Modern Corporate Finance: Theory and Practice

by Chambers, Donald R.; Lacey, Nelson J.

• ISBN13: 9780321014474
• ISBN10: 0321014472
• Edition: 2nd
• Format: Hardcover
• Copyright: 1998-10-01
• Publisher: Pearson College Div

Summary

Reinforced by economic principles, this book approaches corporate finance from a modernist perspective. Modern Corporate Finance strikes an excellent balance between theory and application to demonstrate the usefulness of finance in corporate decision-making. Realistic exercises and examples make the theoretical material relevant.

Table of Contents

Preface	xv
1 Introduction to Modern Corporate Finance	1	(38)
Modern Corporate Finance	2	(1)
The Meaning of Corporate Finance	3	(15)
What is Finance?	3	(3)
Defining the Corporation	6	(10)
What is Meant by Modern?	16	(2)
The Goal or Purpose of the Corporation	18	(2)
Corporate Ownership	18	(2)
Owners Versus Managers	20	(1)
Economic Foundations of Finance	20	(8)
Underlying Assumptions	21	(1)
The First Principle: Positive Marginal Utility of Wealth	22	(1)
The Second Principle: Diminishing Marginal Utility of Wealth	23	(2)
The Third Principle: Diminishing Marginal Return	25	(1)
The Fourth Principle: Conservation of Value	25	(1)
A Summary of the Four Economic Principles	26	(2)
Time and Risk	28	(11)
Time Value and the Concept of Different Commodities	30	(1)
Risk and the Concept of Different Commodities	31	(8)
2 Markets and Contracts	39	(36)
Market Efficiency	41	(4)
Inefficient Markets	45	(3)
Liquid Assets	47	(1)
Liquidity and Corporate Finance	47	(1)
Acquiring Assets in the Financial System	48	(27)
Real Versus Financial Assets	49	(3)
Asset Ownership Through Financial Intermediation	52	(3)
Real Asset Ownership and Governments	55	(2)
Taxation	57	(1)
Governments and Money	57	(18)
3 The Time Value of Money	75	(40)
Time Value	75	(6)
Dollars Through Time as Different Commodities	76	(1)
Discounting Cash Flows	77	(2)
Compounding Cash Flows	79	(1)
Time Lines	80	(1)
Interest Rates and Present Value	80	(1)
A Summary of Time Value	81	(1)
The Techniques of Discounting and Compounding	81	(14)
Future Values	82	(13)
The Time Values for More Than One Cash Flow	95	(5)
Compounding Multiple Cash Flows	95	(1)
Discounting Multiple Cash Flows	96	(4)
The Present Value of Annuities	100	(3)
Developing a Shortcut Procedure for Annuities	101	(2)
Beginning and Ending Payments	103	(1)
The Future Value of an Annuity	103	(2)
Solving for the Interest Rate	105	(1)
Solving for the Time Period	105	(10)
4 The Valuation of Financial Securities	115	(30)
Review of Discounting Annuities	116	(5)
Special Annuities	116	(5)
Financial Securities	121	(10)
U.S. Treasury Bills	122	(1)
Calculating the Interest Rate of Treasury Bills	122	(2)
Coupon-Paying Bonds	124	(6)
Yield to Maturity	130	(1)
The Valuation of Common Stock	131	(14)
The Discounted Cash Flow Model	132	(13)
5 The Techniques of Capital Budgeting	145	(34)
Creating Value	146	(3)
Keeping Score	148	(1)
The Required Rate of Return in Project Analysis	149	(1)
A Summary of Value Creation	149	(1)
Net Present Value	149	(4)
The NPV Rule in Capital Budgeting	150	(3)
Competitors of NPV	153	(8)
The Profitability Index	153	(1)
The Internal Rate of Return	154	(6)
The Accounting Rate of Return	160	(1)
NPV Versus IRR-Which Method is Better?	161	(7)
Accept-or-Reject Projects Versus Ranking Projects	162	(2)
Capital Rationing	164	(1)
NPV Versus IRR for Nonstandard Projects	165	(3)
Estimating the Required Rate of Return-An Advantage to the IRR?	168	(1)
Project Selection and the Required Rate of Return	168	(11)
6 Estimating Project Cash Flows	179	(30)
Estimating Project Cash Flows	180	(6)
Incremental Cash Flow Versus Accounting Profit	181	(1)
Cash Flow and Taxes	182	(1)
Depreciation (and other Noncash Expenses) and Cash Flow	183	(2)
Sunk Costs and Cash Flow	185	(1)
Project Side Effects and Cash Flow	186	(1)
Summary of Cash Flow Estimation	186	(1)
Estimating Cash Flow and NPV for Project Prose	186	(10)
The Initial Investment Phase	187	(1)
The Long-Term Cash Flow Phase	188	(4)
The Terminal Cash Flow Phase	192	(1)
Total Project Cash Flows and NPV	193	(1)
Has Everything Been Included?	194	(2)
Errors in Project Cash Flow Estimation	196	(2)
Managerial Bias	196	(1)
Misestimation	197	(1)
Sensitivity Analysis	198	(11)
7 Advanced Topics in Capital Budgeting	209	(30)
Overview-Complexities in Capital Budgeting Analysis	210	(1)
Projects with Unequal Lives	210	(6)
NPV Versus IRR: The Controversy Revisited	210	(1)
The Hidden Reinvestment or Replication Assumption	211	(1)
Solving the Problem of Unequal Lives	212	(4)
Least-Cost Decisions	216	(2)
Least Cost and Unequal Lives	217	(1)
Inflation and Investment Decisions	218	(6)
The Mathematics of Inflation	220	(1)
Interest Rates and the Fisher Effect	221	(1)
Estimating the Real Rate of Interest	221	(1)
Using the Fisher Effect in Investment Decisions	222	(1)
Adjusting for Inflation in a Corporate Context	223	(1)
Capital Rationing	224	(11)
Capital Rationing and the Profitability Index	224	(11)
Appendix: Integer Linear Programming	235	(4)
8 Risk and Diversification	239	(30)
A Conceptual Analysis of Risk	239	(5)
What is Uncertainty?	240	(1)
What is Risk?	241	(1)
Risk-Averse Behavior	241	(3)
Return and Risk on Individual Assets	244	(10)
Distributions of Returns	244	(3)
Mean Returns	247	(2)
The Standard Deviation of Returns	249	(3)
The Normal Distribution	252	(1)
Risk and Reward	252	(1)
The Problem with Standard Deviation as a Risk Measure	253	(1)
Return and Risk on Portfolios	254	(15)
Portfolio Returns	254	(1)
A First Look at Portfolio Risk	255	(1)
The Covariance	256	(1)
The Correlation Coefficient	257	(1)
Calculating Portfolio Variance and Standard Variation	258	(1)
The Relationship Between Covariance and Portfolio Standard Deviation	259	(2)
Measuring Portfolio Risk with Diversification	261	(8)
9 Modern Portfolio Theory and the Capital Asset Pricing Model	269	(28)
Portfolio Management Theory	270	(8)
The Markowitz Model: Risky Assets Only	270	(2)
An Alternative Framework: Risky and Risk-Free Assets	272	(1)
The Market Portfolio	273	(2)
Summary and Illustration of Risk	275	(3)
Beta	278	(8)
Systematic Risk and Beta	278	(4)
Using Beta to Calculate Expected Rates of Return	282	(3)
The CAPM and Corporate Risk Management	285	(1)
Why All Securities Lie on the Security Market Line	285	(1)
The CAPM and Capital Budgeting	286	(9)
Appendix: Why Expected Returns Lie in a Straight Line Against Beta	295	(2)
10 Introduction to Options	297	(28)
The Importance of Option Theory	298	(1)
The Mechanics of Options	298	(7)
A Graphical Look at Options	299	(5)
Who Pays the Profits to Call Option Buyers?	304	(1)
Call Option Pricing Prior to Expiration	305	(1)
The Black-Scholes Option Pricing Model	305	(5)
Systematic Risk and Option Pricing	305	(1)
Foundations of the Black-Scholes Option Pricing Model	306	(1)
The Five Variables in the Black-Scholes Option Pricing Model	306	(4)
Summary of the Black-Scholes Option Pricing Model	310	(1)
Option Pricing-A Two-State Example	310	(1)
An Application of Option Theory to the Equity of a Firm	311	(10)
Appendix: The Black-Scholes Option Pricing Model	321	(4)
11 Financial Leverage	325	(38)
An Introduction to Corporate Financing	325	(1)
An Overview of Corporate Financing	326	(5)
Financing in Perfect Markets	329	(1)
The Traditionalist Versus the Modernist Positions on Capital Structure	330	(1)
The Mechanics of Financial Leverage	331	(9)
Being Unlevered: The Case of No Debt	332	(1)
Being Levered: The Case of Debt	332	(2)
Financial Leverage from the Perspective of Debtholders and Equityholders	334	(5)
A Summary of the Mechanics of Leverage	339	(1)
Capital Structure and Firm value-The Traditionalists'View	340	(1)
Capital Structure and Firm Value-The Modernists'View	341	(22)
Capital Structure Irrelevancy Using Market Efficiency and Net Present Value	343	(2)
Capital Structure Irrelevancy Using Arbitrage	345	(3)
Capital Structure Irrelevance Using Homemade Leverage	348	(15)
12 Financing: Why Might It Matter	363	(28)
The Rationale for Capital Structure Relevance	364	(2)
The No-Free-Lunch Analogy for Capital Structure Relevance	364	(2)
Capital Structure with Corporate Taxes	366	(5)
How Corporate Taxes Are Levied	366	(1)
Financial Leverage with Corporate Income Taxes	366	(3)
Summary of Financial Leverage and Corporate Taxation	369	(1)
Illustrating Financial Leverage and Taxes with an M&M Proposition	369	(2)
The Miller Tax Model	371	(4)
Prop Wash and the Miller Tax Model	372	(1)
Which Model Is Better: M&M or Miller?	373	(2)
Bankruptcy and Capital Structure	375	(4)
Bankruptcy and Option Theory	377	(1)
Risky Projects and the Games Shareholders Can Play	378	(1)
Summary of Bankruptcy and Capital Structure	379	(1)
Transactions Costs, Agency Costs, and Information Signaling	379	(1)
Wrapping Up	380	(11)
13 The Dividend Decision	391	(30)
An Overview of the Firm's Dividend Decision	391	(4)
Why Are Dividends Special?	393	(1)
The Dividend Payment Flow	394	(1)
The Traditionalists' View of Cash Dividends	395	(1)
The Modernists' Viewpoint-The M&M Model Without Taxes	396	(5)
Homemade Dividend in a Perfect Market	397	(2)
How Can the Firm's Dividend Policy Be Irrelevant?	399	(1)
What About Superior Investment Opportunities?	400	(1)
Summary of the Modernist Viewpoint on Dividend Policy	401	(1)
Market Imperfections and Dividend Policy	401	(2)
The M&M Model with Taxes	401	(2)
The Miller Tax Model	403	(1)
Summary of the Two Tax Models for Dividends	404	(1)
Dividends and Bankruptcy	404	(3)
Bankruptcy and Option Theory	405	(1)
The Bankruptcy Option in Practice	405	(2)
Dividends and Agency Costs	407	(1)
Dividends and Information Signaling	408	(1)
Stock Dividends and Stock Splits	409	(2)
A Final Wrap-up	411	(10)
14 Corporate Ethics and Shareholder Wealth Maximation	421	(22)
Corporate Ethics Introduced	422	(1)
Can Corporations Act Ethically	423	(1)
Two Approaches to Corporate Ethics	424	(2)
The Contractual-Rights Approach to Corporate Ethics	424	(1)
The Societal-Good Approach to Corporate Ethics	425	(1)
Debating the Two Approaches to Corporate Ethics	425	(1)
Unrequired Behavior Versus Required Behavior: Outhttas Versus Gottas	426	(2)
Oughttas	427	(1)
Gottas	427	(1)
Personal Versus Public-Policy Debates	428	(2)
Personal Ethical Decisions	428	(1)
Public-Policy Ethical Decisions	428	(2)
Corporate Ethics and Shareholder Wealth Maximization	430	(2)
Corporate Ethics and Market Values	432	(5)
Appendix 14.1: Overviewing the History of the Philosophy of Ethics and Economics	437	(3)
Appendix 14.2: The Origin of Individual Rights	440	(3)
15 Financial Analysis	443	(32)
Two Views of Financial Analysis	445	(2)
Modernists'View of Financial Analysis	445	(2)
Traditionalists'View of Financial Analysis	447	(1)
Financial Statements	447	(7)
The Balance Sheet	448	(3)
The Income Statement	451	(3)
Summary of Income Statements	454	(1)
Ratio Analysis	454	(6)
Standards for Comparison of Financial Ratios	455	(1)
Financial Ratio Example: The Walt Desney Company	455	(3)
Problems with Ratio Analysis	458	(1)
Systems of Ratio Analysis	459	(1)
Financial Ratios As a Predictor of Performance	459	(1)
Statement of Cash Flows	460	(15)
The Statement of Cash Flows as a Summary of Balance Sheet Changes	460	(1)
Complex Aspects of the Statement of Cash Flows	460	(3)
The Starting Formate for a Statement of Cash Flows	463	(1)
Alternative formats for a Statement of Cash Flows	463	(1)
Summary of Statement of Cash Flows	464	(11)
16 Working Capital Management	475	(24)
An Overview of Working Capital Management	476	(1)
The Three Tasks of Working Capital Management	476	(1)
Current Asset Management	477	(13)
Cash Management	477	(5)
Marketable Securities Management	482	(8)
Inventory Management	490	(1)
Current Liability Management	490	(9)
Accounts Payable Management	491	(1)
Bank Loan and Notes Payable Management	492	(1)
Current Debt Management	492	(7)
17 Corporate Financial Planning	499	(22)
Short-Term Financial Planning and the Cash Budget	500	(4)
Cash Forecasting	504	(1)
Long-Range financial Planning	505	(16)
The Accounting Mechanics of a Financial Planning Model	505	(1)
Condensing the Balance Sheet	506	(1)
An Example of Compiling a Forecast	507	(1)
The Slack Variable	508	(1)
Using a Financial Planning Model	509	(1)
The Planning Process of a New Business	509	(1)
Summary of the Financial Planning Process	510	(11)
18 International Finance	521	(32)
An Overview of International Finance	522	(1)
The Economics of Multiple Currencies	522	(7)
The Foreign Exchange Market	522	(1)
Exchange Rates	523	(1)
The Spot Market for Foreign Exchange	524	(2)
Perfect Markets and the Law of One Price	526	(1)
The Law of One Price and Arbitrage Opportunities	527	(1)
Imperfect Markets and the Law of One Price	528	(1)
Purchasing Power Parity	528	(1)
Multiple Currencies and the Passage of Time	529	(10)
Forward contracts	530	(1)
Futures Contracts	531	(4)
Forward and Futures Contracts as a Double-Edged Sword	535	(1)
To the Rescue: Options on Foreign Currency Risk	536	(1)
Interest Rates and the Law of One Price	536	(2)
The Interest Rate Parity Theorem	538	(1)
Summary of the Forward, Futures, and Options Markets	539	(1)
Multiple Currencies with Time and Risk	539	(2)
A Review of the Theory of Risk	539	(1)
The International Capital Asset Pricing Model	540	(1)
Systematic Risk and Multiple Currencies	540	(1)
Political Risk	541	(2)
Overview of Political Risk	541	(1)
Political Risk and Investment Decisions	542	(1)
Innovative Financial Arrangements	542	(1)
Practical Considerations of International Financial Management	543	(10)
Payment for Goods	543	(1)
Receipt of Goods	543	(10)
19 Mergers and Other Reorganizations	553	(22)
The Market for Corporate Control	554	(4)
Mergers and Corporate Finance	555	(1)
Friendly Versus Hostile Mergers	556	(1)
The Traditional View of Corporate Reorganizations	558	(4)
Types of Mergers	558	(1)
Merger Law	558	(1)
The Medium of Exchange in a Merger	559	(1)
Motivations for Mergers-The Traditionalists' View	560	(2)
Legal and Tax Aspects of Mergers	562	(1)
The Modernists' View of Mergers	562	(6)
Mergers Motivated by Managers	563	(1)
Mergers Motivated by Owners	564	(1)
Mergers and Changes in Shareholder Wealth	565	(1)
Do the Tables Tell the Entire Story?	566	(2)
A Modernists' Fairy Tale	568	(1)
Divestitures and Liquidations	569	(6)
20 Financial Engineering	575
An Overview of Financial Engineering	576	(1)
Environmental Risk and Core Business Risk	576	(1)
Risk Exposure Profiles	577	(2)
Combining Risk Exposure Profiles: An Introduction	579	(3)
The Use of Derivatives in Financial Engineering	582	(11)
Call Options	582	(2)
Put Options	584	(1)
Forward Contracts and Futures Contracts	585	(3)
Combining Derivative Positions	588	(2)
Interest Rate Derivatives	590	(1)
Delta Hedging	591	(2)
Financial Engineering and Financial Theory	593