Fundamentals of Corporate Finance, 2nd Edition

Cover......Page 1
Title Page......Page 4
Copyright Page......Page 7
About the Authors......Page 19
Bridging Theory and Practice......Page 21
Applications That Reflect Real Practice......Page 22
Teaching Every Student to Think Finance......Page 23
Practice Finance to Learn Finance......Page 24
Preface......Page 25
Acknowledgments......Page 29
Contents......Page 9
PART 1 Introduction......Page 32
CHAPTER 1 Corporate Finance and the Financial Manager......Page 33
INTERVIEW WITH: Leslie Tillquist, PA Consulting Group......Page 34
1.2 The Four Types of Firms......Page 35
Corporate Taxation Around the World......Page 40
1.4 The Financial Manager’s Place in the Corporation......Page 42
1.5 The Stock Market......Page 45
NYSE, AMEX, DJIA, S&P 500: Awash in Acronyms......Page 47
1.6 Financial Institutions......Page 48
Summary......Page 50
Problems......Page 52
CHAPTER 2 Introduction to Financial Statement Analysis......Page 54
INTERVIEW WITH Hiral Tolia, CBIZ Valuation Group, LLC......Page 55
2.1 Firms’ Disclosure of Financial Information......Page 56
2.2 The Balance Sheet......Page 57
2.3 Balance Sheet Analysis......Page 61
2.4 The Income Statement......Page 64
2.5 Income Statement Analysis......Page 66
COMMON MISTAKE: Mismatched Ratios......Page 71
2.6 The Statement of Cash Flows......Page 73
2.7 Other Financial Statement Information......Page 76
2.8 Financial Reporting in Practice......Page 77
Practitioner INTERVIEW WITH Sue Frieden, Ernst & Young......Page 79
Summary......Page 80
Problems......Page 83
Data Case......Page 89
PART 2 Interest Rates and Valuing Cash Flows......Page 92
CHAPTER 3 Time Value of Money: An Introduction......Page 93
INTERVIEW WITH: Nicole Wickswat, Intel Corporation......Page 94
3.1 Cost-Benefit Analysis......Page 95
3.2 Market Prices and the Valuation Principle......Page 97
3.3 The Time Value of Money and Interest Rates......Page 99
3.4 Valuing Cash Flows at Different Points in Time......Page 104
COMMON MISTAKE: Summing Cash Flows Across Time......Page 105
Rule of 72......Page 107
Summary......Page 109
Problems......Page 111
CHAPTER 4 Time Value of Money: Valuing Cash Flow Streams......Page 114
INTERVIEW WITH: Gregory Goin, McFee Financial Group......Page 115
4.1 Valuing a Stream of Cash Flows......Page 116
Using a Financial Calculator: Solving for Present and Future Values of Cash Flow Streams......Page 119
4.2 Perpetuities......Page 120
Historical Examples of Perpetuities......Page 122
4.3 Annuities......Page 123
4.4 Growing Cash Flows......Page 127
4.5 Solving for Variables Other Than Present Value or Future Value......Page 130
Summary......Page 137
Problems......Page 139
Data Case......Page 144
CHAPTER 4 APPENDIX: Using a Financial Calculator......Page 145
CHAPTER 5 Interest Rates......Page 148
INTERVIEW WITH: Jason Moore, Bradford & Marzec, LLC......Page 149
5.1 Interest Rate Quotes and Adjustments......Page 150
COMMON MISTAKE: Using the EAR in the Annuity Formula......Page 153
5.2 Application: Discount Rates and Loans......Page 155
5.3 The Determinants of Interest Rates......Page 158
How Is Inflation Actually Calculated?......Page 161
Practitioner INTERVIEW WITH Frederic S. Mishkin, Columbia University......Page 163
COMMON MISTAKE: Using the Annuity Formula When Discount Rates Vary......Page 164
5.4 The Opportunity Cost of Capital......Page 167
Interest Rates, Discount Rates, and the Cost of Capital......Page 168
Summary......Page 169
Critical Thinking......Page 170
Problems......Page 171
CHAPTER 6 Bonds......Page 175
INTERVIEW WITH: Andrew DeWitt, PIMCO......Page 176
6.1 Bond Terminology......Page 177
6.2 Zero-Coupon Bonds......Page 178
6.3 Coupon Bonds......Page 182
The U.S. Treasury Market......Page 183
Finding Bond Prices on the Web......Page 185
6.4 Why Bond Prices Change......Page 187
Clean and Dirty Prices for Coupon Bonds......Page 193
6.5 Corporate Bonds......Page 195
Practitioner INTERVIEW WITH Lisa Black, Teachers Insurance and Annuity Association......Page 196
The Credit Crisis and Bond Yields......Page 199
Summary......Page 201
Critical Thinking......Page 202
Problems......Page 203
Data Case......Page 206
CHAPTER 6 APPENDIX A: Solving for the Yield to Maturity of a Bond Using a Financial Calculator......Page 208
CHAPTER 6 APPENDIX B: The Yield Curve and the Law of One Price......Page 209
CHAPTER 7 Stock Valuation......Page 213
INTERVIEW WITH: Christopher Ellis-Ferrara, AllianceBernstein......Page 214
7.1 Stock Basics......Page 215
7.2 The Mechanics of Stock Trades......Page 218
7.3 The Dividend-Discount Model......Page 219
7.4 Estimating Dividends in the Dividend-Discount Model......Page 223
COMMON MISTAKE: Forgetting to “Grow” This Year’s Dividend......Page 227
7.5 Limitations of the Dividend-Discount Model......Page 229
7.6 Share Repurchases and the Total Payout Model......Page 231
7.7 Putting It All Together......Page 232
Summary......Page 233
Problems......Page 235
PART 2 INTEGRATIVE CASE......Page 238
PART 3 Valuation and the Firm......Page 240
CHAPTER 8 Investment Decision Rules......Page 241
INTERVIEW WITH: Scott Ladner, Parsons Brinckerhoff......Page 242
8.1 The NPV Decision Rule......Page 243
8.2 Using the NPV Rule......Page 245
8.3 Alternative Decision Rules......Page 247
USING EXCEL: Computing NPV and IRR......Page 248
COMMON MISTAKE IRR: Versus the IRR Rule......Page 254
Why Do Rules Other Than the NPV Rule Persist?......Page 255
8.4 Choosing Between Projects......Page 257
Practitioner INTERVIEW WITH Dick Grannis, QUALCOMM......Page 261
8.5 Evaluating Projects with Different Lives......Page 263
8.6 Choosing Among Projects When Resources Are Limited......Page 266
8.7 Putting It All Together......Page 269
Summary......Page 270
Critical Thinking......Page 271
Problems......Page 272
Data Case......Page 277
CHAPTER 9 Fundamentals of Capital Budgeting......Page 278
INTERVIEW WITH: Kelly Cox, Boeing Corporation......Page 279
9.1 The Capital Budgeting Process......Page 280
9.2 Forecasting Incremental Earnings......Page 281
9.3 Determining Incremental Free Cash Flow......Page 285
COMMON MISTAKE: The Opportunity Cost of an Idle Asset......Page 291
COMMON MISTAKE: The Sunk Cost Fallacy......Page 292
9.5 Analyzing the Project......Page 296
Practitioner INTERVIEW WITH David Holland, Sports and Entertainment Solutions......Page 299
9.6 Real Options in Capital Budgeting......Page 301
Summary......Page 302
Problems......Page 304
Data Case......Page 310
CHAPTER 9 APPENDIX MACRS: Depreciation......Page 311
CHAPTER 10 Stock Valuation: A Second Look......Page 313
INTERVIEW WITH: David Mandell, William Blair & Company......Page 314
10.1 The Discounted Free Cash Flow Model......Page 315
10.2 Valuation Based on Comparable Firms......Page 319
Practitioner INTERVIEW WITH Marilyn Fedak, AllianceBernstein......Page 326
10.3 Information, Competition, and Stock Prices......Page 327
Forms of Market Efficiency......Page 329
10.4 Individual Biases and Trading......Page 333
Summary......Page 336
Problems......Page 337
Data Case......Page 341
PART 3 INTEGRATIVE CASE......Page 343
PART 4 Risk and Return......Page 346
CHAPTER 11 Risk and Return in Capital Markets......Page 347
INTERVIEW WITH: Sunita S. Mohanty, Absolute Return for Kids......Page 348
11.1 A First Look at Risk and Return......Page 349
11.2 Historical Risks and Returns of Stocks......Page 351
Arithmetic Average Returns Versus Compound Annual Returns......Page 356
USING EXCEL: Computing the Standard Deviation of Historical Returns......Page 359
11.3 The Historical Tradeoff Between Risk and Return......Page 362
11.4 Common Versus Independent Risk......Page 363
11.5 Diversification in Stock Portfolios......Page 365
Summary......Page 370
Critical Thinking......Page 372
Problems......Page 373
CHAPTER 12 Systematic Risk and the Equity Risk Premium......Page 376
INTERVIEW WITH: Alexander Morgan, Pantheon Ventures......Page 377
12.1 The Expected Return of a Portfolio......Page 378
12.2 The Volatility of a Portfolio......Page 381
USING EXCEL: Calculating the Correlation Between Two Sets of Returns......Page 385
NOBEL PRIZE: Harry Markowitz......Page 388
12.3 Measuring Systematic Risk......Page 389
Index Funds......Page 391
COMMON MISTAKE: Mixing Standard Deviation and Beta......Page 393
USING EXCEL: Calculating a Stock’s Beta......Page 396
12.4 Putting It All Together: The Capital Asset Pricing Model......Page 397
Why Not Estimate Expected Returns Directly?......Page 398
NOBEL PRIZE: William Sharpe......Page 399
Summary......Page 403
Problems......Page 404
CHAPTER 12 APPENDIX: Alternative Models of Systematic Risk......Page 409
CHAPTER 13 The Cost of Capital......Page 412
INTERVIEW WITH: John Drum, KPMG LLP......Page 413
13.1 A First Look at the Weighted Average Cost of Capital......Page 414
13.2 The Firm’s Costs of Debt and Equity Capital......Page 417
COMMON MISTAKE: Using the Coupon Rate as the Cost of Debt......Page 418
13.3 A Second Look at the Weighted Average Cost of Capital......Page 421
13.4 Using the WACC to Value a Project......Page 425
13.5 Project-Based Costs of Capital......Page 427
Practitioner INTERVIEW WITH Shelagh Glaser, Intel......Page 429
13.6 When Raising External Capital Is Costly......Page 430
Summary......Page 432
Critical Thinking......Page 433
Problems......Page 434
Data Case......Page 437
PART 4 INTEGRATIVE CASE......Page 439
PART 5 Long-Term Financing......Page 440
CHAPTER 14 Raising Equity Capital......Page 441
INTERVIEW WITH: Sandra Pfeiler, Goldman Sachs......Page 442
14.1 Equity Financing for Private Companies......Page 443
14.2 Taking Your Firm Public: The Initial Public Offering......Page 447
14.3 IPO Puzzles......Page 456
2008–2009: A Very Cold IPO Market......Page 458
14.4 Raising Additional Capital: The Seasoned Equity Offering......Page 460
Summary......Page 464
Problems......Page 465
CHAPTER 15 Debt Financing......Page 469
INTERVIEW WITH: Eric Hassberger, Strategic Hotels & Resorts......Page 470
Debt Financing at Hertz: Bank Loans......Page 471
Debt Financing at Hertz: Private Placements......Page 472
Debt Financing at Hertz: Public Debt......Page 474
15.2 Bond Covenants......Page 476
15.3 Repayment Provisions......Page 477
Summary......Page 483
Problems......Page 484
CHAPTER 15 APPENDIX: Using a Financial Calculator to Calculate Yield to Call......Page 486
PART 5 INTEGRATIVE CASE......Page 487
PART 6 Capital Structure and Payout Policy......Page 490
CHAPTER 16 Capital Structure......Page 491
INTERVIEW WITH: Christopher Cvijic, Morgan Stanley......Page 492
16.1 Capital Structure Choices......Page 493
16.2 Capital Structure in Perfect Capital Markets......Page 495
COMMON MISTAKEL: Capital Structure Fallacies......Page 501
NOBEL PRIZE: Franco Modigliani and Merton Miller......Page 503
16.3 Debt and Taxes......Page 504
Bankruptcy Can Be Expensive......Page 510
16.5 Optimal Capital Structure: The Tradeoff Theory......Page 511
16.6 Additional Consequences of Leverage: Agency Costs and Information......Page 513
Airlines Use Financial Distress to Their Advantage......Page 514
Financial Distress and Rolling the Dice, Literally......Page 515
16.7 Capital Structure: Putting It All Together......Page 518
Summary......Page 519
Problems......Page 521
CHAPTER 16 APPENDIX: The Bankruptcy Code......Page 528
CHAPTER 17 Payout Policy......Page 529
INTERVIEW WITHL: Nitin Garg, Intuit......Page 530
17.1 Cash Distributions to Shareholders......Page 531
17.2 Dividends Versus Share Repurchases in a Perfect Capital Market......Page 534
COMMON MISTAKE: Repurchases and the Supply of Shares......Page 537
COMMON MISTAKEL: The Bird in the Hand Fallacy......Page 539
17.3 The Tax Disadvantage of Dividends......Page 540
17.4 Payout Versus Retention of Cash......Page 545
17.5 Signaling with Payout Policy......Page 549
Royal & SunAlliance’s Dividend Cut......Page 551
Practitioner INTERVIEW WITH John Connors, Microsoft (Retired)......Page 552
17.6 Stock Dividends, Splits, and Spin-Offs......Page 553
Berkshire Hathaway’s A and B Shares......Page 554
17.7 Advice for the Financial Manager......Page 555
Summary......Page 556
Problems......Page 558
Data Case......Page 560
PART 6 INTEGRATIVE CASE......Page 562
PART 7 Financial Planning and Forecasting......Page 564
CHAPTER 18 Financial Modeling and Pro Forma Analysis......Page 565
INTERVIEW WITH: David Hollon, Goldman Sachs......Page 566
18.1 Goals of Long-Term Financial Planning......Page 567
18.2 Forecasting Financial Statements: The Percent of Sales Method......Page 568
COMMON MISTAKE: Confusing Stockholders’ Equity with Retained Earnings......Page 571
18.3 Forecasting a Planned Expansion......Page 573
COMMON MISTAKE: Treating Forecasts as Fact......Page 577
18.4 Growth and Firm Value......Page 578
18.5 Valuing the Expansion......Page 582
COMMON MISTAKE: Confusing Total and Incremental Net Working Capital......Page 584
Summary......Page 588
Problems......Page 589
CHAPTER 18 APPENDIX: The Balance Sheet and Statement of Cash Flows......Page 593
CHAPTER 19 Working Capital Management......Page 595
INTERVIEW WITH: Waleed Husain, Comcast......Page 596
19.1 Overview of Working Capital......Page 597
19.2 Trade Credit......Page 601
COMMON MISTAKE: Using APR Instead of EAR to Compute the Cost of Trade Credit......Page 603
The 5 C’s of Credit......Page 605
19.4 Payables Management......Page 609
19.5 Inventory Management......Page 611
Inventory Management Adds to the Bottom Line at Gap......Page 612
19.6 Cash Management......Page 613
Summary......Page 615
Problems......Page 617
Data Case......Page 620
CHAPTER 20 Short-Term Financial Planning......Page 622
INTERVIEW WITH: Teresa Wendt, Lockheed Martin......Page 623
20.1 Forecasting Short-Term Financing Needs......Page 624
20.2 The Matching Principle......Page 629
20.3 Short-Term Financing with Bank Loans......Page 632
Short-Term Financing and the Financial Crisis of the Fall of 2008......Page 635
A Seventeenth-Century Financing Solution......Page 637
20.6 Putting It All Together: Creating a Short-Term Financial Plan......Page 640
Summary......Page 641
Critical Thinking......Page 642
Problems......Page 643
PART 7 INTEGRATIVE CASE......Page 647
PART 8 Special Topics......Page 652
CHAPTER 21 Option Applications and Corporate Finance......Page 653
INTERVIEW WITH: Deniz Gulunay, BP......Page 654
21.1 Option Basics......Page 655
21.2 Option Payoffs at Expiration......Page 658
21.3 Factors Affecting Option Prices......Page 665
21.4 The Black-Scholes Option Pricing Formula......Page 667
21.5 Put-Call Parity......Page 669
21.6 Options and Corporate Finance......Page 672
Summary......Page 674
Problems......Page 675
Data Case......Page 677
CHAPTER 22 Mergers and Acquisitions......Page 679
INTERVIEW WITH: Kyle Finegan, Croft & Bender LLC......Page 680
22.1 Background and Historical Trends......Page 681
22.2 Market Reaction to a Takeover......Page 683
22.3 Reasons to Acquire......Page 684
22.4 The Takeover Process......Page 690
22.5 Takeover Defenses......Page 696
Weyerhaeuser’s Hostile Bid for Willamette Industries......Page 699
22.6 Who Gets the Value Added from a Takeover?......Page 700
The Leveraged Buyout of RJR-Nabisco by KKR......Page 703
Summary......Page 705
Problems......Page 707
CHAPTER 23 International Corporate Finance......Page 710
INTERVIEW WITH: Rob Harvey, Cisco Systems......Page 711
23.1 Foreign Exchange......Page 712
23.2 Exchange Rate Risk......Page 714
23.3 Internationally Integrated Capital Markets......Page 723
23.4 Valuation of Foreign Currency Cash Flows......Page 725
23.5 Valuation and International Taxation......Page 729
23.6 Internationally Segmented Capital Markets......Page 731
23.7 Capital Budgeting with Exchange Rate Risk......Page 734
Summary......Page 736
Problems......Page 738
Data Case......Page 742
A......Page 744
B......Page 745
C......Page 746
D......Page 749
E......Page 750
F......Page 751
G......Page 753
I......Page 754
L......Page 756
M......Page 757
N......Page 758
O......Page 759
P......Page 760
R......Page 762
S......Page 763
T......Page 766
V......Page 767
Z......Page 768