Fundamentals of Corporate Finance

by Ross, Stephen A.; Westerfield, Randolph W.; Jordan, Bradford D.

• ISBN13: 9780072312904
• ISBN10: 0072312904
• Edition: 5th
• Format: Hardcover
• Copyright: 2000-06-01
• Publisher: McGraw-Hill

Table of Contents

Part One Overview of Corporate Finance	1	(46)
Introduction to Corporate Finance	2	(19)
Corporate Finance and the Financial Manager	3	(2)
What Is Corporate Finance?	3	(1)
The Financial Manager	3	(1)
Financial Management Decisions	3	(1)
Capital Budgeting	3	(1)
Capital Structure	4	(1)
Working Capital Management	5	(1)
Conclusion	5	(1)
Forms of Business Organization	5	(4)
Sole Proprietorship	6	(1)
Partnership	6	(1)
Corporation	7	(1)
A Corporation by Another Name...	8	(1)
The Goal of Financial Management	9	(3)
Possible Goals	9	(1)
The Goal of Financial Management	10	(1)
A More General Goal	11	(1)
The Agency Problem and Control of the Corporation	12	(4)
Agency Relationships	12	(1)
Management Goals	12	(2)
Do Managers Act in the Stockholders' Interests?	14	(1)
Managerial Compensation	14	(1)
Control of the Firm	14	(1)
Conclusion	15	(1)
Stakeholders	15	(1)
Financial Markets and the Corporation	16	(2)
Cash Flows to and from the Firm	16	(1)
Primary versus Secondary Markets	17	(1)
Primary Markets	17	(1)
Secondary Markets	17	(1)
Summary and Conclusions	18	(3)
Financial Statements, Taxes, and Cash Flow	21	(26)
The Balance Sheet	21	(5)
Assets: The Left-Hand Side	22	(1)
Liabilities and Owners' Equity: The Right-Hand Side	22	(1)
Net Working Capital	23	(1)
Liquidity	23	(1)
Debt versus Equity	24	(1)
Market Value versus Book Value	25	(1)
The Income Statement	26	(3)
GAAP and the Income Statement	27	(1)
Noncash Items	28	(1)
Time and Costs	28	(1)
Taxes	29	(2)
Corporate Tax Rates	29	(1)
Average versus Marginal Tax Rates	29	(2)
Cash Flow	31	(7)
Cash Flow from Assets	32	(1)
Operating Cash Flow	32	(1)
Capital Spending	33	(1)
Change in Net Working Capital	33	(1)
Conclusion	33	(1)
A Note on ``Free'' Cash Flow	34	(1)
Cash Flow to Creditors and Stockholders	34	(1)
Cash Flow to Creditors	34	(1)
Cash Flow to Stockholders	34	(2)
An Example: Cash Flows for Dole Cola	36	(1)
Operating Cash Flow	36	(1)
Net Capital Spending	37	(1)
Change in NWC and Cash Flow from Assets	37	(1)
Cash Flow to Stockholders and Creditors	37	(1)
Summary and Conclusions	38	(9)
Part Two Financial Statements and Long-Term Financial Planning	47	(70)
Working with Financial Statements	48	(38)
Cash Flow and Financial Statements: A Closer Look	49	(4)
Sources and Uses of Cash	49	(2)
The Statement of Cash Flows	51	(2)
Standardized Financial Statements	53	(4)
Common-Size Statements	54	(1)
Common-Size Balance Sheets	54	(1)
Common-Size Income Statements	55	(1)
Common-Size Statements of Cash Flows	55	(1)
Common-Base Year Financial Statements: Trend Analysis	55	(1)
Combined Common-Size and Base-Year Analysis	56	(1)
Ratio Analysis	57	(11)
Short-Term Solvency, or Liquidity, Measures	58	(1)
Current Ratio	58	(1)
The Quick (or Acid-Test) Ratio	59	(1)
Other-Liquidity Ratios	59	(1)
Long-Term Solvency Measures	60	(1)
Total Debt Ratio	60	(1)
A Brief Digression: Total Capitalization versus Total Assets	61	(1)
Times Interest Earned	61	(1)
Cash Coverage	61	(1)
Asset Management, or Turnover, Measures	62	(1)
Inventory Turnover and Days' Sales in Inventory	62	(1)
Receivables Turnover and Days' Sales in Receivables	63	(1)
Asset Turnover Ratios	64	(1)
Profitability Measures	64	(1)
Profit Margin	65	(1)
Return on Assets	65	(1)
Return on Equity	65	(1)
Market Value Measures	66	(1)
Price-Earnings Ratio	66	(1)
Market-to-Book Ratio	67	(1)
Conclusion	67	(1)
The Du Pont Identity	68	(2)
Using Financial Statement Information	70	(6)
Why Evaluate Financial Statements?	70	(1)
Internal Uses	70	(1)
External Uses	70	(1)
Choosing a Benchmark	71	(1)
Time-Trend Analysis	71	(1)
Peer Group Analysis	71	(4)
Problems with Financial Statement Analysis	75	(1)
Summary and Conclusions	76	(10)
Long-Term Financial Planning and Growth	86	(31)
What is Financial Planning?	87	(3)
Growth as a Financial Management Goal	88	(1)
Dimensions of Financial Planning	88	(1)
What Can Planning Accomplish?	89	(1)
Examining Interactions	89	(1)
Exploring Options	89	(1)
Avoiding Surprises	89	(1)
Ensuring Feasibility and Internal Consistency	90	(1)
Conclusion	90	(1)
Financial Planning Models: A First-Look	90	(3)
A Financial Planning Model: The Ingredients	90	(1)
Sales Forecast	90	(1)
Pro Forma Statements	91	(1)
Asset Requirements	91	(1)
Financial Requirements	91	(1)
The Plug	91	(1)
Economic Assumptions	92	(1)
A Simple Financial Planning Model	92	(1)
The Percentage of Sales Approach	93	(6)
The Income Statement	93	(2)
The Balance Sheet	95	(1)
A Particular Scenario	96	(1)
An Alternative Scenario	97	(2)
External Financing and Growth	99	(8)
EFN and Growth	100	(2)
Financial Policy and Growth	102	(1)
The Internal Growth Rate	102	(1)
The Sustainable Growth Rate	103	(1)
Determinants of Growth	104	(3)
Some Caveats Regarding Financial Planning Models	107	(1)
Summary and Conclusions	107	(10)
Part Three Valuation of Future Cash Flows	117	(126)
Introduction to Valuation: The Time Value of Money	118	(22)
Future Value and Compounding	119	(6)
Investing for a Single Period	119	(1)
Investing for More Than One Period	119	(5)
A Note on Compound Growth	124	(1)
Present Value and Discounting	125	(3)
The Single-Period Case	125	(1)
Present Values for Multiple Periods	126	(2)
More on Present and Future Values	128	(7)
Present versus Future Value	128	(1)
Determining the Discount Rate	129	(4)
Finding the Number of Periods	133	(2)
Summary and Conclusions	135	(5)
Discounted Cash Flow Valuation	140	(39)
Future and Present Values of Multiple Cash Flows	141	(7)
Future Value with Multiple Cash Flows	141	(3)
Present Value with Multiple Cash Flows	144	(3)
A Note on Cash Flow Timing	147	(1)
Valuing Level Cash Flows: Annuities and Perpetuities	148	(8)
Present Value for Annuity Cash Flows	148	(1)
Annuity Tables	149	(1)
Finding the Payment	150	(1)
Finding the Rate	151	(2)
Future Value for Annuities	153	(1)
A Note on Annuities Due	154	(1)
Perpetuities	154	(2)
Comparing Rates: The Effect of Compounding	156	(4)
Effective Annual Rates and Compounding	156	(1)
Calculating and Comparing Effective Annual Rates	156	(2)
EARs and APRs	158	(1)
Taking It to the Limit: A Note on Continuous Compounding	159	(1)
Loan Types and Loan Amortization	160	(5)
Pure Discount Loans	161	(1)
Interest-Only Loans	161	(1)
Amortized Loans	162	(3)
Summary and Conclusions	165	(14)
Interest Rates and Bond Valuation	179	(38)
Bonds and Bond Valuation	179	(9)
Bond Features and Prices	180	(1)
Bond Values and Yields	180	(4)
Interest Rate Risk	184	(2)
Finding the Yield to Maturity: More Trial and Error	186	(2)
More on Bond Features	188	(5)
Is It Debt or Equity?	189	(1)
Long-Term Debt: The Basics	189	(1)
The Indenture	190	(1)
Terms of a Bond	191	(1)
Security	191	(1)
Seniority	192	(1)
Repayment	192	(1)
The Call Provision	192	(1)
Protective Convenants	193	(1)
Bond Ratings	193	(2)
Some Different Types of Bonds	195	(4)
Government Bonds	195	(1)
Zero Coupon Bonds	196	(2)
Floating-Rate Bonds	198	(1)
Other Types of Bonds	199	(1)
Bond Markets	199	(5)
How Bonds Are Bought and Sold	200	(1)
Bond Price Reporting	200	(4)
Inflation and Interest Rates	204	(2)
Real versus Nominal Rates	204	(1)
The Fisher Effect	205	(1)
Determinants of Bond Yields	206	(4)
The Term Structure of Interest Rates	206	(3)
Bond Yields and the Yield Curve: Putting It All Together	209	(1)
Conclusion	210	(1)
Summary and Conclusions	210	(7)
Stock Valuation	217	(26)
Common Stock Valuation	217	(10)
Cash Flows	218	(1)
Some Special Cases	219	(1)
Zero Growth	219	(1)
Constant Growth	220	(3)
Nonconstant Growth	223	(2)
Components of the Required Return	225	(2)
Some Features of Common and Preferred Stocks	227	(5)
Common Stock Features	227	(1)
Shareholder Rights	228	(1)
Proxy Voting	229	(1)
Classes of Stock	229	(1)
Other Rights	230	(1)
Dividends	230	(1)
Preferred Stock Features	231	(1)
Stated Value	231	(1)
Cumulative and Noncumulative Dividends	231	(1)
Is Preferred Stock Really Debt?	231	(1)
The Stock Markets	232	(5)
Dealers and Brokers	232	(1)
Organization of the NYSE	233	(1)
Members	233	(1)
Operations	233	(1)
Floor Activity	234	(1)
Nasdaq Operations	235	(1)
Stock Market Reporting	236	(1)
Summary and Conclusions	237	(6)
Part Four Capital Budgeting	243	(108)
Net Present Value and Other Investment Criteria	244	(34)
Net Present Value	245	(4)
The Basic Idea	245	(1)
Estimating Net Present Value	246	(3)
The Payback Rule	249	(4)
Defining the Rule	249	(2)
Analyzing the Rule	251	(1)
Redeeming Qualities of the Rule	251	(1)
Summary of the Rule	252	(1)
The Discounted Payback	253	(4)
The Average Accounting Return	257	(1)
The Internal Rate of Return	257	(9)
Problems with the IRR	261	(1)
Nonconventional Cash Flows	261	(2)
Mutually Exclusive Investments	263	(3)
Redeeming Qualities of the IRR	266	(1)
The Profitability Index	266	(1)
The Practice of Capital Budgeting	267	(2)
Summary and Conclusions	269	(9)
Making Capital Investment Decisions	278	(39)
Project Cash Flows: A First Look	279	(1)
Relevant Cash Flows	279	(1)
The Stand-Alone Principle	279	(1)
Incremental Cash Flows	280	(2)
Sunk Costs	280	(1)
Opportunity Costs	280	(1)
Side Effects	281	(1)
Net Working Capital	281	(1)
Financing Costs	282	(1)
Other Issues	282	(1)
Pro Forma Financial Statements and Project Cash Flows	282	(5)
Getting Started: Pro Forma Financial Statements	282	(2)
Project Cash Flows	284	(1)
Project Operating Cash Flow	284	(1)
Project Net Working Capital and Capital Spending	284	(1)
Projected Total Cash Flow and Value	285	(2)
More on Project Cash Flow	287	(11)
A Closer Look at Net Working Capital	287	(2)
Depreciation	289	(1)
Modified ACRS Depreciation (MACRS)	290	(1)
Book Value versus Market Value	291	(1)
An Example: The Majestic Mulch and Compost Company (MMCC)	292	(1)
Operating Cash Flows	293	(1)
Change in NWC	293	(2)
Capital Spending	295	(1)
Total Cash Flow and Value	295	(3)
Conclusion	298	(1)
Alternative Definitions of Operating Cash Flow	298	(3)
The Bottom-Up Approach	299	(1)
The Top-Down Approach	299	(1)
The Tax Shield Approach	300	(1)
Conclusion	300	(1)
Some Special Cases of Discounted Cash Flow Analysis	301	(6)
Evaluating Cost-Cutting Proposals	301	(2)
Setting the Bid Price	303	(2)
Evaluating Equipment Options with Different Lives	305	(2)
Summary and Conclusions	307	(10)
Project Analysis and Evaluation	317	(34)
Evaluating NPV Estimates	317	(3)
The Basic Problem	318	(1)
Projected versus Actual Cash Flows	318	(1)
Forcasting Risk	318	(1)
Sources of Value	319	(1)
Scenario and Other What-If Analyses	320	(4)
Getting Started	320	(1)
Scenario Analysis	321	(1)
Sensitivity Analysis	322	(1)
Simulation Analysis	323	(1)
Break-Even Analysis	324	(6)
Fixed and Variable Costs	324	(1)
Variable Costs	324	(2)
Fixed Costs	326	(1)
Total Costs	326	(1)
Accounting Break-Even	327	(2)
Accounting Break-Even: A Closer Look	329	(1)
Uses for the Accounting Break-Even	329	(1)
Operating Cash Flow, Sales Volume, and Break-Even	330	(5)
Accounting Break-Even and Cash Flow	330	(1)
The Base Case	330	(1)
Calculating the Break-Even Level	331	(1)
Payback and Break-Even	331	(1)
Sales Volume and Operating Cash Flow	332	(1)
Cash Flow, Accounting, and Financial Break-Even Points	333	(1)
Accounting Break-Even Revisited	333	(1)
Cash Break-Even	333	(1)
Financial Break-Even	333	(2)
Conclusion	335	(1)
Operating Leverage	335	(3)
The Basic Idea	335	(1)
Implications of Operating Leverage	335	(1)
Measuring Operating Leverage	336	(1)
Operating Leverage and Break-Even	337	(1)
Additional Considerations in Capital Budgeting	338	(5)
Managerial Options	338	(1)
Contingency Planning	339	(1)
Options in Capital Budgeting: An Example	340	(1)
Strategic Options	341	(1)
Conclusion	341	(1)
Capital Rationing	342	(1)
Soft Rationing	342	(1)
Hard Rationing	342	(1)
Summary and Conclusions	343	(8)
Part Five Risk and Return	351	(66)
Some Lessons from Capital Market History	352	(29)
Returns	353	(4)
Dollar Returns	353	(2)
Percentage Returns	355	(2)
The Historical Record	357	(5)
A First Look	358	(2)
A Closer Look	360	(2)
Average Returns: The First Lesson	362	(4)
Calculating Average Returns	362	(1)
Average Returns: The Historical Record	363	(2)
Risk Premiums	365	(1)
The First Lesson	366	(1)
The Variability of Returns: The Second Lesson	366	(6)
Frequency Distributions and Variability	366	(1)
The Historical Variance and Standard Deviation	366	(3)
The Historical Record	369	(1)
Normal Distribution	369	(1)
The Second Lesson	370	(1)
Using Capital Market History	371	(1)
Capital Market Efficiency	372	(4)
Price Behavior in an Efficient Market	372	(1)
The Efficient Markets Hypothesis	373	(1)
Some Common Misconceptions about the EMH	374	(1)
The Forms of Market Efficiency	375	(1)
Summary and Conclusions	376	(5)
Return, Risk, and the Security Market Line	381	(36)
Expected Returns and Variances	382	(3)
Expected Return	382	(2)
Calculating the Variance	384	(1)
Portfolios	385	(4)
Portfolio Weights	386	(1)
Portfolio Expected Returns	386	(1)
Portfolio Variance	387	(2)
Announcements, Surprises, and Expected Returns	389	(3)
Expected and Unexpected Returns	390	(1)
Announcements and News	390	(2)
Risk: Systematic and Unsystematic	392	(1)
Systematic and Unsystematic Risk	392	(1)
Systematic and Unsystematic Components of Return	393	(1)
Diversification and Portfolio Risk	393	(4)
The Effect of Diversification: Another Lesson from Market History	393	(1)
The Principle of Diversification	394	(1)
Diversification and Unsystematic Risk	395	(1)
Diversification and Systematic Risk	396	(1)
Systematic Risk and Beta	397	(2)
The Systematic Risk Principle	397	(1)
Measuring Systematic Risk	397	(1)
Portfolio Betas	398	(1)
The Security Market Line	399	(8)
Beta and the Risk Premium	399	(1)
The Reward-to-Risk Ratio	400	(1)
The Basic Argument	401	(1)
The Fundamental Result	402	(2)
The Security Market Line	404	(1)
Market Portfolios	404	(1)
The Capital Asset Pricing Model	405	(2)
The SML and the Cost of Capital: A Preview	407	(1)
The Basic Idea	407	(1)
The Cost of Capital	407	(1)
Summary and Conclusions	408	(9)
Part Six Cost of Capital and Long-Term Financial Policy	417	(136)
Cost of Capital	418	(29)
The Cost of Capital: Some Preliminaries	419	(1)
Required Return versus Cost of Capital	419	(1)
Financial Policy and Cost of Capital	420	(1)
The Cost of Equity	420	(4)
The Dividend Growth Model Approach	420	(1)
Implementing the Approach	421	(1)
Estimating g	421	(1)
Advantages and Disadvantages of the Approach	422	(1)
The SML Approach	422	(1)
Implementing the Approach	422	(1)
Advantages and Disadvantages of the Approach	423	(1)
The Costs of Debt and Preferred Stock	424	(1)
The Cost of Debt	424	(1)
The Cost of Preferred Stock	425	(1)
The Weighted Average Cost of Capital	425	(7)
The Capital Structure Weights	426	(1)
Taxes and the Weighted Average Cost of Capital	426	(2)
Calculating the WACC for Eastman Chemical	428	(1)
Eastman's Cost of Equity	428	(1)
Eastman's Cost of Debt	428	(1)
Eastman's WACC	429	(1)
Solving the Warehouse Problem and Similar Capital Budgeting Problems	429	(2)
Performance Evaluation: Another Use of the WACC	431	(1)
Divisional and Project Costs of Capital	432	(4)
The SML and the WACC	432	(1)
Divisional Cost of Capital	433	(1)
The Pure Play Approach	434	(1)
The Subjective Approach	434	(2)
Flotation Costs and the Weighted Average Cost of Capital	436	(3)
The Basic Approach	436	(2)
Flotation Costs and NPV	438	(1)
Summary and Conclusions	439	(8)
Raising Capital	447	(38)
The Financing Life Cycle of a Firm: Early-Stage Financing and Venture Capital	448	(2)
Venture Capital	448	(1)
Some Venture Capital Realities	449	(1)
Choosing a Venture Capitalist	449	(1)
Conclusion	450	(1)
Selling Securities to the Public: The Basic Procedure	450	(1)
Alternative Issue Methods	451	(2)
Underwriters	453	(2)
Choosing an Underwriter	454	(1)
Types of Underwriting	454	(1)
Firm Commitment Underwriting	454	(1)
Best Efforts Underwriting	454	(1)
The Aftermarket	454	(1)
The Green Shoe Provision	455	(1)
IPOs and Underpricing	455	(6)
Underpricing: The Case of Conrail	455	(2)
Evidence on Underpricing	457	(3)
Why Does Underpricing Exist?	460	(1)
New Equity Sales and the Value of the Firm	461	(1)
The Costs of Issuing Securities	462	(4)
The Costs of Selling Stock to the Public	462	(3)
The Costs of Going Public: The Case of Multicom	465	(1)
Rights	466	(8)
The Mechanics of a Rights Offering	466	(1)
Number of Rights Needed to Purchase a Share	467	(1)
The Value of a Right	468	(2)
Ex Rights	470	(1)
The Underwriting Arrangements	471	(1)
Rights Offers: The Case of Time-Warner	471	(1)
Effects on Shareholders	472	(1)
The Rights Offerings Puzzle	473	(1)
Dilution	474	(3)
Dilution of Proportionate Ownership	474	(1)
Dilution of Value: Book versus Market Values	475	(1)
A Misconception	476	(1)
The Correct Arguments	476	(1)
Issuing Long-Term Debt	477	(1)
Shelf Registration	477	(1)
Summary and Conclusions	478	(7)
Financial Leverage and Capital Structure Policy	485	(35)
The Capital Structure Question	486	(1)
Firm Value and Stock Value: An Example	486	(1)
Capital Structure and the Cost of Capital	487	(1)
The Effect of Financial Leverage	487	(6)
The Basics of Financial Leverage	488	(1)
Financial Leverage, EPS, and ROE: An Example	488	(1)
EPS versus EBIT	489	(2)
Corporate Borrowing and Homemade Leverage	491	(2)
Capital Structure and the Cost of Equity Capital	493	(3)
M&M Proposition I: The Pie Model	493	(1)
The Cost of Equity and Financial Leverage: M&M Proposition II	493	(3)
Business and Financial Risk	496	(1)
M&M Propositions I and II with Corporate Taxes	496	(6)
The Interest Tax Shield	497	(1)
Taxes and M&M Proposition I	497	(2)
Taxes, the WACC, and Proposition II	499	(1)
Conclusion	499	(3)
Bankruptcy Costs	502	(1)
Direct Bankruptcy Costs	502	(1)
Indirect Bankruptcy Costs	503	(1)
Optimal Capital Structure	503	(5)
The Static Theory of Capital Structure	504	(1)
Optimal Capital Structure and the Cost of Capital	505	(1)
Optimal Capital Structure: A Recap	506	(1)
Capital Structure: Some Managerial Recommendations	506	(1)
Taxes	506	(2)
Financial Distress	508	(1)
The Pie Again	508	(2)
The Extended Pie Model	508	(1)
Marketed Claims versus Nonmarketed Claims	509	(1)
Observed Capital Structures	510	(1)
A Quick Look at the Bankruptcy Process	511	(3)
Liquidation and Reorganization	511	(1)
Bankruptcy Liquidation	512	(1)
Bankruptcy Reorganization	512	(1)
Financial Management and the Bankruptcy Process	513	(1)
Agreements to Avoid Bankruptcy	514	(1)
Summary and Conclusions	514	(6)
Dividends and Dividend Policy	520	(33)
Cash Dividends and Dividend Payment	521	(4)
Cash Dividends	521	(1)
Standard Method of Cash Dividend Payment	522	(1)
Dividend Payment: A Chronology	522	(1)
More on the Ex-Dividend Date	523	(2)
Does Dividend Policy Matter?	525	(2)
An Illustration of the Irrelevance of Dividend Policy	525	(1)
Current Policy: Dividends Set Equal to Cash Flow	525	(1)
Alternative Policy: Initial Dividend Greater than Cash Flow	526	(1)
Homemade Dividends	526	(1)
A Test	527	(1)
Real-World Factors Favoring a Low Payout	527	(3)
Taxes	528	(1)
Expected Return, Dividends, and Personal Taxes	529	(1)
Flotation Costs	529	(1)
Dividend Restrictions	529	(1)
Real-World Factors Favoring a High Payout	530	(2)
Desire for Current Income	530	(1)
Uncertainty Resolution	531	(1)
Tax and Legal Benefits from High Dividends	531	(1)
Corporate Investors	531	(1)
Tax-Exempt Investors	531	(1)
Conclusion	532	(1)
A Resolution of Real-World Factors?	532	(3)
Information Content of Dividends	532	(1)
The Clientele Effect	533	(2)
Establishing a Dividend Policy	535	(4)
Residual Dividend Approach	535	(2)
Dividend Stability	537	(1)
A Compromise Dividend Policy	538	(1)
Stock Repurchase: An Alternative to Cash Dividends	539	(3)
Cash Dividends versus Repurchase	539	(2)
Real-World Considerations in a Repurchase	541	(1)
Share Repurchase and EPS	541	(1)
Stock Dividends and Stock Splits	542	(3)
Some Details on Stock Splits and Stock Dividends	542	(1)
Example of a Small Stock Dividend	543	(1)
Example of a Stock Split	543	(1)
Example of a Large Stock Dividend	544	(1)
Value of Stock Splits and Stock Dividends	544	(1)
The Benchmark Case	544	(1)
Popular Trading Range	544	(1)
Reverse Splits	545	(1)
Summary and Conclusions	545	(8)
Part Seven Short-Term Financial Planning and Management	553	(56)
Short-Term Finance and Planning	554	(32)
Tracing Cash and Net Working Capital	555	(2)
The Operating Cycle and the Cash Cycle	557	(6)
Defining the Operating and Cash Cycles	557	(1)
The Operating Cycle	557	(1)
The Cash Cycle	558	(1)
The Operating Cycle and the Firm's Organizational Chart	559	(1)
Calculating the Operating and Cash Cycles	560	(1)
The Operating Cycle	560	(1)
The Cash Cycle	561	(1)
Interpreting the Cash Cycle	562	(1)
Some Aspects of Short-Term Financial Policy	563	(7)
The Size of the Firm's Investment in Current Assets	563	(3)
Alternative Financing Policies for Current Assets	566	(1)
An Ideal Case	566	(1)
Different Policies for Financing Current Assets	566	(2)
Which Financing Policy Is Best?	568	(1)
Current Assets and Liabilities in Practice	569	(1)
The Cash Budget	570	(3)
Sales and Cash Collections	570	(1)
Cash Outflows	571	(1)
The Cash Balance	572	(1)
Short-Term Borrowing	573	(3)
Unsecured Loans	573	(1)
Compensating Balances	573	(1)
Cost of a Compensating Balance	574	(1)
Letters of Credit	574	(1)
Secured Loans	575	(1)
Accounts Receivable Financing	575	(1)
Inventory Loans	576	(1)
Other Sources	576	(1)
A Short-Term Financial Plan	576	(1)
Summary and Conclusions	577	(9)
Cash and Liquidity Management	586	(23)
Reasons for Holding Cash	586	(2)
The Speculative and Precautionary Motives	586	(1)
The Transaction Motive	587	(1)
Compensating Balances	587	(1)
Costs of Holding Cash	587	(1)
Cash Management versus Liquidity Management	588	(1)
Understanding Float	588	(7)
Disbursement Float	588	(1)
Collection Float and Net Float	589	(1)
Float Management	590	(1)
Measuring Float	590	(1)
Some Details	591	(1)
Cost of the Float	592	(2)
Ethical and Legal Questions	594	(1)
Electronic Data Interchange: The End of Float?	594	(1)
Cash Collection and Concentration	595	(5)
Components of Collection Time	595	(1)
Cash Collection	595	(1)
Lockboxes	596	(1)
Cash Concentration	597	(1)
Accelerating Collections: An Example	597	(3)
Managing Cash Disbursements	600	(1)
Increasing Disbursement Float	600	(1)
Controlling Disbursements	600	(1)
Zero-Balance Accounts	601	(1)
Controlled Disbursement Accounts	601	(1)
Investing Idle Cash	601	(3)
Temporary Cash Surpluses	602	(1)
Seasonal or Cyclical Activities	602	(1)
Planned or Possible Expenditures	602	(1)
Characteristics of Short-Term Securities	603	(1)
Maturity	603	(1)
Default Risk	603	(1)
Marketability	603	(1)
Taxes	603	(1)
Some Different Types of Money Market Securities	603	(1)
Summary and Conclusions	604	(5)
Appendix 19A Determining the Target Cash Balance	609	(41)
The Basic Idea	609	(1)
The BAT Model	610	(4)
The Opportunity Costs	611	(1)
The Trading Costs	612	(1)
The Total Cost	612	(1)
The Solution	613	(1)
Conclusion	614	(1)
The Miller-Orr Model: A More General Approach	614	(2)
The Basic Idea	614	(1)
Using the Model	614	(2)
Implications of the BAT and Miller-Orr Models	616	(1)
Other Factors Influencing the Target Cash Balance	616	(3)
Credit and Inventory Management	619	(31)
Credit and Receivables	619	(2)
Components of Credit Policy	620	(1)
The Cash Flows from Granting Credit	620	(1)
The Investment in Receivables	621	(1)
Terms of the Sale	621	(4)
The Basic Form	621	(1)
The Credit Period	622	(1)
The Invoice Date	622	(1)
Length of the Credit Period	622	(1)
Cash Discounts	623	(1)
Cost of the Credit	624	(1)
Trade Discounts	624	(1)
The Cash Discount and the ACP	624	(1)
Credit Instruments	625	(1)
Analyzing Credit Policy	625	(3)
Credit Policy Effects	625	(1)
Evaluating a Proposed Credit Policy	626	(1)
NPV of Switching Policies	626	(2)
A Break-Even Application	628	(1)
Optimal Credit Policy	628	(2)
The Total Credit Cost Curve	628	(1)
Organizing the Credit Function	629	(1)
Credit Analysis	630	(3)
When Should Credit Be Granted?	630	(1)
A One-Time Sale	631	(1)
Repeat Business	631	(1)
Credit Information	632	(1)
Credit Evaluation and Scoring	633	(1)
Collection Policy	633	(3)
Monitoring Receivables	633	(2)
Collection Effort	635	(1)
Inventory Management	636	(2)
The Financial Manager and Inventory Policy	636	(1)
Inventory Types	636	(1)
Inventory Costs	637	(1)
Inventory Management Techniques	638	(7)
The ABC Approach	638	(1)
The Economic Order Quantity Model	639	(1)
Inventory Depletion	639	(1)
The Carrying Costs	640	(1)
The Shortage Costs	640	(1)
The Total Costs	641	(1)
Extensions to the EOQ Model	642	(1)
Safety Stocks	643	(1)
Reorder Points	643	(1)
Managing Derived-Demand Inventories	643	(1)
Materials Requirements Planning	643	(1)
Just-in-Time Inventory	643	(2)
Summary and Conclusions	645	(5)
Appendix 20A More on Credit Policy Analysis	650	(7)
Two Alternative Approaches	650	(2)
The One-Shot Approach	651	(1)
The Accounts Receivable Approach	651	(1)
Discounts and Default Risk	652	(5)
NPV of the Credit Decision	653	(1)
A Break-Even Application	654	(3)
Part Eight Topics in Corporate Finance	657	(88)
International Corporate Finance	658	(27)
Terminology	659	(1)
Foreign Exchange Markets and Exchange Rates	660	(5)
Exchange Rates	661	(1)
Exchange Rate Quotations	661	(1)
Cross-Rates and Triangle Arbitrage	662	(2)
Types of Transactions	664	(1)
Purchasing Power Parity	665	(3)
Absolute Purchasing Power Parity	665	(1)
Relative Purchasing Power Parity	666	(1)
The Basic Idea	667	(1)
The Result	667	(1)
Currency Appreciation and Depreciation	668	(1)
Interest Rate Parity, Unbiased Forward Rates, and the International Fisher Effect	668	(4)
Covered Interest Arbitrage	669	(1)
Interest Rate Parity	670	(1)
Forward Rates and Future Spot Rates	671	(1)
Putting It All Together	671	(1)
Uncovered Interest Parity	671	(1)
The International Fisher Effect	672	(1)
International Capital Budgeting	672	(3)
The Home Currency Approach	673	(1)
The Foreign Currency Approach	674	(1)
Unremitted Cash Flows	675	(1)
Exchange Rate Risk	675	(3)
Short-Run Exposure	675	(1)
Long-Run Exposure	676	(1)
Translation Exposure	677	(1)
Managing Exchange Rate Risk	678	(1)
Political Risk	678	(1)
Summary and Conclusions	679	(6)
Risk Management: An Introduction to Financial Engineering	685	(28)
Hedging and Price Volatility	685	(5)
Price Volatility: A Historical Perspective	686	(1)
Interest Rate Volatility	687	(1)
Exchange Rate Volatility	687	(1)
Commodity Price Volatility	688	(1)
The Impact of Financial Risk: The U.S. Savings and Loan Industry	688	(2)
Managing Financial Risk	690	(4)
The Risk Profile	691	(1)
Reducing Risk Exposure	691	(2)
Hedging Short-Run Exposure	693	(1)
Cash Flow Hedging: A Cautionary Note	693	(1)
Hedging Long-Term Exposure	694	(1)
Conclusion	694	(1)
Hedging with Forward Contracts	694	(3)
Forward Contracts: The Basics	694	(1)
The Payoff Profile	695	(1)
Hedging with Forwards	695	(2)
A Caveat	697	(1)
Credit Risk	697	(1)
Forward Contracts in Practice	697	(1)
Hedging with Futures Contracts	697	(4)
Trading in Futures	698	(1)
Futures Exchanges	698	(2)
Hedging with Futures	700	(1)
Hedging with Swap Contracts	701	(2)
Currency Swaps	701	(1)
Interest Rate Swaps	701	(1)
Commodity Swaps	702	(1)
The Swap Dealer	702	(1)
Interest Rate Swaps: An Example	702	(1)
Hedging with Option Contracts	703	(5)
Option Terminology	704	(1)
Options versus Forwards	704	(1)
Option Payoff Profiles	704	(1)
Option Hedging	704	(1)
Hedging Commodity Price Risk with Options	705	(1)
Hedging Exchange Rate Risk with Options	706	(1)
Hedging Interest Rae Risk with Options	707	(1)
A Preliminary Note	707	(1)
Interest Rate Caps	708	(1)
Other Interest Rate Options	708	(1)
Summary and Conclusions	708	(5)
Options and Corporate Securities	713	(32)
Options: The Basics	714	(4)
Puts and calls	714	(1)
Stock Option Quotations	714	(1)
Option Payoffs	715	(3)
Fundamentals of Option Valuation	718	(5)
Value of a Call Option at Expiration	718	(1)
The Upper and Lower Bounds on a Call Options' Value	718	(1)
The Upper Bound	719	(1)
The Lower Bound	719	(1)
A Simple Model: Part I	720	(1)
The Basic Approach	721	(1)
A More Complicated Case	721	(1)
Four Factors Determining Option Values	722	(1)
Valuing a Call Option	723	(3)
A Simple Model: Part II	723	(1)
The Fifth Factor	724	(1)
A Closer Look	725	(1)
Equity as a Call Option on the Firm's Assets	726	(3)
The Debt Is Risk-Free	727	(1)
The Debt Is Risky	727	(2)
Warrants	729	(3)
The Difference between Warrants and Call Options	729	(1)
Warrants and the Value of the Firm	730	(1)
The Effect of a Call Option	730	(1)
The Effect of a Warrant	730	(2)
Warrant Value and Stock Value	732	(1)
Earnings Dilution	732	(1)
Convertible Bonds	732	(4)
Fatures of a Convertible Bond	733	(1)
Value of a Convertible Bond	733	(1)
Straight Bond Value	733	(1)
Conversion Value	734	(1)
Floor Value	734	(1)
Option Value	735	(1)
Reasons for Issuign Warrants and Convertibles	736	(1)
The Free Lunch Story	736	(1)
The Expensive Lunch Story	736	(1)
A Reconciliation	737	(1)
Other Options	737	(2)
The Call Provision on a Bond	738	(1)
Put Bonds	738	(1)
The Green Shoe Provision	738	(1)
Insurance and Loan Guarantees	738	(1)
Summary and Conclusions	739	(6)
Appendix 23A The Black-Scholes Option Pricing Model	745
Mergers and Acquisitions	750	(32)
The Legal Forms of Acquisitions	751	(4)
Merer of Consolidation	752	(1)
Acquisition of Stock	752	(1)
Acquisition of Assets	753	(1)
Acquisition Classifications	753	(1)
A Note on Takeovers	754	(1)
Taxes and Acquisitions	755	(1)
Determinants of Tax Status	755	(1)
Taxable versus Tax-Free Acquisitions	755	(1)
Accounting for Acquisitions	756	(2)
The Purchase Method	756	(1)
Pooling of Interests	756	(1)
Which Is Better: Purchase or Pooling of Interests?	757	(1)
Gains from Acquisition	758	(6)
Synergy	758	(2)
Revenue Enhancement	760	(1)
Marketing Gains	760	(1)
Strategic Benefits	760	(1)
Market Power	760	(1)
Cost Reductions	760	(1)
Economies of Scale	761	(1)
Economies of Vertical Integration	761	(1)
Complementary Resources	761	(1)
Lower Taxes	761	(1)
Net Operating Losses	762	(1)
Unused Debt Capacity	762	(1)
Surplus Funds	762	(1)
Asset Write-Ups	762	(1)
Reductions in Capital Needs	763	(1)
Avoiding Mistkaes	763	(1)
A Note on Inefficient Management	764	(1)
Some Financial Side Effects of Acquisitions	764	(2)
EPS Growth	764	(1)
Diversification	765	(1)
The Cost of an Acquisition	766	(2)
Cash Acquisition	767	(1)
Stock Acquisition	767	(1)
Cash versus Common Stock	768	(1)
Defensive Tactics	768	(5)
The Corporate Charter	769	(1)
Repurchase and Standstill Agreements	769	(1)
Exclusionary Self-Tenders	770	(1)
Poison Pills and Share Rights Plans	770	(2)
Going Private and Leveraged Buyouts	772	(1)
Other Devices and Jargon of Corporate Takeovers	772	(1)
Some Evidence on acquisitions	773	(2)
Summary and Conclusions	775	(7)
Leasing	782
Leases and Lease Types	782	(3)
Leasing versus Buying	783	(1)
Operatng Leases	784	(1)
Financial Leases	784	(1)
Tax-Oriented Leases	784	(1)
Leveraged Leases	785	(1)
Sale and Leaseback Agreements	785	(1)
Accounting and Leasing	785	(2)
Taxes, the IRS, and Leases	787	(1)
The Cash Flows from Leasing	788	(2)
The Incremental Cash Flows	788	(1)
A Note on Taxes	789	(1)
Lease or Buy?	790	(2)
A Preliminary Analysis	790	(1)
Three Potential Pitfalls	791	(1)
NPV Analysis	791	(1)
A Misconception	791	(1)
A Leasing Paradox	792	(1)
Reasons for Leasing	793	(3)
Good Reasosn for Leasing	793	(1)
Tax Advantages	794	(1)
A Reduction of Uncertainty	795	(1)
Lower Transactions Costs	795	(1)
Fewer Restrictions and Security Requirements	795	(1)
Bad Reasons for Leasing	795	(1)
Leasing and Accounting Income	795	(1)
100 Percent Financing	796	(1)
Low Cost	796	(1)
Other Reasons for Leasing	796	(1)
Summary and Conclusions	796
Appendix A---Mathematical Tables	A-1
Appendix B---Key Equations	B-1
Appendix C---Answers to Selected End-of-Chapter Problems	C-1
Index