PART ONE:THE WORLD OF FINANCE 1
Glossary 1
Index 1
Chapter1:Finance and the Firm 1
The Field of Finance 2
Chapter1:Finance and the Firm1 2
PART ONE THE WORLD OF FINANCE 2
Contents 2
The Role of the Financial Manager 3
Financial Management 3
Finance Career Paths 3
The Basic Financial Goal of the Firm 5
In Search of Value 6
Legal and Ethical Challenges in Financial Management 9
Finance at Work: Melanie Rosen.Electronic Media.The New York Times 9
Agency Issues 10
The Interests of Society as a Whole 11
The Interests of Other Groups 11
The Proprietorship 12
Forms of Business Organization 12
The Partnership 13
What s Next 14
The Corporation 14
Summary 15
Self.Test 16
Review Questions 16
Producing Pro Forma Financial Statements 17
Answers to Self-Test 17
Build Your Communication Skills 17
Chapter2:Financial Markets and Interest Rates 18
Chapter 2: Financial Markets and Interest Rates 18
The Financial System 19
Securities 20
Financial Intermediaries 20
Financial Markets 21
The Primary Market 21
The Secondary Market 21
The Money Market 22
The Capital Market 22
Security Exchanges 22
The Over-the-Counter(OTC)Market 22
Market Efficiency 23
Securities in the Financial Marketplace 23
Securitics in the Moncy Market 23
Ethical Connections: The Dog Ate My Investment 24
Securities in the Capital Market 25
Financial Management and You: How to Buy Treasury Securities without Using a Broker 28
Interest 29
Determinants of Interest Rates 29
The Yield Curve 32
What s Next 33
Summary 33
Self-Test 35
Review Questions 35
Build Your Communication Skills 35
Problems 36
Answers to Self-Test 36
Chapter 3: Financial Institutions 38
Chapter3:Financial Institutions 38
Financial Intermediation 39
Denomination Matching 40
Absorbing Credit Risk 41
Commercial Banks 41
Bank Regulation 42
Commercial Bank Operations 42
Ethical Connections: How Ethical Is Your Financial Institution? 44
The Federal Reserve System 44
Organization of the Fed 45
Controlling the Money Supply 46
Savings and Loan Associations 47
Legislation Affecting S Ls 47
The Discount Window 47
Regulation of S Ls 48
Mutual Companies versus Stockholder Owned Companies 48
The Problem of Matching Loan and Deposit Maturities 48
S Ls Real Assets 49
Gredit Unions 50
The Common Bond Requirement 50
Members as Shareholders 50
Credit Unions Compared to Banks 50
Credit Union Regulation 50
Finance Companies,Insurance Companies,and Pension Funds 51
Types of Finance Companies 51
Insurance Companies 52
Financial Management and You:The Social Security Sytem 53
What s Next 54
Summary 54
Build Your Communication Skills 55
Review Questions 55
Self-Test 55
Answer to Self-Test 56
PART TWO ESSENTIAL CONCEPTS IN FINANCE 57
Chapter 4:Review of Accounting 57
Chapter4:Review of Accounting 57
PART TWO:ESSENTIAL CONCEPTS IN FINANCE 57
Reviw of Accounting 58
Fundamentals 58
Basic Accounting Financial Statements 59
The Income Statement 59
Ethical Connections:Box Office Hits—Who Profits? 62
The Balance Sheet 63
The Statement of Cash Flows 66
Depreciation 69
Calculating the Amount of Depreciation Expense 69
Income Taxes 71
Financial Management and You: Your Personal Tax Rates 72
Whats Next 73
Summary 73
Self-Test 73
Review Questions 74
Build Your Communication Skills 74
Problems 75
Answers to Self-Test 78
Chapter5:Analysis of Financial Statements 79
Chapter5:Analysis of Financial Statements 79
Assessing Financial Health 80
Financial Ratios 81
Misleading Numbers 81
The Basic Financial Ratios 83
Caculating the Ratios 83
Finance at Work: Lee Anne Schuster,Kitchell Contractors,Marketing 94
Trend Analysis and Industry Comparisons 94
Trend Analysis 95
Industry Comparisons 96
Summary Analysis: Trend and Industry Comparisons Together 96
Locating Information about Financial Ratios 98
What s Next 100
Summary 100
Equations Introduced in This Chapter 101
Self-Test 102
Review Questions 102
Build Your Communication Skills 102
Problems 103
Answers to Self-Test 110
Chapter:6: Forecasting for Financial Planning 111
Chapter6:Forecasting for Financial Planning 111
Why Forecasting Is Important 112
Forecasting Approaches 113
Why Forecasts Are Sometimes Wrong 114
Forecasting Sales 115
Forecasting Finaancial Statements 116
Budgets 117
Finance at Work: Keith Ender,Customer Service Representative,James River Paper Company 126
Analyzing Forecasts for Financial Planning 127
Whats Next 128
Summary 128
Self-Test 129
Review Questions 129
Build Your Communication Skills 129
Problems 129
Answers to Self-Text 135
Chapter7: Risk and Return 136
Chapter7:Risk and Return 136
Risk 137
Risk Aversion 137
The Risk-Return Relationship 137
Measuring Risk 138
Using Standard Deviation to Measure Risk 138
Using the Coefficient of Variation to Measure Risk 142
The Types of Risks Firms Encounter 144
Business Risk 144
Financial Risk 146
Portfolio Risk 148
Dealing With Risk 154
Risk-Reduction Methods 154
Compensating for the Presence of Risk 155
Financial Management and You: Mutual Funds and Risk 155
What s Next 158
Summary 158
Equations Introduced in This Chapter 159
Self-Test 160
Review Questions 161
Build Your Communication Skills 161
Problems 161
Answers to Self-Test 165
Chapter8: The Time Value of Money 167
Chapter8:The Time Value of Money 167
Why Money Hals Time Value 168
Measuring the Time Value of Money 168
The Future Value of a Single Amount 169
The Sensitivity of Future Values to Changes i n Interest Rates of the Number of Compounding Periods 172
The Present Value of a Single Amount 172
The Sensitivity of Present Values to Changes in k and n 175
Working with Annuities 176
Future Value of an Ordinary Annuity 176
The Present Value of an Ordinary Annuity 179
Ethical Connections: When a Million Isn t a Million.Taking a Chance on the Time Value of Money 181
Future and Present Values of Annuities Due 181
Perpetuities 183
Present Value of an Investment with Uneven Cash Flows 183
Special Time Value of Money Problems 185
Finding the Interest Rate 185
Finding the Number of Periods 188
Solving for the Payment 189
Compounding More than Once per Year 191
What s Next 194
Equations Introduced in This Chapter 195
Summary 195
Self-Test 197
Review Questions 198
Build Your Communication Skills 198
Problems 198
Answers to Self-Test 202
Chapter9: Bond and Stock Valuation 203
Chapter9:Bond and Stock Valuation 203
The Importance of Bond and Stock Valuation 204
A General Valuation Model 204
Bond Valuation 205
Semi-Annual Coupon Interest Payments 207
The Yield to Maturity of a Bond 208
The Relationship Between Bond YTM and Price 210
Finding the Present Value of Preferred Stock Dividends 212
Preferred Stock Valuation 212
The Yield on Preferred Stock 213
Common Stock Valuation 214
Common Stock Going Concern Valuation Models 214
Balance Sheet Valuation Approaches 217
Deciding Which Stock Valuation Approach to Use 218
The Yield on Common Stock 218
What s Next 218
Summary 219
Equations Introduced in This Chapter 220
Self-Test 221
Review Questions 222
Build Your Communication Skills 222
Problems 222
Answers to Self-Test 226
Appendix 9A: Common Stock Valuation: Supernormal Growth 228
PART THREE LONG-TERM FINANCIAL MANAGEMENT DECISIONS 230
Chapter10: Capital Budgeting Decision Methods 230
Chapter10:Capital Budgeting Decision Methods 230
PART THREE:LONG-TERM FINANCIAL MANAGEMENT DECISIONS 230
The Capital Budgeting Process 231
Decision Practices 231
Types of Projects 232
Capital Budgeting Cash Flows 232
Stages in the Capital Budgeting Proess 232
Capital Budgeting Decision Methods 233
The Net Present Value(NPV)Method 234
The Intermal Rate of Return(IRR)Method 240
Problems with the IRR Method 243
Conflicting Rankings between the NPV and IRR Methods 243
Capital Rationing 244
Finance at Work: Jim Bruner,Former Maricopa County Supervisor,State of Arizona 246
Risk and Capital Budgeing 247
Measuring Risk in Capital Budgeting 248
Adjusting for Risk 249
What s Next 250
Summary 250
Equations Introduced in This Chapter 251
Review Questions 252
Self-Test 252
Build Your Communication Skills 253
Problems 253
Answers to Self-Test 260
Appendix 10A: Wrinkles in Capital Budgeting 262
Non-Simple Projects 262
Multiple IRRs 263
Mutually Exclusive Projects with Unequal Project Lives 264
Comparing Projects with Unequal Lives 265
Equations Introduced in This Appendix 267
Chapter11: Estimating Incremental Cash Flows 268
Chapter11:Estimating Incremental Cash Flows 268
Incremental Cash Flows 269
Types of Incremental Cash Flows 270
Initial Investment Cash Flows 270
Operating Cash Flows 271
Cash Flows at the End of a Project s Life 274
Incremental Cash Flows of an Expansion Project 274
Financial Management and You: The Incremental Costs of Studying Abroad 275
An Asset Replacement Decision 280
Financing Cash Flows 281
Self-Test 282
Summary 282
Whats Next 282
Build Your Communication Skills 283
Review Questions 283
Problems 284
Answers to Self-Test 287
Chapter12:The Cost of Capital 288
Chapter 12: The Cost of Capital 288
The Cost of Capital 289
Sources of Capital 290
The Cost of Debt 290
The Cost of Preferred and Common Stock Funds 292
The Weighted Average Cost of Capital(WACC) 297
The Marginal Cost of Capital(MCC) 299
Finance at Work: Interview with Fred Higgins:Mint Mart Foods.Inc.CEO 300
The Firm s MCC Schedule 300
The MCC Schedule and Capital Budgeting Decisions 304
The Optimal Capital Budget 306
The Importance of MCC to Capital Budgeting Dccisions 307
What s Next 307
Summary 307
Equations Introduced in This Chapter 308
Self-Test 309
Review Questions 310
Build Your Communication Skills 310
Problems 310
Answers to Self-Test 315
Chapter13:Capital Structure Basics 316
Chapter 13: Capital Structure Basics 316
Breakeven Analysis and Leverage 317
Constructing a Sales Breakeven Chart 317
Applying Breakeven Analysis 320
Leverage 323
Operating Leverage 323
Financial Leverage 326
Combined Leverage 328
LBOs 329
Ethical Connections: Ei Tu,Wilson? 330
Capital Structure Theory 331
Tax Deductibility of Interest 331
Modigliani and Miller 331
Toward an Optimal Capital Structure 332
What s Next 334
Summary 334
Equations Introduced in This Chapter 335
Review Questions 337
Build Your Communication Skills 337
Self-Test 337
Problems 338
Answers to Self-Test 341
Chapter14:Corporate Bonds,Preferred Stock,and Leasing 343
Chapter14: Corporate Bonds,Preferred Stock,and Leasing 343
Bond Basics 344
Features of Bond Indentures 344
Severity 345
Plans for Paying off the Bond Issue 346
Call Provisions 346
Restrictive Covenants 348
The Independent Trustee of the Bond Issue 349
Types of Bonds 349
Secured Bonds 349
Convertible Bonds 351
Variable Rate Bonds 352
Putable Bonds 354
Junk Bonds 354
International Bonds 354
Ethical Connections: Repealing a Subsidy Generates Trash Talk 355
Super Long-Term Bonds 355
Preferred Srock Dividends 356
Preferred Srock Investors 356
Preferred Srock 356
Leasing 357
Genuine Leases versus Fakes 357
Operating and Financial(Capital )Leases 358
What s Next 359
Summary 359
Self-Test 360
Equations Introduced in This Chapter 360
Review Questions 361
Build Your Communication Skills 361
Problems 361
Answers to Self-Test 363
Appendix 14A: Bond Refunding 363
A Sample Bond Refunding Problem 364
Chapter15:Common Stock 367
Chapter15: Common Stock 367
The Characteristies of Common Stock 368
Stock Issued by Private Corporations 370
Stock Issued by Publicly Traded Corporations 370
Finance at Work: Chris Heller:Corporare Communications Consultant 371
Institutional Ownership of Common Stock 372
Voting Rights of Common Stockholders 372
Proxies 372
Board of Directors Elcctions 373
The Pros and Cons of Equity Financing 375
Disadvantages of Equity Financing 375
Advantages of Equity Financing 376
Issuing Common Stock 376
The Function of Investment Bankers 377
Pricing New Issues of Stock 379
Rights and Warrants 380
Preemptive Rights 380
Warrants 383
What s Next 385
Summary 385
Equations Introduced in This Chapter 386
Self-Test 387
Review Questions 387
Build Your Communication Skills 387
Problems 387
Answers to Self-Test 389
Chapter16:Dividend Policy 391
Chapter 16: Dividend Policy 391
Dividends 392
Why a Dividend Policy Is Necessary 392
Factors Affecting Dividend Policy 393
Need For Funds 393
Management Expectations and Dividend Policy 393
Stockholders Preferences 393
Restrictions on Dividend Payments 394
Cash versus Earnings 394
Leading Dividend Theories 396
The Residual Theory of Dividends 396
The Clientele Dividend Theory 397
The Signaling Dividend Theory 397
Modigliani and Miller s Dividend Theory 398
The Mechanies of Paying Dividends 398
The Bird-in-the-Hand Theory 398
Financial Management and You: Dividend Reinvestment Records Can Avoid Tax Headaches 400
Dividend Reinvestment Plans 400
Alternatives to Cash Dividends 400
Stock Dividends and Stock Splits 400
What s Next 405
Summary 405
Review Questions 406
Build Your Communication Skills 406
Equations Introduced in This Chapter 406
Self-Test 406
Problems 407
Answers to Sefl-Test 409
PART FOUR SHORT-TERM FINANCIAL MANAGEMENT DECISIONS 410
Chapter 17: Working Capital Policy 410
PART FOUR:SHORT-TERM FINANCIAL MANAGEMENT DECISIONS 410
Chapter17:Working Capital Policy 410
Managing Working Capital 411
Why Businesses Accumulate Working Capital 412
Fluctuating Current Assets 412
Permanent and Temporary Current Assets 413
Estabilsbing the Optimal Level of Current Assets 414
Liquidity versus Profitability 414
Managing Current Liabilities:Risk and Return 415
Three Working Capital Financing Approaches 415
The Aggressive Approach 416
The Conservative Approach 417
The Moderate Approach 418
Working Capital Financing and Financial Ratios 418
What s Next 419
Finance at Work: Interview with Michaet Coleman.Vice President of Tek Soft 420
Summary 421
Self-Test 421
Build Your Communication Skills 422
Review Questions 422
Problems 423
Answers to Self-Test 426
Chapter18:Managing Cash 428
Chapter 18: Managing Cash 428
Cash Management Concepts 429
Determining the Optimal Cash Balance 429
The Minimum Cash Balance 430
The Maximum Cash Balance 431
Determining the Optimal Cash Balance 432
Finance at Work: Karen Noble,Professional Glofer 434
Forecasting Cash Needs 435
Developing a Cash Budget 436
Managing the Cash Flowing in and out of the Firm 440
Increasing Cash Inflows 440
Decreasing Cash Outflows 443
Speeding Up Cash Iuflows 443
Slowing Down Cash Outflows 444
What s Next 445
Summary 445
Review Questions 446
Self-Test 446
Build Your Communication Skills 446
Equations Introduced in This Chapter 446
Problems 447
Answer to Self-Test 449
Chapter 19: Accounts Receivable and Inventory 451
Chapter19:Accounts Receivable and Inventory 451
Why Firms Accumulate Accounts Receivable and Inventory 453
How Accounts Receivable and Inventory Affect Profitability and Liquidity 454
Findig Optimal Levels of Accounts Receivable and Inventory 455
The Optimal Level of Accounts Receivable 455
The Optimal Level of Inventory 460
The ABC Inventory Classification System 466
Just-in-Time Inventory Control(JIT) 466
Inventory Management Approaches 466
Making Credit Decisions 467
Collection Policies to Handle Bad Debts 468
Finance at Work: Joann K.Jones,CEO of Capital Electric Supply 470
What s Next 471
Summary 471
Equations Introduced in This Chapter 472
Self-Test 472
Review Questions 473
Bulid Your Communication Skills 473
Problems 474
Answers to Self-Test 478
Chapter 20: Short-Term Financing 482
Chapter20:Short-Term Financing 482
The Need for Short-Term Financing 484
Short-Term Financing versus Long-Term Financing 484
Short-Term Financing Alternatives 485
Short-Term Loans from Banks and Other Institutions 485
Trabe Credit 486
Commercial Paper 488
How Loan Terms Affect the Effective Interest Rate of a Loan 489
The Effective Interest Rate Discount Loans 490
Compensating Balances 491
Loan Maturities Shorter than One Year 492
A Comprehensive Example 493
Computing the Amount to Borrow 494
Collateral for Short-Term Loans 495
Accounts Receivable as Collateral 495
Inventory as Collateral 495
Financial Management and You: Easy Com,Easy Go:The Cost of Credit 496
Summary 497
What s Next 497
Equations Introduced in This Chapter 498
Self-Test 499
Review Questions 500
Build Your Communications Skills 500
Problems 500
Answers to Self-Test 501
Chapter21:International Finance 503
PART FIVE:FINANCE IN THE GLOBAL ECONOMY 503
Chapter 21: International Finance 503
Financial Advantages of Foreign Operations 504
Multinational Corporations 504
PART FIVE FINANCE IN THE GLOBAL ECONOMY 504
Ethical Issues Facing Multinational Corporations 505
Comparative Advantage 506
Exchange Rates and Their Effects 507
Fluctuating Exchange Rates Cross Rates 508
Exchange Ratc Effects on MNCS 510
Exchange Ratc Effects on Foreigri Stock and Bond Investments 510
Managing Risk 511
Hedging 511
Diversification Benefits of Foreign Investments 511
American Depository Receipts 512
Finance At Work: Interview with Don Burton,International Import-Export Institure 513
Exchange Rate Theories 514
Purchasing Power Parity Theory 514
International Fisher Effect 515
Interest Rate Parity Theory 515
Other Factors Affecting Exchange Rates 515
Government Intervention in Foreign Exchange Markets 516
Cultural Risk 517
Political Risk 517
Political and Cultural Risks Facing MNCs 517
International Trade Agreements 518
NAFTA 518
GATT 519
European Union 519
Free Trade versus Fair Trade 519
Summary 520
Equations Introduced in This Chaper 521
Self-Test 521
Review Questions 521
Build Your Communication Skills 521
Problems 522
Answers to Self-Test 523