CORPORATE FINANCE - gbv.de · INTRODUCTION TO CORPORATE FINANCE 7 ... 10.4 More about Project Cash Flow 305. ... Total Cash Flow and Value 314 Conclusion 314 . .•-

Ninth Edition

CORPORATE FINANCE

Stephen A. RossMassachusetts Institute of Technology

Randolph W. WesterfieidUniversity of Southern California

University of Kentucky

McGraw-HISIBrwin

Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis

Bangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico City

Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

CHAPTER!

INTRODUCTION TO CORPORATE FINANCE 7

1.1 Corporate Finance and the Financial Manager 2What Is Corporate Finance? 2The Financial Manager 2 (

Financial Management Decisions 2"'•.;. Capital Budgeting 2

' v , Capital Structure ;3:, / .-, Working Capital Management 4' ...• , Conclusion 4 . . • , • 1

1.2 Forms of Business Organization 4Sole Proprietorship 4

v Partnership 5 . . .Corporationl 5 ,A Corporation by Another Name . . . 7

1.3 The Goal of Financial Management 7Possible Goals 8The Goal of Financial Management 8A More General Goal 9 , . ' . * _ .Sarbanes-Oxley 9

1.4 The Agency Problem and Control of the' Corporation 70 .

..: Agency Relationships 70: Management Goals 77'

Do Managers Act in the'Stockholders' Interests? 71. Managerial Compensation ' 11• ,\ " Control of the-Firm 12 • •

.-" • '.Conclusion 12Stakeholders 72

1.5 Financial Markets and the Corporation 13Cash Flows to and from the Firm 14Primary versus Secondary Markets 74

! • Primary Markets 14 ,•••• .-,-" Secondary Markets 15

Dealer versus Auction Markets 15Trading in Corporate Securities 75

'Listing, 161.6 Summary and Conclusions 16

CHAPTER 2

FINANCIAL STATEMENTS, TAXES,AND CASH FLOW 79

2.1 The Balance Sheet 20Assets: The Left Side 20Liabilities and Owners' Equity: The Right Side 20Net Working Capital 27Liquidity 22Debt versus Equity 23Market Value versus Book Value 23

2.2 The Income Statement 24GAAP and the Income Statement 25Noncash Items 26t ime and Costs 26

2.3 Taxes 28Corporate Tax Rates 28Average versus Marginal Tax Rates 29

2.4 Cash Flow 30Gash Flow from Assets 31

. . . Operating Cash Flow 31Capital Spending 32Change in Net Working Capital 32Conclusion 33A Note about "Free" Cash Flow 33

Cash Flow to Creditors and Stockholders 33Cash Flow to Creditors 33Cash Flow to Stockholders 33

An Example: Cash Flows for Dole Cola 35Operating Cash Flow 35Net Capital Spending 36Change in NWC and Cash Flow from Assets 36

, . Cash Flow to Stockholders and Creditors 362.5 Summary and Conclusions 37

CHAPTER 3

WORKING WITH FINANCIAL STATEMENTS 46

3.1 ' Cash Flow and Financial Statements:; A Closer Look 47

Sources and Uses of Cash 47The Statement of Cash Flows 49

3.2 Standardized Financial Statements 5 /• Common-Size Statements 57 ^ : ,

. Common-Size Balance.;SheetS:'51:';, , ;

Common-SizeIncome.StatementsK52 . ' . ;

Common-Size StatemenisofCashFlows ..-• 53,,Common-Base Year Financial Statements: :Trend Analysis . 53 ' K - i / " •. '

XXXI

> Combined Common-Size and BaseYear Analysis 53 '

3.3 Ratio Analysis 54Short-Term Solvency, or Liquidity, Measures 55

' Current Ratio 55The Quick (or Acid-Test) Ratio ,56Other Liquidity Ratios 57

Long-Term Solvency Measures 57> Total Debt Ratio 57

A Brief Digression; Total Capitalization versusTotal Assets 58Times Interest Earned 58

•Cash Coverage 59 . ' ' ;:

Asset Management, or Turnover, Measures 59Inventory Turnover and Days'Sales in Inventory 59

., ., ReceivablesTurnoyer and Days'Sales, * ,in Receivables. 60, ' . • • *, . ,Asset Turnover Ratios 61 •

Profitability Measures 61Profit Margin 62 " ;Return on Assets 62 •Return on Equity 62 • • " _ , ' ,

Market Value Measures 63Price-Earnings Ratio 63 ,

Price-Sales Ratio 63 . • • . .

Market-to-Book Ratio 64Conclusion 64 ,

3.4 The Du Pont Identity 65A Closer Look at ROE 65An Expanded Du Pont Analysis 67

3.5 Using Financial Statement Information 69Why Evaluate Financial Statements? 69

Internal Uses 69 •External Uses .'69

Choosing a Benchmark 70Time Trend Analysis 70 .Peer Group Analysis 70 ' • .

Problems with Financial Statement Analysis 743.6 Summary and Conclusions 76

CHAPTER 4

LONG-TERM FINANCIAL PLANNINGAND GROWTH 87

4.1 What Is Financial Planning? 88Growth as a Financial Management Goal 88Dimensions of Financial Planning 89What Can Planning Accomplish? 90, Examining Interactions 90

Exploring Options 90Avoiding Surprises 90Ensuring Feasibility and Internal Consistency 90Conclusion '" 90

4.2 Financial Planning Models: A First Look 97A Financial Planning Model: The Ingredients 97

Sales Forecast 91Pro Forma Statements 97Asset Requirements 92

' ' . Financial Requirements 92The Plug 92

Economic Assumptions 92A Simple Financial Planning Model 92

4.3 The Percentage of Sales Approach 94The Income Statement 94The Balance Sheet 95A Particular Scenario 97An Alternative Scenario 98

4.4 External Financing and Growth 99EFN and Growth 99Financial Policy and Growth 703• The Internal Growth Rate 103

The Sustainable Growth Rate 103Determinants of Growth 105

A Note about Sustainable Growth RateCalculations 706

4.5 Some Caveats Regarding FinancialPlanning Models 708

4.6 Summary and Conclusions 709

PART J Valuation of Future Cash Flow

C H A P T E R S . • • . ' ' / ' " ' • '

INTRODUCTION TO VALUATION: THE TIME VALUEOF MONEY 779 ,

5.1 Future Value and Compounding 720.' *.' Investing for a Single Period : 720, Investing for More Than One Period .720

• A Note about Compound Growth 726

5.2

5.3

5.4

Present Value and Discounting 727The Single-Period Case 727Present values for Multiple Periods 728More about Present and Future values 737Present versus Future Value 737Determining the Discount Rate 732Finding the Number of Periods 736Summary and Conclusions 739

CHAPTER 6

DISCOUNTED,CASH FLOW VALUATION 144

6.1 Future and Present values of MultipleCash Flows 745 ,

;'•;":.,: ", Future Value with Multiple Cash"Flows 745" -Present Value with Multiple Cash Flows 748

:. A Note about Cash Flow Timing 7576.2 Valuing Level Cash Flows: Annuities

and Perpetuities 752'•'•••'• Present,Value for Annuity Cash Flows 753

".-*. Annuity Tables 154 . • .,• / . Finding the'Payment_ 155 -

/- Finding the Rate 157 . ,•:•' , Future Value for Annuities 759 ,

- {A Note about Annuities Due 160•'.'•;!" Perpetuities 760- " -, .i Growing Ahnuitiesand Perpetuities 7676.3 Comparing Rates: The Effect of Compounding 763'"'.: Effective Annual Rates and Compounding 763

Calculating arid Comparing Effective" Annual Rates ,764 ;

..•"'••• , EARs;and APRs- 766 ' , ' ,* Taking It to the Limit: A Note about Continuous" •••. . Cbrnpounding :. 767 . •.• -'6.4 Loan Types and Loan Amortization 769

. .Pure Discount Loans 769,'.."'V--. Interest-Only Loans 169'L-'••-•': . .Amortized Loans 170 ;/ '• , , ,

6.5 , Summary arid Conclusions 7 75

C H A P T E R 7 / . ' .-, .; '..- • "•'•• '', • •

INTEREST RATES A N D B O N D V A L U A T I O N 790

7:1 Bonds and Bond Valuation 797•" . Bond Features and: Prices 191

, .Bond Values and Yields .797 ., , , : ; InterestRate Risk 795

Finding the Yield to Maturity: More Trial and Error 7967.2 More about Bond Features 207

." Is It Debt or Equity? 207: :. .'Long-TermDebt: The Basics 207

. .'.:-. The Indenture 203 : ,. Terms~ofa Bond 203 . . .

",, ..-'.•". , Security" 204 , '•': .'.'• ' ,Seniority 204 '•

' • • ' . ' • : " • .Repayment 204 ' . •

'.'•'"• : .'The Call Provision : 205 .:,},[ Protective Covenants 205 . . -7.3 Bond Ratings 2067.4 Some Different Types of Bonds 207

, G o v e r n m e n t B o n d s 2 0 7 . '.

Z e r o C o u p o n B o n d s 208F l o a t i n g - R a t e B o n d s , , 2 0 9 ,., . . . ,

• •, O t h e r T y p e s o f B o n d s , : 2 7 0 v ' : r - , ' , ; • , ; • ;

7.5. Bond Markets 272 ;; ''. Y ^ ;How Bonds Are Bought'apd Sold '212^:'':-. • ;.'.

•" Bond.Price Repor t ing, 274,,,; ' " ; • ; . , ; > , - " •A Note about Bond Price Quotes , 2 7 5 , , . . . . : ;

7.6 Inflation and Interest Rates 277Real versus Nomina l rRates . 2 7 7 ' "•;•",'••"'. • ; ;

; •' T h e Fisher E f fec t / '27 '8 ; i ; ; ; : ' / ' : V; ' ; ! ' ; : , : \ ; A ••(*;,, •',''/•Inf lat ion and Present Values .279 : ...

7.7 D e t e r m i n a n t s o f B o n d Y i e l d s 2 2 0 ;:T h e T e r m S t r u c t u r e o f In te res t ;Rates-^ 220 :• 1 ,

: B o n d Y i e l d s a n d t h e 'Yield-, Curve : , . P u t t i n g , ..••-•,It A i r T o g e t h e r ' ' 2 2 7 , , " ; j ' '.•','.,',, ; ; \ ; ' '. -.-

•• ' C o n c l u s i o n " - , 2 2 3 ' : f *__,",•'•;' ' '•; ' . '--•.*•", ••-• • .-," ,

7.8 Summary andi Conclusions" ,224 '

• C H A P T E R - 8 ;-•>; ::;-;:J::y;-;':J:',;*:: : ; . > ; : '*-.\^'^

STOCK VALUATION^ 237 ' > ; ;

: ^ ;

8.1 Common Stock Valuation •232''• -, ' . C a s h F l o w s : 232- }•{'*,- /•.. V : 5 > v \ - . ^ . ' " ' . " '''••'.':'

• S o m e S p e c i a l C a s e s - .234,./;".",,., . / , , - . ,

• '• ' ' \ Zero:Growth]::23'4^-'-'''[,:\,U:•:•*'',,. •, •' ; '"': '

; . • ' • Constant Growth ,,234 • ; , : ; ; > ' v ' - - . ! r •.. .; •,', •• NonconstantGrowth ,237 :,:- " ' • • ' • • „ ' ' ' . :

• ' '- --, Two-Stage Growthy239\X; V ; ',:'''-.' • • ,: ;

• Components of the'Required Return. 240 ;.,8.2 Some Features of Common and

Preferred Stocks 242; 'CommonStbckFeatures 242' •• ; , ...

• ;-: " Shareholder -Rights; ̂ 242.-:.';. "", ,' '. (\•.' ' : , p r o x y V o t i n g ' ^ 2 4 3 ' . ^ •, ;';••';• •'•'•',-•;-'• •', / ' • " ' . '

• - :_,-, "Classes of.Stock':• 244 \ _'.'{:;:;,,-,•.'];"•: : ,'

• •• . ' Other Rights: 244 V j " , * ' ' ' '•: ' ; , ' V "'<;-•_ ;.- '•"•';•,; •,.

•- '' ,'•.. • -'Dividends'- :244:-.:,!ll,y".•;:,;,.f-,.^:^:y'.'-:\- ; • „ * - " , .

P r e f e r r e d S t d c k F e a t u r e s - > 2 4 5 ; , , ; * ; * • ' , : . : ' . , •

•/":,' StatedValue':245'f./::fv':i::^'':•.< . '" Jr.•, ',• ,' Cumulative"andNoncumulative,Dividends- 245.. . . . ' '• te Preferred Stock Really, Debt?',245 .••';'•''; .8.3 The Stock Ma rke t s f ) 246 ' '

Dealers and. Brokers -'246': ;:',;,' c ' , , * ,. .Organization o f t he : NYSE ; , 247 ; ; , ; . - ; ; ;;:- J, '• ', Members ^247- ''••':. , " , / - ; - • ' , ] ; / • , , ' " , , '; v" ; , ,

• :- •'• 'Operations1 \248'-.'!'';..: v , " ' ' ; ; • • ' ' * ' " . : ] • ,> V ' • '

„ • • ' , , • , Floor Activity, ,:2$8' ; A , : ; . v J ' , : , ,". ' ;•;•,-,: •- ,•''•'• -•

.'. NASDAQ Operations^,•;2'49y:-"~;[ ; . : ; ;,,"" :'?:,.",•" - - •,'. ECNS:'250;}.:.:'--,, : - : / ; T / J : - V ; ' , Y V , - '-".',,'V:

Stock Market-Reporting'., "25p_".;'•;, "'",•,•.-'/•'"'' •8.4 SummaryandConclusions 252

CHAPTER*

NET PRESENT VALUE AND OTHERINVESTMENT CRITERIA 260" ', : :,/:" *•' '''

9.1 Net Present Value 267- The Basic Idea 267 - ;l

Estimating Net Present Value 2629.2 The Payback Rule 265

Defining the Rule 265Analyzing the Rule 266Redeeming Qualities of the Rule 267Summary of the Rule 268

9.3 The Discounted Payback 2689.4 The Average Accounting Return 2779.5 The Internal Rate of Return 273_;: Problems with the IRR 277

"'••• Nonconventional Cash Flows 277•: Mutually Exclusive Investments .279 .- •

Investing or Financing? 281. Redeeming Qualities of the IRR 282

The Modified Internal Rate of Return (MIRR) 283• • . Method #1: The Discounting Approach 283

Method #2: The Reinvestment Approach 283';..'- , Method #3: The Combination Approach 283,

, MIRR or IRR: Which Is Better? 2849.6 The Profitability Index 284 • ,• ' ' '/9.7 The Practice of Capital Budgeting -2859.8 Summary and Conclusions 288

CHAPTER 10

MAKING CAPITAL INVESTMENT DEdSIONS 298

10.1 Project Cash Flows: A First Look 299.Relevant Cash Flows 299 . .'", :

The Stand-Alone Principle 299 ;

10.2 Incremental Cash Flows 299Sunk Costs 300 • .- -,Opportunity Costs 300

' Side Effects 300 . , . • ' . . . - . -Net Working Capital 301 , ' , ' • ' 'Financing Costs 307

. Other Issues 307 . ' '.10.3 Pro Forma Financial Statements and Project

Cash Flows 302/ Getting Started: Pro Forma Financial Statements " 302

•'-. . Project Cash Flows; .303 , '; Project Operating Cash Flow. 303

Project Net Working Capital and Capital Spending 304Projected total Cash Flow and Value * .304

10.4 More about Project Cash Flow 305.A Closer Look at Net Working Capital' 305 ; •,'•;- ' '.'Depreciation 308 ' . ; ; - ••;

Modified ACRS Depreciation (MACRS)- 308Book Value versus Market Value,; 309

An Example: The Majestic Mulch and Compost ;

Company (MMCC) 37 7 x . . ','. ,. - ;Operating Cash Flows 311 , ,,. ' ; - ; -:

Change in NWC 311 . - '.-,,"••Capital Spending 314 ...Total Cash Flow and Value 314Conclusion 314 . .•-

10.5 Alternative Definitions of Operating Cash Flow 375,The Bottom-Up Approach 376The Top-Down Approach 376 . .The Tax Shield Approach .376 - , ' " . - , • ;

Conclusion 377 . , '10.6 Some Special Cases of Discounted Cash

Flow Analysis 37 7Evaluating Cost-Cutting Proposals '377Setting the Bid Price 379 . . . . . .Evaluating Equipment Options with Different Lives 327


CHAPTER 11

PROJECT ANALYSIS AND EVALUATION 335 .

11.1 Evaluating NPV Estimates 336The Basic Problem 336 :

Projected versus Actual Cash Flows 336Forecasting Risk 336 . . .S o u r c e s o f V a l u e 3 3 7 ••:. , ••• , • • . - , ' • ' , '

11.2 Scenario and Other What-lf Analyses 338 ,G e t t i n g S t a r t e d 3 3 8 " ' . '• , . ' . :: •."••,•

S c e n a r i o A n a l y s i s 339 -'. , "'','•;. :

S e n s i t i v i t y A n a l y s i s 3 4 7 • . ' . - ' . , ' • .,

S i m u l a t i o n A n a l y s i s 342 . . . ., *, .: .

1 1 . 3 B r e a k - E v e n A n a l y s i s 342

Fixed and Variable Costs 343 '••:.• 'Variable Costs 343 , . ... . .'•

Fixed Costs 344 , . • , ; ,Total Costs 344 , . : . '.'

Accounting Break-Even 346 : *Accounting Break-Even: A Closer Look 346Uses for the Accounting Break-Even . 348., ', .

11.4 Operating Cash Flow, Sales Volume, and •<•'.Break-Even 348Accounting Break-Even and Cash Flow ,349

The Base Case 349 > .'••••: .. , ,-,-

Calculating the BreakrEven Level 349"•; Payback and Break-Even 350

Sa|es Volume arid Operating Cash Flow-Cash Flow, Accounting, and FinancialBreak-Even Points'- 350 '•'• , ,. ! ".

, : Accounting Break-Even Revisited 351.',•• C a s h B r e a k - E v e n 3 5 1 .""• - • '.;•'• , .

'. {FinancialBreak-Even 352 . '•• .•Conclusion 352 " ,

350.

11.5 Operating Leverage 353The Basic Idea 353.Implications of Operating Leverage 354Measuring Operating Leverage 354

. Operating Leverage and Break-Even 35511.6 Capital Rationing 356

Soft Rationing 356Hard Rationing 357

;11.7 Summary and Conclusions 357

C H A P T E R 1 2 • • ' • ' , •• , . • ;• , . - : • - - ' • / ,'•• . . " . - . ; -

SOME LESSONS FROM CAPITAL MARKET HISTORY 365

12.1

12.2

12.3

12.4

12.5

12.6

12.7

R e t u r n s ,366 ..•,-,'•. .. , . ' - , " • . ; . . . " • , . . ' - " ' ' ' "

D o l l a r R e t u r n s " 366 , • ;, / , .

P e r c e n t a g e R e t u r n s 368.' :/. . . . ' . , - , '

; The Historical Record 370 . ;, ,A First Look ,370 . ; '„':. • / '"_. [. - . :

A Closer Look 3 7 2 , .

A v e r a g e R e t u r n s : T h e F i r s t L e s s o n 3 7 6 . . ...

Calculating Average Returns 376 , .Average Returns: the Historical Record 376Risk Premiums 377,, ,. ' • , ,, ' . ' , , • . -The First Lesson 377 : , - , ' - : ,The Variability of Returns: The Second Lesson 378 .Frequency Distributions and Variability ^ 378The Historical Variance and Standard Deviation 379The Historical Record 387 ! .Normal Distribution 387The Second Lesson 383; . , ;. " . ..Using Capital Market History 383 .More on the Stock Market Risk Premium .384More about Average Returns ,385 , :

;; Arithmetic versusi Geometric Averages 386 .' Calculating Geometric Average Returns 386 " ;'-'Arithmetic Average Return or GeometricAverage Return? 388 : ,Capital Market Efficiency 389,.

: Price Behavior in an Efficient Market 389The Efficient Markets Hypothesis 397Sortie Commonr Misconceptions about the EMH 397 .The Forms of Market Efficiency 393Summary and Conclusions .394

CHAPTER13 .

RETURN, RISK, AND THE SECURITY MARKET LINE 407

.13.-1 Expected Returns and Variances 402

Expected Return 402Calculating the Variance 404

1312 Portfolios 405••-•'• Portfolio Weights 406

^Portfolio Expected Returns 406Portfolio Variance 407

13.3 Announcements, Surprises, andExpected Returns 409Expected and Unexpected Returns 409Announcements and News 409

13.4 Risk: Systematic and Unsystematic 47 7• Systematic and Unsystematic Risk 47 7

* Systematic and Unsystematic Components• , of Return 47 713.5 Diversification and Portfolio Risk 412

The Effect of Diversification: Another Lessonfrom Market History 472The Principle of Diversification 473Diversification and Unsystematic Risk 414Diversification and Systematic Risk 475

13.6 Systematic Risk and Beta 475:•:'. The Systematic Risk Principle 476

Measuring Systematic Risk 476Portfolio Betas 477

13.7 The Security Market Line 479'"•': Beta and the Risk Premium 479

.-'•••.' : , The Reward-to-Risk Ratio 420, •'."; The Basic Argument 421

. • ••• ; ' . ' The Fundamental Result 423The Security Market Line 424

,',' v•. t•. Market Portfolios 424The Capital Asset Pricing Model 424

13.8 The SML and the Cost of Capital:A Preview 427

1 The Basic Idea 427The Cost of Capital 427


PART 6 Cost or Capital and Lone-Term Financial Poll

CHAPTER 14

COST OF CAPITAL 437

14.1 The Cost of Capital: Some Preliminaries 438Required Return versus Cost of Capital 438Financial Policy and Cost of Capital 439

14.2 The Cost of Equity 439The Dividend Growth Model Approach 439.

Implementing the Approach 439Estimating g 440 -,.

Advantages and Disadvantages of the -Approach 441 ,.-.-.* , , , , , - '

. . T h e S M L A p p r o a c h 4 4 7 - • , ,

' : I m p l e m e n t i n g t h e A p p r o a c h 4 4 2 . . . ,

. Advantages and Disadvantages of the '. '"' / ' A p p r o a c h 4 4 2 •".'••' • .. '. ' ,-.... '..*•. , ••. '

14.3 The Costs of Debt and Preferred Stock 443T h e C o s t o f D e b t 4 4 3 ; . ':, ,\ . ,;'. . , . '

The Cost of Preferred Stock; 44414.4 The Weighted Average Cost of Capital 445

The Capital Structure Weights; 445: ;:v :

Taxes and the Weighted Average Cost of Capital 446Calculating the WACC for Eastman Chemical 447

Eastman's Cost of Equity 447,''-'••}<'••:••' ' / ' • ••

Eastman's Cosf of Debt 449''. "'.-;,•Eastman's WACC 450 :"'?".:('- ... . ',, • ' .

Solving the Warehouse Problem and Similar CapitalBudgeting Problems 450 . ,'. .; •.: , , '"•'•• •Performance Evaluation: Another Use of theWACC 453 :':',"• ' ': " ' •; ';,' v

14.5 Divisional and .Project Costs of Capital 454The SML and the WACC 455 :

Divisional Cost of Capital 456The Pure Play Approach 456The Subjective Approach 457

14.6 Flotation Costs and the Weighted Average Costof Capital 458The Basic Approach 459 . . ,Flotation Costs and NPV 460 •Internal Equity and Flotation Costs 462 ,


CHAPTER 15

RAISING CAPITAL 477 .'?''/

15.1 The Financing Life Cycle of a Firm: Early-StageFinancing and Venture Capital 472 ,:Venture Capital 472 .

Some Venture Capital Realities 473Choosing a Venture Capitalist 473Conclusion 474

15.2 Selling Securities to the Public: The BasicProcedure 474

15.3 Alternative Issue Methods 47515.4 Underwriters 477

Choosing an Underwriter 478Types of Underwriting 478

Firm Commitment Underwriting 478Best Efforts Underwriting 478

' Dutch Auction Underwriting 479The Aftermarket 479The Green Shoe Provision 480Lockup Agreements 480The Quiet Period 480

15.5 IPOs and Underpricing 487IPO Underpricing: The 1999-2000 Experience 487Evidence on Underpricing 487Why Does Uriderpricing Exist? 484

15.6 New Equity Sales and the Value of the Firm 48715.7 The Costs of Issuing Securities 488

The Costs of Selling Stock to the Public 488The Costs of Going Public: The Case of Symbion 490

15.8 Rights 492;; The Mechanics of a Rights Offering 492

Number of Rights Needed to Purchase a Share 493The Value of a Right 494

, ., . • Ex Rights .496the Underwriting Arrangements 497Effects on Shareholders 497

15.9 Dilution 498Dilution of Proportionate Ownership 498Dilution of Value: Book versus Market Values 498, A Misconception 499

•,." The Correct Arguments 50015.10 Issuing Long-Term Debt 50015.11 Shelf Registration 50715.12 Summary and Conclusions 502

CHAPTER16

FINANCIAL LEVERAGE AND CAPITALSTRUCTURE POLICY 508

16.1 The Capital Structure Question 509

: Firm Value arid Stock Value: An Example 509Capital Structure and the Cost of Capital 570

16.2 The Effect of Financial Leverage 570The Basics of Financial Leverage 57 7

Financial Leverage, EPS, and ROE: An Example 511EPS versus EBIT 512

Corporate Borrowing and Homemade Leverage 57416.3 Capital Structure and the Cost of Equity

Capital 575M&M Proposition I: The Pie Model 575The Cost of Equity and Financial Leverage: M&MProposition II 576Business and Financial Risk 578

16.4 M&M Propositions I and II with CorporateTaxes -579- . , •,:" -; - ,' , , ; • •The Interest Tax Shield 520Taxes and M&M Proposition 1. 520Taxes, the WACC, and Proposition II 527 . .Conclusion 522

16.5 Bankruptcy Costs 524Direct Bankruptcy Costs 525Indirect Bankruptcy Costs 525

16.6 Optimal Capital Structure 526The Static Theory of Capital Structure 526Optimal Capital Structure and the Costof Capital 527Optimal Capital Structure: A Recap 528Capital Structure: Some ManagerialRecommendations 530 ,

Taxes 530 :Financial Distress 530

16.7 The Pie Again 530The Extended Pie Model 537Marketed Claims versus Nonmarketed Claims 532

16.8 The Pecking-Order Theory 532Internal Financing and the Pecking Order 532Implications of the Pecking Order 533

16.9 Observed Capital Structures 53416.10 A Quick Look at the Bankruptcy Process 536

Liquidation and Reorganization 536Bankruptcy Liquidation 536Bankruptcy Reorganization 537

Financial Managernent and the BankruptcyProcess 538Agreements to Avoid Bankruptcy 539


1 7 . 2

Standard Method of Cash DividendPayment 547Dividend Payment: A Chronology 547More about the Ex-Dividend Date 548Does Dividend Policy Matter? 550An Illustration of the Irrelevance of DividendPolicy 550

Current Policy: Dividends Set Equal toCash Flow 551Alternative Policy: Initial Dividend Greater Than CashFlow 551

H o m e m a d e D i v i d e n d s 5 5 7 , .-_.,...,v .%,..

17.3

17.4

17.5

17.6

17.7

17.8

CHAPTER 17

DIVIDENDS AND PAYOUT POLICY 546

17.1 Cash Dividends and Dividend Payment 547Cash Dividends 547 17.9

Real-World,Factors Favoring a Low ; •'• ,'y-Dividend Payout 553 , ;

Taxes" ,'553.'"/'":'';- "; .; ,'•;,; >.'"';- :-'-V:>-: . ',;.•" „•"' ".Flotation Costs' 553 ';' ,''.':; / •'/'.,.;,; ; " \ . - j i "Dividend Restrictions* 553. -'_"'. '• '-._ '••'•<,.•.' ,.'.Real-World Factors Favoring a High -Dividend Payout 554 , ';Desire for Current Income 554 ;, , .Tax and Other Benefits from High Dividends 555

Corporate Investors 555 , ,".Tax-Exempt Investors^ 555 • < ,.'• , : •••'

C o n c l u s i o n 5 5 5 :•,•/;!. •''- '••-,. , - - '

A Resolution of Real-World Factors? 555Information Content of Dividends 556The Clientele Effect 557. '.."••Stock Repurchases: An Alternative to CashDividends 558 .

Cash Dividends versus Repurchase 559Real-World Considerations in aRepurchase 560 . V r

Share Repurchase and EPS 567What We Know and Do Not Know aboutDividend and Payout Policies 567Dividends and Dividend Payers 567Corporations Smooth Dividends 564Putting It All Together 564Some Survey Evidence on Dividends 566-Stock Dividends and Stock Splits 568.'Some Details about Stock Splits and StockDividends 568 , ' .' ' ' ' - .

Example of a Small Stock Dividend 568Example of a Stock Split 569 . -Example of,a Large Stock Dividend 569

Value of Stock Splits and Stock Dividends 569The Benchmark Case- 570 •• 'Popular Trading.Range 570 •

Reverse Splits 570 ; ' -Summary arid Conclusions 577

C H A P T E R 1 8 . . v : , ; v > : ' . " ;:•{ % : , / . ; : / • ; ;'•

SHORT-TERM FINANCE AND PLANNING 579

18.1 Tracing Cash and Net Working Capital 580

18.2 The Operating Cycle and the Cash Cycle 587: Defining the Operating arid Cash Cycles 582• The Operating Cycle .582.::, . .

. The Cash Cycle ,582 './The Operating Cycle arid the Firm's Organizational

' .',,'.' C h a r t " 5 8 3 . - ' ^ - " i f { ? " ':•'.. ; "• ' ; ' . - ' ' ' .Calculatingthe Operating arid Cash Cycles 584,

.' :. , The Operating Cycle 5 8 5 ; , . ^: •• '. ' • • ' , . . •• •-'•• ."•• The.Cash Cycle 586* , '•;'•'.", ",: -;.' '' • '

Interpreting tHe Cash Cycle "587 ,18.3 Some Aspects of Short-Term Financial Policy 587

The Size of the Firrn's Investment in Current' ' ; A s s e t s 5 8 8 - '•"• ' "•_ '-. :•'-' . * : ' - ' • ' ' • . " • • /

Alternative Financing Policies for Current' " : A s s e t s : 589, -,. " • • • • , > :•-\

';• An Ideal Case:'589 '." ' •

Different'Policies for Financing Current Assets 589Which Financing Policy Is Best? 592

, Current Assets and Liabilities in Practice 593

18.4 The Cash Budget 594 •Sales and Cash Collections; 594 'Cash Outflows 595 JThe Cash Balance 595

18.5 Short-Term Borrowing 596Unsecured Loans 597

Compensating Balances 597Cost of a Compensating Balance 597Letters of Credit 598

Secured Loans 598Accounts Receivable Financing 598Inventory Loans 599

Other Sources 59918.6 A Short-Term Financial Plan 60018.7 Summary and Conclusions 607

CHAPTER 19

CASH AND LIQUIDITY MANAGEMENT 672

19.1 Reasons for Holding Cash 673The Speculative and Precautionary Motives 673The Transaction Motive 673Compensating Balances 673Costs of Holding Cash 613Cash Management versus LiquidityManagement 674

19.2 Understanding Float 674Disbursement Float 674Collection Float and Net Float 675

• - Float Management 676. . ; Measuring Float 676 •• •

• - Some Details , 67 7Cost of the Float 617

. Ethical and Legal Questions 619Electronic Data Interchange and Check 21: The End of

• Float? 620-19.3 Cash Collection and Concentration 627

Components of Collection Time 627Cash Collection 627Lockboxes 627Cash Concentration 623Accelerating Collections: An Example - 624

19.4 Managing Cash Disbursements 625Increasing Disbursement Float 625Controlling Disbursements 626

Zero-Balance Accounts 626Controlled Disbursement Accounts 627

19.5 Investing Idle Cash 627".-:' Temporary Cash Surpluses 627

. Seasonal or Cyclical Activities 627Planned or Possible Expenditures 62 7

Characteristics of Short-Term Securities 628Maturity 628,Default Risk 628Marketability 628Taxes 628

Some Different Types of Money MarketSecurities 629

19.6 Summary and Conclusions 63019A Determining the Target Cash Balance 634

The Basic Idea 634The BAT Model 635

The Opportunity Costs 636The Trading-Costs 637The Total Cost: 637The Solution. 638:Conclusion' • 639

The MiileHDrr Model: A More GeneralApproach 639.

The Basicjdea 639Using the'Model 639

Implicatioris of the BAT and Miller-OrrModels ,647>.,,Other Factors Influencing the Target CashBalance 641.'•';,

CHAPTER 20

CREDIT AND INVENTORY MANAGEMENT 644

20.1 Credit and Receivables 645Components of Credit Policy 645The Cash Flows from Granting Credit 645The Investment in Receivables 646

20.2 Terms of the Sale 646The Basic Form 647The Credit Period 647

• The Invoice Date 647Length of the Credit Period 647

Cash Discounts 648Cost of the Credit 649. . • ;trade Discounts 649The Cash Discount and the ACP 649

Credit Instruments 65020.3 Analyzing Credit Policy 650

Credit Policy Effects 650Evaluating a Proposed Credit Policy 657

NPV of Switching Policies 651ABreak-Even Application 653

20.4 Optimal Credit Policy 653,The Total Credit Cost Curve 653Organizing the Credit Function 654 •

20.5 Credit Analysis 655When Should Credit Be Granted? 655, A One-Time Sale 655. Repeat Business 656 . .

Credit Information 657 .

Credit Evaluation and Scoring 657 . . .

20.6 Collection Policy 658Monitoring Receivables 658Collection Effort 659

20.7 Inventory Management 659The Financial Manager and InventoryPolicy 660Inventory Types 660Inventory Costs .660 . . .

20.8 Inventory Management J , / , ;,Techniques 667 : ',., , :The ABC Approach : .667. • , , , . ' * ; / , . ,

; The Economic Order Quantity Model 662'

. Inventory Depletion 662; , " . . .

., TheCarryingCosts 664 • " '.

, The Shortage Costs .664 \ "•; , ,

•-' . The•Total Costs 664 : • ' . "• ','".".,

,. , Extensions to the EOQ Model 666.. " :•„ •;.", Safety.Stocks 666 '•• . }. ' ' , ' '.•'-. • ' •' „ * .

' ',-, . R e o r d e r P o i n t s 6 6 6 . '"•-; ::""•'•'•••','"•:'••

, Managing Derived-Demand Inventories : 666Materials Requirements Planning . 668 - .

'•",' Just-in-time Inventory ...668' " • .20.9 Summary and Conclusions .66820A More about Credit Policy Analysis 674

T w o A l t e m a t i v e . A p p r o a c h e s 674. ."',/; •,.;.. ••'••,,. The One-ShotApproach '.675. ;.„>-.• •. ';.-•...

• The Accounts Receivable Approach 675

Discounts and Default Risk 676NPV of the Credit Decision 677A Break-Even Application 678

CHAPTER21

INTERNATIONAL CORPORATE FINANCE 687

21.1 Terminology 682 /21.2 Foreign Exchange Markets and Exchange

' 'Rates 683 ' / ' , • .-. Exchange Rates 684 ;,' • Exchange:Rate Quotations , 684

•';,." , Crdss-Rates and Triangle Arbitrage 685-- - .* Types of Transactions ' 687 ' . , „• , >

21.3 Purchasing Power Parity 688Absolute Purchasing Power Parity 688 ..

,; Relative Purchasing,PowerParity 690 -•; . The Basic Idea, 690 , ' . .

: ';•";. The Result 690 ': Currency Appreciation and Depreciation 69,7

21.4 Interest Rate Parity, Unbiased Forward Rates, andthe International Fisher Effect 692Covered Interest Arbitrage 692Interest Rate Parity 693Forward Rates and Future Spot Rates 694Putting It All Together 694

Uncovered Interest Parity 695The International Fisher Effect 695

21.5 International Capital Budgeting 696Method 1: The Home Currency Approach 696Method 2: The Foreign CurrencyApproach 697Unremitted Cash Flows 698

21.6 Exchange Rate Risk 698Short-Run Exposure 698Long-Run Exposure 699

Translation Exposure 700Managing Exchange Rate Risk 707

21.7 Political Risk 70721.8 Summary and Conclusions 702

APPENDIX A

MATHEMATICAL TABLES A-i

APPENDIX B

KEY EQUATIONS B-1

APPENDIX C

ANSWERS TO SELECTED END-OF-CHAPTERPROBLEMS C-1 :•••'•:::• .•'.

Index i-1

Documents

CORPORATE FINANCE - gbv.de · INTRODUCTION TO CORPORATE FINANCE 7 ... 10.4 More about Project Cash Flow 305. ... Total Cash Flow and Value 314 Conclusion 314 . .•-