Van horne s fundamentals of financial management

Do you want to understand how financial decisions impact the value of a company? If you are new to financial management or studying for a professional qualification, this user-friendly textbook makes the challenges facing today’s rapidly changing business world easier to understand Now in its 13th edition, Fundamentals of Financial Management maintains its dedication to the financial decision-making process and the analysis of value creation, but develops a more international scope and introduces new topics into the debate Current discussions on corporate governance, ethical dilemmas, globalization of finance, strategic alliances and the growth of outsourcing have been added with examples and boxed features to aid understanding and provide a more global perspective of financial management What’s New? • Chapter - Expanded coverage of Corporate Social Responsibility including the concept of Sustainability • Chapter – The discussion of financial statement analysis includes the push for convergence of accounting standards around the world • Chapter – Cash and marketable securities management material expanded and updated • Chapter 24 - The updated chapter on International Financial Management includes discussion of Islamic sukuk bonds On the reading list for Association of Chartered Certified Accountants (ACCA) Qualification Paper (F9) Financial Management Suggested reading for Certified Management Accountant (CMA) examination Translated into over ten languages and received first place among business academic texts in Pearson’s top 50 best seller’s translation list “This is the best book I have found so far.” Jean Bellemans, Free University of Brussels “The book provides the reader with information about the current ‘hot-topics’ in finance and has a clear emphasis on the basic principles of financial management without repetition Furthermore, as simple language is used, the book can be easily understood by students that are not native speakers of English.” Axel-Adam Müller, Lancaster Authors: James C Van Horne, Professor of Banking and Finance at Stanford University is also the author of Financial Management and Policy, a Pearson Education text Fundamentals of Financial Management James C Van Horne John M Wachowicz, Jr 13th Edition 13th Edition Van Horne Wachowicz Visit www.pearsoned.co.uk/wachowicz to access free student resources including: • Self-test multiple-choice, true/false and essay questions • Link to author’s award-winning website for even more online testing material, along with exercises and regularly updated links to additional support material • Online glossary to explain key terms • Excel templates for spread-sheet approach to end-of-chapter problem solving • New for this edition! Link to PowerPoint slides on key chapters and learn how to use Excel to solve problems Ideal for introductory courses in financial management, for a professional qualification and as a reference for practitioners Fundamentals of Financial Management “…a useful text either as preparation for a second year course, or as a text for a first year financial management course that provides a ‘first sweep’ of the major financial management topics Not many texts cover this ground well.” Brian Wright, Exeter John M Wachowicz, Jr., Professor of Finance at The University of Tennessee an imprint of CVR_VANH3630_13_SE_CVR.indd Front cover image: © Getty Images www.pearson-books.com 23/9/08 10:35:34 FUNO_A01.qxd 9/19/08 13:56 Page i Fundamentals of Financial Management Visit the Van Horne and Wachowicz: Fundamentals of Financial Management thirteenth edition Companion Website at www.pearsoned.co.uk/wachowicz to find valuable student learning material including: l l l l l l l •• Learning objectives for each chapter Multiple choice, true/false and essay questions to test your understanding PowerPoint presentations for each chapter to remind you of key concepts An online glossary to explain key terms and flash cards to test your knowledge of key terms and definitions in each chapter Excel templates for end of chapter problems to help you model a spread sheet approach to solving the problem Link to author’s own award-winning website with even more multiple choice and true/false questions, as well as web-based exercises and regularly updated links to additional support material New to this edition, PowerPoint presentations for key chapters integrating and demonstrating how Excel can be used to solve calculations FUNO_A01.qxd 9/19/08 13:56 Page ii We work with leading authors to develop the strongest educational materials in business and finance, bringing cutting-edge thinking and best learning practice to a global market Under a range of well-known imprints, including Financial Times Prentice Hall, we craft high quality print and electronic publications which help readers to understand and apply their content, whether studying or at work To find out more about the complete range of our publishing, please visit us on the World Wide Web at: www.pearsoned.co.uk •• FUNO_A01.qxd 9/19/08 13:56 Page iii Fundamentals of Financial Management thirteenth edition James C Van Horne Stanford University John M Wachowicz, Jr The University of Tennessee •• FUNO_A01.qxd 4/18/09 10:23 AM Page iv Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk Previous editions published under the Prentice Hall imprint Thirteenth edition published 2008 © Pearson Education Limited 2009, 2005 © 2001, 1998 by Prentice-Hall, Inc The rights of James C Van Horne and John M Wachowicz, Jr to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners ISBN: 978-0-273-71363-0 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing-in-Publication Data Van Horne, James C Fundamentals of financial management / James C Van Horne, John M Wachowicz – 13th ed p cm Includes bibliographical references and index ISBN 978-0-273-71363-0 (pbk : alk paper) Corporations–Finance Business enterprises–Finance I Wachowicz, John Martin II Title HG4026.V36 2008 658.15—dc22 2008027365 10 12 11 10 09 Typeset in 10/12pt Minion by 35 Printed and bound by Ashford Colour Press Ltd., Gosport The publisher’s policy is to use paper manufactured from sustainable forests •• FUNO_A01.qxd 9/19/08 13:56 Page v To Mimi, Drew, Stuart, and Stephen James C Van Horne To Emerson, John, June, Lien, and Patricia John M Wachowicz, Jr •• FUNO_A01.qxd 9/19/08 13:56 Page vi •• FUNO_A01.qxd 9/19/08 13:56 Page vii Brief Contents l l l Part Introduction to Financial Management The Role of Financial Management The Business, Tax and Financial Environments 17 l l l Part Valuation The Time Value of Money 41 The Valuation of Long-Term Securities 73 Risk and Return 97 Appendix A Measuring Portfolio Risk 117 Appendix B Arbitrage Pricing Theory 119 l l l Part Tools of Financial Analysis and Planning Financial Statement Analysis 127 Appendix Deferred Taxes and Financial Analysis 158 Funds Analysis, Cash-Flow Analysis, and Financial Planning 169 Appendix Sustainable Growth Modeling 190 l l l Part Working Capital Management 10 11 Overview of Working Capital Management 205 Cash and Marketable Securities Management 221 Accounts Receivable and Inventory Management 249 Short-Term Financing 281 l l l Part Investment in Capital Assets 12 Capital Budgeting and Estimating Cash Flows 307 13 Capital Budgeting Techniques 323 Appendix A Multiple Internal Rates of Return 341 Appendix B Replacement Chain Analysis 343 14 Risk and Managerial (Real) Options in Capital Budgeting 353 vii •• FUNO_A01.qxd 9/19/08 13:56 Page viii Brief Contents l l l Part The Cost of Capital, Capital Structure, and Dividend Policy 15 Required Returns and the Cost of Capital 381 Appendix A Adjusting the Beta for Financial Leverage 407 Appendix B Adjusted Present Value 408 16 Operating and Financial Leverage 419 17 Capital Structure Determination 451 18 Dividend Policy 475 l l l Part Intermediate and Long-Term Financing 19 The Capital Market 505 20 Long-Term Debt, Preferred Stock, and Common Stock 527 Appendix Refunding a Bond Issue 544 21 Term Loans and Leases 553 Appendix Accounting Treatment of Leases 567 l l l Part Special Areas of Financial Management 22 Convertibles, Exchangeables, and Warrants 577 Appendix Option Pricing 589 23 Mergers and Other Forms of Corporate Restructuring 603 Appendix Remedies for a Failing Company 630 24 International Financial Management 647 Appendix 679 Glossary 689 Commonly Used Symbols 705 Index 707 viii •• FUNO_A01.qxd 9/19/08 13:56 Page ix Contents Acknowledgements xix Preface xxi l l l Part Introduction to Financial Management The Role of Financial Management Objectives Introduction What Is Financial Management? The Goal of the Firm Corporate Governance Organization of the Financial Management Function Organization of the Book 10 Key Learning Points 13 Questions 14 Selected References 14 The Business, Tax, and Financial Environments 17 Objectives 17 The Business Environment 18 The Tax Environment 20 The Financial Environment 27 Key Learning Points 35 Questions 36 Self-Correction Problems 37 Problems 37 Solutions to Self-Correction Problems 38 Selected References 39 l l l Part Valuation The Time Value of Money 41 Objectives 41 The Interest Rate 42 Simple Interest 43 Compound Interest 43 Compounding More Than Once a Year 59 Amortizing a Loan 62 Summary Table of Key Compound Interest Formulas 63 Key Learning Points 63 ix •• FUNO_Z03.qxd 9/19/08 14:12 Page 705 Commonly Used Symbols ABS ACH AMT A/P APR APT APV APY A/R ARC B2B BAs BPO β CAPM CD CE CFt CML COD CSR C/V/P CV Dp Dt DCF DFL DOL DRIP DTC DTL EAT EBIT EBT EC EDI EFT EOM EOQ EPS EVA™ FASB FEDI FRN Asset-backed securities Automated clearing house Alternative minimum tax Accounts payable Annual percentage rate Arbitrage pricing theory Adjusted present value Annual percentage yield Accounts receivable Accounts receivable conversion Business-to-business Bankers’ acceptances Business process outsourcing Beta Capital-asset pricing model Negotiable certificate of deposit Certainty equivalent Cash flow at time t Capital market line Cash on delivery Corporate social responsibility Cost/volume/profit Coefficient of variation Dividend on preferred stock Dividend at time t Discounted cash flow Degree of financial leverage Degree of operating leverage Dividend reinvestment plan Depository transfer check Degree of total leverage Earnings after taxes Earnings before interest and taxes Earnings before tax Electronic commerce Electronic data interchange Electronic funds transfer End of month Economic order quantity Earnings per share Economic value added Financial Accounting Standards Board Financial EDI Floating-rate note FV FVA Future value Future (compound) value of an (ordinary) annuity FVIF Future value interest factor FVIFA Future value interest factor of an (ordinary) annuity FWP Free-writing prospectus FX Foreign exchange g Growth rate i Interest rate per time period IPO Initial public offering IRR Internal rate of return IRS Internal Revenue Service JIT Just-in-time Before-tax cost of debt kd ke Cost of equity capital ki After-tax cost of debt ko Overall cost of capital kp Cost of preferred stock LBO Leveraged buyout L/C Letter of credit LIBOR London interbank offered rate LLC Limited liability company MACRS Modified Accelerated Cost Recovery System MBO Management buyout MMFs Money market mutual funds MMP Money market preferred stock MTN Medium-term note n Number of periods NAICS North American Industry Classification System NOI Net operating income NOPAT Net operating profit after tax NPV Net present value NWC Net working capital OP Order point Pt Market price at time t PBP Payback period PCAOB Public Company Accounting Oversight Board P/E Price/earnings ratio PI Profitability index PPP Purchasing-power parity 705 •• FUNO_Z03.qxd 9/19/08 14:12 Page 706 Commonly Used Symbols PTD PV PVA PVIF PVIFA Q BE r Rf bj bm RADR RDC ROE ROI RPs SBE Payable through draft Present value Present value of an (ordinary) annuity Present value interest factor Present value interest factor of an (ordinary) annuity Break-even sales quantity Interest rate or return Risk-free rate Expected return on security j Expected return on market portfolio Risk-adjusted discount rate Remote deposit capture Return on equity Return on investment Repurchase agreements (repos) Break-even sales revenue SCM SEC SGR SML SOX S&P SWIFT σ σ2 Σ t UCC WC WKSIs YTM ZBA Supply chain management Securities and Exchange Commission Sustainable growth rate Security market line Sarbanes-Oxley Act of 2002 Standard & Poor’s Society for Worldwide Interbank Financial Telecommunication Standard deviation Variance Summation sign Time period Uniform commercial code Working capital Well-known seasoned issuers Yield to maturity Zero balance account 706 •• FUNO_Z04.qxd 9/19/08 14:13 Page 707 Index Note: Emboldened page references indicate items that appear in the Glossary A/R management payoff 257 abandonment value 370, 689 ABC method of inventory control 264–5, 689 absolute-priority rule 634, 689 acceptance criterion 325, 327, 328, 668–9 accountants 132 accounting methods, differences in 654–6 accounting profit 396 accounting statement of cash flows 176–80 analysis 179 content and alternative forms of the statement 176–9 accounting treatment 560–1, 618–20 accounts payable 282 aging 144 accounts receivable 298–300, 689 aging 143–4, 689 -backed loans 294–5 conversion (ARC) 225–6, 689 entries 226 and inventory management 250–79 credit applicant, analysis of 258–63 see also credit and collection policies; inventory management and control accrual method 134 accrued expenses 286, 689 acid-test (quick) ratio 139–40, 689 acquisitions see mergers activity 152 activity ratios 142–8, 689 aging accounts receivable 143–4 Aldine’s liquidity 148 inventory activity 145 operating cycle versus cash cycle 146–8 payables activity 144 receivables activity 142–3 total asset (capital) turnover 148 actual returns 99, 102 additional paid-in capital 131, 136, 538, 689 adjusted present value (APV) 408–10, 689 adjustment to discount rate (ADR) 392–3 adjustment to initial outlay (AIO) 392, 393 ‘after-tax incremental operating cash flows’ 309–17 asset expansion 314–16 asset replacement 316–17 calculation 312–14 cash flow checklist 309–10 tax considerations 310–12 agency costs 460, 463–4, 467, 608, 689 Agency for International Development (AID) 652 agency problems 5, 580 agency (theory) 5, 689 agent(s) 5, 689 aggressive financing policy 214 aging accounts payable 144 aging accounts receivable 143–4, 689 aging schedule analysis 294 Aldine’s liquidity 148 Alternative Depreciation System 312 alternative minimum tax (AMT) 21, 24, 562, 689 alternative minimum taxable income (AMTI) 21 Altria 625 American Depository Receipts (ADRs) 519 American Stock Exchange 31, 522 amortization effect 533 amortization schedule 62, 689 amortized loan 54, 62–3, 554 amortizing capital lease and reducing obligation 570 Anheuser-Busch acceptance criterion for investments 327, 328 annual interest rate 284, 285 effective 61–2, 87, 291n, 694 annual percentage rate (APR) 61 annual percentage yield (APY) 61 annual turnover ratio 188 annuities 50–6, 689 consolidated (consol) 75, 692 due 54–6, 689 ordinary 50–3, 54, 689, 699 perpetuity 54 unknown interest (discount) rate 53–4 unknown periodic payment (receipt) 54 antitakeover amendments 620–2 antitakeover devices 622 Antitrust Division of Department of Justice 617 appreciation 666 approved (legal) list of securities 485 approved list 461 arbitrage 689 pricing theory (APT) 114, 119–21, 690 support 457–8 area of normal distribution that is Z standard deviations to left or right of mean 688 arrearage 535, 690 Arthur Andersen 514 as-needed basis 271 as-produced basis 271 Asia 231, 663 Asquith, P 495n, 520n Asset Depreciation Range (ADR) system 22 Asset Depreciation Range System 22 asset/assets 172, 690 -backed securities (ABS) 531, 690, 696 -based financing 295 depreciable 312 efficiency 151 expansion 314–16 fixed, gross additions to 174 fixed, gross change in 174–5 forecasting 187–8 management decision optimal amount (level) of current 208–9 purchase 618 replacement 316–17 securitization 531–2, 690 -to-sales ratio, total 191, 193 total 148, 691, 701 see also capital-asset pricing model (CAPM); current assets assigned (stated) value 538, 690 authorized shares 538 Automated Clearing House (ACH) 225, 689, 690 debit 226 electronic transfer 227 transfers 232 availability float 224 average collection period 149, 250, 258 average tax rate 21 aysmmetric (unequal) information 521–2 Bacon, F 222 bad-debt losses 256, 258 Bagwell, L.S 494n Bahamas 650 balance 131 balance sheet 128, 153, 155, 171, 172, 690 forecast 170, 189 information 130–1 ratios 138–41 balloon payment 533, 554, 690 bank checking 259 707 •• FUNO_Z04.qxd 9/19/08 14:13 Page 708 Index bankers’ acceptances (BAs) 239, 288, 669, 690 Bankruptcy Act 632 bankruptcy costs 459–60, 463–4 Bankruptcy Reform Act 1978 634 base case 338 bearer bond certificates 75n Bechtel Corporation 519 before-hand (ex ante) market risk premium 388 before-tax cost of debt plus risk premium approach 389–90 beginning inventory 692 below-face-value purchase price 77 benchmarking 137 best efforts offering 508, 690 beta 110, 120, 387–8, 690, 691 adjusted 689 adjustment for financial leverage 407–8 historical 110–11 index of systematic risk 108–9 required returns and cost of capital 400 Bierce, A 17 bill of exchange see international trade draft bill of lading 669, 670, 690 billing, earlier 224 Black, F 133, 593–5 Blackstone Group 624 blue sky laws 516, 690 Board of Directors, role of bond/bonds 75, 690 discount 85, 690 dual currency 650 -equivalent yield 86, 237 exchangeable 584–5, 694 features 528–9 financing, international 659 finite maturity 76–8 foreign 659 income 530, 696 issue refunding 544–6 junk 530, 696 market, European 663 multiple currency 660 perpetual 75–8 premium 85, 690 prices, behavior of 85–6 ratings 529 registered 75n retirement 532–4 secured 529 serial 701 straight 582–4, 702 Treasury 238, 703 unsecured 529 valuation 75–8 Yankee 659 book profits 158 book value 390, 538–9, 690 versus market value 74 borrow, ability to 482–3 B.P Direct Access Plan 493 break-even analysis 421–3, 690 break-even chart 421–2, 690 break-even point 429n, 690 and degree of operating leverage (DOL) 425–6 quantity 421–2, 423 sales 422–3 Brilloff, A 128 British Virgin Island 658 budget ceiling 337 budgeting see capital budgeting Burr Porter, R 393n Bush, G.W 24 business environment 18–20 business process outsourcing (BPO) 233–4, 690 business risk 135, 407, 433–4, 690 and degree of operating leverage (DOL) 426–7 business-to-business (B2B) 271, 690 exchange 271, 690 buyout see leveraged; management call feature see call provision call option 589, 590, 690 call premium 544, 690 call price 78n, 385n, 533, 579, 690 call privilege, value of 534 call provision 385n, 533–4, 690 Cameco Corporation 466 Canada 226, 493, 615, 698 capital 481 additional paid-in 131, 136, 538, 689 expenditure 183, 557 gains and losses 26, 691 gains yield 87 impairment rule 481 lease, recording value of 568–70 rationing 336–7, 691 venture 519 see also capital budgeting; capital market; capital structure; capital-asset pricing model (CAPM); cost of capital capital budgeting 691 and estimating cash flows 308–22 investment project proposals 308–9 see also ‘after-tax incremental operating cash flows’ international 648–9 techniques 324–50 capital market 27–8, 506–26, 691 initial financing 519–20 private placement 516–18 privileged subscription 509–12 public issue 507–9 secondary market 522 security offerings, regulation of 512–16 signaling effects 520–2 capital rationing 336–7 dependency and mutual exclusion 330 multiple internal rates of return 334–6, 341–3 project monitoring: progress reviews and post-completion audits 340 ranking problems 330–4 replacement chain analysis 343–5 single-point estimates 338–40 see also project evaluation and selection see also risk and managerial (real) options in capital budgeting capital structure 452–72, 691 financial signaling 465 financing checklist 466–7 market imperfections and incentive issues 458–61 net operating income approach 453–5 optimal 455, 698 ratios 439, 467 taxes, effect of 461–3 taxes and market imperfections combined 463–4 timing and financial flexibility 465–6 total-value principle 456–8 traditional approach 455–6 capital-asset pricing model (CAPM) 106–14, 387–9, 690–1 approach to project selection 396–8 beta: index of systematic risk 108–9 challenges to 113–14 characteristic line 107–8 index 106 required rates of return and security market line 109–12 required returns and cost of capital 399, 400, 401, 403, 405, 408 returns and stock prices 112–13 risk and return 119, 120, 121 unsystematic (diversifiable) risk 109 capitalization rate 453, 691 total 141 capitalized expenditures 312, 691 Carroll, L 476 carryback and carryforward 25–6 Case v Los Angeles Lumber Products Company (1939) 634 cash before delivery (CBD) 283 budget 170, 180, 691 commitment 698 concentration 227–8, 691 conversion cycle see cash cycle cycle 146–8, 691 on delivery (COD) 283 disbursements 182–3 discount 253, 283, 691 dividend 25, 488–9, 557, 691 equivalents 130, 691 initial cash outflow (ICO) 312, 313, 326 initial cash outlay (ICO) 338 708 •• FUNO_Z04.qxd 9/19/08 14:13 Page 709 Index cash (continued) insolvency 432, 438, 691 management 223, 657–8 marginal 383 and marketable securities management 222–47 cash balances to maintain 234–5 cash handling, motives for 222–3 cash receipts 223–8 electronic commerce 231–3 outsourcing 233–4 slowing down cash payouts 228–31 see also investment in marketable securities outlay 310 segment, controllable 236, 242 see also cash flow cash flow 356–7 ability to service debt 436–8, 466–7 approach versus earnings per share approach 617 checklist 309–10 for debt alternative schedule 565 estimation 184–6, 616–17 expected net 326 forecasting 180–4 free 460, 615–16 future, expectations of 521 interim incremental net 312, 313–14 net, and cash balance 183–4 patterns 330, 331–3 terminal-year incremental net 313, 314 see also accounting statement; ‘after-tax incremental operating cash flows’; discounted caveat emptor 514 certainty equivalent (CE) 102, 691 Chambers, D.R 490n changing state of incorporation 621 CHAPS 691 characteristic line 107–8, 387, 396, 397, 691 Charets, G 490n chattel mortgage 296, 558–9, 691 Chebyshev’s inequality 363n check truncation 226–7 see also depository Check Clearing for the 21st Century Act (Check 21) 226–7, 228, 691 Chile 650–1 claims 172 Clayton Act 1914 617, 691 clean draft 668n cleanup provision 289 Clearing House Interbank Payments System (CHIPS) 232, 691 closing the deal 617–20 Coca-Cola 455, 665 coefficient of variation (CV) 101, 691 collateral 293 collect basis 291 collection 181–2, 223–5 float 223–4 improvement 225–7 and other cash receipts 181–2 process 257 comment letter 513 Comment, R 494n commercial bank loans 658–9 commercial banks 29 commercial paper 239–40, 287–8, 691 bank-supported 287–8 commitment fee 289, 292, 554, 691 common shareholders, rights of 539–42 common stock 131, 592, 594, 691 dual class 542–3, 694 and its features 538–9 price 591 purchase 618 valuation calculations 83 see also long-term debt, preferred stock and common stock; strategic acquisitions involving common stock common-size analysis 153–6, 691 company’s own experience 259–60 comparison 136 compensating balance 227, 291–2, 691 competitive advantage 382–3 competitive bid versus negotiated offerings 507–8 components 209 composition 630 compound growth 46–7 compound interest 43–58, 691 annual 77–8 formulas 63 mixed flows 57 more than once a year 59–62 see also annuities; single amounts compounding, continuous 59, 60–1 compounding periods on future values 62 compounding periods, semiannual 59–60, 77–8, 86–7 conditional sales contract 559, 692 confirmed letter 669–70 conglomerate 700 consolidated annuities (consol) 75, 692 consolidation 617, 692 consumer credit 261 contribution margin per unit 251 control 483 -enhancing measures 543 convergence 129 conversion 532 premium see premium over conversion value price 692 ratio 692 value 692 convertible securities 536, 578–81, 590, 692 conversion price and conversion ratio 578 conversion value and premium over conversion value 578–9 financing with convertibles 579–80 forcing conversion 580–1 stimulating conversion 581 value of 581–4 core competencies 233 corporate annual reports 170 corporate goal corporate governance 8, 692 corporate income taxes 21–6 alternative minimum tax 21 capital gains and losses 26 carryback and carryforward 25–6 depreciation 21–3 dividend income 25 interest expense versus dividends paid 25 modified accelerated cost recovery system 23–4 quarterly tax payments 21 ‘temporary’ tax relief provisions 24–5 corporate restructuring 692 corporate securities 506 corporate social responsibility (CSR) 5–7, 692 corporate spin-offs 624, 625 corporate taxes 461–2, 463 corporation 19–20, 692 correlation coefficient 118, 365–6, 692 cost bankruptcy 459–60, 463–4 of borrowing 290–2 of capital 692 see also overall cost of capital; required returns and cost of capital; weighted average cost of debt (capital) 383, 692 of equity capital 383, 692 explicit 466 factoring 298–9 financing 580 fixed 361 fixed operating 420 flotation 392–3, 479, 508–9, 695 of goods purchased/manufactured 692 of goods sold 131, 144, 692 operating 361 opportunity 251, 310, 698 of preferred stock (capital) 383, 692 recovery period 22 sunk 310, 702 of term loans 554–5 trade-off 212–15 transactions 461, 479 variable 420 versus savings 254 /volume/profit analysis see break-even analysis countertrade 670, 692 coupon effect 86 coupon rate 75, 528, 692 709 •• FUNO_Z04.qxd 9/19/08 14:13 Page 710 Index covariance 118, 692 negative 103 and portfolio risk 103–4 weighted 104 zero 103 covenant 483, 556, 692 protective 528 coverage 152 ratios 141–2, 436–8, 692 cram down 632 credit analysis 260–2 applicant, analysis of 258–63 and collection policies 250–8 credit standards 250 credit terms 252–4 default risk 254–5 procedures 255–6 consumer 261 continuous form of 285 decision and line of credit 262–3 extending line of 290 line of 288–9, 697 open-account 668 period 252–3, 692 ratings and reports 259 -scoring system 261–2, 692 standard 692 terms 252–4 unions 29 CS First Boston 556 cumulative dividends feature 535 cumulative feature 530 cumulative voting 540–1, 692 currency bonds, dual 650 cocktail bonds 650 futures 663 market hedges 660–4 option 660, 664, 693 risk 652 swaps 664 current assets decisions 215–16 current assets finance: short-term and longterm mix 210–15 hedging (maturity matching) approach 211–12 short-term versus long-term financing 212–15 current income desires 485 current ratio 136, 138–9, 149, 693 customer consolidation 299 Damovo 635 Dann, L.Y 494n Dartmouth College decision (1819) 19 data interchange 232 see also electronic DeAngelo, H 626n DeAngelo, L 626n debenture 529–30, 693 subordinated 702 debt capacity 436, 693 contracts, restrictions in 483 cost of 384–5 financing 455, 562–7, 628–9 funds, ascribing of to groups 401 and incentive to manage efficiently 460 payments schedule 565 -plus-option characteristic 581 ratio 693 -service burden 693 -service coverage 437–8, 467 -specific burden 436–7, 438 straight 578, 702 -to-equity ratio 140, 455 -to-total-assets ratio 140–1 see also long-term debt decision trees 369 declaration date 495, 693 deed of trust see indenture default 693 risk 32–3, 254–5 defenses 620–2 deferred taxes 158–9, 693 degree of financial leverage (DFL) 432–4, 435, 693, 693 degree of operating leverage (DOL) 423–7, 436, 693 degree of total leverage (DTL) 435–6, 693 Dell Inc 147, 542 dependency 330 dependent (contingent) project 693 deposit float 224 deposit institutions 29 depository transfer check (DTC) 227, 228, 693 depreciable asset, sale of disposal of 312 depreciable basis 312, 693 depreciation 21–3, 174–5, 666, 693 accelerated 22, 311, 689 Alternative Depreciation System 312 Asset Depreciation Range System 22 back 174 bonus 24, 25, 311 calculation 23 charge 23 declining-balance 22, 693 financial statement analysis 132 method 310–12 recapture 565 straight-line 22, 702 derivative security 578, 693 detour: cost of borrowing 290–2 dilution 477, 579–80, 693 direct method 176–8 direct (primary) securities 29 director resignation policy 542 disbursement cash 182–3 controlled 229–31, 692 float 230, 693 payroll 229–30 projected for purchases and operating expenses 183 projected total cash 183 remote 230–1, 700 discount basis 291 cash 253, 283, 691 forward 660 from par value 77 quantity 283 rate, adjustment to (ADR) 392–3 rate (capitalization rate) 47, 326, 693 discounted cash flow (DCF) 324, 325, 368, 372, 693 discounting 546 to present value at risk-free rate 359–60 trade bills 659 disperison, expectation and measurement of 356–7 dispute-management process 257 diversification 104–6, 365, 585 divestiture 623–6, 693 dividend 26, 79–80, 174, 493 cash 25, 488–9, 557, 691 cumulative 535 current 477 disbursements 229–30 discount models 80–3, 386–7 extra 695 future, estimation of 386 income 25 paid 25 payments 183 -payout ratio 3, 81, 476, 484, 693 policy 476–502 borrow, ability to 482–3 control 483 corporate policy, implications for 380–1 debt contracts, restrictions in 483 dividends as passive residual 476 empirical testing 480 funding needs of the firm 482 investment/financing decision 493 irrelevance of dividends 477–8 legal rules 481–2 liquidity 482 possible signaling effect 493–5 procedural aspects 495 regular and extra dividends 486 reinvestment plans 495–6 relevance of dividends 478–80 repurchase, method of 491–2 repurchasing as part of 492–3 reverse stock split 490 stability, valuation of 485 710 •• FUNO_Z04.qxd 9/19/08 14:13 Page 711 Index dividend (continued) stock dividends 486–7, 488–90 stock splits 487–90 target payout ratios 485–6 regular 700 stock 486–7, 488–90, 701 yield 478, 693 Dividend Reinvestment Plan (DRIP) 493, 693 documentary draft 668n dot-com company 180, 693 double declining balance (DDB) method (aka 200declining balance) 22, 23 double taxation 19, 693 draft 282, 670, 693–4 clean 668n sight 282n, 668 drawee 668 Drexel Burnham Lambert 530 Du Pont approach 150, 151 dual approach 405 Duff & Phelps 287 Dun & Bradstreet 136, 259, 260, 261, 263, 284 Dutch auction 491, 494, 694 e-proxies 540 earning power 150–1 earnings after taxes (EAT) 3, 694 available to common shareholders (EACS) 428 before interest and taxes (EBIT) 453, 690, 693 -earnings per share (EPS) analysis 467 -earnings per share (EPS) break-even analysis 428–32, 694 -earnings per share (EPS) break-even chart 428–30, 431–2 -earnings per share (EPS) indifference point 427, 430, 431, 467 operating and financial leverage 420–1, 423–5, 433, 434, 436, 437–8 impact 608–10 maximization 3–4 muliplier approach, conversion to 81–2 per share (EPS) 432, 693, 694, 695 approach versus cash-flow approach 617 basic 579 ‘bootstrapping’ 611–12 diluted 579 expected 611 operating and financial leverage 433–4 role of financial management see also earnings before interest and taxes (EBIT) see also price/earnings ratio economic exposure 653, 656 economic order quantity (EOQ) 265–8, 271, 273, 694 economic profit 394–5, 396 economic rationale for leasing 561–2 Economic Stimulus Act (ESA) 2008 24, 25, 311 economic value added (EVA) 394–6, 694 economies of scale 604, 694 E.F Hutton (brokerage firm) 231 effective annual yield (EAY) method 237 effective rate 61 efficiency 115 ratios see activity ratios efficient financial market 114–16, 694 Ehrhardt, M.C 338n electronic commerce (EC) 231–3, 694 electronic data interchange (EDI) 231–3, 694 see also financial electronic funds transfer (EFT) 232, 694 electronic lockbox 694 electronic mail (e-mail) 231 ending inventory 692 Enron 514 envelope curve 604 equilibrium price 112 equipment financing 558–9 equipment trust certificate 531, 694 equitable (technical) insolvency 630 equity carve-out 624–6, 694 cost of 386–7 before-tax cost of debt plus risk premium approach 389–90 capital-asset pricing model (CAPM) 387–9 dividend discount model approach 386–7 kicker 629 multiplier 151n estimating cash flows see capital budgeting and estimating cash flows Euro 662–3, 694 Euro commercial paper (Euro CP) 240 Euro medium-term note (Euro MTN) 556, 694 Eurobond 659, 694 Eurocurrency 659, 694 Eurodollar 241, 694 certificates of deposit (Euro CDs) 240, 241 financing 659 time deposits (Euro TDs) 241 Europe 20, 77, 231, 635, 659 European bond market 663 European Central Bank 663 European insolvency law 635 European Union 129, 232 event risk 517, 694 ex-dividend date 495, 694 ex-rights date 510–11, 694 exchange market foreign 651 forward 660–2 exchange premium 585 exchange rate 648, 653, 662, 694 behavior, macro factors governing 665–8 current 654–5 forward 652, 695 historical 654–5 spot 652, 701 see also exchange rate risk exposure exchange rate risk exposure 652–68 cash management and adjusting intracompany accounts 657–8 currency market hedges 660–4 economic exposure 656 hedging exchange-rate risk expsosure 664–5 international financing hedges 658–60 macro factors governing exchange-rate behavior 665–8 natural hedges 656–7 transactions exposure 656 translation exposure 653–6 exchange ratio 608 exchangeable bond 584–5, 694 exercise price 587, 690, 694, 700 expected value 356, 357n, 694 of net present value (NPV) 365–6 export factoring 670–1 Export-Import Bank of the United States (Eximbank) 652 extension 630 Ezzell, J.R 393n face value 75, 77, 695 see also par value facsimile transmission (fax) 231 factor 695 analysis 120 factoring 695 accounts receivable 298–300 costs 298–9 failing company, remedies for 630–4 Fama, E.F 114, 115, 490n Federal Agency 695 securities 239 Federal Financing Bank 239 Federal Housing Administration 239 Federal income tax 183 Federal regulation 512–16 Federal Reserve 228, 231 Bank 224 System 224, 230 Wire System (Fedwire) 228 Federal Trade Commission 136, 617 field warehouse receipt 297, 695 fifty percent dividend-payout ratio 484 finance companies 30 Financial Accounting Standards Board (FASB) 129, 130, 561, 569, 619, 653, 695 No 13 567, 570, 695 No 52 655 No 123 133 financial acquisition 608 financial brokers 30 financial electronic data interchange (FEDI) 232, 233, 695 financial environment 27–35 financial brokers 30 financial intermediaries 29–30 financial markets 27–9 711 •• FUNO_Z04.qxd 9/19/08 14:13 Page 712 Index financial environment (continued) funds, allocation of and interest rates 32–5 purpose of financial markets 27 secondary market 31–2 financial failure 630 financial flexibility 465–6 financial intermediaries 29–30, 517, 659, 695 financial lease 559, 695 financial leverage 420, 427–34, 695 absence of 407 (debt) ratios 140–1 earnings before interest and taxes (EBIT)earnings per share (EPS) break-even or indifference analysis 428–32 see also degree of financial leverage financial management 695 financial markets 27–9, 506, 695 efficient 114–16, 694 financial ratio 135–7, 152, 695 financial risk 407, 432–4, 695 financial signaling 465, 467, 480 financial statement 259 analysis 128–67, 695 balance sheet information 130–1 balance sheet ratios 138–41 common-size and index analysis 153–6 deferred taxes 158–9 financial ratios 135–7 income statement information 131–4 ratios, types of 137–8 trend analysis 152–3 see also balance sheet ratios; forecasting; income statement and income statement/balance sheet ratios items as indexes relative to a base year 154–6 items as percentages of tools 153–4 percentage 691 Financial Times 662 financing (and asset) needs over time 214 financing costs 580 financing decision finite maturity bonds 76–8 firm 690 commitment underwriting see underwriting goal of 3–7 -portfolio approach 364–8, 404–5 risk, total 433–4, 436, 702 first mortgage 531 first-in, first-out (FIFO) inventory 655 first-mover advantage 369, 372 Fisher effect 666 Fisher, I 34, 490n Fisher’s rate of intersection 332 Fitch’s 287 fixed costs 361 fixed operating costs (FC) 420 fixed price self-tender offer 491, 494 flexibility 300, 467 floating lien 296, 695 floating-rate note (FRN) 659, 695 floor planning see trust receipt flotation costs 392–3, 479, 508–9, 695 flow of funds (sources and uses) statement 170–6, 695 adjustments 173–5 alternative ‘funds’ definitions 171 analysis of sources and uses 175–6 sources and uses, definition of 172–3 forecast balance sheet 170, 189 forecasting financial statements 186–9, 695 forecast balance sheet 187–9 forecast income statement 186–7 ratios, uses of and implications 18 foreclosure 531 foreign bond 659 foreign exchange market 651 foreign stocks in the United States 519 forfaiter 671, 695 forfaiting 671, 695 Form 13D 514, 622 forward contract 660, 695 forward discount 660 forward exchange market 660–2 forward exchange rate 652, 695 forward premium 660 forward rates 662 France 541, 635 Franklin, B 281, 528 free cash segment 236, 242 free-writing prospectuses (FWPs) 516, 695 Freescale Semiconductor Inc 624 freeze-out provision 621 French, K 114 full-service (maintenance) lease 559 functional currency 653, 655 funding needs of the firm 482 funds, allocation of 32–5 funds provided by operations 174 future (compound) value 44–6, 59 of (ordinary) annuity 51, 52, 54, 55 future earnings 610 future (terminal) value 43 future value interest factor 44, 47, 50 of $1 at percent at the end of n periods 680–1 of an annuity (FVIFA) 53, 54 of an (ordinary) annuity of $1 per period at for n periods 684–5 future value (terminal value) 45, 46, 61, 693, 695 futures contract 663, 664, 695, 695 FVAD 54, 55 gearing 695 General Motors Acceptance Corporation (GMAC) 287 general partner 18–19, 695 Generally Accepted Accounting Principles (GAAP) 129 geographic concentration 272 Germany 541, 635 Gillespie, W 490n giro system 231 globalization 299 glossary 689–703 going concern value 74, 630, 695–6 going private 626, 696 Goizueta, R golden parachute 622 Goldman Sachs 388, 537, 556 goodwill 618, 696 Gordon Dividend Valuation Model 81n Gordon, M.J 81n governance Government National Mortgage Association (GNMA) 239 government-sponsored enterprises (GSEs) 239 greenmail 622 Grinblatt, M.S 490n group-specific required return 399–400 growth phases 387 half-year convention 23, 24, 311 Hamada, R.S 407n handicapping 48 hard currencies 670 Hartmarx Corp 295 hedge 582, 595, 696, 698 natural 656–7, 698 hedged position 593 hedging 658–60 exchange-rate risk expsosure 664–5 (maturity matching) approach 211–12, 384, 696 with options 593 Hekman, C.R 656 Hermes 614 Hertz, D.B 361n Hewlett-Packard 190 high-yield bonds see junk bonds Hillier, F.S 363n holding it long 593 Holiday Corporation 481 Holmes, S 307, 324, 452 Hong Kong 518, 658 hubris hypothesis 607 hurdle rate 327, 393, 394, 696 Ibbotson Associates 110 Icahn, C 604 impairment 696 incentive issues 458–61, 467 incentive to manage efficiently and debt 460 incentive plan for collection staff 257 income bond 530, 696 net operating income (NOI) 453–5, 458, 698 right to 539 see also income statement; income taxes 712 •• FUNO_Z04.qxd 9/19/08 14:13 Page 713 Index income statement 129, 138, 154, 155, 158, 170, 696 and income statement/balance sheet ratios 138, 141–51 common-size and index analysis 153–6 coverage ratios 141–2 profitability ratios 148–51 see also activity ratios information 131–4 income taxes Federal 183 personal 26 see also corporate indenture 528, 696 independent project 330, 696 index 106 analysis 153–6, 696 indifference analysis 428–32 curve 404–5, 696 map 404–5 point (EBIT-EPS indifference point) 429n, 696 indirect method 176–8 industry attractiveness 382 infinity 54 inflation 34–5, 696 anticipated 310 information asymmetric 521–2 content 485, 490 effect 606 probabilistic 185–6 publicly available 115 sources 258–60 initial cash outflow (ICO) 312, 313, 326 initial cash outlay (ICO) 338 initial financing 519–20 initial public offering (IPO) 519–20, 614–15, 696 roll-up 614, 696 insolvency cash 432, 438, 691 equitable (technical) 630 law 635 legal 630 rule 482 institutional considerations 485 institutional restrictions 460–1, 479 insurance company 29–30 term loans 555 Intel 542 interest 26, 696 coverage 467 coverage ratio 141, 436, 437, 696 expense versus dividends paid 25 rate, unknown 49, 53–4 simple 43, 701 see also compound interest; interest rate interest rate 32–5, 42 cost of borrowing 290–1 effective 698 employed 590 methods of computing 291 nominal (stated) 59, 698 parity 662, 666–8 term structure 33, 702 (yield) risk 85, 237, 696 see also annual internal rate of return 83–4, 325–7, 696, 701 capital budgeting techniques 325–6, 330, 338 multiple 334–6, 341–3 required returns and cost of capital 402–3 risk and managerial options in capital budgeting 362, 364 Internal Revenue Code 482 see also Subchapter S Internal Revenue Service 482, 561 International Accounting Standards Board (IASB) 129, 561, 569 International Financial Reporting Standard 3R 619 international bond financing 659 international cash management 231 international financial management 648–77 international capital budgeting 648–9 political risk 650–2 risk factors 649 structuring international trade transactions 668–71 taxation 649–50 see also exchange-rate risk exposure International Financial Reporting Standards (IFRS) 129, 619 international financing hedges 658–60 international Fisher effect 666–7 international/global securities offering 509 Internet 271 interpolate 84–5, 326–7, 696 intracompany accounts, adjustment of 657–8 intrinsic value 74–5, 115, 696 inventory 136 activity 145 backed loans 295–8 beginning 692 distribution 264 ending 692 management see accounts receivable and inventory management turnover in days (ITD) 145, 147, 149 turnover (IT) ratio 145 see also inventory management and control inventory management and control 263–73 classification: what to control 264–5 economic order quantity 265–8 financial manager and inventory 271–3 just-in-time 271 order point: when to order 268 safety stock 268–70 investment aggressive 108 analysts and lenders, surveying of 439 banker 30, 507, 696 and claims (against those investments) 171 cost analysis 361 decision 2–3 defensive 108 grade quality 33, 440 in marketable securities 235–44 common money market instruments 238–41 marketable securities portfolio 235–6 selection of securities for portfolio segments 241–4 variables in marketable securities selection 236–8 project proposals 308–9 scale 330 invoice 223, 696 IOSCO 129 Islamic bonds (Sukuki) 660, 661, 696 Italy 635 January effect 114 Japan 129, 659 Jarrell, G.A 494n Jensen, M.C 5, 460, 490n Job Creation and Worker Assistance Act (JCWAA) 2002 25 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) 2003 25 joint venture 623, 696 junk bond 530, 696 just-in-time (JIT) 148, 263–4, 271, 272, 622, 696 Keynes, J.M 222 Kirk, J.T 353 KPMG 129, 614 Kraft Foods 625 Kuwait 129 lagging 658 Latin America 20 Laughlin, E.J 146n lead time 268, 696 leading 658 leaning on the trade see stretching accounts payable lease 696 economic rationale 561–2 financial 559, 695 financing evaluation in relation to debt financing 562–7 example for analysis 562–3 present value for borrowing alternative 564–6 present value for lease alternative 563–4 tax rate, importance of 566–7 713 •• FUNO_Z04.qxd 9/19/08 14:13 Page 714 Index lease (continued) full service 559 leveraged 697 net 559, 562, 698 operating 559, 570, 698 see also term loans and leases legal insolvency 630 legal proceedings 631 Lehman Brothers 556 lessee’s incremental borrowing rate 568n letter of credit (L/C) 287–8, 669–70, 697 letter stock 519, 697 leverage 152, 420, 697 gains 607 mechanical 420 see also financial; operating; total leveraged buyout (LBO) 608, 627–9, 697 leveraged leasing 697 leveraged recapitalization 621 Levi Strauss & Co 626 liability assumption of 616 structure and current asset decisions 215–16 total 701 lien (creditor claim) 530, 558, 697 life insurance companies 29–30 limited liability company (LLC) 20, 26, 697 limited liability partnership (LLP) 20 limited partner 18–19, 697 line of credit 288–9, 697 Lintner, J 486n liquidation 623, 631–2, 697 value 74, 538–9, 697 voluntary 631 voluntary corporate 623 liquidity 33, 139, 152, 236–7, 482, 697 Aldine’s 148 ratios 138–40, 697 acid-test (quick) ratio 139–40 current ratio 138–9 Listing Admission 539, 697 Lloyd’s of London 652 loan agreement 697 amortization 54, 62–3, 554 commercial bank 658–9 receivable 294 transactions 289–90 unsecured 288–90, 292, 703 see also secured; term loans and leases lockbox 225, 226, 697 electronic 225, 694 retail 225, 697 wholesale 225, 697 lockup provision 621–2 London Interbank Offered Rate (LIBOR) 291, 659, 697 long-term debt, preferred stock and common stock 528–51 bond issue refunding 544–6 bonds, retirement of 532–4 bonds and their features 528–9 common shareholders, rights of 539–42 common stock and its features 538–9 dual-class common stock 542–3 preferred stock and its features 534–7 see also types of long-term debt instruments long-term financing 214 long-term-debt-to-total-capitalization ratio 141 lot sizes, small 272 McDonald’s 666 mail float 223–4 mailbox rule 229n Majluf, N.S 521n majority rule system 541 majority voting 540–2, 697 management buyout (MBO) 627, 697 commitment, strong 272 improved 606 personal agenda 607–8 managerial entrenchment hypothesis 620–1 managerial (real) option 354, 697 see also risk and managerial (real) options in capital budgeting manufacturing flexibility 272 margin of safety 215 marginal cost 383 marginal rate 21 marked-to-market 664 market analysis 361 efficiency 115–16 imperfections 458–61 imperfections and taxes combined 463–4 over-the-counter 31, 522, 539 portfolio 106–7 price 700 required rate of return 83 return 111–12, 388–9 risk premium 111 -to-book-value ratio 114 value 74, 114, 390, 539, 588, 697 fair 559, 695 impact 610–12 line 593 versus intrinsic value 74–5 see also capital; financial; money; primary; secondary marketability (liquidity) 33, 236–7, 697 Masulis, R.W 490n material handling 272 maturity 33–4, 75, 238, 528, 697 Meckling, W.H 5, 460 medium-term note (MTN) 555–6, 694, 697 Mehta, D 261n ‘members’ 20 Mencken, H.L 42 merchant banks 659 mergers and other forms of restructuring 604–43, 697 acquisitions and capital budgeting 615–17 acquisitions, financial 608 closing the deal 617–20 divestitures 623–6 failing company, remedies for 630–4 leveraged buyouts 627–9 ownership restructuring 626–7 price provision, fair 621 strategic alliances 622–3 takeovers, tender offers and defenses 620–2 value, sources of 604–8 see also strategic acquisitions involving common stock Merrill Lynch 110, 111, 388, 537, 556 Metastasio, P 205 Mexico 698 mezzanine financing 629 Microsoft 623 Middle East 129, 663 Miller, M.H 455–9, 462–4, 477 mixed flows 57 Modified Accelerated Cost Recovery System (MACRS) depreciation 22, 23–4, 158, 311, 312, 316 modified plurality voting 541–2 Modigliani, F 455–9, 462–4, 477 money market 27–8, 697 credit 287–8 instruments 238–41, 697 mutual funds (MMFs) 243–4, 697 preferred stock (MMP) 241, 537, 697 Monthly Income Preferred Securities (MIPS) 537 Moody’s Investors Service 32–3, 141, 287, 439–40, 529 Morgan, J.P 505 mortgage banker 30, 697 bond 530–1, 698 chattel 296, 558–9, 691 first 531 second 531 motivations 626–7 Motorola Inc 542, 624 MSNBC (cable network) 623 Mullins Jr, D.W 495n, 520n multifactor model 114, 120 multinational company 650, 698 multiple-currency bonds 660 mutual exclusion 330 mutual investment funds 30 mutual savings banks 29 mutually exclusive project 698 Myers, S.C 408, 410, 521n NACHA rules 226 Nai-Fu Chen 120n 714 •• FUNO_Z04.qxd 9/19/08 14:13 Page 715 Index National Association of Securities Dealers Automated Quotation Service (NASDAQ) 31, 514, 539 natural hedge 656–7, 698 NBC 623 Neal, Gerber & Eisenberg (law firm) 542 negative pledge clause 529, 557, 698 negotiable certificate of deposit (CD) 240, 698 negotiated financing 287–98 detour: cost of borrowing 290–2 money market credit 287–8 unsecured loans 288–90 see also secured (asset-based) loans negotiated offerings versus competitive bid 507–8 negotiated settlements 634 net book value 23, 699 net float 229, 698 net lease 559, 562, 698 net operating income (NOI) 453–5, 458, 698 net operating profit after tax (NOPAT) 395, 698 net period – cash discount 283 net period – no cash discount 283 net present value (NPV) 698, 701 capital budgeting techniques 325, 330, 332, 334–6, 338 dividend policy 476 positive 382 project evaluation and selection 327–9 required returns and cost of capital 393, 402–3 risk and managerial options in capital budgeting 359–60, 363, 368 sensitivity graph 339 sensitivity matrix 339 net proceeds 393 net revenues 691 net sales 691 net of tax approach 159 netting system 658, 698 New York Bond Exchange 31, 522 New York Stock Exchange 31 and Archipelago Holdings 520 capital market 522 long-term debt, preferred stock and common stock 539 mergers and other forms of corporate restructuring 609 required returns and cost of capital 389 risk and return 115 New York Times 662 Nike 623 no cash discount 283 no trade credit 283 nominal rate 61, 694, 698 noncash payments 616 nonnotification basis 294 nonzero coupon bonds 76–7 normal (continuous) probability distribution 100 North American Industry Classification System (NAICS) 398, 698 note 528 notification basis 294 number of compounding (discounting) periods, unknown 50 open-account arrangement 282 open-account credit 668 open-market purchase 491 operating costs 361 operating cycle 146–8, 698 operating, investing and financing activities 177 operating lease 559, 570, 698 operating leverage 420–7, 698 break-even analysis 421–3 see also degree of operating leverage (DOL) opportunity cost 251, 310, 698 opportunity loss 363 option to abandon 368, 370–2 option to expand (or contract) 368, 369–70 option features 34 option to postpone 368, 372 option pricing 133, 589–95 option value 591, 592, 594 option writer 589 order point 269, 698 organization of financial management function 8–10 organized exchanges 31 outsourcing 208, 233–4, 263, 623, 698 over-the-counter (OTC) market 31, 522, 539 overall cost of capital of the firm 383–96 debt, cost of 384–5 economic value added 394–6 flotation costs: limitations 392–3 preferred stock, cost of 385–6 weighted average cost of capital 390–1 weighted average cost rationale 393–4 weighting system limitation 391–2 see also equity, cost of overdraft basis 659 Overseas Private Investment Corporation 652 oversubscription privilege 511–12, 698 ownership restructuring 626–7 PA Consulting 614 Panama 650 par value 528, 538, 698 participating feature 535 participating preferred stock 535, 698 partnership 18–19, 698 general 698 limited 698 Patton, General G.S 98 payable through draft (PTD) 229, 698 payables activity 144 payback period (PBP) 324–5, 698 payble turnover in days (PTD) (average payable period) 144, 146 payble turnover (PT) ratio 144 payment 232 date 495, 698 on final due date 283–4 payroll disbursements 229–30 pension funds 30 percentage financial statements 691 periodic payment (receipt), unknown 54 permanent working capital 209–10, 699 perpetual bonds 75–8 perpetuity 54, 699 personal property 691 ‘playing the float’ 228–9 pledge of receivables 294 plurality voting 540–1, 699 poison pill 621, 699 political risk 650–2 pooling of interests (method) 618, 699 portfolio 699 management 242–3 return 103 risk and covariance, importance of 103–4 expectation and measurement 365 measurement 117–19 post-completion audit 699 preauthorized debit 224, 699 precautionary motive 222 preemptive right 509, 699 preferred stock 534–7, 699 cost 385–6 money market (MMP) 241, 537, 697 participating 535, 698 valuation 78–9 see also long-term debt, preferred stock and common stock premium 77, 583–4 buy-back offer 622 over conversion value 583, 699 over floor value 583 over straight bond value 583, 699 over theoretical value 588 Prentice Hall 136 prepackaged bankruptcy (prepack) 634, 699 present value 43, 47–9, 59–60, 693, 699 of an (ordinary) annuity (PVA) 55 for borrowing alternative 564–6 interest factor 47–8 of $1 at percent for n periods 682–3 of an (ordinary) annuity 52, 53, 56 of an (ordinary) annuity of $1 per period at 1for n periods 686–7 interest factors of an annuity (PVIFAs) 327 of interest payments 77 for lease alternative 563–4 of mixed cash flows 58 of (ordinary) annuity 52, 56 of principal payment at maturity 77 see also adjusted; net price-yield relationship 86 715 •• FUNO_Z04.qxd 9/19/08 14:13 Page 716 Index price/earnings (P/E) ratio 114, 537, 612, 699 prices, historical sequence of 115 primary market 28–9, 506, 699 prime rate (prime) 290–1, 699 principal see par value private placement 507, 509, 516–18, 586, 699 privileged subscription 509–12, 699 probabilistic information, uses of 185–6 probability conditional 359 distribution 403–4, 699 continuous 100 discrete (noncontinuous) 100 information, use of 362–4 for internal rate of return 362 to measure risk 99–101 risk and managerial options in capital budgeting 355, 357n, 358 series for abandonment 371, 372 initial 359 joint 359, 360 ratios 699 tree approach 358–61, 370n processing float 224, 225 production outlays 182–3 professional limited liability companies (PLLC) 20 profit 174, 258 accounting 396 book 158 economic 394–5, 396 margin, gross 148, 150 margin, net 149, 150, 191 maximization 3, 699 net operating profit after tax 395, 698 profitability 152 index (PI) 325, 329–30, 336 moves together with risk 209 ratios 148–51 in relation to investment 150 in relation to sales 148–50 and risk 215–16 varies with liquidity 209 versus required return 251, 253, 255 working capital management 206–8 project conventional 328 evaluation on basis of total risk 401–5 evaluation and selection 324–30 internal rate of return 325–7 net present value (NPV) 327–9 payback period 324–5 profitability index 329–30 life 330, 333–4 monitoring: progress reviews and postcompletion audits 340 see also total project risk projected net cash flows and cash balances 184 projected sales and collections 182 promissory note 282, 559, 630, 699 property and casualty companies 29 prospectus 512–13, 699 proxy 540, 699 companies 397–8 contests 540 Public Company Accounting Oversight Board (PCAOB) 8, 699 public issue 507–9, 512, 699 pulling inventory 271 purchase (method) 618, 690, 700 purchasing-power parity (PPP) 665–6, 700 pure play 626, 700 purpose of financial markets 27 pushing inventory 271 put option 589–90, 700 PVAD 55, 56 qualified institutional buyers 517 quality, dependable 272 quantity discount 283 Quarterly Income Preferred Securities (QUIPS) 537 Radcliffe, R.C 490n ranking problems 330–4 rate above prime 291 rates of return (yields) 83–7 ratios 18, 137–8 ready cash segment 235, 236, 241–2 recapitalization 454, 621, 700 receivable loan 294 receivable turnover in days (RTD) (average collection period) 143, 147 receivable turnover (RT) ratio 142 receivables 142–3, 689 receiving, efficient 272 reconciliation 177–9 record date 495, 700 red herring 513, 700 refunding 700 registered bonds 75n registration statement 512, 700 reinvoicing center 658, 700 relative abnormal stock 521, 613 relative dispersion (risk) 101 relative priority basis 634 relative risk 691 remote deposit capture (RDC) 227, 700 reorganization 632–4, 700 replacement chain 333, 343–5 reporting earnings 570 reports, redesigned 257 repurchase agreements (RPs, repos) 238–9, 700 required rate of return 83, 109–12, 459 required returns and cost of capital 382–417 adjusted present value 408–10 beta adjustment for financial leverage 407–8 capital-asset pricing model (CAPM) approach to project selection 396–8 debt funds, ascribing of to groups 401 group-specific required return 399–400 projects evaluation on basis of total risk 401–5 qualifications 400 required returns with leverage 398 value creation 382–3 see also overall cost of capital of the firm residual value 559, 560, 700 Resorts International 634 restrictions, negotiation of 558 restructuring see mergers and other forms of restructuring retained earnings 131, 477 retirement 536 funds 30 return 700 actual 99, 102 on assets (ROA) 569 on equity 150–1 excess 107, 382 expected 99–101, 102, 112, 113, 694 on investment (ROI) 150, 209 required 112 and stock prices 112–13 see also internal rate of return; risk and return Reuters Investor 110, 387 Revenue Reconciliation Act 1993 26 reverse stock split 490, 700 reverse synergy 605 reverse takeovers 520 revolving credit agreement 289, 555, 700 Richards, V.D 146n right 509, 585, 700 rights offering 509 see also privileged subscription rights-on market 510–11 risk 700 -adjusted discount rate (RADR) 401–3, 700 averse 102, 700 and earnings before interest and taxesearnings per share break-even analysis 431–2 -expected return profile 32 -free rate 111–12, 370n, 388–9 and managerial (real) options in capital budgeting 354–79 firm-portfolio approach 364–8 option to abandon 370–2 option to expand (or contract) 369–70 option to postpone 372 project risk, problem of 354–7 valuation implications 368–9 see also total project risk political 650–2 portfolio 103–4, 117–19, 365 premium 102, 111–12 and profitability 215–16 and return 98–125 arbitrage pricing theory 119–21 attitudes towards risk 101–2 716 •• FUNO_Z04.qxd 9/19/08 14:13 Page 717 Index risk (continued) definition of return 98 definition of risk 98–9 diversification 104–6 efficient financial markets 114–16 market efficiency 115–16 in portfolio context 103–4 portfolio risk, measurement of 117–19 probability distributions to measure risk 99–101 see also capital-asset pricing model (CAPM) short-term versus long-term financing 212 unsystematic 105–6, 109, 703 versus costs trade-off 212–15 working capital management 206–8 see also business risk Risk Management Association 136, 138, 259 risky investments, combinations of 367–8 role of financial management 2–14 asset management decision corporate governance financing decision firm, goal of 3–7 investment decision 2–3 organization of financial management function 8–10 Roll, R 120, 490n, 607 roll-up 614–15, 700 Ross, S.A 119, 120 Rule of 72 51 Rule 144 519 Rule 144a 517, 518, 522 Rule 415 508, 556 S corporation 20, 26 safety (of principal) 236, 700 safety stock 268–70, 700 sales 258 enhancement and operating economies 604–6 forecast 180–1 and leaseback 560, 700 profitability 151 -to-toal-assets ratio 193 Samurai bonds 659 Sarbanes-Oxley Act 2002 8, 395, 514, 515, 518, 699, 700 savings and loan associations 29 scale differences 331 Schipper, K 624n Scholes, M 133, 593–5 seasonal dating 253–4, 283, 700 second mortgage 531 secondary market 28–9, 31–2, 506–7, 514, 522, 700 secured (asset-based) loans 288, 292–8, 701 accounts-receivable-backed loans 294–5 collateral 293 inventory-backed loans 295–8 secured bonds 529 Securities Act 1933 509, 512–14, 516, 701 Securities Exchange Act 1934 512, 701 Securities and Exchange Commission (SEC) 700, 701 capital market 509, 512–14, 515, 516, 518 cash and marketable securities management 240n dividend policy 491 financial statement analysis 136 Form 13-D 622 long-term debt, preferred stock and common stock 528, 540 mergers and other forms of corporate restructuring 620, 626 role of financial management Security Market Line (SML) 109–12, 113, 387, 389, 701 security/securities 701 agreement 293 approved (legal) list 485 asset-backed 531, 690, 696 corporate 506 derivative 578, 693 device 293 direct (primary) 29 divisibility 479 Federal Agency 239 indirect (secondary) 29 innovation, long-term 537 interest 293 international 509 listed 539, 697 marketable 231 see also cash and marketable securities management new, selling of 509 offerings, regulation of 512–16 rating 439–40, 467 Treasury 106, 236, 238, 388 Trust-Originated Preferred Redeemable 537 Trust-Preferred 537 trust-preferred (TPS) 537 see also convertible; valuation of long-term securities seed money 519 self-liquidating principle 212 self-tender offer 491, 701, 702 sell-off 701 partial 624 Selling, T.I 655n sensitivity analysis 338–40, 701 sensitivity matrix 339–40 sequential investigation process 261, 262 serial bonds 701 serial payments 533 Shakespeare, W 554 shareholders equity 131, 153, 155, 188–9, 701 interest hypothesis 621 rights 529–42, 621 shares authorized 538 buybacks 494 issued 538 new, right to purchase 542 outstanding 538 repurchases 493, 609 stub 621 Sharia’h 660 shark repellent 620, 701 Sharpe, W 106 shelf registration 508–9, 556, 690, 701 short-term financing 214, 282–306 composition 300–1 factoring accounts receivable 298–300 see also negotiated financing; spontaneous financing short-term municipals 241 Shrieves, R.E 396n sight draft 282n, 668 signaling effects 493–5, 520–2 simulation approach 361–2 single amounts 44–50 compound growth 46–7 future (compound) value 44–6 present (discounted) value 47–9 unknown interest (discount) rate 49 unknown number of compounding (discounting) periods 50 single euro payments area (SEPA) 228, 232 single point estimates 338–40 sinking fund 54, 533, 701 six-month figure 188 Skyworks Solutions Inc 299 slowing down cash payouts 228–31 small-firm (size) effect 114 Smith, A 624n Smith Jr, C.W 520n Society for Worldwide Interbank Financial Telecommunications (SWIFT) 232, 701 sole proprietorship 18, 701 Sorter, G.H 655n sources and uses of funds statement see flow of funds statement special-purpose entities (SPEs) 532 special-purpose vehicle (SPV) 531, 537 speculative grade 33, 440 speculative motive 222 spin-off 624, 625, 701 spontaneous financing 210, 282–6, 701 accounts payable (trade credit from suppliers) 282–6 accrued expenses 286 stagger terms of boards of directors 621 stakeholders 5, 701 Stancill, J.M 235n Standard & Poor’s (S&Ps) 32–3 500 stock index 107, 111, 388, 701 financial statement analysis 141 717 •• FUNO_Z04.qxd 9/19/08 14:13 Page 718 Index Standard & Poor’s (S&Ps) (continued) long-term debt, preferred stock and common stock 529 operating and financial leverage 439–40 short-term financing 287 Stock Reports 387 standard deviation 701 calculation 361 and expected return 99–101 required returns and cost of capital 404 risk and managerial options in capital budgeting 356–7, 365–6 standby arrangement 511–12, 701 standstill agreement 622 state regulation 516 statement of cash flows 179, 181, 701 of changes in financial position see flow of funds statement of earnings 133 see also financial statement; flow of funds statement; income statement Statement of Financial Accounting Standards (SFAS) 129 statement of retained earnings 133, 701 stay 631 steady-state model 190–2 stock market crash 1987 115 overpriced 113 price and returns 112–13 volatility 592 relative abnormal 521, 613 repurchase 702 safety 268–70, 700 split 487–90, 702 Treasury 493, 538, 703 underpriced 113 see also preferred stock Stock Exchanges see American; New York stockout 145, 702 stop order 513–14 straight bond value 582–4, 702 straight debt (or equity) 578, 702 strategic acquisitions involving common stock 608–15 earnings impact 608–10 empirical evidence on mergers 612–14 market value impact 610–12 roll-up transactions 614–15 strategic alliance 622–3, 702 stretching 702 stub shares 621 Subchapter S of Internal Revenue Code 26 subscription right see right subsidiary 399, 702 substitute checks 227 sunk costs 310, 702 supermajority merger approval provision 621 supplier network, manageable 272 supply chain management (SCM) 271, 702 supply chain visibility 207 surplus 481 sustainability 5, 7, 702 sustainable growth modeling 170, 190–4 synergy 604, 702 systematic risk 105–6, 702 takeover 613, 620–2, 702 target payout ratios 485–6 tax 466, 649–50 alternative minimum tax (AMT) 21, 24, 562, 689 alternative minimum taxable income (AMTI) 21 average tax rate 21 considerations 310–12 corporate 461–2, 463 deferred 158–9, 693 and dividends 478–9 double 19, 693 effect of 461–3 environment 20–6 corporate income taxes 21–6 personal income taxes 26 Federal income tax 183 -free transaction 618 and market imperfections combined 463–4 personal 463 quarterly tax payments 21 rate, importance of 566–7 reasons 607 relief provisions, temporary 24–5 -return profits 158 shield 408–9, 462–4, 702 taxability 34 taxable transaction 618 treatment 561 see also corporate income taxes Tax Reform Act 1986 22, 311 technological enhancements 257 temporal method 654 tender offer 620–2, 702 Tennessee Valley Authority (TVA) 239 term loans and leases 554–75, 702 accounting treatment of leases 567–70 equipment financing 558–9 lease financing 559–62 loan agreements, provisions of 556–8 term loans 554–6 see also lease financing evaluation in relation to debt financing 562–7 terminal warehouse receipt 297, 702 terms of offering 509–10 terms of sale 282–3 three Cs of credit analysis: character, capacity and capital 259 thrift certificates of deposit 240 ticker symbol 110, 111, 702 time 209–10 -adjusted cash flows 42 draft 282, 668 effect of to expiration 590 line 51, 52, 55, 56, 58 value of money 42–77 compound interest formulas 63 interest rate 42 loan amortization 62–3 simple interest 43 see also compound interest times interest earned see interest coverage ratio timing 465–6, 467 Titman, S 490n Tolkien, J.R.R 420 tombstone advertisement 514–15, 516, 702 total leverage 435–6, 702 see also degree of total leverage total project risk 357–64 probability distribution information, use of 362–4 probability tree approach 358–61 simulation approach 361–2 total risk and projects evaulation 401–5 total-value principle 456–8, 477 trade acceptance 282, 669 bills 658–9 checking 259 credit 261, 702 -credit insurance 299 discount 283 draft, international 668–9 facilitation 670 liabilities 282, 702 -off 251–2 transactions, international 668–71 traditional approach (to capital structure) 702 traditional underwriting 407–8 trailing P/E ratio see price/earnings (P/E) ratio transactions costs 461, 479 exposure 652–3, 656 loan 289–90 motive 222 transitional range 486n translation exposure 652, 653–6 translation gain/loss 653, 655, 702 transportation system, controlled 272 Treasury 311 bills 238, 239, 242, 702 bonds 238, 703 notes 238, 703 securities 106, 236, 238, 388 stock 493, 538, 703 trend analysis 152–3 Trust Indenture Act 1939 528 trust receipt 296–7, 703 Trust-Originated Preferred Redeemable Securities (TOPRS) 537 718 •• FUNO_Z04.qxd 9/19/08 14:13 Page 719 Index trust-preferred securities (TPS) 537 trustee 528, 703 Truth in Securities Act see Securities Act 1933 turnover ratios see activity ratios TWA 634 two-factor model 119–20 two-phase growth 83 two-tier tender offer 620, 703 types of long-term debt instruments 529–32 asset securitization 531–2 debentures 529–30 equipment trust certificates 531 income bonds 530 junk bonds 530 mortgage bonds 530–1 uncertainty and margin of safety 215 underwriting 703 spread 507 syndicate 507, 703 undue retention of earnings rule 482 Uniform Commercial Code 293, 296, 703 unit contribution margin 422, 703 United Kingdom 518, 541, 615, 635, 667 valuation on expiration date 590 valuation implications 368–9 valuation of long-term securities 74–94 bond valuation 75–8 book value versus market value 74 common stock valuation 79–83 key present value formulas 88 liquidation value versus going-concern value 74 market value versus intrinsic value 74–5 preferred stock valuation 78–9 rates of return (yields) 83–7 value 74 assigned (stated) 538, 690 conservation 477–8 creation 3–4, 382–3 Economic Value Added 394–6, 694 face 75, 77, 695 fair 133, 481 future compound 44–6, 59 going concern 74, 630, 695–6 intrinsic 74–5, 115, 696 liquidation 74, 538–9, 697 net book 23, 699 option 591, 592, 594 par 528, 538, 698 residual 559, 560, 700 of rights 510–11 sources of 604–8 hubris hypothesis 607 information effect 606 leverage gains 607 management, improved 606 management’s personal agenda 607–8 sales enhancement and operating economies 604–6 tax reasons 607 wealth transfers 606–7 total 456–8, 477 see also book value; expected value; future value; market value; present value; time value Value Line 110, 111 Investment Survey 387 values, relationship between 588–9 Van Horne, J.C 32n, 86n, 664n variable costs (VC) 420 variance 100, 701 -covariance matrix 117 of distribution 356 venture capital 519 Vermaelen, T 494n virtual corporation 623, 703 Viscione, J.A 213n volatility, influence of 590–1 Volkswagen AG 400 voluntary corporate liquidation 623 voluntary liquidation 631 voluntary settlements 630–1 voting cumulative 540–1, 692 rights 535–6, 539–42 Wachowicz Jr, J.M 338n, 396n wages 182–3 Wall Street Journal 662 warrants 585–9, 590, 703 valuation 587–8 wealth transfers 606–7 weighted average cost of capital (WACC) 390–1, 393–4, 408, 410 weighting system limitation 391–2 well-known seasoned issues (WKSIs) 515–16, 703 white knight 620, 703 Wilde, O 74 Williams, J.B 79n, 81n wire transfer 228, 231, 232, 703 Woolridge, J.R 490n work-in-process 263 working capital gross 206, 696 management 206–19, 703 classification 209–10 concepts 206 current assets finance: short-term and long-term mix 210–15 liability structure and current asset decisions 215–16 optimal amount (level) of current assets 208–9 profitability and risk 206–8 significance 206 net 206, 698 permanent 209–10, 699 requirement 556–7 temporary 210, 702 WorldCom 514 Yankee bonds 659 Yankee certificates of deposit 240 Yankee commercial paper 240 yield 83, 98n, 237–8 annual percentage yield (APY) 61 behavior of on corporate securities 34 curve 33–4, 388, 703 effective 61 effective annual yield (EAY) method 237 to maturity (YTM) 83–7, 384–5, 703 on preferred stock 87 Z-score 363 zero balance account (ZBA) 230, 703 zero-coupon bond 77, 703 719 •• ... person owns the business, holds title to all its assets, and is personally responsible for all of its debts A proprietorship pays no separate income taxes The owner merely adds any profits or subtracts... subtracts any losses from the business when determining personal taxable income This business form is widely used in service industries Because of its simplicity, a sole proprietorship can be established... will discover some of the pluses and minuses of each alternative form of business organization l l l Sole Proprietorships Sole proprietorship A business form for which there is one owner This single