Ebook Financial management Concepts and applications Part 2

(BQ) Part 2 book Financial management Concepts and applications has contents Assessing the cost of capital What return investors require; understanding financing and payout decisions; designing an optimal capital structure; measuring and creating value,... and other contents.

Find more at www.downloadslide.com Part 3    Financing Long-Term Needs Overview of Capital Markets: Long-Term Financing Instruments Learning Objectives There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can – Mark Twain obj 9.1 Assess the key features of bonds and credit ratings obj 9.2 Earlier in this book, we focused on sizing up a firm’s prospects and understanding the short-term financial requirements of the firm In particular, Chapter introduced short-term financing instruments with maturities less than one year, traded in what are known as money markets Then, Chapter presented a bridge between short-term and long-term financing and introduced the underpinnings of the valuation of financial securities such as bonds and stocks Now, we’ll focus our attention on understanding the longterm financing instruments issued by firms and the markets in which they trade This chapter is the first of four that examine various aspects of a firm’s financial needs for more than one year, with securities such as bonds and stocks traded in what are known as capital markets If a firm is not able to meet its financial requirements through internally generated funds and some short-term borrowing, then it must seek external financing through capital markets Later in the book, we’ll look at the cost of raising capital in Chapter 10, financing and dividend decisions in Chapter 11, and how to determine an appropriate mix of debt and equity in Chapter 12 But first, in this chapter, we examine the distinctive features of three important types of financial instruments that were briefly introduced in Chapter 7: bonds, preferred shares, and common shares We then present an overview of capital markets, with a general focus on the stock market because it is more complex than the bond market Later, we focus on the efficiency of stock markets, or the extent to which securities trade at fair prices, as this is an important consideration for firms issuing stocks Finally, in the Appendix to this chapter, we present additional details on understanding bond and stock information from an investor’s perspective Let’s see how financial instruments such as bonds and stocks fit in our financial management framework, as depicted in Figure 9.1 As shown in the figure, issuing financial instruments is part of a firm’s financing decisions, and accessing external financing impacts a firm’s ability to grow, as well as its overall risk Assess the key features of preferred shares obj 9.3 Assess the key features of common shares, describe historical returns of major asset classes, and explain the difference between arithmetic and geometric returns obj 9.4 Describe key elements of capital markets obj 9.5 Explain the concept of market efficiency and describe the various forms of the efficient market hypothesis obj 9.6 Explain why understanding capital markets and longterm financing instruments is relevant for managers money market: A financial market in which very liquid, safe, shortterm investments are traded capital markets (securities markets): Markets for long-term financing such as issuing bonds or equity 167 Find more at www.downloadslide.com 168 Part 3  Financing Long-Term Needs Fig 9.1 Financial Management Framework: Long-Term Financing Decisions the enterprise financing operating • Debt financing • New equality • Dividend policy investing Growing profits, dividends, cash flow Managing the risk profile growth risk 9.1 Bonds Objective 9.1 Assess the key features of bonds and credit ratings principal: The original or face amount of a loan on which interest is paid bondholders: Owners of bonds securities markets: See capital markets Markets for long-term financing such as issuing bonds or equity Let’s begin our exploration of capital markets by looking at bonds, which were briefly introduced in Chapter From a firm’s perspective, bonds are simply a form of borrowing At the most basic level, bonds are loan contracts or promises made by a firm indicating scheduled repayment of the principal amount—or the amount of money being lent—along with interest or coupon payments typically paid every six months Bonds are issued by a firm, and because they represent a major form of long-term financing, they are a type of financial instrument Bond investors, also called bondholders, can be thought of as a type of lender The majority of these investors are commonly referred to as institutional investors, such as pension funds, mutual funds, endowment funds, and insurance companies However, once a firm has issued a bond, the bondholder can choose to sell or trade that bond to another party in exchange for money equal to the value of the bond In fact, there are usually active markets whereby corporate and government-issued bonds can be traded; these are known generically as securities markets (or capital markets) or specifically as bond markets 9.1.1 Changing Bond Yields As we saw in Chapter 7, bond prices move inversely to changes in yields or interest rates—or conversely, yields move inversely to bond price changes Let’s briefly examine the implications of this observation for firms that may be considering issuing bonds As we so, it is important for us to recognize that both short-term and long-term interest rates or yields change over time, sometimes substantially, usually in a similar direction Find more at www.downloadslide.com Chapter 9  Overview of Capital Markets: Long-Term Financing Instruments 20 1-year 30-year 15 10 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 1978 1976 1974 1972 1970 1968 1966 1962 –5 1964 Source: Federal Reserve http://www.federalreserve.gov/econresdata/statisticsdata.htm (accessed March 1, 2012) but not always in lockstep As a result, firms may be facing different costs today if they issue bonds with short maturities (such as one year) or long maturities (such as thirty years) compared with, say, issuing such bonds next year Corporate bond yields often move in a similar direction to yields on governmentissued bonds, but of course, corporate bond yields are higher than similar time-to-­ maturity government bond yields because owning a corporate bond is riskier Figure 9.2 shows the yield on U.S treasuries (or government-issued bonds) with one-year and thirty-year maturities, from 1962 to 2012 Notice that yields or interest rates peaked around 1981, then steadily declined through 2012 As we will see in Chapter 10, this decline in rates resulted in a dramatic decline in firms’ cost of capital, which in turn impacted the attractiveness of projects in which firms considered investing From the figure, we can also determine periods during which the yield curve was inverted by looking for times when short-term rates exceeded long-term rates, such as around 1980, 1988, 2000, and 2006 Each of these periods occurred just prior to the last four U.S recessions, which started in 1981, 1990, 2001, and 2007 Key takeaways from this figure are (1) for investors, bond yields and hence prices can change dramatically over time; (2) firms may face different costs over time—as indicated by the varying yields—when issuing bonds; and (3) the relative cost of issuing short-term bonds (such as those with a one-year maturity) versus long-term bonds (such as those with a thirty-year maturity) may change over time, so firms need to carefully consider the length of the borrowing period 9.1.2 Bond Features Issuing bonds is attractive from a firm’s perspective because any interest payments are deductible as expenses for tax purposes, making bonds a relatively low-cost alternative for obtaining capital Bonds are typically issued at face value with a particular maturity date Generally, maturity dates range from one year to thirty years In rare cases, 100-year or century bonds have been issued—for example, the Walt Disney Company issued century bonds in 1993 that became known as Sleeping Beauty bonds In an even more extreme example, the Toronto Grey and Bruce Railway issued a 1,000-year bond in 1883 That 169 Fig 9.2 U.S Treasury Yields Percent, One-Year and Thirty-Year Maturities, 1962–2012 Find more at www.downloadslide.com 170 Part 3  Financing Long-Term Needs sinking fund: A cash fund set aside by the firm in order to meet future debt obligations variable rate: A floating or nonfixed loan rate, often tied to changes in the prime rate or LIBOR prime rate: The rate offered by lending institutions, such as banks, to their most creditworthy customers LIBOR (London Inter-Bank Offered Rate): The rate at which banks offer to lend in the London inter-bank market; often used as the basis for floating-rate loans bond, which is due to mature in 2883, appears to have the longest term to maturity on record, and it remains on the books of the Canadian Pacific Limited Bonds differ by the types of features they have For example, some bonds include a sinking fund feature, which requires the firm to repurchase a portion of its bonds on a regular basis throughout the life of the bonds or set aside an equivalent amount This feature is intended to reassure bondholders that they won’t be left with losses if the firm is unable to meet its principal repayment obligation at maturity In some cases, the firm may repurchase a portion of its bonds in the bond market, or it may buy back bonds directly from the bondholders by paying the face value Although most bond contracts specify a fixed coupon rate—recall that the coupon rate reflects the annual amount of interest payments and is expressed as a percentage of the face value of the bond—other contracts indicate a variable rate For example, the contract might specify repayment at the prime rate plus a certain percent (often in the 1/2 to percent range) The prime rate is a benchmark set by each financial institution as the rate at which interest is charged to its most-favored (i.e., least risky) customers An alternative benchmark rate common in Europe (but used worldwide) is the London Interbank Offered Rate, or Libor Libor is the average rate at which major banks in ­London borrow among themselves and is a benchmark rate for trillions of dollars of mortgages, loans, and payments to individuals and businesses In the News The Libor Scandal On June 27, 2012, British investment bank Barclays PLC agreed to pay a fine of $453 million to U.S and British authorities to settle allegations that the firm manipulated Libor over a period of at least five years Barclays’ CEO Robert Diamond was forced to resign Suspicions of manipulation were originally raised by the Wall Street Journal in a May 29, 2008, article Libor borrowing rates are set daily for ten currencies and 15 maturities The most popular rate is the three-month dollar rate A panel of 18 London-based banks submits estimates of their costs for borrowing at each rate The actual rate is set as an average, excluding the four highest and four lowest submissions Investigations into the Libor scandal revealed two types of manipulation used by Barclays and other investment banks to influence Libor In one type of manipulation, which was used during the financial crisis of 2007–2009, Barclays submitted estimates that were lower than their true costs because they did not want to reveal to the marketplace how costly borrowing had become for fear it might make the bank’s financial position appear weak In the other type, Barclays’ traders colluded with traders from other banks to influence certain Libor rates in order to increase profits or decrease losses on their exposure to products tied to Libor rates The fallout from the Libor scandal continues By early 2013, two other banks implicated in the rate manipulation scandal—the large Swiss investment bank UBS and the Royal Bank of Scotland—agreed to large settlements with various regulatory authorities In mid-2013 it was announced that a subsidiary of NYSE Euronext was appointed as the new administrator of Libor, taking over from a subsidiary of the British Bankers Association, with a transfer expected in 2014 Sources: D Enrich and M Colchester, “Embattled FSA Is Under Fire for Libor Policing,” Wall Street Journal, July 6, 2012 and “NYSE Euronext Subsidiary to Become New Administrator Of Libor” (Press release) NYSE Euronext, July 9, 2013 Find more at www.downloadslide.com Chapter 9  Overview of Capital Markets: Long-Term Financing Instruments Issue size: $3 billion Face (par) value: $1,000 Maturity date: December 16, 2036 Coupon rate: 5.875% Coupon frequency: Semiannually Sinking fund: None 171 Fig 9.3 Home Depot Bond Features Callable: Yes Type of rate: Fixed Payment currency: U.S dollar Day/count basis: 30/360* *For the purposes of quoting yields, the U.S convention is to assume each month has 30 days and a year has 360 days In some other countries, it is assumed that a year has 365 days for yield calculations Source: Morningstar Inc http://quicktake.morningstar.com/StockNet/Bondsquote.aspx?bid = 09db65ea 9d26041b644453391d82de18&bname = Hm + Depot + 5.875%25 + %7c + Maturity%3a2036&ticker = HD&country = USA&clientid = dotcom (accessed September 17, 2012) Another common feature of some bonds is a call provision With callable bonds (also known as redeemable bonds), a firm can choose to pay back the investor at a prespecified date prior to the maturity date, usually at a prespecified price above the face value, representing a premium to the bondholder For example, when interest rates have declined and it is cheaper for the company to reissue new bonds with lower coupon rates, it may choose to call its outstanding bonds This provision is beneficial to the firm because it adds flexibility to its financial strategy and gives the firm the option of refinancing its debt obligations at a lower rate if interest rates decline Because bondholders not have a direct say in how a firm is run, their interests are protected to a degree through bond covenants These covenants place some restrictions on the firm in such a way as to improve the odds that the bondholders will be repaid For example, covenants might specify a maximum allowable debt-to-equity ratio for the firm, a minimum level of working capital, a maximum limit on annual capital expenditures, or a limit on the amount of dividend payments Figure 9.3 summarizes these features and other issue details for the Home Depot bond introduced earlier in “Time Value of Money Basics and Applications.” 9.1.3 Bond Ratings When a company is planning to issue a bond, potential investors want a method of assessing the perceived riskiness of the bond investment In other words, they want to assess the possibility of default, or the firm’s failure to meet its interest and principal repayment obligations Bond-rating agencies fulfill this need by providing an assessment of the creditworthiness of the firm Major rating agencies include Moody’s, Standard & Poor’s (S&P), and Fitch These agencies assess the financial health of a firm by completing a process similar to the business size-up process described in Chapter They then assign the firm’s bonds a rating based on their findings For long-term bonds (i.e., those with a maturity of more than one year), these ratings are based on the likelihood of repayment of principal, the capacity and willingness of the firm to meet its financial commitments, the nature of the financial obligation (such as the maturity and any special features of the bond), and any protection afforded to bondholders by the firm in the event of bankruptcy or reorganization call provisions: A description of terms under which a firm may redeem all or part of a bond or preferred share issue callable (redeemable): A type of bond whereby the firm can choose to pay back the lender at a prespecified date prior to the maturity date covenants: Provisions in a bond or debt agreement specifying restrictions or requirements on the borrower default: Failure to make debt obligation payments Find more at www.downloadslide.com 172 Part 3  Financing Long-Term Needs In-depth What Credit-Rating Agencies Do Credit-rating agencies such as Moody’s, S&P, and Fitch provide opinions about the creditworthiness of debt issues such as bonds issued by companies or governments In short, these agencies assess the probability that an issuer may default on its obligation Credit ratings are meant to be a forward-looking assessment that takes into account historical and current information about a firm, its industry, and general economic conditions These ratings focus strictly on credit quality, not on the suitability or merit of the investment The assignment of credit ratings is not an exact science, and much objective judgment is involved Credit ratings are useful because they facilitate the issuance and purchase of debt They also impact the cost of borrowing because an issuer with a higher rating is able to have a lower interest rate on its debt Most ratings are determined by a team of analysts who obtain information from published sources (such as annual reports) and discussions with management The process starts with a request for a rating from an issuer, followed by an initial evaluation, a meeting with management, and the analysis Rating agencies typically have committees that review the analysis and vote on the rating to be assigned After the issuer is notified of the rating, the agency’s opinion is published and made public A credit analysis usually involves assessment of both business risk and financial risk Business risk assessment examines country risk, industry characteristics, and a firm’s position relative to its peers In comparison, financial risk assessment examines a firm’s accounting data and various ratios, liquidity, cash flows, capital structure, and overall governance Rating agencies don’t offer their services for free; they have a financial incentive to so There are a variety of possible business models whereby rating agencies earn profits The most common payment structure is the issuer-pay model, whereby the firm requesting the rating pays the credit-rating agency This model has been criticized because it creates a potential conflict of interest for the rating agencies, but the agencies try to mitigate this effect by separating the parts of the business that negotiate business terms from those that perform the analysis Potential conflicts of interest are also reduced by reputation effects In other words, any incentive an agency has to issue a biased rating is offset by the likelihood that investors will come to see the agency’s ratings as biased and therefore no longer make decisions based on those ratings This, in turn, makes firms less likely to contract with the agency in the future Source: Much of this description is from Standard & Poor’s Guide to Credit Rating Essentials, 2010 Ratings range from Aaa—the highest rating—to Aa, A, Baa, Ba, B, and below A summary of the various ratings, as provided by Moody’s investor service is presented in Figure 9.4.1 Bonds with ­ratings of Baa - and higher are known as investment grade bonds Most institutional investors are restricted to investment grade bonds Investments rated below Baa - are known as speculative, high-yield, or junk bonds Prior to 1980, most high-yield bonds were so-called fallen angels—bonds that initially received an investment grade but had since become riskier Since that time, due in part to financier Michael Milken, a huge market for firms to initially issue risky bonds has developed Fitch uses the same scale as S&P Moody’s uses a similar but slightly different ratings scale: Aaa, Aa, A, Baa, Ba, B, and below Also, instead of plus/minus notches, Moody’s uses numbers So, within Baa, there is Baa1 (similar to S&P’s BBB +), Baa2 (BBB), and Baa3 (BBB -) Find more at www.downloadslide.com Chapter 9  Overview of Capital Markets: Long-Term Financing Instruments 173 FIG 9.4 General Summary of the Opinions Reflected by Moody’s Credit Ratings Global Long-Term Rating Scale Aaa Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk Aa Obligations rated Aa are judged to be of high quality and are subject to very low credit risk A Obligations rated A are judged to be upper-medium grade and are subject to low credit risk Baa Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics Ba Obligations rated Ba are judged to be speculative and are subject to substantial credit risk B Obligations rated B are considered speculative and are subject to high credit risk Caa Obligations rated Caa are judged to be speculative of poor standing and are subject to very high credit risk Ca Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest C Obligations rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest Note: Moody’s appends numerical modifiers 1, 2, and to each generic rating classification from Aaa through Caa The modifier indicates that the obligation ranks in the higher end of its generic rating category; the modifier indicates a mid-range ranking; and the modifier indicates a ranking in the lower end of that generic rating category Additionally, a “(hyb)” indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.* * By their terms, hybrid securities allow for the omission of scheduled dividends, interest, or principal payments, which can potentially result in impairment if such an omission occurs Hybrid securities may also be subject to contractually allowable write-downs of principal that could result in impairment Together with the hybrid indicator, the long-term obligation rating assigned to a hybrid security is an expression of the relative credit risk associated with that security Source: Moody’s Standing Committee on Rating Systems & Practices 9.2  Preferred Shares The second type of financial instrument we will look at—and the least frequently used of the three—is preferred shares Issuance of preferred shares is another long-term form of financing available to firms Preferred shares are often described as hybrid securities, or a mix of bonds and stocks They have some similarities to bonds, but they have some major differences as well Although categorized on the balance sheet as a form of equity (because from the debt holders’ perspective, preferred equity provides a cushion in the event of bankruptcy), preferred shares are also very different from common shares Like bonds, preferred shares are issued with a face value Unlike bonds, most preferred shares (known as perpetual preferreds) carry no obligation on the part of the firm to Objective 9.2 Assess the key features of preferred shares Find more at www.downloadslide.com 174 Part 3  Financing Long-Term Needs cumulative feature: A feature of preferred shares whereby any missed dividend payments by the firm are cumulated and paid to preferred shareholders before common shareholders receive dividends dividend payout: The amount of dividends distributed to shareholders repay the initial investment of the preferred shareholders Instead, preferred shareholders receive a steady stream of dividends The dividend is specified at a predetermined rate, a percentage of the face value For example, if the preferred share is issued with a face value of $40 and the dividend is specified as percent of the face value, preferred shareholders can expect to receive $2.40 per share in dividends each year (i.e., $40 * 0.06) As with common shares, preferred share dividends are typically paid quarterly, so in this example the preferred shareholder would receive $0.60 every three months for each share owned Preferred shareholders have different rights than common shareholders For example, a firm must make dividend payments to preferred shareholders before paying any dividends to common shareholders Many preferred shares also have a cumulative ­feature Here, if a firm is low on cash and can’t afford to make regularly scheduled preferred dividend payments, the dividends owed to preferred shareholders cumulate and must be paid before any further dividends can be paid to common shareholders In addition, in the event of bankruptcy and liquidation by a firm, all preferred shareholders receive any claims before common shareholders but after both secured and unsecured creditors (although in most bankruptcy-related liquidations, there is no money left for any equity holders) From a firm’s perspective, preferred shares are not as desirable as bonds because the firm is not able to deduct preferred dividend payments for tax purposes like it can for bond interest expenses As mentioned previously, preferred shares are generally the least common form of financing relative to bonds and common equity Preferred shares tend to be issued by stable companies with expected steady cash flows, but they are also ­prevalent among private firms that have received funding from venture capitalists Furthermore, due to regulatory capital requirements, there tends to be a concentration of preferred shares in the banking industry From a preferred shareholder’s perspective, there tends to be an inverse relationship between preferred share prices and interest rates, as we saw in Chapter Just like bonds, as interest rates increase, the price of preferred shares tends to decrease, and vice versa However, the relationship between preferred share prices and interest rates can become uncoupled if a firm is experiencing financial distress and its long-term survivability is in question In this situation, the firm may be viewed as a high credit risk, so its preferred shares will decline in value regardless of the general level of interest rates in the overall economy 9.3  Common Shares Objective 9.3 Assess the key features of common shares, describe historical returns of major asset classes, and explain the difference between arithmetic and geometric returns The third type of financial instrument we’ll consider is common shares or stocks The issuance of common shares represents a very different form of financing than bonds Common shareholders (or common equity holders) are the ultimate owners of a firm They are often referred to as residual claimants because they have a claim on any of the income earned by the firm only after other stakeholders—such as bondholders—have been paid (for example, after bondholders have received their interest payments) Common shares are perpetual instruments, lasting as long as the firm itself lasts As with bonds, an active market has developed for trading common shares Common shareholders benefit directly or indirectly through the earnings of a firm If the firm has earnings available to common shareholders, it has two choices of what to with these earnings: It can either pay dividends to the common shareholders or retain the earnings to finance future projects and investments Typically, established firms have dividend payout policies whereby a certain percentage of earnings, such as 30 percent, is paid in dividends on average over a long period This is not to imply that firms strictly Find more at www.downloadslide.com Chapter 9  Overview of Capital Markets: Long-Term Financing Instruments 175 follow such a policy on a year-by-year basis, since earnings tend to fluctuate from year to year Rather, we tend to observe that in the short run, firms stick to a stable dollar dividend policy For example, let’s suppose a firm had a target payout of 40 percent Let’s also suppose that average earnings per share over the past three years were $5.00 The firm might initially pay out $2.00 per share per year for several years Then, a few years later, when average earnings per share have grown to, say, $6.00, the firm might increase its dividend to $2.40, again in line with the 40 percent payout target Typically, dividends are paid on a regular quarterly schedule However, in some cases, growing firms with frequent needs for additional investments might elect not to pay out any dividends For instance, Microsoft Corporation went public in 1986 but didn’t start paying dividends until 2003 Note that although firms are obliged to make regular interest payments to bondholders, firms have no contractual obligation to pay dividends to common shareholders on a regular basis Still, as the ultimate owners of the firm, common shareholders have rights One of the major shareholder rights is the right to vote; this right highlights the collective power that shareholders have over the firm Voting enables shareholders to elect a board of directors to act in their best interest The mandate of the board of directors is to ensure that management makes decisions that are consistent with maximizing the value of common shares Thus, any action taken by the firm’s management team, including the chief executive officer, must be justified to the board It is also important to note that different countries engage in different practices related to common shareholders and have different regulations governing shareholder rights For example, in some countries, firms have more than one class of shares A superior class of shares is typically held by a founding individual or family, and multiple votes may be associated with those shares A multiple class share structure like this allows the individual or family to maintain control while still being able to raise capital through the issuance of inferior voting shares This structure is not as common in the United States as in other countries because some stock exchanges (including the New York Stock Exchange) restrict dual class shares However, there have been some high profile cases of dual class shares listed on the NASDAQ exchange, including Google and Facebook 9.3.1 Historical Returns The return to investors from buying stocks varies considerably depending on the time frame associated with the purchase and sale Figure 9.5 compares the average annual return (including the reinvestment of dividends or interest payments) on a variety of Compound Returns Mean Returns Volatility (geometric) (arithmetic) (standard deviation) Small stocks 16.9% 25.6% 49.1% 9.6% 11.6% 20.3% Large stocks 9.2% 11.0% 19.2% 30-year treasury bonds 5.6% 6.3% 12.3% 90-day T-bills 3.9% 4.0% 3.4% Inflation 3.0% 3.1% 4.1% All stocks Note: Thirty-year treasury bond returns are since 1942 Source: The Center for Research in Security Prices database (CRSP) Fig 9.5 U.S Stock Returns, 30-Year Treasury ­Returns, 90-day T-Bill Returns, and Inflation, 1926–2012 Find more at www.downloadslide.com 176 Part 3  Financing Long-Term Needs investments and the volatility (or standard deviation) of annual returns since 1926 Note that the figure looks at stocks of various sizes, long-term treasury (government) bonds, and short-term treasury bills (T-bills), as well as inflation As shown in Figure 9.5, returns may be measured either geometrically or arithmetically Geometric returns compare the initial investment value with the final wealth value in order to determine the rate of return over the intervening period The geometric return over n periods is calculated as follows: final value 1n b - Geometric returnn = a initial value For example, if a nondividend paying stock was selling for $10 per share and three years later it was selling for $13, its geometric or average annual compound return is2: a $13 13 b - = 0.0914 = 9.14 percent $10 Arithmetic returns, on the other hand, are the mean (or average) return across each period (often a year) over n periods They are calculated using the following equation: Arithmetic returnn = a n returni n i=1 geometric returns: A return measure comparing initial wealth and ending wealth and the rate at which it grows arithmetic returns: A return measure that takes a simple average of returns, summing returns and dividing by the number of observations Reusing our same example stock, suppose that after starting out selling for $10, a year later the stock’s price is $9, after two years it is $11, and then finally, after three years, it is $13 Here, the return in each of the three years was –10.00 percent, 22.22 percent, and 18.18 percent, which gives us an overall arithmetic average of 10.13 percent We can categorize stocks based on their size Small stocks are defined by the Center for Research in Security Prices (CRSP) as those in the smallest decile (or 10 percent) of the entire U.S stock sample as measured by market capitalization (the number of shares multiplied by the stock price), whereas large stocks are those in the largest decile In ­Figure 9.5, we see that over the long run, stocks have tended to yield higher returns than bonds, but they have done so with greater volatility Furthermore, both stocks and government bonds have provided returns greater than the rate of inflation, and small stocks have provided greater returns than large stocks Figure 9.6 compares the extent to which a dollar invested on December 31, 1925, has grown over time if invested strictly in small stocks, large stocks, treasury bonds, or T-bills As we look at the 87-year span, we see the dramatic impact on wealth from investing in small stocks compared to other stock investments (Of course, there is no guarantee that that trend will continue in the future!) We also see the rather steady increase in the value of stock investments between the early 1940s and the late 1990s (as indicated on the chart by a fairly straight upward sloping line), but with flatter and bumpier performance since then We additionally see a clear superior performance of stock versus bond investments during the period from the early 1940s to the late 1990s Finally, we see how bond and T-bill investments have done somewhat better than inflation and stocks have done considerably better An alternative method of calculation is to use a spreadsheet such as Excel and insert into the “rate” function the following information: Nper = 3, PMT = 0, PV = −10, FY = 13, or putting it all together, = rate(3, 0, - 10, 13) Find more at www.downloadslide.com Glossary permanent capital: The amount of interest-bearing debt plus preferred and common equity perpetuity: A stream of equal and regular payments forever preferred shares (preferred stock): A class of stock, typically dividend bearing, that has preference over common stock in terms of both dividend payments as well as claim on assets preferred stock: See preferred shares prepaid expenses: Short-term expense expected to yield benefits in the near term present value: The current value of the value of an asset at a specified time in the future; the current value of an investment today that will grow to a specified amount by a specified time in the future given an interest rate present value factor: The value today of a dollar received at a particular time in the future, discounted at a specified discount or interest rate present value of annuity factor: The value today of a stream of dollars received at particular times in the future, discounted at a specified discount or interest rate price-earnings (P/E) valuation model: A model of the intrinsic value of a stock based on projected earnings prime rate: The rate offered by lending institutions, such as banks, to their most creditworthy customers principal: The original or face amount of a loan on which interest is paid private equity firm: An investment firm that invests shareholders’ money in private firms, including those with high growth potential, leveraged buyouts, and distressed firms private placement: The sale of securities to a selected group of wellinformed investors pro forma financial statements: The presentation of financial statements, such as income statements and balance sheets, typically used as forecasts, on an “as if” basis profit margin: The ratio of net earnings to revenue profitability index: A method for evaluating investment projects that takes the ratio of present value of net cash flows to the initial investment profits: See net earnings 313 R ratio analysis (financial ratios): The use of financial statement-related ratios to analyze the performance of the firm real assets: Assets used to produce goods and services real option: The alternative or choice, but not obligation, to make a particular business investment decision, often related to timing receivables: See accounts receivable recession: A downturn in a country’s economic activity, typically measured as two consecutive quarters of decline in real (or inflation-adjusted) gross domestic product redeemable: See callable relative valuation methods: An approach to estimating the equity value of a firm based on a comparison of valuations assigned to comparable firms retained earnings: The cumulative amount of earnings retained or reinvested in the firm and not paid out as dividends retention ratio: The proportion of earnings reinvested in the firm and not paid out as dividends return on assets (ROA): A measure of the effectiveness of the utilization of a firm’s assets: the ratio of net earnings less preferred dividends, to total assets return on capital employed (ROCE): A measure of the effectiveness of the utilization of a firm’s invested capital: the ratio of net operating profits after tax, to invested capital return on equity (ROE): A measure of the effectiveness of the utilization of common shareholders’ equity: the ratio of net earnings less preferred dividends, to common shareholders’ equity return on invested capital (ROIC): A measure of the effectiveness of the utilization of a firm’s capital: the ratio of after-tax operating profits, to capital employed Capital employed is measured as net working capital plus fixed assets, or alternatively as interest-bearing debt plus equity return on net assets (RONA): See return on invested capital revenues (sales): The resource inflow to a firm through the sale of goods or the provision of services promissory notes: Promises by a firm to repay the lender, such as a bank, a certain amount of money by a specified date at a specified interest rate rights offer: A type of seasoned equity offering whereby shares are offered only to existing shareholders prospectus: A regulatory document filed with authorities, such as the SEC, that describes the details of a security offering in order to help investors make informed decisions S public issue: See public offering public offering (public issue): The sale of newly issued securities to the public pure risk: The chance of a loss but no chance of a gain Q quick ratio (acid test): A measure of a firm’s liquidity: the ratio of current assets, excluding inventories, to current liabilities S corporation: A business structure in the United States whereby income, losses, and deductions pass through to its shareholders for federal tax purposes sales: See revenues scenario analysis: A process similar to sensitivity analysis whereby several variables are changed simultaneously seasoned equity offering (SEO): The additional sale of equity securities to the public by an already-public firm secured loans: Loans backed by assets of a firm as collateral securities markets: See capital markets Find more at www.downloadslide.com 314 Glossary sensitivity analysis: A process that involves investigating a firm’s pro forma statements and quantifying the effects of changing an assumption on a key variable such as net earnings or required financing share repurchase: The process by which a firm buys back some of its own common shares shareholder control: A majority voting equity stake in a firm shareholders’ equity: See equity timeline: The representation of the amount and timing of cash inflows or outflows trade credit: The practice of extending credit to customers, allowing for deferred payment trade-off model of capital structure: An idea that managers consider both the value of interest tax shields and the cost of financial distress when choosing the appropriate debt-equity mix shelf offering: A regulatory provision that allows a firm to issue more shares at a future date without issuing a new prospectus U sinking fund: A cash fund set aside by the firm in order to meet future debt obligations underwriting: The process, initiated by investment banks, of marketing new security issues to the public size-up: A process for assessing external and internal factors and strengths and weaknesses pertaining to a firm unlevered firm: A firm that does not have any interest-bearing debt as part of its capital structure; an all-equity firm sole proprietorship: A business structure with one owner and manager sources and uses statement (statement of change in financial position): A financial statement that documents all fund inflows and outflows over a period of time, based on changes in balance sheet item amounts speculative risk: The chance of a loss or gain standard deviation: A statistical measure that captures the extent to which actual outcomes deviate from average or expected outcomes statement of change in financial position: See sources and uses statement stock options: Often provided to managers as a form of compensation, giving the holder the right to purchase shares at a particular price for a particular time supply risk: The chance that the firm may suffer supply-related losses by not being able to meet demand sustainable growth rate: The rate of growth in revenue that a firm can sustain without negatively impacting its financial resources such as needing to issue new equity, changing its payout of dividends, or changing its debt policy SWOT analysis: A process for assessing the strengths, weaknesses, opportunities, and threats pertaining to a firm synergies: The additional value created by the combination of two entities into one, through increased revenues or reduced costs T technical analysis: A method of evaluating the worth of securities based on examining patterns and trends in historical prices terminal value: The value of assets either at the end of their economic life or at an arbitrary time in the future time value of money: The idea that one dollar today is worth more than one dollar tomorrow because of its earning potential V value-based management: A strategic management approach that assists firms in developing a culture that focuses on value creation variable costs: Costs that vary over a period with changes in the volume of operations variable rate: A floating or nonfixed loan rate, often tied to changes in the prime rate or LIBOR venture capital firm: An investment firm that invests shareholders’ money in private start-up firms with high growth potential W weighted average cost of capital (WACC): See cost of capital working capital: The difference between current assets and current liabilities on the balance sheet working capital gap: The difference (measured in days) between the time payment to suppliers is required and payment from customers is received working capital management: The process of managing short-term decisions pertaining to current assets and current liabilities Y yield curve: A plot at a particular time of the different (typically government) borrowing rates, with differing times to maturity yield to maturity (YTM): The internal rate of return (IRR) of a bond when held to maturity Z zero coupon bond: A type of bond with no coupon payments Find more at www.downloadslide.com Index A Abandonment option, 158 Accounting financial management and, 9–10 international accounting presentation, 62 United States methods, 62 Accounts payable, 49–50 See also Working capital management age of, 74–75 discounts on, 94 management of, 94 Accounts receivable, 48 See also Working capital management age of accounts receivable, 74 aging schedules, 93 management of, 93–94 Accrual accounting method, 58 Acid test, 76–77 Acquisitions See Mergers and acquisitions Adding back noncash items, 261 Adjusted present value (APV) formula, 250 Adjustment for foreign currency translation, 53 Advanced Micro Devices (AMD), Age of accounts payable, 74–75 of accounts receivable, 74 of inventory, 73–74 Aging schedules, 93 All-equity firms, 219–220 debt vs., 239–240 Alternatives and decision-making, 152–153 American Depositary Receipts (ADRs), 185 Amortization, 48–49 as operating expense, 55 Anderson, Ronald, 243n Angel investors, 179 Annual reports, 83–84 Annuities, 135–136 bonds, annuity stream for, 140 Arithmetic returns on common shares, 176 The Art of War (Sun Tzu), 18 Asset-backed commercial paper (ABCP), 101 Assets, on balance sheets, 47–49 goodwill as, 49 pro forma balance sheets, establishing for, 110–111 real assets, useful life of, 49 Asset turnover (AT) return on equity (ROE) and, 68 sustainable growth rate and, 120 in Walmart case study, 293 Asymmetric information, 226–227 Auction process IPOs, 182 Audits under Sarbanes-Oxley Act (SOX), 181 B Bad debt, 93 Balance sheets, 9, 45–47 See also Pro forma balance sheets assets on, 47–49 equity on, 51–53 income statements, connecting, 57–58 liabilities on, 49–51 in Walmart case study, 289–290, 297–299 Banker’s acceptance (BA), 100–101 Bank of America, 185 Bankruptcy See also Financial distress cost of indirect bankruptcy/financial distress, 224–225 defined, 224 largest U.S bankruptcy, 225 relaxing assumption about, 223–225 Banks See Interest and interest rates; Loans Barbarians at the Gate: The Fall of RJR Nabisco (Burrough & Helyar), 243n Barclays, 170 Bargaining power of customers, 31 of suppliers, 31 Barry, Julien, 255, 255n Best efforts IPOs, 182 Beta (ß), 193, 206 capital asset pricing model (CAPM) and, 206, 207–208 levered/unlevered betas (ß), 249–250 Target capital structure example and cost of equity, 249–250 Black, Fisher, 157 Black-Scholes model, 157–158 Blake, Frank, 41 Bloomberg beta (ß) of companies, 208 quarterly earnings information, 193 stock information, 191 Bondholders, 168 Bonds, 4, 168–173 callable bonds, 171 convertible shares, 56 covenants, 171 face value of, 140 features of, 169–171 financial calculator for present value of, 141 Home Depot example, 143 as long-term liabilities, 50 optimal timing for issuing, 244 private placement and, 178–179 ratings, 171–173 sinking fun features, 170 timeline for valuation of, 141 time value of money and, 139–143 understanding bond information, 191 variable rate bonds, 170 yields, changes in, 168–169 Book value of assets, 48 component weights and, 208 of equity, 52–53 of equity plus adjustments approach, 258–259 Bottom line, determining, 56 Bridge loans, 100 British Bankers Association, 170 Budgeting See Capital budgeting; Cash budgets Buffett, Warren, 151, 194 Bureau of Economic Analysis website, 20 Burrough, Bryan, 243n Business cycle, 21 sector-related fluctuations in, 23–24 yield curve and, 26–27 Business risk, 241–242 credit analysis and, 172 315 Find more at www.downloadslide.com 316 Index C Callable bonds, 171 Call provision for bonds, 171 Capacity/leverage 76 Capacity trend, 21 Capital expenditures (Capex), 262 defined, 261 Capital asset pricing model (CAPM) beta (ß) and, 206, 207–208 cost of equity, estimating, 205–206 in Home Depot example, 210 market risk premium (MRP) and, 205–206, 207 risk-free rate and, 205–206, 207 in Walmart case study, 301 Capital assets, 48 Capital budgeting, 5, 153–161 See also Internal rate of return (IRR) capital rationing, 163–164 CFOs, survey of, 165 defined, 151 equivalent annual cost method, 162–163 modified internal rate of return (MIRR), 160–161 mutually exclusive projects and, 163–164 net present value (NPV) method, 155–157 payback method, 154–155 profitability index and, 161–162 project lengths and, 162–163 relevance for managers, 164–165 Capital gains tax and share repurchase, 229 Capital markets, 27–28, 167 See also IPOs (initial public offerings) for bonds, 168 cross-listing of shares, 185 financial intermediaries and, 185–186 market efficiency and, 186–188 over-the-counter (OTC) markets, 185 overview of, 177–178 private equity and, 178–179 private placement process, 178 private vs public markets, 177–178 public offerings, 178 relevance for managers, 188–189 rights offers, 184 seasoned equity offerings (SEOs), 184 seasoned offerings, 184 shelf offerings, 184 venture capital and, 178–179 Capital rationing, 163–164 Capital structure, 5, 216–218 See also Dividend policy; Financial distress; FIRST approach asymmetric information and, 226–227 corporate taxes, impact of, 222–223 Home Depot example of changing, 248 Modigliani-Miller argument, 215, 218–221 optimal capital structure, 235 pecking-order model of, 227 relaxing assumptions about, 221–227 relevance for managers, 230 Target capital structure example and cost of equity, 249–250 trade-off model of, 225–226 CAPM (capital asset pricing model) See Capital asset pricing model (CAPM) Cash equivalents, 48 sources and uses of, 91 Cash budgets, 113–115 cash inflows, establishing, 113 cash outflows, establishing, 113–114 net cash flows, establishing, 114–115 Cash conversion cycles, 87 Cash flow cycle, 1–4 defined, Orange Computers example, 95–96 Cash flow cycles, 87–91 Cash flows See also Cash budgets; Cash flow statements; Free cash flows (FCF); Net cash flows annuities and, 135–136 attributable to exchange rate movements, 63 coverage, 242 from financing activities, 61–63 from investing activities, 61 operating activities and, 59–61 payback method and, 154–155 perpetuities, 136–139 relevance for managers, 101–102 Cash flow statements, 9, 58–63 in Walmart case study, 289–290, 291 Cash inflows cash budgets, establishing for, 113 timelines representing, 132–133 Cash outflows cash budgets, establishing for, 113–114 timelines representing, 132–133 C corporations, 10–12 Center for Research in Security Prices (CRSP), 176–177 CEOs component weights and, 209 shareholder control and, 243 CFOs capital structure policy, survey on, 230 component weights and, 209 finance function, survey on importance of, 217–218 “CFO Views on the Importance and execution of the Finance Function” (Servaes & Tufano), 217–218 Chapter bankruptcy, 224 Chapter 11 bankruptcy, 224 Character of managers, 39 Chief financial officers (CFOs), 18 Citigroup, 185 Clienteles, 229 Colchester, M., 170 Collection period, 74 Columns and rows in spreadsheets, 126 Commercial paper, 100 and financial crisis of 2007-2009, 101 Common dividends, 57 Common equity, 4, 46, 53 Common shareholders, equity and, 51–53 net earnings available to, 57 Common shares, 51, 174–177 arithmetic returns, 176 dividends for, 147, 174–175 formulas for valuation of, 146–147 geometric returns, 176 historical returns on, 175–177 in seasoned equity offerings (SEOs), 184 share repurchase, 228–229 size of stocks, 176 timeline for valuation of, 146 time value of money and, 146–148 Common-size ratios, 80–81 Comparable analysis, 268–269 in Walmart case study, 304–306 Competition FIRST approach and, 245 Five Forces of, 30–32 profitability of industry and, 32 Walmart case study and, 286 Competitive environment, 30–31 Component weights estimating, 208–209 in Home Depot example, 210 in Walmart case study, 301–302 Compounded interest, 131–132 Constant growth dividend discount model, 270 Consumer price index (CPI) and inflation, 25 Find more at www.downloadslide.com Index net present value (NPV) method, 155–156 Coupon rate, 140 for bonds, 170 setting of, 142 Covenants in bonds, 171 Coverage ratios, 77 CPI (consumer price index) and inflation, 25 Credit-rating agencies for bonds, 171, 172 optimal capital structure, determining, 236 Crosby, Tim, 92 Crossan, Mary, 39n “The Cross-Enterprise Leader” (Crossan, Gandz & Seijts), 39n Cross-listing of shares, 185 Cumulative dividends for preferred shares, 174 Current assets, 48 pro forma balance sheets, establishing for, 110–111 Current business, assessment of, Current liabilities, 49–50 Current ratio, 76 Curtin, Richard, 284n Cyclical industries, 33 optimal capital structure and minimizing cost of capital, example of, 247–250 D relevance for managers, 212–213 Damodaran, Aswath, 52, 67, 217 Debt See also Capital structure; Cost of capital; Cost of debt all-equity firm vs., 239–240 financial flexibility and, 237 market value of debt, 274–275 Modigliani-Miller argument and, 218–221 optimal level of, 245–246 optimal timing for acquiring, 244 as percentage of capital across industries, 217 sustainable growth rate and, 120 Debt service coverage ratio, 78, 242 Debt-to-assets ratio, 76–77 Debt-to-capital ratio, 77 Debt-to-EBITDA ratio, 242 Debt-to-equity ratio, 76–77 Decision-making See also Capital budgeting alternatives, generating, 152–153 analysis and assessment in, 153 evaluation criteria and, 152 preferred alternative, choosing, 153 process for, 151–153 real options and, 157–158 relevance for managers, 164–165 short and long term concerns and, 151–152 Defaults on bonds, 171 Contracts with shareholders, 6–7 Convertible shares, 56 Corporate bonds See Bonds Corporate commercial paper, 101 Corporate social responsibility (CSR) policies, 6–7 Corporate taxes capital structure, impact on, 222–223 and financial distress costs, 225–226 in international markets, 223 Corporations, 10–11 government borrowing and, 26 Sarbanes-Oxley Act (SOX) and, 181 Cost accounting, Cost of capital, 155, 167–193 component weights, estimating, 208–209 example, 195–197 free cash flow to the firm method and, 262–263 Home Depot example, 209–210 hurdle rates and, 211–212 implications of, 197–198 of Target Corporation, 302 Walmart case study, assessment in, 301–302 Cost of debt estimating, 201–202 in Modigliani-Miller argument, 218–220 optimal level of debt and, 246 permanent capital and, 202 in Walmart case study, 301 Cost of equity capital asset pricing model (CAPM) for estimating, 205–206 dividend model approach to estimating, 204–205 estimating, 204–208 for levered firm, 220–221 in Modigliani-Miller argument, 218–220 Target capital structure example, 249–250 in Walmart case study, 301 Cost of goods sold, establishing, 106–107 Cost of sales defined, 54 on income statements, 53–57 Costs equivalent annual cost method, 162–163 opportunity costs, 130–131 of reducing inventory, 99 317 Greece, default on debt by, 26 Russia, default on debt by, 26 Deferred tax liabilities, 50–51 Deflation, 25 Demand risk, sizing-up, 36–38 Depreciation, 48–49 deferred income tax and, 50–51 as operating expense, 55 pro forma income statements, establishing expenses for, 108 straight-line depreciation, 49 tax liabilities and, 50–51 Depressions See Great Depression Diamond, Neil, 179 Diamond, Robert, 170 Diluted earnings per share, 56–57 Ding, Yuan, 62 Discounted cash flow (DCF) method, 259–267 common mistakes with, 265 enterprise value (EV), 265–266 free cash flow to the firm method, 259–262 in Walmart case study, 304, 305 Discount rate, 24, 133–134 for bonds, 140 internal rate of return (IRR) and, 158–159 net present value (NPV) method and, 155–156 Discounts on accounts payable, 94 for quick payments, 99 Dispersion of expected returns, 199–200 Diversification and risk, 200 Dividend discount model, 146 cost of equity, estimating, 204–205 multistage dividend discount model, 148 Dividend payout ratio, 119, 228 Dividend policy, 57, 215, 227–228 for common shares, 147, 174–175 importance of, 229–230 perfect capital markets and, 233–234 share repurchase and, 228–229 Dividends, 4–5, 57 for common shares, 147, 174–175 cost of equity estimates and, 204–205 information on, 193 for preferred shares, 144, 173–174 sustainable growth rate and, 120 Double-entry bookkeeping, 88–89 Dow Jones Industrial Average, 27 beta (ß) of companies, 208 Dual class shares, 175 Google and, 243 Find more at www.downloadslide.com 318 Index Dual-entry bookkeeping, 88–89 Duke, Mike, Duke Energy Corporation, 24 Dun & Bradstreet, 79 DuPont method, 68, 119 Dylan, Bob, 179 E Earnings before interest, taxes, depreciation, and amortization (EBITDA) See EBITDA (earnings before interest, taxes, depreciation, and amortization) Earnings before interest and taxes (EBIT) See EBIT (earnings before interest and taxes) Earnings before taxes (EBT) for pro forma income statements, 109 Earnings per share (EPS) See EPS (earnings per share) EBITDA (earnings before interest, taxes, depreciation, and amortization), 55 See also EV/EBITDA model cash flow coverage and, 242 debt service coverage ratio and, 78 debt-to-EBITDA ratio, 242 enterprise value-to-EBITDA model, 270–271 margin percentage, 70 EBITDAR in Walmart case study, 288 EBIT (earnings before interest and taxes), 55–56 actual vs anticipated EBIT, 238–239 breakeven EBIT calculations, 239–240 debt service coverage ratio and, 78 FIRST approach and, 238–241 margin percentage, 70 for pro forma income statements, 109 EBT (earnings before taxes) for pro forma income statements, 109 Economic value added (EVA) approach, 273–276 Target Corporation and, 303 in Walmart case study, 302–303 Economy opportunities and risks and, 32–33 size-up of, 20–28 Walmart case study, analyzing for, 283–284 yield curve and, 26 Edelman, Benjamin, 182 Efficient market hypothesis (EMH), 186 event study sample testing, 187 semistrong form, 187–188 strong form, 188 weak form, 187 Eisenmann, Thomas R., 182 Electronic Data Gathering, Analysis, and Retrieval system (EDGAR), 20 Enrich, D., 170 Enron scandal, Sarbanes-Oxley Act (SOX) and, 181 Enterprise value (EV), 265–266 See also EV/ EBITDA model enterprise value-to-EBITDA model, 270–271 of firm, 193 EPS (earnings per share), 56 EBIT (earnings before interest and taxes) and, 238–241 FIRST approach and, 237–238 Equity See also Cost of equity; Return on equity (ROE) on balance sheets, 51–53 book value of, 52–53 common equity, 4, 46, 53 existing shares and, 241 financial flexibility and, 237 market value of, 52–53 optimal timing for issuing, 244 pro forma balance sheets, establishing for, 111–113 sustainable growth rate and, 120 Equity and debt structure, 219–220 Equivalent annual cost method, 162–163 Ethics and maximizing shareholder value, 6–7 Euronext N.V., 185 EVA (economic value added (EVA) approach) See Economic value added (EVA) approach Evaluation criteria and decision-making, 152 EV/EBITDA model, 270–271 advantages/disadvantages of, 271 cross-industry comparisons, 272 mergers and acquisitions, valuing, 177–178 for stocks, 193 and Target Corporation, 306 in Walmart case study, 304–305 Event studies and semistrong form of efficient market hypothesis (EMH), 187–188 Evolution Petroleum Corp., long-term debt of, 219n Excel spreadsheets See Spreadsheet analysis Exchange traded funds (ETFs), 206 Expected inflation, 25–26 Expected return capital asset pricing model (CAPM) and, 205–206 cost of equity and, 205 dispersion of, 199–200 hurdle rates and, 211–212 trade-offs with risk, 199 Expense ratios, 70–71 Expenses gross profits and, 55 on income statements, 53–57 operating expenses, 55 pro forma income statements, establishing for, 108 External environment financial management and, 12–16 operating decisions and, 19 External funding required, 104 F Facebook, IPO of, 182 Face value of bonds, 140 Facilities, operating systems and, 33–36 Factoring of receivables, 100 Farna, Eugene, 186n Federal Reserve System (The Fed), 24–25 too big to fail institutions, bailout of, 252 website, 20 Financial accounting, Financial assets, Financial calculators annuity, determining present value of, 136 bonds, finding present value of, 141 tips for using, 137 Financial crisis, 237 Financial distress, 215 corporate taxes and, 225–226 impact of, 223–225 indirect bankruptcy/financial distress, 224–225 Financial flexibility, 235–236 Financial Forecasting Spreadsheet, 106 Financial health of Walmart, analyzing, 288–295 Financial instruments, Financial intermediaries, 185–186 Financial leverage, 215 return on equity (ROE) and, 68 Financial management, 1–4 accounting and, 9–10 framework for, 12–16 nonfinancial perspective of, 7–8 role of, 5–7 Financial ratios, 66 Financial risk, 242 credit analysis and, 172 Financial statements See also Pro forma financial statements annual reports and, 83 demand risk assessment and, 38 international financial statements, 62 Find more at www.downloadslide.com Index relevance to managers, 63 United States methods, 62 Financing, 215–234 See also Interest and interest rates cash flows from, 61–63 decisions, 19 defined, short-term financing, 99–101 sustainable growth rate and, 119 Firm commitment IPOs, 182 Firms, types of, 10–12 FIRST approach, 235–244 earnings per share (EPS) and, 237–238 EBIT (earnings before interest and taxes) and, 238–241 evaluating, 244–250 financial flexibility, 235–236 price-earnings (P/E) valuation model and, 238 Fitch bond ratings, 171, 172 Five Forces, 30–32 in Home Depot example, 41 Walmart case study and, 285 Fixed assets, 48 pro forma balance sheets, establishing for, 111 return on invested capital (ROIC) and, 72 Fixed asset turnover, 73 Fixed rate loans, 99 Ford Motor Company, financial flexibility of, 237 Foreign currency translation, adjustment for, 53 Foreign markets See International markets Formulas, 125–128 annuity, formula for present value of, 136 for common share valuation, 146–147 growing perpetuity, formula for present value of, 139 for modified internal rate of return (MIRR), 160–161 perpetuity, formula for present value of, 138 preferred shares, estimating cost of, 203 terminal value, estimating, 264 Four Ps of Marketing, 37–38 Free cash flows (FCF) enterprise value (EV) and, 265–266 estimating, 260–262, 263–264 terminal value, estimating, 264–265 timeline for, 266 Free cash flow to the firm method, 259–262 advantages/disadvantages of, 267 cost of capital and, 262–263 terminal value, estimating, 264–265 Fundamental analysis and semistrong form of efficient market hypothesis (EMH), 187 Future financing needs, assessment of, Future taxes, 50–51 Future value (FV), 131–133 of bonds, 140 timeline and, 133 G Gandz, Jeffrey, 39n GDP (gross domestic product), 20–21 business cycle and, 21 components of, 21–23 in Home Depot example, 40 sector-related fluctuations in, 23–24 U.S real GDP annual change percentage, 22 Generally accepted accounting principles (GAAP), 9, 62 General Motors, General partnerships, 10–11 Geometric returns on common shares, 176 Global Industry Classification Standard (GICS), 29n Going public See IPOs (initial public offerings) Goldman Sachs, 185 Goodwill as asset, 49 Google IPO of, 182 long-term debt of, 219n OpenIPO and, 186 shareholder control and, 243 Government See also Bonds yield curve and, 26 Graham, Ben, 151 Graham, John, 165, 213, 230, 230n, 245–246, 251 Great Depression inflation and, 25 stock prices and, 27 Great Recession, 251 Walmart case study and, 283–284 Greece, default on debt by, 26 Gross domestic product (GDP) See GDP (gross domestic product) Gross margin percentage, 70 Gross profits, 55 for pro forma income statements, 106–107, 109 319 Home Depot balance sheet example, 46–47 bond features example, 171 bond prices and yields example, 143 capital structure, example of changing, 248 cash flow statement example, 60 common-size income statements, 80–81 consolidated statements of earnings, 54 cost of capital example, 209–210 economic value added (EVA) and, 274–275 performance measures, 78–83 pro forma statements, 121–123 size-up process example, 40–42 stock information, 192–193 sustainable growth rate and, 121–123 working capital gap example, 96–99 working capital management example, 94 Housing crisis, 251 Human resources, 10 in Home Depot example, 41 sizing-up management of, 38–40 Hurdle rate, 155–156 capital rationing and, 164 cost of capital and, 211–212 internal rate of return (IRR) and, 158–159 I H Imports and exports See also International markets banker’s acceptance (BA), 100–101 net importing/exporting countries, 22, 23 Income statements, 9, 53–58 balance sheets, connecting, 57–58 cost of sales on, 53–57 expenses on, 53–57 profits on, 53–57 pro forma income statements, generating, 105–109 revenues on, 53–57 Income taxes See Taxes Indirect bankruptcy/financial distress, 224–225 Industries cyclical industries, 33 life cycles, 29–30 Inflation, 24–25 CPI (consumer price index) and, 25 interest rates and, 25–26 Information gathering for size-up, 20 Harris, Ford W., 92 Harvey, Campbell, 165, 213, 230, 230n, 251 Helyar John, 243n High-yield bonds, 172–173 Information technology (IT), 10 Initial public offerings (IPOs) See IPOs (initial public offerings) INSEAD, 6–7 Growing perpetuities, 138–139 Find more at www.downloadslide.com 320 Index Intensity of rivalries, 31 Interest and interest rates, 24–25 See also Bonds; Discount rate; Libor (London Interbank Offered Rate); Prime rate compounded interest, 131–132 inflation and, 25–26 modified internal rate of return (MIRR) and, 160 pro forma income statements, establishing expenses for, 108 sensitivity analysis and, 117 yield curve, 26 Interest coverage ratios, 77 Interest tax shield, 222–223 Internal rate of return (IRR), 158–161 modified internal rate of return (MIRR), 160–161 mutually exclusive projects and, 163–164 spreadsheet for, 159 strengths/weakness of, 159–160 International accounting presentation, 62 International Accounting Standards Board (IASB), 62 International markets common shares in, 175 corporate taxes across, 223 foreign currency translation, adjustment for, 53 IPOs, first-day returns of, 184 International Monetary Fund’s World Economic Outlook for the United States, 283 Internet financial intermediaries and, 186 stock information on, 191–193 Inventory See also Working capital management age of inventory, 73–74 on balance sheets, 48 costs of reducing, 99 just-in-time inventory system, 95 management of, 92–93 operating systems and, 34–36 Inventory period, 73–74 Inventory turnover, 73–74 Investing, 4, See also Capital budgeting annuities and, 135–136 cash flows from, 61 decisions, 19 hurdle rate and, 155–156 issues related to, real options for, 157–158 sustainable growth rate and, 119 Walmart case study, assessing investments in, 300 Investment banks, 185–186 Investment grade bonds, 172 Investors clienteles, 229 FIRST approach and, 245 IPOs (initial public offerings), 30, 179–185 advantages/disadvantages of, 181 cost of, 182 Facebook IPO, 182 first-day returns of international IPOs, 184 first-day returns of U.S IPOs, 183 Google IPO, 182 number of U.S IPOs, 183 OpenIPO, 186 prospectus in, 181 IRR (internal rate of return) See Internal rate of return (IRR) Lines of credit, 96 Liquidation of firm, 224 Liquidity measures, 75–76 Liquidity preference, 26 Loans as liability, as long-term liabilities, 50 as short-term financing, 99–100 London Interbank Offered Rate (Libor) See Libor (London Interbank Offered Rate) Long-term assets, 48 Long-term debt-to capital ratio, 77 Long-term financing decisions, Long-term liabilities, 50 Lowe’s Companies, 79–80 common-size income statements, 80–81 Iteration method, 127 performance ratios for, 80 J M Jeanjean, Thomas, 62 JP Morgan Chase, 185 Junk bonds, 172–173 Just-in-time inventory system, 95 Management See also Decision-making; Financial management character of managers, 39 human resource management, sizing-up, 38–40 value, creation of, 16 Walmart case study analyzing, 287–288 Management buyout (MBO), 256 Marketable securities, 48 Market capitalization (market cap), 193 Market efficiency, 186–188 See also Efficient market hypothesis (EMH) Marketing financial managers and, sizing-up management of, 36–38 Walmart case study analyzing, 287 Market risk, 200 Market risk premium (MRP) and capital asset pricing model (CAPM) and, 205–206, 207 Market value component weights and, 209 of debt, 274–275 of equity, 52–53 Market value added (MVA) approach, 274–275 Target Corporation and, 303 in Walmart case study, 303 MarketWatch on Lehman Brothers Holdings, Inc bankruptcy, 225 Markowitz, Harry, 205 Mergers and acquisitions comparable transactions, valuing, 277–278 defined, 276 valuing, 276–278 K Kansas City Railroad preferred shares example, 145 Key success factors, 29 Kravis, Henry, 235 Kroger Co., return on equity (ROE) and, 69 L Large stocks, 176 Lehman Brothers Holdings, Inc., bankruptcy of, 225 Leveraged buyout (LBO), 217, 256 Leverage measures, 76–78 Levered firms cost of equity for, 220–221 value of, 219 Liabilities, on balance sheets, 49–51 deferred income taxes as, 50–51 pro forma balance sheets, establishing for, 111–113 Libor (London Interbank Offered Rate), 100 bonds and, 170 scandal, 170 Liens, 100 Life cycles of industries, 29–30 Limited liability companies (LLCs), 10–11 Find more at www.downloadslide.com Index Merton, Bob, 157 Miller, Merton, 218, 229, 229n Modified internal rate of return (MIRR), 160–161 example of, 161 Modigliani, Franco, 218, 229 Modigliani-Miller argument, 215, 218–221 Money markets, 167 Money supply and inflation, 24–25 Moody’s bond ratings, 171, 172 Moral hazard, 252 Morgan Stanley, 185 Morningstar.com OpenIPO and, 186 stock information on, 191 Mortgages, subprime, 251 Moyer, L., 179 Multistage dividend discount model, 148 Mutually exclusive projects, 163–164 MVA (market value added (MVA) approach) See Market value added (MVA) approach N NASDAQ dual class shares and, 175 OMX, 185 Neighborhood Markets, 282 Net cash flows cash budgets, establishing for, 114–115 payback method and, 154–155 Net earnings, 4, 56 and net earnings available to common shareholders, 57 retained earnings and, 58 Net exporting countries, 22 Net importing countries, 22 United States as, 23 Net income, Net operating profits after tax (NOPAT) See NOPAT (net operating profits after tax) Net present value (NPV) method, 155–157 creating projects with NPV, 257 multi-period example, 156 profitability index and, 161–162 spreadsheets for calculating, 157 strengths/weaknesses of, 157 Net present value rule, 157 Net profits, Net worth, 51 New entrants, threat of, 31 New York Stock Exchange (NYSE) See NYSE (New York Stock Exchange) Noncash items, adding back, 261 NOPAT (net operating profits after tax), 273 return on capital employed (ROCE) and, 273 in Walmart case study, 302 Notes payable, 49–50 NPV (net present value) method See Net present value (NPV) method NYSE Euronext, 170, 185 NYSE (New York Stock Exchange), 12, 185 as source of stock information, 191 O OMX, 185 OpenIPO, 186 Operating expenses, 55 Operating margins for stock, 193 Operations, cash, generation of, cash flows relating to, 59–61 decision-making and, 19 financial managers and, Six Ps of Operations, 33–36 sizing-up management of, 33–36 sustainable growth rate and, 119 Walmart case study analyzing, 276 Opportunities and PEST (political, economic, social, and technological) factors, 32–33 Opportunity costs, 130–131 Optimal capital structure, 235 cost of capital, example on minimizing, 247–250 relevance for managers, 250–252 summary of FIRST criteria, 245 Optimal timing, 244 Other assets, 48, 49 Other current assets, 48 Other long-term liabilities, 51 Over-the-counter (OTC) markets, 185 P Pacific Gas & Electric Company’s preferred share price, 202–204 Page, Larry, 243 Paid-in capital, 51 Partners and partnerships general partnerships, 10–11 operating systems and, 34–36 Parts and operating systems, 34–36 Par value of bonds, 140 Patents as assets, 49 Payable period, 75 Payback method, 154–155 strengths/weaknesses of, 155 321 Payout policy See Dividend policy Pecking-order model of capital structure, 227 People See also Human resources operating systems and, 34–36 Perfect capital markets assumptions, 219 dividend policy and, 233–234 Performance measures, 65–83 common-size ratios, 80–81 Home Depot example, 78–83 leverage measures, 76–78 liquidity measures, 75–76 profitability measures, 69–72 relevance for managers, 84–85 resource management measures, 72–75 return on equity (ROE), 66–69 in Walmart case study, 292–293 Performance ratios, summary of, 79 Permanent capital, 99, 202 Perpetual preferred shares, 173 Perpetuities, 136–139 growing perpetuities, 138–139 PEST (political, economic, social, and technological) factors, 32–33 Place in marketing mix, 37 Plant, operating systems and, 33–36 Political factors, opportunities and risks and, 32–33 Porter, Michael, 30–32 See also Five Forces Preferred shares, 173–174 convertible shares, 56 dividends for, 144, 173–174 as equity on balance sheet, 51 estimating cost of, 202–204 Kansas City Railroad example, 145 as perpetuities, 137 timeline for valuation of, 144 time value of money and, 143–145 Premium cost of debt and, 201 market risk premium (MRP), 206 Prepaid expenses, 48 Present value (PV), 133–135 See also Net present value (NPV) method adjusted present value (APV) formula, 250 of annuities, 136 of bonds, 139–140 of common shares, 146 discount rate and, 133–134 net present value (NPV) method, 155–157 of perpetuities, 136–139 of preferred shares, 144 timeline for, 135 Find more at www.downloadslide.com 322 Index Price in marketing mix, 37–38 stock price information, 191–193 Price-earnings (P/E) valuation model, 238, 267–270 advantages/disadvantages of, 269–270 comparable analysis and, 268–269 and constant growth dividend discount model, 270 cross-industry comparisons, 272 historical price-earnings multiples, 269 for stocks, 193 Price-to-book (P/B) ratio cross-industry comparisons, 272 for stocks, 193 Price-to-cash flow (P/CF) ratio for stocks, 193 Price-to-sales (P/S) ratio for stocks, 193 Prime rate for bonds, 170 loans, 99–100 Principal of bonds, 168 Private equity, 178–179 Private equity firms, 179 Private placement process, 178 Sesac Inc example, 179 Process, operating systems and, 33–36 Product in marketing mix, 37–38 operating systems and, 33–36 Profitability index, 161–162 measures, 69–72 in Walmart case study, 293 Profit margin (PM) return on equity (ROE) and, 68 sustainable growth rate and, 120 Profits, See also Gross profit on income statements, 53–57 Pro forma balance sheets, 110–113 assets, establishing, 1–111 equity, establishing, 111–113 liabilities, establishing, 111–113 in Walmart case study, 297–299 Pro forma financial statements, 104 See also Sensitivity analysis income statements, generating, 105–109 relevance for managers, 123–124 Pro forma income statements cost of goods sold, establishing, 106–107 expenses, establishing, 108 gross profit, establishing, 106–107 Walmart case study, projecting in, 295–296 Project lengths and capital budgeting, 162–163 Promissory notes, 99 Promotion in marketing mix, 37–38 Prospectus in IPO process, 181 Public offerings, 178 See also IPOs (initial public offerings) Pure risk, 198–199 Q Quick ratio, 76–77 R Ratings for bonds, 171–173 Ratio analysis, 66 Real assets, 1, Real options, 157–158 Recessions, 21 See also Great Recession sector performance and, 24 Redeemable bonds, 171 Reeb, David, 243n Regression analysis, 207–208 Relative valuation methods, 267–272 price-earnings valuation model, 267–270 Research and development (R&D) as operating expense, 55 Residual claimants, 4, 174 Resource management, 72–75 in Walmart case study, 293 “Retail Industry Outlook Survey: Modest Gains Keep Cautious Optimism in Style” (KMPG), 284 Retained earnings, 5, 53, 57 net earnings and, 58 for pro forma income statements, 109 Retention ratio (RR), sustainable growth rate and, 119–120 Return on assets (ROA), 69 for stocks, 193 Return on capital employed (ROCE), 274 Return on equity (ROE), 66–69 See also DuPont method resource management measures and, 72–73 by sector, 67 for stocks, 193 sustainable growth rate and, 119 of Target Corporation, 295 in Walmart case study, 293–294 Return on invested capital (ROIC), 71–72, 102 of Target Corporation, 294 in Walmart case study, 294 Return on investment (ROI) in Walmart case study, 288 Return on net assets (RONA), 274 Revenues defined, 54 on income statements, 53–57 and industry life cycles, 30 sustainable growth rate and, 118–119 Rights offers, 184 Risk See also Business risk; Financial risk defining, 198–201 dispersion of expected returns, 199–200 diversification and, 200 expected returns and, 199 minimizing, 241–242 PEST (political, economic, social, and technological) factors, 32–33 preferred shares, estimating cost of, 202–204 pure risk, 198–199 speculative risk, 199 supply risk, sizing-up, 33–36 unsystematic risk, 200 in Walmart case study, 288 Risk-free rate, capital asset pricing model (CAPM) and, 205–206, 207 Ritter, Jay, 183–184 Rivalries, intensity of, 31 ROA (return on assets) See Return on assets (ROA) ROCE (return on capital employed), 274 Rockefeller, John D., 215 ROE (return on equity) See Return on equity (ROE) ROIC (return on invested capital) See Return on invested capital (ROIC) ROI (return on investment) in Walmart case study, 288 RONA (return on net assets), 274 Royal Bank of Scotland, 170 Rule 144a private placement, 179 Rush, 179 Russia, default on debt by, 26 S Sales See also Cost of sales sensitivity analysis and, 116 Sam’s Club, 282 Sarbanes-Oxley Act (SOX), 181 Scenario analysis, 115–116 Scholes, Myron, 157 Scorecards, accountant providing, S corporations, 10–11 Seasoned equity offerings (SEOs), 184 stock prices and, 227 Seasoned offerings, 184 Find more at www.downloadslide.com Index SEC (Securities and Exchange Commission) See Securities and Exchange Commission (SEC) Sector performance case study of, 24 Size-ups, 18 capital markets and, 27–28 checklist for, 28 Stock options, 56 Stocks See also Common shares; Preferred shares; Shares and shareholders diversification, portfolios and, 200 of demand risk, 36–38 external environment and, 19 Stolowy, Harve, 62 Secured loans, 100 gathering information for, 20 Straight-line depreciation, 49 Securities See also Beta (ß); Bonds; Capital markets; Common shares; Preferred shares Home Depot example, 40–42 Strong form of efficient market hypothesis (EMH), 188 fluctuations in, 23–24 bid price, 193 Internet, stock information on, 191–193 price, information on, 191–193 Securities and Exchange Commission (SEC), 20 generally accepted accounting principles (GAAP) and, 62 Rule 144a private placement, 179 Securities markets See Capital markets Seijts, Gerard, 39n Selling, general, and administrative (SG&A) expenses, 55 pro forma income statements, establishing expenses for, 108 and Walmart case study, 284–285 Semiannual yield to maturity for bonds, 140 Sensitivity analysis, 115–118 interest rate sensitivity, 117 sales sensitivity, 116 in Walmart case study, 299–300 working capital sensitivity, 117–118 Sergey, Brin, 243 Servaes, Henri, 217, 230, 251 Sesac Inc example of private placement, 179 SG&A expenses See Selling, general, and administrative (SG&A) expenses Share repurchase, 228–229 Shares and shareholders, 242–244 convertible shares, 56 dividend policy, 57 earnings per share (EPS), 56 equity, 46 maximizing shareholder value, 6–7 of human resource management, 38–40 of marketing management, 36–38 of operations management, 33–36 of overall economy, 20–28 questions during, 28 relevance for managers, 42–43 of supply risk, 33–36 in Walmart case study, 283–295 Small stocks, 176 Social trends, opportunities and risks and, 32–33 Sole proprietorships, 10–11 Subprime mortgage business, 251 Substitutes, threat of, 31 Succession, planning for, 38 Sun Tzu, 18 Supply risk, 33–36 Sustainable growth rate, 118–123 SWOT analysis, 18 Synergies, 276 Systematic risk, 200 Sources and uses statements, 58, 90–91 T Sozzi, Brian, Target Corporation Speculative bonds, 172–173 Speculative risk, 199 Spreadsheet analysis, 125–128 iteration method, using, 127 what if? questions and, 128 Spreadsheets annuities, determining present value of, 136 bonds, finding present value of, 141 cost of capital of, 302 economic value added (EVA) of, 303 EV/EBITDA analysis of, 306 market value added (MVA) approach and, 303 return on equity (ROE) of, 2925 return on invested capital (ROIC) of, 294 for equivalent annual cost method, 162–163 Taxes See also Cost of capital; Cost of debt for internal rate of return (IRR) example, 159 deferred income taxes, 50–51 net present value (NPV), calculating, 157–158 pro forma earnings before tax, estimating, 109 tips for using, 137 S&P (Standard & Poor’s) index See Standard & Poor’s (S&P) index share repurchase and, 229 T-bills See U.S Treasury bonds Technology Standard deviation, 200 information technology (IT), 10 Standard & Poor’s (S&P) index, 27–28 opportunities and risks and, 32–33 bond ratings, 171, 172 role of, 10 dividend payout ratio, average of, 228 weak from of efficient market hypothesis (EMH) and technical analysis, 187 stock options, 56 Global Industry Classification Standard (GICS), 29n value and, 257 Temporary working capital, 99 summary of opinions of, 173 10-K documents, 83–84 Sharpe, Bill, 205 323 Terminal value, 264–265 Shelf offerings, 184 Statement of change in financial position, 58, 90–91 Shiller, Robert, 28 Stock certificates, Stock exchanges, 185 Thomson One, 30 Short-term financing, 99–101 banker’s acceptance (BA), 100–101 Stockholder’s equity, 51 commercial paper, 100 Stock markets Text in spreadsheets, entering, 126 Thomson Reuters/University of Michigan Index of Consumer Sentiment, February 2012, 284 Sinking funds, 170 average U.S stock prices, 27–28 Threat of new entrants, 31 Six Flags example of optimal level of debt, 245–246 business cycle and, 23 Threat of substitutes, 31 capital asset pricing model (CAPM) and, 206 Tiffany & Co., 24 Six Ps of Operations, 33–36 efficiency of U.S stock market, 188 return on equity (ROE) and, 69 Find more at www.downloadslide.com 324 Index Timelines, 132–133 for common share valuation, 146 free cash flows (FCF), estimating, 263–264 for free cash flows (FCF), 266 growing perpetuity, depiction of present value of, 139 perpetuity, depiction of present value of, 138 for preferred share valuation, 144 for present values, 135 Time value of money, 129–139 annuities and, 135–136 bonds, application to, 139–143 common shares, 146–148 future values and, 131–133 opportunity costs and, 130–131 perpetuities, 136–139 economic value added (EVA) approach, 273–276 EV/EBITDA model, 270–271 free cash flow to the firm method, 259–262 maximizing shareholder value, 6–7 mergers and acquisitions, valuing, 276–278 overview of, 256–257 price-earnings valuation model, 267–270 relative valuation methods, 267–272 relevance for managers, 278 Walmart case study, valuation in, 302–307 Value-based management, 273–276 Value Line on beta (ß) of companies, 208 Value proposition, 37 Van Binsbergen, Jules, 245–246 Vandenbosch, Mark, 36n marketing, analyzing, 287 operations, analyzing, 287 performance measure summary, 292–293 pro forma balance sheets in, 297–299 pro forma income statements, projecting, 295–296 relevance for managers, 307 strengths/weaknesses, analyzing, 286–295 valuation in, 302–307 Walton, Sam, 281 Weighted-average cost of capital (WACC) See Cost of capital Working capital, 1, free cash flow to the firm method and, 262 permanent working capital, 99 resource management measures and, 73 preferred shares, 143–145 present values, 133–135 relevance for managers, 148–149 Trade credit, 93–94 Trademarks as assets, 49 Trade-off model of capital structure, 225–226 Treasury stock, 53 Tufano, Peter, 217, 230, 251 Twain, Mark, 167 Tyco scandal, 6, 181 Variable costs, 70 Variable rate bonds, 170 Variable rate loans, 99 Venture capital, 178–179 amount invested in U.S., 180 number of deals in U.S., 180 Venture capital firms, 179 Vermaelen, Theo, 6–7 U W R Hambrecht and Company, 186 Walmart case study, 7–8, 281–308 alternate scenarios, examining, 299–300 balance sheets, analyzing, 289–290 capital raising, assessing, 301–302 cash flow statements in, 289–290, 291 comparable analysis in, 304–306 competition and, 285–286 consolidated statements of income, 289 cost of capital, assessing, 301–302 creating value in, 306–307 discounted cash flow (DCF) method and, 304, 305 economy, analysis of, 283–284 financial health, analyzing, 288–295 industry, analysis of, 284–286 investments, assessing, 300 management, analyzing, 287–288 return on invested capital (ROIC) and, 72 sensitivity analysis and, 117–118 spreadsheets relating to, 128 temporary working capital, 99 Working capital gap, 96 Home Depot example, 96–99 ratios across industries, 98 Working capital management, 5, 92–99 Home Depot example, 94 Orange Computers example, 95–96 ratios across industries, 98 WorldCom Inc bankruptcy of, 225 Sarbanes-Oxley Act (SOX) and, 181 UBS (Switzerland), 170 Unbiased expectations, 26 Underwriting and financial intermediaries, 186 Unlevered firms, value of, 219 Unsystematic risk, 200 US stock returns, 175 U.S Treasury bonds, 176–177 returns, 175 yields, 169 V Value, 255–280 See also Book value; Market value comparable analysis for, 268 cost of capital and, 197 creating value, 273–276 W Y Yahoo!Finance, 191 quarterly earnings information, 193 Yang, Jie, 245–246 Yield curve, 26–27 Yield to maturity (YTM) for bonds, 140 and cost of debt, 201 setting of, 142 Yoon, A., 179 Z Zero coupon bonds, 140 Find more at www.downloadslide.com This page intentionally left blank Find more at www.downloadslide.com MyFinanceLab™ The Key to Your Success in Three Easy Steps! Use the Financial Calculator to solve math problems right in MyFinanceLab! The Financial Calculator is available as a smartphone application as well as on a computer and includes important functions such as future and present value a Sample Test to assess 1.  Take  your knowledge Fifteen helpful tutorials show instructors and students the many ways to use the Financial Calculator in MyFinanceLab Tutorials include lessons on calculator functions such as IRR and bond valuation 2.  Review your personalized Study Plan to see where you need more work 3.  Use  the Study Plan exercises and step-by-step tutorials to get practice—and individualized feedback—where you need it If your instructor assigns homework and tests using MyFinanceLab The MyFinanceLab Course Home page uses graphs to let students know their current progress in the course and it has a detailed calendar that not only displays due dates, but allows instructors to add entries Select end-of-chapter problems are now available in MyFinanceLab as simulated Excel problems Each problem has algorithmically generated values and allows students to solve the problem as they would in Excel Each problem is autograded and has both Excel and problem-specific Learning Aids Did your textbook come with a MyFinanceLab Student Access Kit? If so, go to www.pearsonmylab.com to register using the code If not, you can purchase access to MyFinanceLab online at www.pearsonmylab.com Find more at www.downloadslide.com Use the Financial Calculator to solve math problems right in MyFinanceLab! The Financial Calculator is available as a smartphone application as well as on a computer and includes important functions such as future and present value Fifteen helpful tutorials show instructors and students the many ways to use the Financial Calculator in MyFinanceLab Tutorials include lessons on calculator functions such as IRR and bond valuation Select end-of-chapter problems are now available in MyFinanceLab as simulated Excel problems Each problem has algorithmically generated values and allows students to solve the problem as they would in Excel Each problem is autograded and has both Excel and problem-specific Learning Aids Did your textbook come with a MyFinanceLab Student Access Kit? If so, go to www.pearsonmylab.com to register using the code If not, you can purchase access to MyFinanceLab online at www.pearsonmylab.com ... 52. 22 52. 22 52. 22 Open $ 52. 21 52 21 52. 21 Bid $ 51.65 51.65 Ask $ 51.67 51.67 1-year target est $ 55.39 52. 21 Day’s range $ 51.38– 52. 61 51.38– 52. 61 51.38– 52. 61 51.38– 52. 61 5 2- week range $ 28 .13–53 .28 28 .13–53 .28 28 .13–53 .28 28 .13–53 .28 ... 11,500,000 11,976 ,20 0 1.16 1.16 1.16 1.16 2. 24% 2. 24% 2. 24% 2. 24% 2. 65 14-Aug- 12 2.65 Shares outstanding mil 1,531 Enterprise value $mil (ttm) 86,799 Market cap $mil 87,570 2. 65 16-Aug- 12 1,531 79,090 79,000 79,089 79,089... $ 28 .13–53 .28 28 .13–53 .28 28 .13–53 .28 28 .13–53 .28 5 2- week high date 20 -Jun- 12 5 2- week low date 09-Aug-11 Volume 8,399,954 8,900,000 9,939,011 9,939,011 Average volume (3m) 11,976 ,20 0 Dividend