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contents Part I The World of Fianace Chapter Finance and the Firm Chapter Finance Markets and Interest Rate 24 Chapter Review of Accounting 44 Part II Essential Concepts in Finance 65 Chapter Chapter Chapter Chapter Chapter Review of Accounting 66 Analysis of Financial Statements 92 Forecasting for Financial Planning 134 Risk and Return 160 The Time Value of Money 194 Part III Capital Budgeting and Business Valuation 237 Chapter The Cost of Capital 238 Chapter 10 Capital Budgeting Decision Methods 270 Chapter 11 Estimating Incremmental Cash Flows 314 Chapter 12 Business Valuation 338 Part IV Long-Term Financing Decisions 381 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Capital Structures Basics 382 Corporate Bonds, Preferred Stock and Leasing 414 Common Stock 440 Dividend Policy 464 Part V Short-Term Financing Decisions 485 Chapter 17 Chapter 18 Chapter 19 Chapter 20 Working Capital Policy 486 Managing Cash 508 Accounts Receivable and Inventory 534 Short-Term Financing 568 Part VI Finance in the Global Economy 593 Chapter 21 International Finance 594 Appendix A-1 615 Glossary G-1 619 Index I-1 627 The World of Finance We begin our study of financial management with a look at what the field of finance is all about and the environment in which financial managers operate Chapter introduces you to finance, explains what financial managers do, states the objective of financial management, and describes the four basic forms of business commonly encountered in the U.S Chapter introduces you to the financial environment in which the firm operates The financial system is explained, along with the various financial markets and the securities that are bought and sold there The importance of financial markets to the firm is emphasized Chapter finishes with a discussion of interest rates, which represent the price of credit in the financial markets Chapter 3 continues with descriptions of the various types of financial institutions through which buyers, sellers, borrowers, and lenders gain access to the financial markets These three chapters set the stage for your study of the principles and practice of managing an individual company’s finances CHAPTERS Finance and the Firm Financial Markets and Interest Rates Financial Institutions Finance and the Firm “The race is not always to the swift, nor the battle to the strong, but that is the way to bet.” —Rudyard Kipling Finance Grabs the Business Headlines Headlines from the front pages of some recent newspapers •• Eurozone rift deepens over debt crisis (Financial Times, June 22, 2012) •• How to Fix Fannie Mae and Freddie Mac: Nationalize ‘em (Los Angeles Times, Jul 10, 2008) •• Treasury Set to Bail Out Fannie Mae and Freddie Mac (MarketWatch, Sep 6, 2008) •• Merrill Lynch Sold, AIG Restructures Amid Losses (NPR, Sep 15, 2008) •• Lehman Files for Bankruptcy, Merrill Sold, AIG Seeks Cash (Wall Street Journal, Sep 16, 2008) People wanted to own their own homes The government wanted to encourage this Real estate agents, appraisers, title insurance companies, home inspectors, mortgage brokers, and interior decorators, to name just a few, profited from this So too did the “smart guys” on Wall Street who bundled mortgages and sold these packages to others Everyone who was making money from home purchases could make even more money if people who hadn’t qualified for mortgage loans could get qualified Thus was born the sub-prime mortgage, which is a mortgage loan made to a person with a low credit rating Although these mortgage loans were riskier than traditional mortgages they paid a higher interest rate, and after all, “riskier” is a relative term The absolute level of risk was widely seen as being very low, since everyone knows, housing prices always go up When this happens, there is always enough value in the house to cover even sub-prime mortgages in the unlikely event that a few might go into default Huge government-sponsored enterprise (GSE) companies with private sector stockholders, with names such as Fannie Mae and Freddie Mac, bought many of these mortgages and bundled them into mortgage-backed securities Fannie Mae and Freddie Mac lowered the standards for the types of mortgages they would buy Fannie Mae and Freddie Mac got effectively nationalized in late 2008 when they went broke There were insurance companies such as AIG that sold an insurance-like product called a credit default swap to protect those holding these mortgage-backed securities in the event of defaulting mortgages The fees were collected by AIG, and it sold way more credit default swaps than it could pay off on AIG got effectively nationalized in early 2009 Everything would have been great if only housing prices had continued to go up as they had for about twenty-five years General Motors (GM) filed for bankruptcy in June of 2009 It received a large infusion of cash from the federal government It emerged from bankruptcy and had an initial public offering (IPO) of $20.1 billion in November of 2010 The U.S Treasury was the largest single stockholder of GM at the time of the IPO Executives at big financial firms received big bonuses if they could report big profits It didn’t matter if the profits were really there, as long as the accountants signed off on the numbers You had the potential to make much higher profits if you borrowed a lot of money (leverage is the polite financial term) to invest more than what your own money would allow Lehman Brothers, a very old and prestigious firm, did this It went bankrupt in late 2008 and doesn’t exist anymore Also in 2008 venerable Merrill Lynch sold itself to Bank of America at a bargain basement price Learning Objectives After reading this chapter, you should be able to: Describe the field of finance Discuss the duties of financial managers Identify the basic goal of a business firm List factors that affect the value of a firm Discuss the legal and ethical challenges financial managers face Identify the different forms of business organization Part I The World of Finance so as to avoid collapse Bear Sterns did the same as Merrill Lynch when it sold itself to JPMorgan Housing prices had been going up much more quickly than personal income for several decades If you didn’t buy that house soon, it would just be more expensive later The people on the selling side were only too happy to encourage you to jump in and buy before it was too late and that house went beyond what your income could support Even those mortgage-backed securities, including those with lots of sub-prime mortgages in them, had been given very high ratings by firms with venerable names such as Moody’s, Standard and Poor’s, and Fitch Surely, there was no reason to worry Then the unthinkable happened Housing prices started to go down Many of these houses had been bought with little or no money down This meant that small decreases in the price of the home could create an “under water” situation where the amount of the mortgage balance was greater than the value of the home This happened to millions of homeowners, both high income and low income By 2012 many homes in high-income neighborhoods had recaptured much of the lost value Home values in low-income neighborhoods continued to see values languish near peak financial crisis levels at this time When some homeowners defaulted, those holding the mortgages lost money The people holding the mortgages were not, of course, the people who had originally lent the money Those mortgages had been sold to others, and these mortgages were now held by the “smart guys” who had bought them as part of the mortgage-backed securities that had become so popular, complete with a high credit rating and insurance It’s interesting that the Main Street mortgage brokers, real estate agents, appraisers, and home inspectors already had their money These defaults did not directly affect the “hicks” who lived outside the hallowed halls of giant Wall Street firms Who were the real dumb guys here? What happens when you buy a billion dollars worth of mortgage-backed securities using five percent of your own money and ninety-five percent borrowed money and then have those mortgages go down in value more than five percent? The answer is you are in big trouble What happens if the insurance company that sold you the insurance that would pay off if your mortgage-backed securities were to default, doesn’t have enough resources to pay off the claims? The answer is both you and the insurance company are in big trouble What if lots of big “sophisticated” firms did this all at the same time? The answer is that we, as taxpayers, have to step forward to keep the whole financial system from falling like a bunch of dominoes Many of these companies were “too big to be allowed to fail.” They had been operating on the edge When one of these big firms failed, other big firms the first firm owed money to (in big money sophisticated transactions called swaps), would fail too Those other firms that were like dominoes down the line are called counter parties These downstream firms held securities that relied on the firms upstream being able to pay what had been promised Nothing would go wrong unless lots of these assets dropped significantly in value at the same time Such a thing was thought to be impossible This was called “systematic risk.” Systematic risk is covered in detail in Chapter If you put all your eggs into a hundred different baskets you are well diversified, unless the baskets are defective and their bottoms all break at the same time We will weave throughout this book what finance can bring to the table to help us understand what went wrong and how optimal financial decision making can take place This is only possible if we make an attempt to understand what went so wrong in what is widely referred to as the Financial Crisis Chapter 1 Finance and the Firm What all these stories have in common? They deal with finance Finance has been the focus of the world’s attention over the past several years Not all this attention has been welcome by people in this field Finance helps us solve problems If done poorly finance can become the problem The part of finance known as Wall Street has been the object of much scorn and criticism due to the spread of the problems of major Wall Street firms to banks and insurance companies around the world, in addition to the economic problems that some blame Wall Street for Companies cutting costs, companies reporting profits or losses, governments concerned about interest rates—this is just a sampling of business stories involving finance that appear every day in the press Finance is at the heart of business management No business firm—or government, for that matter—can exist for long without following at least the basic principles of financial management Was the Financial Crisis the result of greedy bankers trying to line their own pockets at the expense of their stockholders, employees, customers or clients, and taxpayers? Was it the result of government officials who encouraged government sponsored entities to buy mortgages in the open market from loan originators to facilitate home ownership even if some of those mortgages would never have been made without the opportunity to sell them and the accompanying risk to a government entity? This book is about financial management, not blame and politics It is designed to introduce you to basic financial management principles and skills Some of these concepts and skills are surprisingly straightforward; others are quite challenging All, however, will help you in the business world, no matter what career you choose Chapter Overview In this chapter we introduce financial management basics that provide a foundation for the rest of the course First, we describe the field of finance and examine the role of financial management within a business organization Then we investigate the financial goal of a business firm and the legal and ethical challenges financial managers face We end with a description of four forms of business in the U.S economy: sole proprietorship, partnership, corporation, and limited liability company The Field of Finance In business, financial guidelines determine how money is raised and spent Although raising and spending money may sound simple, financial decisions affect every aspect of a business—from how many people a manager can hire, to what products a company can produce, to what investments a company can make For example, on March 31, 2009, Google announced it was entering the venture capital (VC) game It indicated that it would be investing up to $100 million in new companies in an attempt to find “the next big thing.”1 Money continually flows through businesses It may flow in from banks, from the government, from the sale of stock, and so on; and it may flow out for a variety of reasons—to invest in bonds, to buy new equipment, or to hire top-notch employees Businesses must pay constant attention to ensure that the right amount of money is available at the right time for the right use Source: Jessica E Vascellaro, “Google to Commit $100 Million to Venture Capital Fund in its First Year,” The On-line Wall Street Journal (March 31, 2009) Part I The World of Finance In large firms it may take a whole team of financial experts to track the firm’s cash flows and to develop financial strategies For instance, when Bank of America acquired Merrill Lynch on January 1, 2009, teams of financial analysts had to work on every detail of the federally assisted deal that involved Bank of America offering its shares to acquire the shares of Merrill Lynch There were fears that Merrill Lynch would go under, as did Lehman Brothers, if this acquisition of Merrill Lynch by Bank of America had not been executed.2 Finance Career Paths Finance has three main career paths: financial management, financial markets and institutions, and investments Financial management, the focus of this text, involves managing the finances of a business Financial managers—people who manage a business firm’s finances—perform a number of tasks They analyze and forecast a firm’s finances, assess risk, evaluate investment opportunities, decide when and where to find money sources and how much money to raise, and decide how much money to return to the firm’s investors Bankers, stockbrokers, and others who work in financial markets and institutions focus on the flow of money through financial institutions and the markets in which financial assets are exchanged They track the impact of interest rates on the flow of that money People who work in the field of investments locate, select, and manage income-producing assets For instance, security analysts and mutual fund managers both operate in the investment field Table 1-1 summarizes the three main finance career paths Financial Management Financial management is essentially a combination of accounting and economics First, financial managers use accounting information—balance sheets, income statements, and statements of cash flows—to analyze, plan, and allocate financial resources for business firms Second, financial managers use economic principles to guide them in making financial decisions that are in the best interest of the firm In other words, finance is an applied area of economics that relies on accounting for input Because finance looks closely at the question of what adds value to a business, financial managers are central to most businesses Let’s take a look at what financial managers The Role of the Financial Manager Financial managers measure the firm’s performance, determine what the financial consequences will be if the firm maintains its present course or changes it, and recommend how the firm should use its assets Financial managers also locate external financing sources and recommend the most beneficial mix of financing sources while focusing on the financial expectations and risk tolerances of the firm’s owners All financial managers must be able to communicate, analyze, and make decisions based on information from many sources To this, they need to be able to analyze financial statements, forecast and plan, and determine the effect of size, risk, and timing of cash flows We’ll cover all of these skills in this text Finance in the Organization of the Firm Financial managers work closely with other types of managers For instance, they rely on accountants for raw financial data and “Google Ventures Into VC,” Marketwatch.com, March 31, 2009 Chapter 1 Finance and the Firm Table 1-1 Careers in the Field of Finance Career Area Function Financial management Manage the finances of a business firm Analyze, forecast, and plan a firm’s finances; assess risk; evaluate and select investments; decide where and when to find money sources, and how much money to raise; and determine how much money to return to investors in the business Financial markets and institutions Handle the flow of money in financial markets and institutions, and focus on the impact of interest rates on the flow of that money Investments Locate, select, and manage money-producing assets for individuals and groups on marketing managers for information about products and sales Financial managers coordinate with technology experts to determine how to communicate financial information to others in the firm Management experts in the area of supply chain work are also part of this team Financial managers provide advice and recommendations to top management Figure 1-1 shows how finance fits into a typical business firm’s organization The Organization of the Finance Team In most medium-to-large businesses, a chief financial officer (CFO) supervises a team of employees who manage the financial activities of the firm One common way to organize a finance team in a medium-to-large business is shown in Figure 1-2 In Figure 1-2 we see that the chief financial officer (CFO) directs and coordinates the financial activities of the firm The CFO supervises a treasurer and a controller The treasurer generally is responsible for cash management, credit management, and financial planning activities, whereas the controller is responsible for cost accounting, financial accounting, and information system activities The treasurer and the controller of a large corporation are both likely to have a group of junior financial managers reporting to them At a small firm, one or two people may perform all the duties of the treasurer and controller In very small firms, one person may perform all functions, including finance The Basic Financial Goal of the Firm The financial manager’s basic job is to make decisions that add value to the firm When asked what the basic goal of a firm is, many people will answer, “to make a lot of money” or “to maximize profits.” Although no one would argue that profits aren’t important, the singleminded pursuit of profits is not necessarily good for the firm and its owners We will explain why this is so in the sections that follow For now, let’s say that a better way to express the primary financial goal of a business firm is to “maximize the wealth of the firm’s owners.” This is an extremely important, even crucial, point, so we will say it again: The primary financial goal of the business firm is to maximize the wealth of the firm’s owners Part I The World of Finance Board of Directors Chief Executive Officer (CEO) Figure 1-1 The Organization of a Typical Corporation Figure 1-1 shows how finance fits into a typical business organization The vice president for finance, or chief financial officer, operates with the vice presidents of the other business teams Take Note: The point about cash received sooner being better than cash received later works in reverse too It is better to pay out cash later rather than sooner (all other factors being equal, of course) VP for Human Resources (Personnel) VP for Technology and Information Systems VP for Marketing (Sales, Advertising, Product Development) VP for Finance (Chief Financial Officer, CFO) VP for Engineering and Research VP for Production (Manufacturing, Services) Everything the financial manager does—indeed, all the actions of everyone in the firm—should be directed toward this goal, subject to legal and ethical considerations that we will discuss in this chapter and throughout the book Now, what we mean by wealth? Wealth refers to value If a group of people owns a business firm, the contribution that firm makes to that group’s wealth is determined by the market value of that firm This is a very important point: We have defined wealth in terms of value The concept of value, then, is of fundamental importance in finance Financial managers and researchers spend a lot of time measuring value and figuring out what causes it to increase or decrease In Search of Value We have said that the basic goal of the business firm is to maximize the wealth of the firm’s owners—that is, to maximize the value of the firm The next question, then, is how to measure the value of the firm The value of a firm is determined by whatever people are willing to pay for it The more valuable people think a firm is, the more they will pay to own it Then the existing owners can sell it to investors for more than the amount of their investment, thereby increasing current owner wealth The financial manager’s job is to make decisions that will cause people to think more favorably about the firm and, in turn, to be willing to pay more to purchase the business For companies that sell stock to the general public, stock price can indicate the value of a business because stockholders—people who purchase corporate shares of stock—become part owners of the corporation (We will discuss stock in greater detail in Chapter 2.) People will pay a higher price for stock—that is, part ownership of a G-6 Glossary perpetuity An annuity that has an infinite maturity portfolio A collection of assets that are managed as a group preemptive right A security given by some corporations to existing stockholders that gives them the right to buy new shares of common stock at a below-market price until a specified expiration date present value Today’s value of promised or expected future value present value interest factor for an annuity (PVIFA) The factor which, when multiplied by an expected annuity payment, gives you the present value of the annuity stream: 1- n (1 + k) k present value interest factor for a single amount (PVIF) The 1/( + k)n factor that is multiplied by a given future value to solve for the present value primary market The market in which newly issued securities are sold to the public primary reserves Vault cash and deposits at the Fed that go toward meeting a bank’s reserve requirements principal A person who authorizes an agent to act for him or her private corporation A corporation that does not offer its shares to the general public and that can keep its financial statements confidential pro forma financial statements Projected financial statements progressive tax rate structure A tax structure under which the tax rate increases as taxable income increases, usually in a pattern of several steps promissory note A legal document the borrower signs indicating agreement to the terms of a loan proprietorship A business that is not incorporated and is owned by one person prospectus A disclosure document given to a potential investor when a new security is issued publicly traded corporations Corporations that have common stock that can be bought in the marketplace by any interested party and that must release audited financial statements to the public pure time value of money The value demanded by an investor to compensate for the postponement of consumption putable bonds Bonds that can be redeemed before the scheduled maturity date, at the option of the bondholder Q quota A quantity limit imposed by one country on the amount of a given good that can be imported from another country R real option A valuable characteristic of some projects where revisions to that project at a later date are possible real rate of interest The rate that the market offers to lenders to compensate for postponing consumption refunding Issuing new bonds to replace old bonds relative purchasing power parity theory A theory that states that as prices change in one country relative to those prices in another country, for a given traded basket of similar goods and services, the exchange rate will tend to change proportionately but in the opposite direction required reserve ratio The percentage of deposits that determines the amount of reserves a financial institution is required to hold residual income Income left over, and available to common stockholders, after all other claimants have been paid restrictive covenants Promises made by the issuer of a bond to the investor, to the benefit of the investor rights-on A characteristic of common stock such that it is trading with the entitlement to an upcoming right risk The potential for unexpected events to occur risk-adjusted discount rate (RADR) A required rate of return adjusted to compensate for the effect a project has on a firm’s risk risk aversion A tendency to avoid risk that explains why most investors require a higher expected rate of return the more risk they assume risk-free rate of return The rate of return that investors demand in order to take on a project that contains no risk other than an inflation premium risk-return relationship The positive relationship between the risk of an investment and an investor’s required rate of return S sales breakeven point The level of sales that must be achieved such that operating income equals zero savings and loan associations (S&Ls) Financial institutions that take in deposits and make loans (primarily mortgage loans) second mortgage A mortgage bond (a bond secured by real property) that gives the holder second claim (after the first-mortgage bond-holder) on the real property pledged as security secondary market The market in which previously issued securities are traded from one investor to another secondary reserves Marketable securities that can be readily sold to obtain cash secured bond A bond backed by specific assets that the investor may claim if there is a default security A document that establishes the bearer’s claim to receive funds in the future self-liquidating loan A loan that is used to acquire assets that generate enough cash to pay off the loan senior debenture An unsecured bond having a superior claim on the earnings and assets of the issuing firm relative to other debentures Glossary serial payments A mode of payment in which the issuer pays off bonds according to a staggered maturity schedule short-term financing decisions Financial decisions relating to raising funds for a short period of time from sources such as bank loans, trade credit, and commercial paper signaling The message sent by managers, or inferred by investors, when a financial decision is made signaling dividend theory A theory that says that dividend payments often send a signal from the management of a firm to market participants simple project A project that has a negative initial cash flow, followed by positive cash flows only sinking fund A method for retiring bonds The bond issuer makes regular contributions to a fund that the trustee uses to buy back outstanding bonds and retire them spot rate The exchange rate for current delivery stakeholder A party having an interest in a firm (for example, owners, workers, management, creditors, suppliers, customers, and the community as a whole) standard deviation A statistic that indicates how widely dispersed actual or possible values are distributed around a mean stated interest rate The interest rate advertised by the lender Depending on the terms of the loan, the stated rate may or may not be the same as the effective interest rate statement of retained earnings A financial statement that shows how the value of retained earnings changes from one point in time to another stock Certificates of ownership interest in a corporation stock dividend A firm sends out new shares of stock to existing stockholders and makes an accounting transfer from retained earnings to the common stock and capital in excess of par accounts of the balance sheet stock split A firm gives new shares of stock to existing shareholders; on the balance sheet, they decrease the par value of the common stock proportionately to the increase in the number of shares outstanding straight bond value The value a convertible bond would have if it did not offer the conversion option to the investor straight-line depreciation A depreciation rule that allows equal amounts of the cost of an asset to be allocated over the asset’s life strengthening currency A currency that is now convertible into a larger number of units of another currency than previously Subchapter S corporation A small corporation whose income is taxed like a partnership subordinated debenture An unsecured bond having an inferior claim on the earnings and assets of the issuing firm relative to other debentures sunk cost A cost that must be borne whether a proposed capital budgeting project is accepted or rejected surplus economic unit A business, household, or government unit with income greater than its expenditures syndicate A temporary alliance of investment banking firms that is formed for the purpose of underwriting a new security issue T target stock A class of common stock that represents a claim on a part of company tariff A tax imposed by one country on imports from another country temporary current assets The portion of current assets that fluctuates during the company’s business cycle 10-K reports An audited set of financial statements submitted annually by all public corporations to the Securities and Exchange Commission (SEC) 10-Q reports An unaudited set of financial statements submitted quarterly by all public corporations to the Securities and Exchange Commission (SEC) G-7 terminal value The predicted value of a company’s projected free cash flows at a specified future point in time from that point in time to perpetuity time value of money The phenomenon whereby money is valued more highly the sooner it is received trade credit Funds obtained by delaying payment to suppliers transaction cost The cost of making a transaction, usually the cost associated with purchasing or selling a security transfer agent A party, usually a commercial bank, that keeps track of changes in stock ownership, collects cash from a company, and pays dividends to its stockholders treasurer The manager responsible for financial planning, fund-raising, and allocation of money in a business Treasury bills Securities issued by the federal government in minimum denominations of $1,000 in maturities of three, six, or twelve months Treasury bonds and notes Securities issued by the federal government that make semiannual coupon interest payments and pay the face value at maturity Treasury notes come in maturities of one to ten years Treasury bonds come in maturities of more than ten years trend analysis An analysis in which something (such as a financial ratio) is examined over time to discern any changes trustee The party that oversees a bond issue and makes sure all the provisions set forth in the indenture are carried out U uncertainty The chance, or probability, that outcomes other than what is expected will occur underwriting The process by which investment banking firms purchase a new security issue in its entirety and resell it to investors The risk of the new issue is transferred from the issuing company to the investment bankers G-8 Glossary V variable costs Costs that vary with the level of production variable-rate bonds Bonds that have periodic changes in their coupon rates, usually tied to changes in market interest rates W warrant A security that gives the holder the option to buy a certain number of shares of common stock of the issuing company, at a certain price, for a specified period of time weakening currency A currency that is now convertible into a smaller number of units of another currency than previously wealth Assets minus liabilities weighted average cost of capital (ka) or (WACC) The average of all the component costs of capital, weighted according to the percentage of each component in the firm’s optimal capital structure working capital Another name for the current assets on a firm’s balance sheet Y yield to maturity (YTM) The investor’s return on a bond, assuming that all promised interest and principal payments are made on time and the interest payments are reinvested at the YTM rate Z zero-coupon bonds Bonds that pay face value at maturity and that pay no coupon interest Index A ABC system, 549−550 Abiomed Corporation, 357−362, 358f, 359f Absolute purchasing power parity theory, 603 Accelerated depreciation, 78–79 Accept/reject decision, 272 internal rate of return and, 282, 283−284 net present value and, 277, 283−284 Accounting financial statements and, 68−77 See also Financial statements fundamentals of, 67−68 Accounting depreciation, 77−79 Accounts payable, 73, 73f, 341 as current liability, 487 on pro forma balance sheet, 144 Accounts receivable, 72, 73f, 535−543 accumulation of, 536−537 as collateral, 582 collection policies for, 551−553 credit policy and, 538−543, 539t, 542f, 543t as current asset, 490 factoring of, 553 as investment, 536 liquidity and, 536−537 optimal level of, 491, 538−543 calculation of, 538−543, 542f, 543t profitability and, 536−537 on pro forma balance sheet, 143 Accrued expenses, 73f Actuaries, 57 Additional funds needed (AFN), 145 Addition to retained earnings, in pro forma income statement, 142 Administrative expenses, in pro forma income statement, 141 After-tax cost of debt (AT kd), 240−241 Agency, 11−12 Agency costs, 13 Agency problem, 12−13 Agent, 11 principal, 11 transfer, 471 Aggressive working capital financing approach, 492, 493f ratio analysis of, 494−496, 495t, 496t AIG, 3, 12, 13, 44, 66, 161, 508 Alliances, trade, 606−608 American depository receipts (ADRS), 603 American International Group Inc (AIG), 3, 12, 44, 66, 161, 508 Amortization, 71, 78, 215 payments needed for, calculation of, 219, 220t Amortization table, 219, 220t Annual percentage rate, 581 Annuitant, 59 Annuities, 58−59, 203−213 equivalent annual, 311−312 future value interest factor for, 207 interest rate for, calculation of, 215−216 ordinary future value of, 205−207 present value of, 208−211 present value interest factor for, 209 Annuities due, 205 future value, 209−211 present value, 209−211 Annuity compounding periods, 221−222 Arbitrage, 604 Archer, Mary, 92 Articles of incorporation, 16 Articles of partnership, 15 Ask price, 27 Asset(s), 72 on balance sheet, 72, 73f book value of in business valuation, 363−364 in common stock valuation, 356 current, 72 See also Working capital in capital budgeting, 316−317 components of, 490–491 in current ratio, 100 fluctuations in, 488−489, 489f net working capital and, 487−488, 488t optimal level of, 491 permanent, 489−490, 490f in quick ratio, 100−101 temporary, 489−490, 490f expropriation of, 605–606 fixed, 72, 488−490, 489f, 490f market value of, in business valuation, 363−364 noncurrent, 490 replacement value of, in business valuation, 363−364 sale of incremental cash flow from, 319−320, 320t tax effects of, 319−320, 320t Asset accounts, 72, 73f Asset activity ratios, 95, 102, 112 See also Financial ratios average collection period, 102, 112 inventory turnover, 103, 112 total asset turnover, 103, 112 Asset replacement, in capital budgeting, 325, 326f Asset turnover, 103, 112 AT&T, 426 Auditing, 68 Average collection period (ACP), 102, 112 in accounts receivable analysis, 540 Average tax rates, 80−81 Note: Page numbers followed by f indicate figures; those followed by t indicate tables I-1 B Bad debts, collection of, 551−553 Bain Capital, 398 Balance sheets, 72−74, 73f asset accounts on, 72, 73f changes in, 75, 76f liability and equity accounts on, 73−74, 73f, 75, 76f pro forma, 139, 141f, 142−148, 145f, 147f Balancing problem, 146 Bank(s) central See Federal reserve system commercial, 48−49 vs credit unions, 56 regulation of, 47−48 Bank charter, 53 Bank of America, 3, 5−6, 160, 508 Banker’s acceptance, 30 Bear Sterns, 4, 44, 508 Bearer, 26 Beatrice Company, 398 Benchmarking, 110, 111, 111f Best efforts basis, 26 Best efforts offering, vs underwriting, 449 Beta, 177, 177f Beta risk, 287 Bid price, 27 Bill paying strategies, 520, 523 Bird-in-the-hand theory, 470−471 Blackstone Group, 398 Blanket lien, 583 Board of directors, 443 election of, 444−446 Bond(s) 30−32, 415−427 call date for, 418 call premium for, 418 call provision for, 417−418 deferred, 418 convertible, 423−425, 424t corporate, 32, 415 debentures, 417, 422−423 downgraded, 426 exchange rates and, 601 face value of, 31 general obligation, 32 high-yield, 426 international, 426 investment-grade, 32, 416 junk, 32, 416, 426 in leveraged buyout, 398 mortgage, 422 municipal, 32 payoff methods for, 417−418 price of discounted, 348 premium, 348 yield to maturity and, 345−348 I-2 Index putable, 426 rating of, 415−416, 416t refunding of, 418−421, 419t, 420t restrictive covenants for, 421 revenue, 32 risk hierarchy for, 423, 423f secured, 417, 422 staggered maturities for, 417 super long-term, 426−427 terminology for, 31 Treasury, 31−32 trustees for, 422 types of, 422−427 unsecured, 422−423, 423f valuation of, 342−349 with annual coupon interest payments, 342−343 with semiannual coupon interest payments, 345 yield to maturity and, 345−348, 349f variable-rate 425−426 Yankee, 426 yield to maturity of calculation of, 346−348, 349f price, and, 345−348, 349f zero-coupon, 31 Bond indenture, 415−418 Book value, 355 in common stock valuation, 355−356 in complete business valuation, 363−364 Book value per share (BPS) ratio, 104 Borg-Warner Corporation, 398 Breakeven analysis, 391−397 application of, 395−397 breakeven chart in, 392−394, 395f breakeven point in, 391 contribution margin in, 392 cost data in, 393−394, 394t high/low tradeoff in, 391 profit/loss potential in, 395−397 sales revenue in, 393, 394t Breakeven chart, 392−394, 395f Break point, 250−254 debt, 250−252, 251f equity, 252−253, 253f identification of, 250−253, 392−394 See also Breakeven analysis Brokers, 27 Budget(s) capital See Capital budget; Capital budgeting cash, 138, 515−519, 520t, 521−522t in forecasting, 138 Buffet, Warren, 338 Businesses, See also Corporations basic financial goal of, 7−8 organization of, 7−8, 8f valuation of, 8−11, 12t Business ownership, forms of, 14−18, 19t Business risk, 169−170, 170t See also Risk operating leverage and, 387 Business valuation, 340−364 See also Stock price; Value bonds in, 342−349 See also Bond(s), valuation of capital structure changes and, 400−402 common stock in, 351−363 See also Common stock, valuation of for complete business, 363−364 current liabilities in, 342 discounted cash flow model, for 341−342 discount rate in, 341 free cash flow discounted cash flow model for, 363 general valuation model for, 340−342, 342f long-term debt in, 342 market value of assets in, 363−364 preferred stock in, 349−351 present value of future cash flows in, 340–341 replacement value of assets method for, 363−364 terminal value in, 361 total market value in, 341−342, 342f, 361−362 362f Buying, vs leasing, 430−433, 432t C Call date, 418 Call premium, 418 Call price, 417−418 Call provision, 417−418 deferred, 417−418 Capital, 68 cost of See Cost of capital in excess of par, 74 sources of, 68, 240−249 working See Working capital Capital asset pricing model (CAPM), 179−181, 181f for cost of internal common equity, 243−244 Capital budget, 138 optimal, 256, 257t Capital budgeting, 271−290 accept/reject decision in, 272, 277 asset replacement in, 325, 326f capital rationing in, 286 decision practices in, 272 decision trees in, 327−328, 327f equivalent annual annuity approach for, 311−312 financing cash flows in, 320, 321f incremental cash flows in, 272−273, 315−328 See also Incremental cash flows incremental depreciation expense in, 317−318, 318t, 322 for independent projects, 272 internal rate of return method for, 280−284 marginal cost of capital and, 254−257, 253f, 255f, 257t modified internal rate of return method for, 284−286, 325 for multiple internal rates of return, 308−309, 308f for mutually exclusive projects, 272 with unequal project lives, 309−312, 310f, 311f net present value method for, 274−279, 280f, 283−284 for multiple internal rates of return, 308−309, 308f for nonsimple projects, 307 opportunity costs in, 318 payback method for, 273−274 ranking decision in, 272, 278 real options in, 326−328, 327f, 329t replacement chain approach for, 311 risk adjustment in, 289−290 risk measurement in, 287−289 stages of, 273 tax effects in, 317−318, 318t Capital gains, 33, 319 Capital in excess of par, on pro forma balance sheet, 144 Capital leases, 429−430 Capital market, 28 Capital rationing, 286 Capital structure, 247−248, 251−252, 253f, 381, 383−384 combined leverage and, 389−391 financial leverage and, 387−389 operating leverage and, 384−387 optimal, 400−402 Capital structure theory, 398−402 Career paths, 6, 7t Cargill, 17 Carlyle Group, 398 Carrying costs, 544 Cash as current asset, 490 on pro forma balance sheet, 142 Cash balance maximum, 511−512, 512f minimum, 510−511, 511f optimal, 510−514 calculation of, 512−514 Cash budget, 138, 142, 515 development of, 515−519, 520t, 521−522t Cash flow(s) in business valuation, 340−341 changes in, 75, 76f financing, 320, 321f free, calculation of, 356 future, present value of, 340−342 vs income, 74 incremental See Incremental cash flows initial investment, 316−317, 321−322, 322t management of, 519−523, 520f net, 74, 75f, 76f, 77 operating, 317−319, 318t, 322, 322t shutdown, 319−320, 322−323, 324t statement of, 74−77, 75f, 76f stock price and, 9−11, 12t supernormal growth of, 353−354 uneven, present value of, 212−213, 213t Cash management, 508−523 cash budget in, 515−519, 520t, 521−522t cash flow in, 519−523, 520f coping with emergencies in, 511 electronic funds transfer, 523 Index forecasting cash needs in, 514−519 lockbox system in, 523 maximum cash balance and, 511−512 Miller-Orr model for, 512−514, 513f optimal cash balance and, 510−514 calculation of, 512−514 predicting cash needs in, 510 risk considerations in, 519 Cash needs, forecasting of, 514−519 Caterpillar, 594 Casualty insurance, 57−58 C corporations, 17 Central banks See Federal reserve system Central Liquidity Facility (CLF), 56 Certificates of deposit (CDs), negotiable, 30 Charter bank, 47 credit union, 56 savings and loan, 53−55 Chesapeake Energy, 486 Chief financial offer, Chrysler, 12 Citigroup, 13 Clientele dividend theory, 470 Closely held corporations, 17, 443 Coca-Cola, 426 Coefficient of variation, 167−168 changes in, calculation of, 287−289 in risk measurement, 287−289 Collateral, 582−583 accounts receivable as, 582 inventory as, 583 Collections policies, 551−553 Combined leverage, 389−391 Commercial banks, 47 operations of, 48−49 regulation of, 47−48, 48f reserves of, 48−49, 49t Commercial finance companies, 56−57 Commercial paper, 30, 573−575 Common bond requirement, 55 Common stock, 32−33, 441 See also Stock capital gains from, 466−467 characteristics of, 441−444 classes of, 441−442 convertible bonds and, 423−425 convertible preferred stock and, 428 dividends from See Dividends ex-dividend trading of, 471−472 institutional ownership of, 443−444 price of See Stock price of private corporations, 443 on pro forma balance sheet, 144 of publicly traded corporations, 443 target, 442 valuation of, 351−363, 454−456 book value in, 355−356 constant growth dividend model for, 352−353 discounted cash flow model in, 351−352 free cash flow DCF model for, 363 for individual shares, 351−355 liquidation value in, 356 nonconstant growth dividend model for, 353−354 P/E ratio in, 354−355 for total stockholders’ equity, 355−356 voting rights and, 444−446 yield on, 362−363 Common stock issues disadvantages of, 447 flotation costs and, 447 IPOs and, 448, 448f pricing of, 449−451 Companies, See Business; Corporations Comparative advantage, 596−597 Compensating balance, 577−578 Component cost of capital, 240 Compounding/compounding periods annual, 219 annuity, 221−222 calculation of, 216−217 continuous, 222−223 future value and, 199, 200f monthly, 221 present value and, 203, 204f quarterly, 221 semiannual, 219−221 Compound interest, 201−203 Conservative working capital financing approach, 492−493, 494f ratio analysis of, 494−496, 495t, 496t Constant growth dividend model, 244−245, 352−353 Constant growth free cash flow valuation model, 363 Consumer finance companies, 56 Consumer Financial Protection Bureau, 59 Continuous compounding, 222−223 Continuous distribution, 163, 166 Contracts forward, 601 futures, 601 Contribution margin, 392 Controller, Controlling interest, 444 Conversion ratio, 424 Conversion value, 424 Convertible bonds, 423−425, 424t Corporate bonds, 32, 415 See also Bond(s) Corporate stock, 32 See also Stocks Corporations, 16−18, 19t board of directors of, 443 election of, 444−446 C, 17 legal status of, 16 multinational, 595−597 organization of, 7, 8f primary financial goal of, 7−8 private, 17, 443 professional, 17−18 publicly traded, 17, 443 S, 17 valuation of 8−11, 12t See also Stock price; Valuation; Value Correlation, 173−174 Correlation coefficient, 173−174 Cost(s) See also Expense(s) agency, 13 carrying, 544 I-3 fixed, 391 breakeven analysis and, 391−397 business risk and, 169−170 combined leverage and, 390−391 financial leverage and, 387−389 labor costs as, 391 leverage and, 391 operating leverage and, 384−387, 391 reduction of, 178−179 flotation, 246−247, 447 labor, fixed vs variable, 391 opportunity, 196 ordering, 544 sunk, 316 transaction, 512 variable, 391 Cost data, in breakeven analysis, 393−394, 394t Cost of capital, 238−257 component, 249−250 marginal, 249−254 See also Marginal cost of capital (MCC) weighted average, 247−249 Cost of debt, 240−241, 346 See also Required rate of return after-tax, 240−241, 250 break point for, 250−252 in capital structure theory, 400 Cost of equity from new common stock (kn), 246−247 Cost of goods sold (COGS), 69, 103 in pro forma income statement, 140−141 Cost of internal common equity (ks), 243−244 Cost of preferred stock (kp), 242−243 Countrywide Financial, 44 Coupon interest payments, 31, 342−345 annual, 342−345 semiannual, 345 Coupon interest rate, 31 Credit five Cs of, 551 necessity of, 523 revolving, 572 trade, 572−573, 572f Credit line, 571−572 Credit policy, 538 accounts receivable and, 538−543, 539t, 542f, 543t credit scoring in, 551, 552f credit standards in 538, 551 credit terms in, 538 discount percentage/period in, 538, 572−573, 572f loosening/tightening of, 538−539, 539t Credit risk, 47 Credit scoring, 551, 552f Credit standards, 538, 551, 552f Credit term, 538 Credit unions, 55−56 Cross rates, 599−600, 600t Cross-sectional analysis, 110−111, 111t, 111f Crowdfunding, 258 Cultural risks, facing multinational corporations, 606 Cumulative preferred stock, 427, 428 I-4 Index Cumulative voting, for board of directors, 444−445 Currency of European Union, 607−608 exchange rates for, 597−601 See also Exchange rates strengthening, 598−599 weakening, 598−599 Current assets, 72, 73f See also Working capital in capital budgeting, 316−317 components of, 490–491 in current ratio, 100 fluctuations in, 488−489, 489f net working capital and, 487−488, 488t optimal level of, 491 permanent, 489−490 in quick ratio, 112 temporary, 489−490 Current liabilities, 73−74, 490 in business valuation, 342 in capital budgeting, 316−317 in current ratio, 100 management of, 491−492 net working capital and, 487−488, 488t in quick ratio, 100−101 risk-return relationship and, 491−492 Current ratio, 100 D Date of record, 471 Dealers, 27 Debentures, 417 senior, 422−423, 423f subordinated, 422–423, 423f Debt benefits of, 398−402 in capital structure theory, 398−402 collection policies for, 551−553 cost of, 240−241, 398−402 after-tax, 240−241 break point for, 250−252 in capital structure theory, 400−401 leverage and, 383−384 long-term in conservative working capital approach, 492−493, 494f in moderate working capital approach, 494, 495f on pro forma balance sheet, 144 valuation of, 342−349 restrictions on, 421 short term See Short-term financing Debt break point, 250−252, 251f Debt ratios, 101−102 See also Financial ratios debt to equity, 101 debt to total assets, 101 times interest earned, 101−102 Decision tree, 327−328, 327f Declaration date, 471−472, 472f Deductible expense, 69−70 interest as, 399 Default, 35 Default risk premium, 35 Deferred call provision, 417−418 Deficit economic units, 25 Defined benefit plan, 58 Defined contribution plan, 58 Degree of combined leverage (DCL), 390 calculation of, 390 fixed costs and, 390−391 Degree of financial leverage (DFL), 387 calculation of, 387−389 Degree of operating leverage (DOL), 384 calculation of, 384−385, 386−387 fixed costs and, 385 Denomination matching, 46, 46f Deposit maturities, vs loan maturities, 54−55 Depreciation, 77−79 accelerated, 78 accounting, 77−78 economic, 78 straight-line 78 Depreciation basis, 78 Depreciation expense, 70 adjustment for, 74 calculation of, 78−79, 322 deductibility of, 317−318 incremental, in capital budgeting, 317−318, 318t, 322 in pro forma income statement, 142 Depreciation rules, 78 Discounted cash flow (DCF) model, 340−341 in common stock valuation, 351 free cash flow, 356−362 in preferred stock valuation, 349−351 Discount loan, 576−577 Discount percentage/period, 538, 572−573, 572f Discount rate, 201−203 See also Required rate of return in discounted cash flow model, 340−341 risk-adjusted, 289−290, 290t Discount window, 52 Discount yield, 574 Discrete distribution, 163 Disney corporation, 426 Distributions, 163, 164f continuous, 163, 166 discrete, 163 mean of, 163 normal, 163−166, 164f, 167f probability, 163 sales forecast, 164−166, 167f standard deviation of, 164−166 Diversification risk reduction and, 179, 181 via foreign investments, 602−603, 602f Diversification effect, 173 Dividend growth model in common stock valuation, 352−353 constant growth, 244−245 nonconstant growth, 353−354 Dividend payout ratio, 468, 468t Dividend reinvestment plan DRIP, 472 tax implications of 472 Dividends, 33, 69f, 71, 465–467 bird-in-the-hand theory of, 470−471 cash, 468 alternatives to, 472−476 cash vs earnings and, 468 clientele theory of, 470 common stock, 71 restrictions on, 421 valuation of 349−350 declaration of, 471 double taxation of, 16−17 M&M theory of, 471 payment of date of record for, 471 declaration date for, 471, 472f mechanics of, 471−472 payment date for, 471−472, 472f restrictions on, 466−467, 467f time line for, 472f transfer agent for, 471 preferred stock, 427−428 present value of, 349−350 taxation of, 427−428 residual theory of, 469, 469t signaling theory of 470 stock, 473−476 stockholders’ preferences for, 466−467 taxation of, 427−428, 472 Dividends paid, in pro forma income statement, 142 Dividends payable, 471 Dividends policy, 466−467 factors affecting, 466−467, 467f Dividend theories, 469−471 Dividend yield (D1/P0), 244, 362 Dodd-Frank Wall Street Reform and Consumer Protection Act, 59 Double taxation, 16−17 Downgraded bonds, 426 Du Pont equation, 107−108 modified, 108−110 Du Point system, 107−110 E Earnings in P/E ratio, 104, 354−355 retained, 69f, 71, 71f, 74 Earnings before interest, taxes, depreciation, and amortization (EBITDA), 71 Earnings before interest and taxes (EBIT), 70 financial leverage and, 387−389 operating leverage and, 384−387 Earnings per share, 70–71 Economic depreciation, 78 Economic order quantity (EOQ) model, 545−546 Economic units, 25 Economic value added (EVA), 105−107 Effective interest rate, 571, 576 annualizing, 578−580 calculation of, 572−573 with compensating balance, 577−578 for discount loan, 576−577 for loans with maturity of less than one year, 578−580 loan terms affecting, 576−582 Effective tax rates, 80 Elections, board of director, 444−446 Electronic funds transfer, 523 Emerging growth companies (EGCs), 258 Enron, 426 Index Enterprise value, 361 Environmental regulations, multinational corporations and, 596 Equity, 74 on balance sheet, 72, 73, 73f, 74 in capital structure theory, 398−402 Equity break point, 252−253, 253f Equity financing, 447−448 See also Common stock in conservative working capital approach, 492−493, 494f vs debt financing, 447−448 in moderate working capital approach, 494, 495f pros and cons of, 447−448 Equity multiplier, 108, 109 Equivalent annual annuity (EAA), in capital budgeting, 311−312 Effective annual rate (EAR), 578−580 Ethical issues auditing, 68 default on commercial paper payments, 30 financial management, 11−14 leveraged buyouts, 398 multinational corporations, 596 Euro, 605, 607–608 Eurobonds, 426 European Central Bank (ECB), 607 European Monetary Union (EMU), 607–608 European Stability Mechanism, 608 European Union (EU), 607−608 Eurozone, 607−608 Excess financing, 145 Exchange rates, 597−601 cross rates and, 599−600, 600t currency strength and, 598−599 expression of, 598t factors affecting, 604−605 fluctuation of, 598−599, 604−605 government intervention for, 605 hedging and, 601 interest rate parity theory for, 604 international Fisher effect and, 604 multinational corporations and, 600−601 political instability and, 604−605 purchasing power parity theory for, 603−604 sample, 598t Ex-dividend trade, 471−472 Exercise price, 454−456, 456t Expense(s), 69−70, 69f See also Cost(s) accrued, 73 administrative, in pro forma income statement, 69, 141 changes in, 75, 76f deductible, 70 interest as, 399 depreciation, 70, 74 adjustment for, 74 calculation of, 78−79 deductibility of, 317−318 incremental, in capital budgeting, 317−318, 318t, 321−325 in pro forma income statement, 142 fixed business risk and, 169−170, 170t operating leverage and, 384−387 reduction of, 178 on income statement, 69−70, 69f interest, 69, 69f financial risk and, 170 in pro forma income statement, 142 marketing, on pro forma income statement, 140−141 prepaid, 72, 73f selling and administrative, 69 Expropriated assets, 605–606 Ex-rights, 452 sale of, 453−454 External financing long-term, 570, 571f short-term, 568−583 See also Short-term financing sources of, 570, 571f Externalities, 318−319 F Facebook, 270, 440, 448 Face value, 31 Factoring, 553 Factors, 553 Fair trade, vs free trade, 608 Fallen angels, 426 Fannie Mae, 2−3, 13, 44, 52−53, 160 Federal Deposit Insurance Corporation (FDIC), 47−48 Federal funds market, 48−49 Federal Home Loan Mortgage Corporation (Freddie Mac), 2−3, 13, 44, 52−53, 160 Federal Housing Administration (FHA), 52 Federal National Mortgage Association (Fannie Mae), 2−3, 13, 44, 52−53, 160 Federal Open Market Committee (FOMC), 49–50 Federal Reserve System, 47−48, 49−52 bank regulation by, 47−48 Board of Governors of, 49–50 clearing services of, 52 Consumer Financial Protection Bureau within, 59 discount window and, 52 money supply regulation by, 50−52 organization of, 49–50, 51f reserve requirements, 48–49, 49t Fiduciary responsibility, 443 Fiedler, Edgar R., 134 Finance career paths in, 6, 7t in firm’s organization, 6−7, 8f overview of, 5−6 Finance companies, 56−57 Finance team, organization of, 7, 9f Financial Accounting Standards Board (FASB), 67 Financial Crisis (of 2007–2008), 160, 176, 180, 605 affect on commercial paper market, 574 affect on global economy, 593, 602–603 legislation after, 59 partial cause of, 176 I-5 Financial goal, primary, 7−8 Financial institutions, 44−59 Financial intermediaries, 25, 26−27 Financial intermediation, 45−49 Financial leases, 429−430 Financial leverage, 387−389 calculation of, 387−389 in combined leverage, 390−391 degree of, 387 interest expenses and, 389 in leveraged buyouts, 398, 399t risk of, 391 Financial management, 6−7 ethical challenges in, 11−14 legal challenges in, 11−14 Financial managers influences on, 11−14, 15f responsibilities of, 6−7 Financial markets, 27−29 Financial planning, forecasting for See Forecasting Financial ratios, 94−110 See also Ratio analysis asset activity, 95, 102−103 as comparative measures, 95 debt, 95, 101−102 in industry comparisons, 110−111, 111f liquidity, 95, 100−101 market value, 95, 103−105 profitability, 95, 96−99 relationships among, 107−110 in summary analysis, 112−114, 113t in trend analysis, 110−111, 111f, 111t Financial risk (leverage), 170 Financial Stability Oversight Council, 59 Financial statements, 68−77 analysis of, 92−114 industry comparisons in, 110−111, 110t, 111t, 113t ratio analysis in, 94−110 See also Financial ratios; Ratio analysis summary analysis in, 112−114, 113t trend analysis in 110−111, 110t, 111t balance sheet, 72−74, 73f, 75, 76f forecasting of, 138−148 See also Forecasting; Pro forma financial statements income statements, 68−71, 69f pro forma, 138−148 See also Pro forma financial statements statement of cash flows, 74−77, 75f, 76f Financial system, organization of, 25−27 Financing equity, 447−448 See also Common stock; Preferred stock excess, 145 inventory, 583 long-term, 381, 570, 571f short-term, 568−583 See also Loan(s) Financing activities, on statement of cash flows, 75f, 77 Financing cash flows, 320, 321f Firm risk, 287 measurement of, 287 Firms See Business; Corporations First-mortgage bond, 422 I-6 Index Five Cs of credit, 551 Fixed assets, 72, 73f, 489−490, 489f, 490f depreciation of, 77−79 Fixed costs, 391 breakeven analysis and 391−398 business risk and, 169−170, 170t combined leverage and, 390−391 financial leverage and, 388−389 labor costs as, 391 leverage and, 391 operating leverage and, 385 reduction of, 170−171 Flotation costs, 246−247, 447 Ford, 12, 426 Ford Motor Credit Corporation, 57 Forecasting, 136−148 analysis in, 146−148 balancing problem in, 146 budgets in, 138 of cash needs, 514−519 correlational approach to, 137 discounted free cash flow, 356−362, 358f, 359f, 362f experiential approach to, 136 financial statement, 138−148 See also Pro forma financial statements importance of, 136−137 imprecision of, 137 probability approach to, 136−137 sales, 137, 138f distributions of, 164−166, 167f Foreign stock See also International finance/trade American depository receipts and, 603 exchange rates and, 601 Forward contracts, 601 Forward rate, 604 Freddie Mac, 2−3, 13, 44, 52−53, 160 Free cash flow, 356−362 Free cash flow DCF model, 356−362 for complete business, 363 Free trade, vs fair trade, 608 Friedman, Milton, 14, 238 Futures contracts, 601 Future value, 196 of annuity due, 209−211 compounding periods and, 199, 200f interest rate changes and, 199, 200f of ordinary annuity, 205−207, 206f of single amount, 196−200 Future value interest factor, 197−199 Future value interest factor for an annuity, 207 G GATT (General Agreement on Tariffs and Trade), 606, 607 Gekko, Gordon, 568 General expenses, in pro forma income statement, 141 Generally Accepted Accounting Principles (GAAP), 67 General Motors, 3, 12, 426 General Motors Acceptance Corporation, 57 General obligation bonds, 32 General partner, 16 General valuation model, 341−342, 342f Getty, Jean Paul, 44 Ginnie Mae, 52 Globalization See International finance/trade Going concern value, 105 Google, 5, 134 Gordon, Myron, 244 Gordon growth model, 244−245 in common stock valuation, 352−353 Government National Mortgage Association (Ginnie Mae), 52 Government-sponsored enterprise (GSE) companies, mortgage market and, 52–53 Gross profit, 69 Gross profit margin, 96–97, 112 Group of Eight, 605 Grupo Televisa SA, 398 H Half-year convention, 78, 79t Hamilton, Brian, 534 Health insurance, 57 Hedge, 601 High/low tradeoff, in breakeven analysis, 391 High-yield bonds, 426 Home loans, 2−4, 52−53 Human rights issues, multinational corporations, and, 596, 608 Hurdle rate, 280 Hybrid securities, 427 I IBM, 426 Illiquidity risk premium, 35 Income vs cash flow, 74 net See Net income operating, 70 business risk and, 169−170, 170t leverage and, 383−384 net income and, 388−389 variability of, 169−170, 170t volatility of, 169−170, 170t residual, 441−442 Income statement, 68−71, 69f pro forma, 139, 140−141, 140f Income taxes See also Tax(es) in pro forma income statement, 142 Income tax rates, 79−81, 80t average, 80−81 marginal, 79−80, 80t Incremental cash flows, 315−328 in accounts receivable analysis, 538−543, 539t, 542f, 543t asset replacement and, 325, 326f from bond refunding, 418−421 capital budgeting and, 275−277 See also Capital budgeting of expansion project, 321−325 initial investment, 316−317, 321−322, 322t in inventory analysis, 544−549 operating, 317−319, 318t, 322, 322t shutdown, 319−320, 322−323, 324t types of, 316−325 Incremental depreciation expense, 317−318 in capital budgeting, 317−318, 318t, 322 Indenture, 415−418 Independent projects, 272 Industry comparisons, 110−111, 111f in summary analysis, 112−114, 113t in trend analysis, 110−111, 110t, 111t Inflation premium, 34, 34f Initial investment cash flows, 316−317, 321−322, 322t Initial public offerings (IPOs), 448, 448f Institutional investors, 443 Insurance deposit, 47–48 health, 57 liability, 58 life, 57 property and casualty, 57−58 risk reduction and, 178 Insurance companies, 57−58 Interest, 33−37, 37f compound, 201−203 See also Compounding/compounding periods coupon, 31, 342−345 deductibility of, 399 simple, 196 time value of money and, 196−200 See also Time value of money Interest expense, 70 financial leverage and, 389 financial risk and, 170 fixed, financial leverage and, 388−389 in pro forma income statement, 142, 146 Interest rate(s), 33−36 annual percentage rate for, 581 for annuity, calculation of, 215−216 calculation of, 213−216 changes in future value and, 205, 206f present value and, 208−211 compounding periods for See Compounding/compounding periods coupon, 31 determinants of, 33−36 effective, 571, 576 annualizing, 578−580 calculation of, 578−580 with compensating balance, 577−578 for discount loan, 576−577 for loans with maturity of less than one year, 578−580 loan terms affecting, 576−582, 578f inflation premium and, 34, 34f nominal, 33, 34f real, 33−34, 34f risk premiums and, 35–36 of single-amount investment, calculation of, 213−215 stated, 571 yield curve for, 36, 37f Interest rate parity theory, 604 Interest rate spread, 47 Intermediation, 45−49 Internal rate of return (IRR), 280−283, 549 calculation of, 280−282, 324 Index in capital budgeting, 280−283 multiple, capital budgeting for, 308−309, 308f NPV profile and, 282, 283−284 Internal rate of return reinvestment assumption, 285 International bonds, 426 International finance/trade, 594−608 diversification benefits of, 602−603, 602f exchange rates and, 597−601 See also Exchange rates government intervention in, 605 hedging in, 601 international trade agreements and, 606−608 law of comparative advantage and, 596−597 multinational corporations and, 595−597, 605 See also Multinational corporations (MNCs) political instability and, 604−605 risk management in, 601−603 International Fisher effect, 604 International trade agreements, 606−608 Inventory carrying costs of, 544 as collateral, 583 as current asset, 490 as investment, 536 liquidity and, 536−537 optimal level of, 491, 543−549 calculation of, 543−549, 545f, 547f, 548t ordering costs of, 544 profitability and, 536−537 on pro forma Balance sheet, 143 valuation of, 583 Inventory control, 536 Inventory financing, 583 Inventory management ABC system in, 549−550 just-in-time system for, 550 Inventory turnover, 103 Invested capital (IC), 105−106, 107 Investment activities, on statement of cash flows, 75f, 76−77 Investment banking firms, 26 Investment-grade bonds, 32, 416 Investor’s required rate of return, 343, 346 IPOs (initial public offerings), 448, 448f IRR reinvestment assumption, 285 J JOBS Act, 258 JPMorgan Chase, 4, 13, 59, 160, 508 Jumpstart Our Business Startups (JOBS) Act, 258 Junk bonds, 32, 416, 426 Just-in-time inventory (JIT) system, 550 K KB Home, 464 Keynes, John Maynard, 194, 382 Kipling, Rudyard, Koch Industries, 17 Kodak, 136, 426 Kohlberg, Kravis, & Roberts, 398 Komatsu, 594 L Labor costs, fixed vs variable, 391 Labor issues, multinational corporations and, 596, 607 Law of comparative advantage, 596−597 LBOs (leveraged buyouts), 398, 399t Leases, 428−433 accounting treatment of, 429−430 financial (capital), 429−430 genuine vs fake, 428−429 IRS standards for, 428−429 operating, 429−430 vs purchases, 430−433, 432t Legal considerations, 11−14 Lehman Brothers, 3, 6, 44, 160, 508 Lessee, 428 Lessor, 428 Letterman, David, 66 Leverage, 383 breakeven analysis and, 391−398 combined, 389−391 financial, 387−389 operating, 384−387 Leveraged buyouts (LBOs), 398, 399t Leverage effect, 109 Liabilities, 73−74 on balance sheet, 73−74, 73f, 75, 76f changes in, 75, 76f current, 73 in business valuation, 341−342 in capital budgeting, 316−317 in current ratio, 100 management of, 491−492 net working capital and, 487−488, 488t in quick ratio, 100−101 risk-return relationship and, 491−492 long-term, 74 total, vs total debt capital, 106 Liability of partnerships, 16 of private corporations, 443 of proprietorships, 14−15 Liability insurance, 58 Lien, blanket, 583 Life insurance companies, 58 Limited liability companies (LLCs), 18, 19t Limited liability partnerships, 16 Limited partnerships, 16 Line of credit, 571−572 Lintner, John, 179 Liquidation value, 356 in common stock valuation, 356 Liquidity, 35, 72 accounts receivable and, 536−537 inventory and, 536−537 vs profitability, 490−491 Liquidity function, 26 Liquidity ratios, 95, 100−101, 112 See also Financial ratios current, 100, 112 quick, 100−101, 112 I-7 Loan(s) amortized, 78, 215 amortization table for, 219, 220t payments needed for, 219 collateral for, 582−583 accounts receivable as, 582 inventory as, 583 compensating balance for, 577−578 cost of, calculation of, 572−573 discount, 576−577 effective interest rate of, 571, 576 loan terms affecting, 576−582 long-term, vs short-term, 570, 571f with maturity of less than one year, 578−580 mortgage, 52−53 necessary amount of, calculation of, 572−573 payday, 568 self-liquidating, 571 short-term, 571−572 See also Short-term financing terms of, 576−582 Loan-deposit maturity matching, 46−47, 46f Loan Mart, 568 Lockbox system, 523 Long-term debt See also Bond(s) in business valuation, 341−342 in conservative working capital approach, 492−493, 494f in moderate working capital approach, 494, 495f on pro forma balance sheet, 144 valuation of, 342−349 Long-term financing, vs short-term financing, 570, 571f Long-term financing decisions, 381 Long-term liabilities, 74 Lord Byron, 486 Lucent, 426 M MACRS, 78−79, 79t Majority interest, 444 Majority voting, for board of directors, 444–445 Manager, 449 Marginal cost of capital (MCC), 249−254 break points and, 250−253, 251f, 253f capital budgeting decisions and, 254−257, 255f, 256f, 257t change in, calculation of, 253 Marginal tax rate, 79−80, 80t Marketable securities, 72 on pro forma balance sheet, 142 Market efficiency, 29 Marketing expenses, on pro forma income statement, 140 Market risk, 160, 287 Market risk premium, 180 Market to book value (M/B) ratio, 104−105 Market value of bond, 342−345 in business valuation, 361−362, 362f calculation of See Valuation I-8 Index Market value added (MVA), 105−107 Market value ratios, 95, 103−105, 114 See also Financial ratios market to book value ratio, 104−105 price to earnings, 104 Matching principle, 78 Maturity dates, 26, 31 Maturity matching, 46−47, 46f Maturity risk premium, 35−36 Maximum cash balance, calculation of, 512−514 Maytag, 426 Merrill Lynch, 3–4, 5−6, 160, 508 Miller, Merton, 24, 399, 471, 512 Miller-Orr cash management mode, 512−514, 513f Minimum cash balance, 510−511, 511f calculation of, 512−514 Mixed ratio, 99 M&M dividend theory, 471 Moderate working capital financing approach, 494, 495f ratio analysis of, 494−496, 495t, 496t Modified Accelerated Cost Recovery System (MACRS), 78−79, 79t Modified Du Pont equation, 108−110 Modified internal rate of return (MIRR) calculation of, 325 in capital budgeting, 284−286, 325 Modigliani, Franco, 399, 471 Modigliani and Miller dividend theory, 471 Money market, 28 securities in, 29−33 Money supply, control of, 50, 51−52 Montgomery Ward, 398 Monthly compounding, 221 Moody’s bond rating, 415−416, 416t Mortgage-backed securities, 2−4 Mortgage bonds, 422 Mortgage loans, 2−4, 52−53 Mossin, Jan, 179 Multinational corporations (MNDs), 595−597 cultural risks facing, 606 ethical issues facing, 596 exchange rates and, 600−601 financial advantages of, 595−596 law of comparative advantage and, 596−597 political risks facing, 605–606 Municipal bonds, 32 Murphy Oil, 472, 472t Mutually exclusive projects, 272 with unequal project lives, capital budgeting for, 309−312, 310f, 311f Mutuals, 53−54 N Nacional Electricidad SA, 426−427 NAFTA (North American Free Trade Agreement), 606–607 Nasdaq, 17, 28 National Credit Union Administration (NCUA), 56 National Credit Union Share Insurance Fund (NCUSIF), 56 Negotiable certificates of deposit, 30 Neiman Marcus, 398 Net cash flow, 74, 75f, 76f, 77 Net income, 70 coefficient of variation of, 167−168 combined leverage and, 389−391 in dividend payout ratio, 468 financial leverage and, 387−389 operating income and, 387−389 Net present value (NPV), 274−279, 280f calculation of, 275−277 in accounts receivable analysis, 539−543 for multiple internal rates of return, 308−309, 308f real options and, 326−328, 327f, 329t Net present value (NPV) profile, 278−279, 279f, 280f internal rate of return and, 283−284 Net profit margin, 98 in Du Pont equation, 107−108 in modified Du Point equation, 108−109 Net working capital, 73, 487 changes in, 316−317, 318t Net worth, 355 in common stock valuation, 355−356 New York Stock Exchange, 28 Nominal interest rate, 33, 34f Nominal risk-free interest rate, 34 Nonconstant growth dividend model, for common stock valuation, 353−354 Noncumulative preferred stock, 427, 428 Nondiversifiable risk, 176−178, 176f measurement of, 177−178 Nonsimple projects, 307 capital budgeting, for, 307 Normal distribution, 163−166, 164f, 167f North American Free Trade Agreement (NAFTA), 606–607 Notes face (par) value of, 31 principal of, 31 Treasury, 31−32 types of, 31 Notes payable, 73, 73f, 76f, 77 as current liability, 487 on pro forma balance sheet, 144 NPV profile, 278−279, 279f, 280f internal rate of return and, 282, 283−284 O Offer price, 27 Office of the Comptroller of Currency (OCC), 48 Office of Thrift Supervision, 53 Open-market operations, 50, 51 Operating activities, 74 on statement of cash flows, 74, 75f, 76 Operating cash flows, 317−319, 318t, 322, 323t Operating costs See also Expense(s) fixed, business risk and, 169−170, 170t Operating income, 69f, 70 business risk and, 169−170, 170t leverage and, 384 net income and, 385 variability of, 169−170, 170t volatility of, 169−170, 170t Operating leases, 429−430 Operating leverage, 169−170, 170t, 384−387 breakeven analysis and, 391−397 in combined leverage, 389−391 degree of, 384−385 risk of, 387 Operating profit margin, 97–98 Operation Twist, 36 Opportunity costs, 201, 318 Optimal capital budget, 256, 257t Optimal cash balance, 510−514 calculation of, 512−514 Option pricing, 452, 454−456 Ordering costs, 544 Ordinary annuities, 205 future value of, 205−207, 206f present value of, 208−211 Orr, Daniel, 512 Over-the-counter (OTC) market, 28 Ownership, forms of, 14−18, 19t P Partnerships, 15−16, 19t limited, 16 limited liability, 16 Par value, 31, 74 Patton, General George S., 160 Payback method, of capital budgeting, 273−274 Payback period, 273 calculation of 273−274 Payday loans, 568 Payment date, 472, 472f Pension funds, 58 defined benefit plan, 58 defined contribution plan, 58 P/E ratio, 104 in common stock valuation, 354−355 Permanent current assets, 489−490, 489f, 490f Perpetuity, 211−212 Pledge, of collateral, 582 Political instability, international trade and, 604−605 Political risks, facing multinational corporations, 605–606 Portfolio fluctuations in, beta and, 177, 177f standard deviation of, 175 Portfolio risks, 171−178 diversification and, 171−173 measurement of, 173 nondiversifiable, 176−178, 176f, 177f Post, 28 Preemptive rights, 451−454, 453t, 455t Preferred stock, 33, 427−428 See also Stock convertible, 428 corporate investment in, 427−428 cost of, 242−243 cumulative, 427, 428 Index dividends from, 71, 427 See also Dividends taxation of, 427−428 noncumulative, 427, 428 participating, 427 present value of, 349−350 price of See Stock price valuation of, 349−351 yield on, 350−351 Premium bond price at, 348−349, 349f call, 418 inflation, 34, 34f risk, 35−36, 180 Prepaid expenses, 72, 73f Present value, 201, 208−211 of annuity due, 209−211 compounding periods and, 199, 200f discount rate and, 201 of future cash flows, 349 in business valuation, 349−350 interest rate changes and, 199, 200f of investment with uneven cash flows, 212−213, 213t of ordinary annuity, 208−209 of perpetuity, 211−212 of single amount, 201−203 Present value interest factor (PVIF), 202 Present value interest factor for an annuity, 209 Price ask (offer), 27 bid, 27 call, 418 exercise, 454−456, 456t stock See Stock price Price to earnings (P/E) ratio, 104 in common stock valuation, 354−355 Primary market, 27 Primary reserves, 49 Principal, 11, 31 Private corporations, 17, 443 common stock of, 443 Probability distribution, 163 normal, 166, 167f Professional corporations, 17−18 Profit(s) double taxation of, 16−17 gross, 69 vs stock value, 11 Profitability accounts receivable and, 536−537 inventory and, 536−537 vs liquidity, 490−491 Profitability ratios, 95, 96−99 See also Financial ratios calculation of, 96−99 gross profit margin, 96, 97, 99 mixed, 99 net profit margin, 98 operating profit margin, 97–98 return on assets, 98 return on equity, 99–100 Profit margin gross, 96–97 net See Net Profit margin Pro forma balance sheets, 139, 142−146, 141f, 145f Pro forma financial statements, 138−148 in accounts receivable analysis, 538−543, 539t, 542f, 543t additional funds needed in, 145 analysis of, 146−148 balance sheet for 139, 141f, 142−148, 145f, 147f budgets for, 138 excess financing in, 145 forecasting basis, for, 139−140 income statement for, 139, 140−142, 140f, 143f in inventory analysis, 544−549, 547f production of, 139−146 Pro forma income statements, 138−148, 140f, 143f Progressive tax rate structure, 80, 80t Promissory note, 571 Property, plant, and equipment on pro forma balance sheet, 143 Property and casualty insurance companies, 57−58 Proprietorship, 14−15, 19t Prospectus, 449 Proxies, 444 Publicly traded corporations, 17, 443 common stock of, 443 Public warehouse, collateral inventory storage in, 583 Purchasing, vs leasing, 430−433, 432t Purchasing power parity (PPP) theory, 603−604 Pure time value of money, 196 Putable bonds, 426 Q Quantitative easing (QE), 51 Quarterly compounding, 221 Quick ratio, 100−101, 112 Quota, 606–607 R Ranking decision, 272 net present value and, 278 Ratio analysis, 94−110 Du Pont system in, 107−110 industry comparisons in, 110−111, 111f ratios used in, 94−110 See also Financial ratios summary analysis and, 112−114, 113t trend analysis and, 110−111, 110t, 111t, 111f of working capital policy, 494−496, 495t, 496t Real options, 326−328, 327f, 329t Real rate of interest, 33−34, 34f Refunding, 418−421, 419t, 420t Relative purchasing power parity theory, 603 Replacement chain approach, 311 I-9 replacement value of assets method, 363−364 Required rate of return See also Cost of debt adjustment of, 179 in capital asset pricing model, 179−181, 181f in discounted cash flow model, 340−341 investor’s, 340−341 risk and, 179−181, 181f Required reserve ratio, 49, 49t Reserves commercial bank, 48−49, 49t savings and loan, 53 Residual income, 441−442 Residual theory of dividends, 469, 469t Restrictive covenants, 421 Retained earnings, 69f, 71, 71f, 74 on pro forma balance sheet, 144 in residual theory of dividends, 469 statement of, 71, 71f stock dividends and, 474 Return, risk and, 162 Return on assets (ROA), 98 in Du Pont equation, 107−108 Return on equity (ROE), 98–99 in modified Du Point equation, 108−109 Revenue bonds, 32 Revenues, 68−69, 69f Revolving credit agreement, 572 Rights, 451−456, 453t, 455t Rights-on trading, 452−453, 453t Risk, 161−181 adjustment for, in capital budgeting, 289−290, 290t beta, 177, 287 bond, 422−423, 423f breakeven analysis and, 396−397 business, 169−170, 170t operating leverage and, 387 in business valuation, 340−341 compensation for, 179 diversification and, 171−173, 179, 602−603 financial, 170−171 firm, 287−290 measurement of, 287−289 hedging and, 601 management of, 178−179 in international finance, 601−603 market, 287 measurement of, 163−168 in capital budgeting, 287−289 coefficient of variation in, 167−168, 287−289 standard deviation in, 163−166, 167f nondiversifiable, 176−178, 176f, 181 of operating leverage and, 387 portfolio, 171−178 profit/loss potential and, 396−397 project-specific, 287 reduction of, 178−179 stock price and, 10−11, 12t systematic, uncertainty and, 163 I-10 Index Risk-adjusted discount rates (RADRs), 289−290, 290t Risk assessment, 57 Risk aversion, 162 Risk-free rate of return (KRF), 180 Risk premium default, 35 illiquidity, 35 maturity, 35−36 Risk-return relationship, 162 capital asset pricing model and, 179−181 current liabilities and, 491−492 desirable, 179 for leveraged buyouts, 398, 399t RJR Nabisco, 398, 426 S Safeway, 398 Sales breakeven analysis See Breakeven analysis Sales breakeven point, 391 Sales finance companies, 57 Sales forecasts, 137, 138f See also Forecasting distributions of, 164−166 Sales projection, in pro forma income statement, 140 Sales revenue, in breakeven analysis, 393, 394t Sales volatility business risk and, 169 leverage and, 387, 402 operating income and 384−387 reduction of, 178 Sarnoff, Robert W., 464 Savings and loan associations (S&Ls), 53−55 loan-deposit matching by, 54, 55t mutual vs stockholder owned, 53−54 real assets of, 55 regulation of, 53 Savings Association Insurance Fund (SAIF), 53 S corporations, 17 Secondary market, 27−28 Secondary reserves, 49 Second-mortgage bond, 422 Secured bonds, 417 Securities, 26, 29−33 hybrid, 427 marketable, 72 on pro forma balance sheet, 142 in money market, 29−30 trading of, 26–29 Treasury See Treasury securities Securities and Exchange Commission (SEC), 17, 68, 258 Security exchanges, 28 Self-liquidating loan, 571 Selling and administrative expenses, 69 Selling expenses, in pro forma income statement, 140−141 Semiannual compounding, 219−221 Semiannual coupon interest payments, in bond valuation, 345 Senior debentures, 422−423, 423f Serial payments, 417 Share classes, 441−442 Shareholders, credit union, 55 Sharpe, William F., 179 Short-term financing, 485, 568−583 See also Loan(s) in aggressive working capital approach, 492, 493f alternatives for, 570−575 amount to borrow in, calculation of, 581−582 bank loans in, 571−572 collateral for, 582−583 commercial paper in, 573−575 cost of, calculation of, 580–581 vs long-term financing, 570, 571f in moderate working capital approach, 494, 495f need for, 569−570 pros and cons of, 570, 571f trade credit in, 572−573, 572f Shutdown cash flows, 319−320, 322−323, 324t Signaling, 447 Signaling dividend theory, 470 Simple interest, 196 Sinking funds, 417 Small-loan companies, 56 Societal interests, 14, 15f See also Ethical issues international trade and, 596 Sole proprietorship, 14−15 Southland Corporation, 398 Spot rate, 604 Staggered maturities, 417 Stakeholders, 13 Standard deviation, 163−166, 167f calculation of, 164−166 coefficient of variation and, 167−168 interpretation of, 166 of two-asset portfolio, 175 Standard & Poors, bond rating by, 414, 415−416, 416t Stated interest rate, 571 Statement of cash flows, 74−77, 75f, 76f Statement of retained earnings, 71, 71f Statistical independence, 174 Stock, 32−33 capital gains from, 33 common See Common stock controlling interest in, 444 corporate, 32 dividends from See Dividends exchange-listed, 28 ex-dividend trading of, 471−472 foreign See also International finance/ trade American depository receipts and, 603 exchange rates and, 601 preferred See Preferred stock Stock certificates, 442, 442f Stock dividends, 473−476 See also Dividends Stockholders, savings and loan, 53−54 voting rights of, 444−446 Stock price cash flow and, 9−10, 12t determinants of, 9−11, 12t as indicator of firm’s value, risk and, 10−11, 12t after stock dividend, 474−475 after stock split, 476 timing and, 10–11, 12t vs value, 11 Stock splits, 475−476 Straight bond value, 424−425 Straight-line depreciation, 78 Strengthening currency, 598−599 Subordinated debentures, 422–423, 423f Summary analysis, 112−114, 113t Summers, Lawrence, 594 SunGard Data Systems, 398, 399t Sunk costs, 316 Super long-term bonds, 426−427 Supernormal growth dividend model, for common stock valuation, 353−354 Surplus economic units, 25 Swaps, 160, 601 Syndicate, 449 Syrus, Publilius, 270 Systematic risk, 4, 160 T Target stock, 442 Tariffs, 606–607 Tax (es) after-tax cost of debt and, 240−241 asset sale and, 319−320, 320t capital gains, 319 corporate, 16−17 on dividends, 427−428, 472 double taxation and, 16−17 fake leases and, 428−429 income average rates for, 80−81, 80t marginal rates for, 79−80, 80t in pro forma income statement, 142 on lease vs purchase, 430−433, 432t operating cash flows and, 317−319 partnership, 16 on preferred stock dividends, 427−428 Tax deductible expenses, 70 interest as, 399 Tax rates, 79−81, 80t average, 80−81 capital gains, 319 effective, 80−81 marginal, 79−80, 80t progressive, 80, 80t Temporary current assets, 489−490, 490f 10-K reports, 68 10-Q reports, 68 Terminal value, 285, 361 Times interest earned, 101−102 Time value of money, 194−223 future value and, 196−200 measurement of, 196 present value and, 201−203 pure, 196 Todd, Mike, 508 Tombstone ad, 449, 450f Total asset turnover, 103 in Du Pont equation, 107−108 in modified Du Pont equation, 108−109 Index Total debt capital, vs total liabilities, 106 Total market value, of business, 361−362, 362f Total sales revenue, in breakeven analysis, 393, 394t Total stockholders’ equity, valuation of, 355−356 Toys R Us, 398 Trade, international, 594−608 See also International finance/trade Trade agreements, international, 606−608 Trade credit, 572−573 cost of, calculation of, 572−573, 572f Transaction costs, 512 Transfer agent, 471 Treasurer, Treasury securities purchase of 31 Treasury bills (T-bills), 29−30 Treasury bonds (T-bonds), 31−32 Treasury notes (T-notes), 31−32 yield curve, 36–37, 37f Trend analysis, 110, 110t, 111t, 111f industry comparisons and, 110−111, 110t, 111t, 111f in summary analysis, 112−114, 113t Trustee, 422 Trust receipt, 583 Tyco, 426 V U Wall Street, Warehouse, collateral inventory storage in, 583 Warrants, 454−456, 456t Washington Mutual, 44 Weakening currency, 598−599 Wealth, Web sites See Internet Weighted average cost of capital (WACC), 106, 247−249 in capital structure theory, 400−402, 401f cost of equity and, 400 marginal cost of capital and, 249−254 Uncertainty, 163 See also Risk risk measurement and, 163−168 standard deviation and, 166 Underwriting 26, 449 vs best efforts offering, 449 Unlimited liability, 14−15 Univision Communications Inc., 398 Unsecured bonds, 422−423, 423f U.S Treasury, 29 Valuation See also Business valuation of bonds, 342−349 See also Bond(s), valuation of of common stock, 351−363 See also Common stock, valuation of of inventory, 583 of preferred stock, 349−350 of total stockholders’ equity, 355−356 of warrants, 454−546, 456t Value cash flow and, 9−11, 12t enterprise, 361 profits vs., 11 risk and, 10−11, 12t terminal, 285, 361 timing and, 10–11, 12t wealth and, Variable costs, 391 labor costs as, 391 Variable-rate bonds, 425−426 Venture capital (VC) firms, 258 Veterans Administration (VA), 52 Volker, Paul, 59 Volcker Rule, 59 Voting rights, of common stockholders, 444−446 W I-11 Working capital, 72, 73, 486−496 See also Current assets bond-related restrictions on, 421 management of See Working capital policy net, 487 changes in 316−317, 318t Working capital policy, 487−488 aggressive, 492, 493f conservative, 492−493, 494f liquidity vs profitability and, 490−491 management of current liabilities and, 491−492 moderate, 494, 495f optimal level of current assets and, 491 ratio analysis of, 494−496, 495t, 496t risk-return relationship and, 491−492 World Com, 426 World Trade Organization (WTO), 607 World Wide Web See Internet X Xerox, 426 Y Yankee bond, 426 Yield on common stock, 362−363 discount, 574 dividend, 244, 362 on preferred stock, 350−351 Yield curve, 36–37, 37f for interest rates, 36, 37f Yield to maturity (YTM), 345 calculation of, 346−348, 349f price and, 348−349, 349f Z Zero-coupon bonds, 31 Zuckerberg, Mark, 270, 442 Z value, in capital structure theory, 400−402, 401f ... all failed in 2008 Financial institutions are essential to the financial system We rely on them to make business and mortgage loans, to stand behind the insurance policies issued, and to stand behind... mortgage-backed securities Fannie Mae and Freddie Mac lowered the standards for the types of mortgages they would buy Fannie Mae and Freddie Mac got effectively nationalized in late 2008 when they went... them and the accompanying risk to a government entity? This book is about financial management, not blame and politics It is designed to introduce you to basic financial management principles and