Corporate Finance and Investment

by Pike, Richard; Neale, Bill

• ISBN13: 9780273695615
• ISBN10: 0273695614
• Edition: 5th
• Format: Paperback
• Copyright: 2006-01-30
• Publisher: Ft Pr

Summary

Takes a practical approach to corporate finance, applying key concepts and techniques to a broad range of contemporary issues in finance. Examining financial issues from a managerial stand point, this book demonstrates the role finance has to play in explaining and shaping business development.

Table of Contents

List of figures and tables	xiii
Preface	xvi
Guided tour of the book	xx
Guided tour of the companion website	xxii
Acknowledgements	xxiii
Publisher's acknowledgements	xxiv
Part I A FRAMEWORK FOR FINANCIAL DECISIONS
An overview of financial management	3	(21)
Introduction	4	(1)
The finance function	5	(1)
Investment and financial decisions	6	(1)
Cash -- the lifeblood of the business	7	(1)
The emergence of financial management	8	(1)
The finance department in the firm	9	(1)
The financial objective	10	(1)
The agency problem	11	(1)
Managing the agency problem	12	(1)
Social responsibility and shareholder wealth	13	(1)
The corporate governance debate	14	(2)
The risk dimension	16	(1)
The strategic dimension	17	(7)
Summary	20	(1)
Key points	20	(1)
Further reading	21	(1)
Questions	22	(2)
The financial environment	24	(36)
Introduction	25	(1)
Financial markets	25	(2)
The financial services sector	27	(3)
The London Stock Exchange (LSE)	30	(4)
Are financial markets efficient?	34	(7)
A modern perspective -- chaos theory	41	(2)
Short-termism in the City	43	(1)
Reading the financial pages	44	(2)
Taxation and financial decisions	46	(14)
Summary	47	(1)
Key points	47	(1)
Further reading	47	(1)
Appendix: Financial statement analysis	48	(9)
Questions	57	(3)
Present values and financial arithmetic	60	(28)
Introduction	61	(1)
Measuring wealth	61	(1)
Time-value of money	62	(1)
Financial arithmetic for capital growth	63	(2)
Present value	65	(3)
Present value arithmetic	68	(3)
Valuing bonds	71	(2)
Net present value	73	(15)
Summary	77	(1)
Key points	77	(1)
Further reading	77	(1)
Appendix I: The term structure of interest rates and the yield curve	78	(1)
Appendix II: The investment--consumption decision	79	(5)
Appendix III: Present value formulae	84	(2)
Questions	86	(2)
Valuation of assets, shares and companies	88	(33)
Introduction	89	(1)
The valuation problem	89	(1)
Valuation using published accounts	90	(6)
Valuing the earnings stream: P:E ratios	96	(2)
EBITDA -- a halfway house	98	(1)
Valuing cash flows	98	(2)
The DCF approach	100	(3)
Valuation of unquoted companies	103	(1)
Valuing shares: the Dividend Valuation Model	104	(2)
Problems with the Dividend Growth Model	106	(3)
Shareholder value analysis	109	(2)
Economic Value Added (EVA)	111	(10)
Summary	112	(1)
Key points	113	(1)
Further reading	113	(1)
Questions	114	(7)
Part II INVESTMENT DECISIONS AND STRATEGIES
Investment appraisal methods	121	(26)
Introduction	122	(1)
Cash flow analysis	122	(1)
Investment techniques -- net present value	123	(2)
Internal rate of return	125	(2)
Profitability index	127	(1)
Payback period	128	(1)
Accounting rate of return	129	(1)
Ranking mutually exclusive projects	130	(4)
Investment evaluation and capital rationing	134	(13)
Summary	137	(1)
Key points	137	(1)
Further reading	138	(1)
Appendix I: Modified IRR	138	(1)
Appendix II: Multi-period capital rationing and mathematical programming	139	(5)
Questions	144	(3)
Project appraisal -- applications	147	(26)
Introduction	148	(1)
Incremental cash flow analysis	148	(3)
Replacement decisions	151	(2)
Inflation cannot be ignored	153	(2)
Taxation is a cash flow	155	(2)
Use of DCF techniques	157	(2)
Traditional appraisal methods	159	(14)
Summary	163	(1)
Key points	163	(1)
Further reading	164	(1)
Appendix: The problem of unequal lives: Allis plc	164	(2)
Questions	166	(7)
Investment strategy and process	173	(22)
Introduction	174	(1)
Strategic considerations	174	(4)
Advanced manufacturing technology (AMT) investment	178	(2)
Environmental aspects of investment	180	(1)
The capital investment process	181	(7)
Post-auditing	188	(7)
Summary	190	(1)
Key points	190	(1)
Further reading	190	(1)
Questions	191	(4)
Part III INVESTMENT RISK AND RETURN
Analysing investment risk	195	(24)
Introduction	196	(1)
Expected net present value (ENPV): Betterway plc	197	(1)
Attitudes to risk	197	(1)
The many types of risk	198	(2)
Measurement of risk	200	(4)
Risk description techniques	204	(4)
Adjusting the NPV formula for risk	208	(2)
Risk analysis in practice	210	(9)
Summary	211	(1)
Key points	211	(1)
Further reading	212	(1)
Appendix: Multi-period cash flows and risk	212	(3)
Questions	215	(4)
Relationships between investments: portfolio theory	219	(18)
Introduction	220	(1)
Portfolio analysis: the basic principles	221	(2)
How to measure portfolio risk	223	(3)
Portfolio analysis where risk and return differ	226	(1)
Different degrees of correlation	227	(1)
Worked example: Gerrybild plc	228	(3)
Portfolios with more than two components	231	(2)
Can we use this for project appraisal? Some reservations	233	(4)
Summary	234	(1)
Key points	234	(1)
Further reading	234	(1)
Questions	235	(2)
Setting the risk premium: the Capital Asset Pricing Model	237	(34)
Introduction	238	(1)
Security valuation and discount rates	238	(1)
Concepts of risk and return	239	(4)
The relationship between different equity markets	243	(1)
Systematic risk	244	(5)
Completing the model	249	(1)
Using the CAPM: assessing the required return	250	(4)
The underpinnings of the CAPM	254	(1)
Portfolios with many components: the capital market line	255	(2)
How it all fits together: the key relationships	257	(2)
Reservations about the CAPM	259	(1)
Testing the CAPM	260	(1)
Factor models	261	(1)
The Arbitrage Pricing Theory	262	(1)
Issues raised by the CAPM: some food for managerial thought	263	(8)
Summary	266	(1)
Key points	266	(1)
Further reading	266	(1)
Appendix: Analysis of variance	267	(2)
Questions	269	(2)
The required rate of return on investment and Shareholder Value Analysis	271	(25)
Introduction	272	(1)
The required return in all-equity firms: the DGM	272	(4)
The required return in all-equity firms: the CAPM	276	(2)
Using value drivers -- Shareholder Value Analysis (SVA)	278	(2)
Worked example: Safa plc	280	(3)
Using `tailored' discount rates	283	(5)
Another problem: taxation and the CAPM	288	(1)
Problems with `tailored' discount rates	289	(1)
A critique of divisional hurdle rates	290	(6)
Summary	291	(1)
Key points	291	(1)
Further reading	292	(1)
Questions	293	(3)
Identifying and valuing options	296	(27)
Introduction	297	(1)
Share options	297	(7)
Option pricing	304	(5)
Application of option theory to corporate finance	309	(2)
Capital investment options	311	(3)
Why conventional NPV may not tell the whole story	314	(9)
Summary	315	(1)
Key points	315	(1)
Further reading	316	(1)
Appendix: Black--Scholes option pricing formula	316	(2)
Questions	318	(5)
Part IV SHORT-TERM FINANCING AND POLICIES
Treasury management and working capital policy	323	(30)
Introduction	324	(1)
The treasury function	324	(2)
Funding	326	(2)
How firms can use the yield curve	328	(1)
Banking relationships	329	(1)
Risk management	330	(7)
Working capital management	337	(2)
Predicting corporate failure	339	(1)
Cash operating cycle	340	(2)
Working capital policy	342	(4)
Overtrading problems	346	(7)
Summary	348	(1)
Key points	348	(1)
Further reading and website	348	(1)
Questions	349	(4)
Short-term asset management	353	(26)
Introduction	354	(1)
Managing trade credit	354	(7)
Worked example: Pickles Ltd	361	(1)
Inventory management	362	(5)
Cash management	367	(3)
Worked example: Mangle Ltd	370	(2)
Cash management models	372	(7)
Summary	373	(1)
Key points	373	(1)
Further reading	374	(1)
Appendix: Miller--Orr cash management model	374	(2)
Questions	376	(3)
Short- and medium-term finance	379	(32)
Introduction	380	(1)
Trade credit	380	(2)
Bank credit facilities	382	(3)
Invoice finance	385	(2)
Using the money market: bill finance	387	(2)
Hire purchase (HP)	389	(2)
Leasing	391	(2)
Lease evaluation: a simple case	393	(3)
Motives for leasing	396	(2)
Allowing for Corporation Tax in lease evaluation	398	(4)
Financing international trade	402	(9)
Summary	405	(1)
Key points	405	(1)
Further reading	406	(1)
Questions	407	(4)
Part V STRATEGIC FINANCIAL DECISIONS
Long-term finance	411	(36)
Introduction	412	(1)
Guiding lights: corporate aims and corporate finance	412	(1)
How companies raise finance in practice	413	(1)
Shareholders' funds	414	(3)
Methods of raising equity finance	417	(15)
Debt instruments: debentures, bonds and notes	432	(9)
Leasing and sale-and-leaseback (SAL)	441	(6)
Summary	443	(1)
Key points	443	(1)
Further reading	443	(1)
Questions	444	(3)
Returning value to shareholders: the dividend decision	447	(31)
Introduction	448	(1)
The strategic dimension	449	(1)
The legal dimension	450	(1)
The theory: dividend policy and firm value	450	(8)
Objections to dividend irrelevance	458	(5)
The information content of dividends: dividend smoothing	463	(2)
Alternatives to cash dividends	465	(5)
The dividend puzzle	470	(1)
Conclusions	471	(7)
Summary	472	(1)
Key points	472	(1)
Further reading	473	(1)
Appendix: Home-made dividends	473	(2)
Questions	475	(3)
Capital structure and the required return	478	(34)
Introduction	479	(1)
Measures of gearing	480	(4)
Operating and financial gearing	484	(2)
Financial gearing and risk: Lindley plc	486	(3)
The `'traditional' view of gearing and the required return	489	(3)
The cost of debt	492	(2)
The overall cost of capital	494	(2)
Worked example: Damstar plc	496	(2)
More on Economic Value Added (EVA)	498	(1)
Financial distress	499	(5)
Two more issues: signalling and agency costs	504	(1)
Conclusions	504	(8)
Summary	506	(1)
Key points	506	(1)
Further reading	506	(1)
Appendix: Slipping down the credit ratings	507	(1)
Questions	508	(4)
Does capital structure really matter?	512	(29)
Introduction	513	(1)
The Modigliani--Miller message	513	(2)
MM's propositions	515	(4)
Does it work? Impediments to arbitrage	519	(1)
MM with corporate income tax	519	(3)
Capital structure theory and the CAPM	522	(3)
Linking the Betas	525	(1)
MM with financial distress	526	(1)
Calculating the WACC	527	(3)
The adjusted present value method (APV)	530	(2)
Which discount rate should we use?	532	(9)
Summary	533	(1)
Key points	533	(1)
Further reading	534	(1)
Appendix I: Derivation of MM's Proposition II	534	(1)
Appendix II: MM's Proposition III: the cut-off rate for new investment	535	(1)
Appendix III: Allowing for personal taxation: Miller's revision	536	(1)
Questions	537	(4)
Acquisitions and restructuring	541	(52)
Introduction	542	(1)
Takeover waves	542	(6)
Motives for takeover	548	(4)
Financing a bid	552	(2)
Evaluating a bid: the expected gains from takeovers	554	(1)
Worked example: ML plc and CO plc	555	(2)
The importance of strategy	557	(1)
The strategic approach	558	(5)
Post-merger activities	563	(4)
Assessing the impact of mergers	567	(6)
Value gaps	573	(2)
Other forms of value-creating	575	(18)
Summary	582	(1)
Key points	582	(1)
Further reading	582	(2)
Questions	584	(9)
Part VI INTERNATIONAL FINANCE
Managing currency risk	593	(37)
Introduction	594	(2)
The structure of exchange rates: spot and forward rates	596	(2)
Foreign exchange exposure	598	(2)
Should firms worry about exchange rate changes?	600	(1)
Economic theory and exposure management	601	(6)
Exchange rate forecasting	607	(3)
Devising a Foreign Exchange Management (FEM) strategy	610	(4)
Internal hedging techniques	614	(3)
External hedging techniques	617	(6)
Conclusions	623	(7)
Summary	624	(1)
Key points	624	(1)
Further reading	625	(1)
Questions	626	(4)
Foreign investment decisions	630	(31)
Introduction	631	(1)
Advantages of MNCS over national firms	631	(1)
Foreign market entry strategies	632	(2)
The incremental hypothesis	634	(2)
Complexities of foreign investment	636	(1)
The discount rate for Foreign Direct Investment (FDI)	637	(1)
Evaluating FDI	638	(4)
Exposure to foreign exchange risk	642	(3)
How MNCs manage operating exposure	645	(1)
Hedging the risk of foreign projects	646	(1)
Political and country risk	647	(3)
Managing Political and country risk (PCR)	650	(1)
Financing FDI	651	(2)
The WACC for FDI	653	(1)
Applying the APV to FDI	654	(7)
Summary	656	(1)
Key points	656	(1)
Further reading	656	(2)
Questions	658	(3)
Review and behavioural finance	661	(65)
Introduction	662	(1)
Review of main principles in finance	662	(3)
Behavioural finance	665	(5)
The changing finance function -- if we had 20/20 vision!	670	(3)
Summary	671	(1)
Key points	672	(1)
Further reading	672	(1)
Appendices
A. Solutions to self-assessment activities	673	(18)
B. Solutions to selected questions	691	(31)
C. Present value interest factor (PVIF)	722	(2)
D. Present value interest factor for an annuity (PVIFA)	724	(2)
Glossary	726	(9)
References	735	(8)
Index	743