3.4 Internal and Sustainable Growth 70
Determining the Discount Rate 112
Finding the Number of Periods 115
Summary and Conclusions 118
Chapter Review and Self-Test Problems 119
Answers to Chapter Review and Self-Test Problems 119
Critical Thinking and Concepts Review 120
Questions and Problems 121 What’s on the Web? 124 Excel Master It! Problem 124 5 Discounted Cash Flow Valuation 125
5.1 Future and Present Values of Multiple Cash Flows 126 Future Value with Multiple Cash Flows 126 Present Value with Multiple Cash Flows 129
5.2 Valuing Level Cash Flows: Annuities and Perpetuities 134
Present Value for Annuity Cash Flows 135
Annuity Tables 136
Finding the Payment 137
Finding the Rate 139
Future Value for Annuities 140
A Note on Annuities Due 140 Perpetuities 141
5.3 Comparing Rates: The Effect of Compounding Periods 143
Effective Annual Rates and Compounding 143
Calculating and Comparing Effective Annual Rates 144 EARs and APRs 145
EARs, APRs, Financial Calculators, and Spreadsheets 147
5.4 Loan Types and Loan Amortization 148
Pure Discount Loans 148
Interest-Only Loans 148
Amortized Loans 149
Summary and Conclusions 153
Chapter Review and Self-Test Problems 154
Answers to Chapter Review and Self-Test Problems 155
Critical Thinking and Concepts Review 157
Questions and Problems 157
What’s on the Web? 165
Excel Master It! Problem 166
CHAPTER CASE: S&S Air’s Mortgage 167 PART FOUR VALUING STOCKS AND BONDS
6 Interest Rates and Bond Valuation 169
6.1 Bonds and Bond Valuation 170
Bond Features and Prices 170
Bond Values and Yields 170
Interest Rate Risk 173
Finding the Yield to Maturity: More Trial and Error 175
6.2 More on Bond Features 179
Is It Debt or Equity? 180
6.3 Bond Ratings 184
6.4 Some Different Types of Bonds 186
Bonds 186 Zero Coupon Bonds 187 Floating-Rate Bonds 188 Other Types of Bonds 189 Sukuk 189
6.5 Bond Markets 191
How Bonds Are Bought and Sold 191
Bond Price Reporting 191
A Note on Bond Price Quotes 194
6.6 Inflation and Interest Rates 194
Real versus Nominal Rates 194
The Fisher Effect 195
6.7 Determinants of Bond Yields 196
The Term Structure of Interest Rates 196
Bond Yields and the Yield Curve: Putting It All Together 199
Conclusion 200
Summary and Conclusions 200
Chapter Review and Self-Test Problems 201
Answers to Chapter Review and Self-Test Problems 201
Critical Thinking and Concepts Review 202
Questions and Problems 203
What’s on the Web? 207
Excel Master It! Problem 208
CHAPTER CASE: Financing S&S Air’s Expansion Plans
with a Bond Issue 209
7 Equity Markets and Stock Valuation 210
7.1 Common Stock Valuation 211
Cash Flows 211
Some Special Cases 212
Zero Growth 213
Constant Growth 213
Nonconstant Growth 216
Components of the Required Return 218
Stock Valuation Using Comparables, or Comps 219
7.2 Some Features of Common and Preferred Stock 221
Common Stock Features 221
Shareholder Rights. 221
Proxy Voting 223
Classes of Stock 223
Other Rights 224
Dividends 224
Preferred Stock Features 224
Stated Value 225
Cumulative and Noncumulative Dividends 225 Is Preferred Stock Really Debt? 225
7.3 The Stock Markets 225
Dealers and Brokers 226
Organization of the NYSE 226
Members 226
Operations 227
Floor Activity 228
Nasdaq Operations 229
ECNs 229
Stock Market Reporting 232
Summary and Conclusions 233
Chapter Review and Self-Test Problems 233 Answers to Chapter Review and Self-Test Problems 234
Thinking and Concepts Review 234
Nonconventional Cash Flows 256
Mutually Exclusive Investments 258
Redeeming Qualities of the IRR 260
The Modified Internal Rate of Return (MIRR) 260
Method 1: The Discounting Approach 260
Method 2: The Reinvestment Approach 261
Method 3: The Combination Approach 261
MIRR or IRR: Which Is Better? 261
8.5 The Profitability Index 262
8.6 The Practice Of Capital Budgeting 263
Summary and Conclusions 265
Chapter Review and Self-Test Problems 266
Answers to Chapter Review and Self-Test Problems 266
Critical Thinking and Concepts Review 267
Questions and Problems 270 What’s on the Web? 276
Excel Master It! Problem 276
9 Making Capital Investment Decisions 279
9.1 Project Cash Flows: A First Look 280
Relevant Cash Flows 280
The Stand-Alone Principle 280
9.2 Incremental Cash Flows 281
Sunk Costs 281
Opportunity Costs 281
Side Effects 282
Net Working Capital 282
Financing Costs 282
Other Issues 283
9.3 Pro Forma Financial Statements and Project Cash Flows 283
Getting Started: Pro Forma Financial Statements 283
Project Cash Flows 284
Project Operating Cash Flow 284
Project Net Working Capital and Capital Spending
285
Projected Total Cash Flow and Value 285
The Tax Shield Approach 286
9.4 More on Project Cash Flow 287
A Closer Look at Net Working Capital 287
Depreciation 288
Modified ACRS (MACRS) Depreciation 289
Bonus Depreciation 290
Book Value versus Market Value 290
An Example: The Majestic Mulch and Compost Company (MMCC) 291
Operating Cash Flows 292
Changes in NWC 292
Capital Spending 293
Total Cash Flow and Value 293
Conclusion 295
9.5 Evaluating NPV Estimates 295
The Basic Problem 295
Forecasting Risk 296
Sources of Value 297
9.6 Scenario and Other What-If Analyses 297
Getting Started 297
Scenario Analysis 298
Sensitivity Analysis 300
9.7 ADDITIONAL CONSIDERATIONS IN CAPITAL BUDGETING 301
Managerial Options and Capital Budgeting 301
Answers to Chapter Review and Self-Test Problems
306
Critical Thinking and Concepts Review 307
Questions and Problems 308
Excel Master It! Problem 313
CHAPTER CASE: Conch Republic Electronics 314 PART SIX RISK AND RETURN
10 Some Lessons from Capital Market History 315
10.1 Returns 316 Dollar Returns 316
Percentage Returns 318
10.2 The Historical Record 320 A First Look 321 A Closer Look 321
10.3 Average Returns: The First Lesson 326
Calculating Average Returns 326
Average Returns: The Historical Record 326 Risk Premiums 326
The First Lesson 327
10.4 The Variability of Returns: The Second Lesson 328
Frequency Distributions and Variability 328
The Historical Variance and Standard Deviation 328
The Historical Record 331
Normal Distribution 332 The Second Lesson 333 2008: The Bear Growled and Investors Howled 334 Using Capital Market History 336 More on the Stock Market Risk Premium 336 10.5 More on Average Returns 339
Some Common Misconceptions about the EMH 344
The Forms of Market Efficiency 345
Summary and Conclusions 346
Chapter Review and Self-Test Problems 346
Answers to Chapter Review and Self-Test Problems
11.3 Announcements, Surprises, and Expected Returns 363
Expected and Unexpected Returns 363
Announcements and News 364
11.4 Risk: Systematic and Unsystematic 365
Systematic and Unsystematic Risk 366
Systematic and Unsystematic Components of Return 366
11.5 Diversification and Portfolio Risk 367
The Effect of Diversification: Another Lesson from Market History 367
The Principle of Diversification 368
Diversification and Unsystematic Risk 369
Diversification and Systematic Risk 369
11.6 Systematic Risk and Beta 370
The Systematic Risk Principle 370
Measuring Systematic Risk 370
Portfolio Betas 373
11.7 The Security Market Line 374
Beta and the Risk Premium
The Basic Argument 376
The Fundamental Result 377
Excel Master It! Problem 392
CHAPTER CASE: The Beta for FLIR Systems 394
PART SEVEN LONG-TERM FINANCING
12 Cost of Capital 395
12.1 The Cost of Capital: Some Preliminaries 396
Required Return versus Cost of Capital 396
Financial Policy and Cost of Capital 397
12.2 The Cost of Equity 398
The Dividend Growth Model Approach 398
Implementing the Approach 398
Estimating g 398
Advantages and Disadvantages of the Approach 399
The SML Approach 400
Implementing the Approach 400
Advantages and Disadvantages of the Approach 401
12.3 The Costs of Debt and Preferred Stock 401
The Cost of Debt 402
The Cost of Preferred Stock 402
12.4 The Weighted Average Cost of Capital 403
The Capital Structure Weights 403
Taxes and the Weighted Average Cost of Capital 404
Solving the Warehouse Problem and Similar Capital
Budgeting Problems 406
Calculating the WACC for Eastman Chemical 407
Eastman’s Cost of Equity 409
Eastman’s Cost of Debt 410
Eastman’s WACC 413
12.5 Divisional and Project Costs of Capital 413
The SML and the WACC 414
Divisional Cost of Capital 415
The Pure Play Approach 415
The Subjective Approach 416
12.6 Company Valuation With The WACC 417
Summary and Conclusions 420
Chapter Review and Self-Test Problems 420
Answers
420
to
Chapter Review and Self-Test Problems
Critical Thinking and Concepts Review 421
Questions and Problems 422
What’s on the Web? 428
Excel Master It! Problem 428
CHAPTER CASE: Cost of Capital for Master Tools
13 Leverage and Capital Structure 430
13.1 The Capital Structure Question 431
13.2 The Effect of Financial Leverage 432
The Impact of Financial Leverage 432
Financial Leverage, EPS, and ROE: An Example 432 EPS versus EBIT 433
Corporate Borrowing and Homemade Leverage 435
13.3 Capital Structure and The Cost of Equity Capital 437
M&M Proposition I: The Pie Model 437
The Cost of Equity and Financial Leverage: M&M
Proposition
II 437
Business and Financial Risk 439
13.4 Corporate Taxes and Capital Structure 440
The Interest Tax Shield 440
Taxes and M&M Proposition I 441
Conclusion 441
13.5 Bankruptcy Costs 443
Direct Bankruptcy Costs 443
Indirect Bankruptcy Costs 443
13.6 Optimal Capital Structure 444
The Static Theory of Capital Structure 444
Optimal Capital Structure and the Cost of Capital 445
Capital Structure: Some Managerial
Recommendations 447
Taxes 447
Financial Distress 447
Liquidation and Reorganization 450
14.1 Cash Dividends and Dividend Payment 464 Cash Dividends 464
Standard Method of Cash Dividend Payment 465
Dividend Payment: A Chronology 465
on the Ex-Dividend Date 466
14.2 Does Dividend Policy Matter? 468
Some Real-World Factors Favoring a High Payout
470
Desire for Current Income 470
Tax and Legal Benefits from High Dividends 471
Clientele Effects: A Resolution of Real-World Factors? 471
14.3 Stock Repurchases: An Alternative to Cash Dividends 472
Cash Dividends versus Repurchase 474
Real-World Considerations in a Repurchase 475
Share Repurchase and EPS 476
14.4 What We Know And Do Not Know About Dividend and Payout Policies 477
Dividends and Dividend Payers 477 Corporations Smooth Dividends 480
Putting It All Together 480
Some Survey Evidence on Dividends 482
14.5 Stock Dividends and Stock Splits 483
Value of Stock Splits and Stock Dividends 484
The Benchmark Case 484
Popular Trading Range 484
Reverse Splits 484
Summary and Conclusions 485
Chapter Review and Self-Test Problems 486
Answer to Chapter Review and Self-Test Problem 487
Critical Thinking and Concepts Review 487
Questions and Problems 488
What’s on the Web? 491
CHAPTER CASE: Electronic Timing, Inc. 492
15 Raising Capital 493
15.1 The Financing Life Cycle of A Firm: Early-Stage
Financing and Venture Capital 494
Entrepreneurship 494
Venture Capital 494
Stages of Financing 495
Some Venture Capital Realities 497
15.2
Direct Listing 507
Special-purpose acquisition companies 507
15.5 IPOs and Underpricing 508
Evidence on Underpricing 508
IPO Underpricing: The 1999–2000 Experience 510
The Partial Adjustment Phenomenon 513
Why Does Underpricing Exist? 514
15.6 New Equity Sales and the Value of The Firm 516
15.7 The Cost of Issuing Securities 516
15.8 Issuing Long-Term Debt 519
15.9 Shelf Registration 519
Summary and Conclusions 520
Chapter Review and Self-Test Problems 521
Answer to Chapter Review and Self-Test Problem 521
Critical Thinking and Concepts Review 522
Questions and Problems 524
What’s on the Web? 525
CHAPTER CASE: S&S Air Goes Public 526
The Size of the Firm’s Investment in Current Assets 536 Alternative Financing Policies for Current Assets 538
Which Financing Policy Is Best? 540
Current Assets and Liabilities in Practice 541
16.4 The Cash Budget 542
Sales and Cash Collections 542
Cash Outflows 543 The Cash Balance 543
16.5 Short-Term Borrowing 545
Unsecured Loans 545
Secured Loans 545
Accounts Receivable Financing 545
Other Sources 546
16.6 A Short-Term Financial Plan 547
Summary and Conclusions 548
Chapter Review and Self-Test Problems 548
Answers to Chapter Review and Self-Test Problems 549
Critical Thinking and Concepts Review 550
Questions and Problems 551
What’s on the Web? 557
Excel Master It! Problem 557
CHAPTER CASE: Piepkorn Manufacturing Working
Capital Management, Part 1 558
17 Working Capital Management 559
17.1 Float and Cash Management 559
Reasons for Holding Cash 560
The Speculative and Precautionary Motives 560
The Transaction Motive 560
Benefits of Holding Cash 560
Understanding Float 561
Disbursement Float 561
Collection Float and Net Float 561
Float Management 562
Ethical and Legal Questions 563
Electronic Data Interchange and Check 21: The End of
Float? 563
17.2 Cash Management: Collection, Disbursement, and Investment 564
Cash Collection and Concentration 564
Components of Collection Time 564
Cash Collection 565
Lockboxes 565
Cash Concentration 565
Managing Cash Disbursements 566
Increasing Disbursement Float 566
Controlling Disbursements 567
Investing Idle Cash 568
Temporary Cash Surpluses 568
Characteristics of Short-Term Securities 569
Some Different Types of Money Market Securities 570
17.3 Credit and Receivables 571
Components of Credit Policy 571
Terms of Sale 572
The Basic Form 572
The Credit Period 572
Cash Discounts 573
Optimal Credit Policy 575
The Total Credit Cost Curve 575
Organizing the Credit Function 575
Credit Analysis 576
Credit Information 576
Credit Evaluation and Scoring 577
Collection Policy 577
Monitoring Receivables 577
Collection Effort 578
17.4 Inventory Management 579
The Financial Manager and Inventory Policy 579
Inventory Types 579
Inventory Costs 580
17.5 Inventory Management Techniques 580