets Equals the Market Value of the Claims on Those Assets 412 How Firms Estimate Their Cost of Capital 413 Building Intuition: A Firm’s Cost of Capital Is a Weighted Average of All of Its Financing Costs 414

13.2 THE COST OF DEBT 415 Key Concepts for Estimating the Cost of Debt 415 Building Intuition: The Current Cost of Long-Term Debt Is What Matters When Calculating WACC 416 Estimating the Current Cost of a Bond or an Outstanding Loan 416 Taxes and the Cost of Debt 418 Estimating the Cost of Debt for a Firm 418

13.3 THE COST OF EQUITY 421 Common Stock 421

Preferred Stock 426

13.4 USING THE WACC IN PRACTICE 428 Calculating WACC: An Example 428 Limitations of WACC as a Discount Rate for Evaluating Projects 430 Alternatives to Using WACC for Evaluating Projects 433

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and


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PART 5 WORKING CAPITAL MANAGEMENT AND FINANCING DECISIONS

CH AP T ER

Less Risky Than Unseasoned Securities 481 Investment Banking Services 481 Origination 481 Underwriting 482 Distribution 483 The Proceeds 483

14

Working Capital Management

441

14.1 WORKING CAPITAL BASICS 442 Working Capital Terms and Concepts 443 Capital Accounts and Trade-Offs 444

Working

14.2 THE OPERATING AND CASH CONVERSION CYCLES 445 Operating Cycle 446

Cash Conversion Cycle 448

14.3 WORKING CAPITAL MANAGEMENT STRATEGIES 450

14.4 ACCOUNTS RECEIVABLE 452 Aging Accounts Receivable 453

14.5 INVENTORY MANAGEMENT 455 Economic Order Quantity 455 tory Management 456

Just-in-Time Inven-

14.6 CASH MANAGEMENT AND BUDGETING 456 Reasons for Holding Cash 456

Cash Collection 457

14.7 FINANCING WORKING CAPITAL 458 Strategies for Financing Working Capital 458 Financing Working Capital in Practice 460 Sources of Short-Term Financing 461

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

CH AP T ER

15

How Firms Raise Capital

472

15.1 BOOTSTRAPPING 473 How New Businesses Get Started 473 ing of the Firm 474

The Underpricing Debate 485 Consistently Underpriced 485 IPO 486

IPOs Are The Cost of an

15.5 GENERAL CASH OFFER BY A PUBLIC COMPANY 488 Competitive versus Negotiated Sale 489 of a General Cash Offer 490

Flexible Current Asset Management Strategy 450 Restrictive Current Asset Management Strategy 450 The Working Capital Trade-Off 451

Terms of Sale 452

15.4 IPO PRICING AND COST 485

Initial Fund-

15.2 VENTURE CAPITAL 474 The Venture Capital Industry 474 Why Venture Capital Funding Is Different 475 The Venture Capital Funding Cycle 476 Venture Capitalists Provide More Than Financing 479 The Cost of Venture Capital Funding 479

15.3 INITIAL PUBLIC OFFERING 479 Advantages and Disadvantages of Going Public 480

The Cost

15.6 PRIVATE MARKETS AND BANK LOANS 491 Private versus Public Markets 492 Private Placements 492 Private Equity Firms 493 Private Investments in Public Equity 494 Commercial Bank Lending 494 Concluding Comments on Funding the Firm 496 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

E T H I C S C A S E : Profiting from Death: “Janit o r ’s I n s u ra n c e ” 5 0 2 CH AP TE R

16

Capital Structure Policy

504

16.1 CAPITAL STRUCTURE AND FIRM VALUE 505 The Optimal Capital Structure 505 Building Intuition: The Optimal Capital Structure Minimizes the Cost of Financing a Firm’s Activities 506 The Modigliani and Miller Propositions 506 Building Intuition: Capital Structure Choices Do Not Affect Firm Value If They Do Not Affect the Value of the Free Cash Flows to Investors 506 Building Intuition: The Cost of Equity Increases With Financial Leverage 510

16.2 THE BENEFITS AND COSTS OF USING DEBT 514 The Benefits of Debt 514 The Costs of Debt 520 Building Intuition: People Behave Differently toward a Firm in Financial Distress, and This Increases Bankruptcy Costs 522

16.3 TWO THEORIES OF CAPITAL STRUCTURE 526 The Trade-Off Theory 526 The Pecking Order Theory 526 The Empirical Evidence 527

16.4 PRACTICAL CONSIDERATIONS IN CHOOSING A


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CONTENTS Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

A P P E N D I X : Leasing C HA PT ER

535

17.3 DIVIDENDS AND FIRM VALUE 554 Benefits and Costs of Dividends 555 Stock Price Reactions to Dividend Announcements 557 Dividends versus Stock Repurchases 558

17.4 STOCK DIVIDENDS AND STOCK SPLITS 560

17

Dividends, Stock Repurchases, and Payout Policy 545 17.1 DIVIDENDS 546 Building Intuition: Dividends Reduce the Stockholders’ Investment in a Firm 546 Types of Dividends 547 The Dividend Payment Process 548 Building Intuition: Dividend Announcements Send Signals to Investors 549

17.2 STOCK REPURCHASES 551

Stock Dividends 560 Stock Splits 561 for Stock Dividends and Splits 561

Reasons

17.5 SETTING A DIVIDEND PAYOUT 562 What Managers Tell Us 563 Practical Considerations in Setting a Dividend Payout 563 Summary of Learning Objectives • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

How Stock Repurchases Differ from Dividends 551 How Stock Is Repurchased 553

PART 6 BUSINESS FORMATION, VALUATION, AND FINANCIAL PLANNING CHA PT ER

18

CH AP TE R

Business Formation, Growth, and Valuation 569 18.1 STARTING A BUSINESS 570 Making the Decision to Proceed 571 the Right Organizational Form 571 Considerations 574

Choosing Financial

18.2 THE ROLE OF THE BUSINESS PLAN 578 Why Business Plans Are Important 578 The Key Elements of a Business Plan 579

18.3 VALUING A BUSINESS 580 Fundamental Business Valuation Principles 580 Building Intuition: The Value of a Business Is Specific to a Point in Time 580 Building Intuition: The Value of a Business Is Not the Same to All Investors 581 Business Valuation Approaches 581

18.4 IMPORTANT ISSUES IN VALUATION 594 Public versus Private Companies 594 Young (Rapidly Growing) versus Mature Companies 595 Controlling Interest versus Minority Interest 596 Key People 596 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and

19

Financial Planning and Forecasting

606

19.1 FINANCIAL PLANNING 607 The Planning Documents 607 Building Intuition: A Firm’s Strategy Drives Its Business Decisions 609 Concluding Comments 610

19.2 FINANCIAL PLANNING MODELS 610 The Sales Forecast 611 Building a Financial Planning Model 611 A Simple Planning Model 613

19.3 A BETTER FINANCIAL PLANNING MODEL 616 The Blackwell Sales Company 616 The Income Statement 616 The Balance Sheet 617 The Preliminary Pro Forma Balance Sheet 619 The Final Pro Forma Balance Sheet 621

19.4 BEYOND THE BASIC PLANNING MODELS 623 Improving Financial Planning Models 623

19.5 MANAGING AND FINANCING GROWTH 625 External Funding Needed 625 A Graphical View of Growth 628 The Sustainable Growth Rate 629 Growth Rates and Profits 631 Growth As a Planning Goal 631 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and


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PART 7 OPTIONS IN CORPORATE FINANCE AND INTERNATIONAL DECISIONS

CH AP T ER

20

CH AP TE R

Options and Corporate Finance

641

20.1 FINANCIAL OPTIONS 643 Call Options 643 Put Options 644 American, European, and Bermudan Options 644 More on the Shapes of Option Payoff Functions 645 Building Intuition: Payoff Functions for Options Are Not Linear 646

20.2 OPTION VALUATION 646 Limits on Option Values 646 Variables That Affect Option Values 648 The Binomial Option Pricing Model 649 Put-Call Parity 652 Valuing Options Associated with the Financial Securities That Firms Issue 653

20.3 REAL OPTIONS 655 Options to Defer Investment 655 Options to Make Follow-On Investments 656 Options to Change Operations 656 Options to Abandon Projects 657 Concluding Comments on NPV Analysis and Real Options 657

20.4 AGENCY COSTS 658 Agency Costs of Debt 659 Equity 660

Agency Costs of

20.5 OPTIONS AND RISK MANAGEMENT 662

Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

E T H I C S C A S E : Compensation—How Mu ch I s E n oug h? 66 9

21

International Financial Management

671

21.1 INTRODUCTION TO INTERNATIONAL FINANCIAL MANAGEMENT 672 Globalization of the World Economy 672 The Rise of Multinational Corporations 673 Factors Affecting International Financial Management 673 Goals of International Financial Management 675 Basic Principles Remain the Same 676 Building Intuition: The Basic Principles of Finance Apply No Matter Where You Do Business 676

21.2 FOREIGN EXCHANGE MARKETS 677 Market Structure and Major Participants 677 Foreign Exchange Rates 677 The Equilibrium Exchange Rate 679 Foreign Currency Quotations 680

21.3 INTERNATIONAL CAPITAL BUDGETING 685 Determining Cash Flows 685 Exchange Rate Risk 686 Country Risk 686 The Barcelona Example 687

21.4 GLOBAL MONEY AND CAPITAL MARKETS 689 The Emergence of the Euromarkets 689 The Eurocurrency Market 689 The Eurocredit Market 690 International Bond Markets 690

21.5 INTERNATIONAL BANKING 692 Risks Involved in International Bank Lending 692 Eurocredit Bank Loans 693 Summary of Learning Objectives • Summary of Key Equations • Self-Study Problems • Solutions to Self-Study Problems • Critical Thinking Questions • Questions and Problems • Sample Test Problems

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