CORPORATE FINANCE - · PDF fileChief Financial Officer, ... PART 1: INTRODUCTION 2 Chapter 1:...
Transcript of CORPORATE FINANCE - · PDF fileChief Financial Officer, ... PART 1: INTRODUCTION 2 Chapter 1:...
CORPORATE FINANCESECOND EDITION
William L. MegginsonUniversity of Oklahoma
Scott B. SmartIndiana University
Lawrence J. GitmanSan Diego State University
THOMSON*
SOUTH-WESTERN
Australia • Canada • Mexico • Singapore • Spain • United Kingdom • United States
CONTENTS
Smart Ethics VideoTom Cole, Deutsche Bank,
Leveraged Finance Group, page 9
Smart Conceptspage 13
Smart Practices VideoDavid Nickel, Controller for Legal
and Risk Management, Intel Corp.,page 22
Smart Ethics VideoAndy Bryant, Executive Vice President
of Finance and Enterprise Systems,Chief Financial Officer, Intel Corp.,
page 26
About the Authors xxPreface xxi
PART 1: INTRODUCTION 2
Chapter 1: The Scope of Corporate Finance 5Opening Focus: Public or Private? 5
1.1 What Is Corporate Finance? 6
The Core Principles of Finance 6The Five Basic Corporate Finance Functions 9
1.2 Legal Forms of Business Organization 14
Business Organizational Forms in the United States 14Forms of Business Organization Used by Non-U.S. Companies 18
1.3 Goals of the Corporate Financial Manager 21
What Should a Financial Manager Try to Maximize? 21How Can Agency Costs Be Controlled in Corporate Finance? 23
Comparative Corporate Finance: The Growth of Stock MarketCapitalization 24
What Is the Importance of Ethics in Corporate Finance? 25
1.4 Summary 26
Smart Practices VideoJon Olson, Vice President of Finance,
Intel Corp. (former). Currently, ChiefFinancial Officer, Xilinx Corp., page 31
Chapter 2: Financial Statement and Cash Flow AnalysisOpening Focus: Bang & Olufsen's Rising Profits Are Musicto Investors' Ears 30
2.1 Financial Statements 31
Balance Sheet 32Comparative Corporate Finance: Assessing the Market Valueof Global Brands 34
Income Statement 35Statement of Retained Earnings 37Statement of Cash Flows 38Notes to Financial Statements 38
30
IV
CONTENTS
2.2 Cash Flow Analysis 39
The Firm's Cash Flows 39Developing the Statement of Cash FlowsInterpreting the Statement 44
42
2.3 Analyzing Financial Performance Using Ratio Analysis
Using Financial Ratios 45Liquidity Ratios 46Activity Ratios 47Debt Ratios 49Profitability Ratios 50Market Ratios 55
2.4 Summary 56
45
Smart Ethics VideoFrank Popoff, Chairman of the Board(retired), Dow Chemical, page 51
Smart Conceptspage 53
Smart Ideas VideoMichael Brennan, UCLA, page 55
Chapter 3: Time Value of Money 72Opening Focus: Why Is a "$340 Million Jackpot" Really WorthOnly $164 Million? 72
3.1 The Notion of Time Value of Money 73
The Role of Financial Markets 74Comparative Corporate Finance: Save Money?Not Me—I'm an American! 76
3.2 Future Value of a Lump Sum 77
The Concept of Future Value 77The Equation for Future Value 78A Graphic View of Future Value 80
3.3 Present Value of a Lump Sum 80
The Concept of Present Value 81The Equation for Present Value 81A Graphic View of Present Value 83
3.4 Future Value of Cash Flow Streams 83
Finding the Future Value of a Mixed Stream 84Types of Annuities 85Finding the Future Value of an Ordinary Annuity 85Finding the Future Value of an Annuity Due 87
3.5 Present Value of Cash Flow Streams 88
Finding the Present Value of a Mixed Stream 89Finding the Present Value of an Ordinary Annuity 90Finding the Present Value of an Annuity Due 92Finding the Present Value of a Perpetuity 92Finding the Present Value of a Growing Perpetuity 93
3.6 Special Applications of Time Value 95
Compounding More Frequently Than Annually 95Stated versus Effective Annual Interest Rates 98Deposits Needed to Accumulate a Future Sum 99Loan Amortization 100
Smart Conceptspage 94
Smart Ethics VideoKent Womack, Dartmouth College,page 95
CONTENTS
Implied Interest or Growth RatesNumber of Compounding Periods
3.7 Summary 106
102104
PART 2: VALUATION, RISK, AND RETURN 122
Smart Practices VideoTodd Richter, Managing Director,
Head of Equity Healthcare Research,Bank of America Securities, page 148
Smart Conceptspage 152
Smart Practices VideoTodd Richter, Managing Director,
Head of Equity Healthcare Research,Bank of America Securities, page 160
Smart Ideas VideoRobert Shiller, Yale University,
page 162
Chapter 4: Valuation 125Opening Focus: The Bonds That Fell to Earth 125
4.1 Valuation Fundamentals 126
The Fundamental Valuation Model 127
129
4.2 Bond Valuation 129
Bond Vocabulary 129The Basic Equation (Assuming Annual Interest)Risk-Free Bonds 131Risky Bonds 135Bond Prices 138
4.3 Advanced Bond Valuation—The Term Structureof Interest Rates 142
Evaluating the Yield Curve 142Comparative Corporate Finance: Is the Yield Curvea Good Economic Predictor? 143
Term Structure Theories 144
4.4 Stock Valuation 147
Stock Price Quotations 147Preferred Stock Valuation 148The Basic Common Stock Valuation Equation 149Zero Growth 151Constant Growth 151Variable Growth 153How to Estimate Growth 154What If There Are No Dividends? 156Valuing the Enterprise—The Free Cash Flow Approach 158
4.5 Other Approaches to Common Stock Valuation
Book Value 161Liquidation Value 161Price Multiples 161
4.6 Summary 163
160
Chapter 5: The Trade-off between Risk and ReturnOpening Focus: Some Helpful Investment TIPS 172
172
5.1 Risk and Return Fundamentals 173
An Historical Overview of Risk and Return 173
CONTENTS
Comparative Corporate Finance: The Equity Risk Premium in the U.S.and Europe (1900-2004) 178
Risk Aversion 179
5.2 Basic Risk and Return Statistics 181
Return of a Single Asset 181Risk of a Single Asset 183
5.3 Risk and Return for Portfolios 186
Portfolio Returns 186Portfolio Variance—An Example 187The Importance of Covariance 189Variance of a Two-Asset Portfolio 192
5.4 Systematic and Unsystematic Risk 194
What Drives Portfolio Risk? 194Measuring the Systematic Risk of an Individual Security 197Limitations of Beta
5.5 Summary 200
199
Smart Ideas VideoElroy Dimson, London BusinessSchool, page 176
Smart Conceptspage 187
Smart Ethics VideoUtpal Bhattacharya, IndianaUniversity, page 197
Smart Conceptspage 199
Chapter 6: Risk and Return: The CAPM and Beyond 212Opening Focus: CFOs Count on CAPM to Gauge Stockholders'Expectations 212
6.1 Efficient Risky Portfolios 213
The Efficient Frontier with Two Assets 213The Efficient Frontier with Many Assets 215
6.2 Risk-Free Borrowing and Lending 218
Portfolios of Risky and Risk-Free Assets 218Finding the Optimal Portfolio 221
6.3 Equilibrium and the Market Portfolio 224
The Market Portfolio 224The Capital Market Line 225
6.4 The Capital Asset Pricing Model (CAPM) 226
The Security Market Line 226Estimating Betas 228
6.5 Empirical Evidence on the CAPM 231
6.6 Alternatives to the CAPM 234
Arbitrage Pricing Theory 234The Fama-French (F-F) Model 235
Comparative Corporate Finance 237
6.7 The Current State of Asset Pricing Theory 238
6.8 Summary 239
Smart Ideas VideoAndrew Karolyi, The Ohio StateUniversity, page 221
Smart Conceptspage 228
Smart Ideas VideoKenneth French, Dartmouth College,page 235
Smart Ideas VideoAvanidhar Subrahmanyam, UCLA,page 236
Smart Ideas VideoDiane Denis, Purdue University,page 238
Smart Ideas VideoWilliam Sharpe, Stanford University,Co-founder, Financial Engines,page 239
VIII CONTENTS
Smart Practices VideoJon Olson, Vice President of Finance,
Intel Corp. (former). Currently,Chief Financial Officer, Xilinx Corp.,
page 256
Smart Practices VideoDaniel Carter, Executive Vice
President, Chief Financial Officer,Charlotte Russe, page 258
Smart Practices VideoDaniel Carter, Executive Vice
President, Chief Financial Officer,Charlotte Russe, page 259
Smart Practices VideoChris Muscarella, Professor
of Finance and L.W. "Roy"and Mary Lois Clark Teaching Fellow,
page 264
Smart Conceptspage 279
Smart Practices VideoBeth Acton, Vice President and
Treasurer of Ford Motor Co. (former).Currently, Chief Financial Officer,
Comerica, page 284
PART 3: CAPITAL BUDGETING 250
Chapter 7: Capital Budgeting Process and Techniques 253Opening Focus: Producing Flat Out 253
7.1 Introduction to Capital Budgeting 254
What Do Managers Really Want? 254A Capital Budgeting Problem 255
7.2 Accounting-Based Methods 256
Accounting Rate of Return 256
7.3 Payback Methods 258
The Payback Decision Rule 258Pros and Cons of the Payback Method 259Discounted Payback 260Pros and Cons of Discounted Payback 261
7.4 Net Present Value 262
Net Present Value Calculations 262Pros and Cons of NPV 265
7.5 Internal Rate of Return 267
Finding a Project's IRR 267Advantages of the IRR Method 269Problems with the Internal Rate of Return 271IRR, NPV, and Mutually Exclusive Projects 276
7.6 Profitability Index 280
Calculating the Profitability Index 280The Profitability Index and Capital Rationing 282
Comparative Corporate Finance: Capital Budgeting in Sweden,South Africa, and the United Kingdom 284
7.7 Which Techniques Do Firms Actually Use? 284
7.8 Summary 285
Smart Practices VideoPaul Savastano, Director of
Information Technology, Sprint Corp.,page 307
Smart Conceptspage 308
Smart Ethics VideoScott Lee, Texas A&M University,
page 309
Chapter 8: Cash Flow and Capital Budgeting 298Opening Focus: France Telecom Enjoys Orange's Jus 298
8.1 Types of Cash Flows 299
Cash Flow versus Accounting Profit 299Depreciation 301Fixed Asset Expenditures 302Working Capital Expenditures 303Terminal Value 304Incremental Cash Flow 306Opportunity Costs 308
8.2 Cash Flows for Classicaltunes.com 309Comparative Corporate Finance: Is a High Investment Rate Goodfor a Nation's Economic Health? 310
CONTENTS
Year 0 Cash Flow 312Year 1 Cash Flow 312Year 2 Cash Flow 313Terminal Value 313Jazz-Music CD Proj ect NP V 314
8.3 Cash Flows, Discounting, and Inflation 315
8.4 Special Problems in Capital Budgeting 318
Equipment Replacement and Equivalent Annual Cost 318Excess Capacity 320
8.5 The Human Face of Capital Budgeting 321
8.6 Summary 322
Chapter 9: Cost of Capital and Project Risk 338Opening Focus: Cendant Unwinds to Unlock Value 338
9.1 Choosing the Right Discount Rate 339
Cost of Equity 339Weighted Average Cost of Capital (WACC) 343
Comparative Corporate Finance: The Cost of Capital in India 346
Connecting the WACC to the CAPM 347Asset Betas and Project Discount Rates 349A Note on the Equity Risk Premium 353
9.2 A Closer Look at Risk 355
Break-Even Analysis 355Sensitivity Analysis 357Scenario Analysis and Monte Carlo Simulation 358Decision Trees 359
9.3 Real Options 362
Why NPV Doesn't Always Give the Right Answer 362Types of Real Options 363The Surprising Link between Risk and Real Option Values 365
9.4 Strategy and Capital Budgeting 366
Competition and NPV 366Strategic Thinking and Real Options 367
9.5 Summary 368
PART 4: CAPITAL STRUCTUREAND DIVIDEND POLICY 376
Smart Practices VideoDavid Nickel, Controller for Legaland Risk Management, Intel Corp.,page 314
Smart Ideas VideoRaghu Rajan, University of Chicago,page 322
Smart Practices VideoBeth Acton, Vice President andTreasurer of Ford Motor Co. (former).Currently, Chief Financial Officer,Comerica, page 347
Smart Ethics VideoRobert Bruner, University of Virginia,page 352
Smart Conceptspage 357
Smart Ethics VideoDavid Nickel, Controller for Legaland Risk Management, Intel Corp.,page 358
Smart Practices VideoPam Roberts, Executive Directorof Corporate Services, Cummins Inc.,page 359
Smart Practices VideoAndy Bryant, Executive Vice Presidentof Finance and Enterprise Systems,Chief Financial Officer, Intel Corp.,page 365
Smart Ethics VideoJon Olson, Vice President of Finance,Intel Corp. (former). Currently, ChiefFinancial Officer, Xilinx Corp., page 367
Chapter 10: Market Efficiency and Behavioral FinanceOpening Focus: Investors Applaud a CEO's Dismissal—By Purchasing the Wrong Stock! 379
379
10.1 What Is an Efficient Financial Market?
Definitions of Efficiency 381
381
CONTENTS
The Three Forms of Market Efficiency 382Does Empirical Evidence Support Market Efficiency? 383
Smart Ideas VideoLaura Starks, University of Texas,
page 386
Smart Practices VideoJeff Kauffman, Portfolio Manager,
Managing Director, Omega Advisors,page 398
Smart Conceptspage 399
Smart Ideas VideoRobert Shiller, Yale University,
page 400
Smart Practices VideoTodd Richter, Managing Director,
Head of Equity Healthcare Research,Bank of America Securities, page 404
10.2 Empirical Evidence on Market Efficiency 385
Tests for Return Predictability 385Tests for Rapid Price Adjustment 390Tests for Private Information 392
Comparative Corporate Finance: International Market Efficiencyand Headaches for International Mutual Fund Managers 396
10.3 The Behavioral Finance Critique of Market Efficiency 399
Bubbles, Fads, and Cascades: The Empirical Evidenceon Behavioral Finance 400
Theoretical Underpinnings of Behavioral Finance 400Assessing Behavioral Finance and Market Efficiency 403
10.4 What Does Market Efficiency Imply for CorporateFinancing? 404
How Do Markets Process Accounting and Other InformationReleases? 404
How Do Markets Respond to Corporate FinancingAnnouncements? 405
How Can Managers Devise a Corporate "Communications"Policy? 405
10.5 Summary 407
Smart Ideas VideoDavid Mauer, Southern Methodist
University, page 427
Smart Ethics VideoKent Womack, Dartmouth College,
page 437
Smart Practices VideoFrank Popoff, Chairman of the Board
(retired), Dow Chemical, page 438
Chapter 11: An Overview of Long-Term Financing 420Opening Focus: So You Think the U.S. Has a Stock Market-BasedCorporate Finance System? 420
421
431
11.1 The Basic Instruments of Long-Term Financing
Common Stock 422Preferred Stock 425Long-Term Debt 425
11.2 The Basic Choices in Long-Term Financing 430
The Need to Fund a Financial Deficit 430The Choice between Internal versus External FinancingOther Financing Choices 431
Comparative Corporate Finance: What Do Private Pension Fundsand Capital Markets Have in Common? 432
11.3 The Role of Financial Intermediaries in Funding CorporateInvestment 433
What Is a Financial Intermediary, and What Does It Do? 433The Role of Financial Intermediaries in U.S. Corporate FinanceThe Corporate Finance Role of Non-U.S. Financial
Intermediaries 434
11.4 The Expanding Role of Securities Markets in the GlobalEconomy 435
Overview of Securities Issues Worldwide 435The Worldwide Surge in Mergers and Acquisitions 438
434
CONTENTS
11.5 Law and Finance: The Importance of Corporate Governance 439
The Law and Finance Model 440
11.6 Summary 443
Chapter 12: Capital Structure: Theory and TaxesOpening Focus: Capital Structures of America'sMost Admired Companies 450
450
12.1 What Is Financial Leverage and What Are Its Effects? 451
12.2 Worldwide Capital Structure Patterns 454
12.3 An Overview of Capital Structure Theories 460
The Agency Cost/Tax-Shield Trade-off Model 460The Pecking-Order Model 460The Signaling Model 461The Market-Timing Model 461
12.4 The Modigliani & Miller Propositions 462
Assumptions of the M&M Capital Structure Model 462Proposition I 462Proposition II and the WACC 465
12.5 M&M and Taxes 468
The M&M Model with Corporate Taxes 468Determining the Present Value of Debt Tax Shields 469The M&M Model with Corporate and Personal Taxes 470Bond Market Equilibrium with Corporate and Personal Taxes 472
Comparative Corporate Finance: Is the State Withering Away?No, Based on Government Spending Levels 473
Other Tax-Based Models of Capital Structure 475
12.6 A Checklist of How Taxes Should Impact Capital Structure 476
12.7 Summary 477
Chapter 13: Capital Structure: Nontax Determinantsof Corporate Leverage 485Opening Focus: France Telecom Launches a $15 Billion Rights Offeringto Reduce Its Leverage 485
13.1 Costs of Bankruptcy and Financial Distress 486
The Importance of Bankruptcy Costs 488Asset Characteristics and Bankruptcy Costs 490Direct and Indirect Costs of Bankruptcy 492
Comparative Corporate Finance: How Important Is R&D Spendingto Modern Economies? 493
International Differences in Bankruptcy Costs 495
13.2 Agency Costs and Capital Structure 496Using Debt to Overcome the Agency Costs of Outside Equity 497Agency Costs of Outside Debt 498The Agency Cost/Tax Shield Trade-off Model of Corporate
Leverage 499
Smart Ideas VideoMitchell Petersen, NorthwesternUniversity, page 455
Smart Practices VideoKeith Woodward, Vice Presidentof Finance, General Mills, page 461
Smart Conceptspage 470
Smart Ideas VideoRobert Bruner, University of Virginia,page 490
Smart Ideas VideoSheridan Titman, University of Texasat Austin, page 491
CONTENTS
13.3 The Pecking-Order Hypothesis 500
Assumptions Underlying the Pecking-Order Hypothesis 500Limitations of the Pecking Order 502
13.4 Signaling and Market-Timing Models 502
How Signaling with Capital Structure Can Convey Information 502The Market-Timing Model 504
13.5 Developing a Checklist for Capital Structure DecisionMaking 504
Leverage and Firm- and Industry-Specific Operating and FinancialVariables 504
Leverage and Ownership Structure Variables 507Leverage and Macroeconomic and Country-Specific Variables 507
13.6 Summary 509
Chapter 14: The Link between Capital Structureand Capital Budgeting 516
Opening Focus 516
14.1 M&M, Capital Budgeting, and the WACC 517
14.2 The Adjusted Present Value Method 518
14.3 The Flow-to-Equity Method 52014.4 A Checklist for the Interactions between Investmentand Financing Decisions 522
14.5 Summary
Chapter 15: Dividend Policy 528Opening Focus: Microsoft Pays the World's Largest Dividend 528
15.1 Dividend Fundamentals 531
Cash Dividend Payment Procedures 531External Factors Affecting Dividend Policy 532Types of Dividend Policies 533Other Forms of Dividends 534
15.2 Patterns Observed in Payout Policies Worldwide 537
Payout Patterns Observed 537
Introduction to the Agency Cost Model of Dividends 543
15.3 Dividend Irrelevance in a World with Perfect Capital Markets 545
15.4 Real-World Influences on Dividend Policy 547Personal Income Taxes 548Trading and Other Transactions Costs 550The Residual Theory of Dividends 551Paying Dividends as a Means of Communicating Information 551Dividend Payments as Solutions to Agency Problems 553
15.5 A Checklist for Dividend Payments 553
CONTENTS
Comparative Corporate Finance: Dividend Policies of the 25 Most ValuableNon-U.S. Public Companies 554
Developing a Checklist for Dividend Policy 554
15.6 Summary 555
PART 5: LONG-TERM FINANCING 564
Chapter 16: Investment Banking and the Public Saleof Equity Securities 567Opening Focus: Google Tries—and Fails—to Change the Rulesof Initial Public Offerings 567
16.1 Investment Banking 568
An Overview of the Global Investment Banking Industry 568Key Investment Banking Activities 571The Investment Banker's Role in Equity Issues 572
16.2 Legal Rules Governing Public Security Salesin the United States 579
Material Covered in an Offering Prospectus 580Shelf Registration (Rule 415) 582Ongoing Regulatory Requirements for a Publicly Traded Firm 583
16.3 The U.S. Market for Initial Public Offerings 583
Patterns Observed in the U.S. IPO Market 583
Comparative Corporate Finance: The Widely Varying Importanceof Stock Market Finance in Developed Countries 586
Advantages and Disadvantages of an IPO 586Specialized Initial Public Offerings: ECOs, Spin-offs, Reverse LBOs,
and Tracking Stocks 588The Investment Performance of Initial Public Offerings 590
16.4 Seasoned Equity Offerings in the United States 593
Stock Price Reactions to Seasoned Equity Issue Announcements 594Rights Offerings 594
16.5 Private Placements in the United States 595
Traditional Private Placements versus Rule 144A Issues 596
16.6 International Common Stock Offerings
Non-U.S. Initial Public Offerings 596
596
International Common Stock IssuesShare Issue Privatizations 601
16.7 Summary 603
598
Chapter 17: Long-Term Debt and Leasing 610Opening Focus: Once Floated, WorldCom's Bonds Sink 610
17.1 Characteristics of Long-Term Debt Financing 611
The Choice between Public and Private Debt Issues 611Loan Covenants 612Cost of Long-Term Debt 613
Smart Practices VideoDavid Baum, Co-head of MGAfor Goldman Sachs in the Americas,page 572
Smart Practices VideoJay Goodgold, Managing Director,Equities Division, Goldman Sachs,page 575
Smart Ethics VideoJay Ritter, University of Florida,page 578
Smart Ethics VideoJay Ritter, University of Florida,page 591
Smart Ethics VideoJay Ritter, University of Florida,page 592
XIV CONTENTS
Smart Ideas VideoAnnette Poulsen, University of
Georgia, page 619
Smart Ideas VideoEd Altman, New York University,
17.2 Term Loans 615Characteristics of Term Loan Agreements 615Term Lenders 616
17.3 Corporate Bonds 616
Popular Types of Bonds 617Legal Aspects of Corporate Bonds 619Methods of Issuing Corporate Bonds 620General Features of a Bond Issue 620High-Yield Bonds 621
Comparative Corporate Finance: Islamic Finance: How Do You Sell BondsWhen You Cannot Charge Interest? 623
International Corporate Bond Financing 623Bond-Refunding Options 624
17.4 Syndicated Loans 629
Specialized Syndicated Lending 631
17.5 Leasing 631
Basic Types of Leases 632Lease Arrangements 633The Lease Contract 633The Lease-versus-Purchase Decision 634Effects of Leasing on Future Financing 637Advantages and Disadvantages of Leasing 638
page 621 17.6 Summary 639
Smart Ideas VideoMyron Scholes, Stanford University,
and Chairman of Oak Hill PlatinumPartners, page 653
Smart Conceptspage 658
Smart Ethics VideoJohn Eck, President of Broadcast andNetwork Operations, NBC, page 671
Smart Conceptspage 679
Smart Ideas VideoMyron Scholes, Stanford University,
and Chairman of Oak Hill PlatinumPartners, page 684
PART 6: OPTIONS, DERIVATIVES,AND INTERNATIONAL FINANCIALMANAGEMENT 648
Chapter 18: Options Basics 651Opening Focus: Fiat Accompli 651
18.1 Options Vocabulary 653Comparative Corporate Finance: International Derivatives Trading 654
18.2 Option Payoff Diagrams 658
Call Option Payoffs 658Put Option Payoffs 660Payoffs for Portfolios of Options and Other Securities 661Put-Call Parity 665
18.3 Qualitative Analysis of Option Pricing 671
Factors That Influence Option Values 671
18.4 Calculating Option Prices 676
The Binomial Option-Pricing Model 676The Risk-Neutral Method 682
18.5 Summary 684
CONTENTS xv
Chapter 19: Black and Scholes and Beyond 690Opening Focus: The Value of Amazon's Real Options 690
19.1 The Black and Scholes Model 691
Calculating Black and Scholes Options Values 691Comparative Corporate Financing: The Global Valueof Options Trading 692
Volatility 699
19.2 Options Embedded in Other Securities 701
Plain-Vanilla Stocks and Bonds 701Warrants 704Convertibles 706
19.3 Options Embedded in Capital Investments—Real Options
The Option Value of Drilling Rights 710Mini-Case: Real Options at McDonald's—McTreat Spot
709
711
19.4 Summary 715
Appendix 19A: Estimating Volatility for the Black and ScholesModel 722
Chapter 20: International Financial Management 725Opening Focus: Two Floods 725
20.1 Exchange Rate Fundamentals 726
Fixed versus Floating Exchange Rates 726Exchange Rate Quotes 727The Foreign Exchange Market 731
20.2 The Parity Conditions in International Finance 733
Forward-Spot Parity 734Purchasing Power Parity 735Interest Rate Parity 73 8Real Interest Rate Parity (the Fisher Effect) 740The Asset Market Model of Exchange Rates 742
20.3 Managing Financial, Economic, and Political Risk 743
Translation and Economic Risk 745Political Risk 746European Monetary Union and the Rise of Regional Trading Blocs
747The Long-Term Success of World Trade and Foreign Direct
Investment 747Comparative Corporate Finance: What Is Japan's Export-to-GDP Ratio? 750
20.4 Long-Term Investment Decisions 751
Capital Budgeting 751Cost of Capital 753
20.5 Short-Term Financial Decisions 754
Cash Management 754Credit and Inventory Management 756
Smart Conceptspage 696
Smart Practices VideoMyron Scholes, Stanford University,and Chairman of Oak Hill PlatinumPartners, page 700
Smart Ideas VideoMyron Scholes, Stanford University,and Chairman of Oak Hill PlatinumPartners, page 704
Smart Ideas VideoMichael Brennan, UCLA, page 710
Smart Ideas VideoAnjan Thakor, University of Michigan,page 715
Smart Practices VideoMyron Scholes, Stanford University,and Chairman of Oak Hill PlatinumPartners, page 722
20.6 Summary 757
CONTENTS
Smart Practices VideoJackie Sturm, Director of Finance
for Technology and Manufacturing,Intel Corp., page 770
Smart Practices VideoJohn Eck, President of Broadcast andNetwork Operations, NBC, page 778
Smart Conceptspage 786
Smart Practices VideoBeth Acton, Vice President and
Treasurer of Ford Motor Co. (former).Currently, Chief Financial Officer,
Comerica, page 786
PART 7: SHORT-TERM FINANCINGDECISIONS 766
Chapter 21: Strategic and Operational FinancialPlanning 769Opening Focus: GM's Challenges and Plans 769
21.1 Overview of the Planning Process 770Comparative Corporate Finance: Public versus Private Forecasts 771
Successful Long-Term Planning 772The Role of Finance in Long-Term Planning 772
21.2 Planning for Growth 773
Sustainable Growth 773Pro Forma Financial Statements
21.3 Planning and Control 783Short-Term Financing StrategiesThe Cash Budget 786
21.4 Summary 792
778
783
Smart Practices VideoVern LoForti, Chief Financial Officer,
Overland Storage Inc., page 805
Smart Practices VideoJackie Sturm, Director of Finance forTechnology and Manufacturing, Intel
Corp., page 805
Smart Ethics VideoKeith Woodward, Vice President
of Finance, General Mills, page 808
Smart Conceptspage 811
Smart Practices VideoVern LoForti, Chief Financial Officer,\ Overland Storage Inc., page 814
Smart Practices VideoJon Olson, Vice President of Finance,
Intel Corp. (former). Currently, ChiefFinancial Officer, Xilinx Corp., page 826
Chapter 22: Cash Conversion, Inventory, and ReceivablesManagement 804Opening Focus: Effective Short-Term Financial Managementat Dell 804
80622.1 The Cash Conversion Cycle
Operating Cycle 806Cash Conversion Cycle 808Shortening the Cash Conversion Cycle 809
22.2 Cost Trade-offs in Short-Term Financial Management 810
22.3 Inventory Management 812
Investing in Inventory 812Techniques for Controlling Inventory 813
816
816
22.4 Accounts Receivable Standards and Terms
Effective Accounts Receivable ManagementCredit Standards 817
Comparative Corporate Finance: Trade Credit Practicesaround the World 818
Credit Terms 824
22.5 Collecting, Monitoring, and Applying Cash to Receivables
Collection Policy 826Credit Monitoring 826Cash Application 829
826
22.6 Summary 830
CONTENTS XVII
Chapter 23: Liquidity Management 842Opening Focus: The Electronic Payment Revolution? 842
23.1 Cash Management 843
Float 844Cash Position Management 845
23.2 Collections 846
Types of Collection Systems 846
Comparative Corporate Finance: Please Send Money
Lockbox Systems 849
847
Cash Concentration 850Funds Transfer Mechanisms 850
23.3 Accounts Payable and Disbursements 852
Overview of the Accounts Payable Process 852Cash Discounts 853Disbursement Products and Methods 854Developments in Accounts Payable and Disbursements 855
23.4 Short-Term Investing and Borrowing
Short-Term Investing 857Short-Term Borrowing 860
23.5 Summary 862
856
Smart Practices VideoDaniel Carter, Chief Financial Officerof Charlotte Russe, page 850
Smart Conceptspage 854
Smart Conceptspage 860
PART 8: SPECIAL TOPICS 870
Chapter 24: Mergers, Corporate Control, and CorporateGovernance 873Opening Focus: State-Controlled Chinese Oil Company Bidsagainst Chevron for Union Oil of California 873
24.1 Overview of Corporate Control Activities 874
Corporate Control Transactions 875LBOs, MBOs, and Dual-Class Recapitalizations 876Tender Offers, Acquisitions, and Proxy Fights 876Divestitures and Spin-offs 879
24.2 Horizontal, Vertical, and Conglomerate Mergers 880
Horizontal Mergers 880Vertical Mergers 881Conglomerate Mergers 882Other Concentration Classifications 883
88424.3 Merger and Acquisition Transaction CharacteristicsMethod of Payment 884Accounting Treatment 886Shareholder Wealth Effects and Transaction CharacteristicsReturns to Target and Bidding Firm Shareholders 887Returns to Other Security Holders 890International Mergers and Acquisitions 890
887
CONTENTS
24.4 Rationale and Motives for Mergers and Acquisitions 893
Value-Maximizing Motives 893Synergy, Market Power, and Strategic Mergers 894Cash Flow Generation and Financial Mergers 896Non-Value-Maximizing Motives 896
24.5 History and Regulation of Mergers and Acquisitions 898
The History of Merger Waves 898Regulation of Corporate Control Activities 899International Regulation of Mergers and Acquisitions 904
Comparative Corporate Finance: Searching for Effective CorporateGovernance and Value-Enhancing Mergers 905
24.6 Corporate Governance 906
Law and Finance: Capital Markets and National LegalSystems 906
Efficient Capital Markets Promote Rapid EconomicGrowth 907
Privatization's Impact on Stock and Bond MarketDevelopment 909
24.7 Summary 911
Chapter 25: Bankruptcy and Financial Distress 921Opening Focus: WorldCom Emerges from Bankruptcy witha New Name, New Management, and a New Capital Structure—and Is Soon Acquired 921
25.1 Business Failure Fundamentals 922
Types of Business Failure 922Major Causes of Business Failure 924
25.2 Voluntary Settlements 926
Voluntary Reorganization 926Voluntary Liquidation 926
25.3 Bankruptcy Law in the United States 927Comparative Corporate Finance: Companies Can DeclareBankruptcy—Why Not Countries? 929
25.4 Reorganization in Bankruptcy 930
Reorganization Procedures 931Reorganization Plan 932Subsidies to Firms That Reorganize 935Prepackaged Bankruptcies 936
25.5 Liquidation in Bankruptcy 937
Procedures 937Priority of Claims 937Final Accounting 940
25.6 Predicting Bankruptcy 940
25.7 Summary 942
CONTENTS
WEB CHAPTERS
Chapter 26: Entrepreneurial Finance and Venture CapitalOpening Focus: Amazon.com Redefines Electronic Commerceand Epitomizes Entrepreneurial Growth
26.1 The Challenges of Financing EntrepreneurialGrowth Companies
26.2 Venture Capital Financing in the United States
26.3 The Organization and Operations of U.S. VentureCapital Firms
26.4 International Markets for Venture Capital and Private Equity
26.5 Summary
Chapter 27: Risk Management and Financial EngineeringOpening Focus: Southwest Airlines Profits by Hedging Fuel Costs
27.1 Overview of Risk Management
27.2 Forward Contracts
27.3 Futures Contracts
27.4 Options and Swaps
27.5 Financial Engineering
27.6 Summary
Appendix A: Financial Tables T1
Appendix B: Cumulative Probabilities T13
Appendix C: Key Formulas F1
Bibliography B1
Glossary G1
Name Index 11
Company Index 13
Subject Index 16