Finance For Executives: Managing for Value Creation, Sixth Edition
By Gabriel Hawawini and Claude Viallet
Contents
PART i Financial Concepts and Techniques 1
chapter 1 Financial Management and Value Creation: An Overview 1
The Key Question: Will Your Decision Create Value? 2
The Importance of Managing for Value Creation 3
The Saturn Story 4
The Fundamental Finance Principle 5
Measuring Value Creation with Net Present Value 5
Only Cash Matters 6
Discount Rates 6
A Proposal’s Cost of Capital 7
Applying the Fundamental Finance Principle 8
The Capital Budgeting Decision 8
The Payout Policy 10
The Capital Structure Decision 11
The Business Acquisition Decision 11
The Foreign Investment Decision 12
The Role of Financial Markets 12
The Equity Market 13
The Vioxx Recall 14
External Versus Internal Financing 15
The Business Cycle 15
HLC’s Financial Statements 17
The Balance Sheet 17
A Variant of the Standard Balance Sheet: The Managerial
Balance Sheet 19
The Income Statement 20
How Profitable Is the Firm? 21
The Profitability of Equity Capital 21
The Profitability of Invested Capital 22
How Much Cash Has the Firm Generated? 22
Sources and Uses of Cash 23
The Statement of Cash Flows 23
How Risky Is the Firm? 23
Has the Firm Created Value? 25
The Role of the Chief Financial Officer 26
Key Points 26
Further Reading 27
Self-Test Questions 27
chapter 2 The Time Value of Money 31
Present Values and Future Values 32
Compounding 33
Discounting 34
Using a Financial Calculator to Solve Time Value of Money Problems 35
Using a Spreadsheet to Solve Time Value of
Money Problems 36
Interest Rate Quotation and Calculation 36
The Annual Percentage Rate Versus the Effective Annual Rate 37
Nominal Versus Real Rates 38
The Present Value of a Stream of Future Cash Flows 38
The Net Present Value (NPV) Rule 39
The Internal Rate of Return (IRR) Rule 39
The Present Value of a Perpetual Cash-Flow Stream 40
The Present Value of a Growing Perpetuity 41
The Present Value of a Standard Annuity 42
The Present Value of a Growing Annuity 44
The Future Value of an Annuity 46
Key Points 47
Appendix 2.1 Proof of Formula 2.9 and Formula 2.6 49
Further Reading 49
Self-Test Questions 49
Review Questions 50
chapter 3 Risk and Return 53
Measures of Return 54
Realized Returns 54
Expected Return 55
Annualized Returns 55
Measures of Risk 55
Measuring Risk with the Variance of Returns 55
Measuring Risk with the Standard Deviation of Returns 56
Variance versus Standard Deviation 56
Annualized Measures of Risk 56
Return Distributions 57
Mean-Variance Analysis 57
Attitudes Toward Risk 60
Evidence from Financial Markets 61
Combining Two Stocks into a Portfolio 61
Portfolio Expected Return 63
Portfolio Risk and Correlations 63
Diversification Can Reduce Risk and Raise Return 65
The Opportunity Set of a Two-Stock Portfolio 65
The Optimal Portfolio of a Risk-Averse Investor 68
Changes in the Correlation Coefficient 68
Combining More Than Two Stocks into a Portfolio 68
Portfolio Expected Return 69
Portfolio Risk and Diversification 69
Portfolio Diversification in Practice 72
Firm-Specific Risk versus Market Risk 73
The Opportunity Set with More Than Two Stocks 74
Optimal Portfolios when there is a Riskless Asset 75
The Efficient Investment Line 75
The Sharpe Ratio 76
Making Optimal Investment Choices 77
The Market Portfolio and the Capital Market Line 79
The Expected Return of the Market Portfolio 79
Proxies for the Market Portfolio 80
The Sharpe Ratio and the Efficiency of the Market Portfolio 80
The Capital Market Line 80
Modern Investment Management: Allocation Beats Selection 82
A Closer Look at Systematic Risk 83
Beta and the Market Model 84
Calculating Beta 84
The Properties of Beta 85
Estimated Stock Betas 85
Portfolio Beta 86
The Capital Asset Pricing Model 87
The Expected Return of an Individual Stock 87
Using the CAPM to Estimate a Company’s Cost of Equity Capital 88
Using the CAPM to Evaluate Investment Performance 89
Using the CAPM to Test the Informational Efficiency of Stock
Markets 90
Key Points 91
Further Reading 92
Appendix 3.1 How to Get the SML Equation 93
Self-Test Questions 94
Review Questions 95
PART ii Assessing Business Performance 99
chapter 4 Interpreting Financial Statements 99
Financial Accounting Statements 99
The Balance Sheet 100
Current or Short-Term Assets 101
Noncurrent or Fixed Assets 105
Current or Short-Term Liabilities 107
Noncurrent Liabilities 108
Owners’ Equity 110
The Managerial Balance Sheet 110
Working Capital Requirement 111
The Income Statement 114
Net Sales or Turnover 116
Gross Profit 116
Operating Profit 117
Earnings Before Interest and Tax (EBIT) 117
Earnings Before Tax (EBT) 118
Earnings After Tax (EAT) 118
Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) 118
Reconciling Balance Sheets and Income Statements 119
The Structure of the Owners’ Equity Account 120
The Statement of Cash Flows 121
Preparing a Statement of Cash Flows 122
Net Cash Flow from Operating Activities 123
Net Cash Flow from Investing Activities 125
Net Cash Flow from Financing Activities 126
The Statement of Cash Flows 127
Problems with the Statement of Cash Flows 127
Free Cash Flow 128
Key Points 129
Appendix 4.1 Obtaining the Net Cash Flow from Operating Activities Using
Balance Sheet and Income Statement Accounts 132
Measuring Cash Inflow from Sales 132
Measuring Cash Outflow from Operating Activities 132
Cash Outflow from Purchases 132
Cash Outflow from SG&A and Tax Expenses 133
Cash Outflow from Net Interest Expense 134
Net Cash Flow from Operating Activities 134
Appendix 4 . 2 Specimen Financial Statements 136
The GlaxoSmithKline (GSK) Financial Statements 136
GSK’s Balance Sheets and Managerial Balance Sheets 136
GSK’s Balance Sheets 136
Gsk’s Managerial Balance Sheets 139
GSK’s Income Statements 140
GSK’s Statements of Cash Flows 142
Further Reading 144
Self-Test Questions 145
Review Questions 148
Chapter 5 Analyzing Operational Efficiency and Liquidity 153
The Structure of the Managerial Balance Sheet 154
The Three Components of a Firm’s Invested Capital 154
The Two Components of a Firm’s Capital Employed 158
The Structure of OS Distributors’ Managerial Balance Sheet 158
The Matching Strategy 158
A Measure of Liquidity Based on the Funding Structure of Working
Capital Requirement 160
Improving Liquidity through Better Management of the
Operating Cycle 163
The Effect of the Firm’s Economic Sector on Its Working Capital
Requirement 163
The Effect of Managerial Efficiency on Working Capital Requirement 165
The Effect of Sales Growth on Working Capital Requirement 167
Traditional Measures of Liquidity 168
Net Working Capital 168
The Current Ratio 170
The Acid Test or Quick Ratio 171
Key Points 171
Appendix 5.1 Financing Strategies 173
Appendix 5.2 The GlaxoSmithKline Liquidity and Operational Efficiency 176
Gsk’s Liquidity Position 176
Gsk’s Management of the Operating Cycle 177
Further Reading 179
Self-Test Questions 180
Review Questions 182
chapter 6 Analyzing Profitability, Risk, and Growth 189
Measures of Profitability 190
Return on Equity 190
Measuring Return on Equity 190
The Effect of Operating Decisions on ROE 191
The Effect of Financing Decisions on Return on Equity 197
The Incidence of Taxation on Return on Equity 199
Putting It All Together: The Structure of a Firm’s Profitability 200
The Structure of ROE Across Industries 202
Other Measures of Profitability 203
Earnings Per Share (EPS) 203
The Price-to-Earnings Ratio (P/E) 203
The Market-to-Book Ratio 204
Financial Leverage and Risk 204
How Does Financial Leverage Work? 205
Two Related Caveats: Risk and the Ability to Create Value 206
Self-Sustainable Growth 207
Key Points 211
Appendix 6.1 Glaxosmithklines Profitability 213
GSKs Profitability Structure 213
Return on Equity 213
The Effect of Operating Margin on GSK’s Operating Profitability 213
The Effect of Invested Capital Turnover on GSK’s Operating Profitability 217
The Effect of GSK’s Financial Policy on Its Return on Equity 218
The Effect of Taxation on GSK’s Return on Equity 219
Further Reading 219
Self-Test Questions 219
Review Questions 222
PART iii Making Investment Decisions 227
chapter 7 Using the Net Present Value Rule to Make Value-Creating
Investment Decisions 227
The Capital Investment Process 228
Would You Buy This Parcel of Land? 230
The Alternative Investment 230
The Opportunity Cost of Capital 231
The Net Present Value Rule 232
A One-Period Investment 232
A Two-Period Investment without an Intermediate
Cash Flow 234
A Two-Period Investment with an Intermediate Cash Flow 235
Multiple-Period Investments 236
Applying the Net Present Value Rule to a Capital Investment
Decision 237
Why the NPV Rule is a Good Investment Rule 238
NPV Is a Measure of Value Creation 239
NPV Adjusts for the Timing of the Project’s Cash Flows 240
NPV Adjusts for the Risk of the Project’s Cash Flows 240
NPV Is Additive 244
Special Cases of Capital Budgeting 246
Comparing Projects of Unequal Size 246
Comparing Projects with Unequal Life Spans 248
Limitations of the Net Present Value Criterion 251
Managerial or Real Options Embedded in Investment Projects 251
Dealing with Managerial Options 253
Key Points 254
Further Reading 256
Self-Test Questions 256
Review Questions 257
chapter 8 Alternatives to the Net Present Value Rule 261
The Payback Period 261
The Payback Period Rule 262
Why Do Managers Use the Payback Period Rule? 265
The Discounted Payback Period 267
The Discounted Payback Period Rule 268
The Discounted Payback Period Rule versus the Ordinary Payback
Period Rule 269
The Internal Rate of Return 270
The IRR Rule 271
The IRR Rule May Be Unreliable 273
Why Do Managers Usually Prefer the IRR Rule to the NPV Rule? 276
The Profitability Index 277
The Profitability Index Rule 277
Use of the Profitability Index Rule 278
The Average Accounting Return 279
The Average Accounting Return Rule 280
Key Points 280
Further Reading 282
Self-Test Questions 282
Review Questions 283
chapter 9 Identifying and Estimating a Project’s Cash Flows 287
The Actual Cash-Flow Principle 287
The With/Without Principle 288
The Designer Desk Lamp Project 290
Identifying a Project’s Relevant Cash Flows 292
Sunk Costs 292
Opportunity Costs 293
Costs Implied by Potential Sales Erosion 293
Allocated Costs 294
Depreciation Expense 294
Tax Expense 294
Financing Costs 295
Inflation 296
Estimating a Project’s Relevant Cash Flows 297
Measuring the Cash Flows Generated By a Project 298
Estimating the Project’s Initial Cash Outflow 299
Estimating the Project’s Intermediate Cash Flows 303
Estimating the Project’s Terminal Cash Flow 304
Should SMC Launch the New Product? 305
Sensitivity of the Project’s NPV to Changes in the Lamp Price 306
Sensitivity of NPV to Sales Erosion 306
Key Points 307
Further Reading 308
Self-Test Questions 308
Review Questions 310
PART iV Making Financing Decisions 315
chapter 10 Valuing Bonds and Stocks 315
What Are Bonds and Common Stocks? 316
Bond Features and Terminology 316
Common Stock Features and Terminology 317
The Discounted Cash Flow (DCF) Model 318
Valuing Bonds 320
Finding the Price of a Bond when its Yield Is Known 320
How Changes in Yield Affect Bond Prices 321
Bond Price versus Face Value 322
Finding the Yield of a Bond When Its Price Is Known 322
The Market Yield of a Bond Is the Cost of Debt to the Firm 323
Price Quotation and Yield Conventions 323
The Case of Zero-Coupon Bonds 324
The Case of Perpetual Bonds 326
A Closer Look at Bond Yields snd Risk 327
Risk Is the Major Determinant of a Bond’s Yield 327
Credit Risk, Credit Ratings, and Credit Spreads 327
The Term Structure of Interest Rates 329
Finding the Price and the Yield of a Bond If the
Spot Rates are Known 333
Interest-Rate Risk 334
Duration as a Measure of Interest-Rate Risk 335
Valuing Common Stocks 336
Valuation Based on the Dividend-Discount Model (DDM) 336
Valuation Based on Discounted Free Cash Flows 339
Valuing PEC with the Discounted Free Cash Flow Model 341
Valuation Based on Discounted Cash Flows to Equity Holders 343
Comparing the Three Discounted Cash Flow Models 345
Valuation Based on Comparable Firms 345
Direct Valuation of a Firm’s Equity Based on the
Price-to-Earnings Ratio 346
Direct Valuation of a Firm’s Equity Based on the Price-to-Book
Ratio 347
Indirect Valuation of a Firm’s Equity Based on the EV-to-EBITDA Ratio 347
Key Points 348
Appendix 10 .1 The Properties of Duration 350
Further Reading 353
Self-Test Questions 354
Review Questions 355
chapter 11 Raising Capital and Paying Out Cash 359
Estimating the Amount of Required External Funds 360
The Financial System: Its Structure and Functions 364
Direct Financing 364
Indirect or Intermediated Financing 364
Securities Markets 367
How Firms Issue Securities 371
Private Placement 371
Public Offerings 371
Raising Debt Capital 375
Borrowing through Bank Loans 376
Borrowing through Lease Agreements 376
Borrowing by Issuing Short-Term Securities 379
Borrowing by Issuing Corporate Bonds 379
Raising Equity Capital 383
Preferred Stocks 383
Tracking Stock 385
Equity Warrants 385
Contingent Value Rights 385
Distributing Cash to Shareholders 386
Observed Payout Policies 386
How and Why Firms Pay Dividends and Buy Back their Shares 390
How Firms Pay Dividends 391
How Firms Repurchase their Shares 391
Differences Between Dividend Payments and Share Repurchases 392
Does a Firm Payout Policy Affect Its Share Price and the Wealth of Its
Shareholders? 394
Paying an Immediate Special Dividend of $250 Million 396
Buying Back $250 Million of Shares in the Open Market 397
Issuing $100 Million of New Equity to Pay an Immediate Dividend of
$350 Million 398
Investing $250 Million in a Project 399
Payout Policy Is Irrelevant in a Perfect Market Environment as Long as the
Firm’s Investing and Financing Policies do not Change 399
Payout Policy with Market Imperfections 400
Key Points 402
Further Reading 405
Self-Test Questions 406
Review Questions 407
chapter 12 Estimating the Cost of Capital 411
Identifying Proxy or Pure-Play Firms 412
Estimating the Cost of Debt 413
Estimating the Cost of Equity 415
Estimating the Cost of Equity Using the Dividend-Discount Model 415
Estimating the Cost of Equity Using the Capital Asset Pricing Model 417
Estimating the Cost of Capital of a Firm 426
What Is a Firm’s Cost of Capital? 426
The Firm’s Target Capital Structure 427
The Firm’s Costs of Debt and Equity 429
Summary of the Firm’s WACC Calculations 430
Estimating the Cost of Capital of a Project 430
The Project’s Risk Is Similar to the Risk of the Firm 430
The Project’s Risk Is Different from the Risk of the Firm 431
Three Mistakes to Avoid When Estimating a Project’s Cost of
Capital 434
Key Points 438
Further Reading 439
Self-Test Questions 439
Review Questions 440
chapter 13 Designing a Capital Structure 445
The Capital Structure Decision in a World without Corporate Income
Tax and Financial
Distress Costs 446
Effects of Borrowing on the Firm’s Profitability (No Corporate Income Tax
and No Financial
Distress Costs) 446
Understanding the Trade-Off Between Profitability and Risk 449
Effect of Borrowing on the Value of the Firm’s Assets and Its Share Price
(No Corporate Income Tax and No Financial Distress Costs) 450
Effect of Borrowing on the Firm’s Cost of Capital (No Corporate Income
Tax and No Financial Distress Costs) 453
The Capital Structure Decision in a World with Corporate Income Tax
but without Financial Distress Costs 455
Effect of Borrowing on the Value of a Firm’s Assets (with Corporate
Income Tax and No Financial Distress Costs) 456
Effect of Borrowing on the Firm’s Market Value of Equity (with Corporate
Income Tax and No Financial Distress Costs) 460
Effect of Borrowing on the Firm’s Share Price (with Corporate Income Tax
and No Financial Distress Costs) 460
Effect of Borrowing on the Cost of Capital (with Corporate Income Tax
and No Financial Distress Costs) 461
The Capital Structure Decision when Financial Distress is
Costly 464
Formulating a Capital Structure Policy 467
A Closer Look at the Trade-Off Model of Capital Structure 467
Factors Other Than Taxes That May Favor Borrowing 470
Factors Other Than Financial Distress Costs That May Discourage
Borrowing 473
Is There a Preference for Retained Earnings? 475
Putting It All Together 476
Key Points 479
Appendix 13.1 Capital Structure and Systematic Risk (Beta) 481
How to Extract Unlevered Betas from Levered Betas 481
Case 1: The Debt-to-Equity Ratio (D/E) is Constant
Over Time 482
Case 2: The Amount of Debt (D) is Constant Over Time 482
Which Formula Should Be Used to Get Unlevered Betas? 483
Further Reading 484
Self-Test Questions 484
Review Questions 485
PART V Making Business Decisions 487
chapter 14 Valuing and Acquiring a Business 487
Alternative Valuation Methods 488
Valuing a Firm’s Equity Using Comparable Firms 489
Direct Estimation of a Firm’s Equity Value Based on the Equity Value of
Comparable
Firms 492
Indirect Estimation of a Firm’s Equity Value Based on the Enterprise
Value of Comparable Firms 494
Valuing a Firm’s Business Assets and Equity Using the Discounted Cash
Flow (DCF) Method 496
Estimation of OS Distributors’ Enterprise and Equity Values 497
Step 1: Determination of the Length of the Forecasting Period 498
Step 2: Estimation of the Free Cash Flow from Business Assets 498
Step 3: Estimation of the Weighted Average Cost of Capital 502
Step 4: Estimation of the Terminal Value of Business Assets at
the End of Year 5 503
Step 5: Estimation of the DCF Value of Business Assets (Enterprise Value) 504
Step 6: Estimation of the DCF Value of Equity 504
Comparison of DCF Valuation and Valuation by Comparables 505
Estimating the Acquisition Value of OS Distributors 505
Identifying the Potential Sources of Value Creation in an Acquisition 505
Why Conglomerate Mergers Are Unlikely to Create Lasting Value Through
Acquisitions 508
The Acquisition Value of OS Distributors’ Equity 510
Estimating the Leveraged Buyout Value of OS Distributors 514
Estimating the Leveraged Buyout Value of Business Assets Using the
Adjusted Present Value Method (the APV Method) 516
Will OS Distributors Be Able to Service Its Debt? 520
Key Points 523
Further Reading 525
Self-Test Questions 525
Review Questions 526
chapter 15 Managing Corporate Risk 531
What Is Risk? 532
Why Should Firms Manage Risk? 533
Risk Management Can Reduce Corporate Income Tax Payments 534
Risk Management Can Lower the Cost of Protection Against Risk 534
Risk Management Can Lower Financial Distress Costs 534
Risk Management Can Provide Clearer Information to Investors About the
Firm’s Core Activities 534
Risk Management Can Lower Agency Costs 534
Corporate Risk Management 535
Risk Netting 535
Cost Savings 535
Risk Policy 536
Risk Learning 536
The Risk Management Process 536
Step 1: Risk Identification 537
Step 2: Risk Measurement 545
Step 3: Risk Prioritization 546
Step 4: Risk Policy 547
Step 5: Risk Monitoring 551
Key Points 551
Further Reading 552
Self-Test Questions 552
Review Questions 553
chapter 1 6 Understanding Forward, Futures, and Options and Their
Contribution
to Corporate Finance 555
Forward Contracts 556
Price Risk 556
Counterparty Risk 556
Liquidity Risk 557
Futures Contracts and Markets 557
How Futures Markets Mitigate Counterparty Risk 557
How Futures Markets Mitigate Liquidity Risk 558
Available Futures Markets and Contracts 559
Hedging Risk with Futures Contracts 559
The Pricing of Forward and Futures Contracts 562
The Relationship Between the Spot Price and the Forward Price 562
The Relationship Between the Expected Spot Price and the Forward Price 565
Option Contracts 566
Option Contracts Defined 567
Over-The-Counter (OTC) Options Versus Traded Options 567
European versus American Options 567
Option Buyers and Option Writers 568
Call Options 568
Put Options 571
The Put-Call Parity Relationship 574
Getting Option Prices with the Black and Scholes Formula 577
The Price of a European Call on a Non-Dividend-Paying Stock 577
The Price of a European Put on a Non-Dividend-Paying Stock 577
Using a Spreadsheet to Calculate the Price of European Options 577
The Price of European Options on Dividend-Paying Stocks 579
The Price of American Options 579
Response of Option Prices to Changes in Input Values 581
Implied Volatility 582
How Good Is the Black-Scholes Model? 583
Delta: A Measure of the Sensitivity of Option Prices to Changes in the
Underlying Stock Price 583
An Investment in an Option Is Always Riskier Than the Same Investment
in the Underlying Stock 584
Option-Based Investment Strategies 585
Speculating on a Rise in Stock Price with Naked Calls 585
Hedging Against a Drop in Stock Price with Protective Puts 585
Insuring Equity Portfolios 587
Writing Covered Calls to Generate Income 587
Collars: Covered Calls with Protective Puts 587
Hedging Stock Price Volatility with Long Straddles 587
Arbitraging Option Prices with Money Spreads or Time Spreads 588
Securities with Option Features 588
Equity as a Call Option on the Firm’s Assets 588
Corporate Bonds As Risk-Free Bonds and Short Puts on the Firm’s
Assets 591
Collateralized Loans 591
Right Issues, Warrants and Contingent Value Rights 591
Callable and Convertible Bonds 592
Real Options and Strategic Investment Decisions 592
Expanding Abroad 593
Calculating the Project’s NPV with the Option Value 595
Discussion 596
Different Types of Real Options Embedded in Projects 597
Key Points 597
Appendix 16.1 The Binomial Option Pricing Model 601
Creating a Riskless Covered Call Position 601
Finding the Call Price Based on the Riskless Covered Call Position 602
Further Reading 602
Self-Test Questions 602
Review Questions 605
chapter 17 Making International Business Decisions 609
The Firm’s Risk Exposure from Foreign Operations 610
Accounting, or Translation, Exposure 610
Economic Exposure 610
Managing Currency Risk 612
The Foreign-Exchange Market 613
Hedging Contractual Exposure to Currency Risk 614
Hedging Long-Term Contractual Exposure to Currency Risk with Swaps 620
Factors Affecting Changes in Exchange Rates 622
How Differences in Inflation Rates Affect Exchange Rates: The Purchasing
Power Parity Relation 623
The Relationship between Two Countries’ Inflation Rates and Interest
Rates: The International Fisher Effect 624
How Differences in Interest Rates Affect Exchange Rates: The Interest-Rate
Parity Relation 625
The Relation between Forward Rates and Future Spot Rates 626
Putting It All Together 627
Analyzing an International Investment Project 628
The Net Present Value Rule: A Brief Review 628
Surf and Zap Cross-Border Alternative Investment Projects 629
Managing Country Risk 635
Invest in Projects with Unique Fveatures 635
Use Local Sourcing 635
Choose a Low-Risk Financial Strategy 636
Design a Remittance Strategy 636
Consider Buying Insurance Against Country Risk 636
Key Points 637
Appendix 17.1 Translating Financial Statements with the Monetary/Nonmonetary
Method and the All Current Method 639
The Monetary/Nonmonetary Method 639
The All Current Method 640
Which Method Is Better? 642
Appendix 17.2 The Parity Relations 643
The Law of One Price 643
The Purchasing Power Parity Relation 644
The International Fisher Effect 644
The Interest-Rate Parity Relation 645
Strategy 1: Investment in US Dollars 645
Strategy 2: Investment in Euros 646
Further Reading 647
Self-Test Questions 647
Review Questions 648
chapter 18 Managing for Value Creation 653
Measuring Value Creation 654
Estimating Market Value Added 654
Interpreting Market Value Added 657
A Look at the Evidence 658
Identifying the Drivers of Value Creation 660
Linking Value Creation to Operating Profitability, the Cost of Capital,
and Growth Opportunities 661
Only Value-Creating Growth Matters 663
Linking Value Creation to Its Fundamental Determinants 664
Linking Operating Performance and Remuneration to Value Creation 665
Mr. Thomas Hires a General Manager 666
Has the General Manager Achieved His Objectives? 667
Economic Profits Versus Accounting Profits 669
Designing Compensation Plans That Induce Managers to Behave Like Owners 670
Linking the Capital Budgeting Process to Value Creation 671
The Present Value of an Investment’s Future EVA Is Equal to Its MVA 672
Maximizing MVA Is the Same as Maximizing NPV 672
Putting It All Together: The Financial Strategy Matrix 675
The Business Is a Value Creator but Is Short of Cash 676
The Business Is a Value Creator with a Cash Surplus 676
The Business Is a Value Destroyer with a Cash Surplus 677
The Business Is a Value Destroyer That Is Short of Cash 677
Key Points 677
Appendix 18 .1 Adjusting Book Values to Estimate the Amount of Invested Equity
Capital and Operating Profit 679
Adjusting the Book Value of Equity Capital 679
Adjusting Earnings Before Interest and Tax 680
Appendix 18.2 Estimating Market Value Added (MVA) when Future Cash Flows
are Expected to Grow at a Constant Rate in Perpetuity 682
Further Reading 683
Self-Test Questions 683
Review Questions 685
Answers to Self-Test Questions 691
Glossary 741
Credits 763
Index 765