Business finance : Theory and practice

Cover......Page 1
Title Page......Page 4
Copyright Page......Page 5
Contents......Page 6
Preface......Page 14
Plan of the book......Page 16
Publisher’s acknowledgements......Page 17
Part 1 The business finance environment......Page 18
  Objectives......Page 20
  1.1 The role of business finance......Page 21
  1.2 Risk and business finance......Page 22
  1.4 The organisation of businesses – the limited company......Page 23
  1.5 Corporate governance and the role of directors......Page 26
  1.6 Long-term financing of companies......Page 29
  1.7 Liquidation......Page 31
  1.8 Derivatives......Page 32
  1.9 Private equity funds......Page 33
  Summary......Page 34
  Review questions......Page 35
  2.1 Financial decision making......Page 36
  2.2 Business objectives......Page 38
  2.3 Conflicts of interest: shareholders versus managers – the ‘agency’ problem......Page 42
  2.4 Financing, investment and separation......Page 45
  2.5 Behavioural finance......Page 48
  Summary......Page 49
  Problem......Page 50
  Appendix: Formal derivation of the separation theorem......Page 52
  3.1 Introduction......Page 58
  3.2 The financial statements......Page 59
  3.3 Definitions and conventions of accounting......Page 63
  3.4 Problems with using accounting information for decision making......Page 66
  3.5 Creative accounting......Page 67
  3.6 Ratio analysis......Page 70
  3.7 Using accounting ratios to predict financial failure......Page 82
  Summary......Page 83
  Review questions......Page 84
  Problems......Page 85
  Appendix: Jackson plc’s income statement and statement of financial position for 2016......Page 91
Part 2 Investment decisions......Page 94
  4.1 Introduction......Page 96
  4.2 Net present value......Page 97
  4.3 Internal rate of return......Page 104
  4.4 Payback period......Page 111
  4.5 Accounting (or unadjusted) rate of return......Page 114
  4.6 Investment appraisal methods used in practice......Page 116
  Summary......Page 121
  Problems......Page 123
  5.1 Introduction......Page 128
  5.2 Cash flows or accounting flows?......Page 129
  5.3 Do cash flows really occur at year-ends?......Page 132
  5.4 Which cash flows?......Page 133
  5.5 Taxation......Page 134
  5.6 Inflation......Page 136
  5.7 An example of an investment appraisal......Page 138
  5.8 Capital rationing......Page 142
  5.9 Replacement decisions......Page 146
  5.10 Routines for identifying, assessing, implementing and reviewing investment projects......Page 148
  5.11 Investment appraisal and strategic planning......Page 151
  5.12 Value-based management......Page 153
  5.13 Real options......Page 159
  Summary......Page 160
  Further reading......Page 162
  Problems......Page 163
  6.1 Introduction......Page 170
  6.2 Sensitivity analysis......Page 171
  6.3 Use of probabilities......Page 176
  6.4 Expected value......Page 179
  6.5 Systematic and specific risk......Page 182
  6.6 Utility theory......Page 183
  6.7 Attitudes to risk and expected value......Page 186
  6.10 Risk – the story so far......Page 191
  Summary......Page 192
  Further reading......Page 193
  Problems......Page 194
  7.1 The relevance of security prices......Page 200
  7.2 The expected value/variance (or mean/variance) criterion......Page 202
  7.3 Security investment and risk......Page 203
  7.4 Portfolio theory......Page 205
  7.5 The capital asset pricing model......Page 214
  7.6 CAPM: an example of beta estimation......Page 216
  7.8 Tests of CAPM......Page 219
  7.9 CAPM – why the doubts?......Page 221
  7.10 Implications of modern portfolio theory and CAPM......Page 222
  7.11 Lack of shareholder unanimity on risky investment......Page 223
  7.12 Using CAPM to derive discount rates for real investments – the practical problems......Page 224
  7.13 Arbitrage pricing model......Page 226
  Summary......Page 227
  Problems......Page 229
  Appendix: Derivation of CAPM......Page 231
Part 3 Financing decisions......Page 234
  8.1 Introduction......Page 236
  8.2 Ordinary (equity) capital......Page 238
  8.3 Methods of raising additional equity finance......Page 242
  8.4 Preference shares......Page 252
  8.5 Loan notes and debentures......Page 254
  8.7 Warrants......Page 259
  8.9 Asset-backed finance (securitisation)......Page 260
  8.10 Leasing......Page 261
  8.11 Grants from public funds......Page 263
  8.13 Conclusions on long-term finance......Page 264
  Summary......Page 265
  Review questions......Page 268
  Problems......Page 269
  9.1 Introduction......Page 270
  9.2 The London Stock Exchange......Page 271
  9.3 Capital market efficiency......Page 274
  9.4 Tests of capital market efficiency......Page 277
  9.6 Conclusions on, and implications of, capital market efficiency......Page 285
  9.7 Behavioural finance......Page 288
  Summary......Page 290
  Further reading......Page 291
  Problems......Page 292
  10.1 Introduction......Page 293
  10.2 Cost of individual capital elements......Page 294
  10.3 Weighted average cost of capital (WACC)......Page 302
  10.4 The discount rate – CAPM versus the traditional approach......Page 307
  10.5 WACC values used in practice......Page 309
  Summary......Page 310
  Problems......Page 312
  11.1 Introduction......Page 315
  11.2 Is debt finance as cheap as it seems?......Page 316
  11.3 Business risk and financial risk......Page 317
  11.4 The traditional view of gearing......Page 319
  11.5 The Modigliani and Miller view of gearing......Page 321
  11.7 Capital/financial gearing and operating gearing......Page 327
  11.8 Other practical issues relating to capital gearing......Page 328
  11.9 Evidence on gearing......Page 329
  11.10 Gearing and the cost of capital – conclusion......Page 331
  11.11 The trade-off theory......Page 333
  11.12 Pecking order theory......Page 334
  11.14 MM, modern portfolio theory and CAPM......Page 336
  11.15 Weighted average cost of capital revisited......Page 338
  Summary......Page 339
  Further reading......Page 340
  Problems......Page 341
  Appendix I: Proof of the MM cost of capital proposition (pre-tax)......Page 344
  Appendix II: Proof of the MM cost of capital proposition (after tax)......Page 345
  12.1 Introduction......Page 347
  12.2 Modigliani and Miller on dividends......Page 348
  12.3 The traditional view on dividends......Page 350
  12.4 Who is right about dividends?......Page 351
  12.5 Other factors......Page 352
  12.6 Dividends: the evidence......Page 355
  Summary......Page 361
  Further reading......Page 362
  Problems......Page 363
  Appendix: Proof of the MM dividend irrelevancy proposition......Page 367
Part 4 Integrated decisions......Page 370
  13.1 Introduction......Page 372
  13.2 The dynamics of working capital......Page 373
  13.3 The importance of the management of working capital......Page 377
  13.4 Working capital and liquidity......Page 379
  13.5 Overtrading......Page 381
  13.6 Inventories (stock in trade)......Page 382
  13.7 Just-in-time inventories management......Page 389
  13.8 Trade receivables (trade debtors or accounts receivable)......Page 391
  13.9 Cash (including overdrafts and short-term deposits)......Page 395
  13.10 Trade payables (trade creditors)......Page 401
  Summary......Page 403
  Problems......Page 406
  14.1 Introduction......Page 409
  14.2 Takeovers and mergers......Page 410
  14.3 Mergers: the practicalities......Page 413
  14.4 Divestments......Page 422
  Summary......Page 425
  Review questions......Page 426
  Problems......Page 427
  15.1 Introduction......Page 429
  15.2 Foreign exchange......Page 432
  15.3 Problems of internationalisation......Page 439
  15.4 International investment appraisal......Page 447
  15.5 Risks of internationalisation, management of those risks and portfolio theory......Page 448
  Summary......Page 451
  Review questions......Page 453
  Problems......Page 454
  16.1 Introduction......Page 455
  16.3 Organisation of small businesses......Page 458
  16.5 Investment decisions......Page 459
  16.6 Risk and the discount rate......Page 460
  16.7 Sources of finance......Page 461
  16.8 Valuation of small businesses......Page 465
  16.11 Working capital and small businesses......Page 469
  Summary......Page 470
  Review questions......Page 473
  Problems......Page 474
Appendix 1 Present value table......Page 480
Appendix 2 Annuity table......Page 481
Appendix 3 Suggested answers to review questions......Page 482
Appendix 4 Suggested answers to selected problems......Page 495
Glossary......Page 520
References......Page 526
Index......Page 533