Corporate Finance, Twelfth Edition
By Stephen A. Ross, Randolph W. Westerfield, Jeffrey Jaffe and Bradford D. Jordan
Contents:
PART I Overview
Chapter 1
Introduction to Corporate Finance 1
1.1 What Is Corporate Finance? 1
The Balance Sheet Model of the Firm 1
The Financial Manager 3
1.2 The Corporate Firm 4
The Sole Proprietorship 4
The Partnership 4
The Corporation 5
A Corporation by Another Name . . . 7
1.3 The Importance of Cash Flows 8
Identification of Cash Flows 8
Timing of Cash Flows 9
Risk of Cash Flows 10
1.4 The Goal of Financial Management 10
Possible Goals 10
The Goal of the Financial Manager 11
A More General Goal 12
1.5 The Agency Problem and Control
of the Corporation 12
Agency Relationships 13
Management Goals 13
Do Managers Act in the Stockholders’
Interests? 14
Stakeholders 15
1.6 Regulation 16
The Securities Act of 1933 and the
Securities Exchange Act of 1934 16
Sarbanes-Oxley 17
Summary and Conclusions 18
Concept Questions 18
Chapter 2
Financial Statements and Cash Flow 20
2.1 The Balance Sheet 20
Liquidity 21
Debt versus Equity 22
Value versus Cost 22
2.2 The Income Statement 23
Generally Accepted Accounting
Principles 24
Noncash Items 25
Time and Costs 25
2.3 Taxes 26
Corporate and personal Tax Rates 26
Average versus Marginal Tax Rates 26
2.4 Net Working Capital 27
2.5 Cash Flow of the Firm 28
2.6 The Accounting Statement of Cash Flows 31
Cash Flow from Operating Activities 31
Cash Flow from Investing Activities 32
Cash Flow from Financing Activities 32
2.7 Cash Flow Management 33
Summary and Conclusions 34
Concept Questions 34
Questions and Problems 35
Excel Master It! Problem 39
Mini Case: Cash Flows at Warf
Computers, Inc. 40
Chapter 3
Financial Statements Analysis and Financial Models 42
3.1 Financial Statements Analysis 42
Standardizing Statements 42
Common-Size Balance Sheets 43
Common-Size Income Statements 44
3.2 Ratio Analysis 46
Short-Term Solvency or Liquidity Measures 47
Long-Term Solvency Measures 48
Asset Management or Turnover Measures 50
Profitability Measures 52
Market Value Measures 53
3.3 The DuPont Identity 56
A Closer Look at ROE 56
Problems with Financial Statement Analysis 58
3.4 Financial Models 59
A Simple Financial Planning Model 59
The Percentage of Sales Approach 61
3.5 External Financing and Growth 65
The Relationship Between EFN
and Growth 66
Financial Policy and Growth 68
A Note about Sustainable Growth
Rate Calculations 72
3.6 Some Caveats Regarding Financial
Planning Models 73
Summary and Conclusions 74
Concept Questions 74
Questions and Problems 76
Excel Master It! Problem 81
Mini Case: Ratios and Financial Planning at East Coast Yachts 82
PART II Valuation and
Capital Budgeting
Chapter 4
Discounted Cash Flow Valuation 85
4.1 Valuation: The One-Period Case 85
4.2 The Multiperiod Case 89
Future Value and Compounding 89
The Power of Compounding: A Digression 92
Present Value and Discounting 93
Finding the Number of Periods 96
The Algebraic Formula 99
4.3 Compounding Periods 100
Distinction between Annual Percentage
Rate and Effective Annual Rate 101
Compounding over Many Years 102
Continuous Compounding 102
4.4 Simplifications 104
Perpetuity 104
Growing Perpetuity 106
Annuity 107
Growing Annuity 113
4.5 Loan Amortization 114
4.6 What Is a Firm Worth? 118
Summary and Conclusions 120
Concept Questions 121
Questions and Problems 121
Excel Master It! Problem 131
Mini Case: The MBA Decision 132
Appendix 4A: Net Present Value: First
Principles of Finance 132
Appendix 4B: Using Financial Calculators 132
Chapter 5
Net Present Value and Other
Investment Rules 133
5.1 Why Use Net Present Value? 133
5.2 The Payback Period Method 136
Defining the Rule 136
Problems with the Payback Method 137
Managerial Perspective 138
Summary of Payback 139
5.3 The Discounted Payback Period Method 139
5.4 The Internal Rate of Return 139
5.5 Problems with the IRR Approach 143
Definition of Independent and Mutually
Exclusive Projects 143
Two General Problems Affecting Both
Independent and Mutually
Exclusive Projects 143
The Modified Internal Rate of Return (MIRR) 146
Problems Specific to Mutually
Exclusive Projects 148
Redeeming Qualities of IRR 153
A Test 153
5.6 The Profitability Index 153
Calculation of Profitability Index 154
5.7 The Practice of Capital Budgeting 155
Summary and Conclusions 157
Concept Questions 158
Questions and Problems 160
Excel Master It! Problem 167
Mini Case: Bullock Gold Mining 168
Chapter 6
Making Capital Investment Decisions 169
6.1 Incremental Cash Flows: The Key
to Capital Budgeting 169
Cash Flows—Not Accounting Income 169
Sunk Costs 170
Opportunity Costs 171
Side Effects 171
Allocated Costs 172
6.2 The Baldwin Company: An Example 172
An Analysis of the Project 175
Which Set of Books? 177
A Note about Net Working Capital 177
A Note about Depreciation 178
Interest Expense 179
6.3 Alternative Definitions of Operating
Cash Flow 179
The Top-Down Approach 180
The Bottom-Up Approach 180
The Tax Shield Approach 181
Conclusion 182
6.4 Some Special Cases of Discounted
Cash Flow Analysis 182
Evaluating Cost-Cutting Proposals 182
Setting the Bid Price 184
Investments of Unequal Lives: The
Equivalent Annual Cost Method 186
6.5 Inflation and Capital Budgeting 187
Interest Rates and Inflation 187
Cash Flow and Inflation 189
Discounting: Nominal or Real? 190
Summary and Conclusions 192
Concept Questions 193
Questions and Problems 194
Excel Master It! Problems 203
Mini Case: Bethesda Mining Company 203
Chapter 7
Risk Analysis, Real Options, and Capital Budgeting 205
7.1 Sensitivity Analysis, Scenario Analysis,
and Break-Even Analysis 205
Sensitivity Analysis and Scenario Analysis 206
Break-Even Analysis 209
7.2 Monte Carlo Simulation 213
Step 1: Specify the Basic Model 213
Step 2: Specify a Distribution for Each Variable in the Model 214
Step 3: The Computer Draws One Outcome 216
Step 4: Repeat the Procedure 217
Step 5: Calculate NPV 217
7.3 Real Options 218
The Option to Expand 218
The Option to Abandon 219
Timing Options 221
7.4 Decision Trees 222
Summary and Conclusions 224
Concept Questions 225
Questions and Problems 226
Excel Master It! Problem 232
Mini Case: Bunyan Lumber, LLC 233
Chapter 8
Interest Rates and Bond Valuation 235
8.1 Bonds and Bond Valuation 235
Bond Features and Prices 235
Bond Values and Yields 236
Interest Rate Risk 239
Finding the Yield to Maturity: More Trial and Error 241
Zero Coupon Bonds 243
8.2 Government and Corporate Bonds 245
Government Bonds 245
Corporate Bonds 246
Bond Ratings 248
8.3 Bond Markets 249
How Bonds Are Bought and Sold 249
Bond Price Reporting 250
A Note on Bond Price Quotes 253
8.4 Inflation and Interest Rates 254
Real versus Nominal Rates 254
Inflation Risk and Inflation-Linked Bonds 255
The Fisher Effect 256
8.5 Determinants of Bond Yields 258
The Term Structure of Interest Rates 258
Bond Yields and the Yield Curve:
Putting It All Together 260
Conclusion 262
Summary and Conclusions 262
Concept Questions 262
Questions and Problems 263
Excel Master It! Problem 267
Mini Case: Financing East Coast
Yachts’s Expansion Plans with a Bond Issue 268
Chapter 9
Stock Valuation 270
9.1 The Present Value of Common Stocks 270
Dividends versus Capital Gains 270
Valuation of Different Types of Stocks 271
9.2 Estimates of Parameters in
the Dividend Discount Model 275
Where Does g Come From? 275
Where Does R Come From? 277
A Healthy Sense of Skepticism 278
Dividends or Earnings: Which
to Discount? 279
The No-Dividend Firm 279
9.3 Comparables 280
Price-Earnings Ratio 280
Enterprise Value Ratios 282
9.4 Valuing Stocks Using Free Cash Flows 284
9.5 The Stock Markets 285
Dealers and Brokers 285
Organization of the NYSE 286
Types of Orders 289
NASDAQ Operations 289
Stock Market Reporting 290
Summary and Conclusions 291
Concept Questions 292
Questions and Problems 293
Excel Master It! Problem 296
Mini Case: Stock Valuation
at Ragan Engines 297
PART III Risk
Chapter 10
Lessons from Market History 299
10.1 Returns 299
Dollar Returns 299
Percentage Returns 301
10.2 Holding Period Returns 303
10.3 Return Statistics 309
10.4 Average Stock Returns and
Risk-Free Returns 310
10.5 Risk Statistics 312
Variance 312
Normal Distribution and Its Implications
for Standard Deviation 314
10.6 More on Average Returns 315
Arithmetic versus Geometric Averages 315
Calculating Geometric Average Returns 315
Arithmetic Average Return or Geometric
Average Return? 317
10.7 The U.S. Equity Risk Premium: Historical
and International Perspectives 317
10.8 2008: A Year of Financial Crisis 320
Summary and Conclusions 321
Concept Questions 322
Questions and Problems 322
Excel Master It! Problem 325
Mini Case: A Job at East Coast Yachts 326
Chapter 11
Return, Risk, and the Capital Asset Pricing Model 328
11.1 Individual Securities 328
11.2 Expected Return, Variance, and Covariance 329
Expected Return and Variance 329
Covariance and Correlation 330
11.3 The Return and Risk for Portfolios 334
The Expected Return on a Portfolio 334
Variance and Standard Deviation
of a Portfolio 335
11.4 The Efficient Set for Two Assets 338
11.5 The Efficient Set for Many Securities 342
Variance and Standard Deviation
in a Portfolio of Many Assets 344
11.6 Diversification 345
The Anticipated and Unanticipated
Components of News 345
Risk: Systematic and Unsystematic 346
The Essence of Diversification 347
The Effect of Diversification: Another
Lesson from Market History 348
11.7 Riskless Borrowing and Lending 349
The Optimal Portfolio 351
11.8 Market Equilibrium 353
Definition of the Market Equilibrium
Portfolio 353
Definition of Risk When Investors Hold
the Market Portfolio 354
The Formula for Beta 356
A Test 357
11.9 Relationship between Risk and Expected
Return (CAPM) 357
Expected Return on the Market 357
Expected Return on an Individual Security 358
Summary and Conclusions 361
Concept Questions 361
Questions and Problems 362
Excel Master It! Problem 368
Mini Case: A Job at East Coast Yachts, Part 2 369
Appendix 11A: Is Beta Dead? 370
Chapter 12
An Alternative View of Risk
and Return 371
12.1 Systematic Risk and Betas 371
12.2 Portfolios and Factor Models 374
Portfolios and Diversification 377
12.3 Betas, Arbitrage, and Expected Returns 379
The Linear Relationship 379
The Market Portfolio and the
Single Factor 380
12.4 The Capital Asset Pricing Model
and the Arbitrage Pricing Theory 381
Differences in Pedagogy 381
Differences in Application 381
12.5 Empirical Approaches to Asset Pricing 383
Empirical Models 383
Style Portfolios 384
Summary and Conclusions 385
Concept Questions 386
Questions and Problems 387
Excel Master It! Problem 391
Mini Case: The Fama-French Multifactor
Model and Mutual Fund Returns 391
Chapter 13
Risk, Cost of Capital, and Valuation 393
13.1 The Cost of Capital 393
13.2 Estimating the Cost of Equity Capital
with the CAPM 394
The Risk-Free Rate 397
Market Risk Premium 397
13.3 Estimation of Beta 398
Real-World Betas 399
Stability of Beta 399
Using an Industry Beta 401
13.4 Determinants of Beta 402
Cyclicality of Revenues 402
Operating Leverage 402
Financial Leverage and Beta 403
13.5 The Dividend Discount Model Approach 404
Comparison of DDM and CAPM 405
13.6 Cost of Capital for Divisions
and Projects 406
13.7 Cost of Fixed Income Securities 408
Cost of Debt 408
Cost of Preferred Stock 409
13.8 The Weighted Average Cost of Capital 410
13.9 Valuation with WACC 411
Project Evaluation and the WACC 412
Firm Valuation with the WACC 412
13.10 Estimating Eastman Chemical’s
Cost of Capital 415
13.11 Flotation Costs and the Weighted
Average Cost of Capital 417
The Basic Approach 417
Flotation Costs and NPV 418
Internal Equity and Flotation Costs 419
Summary and Conclusions 420
Concept Questions 420
Questions and Problems 422
Mini Case: Cost of Capital for
Swan Motors 426
Appendix 13A: Economic Value Added
and the Measurement of
Financial Performance 427
PART IV Capital Structure
and Dividend Policy
Chapter 14
Efficient Capital Markets
and Behavioral Challenges 428
14.1 Can Financing Decisions Create Value? 428
14.2 A Description of Efficient Capital Markets 430
Foundations of Market Efficiency 432
14.3 The Different Types of Efficiency 433
The Weak Form 433
The Semistrong and Strong Forms 434
Some Common Misconceptions about
the Efficient Market Hypothesis 436
14.4 The Evidence 437
The Weak Form 437
The Semistrong Form 438
The Strong Form 441
14.5 The Behavioral Challenge
to Market Efficiency 442
Rationality 442
Independent Deviations from Rationality 444
Arbitrage 445
14.6 Empirical Challenges to Market
Efficiency 446
14.7 Reviewing the Differences 451
14.8 Implications for Corporate Finance 453
- Accounting Choices, Financial Choices, and Market Efficiency 453
- The Timing Decision 454
- Speculation and Efficient Markets 455
- Information in Market Prices 457
Summary and Conclusions 459
Concept Questions 460
Questions and Problems 463
Mini Case: Your 401(k) Account at
East Coast Yachts 466
Chapter 15
Long-Term Financing 468
15.1 Some Features of Common
and Preferred Stocks 468
Common Stock Features 468
Preferred Stock Features 471
15.2 Corporate Long-Term Debt 472
Is It Debt or Equity? 473
Long-Term Debt: The Basics 473
The Indenture 475
15.3 Some Different Types of Bonds 478
Floating-Rate Bonds 478
Other Types of Bonds 478
15.4 Bank Loans 479
15.5 International Bonds 480
15.6 Patterns of Financing 480
15.7 Recent Trends in Capital Structure 482
Which Are Best: Book or Market
Values? 482
Summary and Conclusions 483
Concept Questions 484
Questions and Problems 485
Chapter 16
Capital Structure 487
16.1 The Capital Structure Question
and the Pie Theory 487
16.2 Maximizing Firm Value versus
Maximizing Stockholder Interests 488
16.3 Financial Leverage and Firm Value:
An Example 490
Leverage and Returns to Shareholders 490
The Choice between Debt and Equity 492
A Key Assumption 494
16.4 Modigliani and Miller: Proposition II
(No Taxes) 494
Risk to Equityholders Rises with
Leverage 494
Proposition II: Required Return to
Equityholders Rises with Leverage 495
MM: An Interpretation 501
16.5 Taxes 503
The Basic Insight 503
Present Value of the Tax Shield 505
Value of the Levered Firm 506
Expected Return and Leverage
under Corporate Taxes 508
The Weighted Average Cost of Capital,
WACC, and Corporate Taxes 509
Stock Price and Leverage under
Corporate Taxes 510
Summary and Conclusions 512
Concept Questions 512
Questions and Problems 513
Mini Case: Stephenson Real Estate
Recapitalization 518
Chapter 17
Capital Structure 519
17.1 Costs of Financial Distress 519
Bankruptcy Risk or Bankruptcy Cost? 519
17.2 Description of Financial Distress Costs 521
Direct Costs of Financial Distress: Legal
and Administrative Costs of Liquidation
or Reorganization 521
Indirect Costs of Financial Distress 523
Agency Costs 524
17.3 Can Costs of Debt Be Reduced? 527
Protective Covenants 527
Consolidation of Debt 528
17.4 Integration of Tax Effects and Financial
Distress Costs 529
Pie Again 530
17.5 Signaling 531
17.6 Shirking, Perquisites, and Bad Investments:
A Note on Agency Cost of Equity 533
Effect of Agency Costs of Equity
on Debt-Equity Financing 535
Free Cash Flow 535
17.7 The Pecking-Order Theory 536
Rules of the Pecking Order 537
Implications 538
17.8 Personal Taxes 539
The Basics of Personal Taxes 539
The Effect of Personal Taxes on
Capital Structure 539
17.9 How Firms Establish Capital
Structure 540
Summary and Conclusions 545
Concept Questions 546
Questions and Problems 546
Mini Case: McKenzie Corporation’s
Capital Budgeting 549
Appendix 17A: Some Useful Formulas
of Financial Structure 550
Appendix 17B: The Miller Model and the
Graduated Income Tax 550
Chapter 18
Valuation and Capital Budgeting
for the Levered Firm 551
18.1 Adjusted Present Value Approach 551
18.2 Flow to Equity Approach 553
Step 1: Calculating Levered Cash
Flow (LCF) 553
Step 2: Calculating RS 554
Step 3: Valuation 554
18.3 Weighted Average Cost
of Capital Method 554
18.4 A Comparison of the APV, FTE,
and WACC Approaches 555
A Suggested Guideline 556
18.5 Valuation When the Discount Rate
Must Be Estimated 558
18.6 APV Example 560
18.7 Beta and Leverage 563
The Project Is Not Scale Enhancing 565
Summary and Conclusions 566
Concept Questions 566
Questions and Problems 567
Mini Case: The Leveraged Buyout
of Cheek Products, Inc. 571
Appendix 18A: The Adjusted Present Value
Approach to Valuing
Leveraged Buyouts 572
Chapter 19
Dividends and Other Payouts 573
19.1 Different Types of Payouts 573
19.2 Standard Method of Cash
Dividend Payment 574
19.3 The Benchmark Case: An Illustration
of the Irrelevance of Dividend Policy 576
Current Policy: Dividends Set Equal
to Cash Flow 576
Alternative Policy: Initial Dividend
Is Greater Than Cash Flow 576
The Indifference Proposition 577
Homemade Dividends 577
A Test 578
Dividends and Investment Policy 579
19.4 Repurchase of Stock 579
Dividend versus Repurchase: Conceptual
Example 581
Dividends versus Repurchases:
Real-World Considerations 582
19.5 Personal Taxes, Dividends,
and Stock Repurchases 583
Firms without Sufficient Cash to Pay
a Dividend 583
Firms with Sufficient Cash to Pay
a Dividend 584
Summary of Personal Taxes 586
19.6 Real-World Factors Favoring
a High-Dividend Policy 587
Desire for Current Income 587
Behavioral Finance 587
Agency Costs 588
Information Content of Dividends
and Dividend Signaling 589
19.7 The Clientele Effect: A Resolution
of Real-World Factors? 591
19.8 What We Know and Do Not Know
about Dividend Policy 593
Corporate Dividends Are Substantial 593
Fewer Companies Pay Dividends 594
Corporations Smooth Dividends 595
Some Survey Evidence about Dividends 597
19.9 Putting It All Together 598
19.10 Stock Dividends and Stock Splits 600
Some Details about Stock Splits
and Stock Dividends 600
Value of Stock Splits and Stock Dividends 602
Reverse Splits 603
Summary and Conclusions 604
Concept Questions 604
Questions and Problems 606
Mini Case: Electronic Timing, Inc. 610
PART V Long‐Term
Financing
Chapter 20
Raising Capital 612
20.1 Early-Stage Financing and
Venture Capital 612
Venture Capital 613
Stages of Financing 614
Some Venture Capital Realities 615
Venture Capital Investments and
Economic Conditions 616
20.2 The Public Issue 616
Direct Listing 617
Crowdfunding 617
Initial Coin Offerings (ICOs) 619
20.3 Alternative Issue Methods 620
20.4 The Cash Offer 621
Investment Banks 623
The Offering Price 625
Underpricing: A Possible Explanation 625
Evidence on Underpricing 627
The Partial Adjustment Phenomenon 628
20.5 The Announcement of New Equity
and the Value of the Firm 629
20.6 The Cost of New Issues 630
The Costs of Going Public: A Case
Study 632
20.7 Rights 634
The Mechanics of a Rights Offering 634
Subscription Price 634
Number of Rights Needed to Purchase
a Share 635
Effect of Rights Offering on Price
of Stock 635
Effects on Shareholders 636
The Underwriting Arrangements 637
20.8 The Rights Puzzle 638
20.9 Dilution 639
Dilution of Percentage Ownership 639
Dilution of Stock Price 639
Dilution of Book Value 640
Dilution of Earnings Per Share 641
Conclusion 641
20.10 Shelf Registration 641
20.11 Issuing Long-Term Debt 642
Summary and Conclusions 643
Concept Questions 643
Questions and Problems 645
Mini Case: East Coast Yachts
Goes Public 648
Chapter 21
Leasing 649
21.1 Types of Leases 649
The Basics 649
Operating Leases 650
Financial Leases 650
21.2 Accounting and Leasing 651
21.3 Taxes, the IRS, and Leases 653
21.4 The Cash Flows of Leasing 654
A Note about Taxes 656
21.5 A Detour for Discounting and Debt
Capacity with Corporate Taxes 656
Present Value of Riskless Cash Flows 656
Optimal Debt Level and Riskless
Cash Flows 656
21.6 NPV Analysis of the Lease-versus-Buy
Decision 658
The Discount Rate 658
21.7 Debt Displacement and Lease Valuation 659
The Basic Concept of Debt
Displacement 659
Optimal Debt Level in the Xomox
Example 660
21.8 Does Leasing Ever Pay? The Base
Case 662
21.9 Reasons for Leasing 663
Good Reasons for Leasing 663
Bad Reasons for Leasing 666
21.10 Some Unanswered Questions 667
Are the Uses of Leases and Debt
Complementary? 667
Why Are Leases Offered by Both
Manufacturers and Third-Party Lessors? 667
Why Are Some Assets Leased More
Than Others? 667
Summary and Conclusions 668
Concept Questions 668
Questions and Problems 669
Mini Case: The Decision to Lease or
Buy at Warf Computers 672
Appendix 21A: APV Approach to Leasing 672
PART VI Options, Futures,
and Corporate Finance
Chapter 22
Options and Corporate Finance 673
22.1 Options 673
22.2 Call Options 674
The Value of a Call Option at Expiration 674
22.3 Put Options 675
The Value of a Put Option at Expiration 676
22.4 Selling Options 677
22.5 Option Quotes 678
22.6 Combinations of Options 679
22.7 Valuing Options 682
Bounding the Value of a Call 683
The Factors Determining Call
Option Values 684
A Quick Discussion of Factors
Determining Put Option Values 687
22.8 An Option Pricing Formula 687
A Two-State Option Model 688
The Black-Scholes Model 690
22.9 Stocks and Bonds as Options 695
The Firm Expressed in Terms
of Call Options 696
The Firm Expressed in Terms
of Put Options 697
A Resolution of the Two Views 698
A Note about Loan Guarantees 699
22.10 Options and Corporate Decisions:
Some Applications 700
Mergers and Diversification 700
Options and Capital Budgeting 702
22.11 Investment in Real Projects
and Options 704
Summary and Conclusions 707
Concept Questions 707
Questions and Problems 708
Excel Master It! Problem 715
Mini Case: Clissold Industries Options 716
Chapter 23
Options and Corporate Finance:
Extensions and Applications 718
23.1 Executive Stock Options 718
Why Options? 718
Valuing Executive Compensation 719
23.2 Valuing a Start-Up 722
23.3 More about the Binomial Model 725
Heating Oil 725
23.4 Shutdown and Reopening Decisions 731
Valuing a Gold Mine 731
The Abandonment and Opening
Decisions 732
Valuing the Simple Gold Mine 734
Summary and Conclusions 738
Concept Questions 738
Questions and Problems 739
Mini Case: Exotic Cuisines’ Employee
Stock Options 741
Chapter 24
Warrants and Convertibles 742
24.1 Warrants 742
24.2 The Difference between Warrants
and Call Options 743
How the Firm Can Hurt Warrant Holders 746
24.3 Warrant Pricing and the
Black-Scholes Model 746
24.4 Convertible Bonds 747
24.5 The Value of Convertible Bonds 748
Straight Bond Value 748
Conversion Value 749
Option Value 750
24.6 Reasons for Issuing Warrants
and Convertibles 751
Convertible Debt versus Straight Debt 751
Convertible Debt versus Common Stock 752
The “Free Lunch” Story 753
The “Expensive Lunch” Story 754
A Reconciliation 754
24.7 Why Are Warrants and Convertibles
Issued? 754
Matching Cash Flows 754
Risk Synergy 755
Agency Costs 755
Backdoor Equity 756
24.8 Conversion Policy 756
Summary and Conclusions 757
Concept Questions 758
Questions and Problems 759
Mini Case: S&S Air’s Convertible Bond 761
Chapter 25
Derivatives and Hedging Risk 763
25.1 Derivatives, Hedging, and Risk 763
25.2 Forward Contracts 764
25.3 Futures Contracts 765
25.4 Hedging 769
25.5 Interest Rate Futures Contracts 771
Pricing of Treasury Bonds 771
Pricing of Forward Contracts 772
Futures Contracts 773
Hedging in Interest Rate Futures 774
25.6 Duration Hedging 778
The Case of Zero Coupon Bonds 778
The Case of Two Bonds with the Same
Maturity but with Different Coupons 779
Duration 780
Matching Liabilities with Assets 782
25.7 Swaps Contracts 784
Interest Rate Swaps 785
Currency Swaps 786
Credit Default Swaps 787
Exotics 787
25.8 Actual Use of Derivatives 788
Summary and Conclusions 790
Concept Questions 790
Questions and Problems 792
Mini Case: Williamson Mortgage, Inc. 794
PART VII Short‐Term
Finance
Chapter 26
Short-Term Finance and Planning 795
26.1 Tracing Cash and Net Working Capital 796
26.2 The Operating Cycle and the Cash Cycle 797
Defining the Operating and Cash Cycles 798
The Operating Cycle and the Firm’s
Organization Chart 799
Calculating the Operating and
Cash Cycles 800
Interpreting the Cash Cycle 803
A Look at Operating and Cash Cycles 803
26.3 Some Aspects of Short-Term
Financial Policy 804
The Size of the Firm’s Investment in
Current Assets 804
Alternative Financing Policies for
Current Assets 807
Which Is Best? 809
26.4 Cash Budgeting 810
Cash Outflow 811
The Cash Balance 811
26.5 The Short-Term Financial Plan 812
Unsecured Loans 812
Secured Loans 812
Other Sources 813
Summary and Conclusions 813
Concept Questions 814
Questions and Problems 814
Excel Master It! Problem 822
Mini Case: Keafer Manufacturing
Working Capital Management 823
Chapter 27
Cash Management 825
27.1 Reasons for Holding Cash 825
The Speculative and Precautionary
Motives 825
The Transaction Motive 826
Compensating Balances 826
Costs of Holding Cash 826
Cash Management versus Liquidity
Management 826
27.2 Understanding Float 827
Disbursement Float 827
Collection Float and Net Float 828
Float Management 829
Electronic Data Interchange and
Check 21: The End of Float? 832
27.3 Cash Collection and Concentration 833
Components of Collection Time 833
Cash Collection 834
Lockboxes 834
Cash Concentration 835
Accelerating Collections: An Example 836
27.4 Managing Cash Disbursements 838
Increasing Disbursement Float 838
Controlling Disbursements 839
27.5 Investing Idle Cash 840
Temporary Cash Surpluses 840
Characteristics of Short-Term Securities 841
Some Different Types of Money
Market Securities 841
Summary and Conclusions 842
Concept Questions 843
Questions and Problems 844
Mini Case: Cash Management
at Richmond Corporation 846
Appendix 27A: Determining the Target
Cash Balance 846
Appendix 27B: Adjustable Rate Preferred
Stock, Auction Rate Preferred
Stock, and Floating-Rate
Certificates of Deposit 846
Chapter 28
Credit and Inventory Management 847
28.1 Credit and Receivables 847
Components of Credit Policy 848
The Cash Flows from Granting Credit 848
The Investment in Receivables 848
28.2 Terms of the Sale 849
The Basic Form 849
The Credit Period 849
Cash Discounts 851
Credit Instruments 852
28.3 Analyzing Credit Policy 853
Credit Policy Effects 853
Evaluating a Proposed Credit Policy 853
28.4 Optimal Credit Policy 855
The Total Credit Cost Curve 856
Organizing the Credit Function 857
28.5 Credit Analysis 857
When Should Credit Be Granted? 857
Credit Information 859
Credit Evaluation and Scoring 860
28.6 Collection Policy 860
Monitoring Receivables 860
Collection Effort 861
28.7 Inventory Management 861
The Financial Manager and
Inventory Policy 862
Inventory Types 862
Inventory Costs 862
28.8 Inventory Management Techniques 863
The ABC Approach 863
The Economic Order Quantity Model 863
Extensions to the EOQ Model 868
Managing Derived-Demand Inventories 868
Summary and Conclusions 870
Concept Questions 871
Questions and Problems 872
Mini Case: Credit Policy at Braam
Industries 875
Appendix 28A: More about Credit Policy
Analysis 875
PART VIII Special Topics
Chapter 29
Mergers, Acquisitions, and
Divestitures 876
29.1 The Basic Forms of Acquisitions 876
Merger or Consolidation 876
Acquisition of Stock 877
Acquisition of Assets 877
A Classification Scheme 878
A Note about Takeovers 878
29.2 Synergy 879
29.3 Sources of Synergy 880
Revenue Enhancement 880
Cost Reduction 881
Tax Gains 883
Reduced Capital Requirements 885
29.4 Two Financial Side Effects
of Acquisitions 886
Earnings Growth 886
Diversification 887
29.5 A Cost to Stockholders
from Reduction in Risk 888
The Base Case 888
Both Firms Have Debt 888
How Can Shareholders Reduce Their
Losses from the Coinsurance Effect? 890
29.6 The NPV of a Merger 890
Cash 890
Common Stock 892
Cash versus Common Stock 893
29.7 Friendly versus Hostile Takeovers 894
29.8 Defensive Tactics 896
Deterring Takeovers before Being in Play 896
Deterring a Takeover after the Company
Is in Play 897
29.9 Have Mergers Added Value? 899
Returns to Bidders 901
Target Companies 902
The Managers versus the Stockholders 902
29.10 The Tax Forms of Acquisitions 904
29.11 Accounting for Acquisitions 906
29.12 Going Private and Leveraged Buyouts 907
29.13 Divestitures 908
Sale 908
Spin-Off 908
Carve-Out 909
Tracking Stocks 909
Summary and Conclusions 910
Concept Questions 910
Questions and Problems 911
Mini Case: The Birdie Golf-Hybrid
Golf Merger 917
Chapter 30
Financial Distress 919
30.1 What Is Financial Distress? 919
30.2 What Happens in Financial Distress? 921
30.3 Bankruptcy Liquidation and
Reorganization 923
Bankruptcy Liquidation 923
Bankruptcy Reorganization 925
30.4 Private Workout or Bankruptcy:
Which Is Best? 928
The Marginal Firm 929
Holdouts 929
Complexity 929
Lack of Information 929
30.5 Prepackaged Bankruptcy 929
30.6 Predicting Corporate Bankruptcy:
The Z-Score Model 931
Summary and Conclusions 932
Concept Questions 933
Questions and Problems 933
Chapter 31
International Corporate Finance 935
31.1 Terminology 936
31.2 Foreign Exchange Markets
and Exchange Rates 936
Exchange Rates 937
31.3 Purchasing Power Parity 942
Absolute Purchasing Power Parity 942
Relative Purchasing Power Parity 943
31.4 Interest Rate Parity, Unbiased
Forward Rates, and the
International Fisher Effect 945
Covered Interest Arbitrage 945
Interest Rate Parity 946
Forward Rates and Future Spot Rates 947
Putting It All Together 948
31.5 International Capital Budgeting 949
Method 1: The Home Currency Approach 950
Method 2: The Foreign Currency
Approach 951
Unremitted Cash Flows 951
The Cost of Capital for International
Firms 952
31.6 Exchange Rate Risk 952
Short-Term Exposure 952
Long-Term Exposure 953
Translation Exposure 954
Managing Exchange Rate Risk 955
31.7 Political Risk 955
The Tax Cuts and Jobs Act of 2017 955
Managing Political Risk 956
Summary and Conclusions 957
Concept Questions 957
Questions and Problems 959
Excel Master It! Problem 961
Mini Case: East Coast Yachts Goes
International 962
Appendix A: Mathematical Tables 963
Appendix B: Solutions to Selected
End-of-Chapter Problems 972
Appendix C: Using the HP 10B and TI BA II Plus
Financial Calculators 975
Glossary 979
Name Index 987
Subject Index 989