PARTⅠ ASSESSING THE FINANCIAL HEALTH OF THE FIRM 3
Chapter 1 Interpreting Financial Statements 3
The Cash Flow Cycle 3
The Balance Sheet 6
Current Assets and Liabilities 7
Shareholders’Equity 7
The Income Statement 9
Measuring Earnings 10
Sources and Uses Statements 13
The Two-Finger Approach 14
The Cash Flow Statement 16
Financial Statements and the Value Problem 20
Market Value versus Book Value 20
Economic Income versus Accounting Income 23
Chapter Summary 26
Additional Resources 27
Chapter Problems 28
Chapter 2 Evaluating Financial Performance 33
The Levers of Financial Performance 33
Return on Equity 34
The Three Determinants of ROE 34
The Profit Margin 36
Asset Turnover 38
Financial Leverage 43
Is ROE a Reliable Financial Yardstick? 49
The Timing Problem 50
The Risk Problem 50
The Value Problem 52
ROE or Market Price? 53
Ratio Analysis 55
Using Ratios Effectively 57
Ratio Analysis of The Timberland Company 58
Appendix: International Differences in Financial Structure 69
Percentage Balance Sheets 69
Comparisons among Publicly Traded Companies 72
International Accounting Differences 76
Chapter Summary 78
Additional Resources 78
Chapter Problems 80
PART Ⅱ PLANNING FUTURE FINCIAL PERFORMANCE 85
Chapter 3 Financial Forecasting 85
Pro Forma Statements 85
Percent-of-Sales Forecasting 86
Pro Forma Statements and Financial Planning 92
Sensitivity Analysis 94
Scenario Analysis 94
Interest Expense 95
Seasonality 96
Forecasting with Computer Spreadsheets 96
Simulation 99
Cash Flow Forecasts 101
Cash Budgets 102
The Techniques Compared 104
Planning in Large Companies 105
Chapter Summary 107
Additional Resources 108
Chapter Problems 108
Chapter 4 Managing Growth 115
Sustainable Growth 116
The Sustainable Growth Equation 117
Too Much Growth 119
Balanced Growth 120
Triad Guarantee’s Sustainable Growth Rate 122
“What If” Questions 122
What to do When Actual Growth Exceeds Sustainable Growth 124
Sell New Equity 124
Increase Leverage 130
Profitable Pruning 130
Sourcing 131
Pricing 132
Is Merger the Answer? 132
Too Little Growth 132
What to do When Sustainable Growth Exceeds Actual Growth 133
Ignore the Problem 135
Return the Money to Shareholders 135
Buy Growth 136
Sustainable Growth and Inflation 137
Sustainable Growth and Pro Forma Forecasts 138
Chapter Summary 139
Additional Resources 140
Chapter Problems 141
PART Ⅲ FINANCING OPERATIONS 145
Chapter 5 Financial Instruments and Markets 145
Financial Instrumsents 146
Bonds 147
Common Stock 153
Preferred Stock 157
Financial Markets 160
Private Placement or Public Issue? 160
Exchanges and Over-the-Counter Markets 161
International Financial Markets 161
Investment Banking 164
Issue Costs 166
Regulatory Changes 167
Efficient Markets 168
What Is an Efficient Market? 168
Implications of Efficiency 171
Appendix: Forward Contracts, Options, and the Management of Corporate Risk 173
Forward Markets 174
Hedging in Money and Capital Markets 178
Hedging with Options 178
Limitations of Financial Market Hedging 180
Valuing Options 182
Chapter Summary 185
Additional Resources 186
Chapter Problems 187
Chapter 6 The Financing Decision 191
Financial Leverage 193
Techniques for Analyzing Financing Alternatives 195
Leverage and Risk 198
Leverage and Earnings 200
How Much to Borrow 204
Tax Benefits and Distress Costs 204
Flexibility and Market Signaling 210
The Financing Decision and Sustainable Growth 214
Selecting a Maturity Structure 217
Inflation and Financing Strategy 218
Appendix: The Irrelevance Proposition 219
No Taxes or Distress Costs 219
Taxes but Still No Distress Costs 222
Chapter Summary 223
Additional Resources 224
Chapter Problems 225
PART Ⅳ EVALUATING INVESTMENT OPPORTUNITIES 231
Chapter 7 Discounted Cash Flow Techniques 231
Figures of Merit 232
The Payback Period and the Accounting Rate of Return 233
The Time Value of Money 234
Equivalence 238
The Net Present Value 239
The Benefit-Cost Ratio 241
The Internal Rate of Return 241
Calculating NPVs, IRRs, and BCRs with a Computer Spreadsheet 244
Bond Valuation: An Example of NPV and IRR Calculations 246
Mutually Exclusive Alternatives and Capital Rationing 248
Determining the Relevant Cash Flows 249
Depreciation 250
Working Capital and Spontaneous Sources 252
Sunk Costs 254
Allocated Costs 255
Excess Capacity 256
Financing Costs 258
Appendix: Mutually Exclusive Alternatives and Capital Rationing 261
What Happened to the Other $578,000? 262
Unequal Lives 263
Capital Rationing 264
The Problem of Future Opportunities 266
A Decision Tree 266
Chapter Summary 267
Additional Resources 268
Chapter Problems 269
Chapter 8 Risk Analysis in Investment Decisions 273
Risk Defined 275
Estimating Investment Risk 277
Three Techniques for Estimating Investment Risk 278
Including Risk in Investment Evaluation 278
Risk-Adjusted Discount Rates 278
The Cost of Capital 280
The Cost of Capital Defined 281
Timberland Company’s Cost of Capital 283
The Cost of Capital in Investment Appraisal 290
Multiple Hurdle Rates 290
Four Pitfalls in the Use of Discounted Cash Flow Techniques 292
The Entity Perspective versus the Equity Perspective 293
Inflation 295
Real Options 297
Excessive Risk Adjustment 300
Economic Value Added 301
EVA and Investment Analysis 302
EVA’s Appeal 304
A Cautionary Note 305
Appendix: Diversification and B-Risk 307
Diversification 309
Measuring Beta 312
Using Beta in Investment Evaluation 313
Beta Risk and Conglomerate Diversification 313
Chapter Summary 314
Additional Resources 315
Chapter Problems 316
Chapter 9 Business Valuation and Corporate Restructuring 319
Valuing a Business 321
Assets or Equity? 321
Dead or Alive? 322
Minority Interest or Control? 324
Discounted Cash Flow Valuation 325
Free Cash Flow 326
The Terminal Value 327
A Numerical Example 330
Problems with Present Value Approaches to Valuation 332
Valuation Based on Comparable Trades 332
Lack of Marketability 337
The Market for Control 338
The Premium for Control 338
Financial Reasons for Restructuring 341
The Empirical Evidence 347
The AT&T-McCaw Merger 349
Chapter Summary 352
Additional Resources 353
Chapter Problems 353
APPENDLX A: PRESENT VALUE OF $1 IN YEAR N, DISCOUNTED AT DISCOUNT RATE K 359
APPENDLX B: PRESENT VALUE OF AN ANNUITY OF $1 FOR N YEARS,DISCOUNTED AT RATE K 361
GLOSSARY 363
SUGGESTED ANSWERS TO END-OF-CHAPTER PROBLEMS 375
INDEX 399