CORPORATE FINANCE - · PDF fileChief Financial Officer, ... PART 1: INTRODUCTION 2 Chapter 1:...

CORPORATE FINANCESECOND EDITION

William L. MegginsonUniversity of Oklahoma

Scott B. SmartIndiana University

Lawrence J. GitmanSan Diego State University

THOMSON*

SOUTH-WESTERN

Australia • Canada • Mexico • Singapore • Spain • United Kingdom • United States

CONTENTS

Smart Ethics VideoTom Cole, Deutsche Bank,

Leveraged Finance Group, page 9

Smart Conceptspage 13

Smart Practices VideoDavid Nickel, Controller for Legal

and Risk Management, Intel Corp.,page 22

Smart Ethics VideoAndy Bryant, Executive Vice President

of Finance and Enterprise Systems,Chief Financial Officer, Intel Corp.,

page 26

About the Authors xxPreface xxi

PART 1: INTRODUCTION 2

Chapter 1: The Scope of Corporate Finance 5Opening Focus: Public or Private? 5

1.1 What Is Corporate Finance? 6

The Core Principles of Finance 6The Five Basic Corporate Finance Functions 9

1.2 Legal Forms of Business Organization 14

Business Organizational Forms in the United States 14Forms of Business Organization Used by Non-U.S. Companies 18

1.3 Goals of the Corporate Financial Manager 21

What Should a Financial Manager Try to Maximize? 21How Can Agency Costs Be Controlled in Corporate Finance? 23

Comparative Corporate Finance: The Growth of Stock MarketCapitalization 24

What Is the Importance of Ethics in Corporate Finance? 25

1.4 Summary 26

Smart Practices VideoJon Olson, Vice President of Finance,

Intel Corp. (former). Currently, ChiefFinancial Officer, Xilinx Corp., page 31

Chapter 2: Financial Statement and Cash Flow AnalysisOpening Focus: Bang & Olufsen's Rising Profits Are Musicto Investors' Ears 30

2.1 Financial Statements 31

Balance Sheet 32Comparative Corporate Finance: Assessing the Market Valueof Global Brands 34

Income Statement 35Statement of Retained Earnings 37Statement of Cash Flows 38Notes to Financial Statements 38

30

IV

CONTENTS

2.2 Cash Flow Analysis 39

The Firm's Cash Flows 39Developing the Statement of Cash FlowsInterpreting the Statement 44

42

2.3 Analyzing Financial Performance Using Ratio Analysis

Using Financial Ratios 45Liquidity Ratios 46Activity Ratios 47Debt Ratios 49Profitability Ratios 50Market Ratios 55

2.4 Summary 56

45

Smart Ethics VideoFrank Popoff, Chairman of the Board(retired), Dow Chemical, page 51


Smart Ideas VideoMichael Brennan, UCLA, page 55

Chapter 3: Time Value of Money 72Opening Focus: Why Is a "$340 Million Jackpot" Really WorthOnly $164 Million? 72

3.1 The Notion of Time Value of Money 73

The Role of Financial Markets 74Comparative Corporate Finance: Save Money?Not Me—I'm an American! 76

3.2 Future Value of a Lump Sum 77

The Concept of Future Value 77The Equation for Future Value 78A Graphic View of Future Value 80

3.3 Present Value of a Lump Sum 80

The Concept of Present Value 81The Equation for Present Value 81A Graphic View of Present Value 83

3.4 Future Value of Cash Flow Streams 83

Finding the Future Value of a Mixed Stream 84Types of Annuities 85Finding the Future Value of an Ordinary Annuity 85Finding the Future Value of an Annuity Due 87

3.5 Present Value of Cash Flow Streams 88

Finding the Present Value of a Mixed Stream 89Finding the Present Value of an Ordinary Annuity 90Finding the Present Value of an Annuity Due 92Finding the Present Value of a Perpetuity 92Finding the Present Value of a Growing Perpetuity 93

3.6 Special Applications of Time Value 95

Compounding More Frequently Than Annually 95Stated versus Effective Annual Interest Rates 98Deposits Needed to Accumulate a Future Sum 99Loan Amortization 100


Smart Ethics VideoKent Womack, Dartmouth College,page 95

CONTENTS

Implied Interest or Growth RatesNumber of Compounding Periods

3.7 Summary 106

102104

PART 2: VALUATION, RISK, AND RETURN 122

Smart Practices VideoTodd Richter, Managing Director,

Head of Equity Healthcare Research,Bank of America Securities, page 148




Smart Ideas VideoRobert Shiller, Yale University,

page 162

Chapter 4: Valuation 125Opening Focus: The Bonds That Fell to Earth 125

4.1 Valuation Fundamentals 126

The Fundamental Valuation Model 127

129

4.2 Bond Valuation 129

Bond Vocabulary 129The Basic Equation (Assuming Annual Interest)Risk-Free Bonds 131Risky Bonds 135Bond Prices 138

4.3 Advanced Bond Valuation—The Term Structureof Interest Rates 142

Evaluating the Yield Curve 142Comparative Corporate Finance: Is the Yield Curvea Good Economic Predictor? 143

Term Structure Theories 144

4.4 Stock Valuation 147

Stock Price Quotations 147Preferred Stock Valuation 148The Basic Common Stock Valuation Equation 149Zero Growth 151Constant Growth 151Variable Growth 153How to Estimate Growth 154What If There Are No Dividends? 156Valuing the Enterprise—The Free Cash Flow Approach 158

4.5 Other Approaches to Common Stock Valuation

Book Value 161Liquidation Value 161Price Multiples 161

4.6 Summary 163

160

Chapter 5: The Trade-off between Risk and ReturnOpening Focus: Some Helpful Investment TIPS 172

172

5.1 Risk and Return Fundamentals 173

An Historical Overview of Risk and Return 173

CONTENTS

Comparative Corporate Finance: The Equity Risk Premium in the U.S.and Europe (1900-2004) 178

Risk Aversion 179

5.2 Basic Risk and Return Statistics 181

Return of a Single Asset 181Risk of a Single Asset 183

5.3 Risk and Return for Portfolios 186

Portfolio Returns 186Portfolio Variance—An Example 187The Importance of Covariance 189Variance of a Two-Asset Portfolio 192

5.4 Systematic and Unsystematic Risk 194

What Drives Portfolio Risk? 194Measuring the Systematic Risk of an Individual Security 197Limitations of Beta

5.5 Summary 200

199

Smart Ideas VideoElroy Dimson, London BusinessSchool, page 176


Smart Ethics VideoUtpal Bhattacharya, IndianaUniversity, page 197


Chapter 6: Risk and Return: The CAPM and Beyond 212Opening Focus: CFOs Count on CAPM to Gauge Stockholders'Expectations 212

6.1 Efficient Risky Portfolios 213

The Efficient Frontier with Two Assets 213The Efficient Frontier with Many Assets 215

6.2 Risk-Free Borrowing and Lending 218

Portfolios of Risky and Risk-Free Assets 218Finding the Optimal Portfolio 221

6.3 Equilibrium and the Market Portfolio 224

The Market Portfolio 224The Capital Market Line 225

6.4 The Capital Asset Pricing Model (CAPM) 226

The Security Market Line 226Estimating Betas 228

6.5 Empirical Evidence on the CAPM 231

6.6 Alternatives to the CAPM 234

Arbitrage Pricing Theory 234The Fama-French (F-F) Model 235

Comparative Corporate Finance 237

6.7 The Current State of Asset Pricing Theory 238

6.8 Summary 239

Smart Ideas VideoAndrew Karolyi, The Ohio StateUniversity, page 221


Smart Ideas VideoKenneth French, Dartmouth College,page 235

Smart Ideas VideoAvanidhar Subrahmanyam, UCLA,page 236

Smart Ideas VideoDiane Denis, Purdue University,page 238

Smart Ideas VideoWilliam Sharpe, Stanford University,Co-founder, Financial Engines,page 239

VIII CONTENTS


Intel Corp. (former). Currently,Chief Financial Officer, Xilinx Corp.,

page 256

Smart Practices VideoDaniel Carter, Executive Vice

President, Chief Financial Officer,Charlotte Russe, page 258

Smart Practices VideoDaniel Carter, Executive Vice

President, Chief Financial Officer,Charlotte Russe, page 259

Smart Practices VideoChris Muscarella, Professor

of Finance and L.W. "Roy"and Mary Lois Clark Teaching Fellow,

page 264


Smart Practices VideoBeth Acton, Vice President and

Treasurer of Ford Motor Co. (former).Currently, Chief Financial Officer,

Comerica, page 284

PART 3: CAPITAL BUDGETING 250

Chapter 7: Capital Budgeting Process and Techniques 253Opening Focus: Producing Flat Out 253

7.1 Introduction to Capital Budgeting 254

What Do Managers Really Want? 254A Capital Budgeting Problem 255

7.2 Accounting-Based Methods 256

Accounting Rate of Return 256

7.3 Payback Methods 258

The Payback Decision Rule 258Pros and Cons of the Payback Method 259Discounted Payback 260Pros and Cons of Discounted Payback 261

7.4 Net Present Value 262

Net Present Value Calculations 262Pros and Cons of NPV 265

7.5 Internal Rate of Return 267

Finding a Project's IRR 267Advantages of the IRR Method 269Problems with the Internal Rate of Return 271IRR, NPV, and Mutually Exclusive Projects 276

7.6 Profitability Index 280

Calculating the Profitability Index 280The Profitability Index and Capital Rationing 282

Comparative Corporate Finance: Capital Budgeting in Sweden,South Africa, and the United Kingdom 284

7.7 Which Techniques Do Firms Actually Use? 284

7.8 Summary 285

Smart Practices VideoPaul Savastano, Director of

Information Technology, Sprint Corp.,page 307


Smart Ethics VideoScott Lee, Texas A&M University,

page 309

Chapter 8: Cash Flow and Capital Budgeting 298Opening Focus: France Telecom Enjoys Orange's Jus 298

8.1 Types of Cash Flows 299

Cash Flow versus Accounting Profit 299Depreciation 301Fixed Asset Expenditures 302Working Capital Expenditures 303Terminal Value 304Incremental Cash Flow 306Opportunity Costs 308

8.2 Cash Flows for Classicaltunes.com 309Comparative Corporate Finance: Is a High Investment Rate Goodfor a Nation's Economic Health? 310

CONTENTS

Year 0 Cash Flow 312Year 1 Cash Flow 312Year 2 Cash Flow 313Terminal Value 313Jazz-Music CD Proj ect NP V 314

8.3 Cash Flows, Discounting, and Inflation 315

8.4 Special Problems in Capital Budgeting 318

Equipment Replacement and Equivalent Annual Cost 318Excess Capacity 320

8.5 The Human Face of Capital Budgeting 321

8.6 Summary 322

Chapter 9: Cost of Capital and Project Risk 338Opening Focus: Cendant Unwinds to Unlock Value 338

9.1 Choosing the Right Discount Rate 339

Cost of Equity 339Weighted Average Cost of Capital (WACC) 343

Comparative Corporate Finance: The Cost of Capital in India 346

Connecting the WACC to the CAPM 347Asset Betas and Project Discount Rates 349A Note on the Equity Risk Premium 353

9.2 A Closer Look at Risk 355

Break-Even Analysis 355Sensitivity Analysis 357Scenario Analysis and Monte Carlo Simulation 358Decision Trees 359

9.3 Real Options 362

Why NPV Doesn't Always Give the Right Answer 362Types of Real Options 363The Surprising Link between Risk and Real Option Values 365

9.4 Strategy and Capital Budgeting 366

Competition and NPV 366Strategic Thinking and Real Options 367

9.5 Summary 368

PART 4: CAPITAL STRUCTUREAND DIVIDEND POLICY 376

Smart Practices VideoDavid Nickel, Controller for Legaland Risk Management, Intel Corp.,page 314

Smart Ideas VideoRaghu Rajan, University of Chicago,page 322

Smart Practices VideoBeth Acton, Vice President andTreasurer of Ford Motor Co. (former).Currently, Chief Financial Officer,Comerica, page 347

Smart Ethics VideoRobert Bruner, University of Virginia,page 352


Smart Ethics VideoDavid Nickel, Controller for Legaland Risk Management, Intel Corp.,page 358

Smart Practices VideoPam Roberts, Executive Directorof Corporate Services, Cummins Inc.,page 359

Smart Practices VideoAndy Bryant, Executive Vice Presidentof Finance and Enterprise Systems,Chief Financial Officer, Intel Corp.,page 365

Smart Ethics VideoJon Olson, Vice President of Finance,Intel Corp. (former). Currently, ChiefFinancial Officer, Xilinx Corp., page 367

Chapter 10: Market Efficiency and Behavioral FinanceOpening Focus: Investors Applaud a CEO's Dismissal—By Purchasing the Wrong Stock! 379

379

10.1 What Is an Efficient Financial Market?

Definitions of Efficiency 381

381

CONTENTS

The Three Forms of Market Efficiency 382Does Empirical Evidence Support Market Efficiency? 383

Smart Ideas VideoLaura Starks, University of Texas,

page 386

Smart Practices VideoJeff Kauffman, Portfolio Manager,

Managing Director, Omega Advisors,page 398


Smart Ideas VideoRobert Shiller, Yale University,

page 400



10.2 Empirical Evidence on Market Efficiency 385

Tests for Return Predictability 385Tests for Rapid Price Adjustment 390Tests for Private Information 392

Comparative Corporate Finance: International Market Efficiencyand Headaches for International Mutual Fund Managers 396

10.3 The Behavioral Finance Critique of Market Efficiency 399

Bubbles, Fads, and Cascades: The Empirical Evidenceon Behavioral Finance 400

Theoretical Underpinnings of Behavioral Finance 400Assessing Behavioral Finance and Market Efficiency 403

10.4 What Does Market Efficiency Imply for CorporateFinancing? 404

How Do Markets Process Accounting and Other InformationReleases? 404

How Do Markets Respond to Corporate FinancingAnnouncements? 405

How Can Managers Devise a Corporate "Communications"Policy? 405

10.5 Summary 407

Smart Ideas VideoDavid Mauer, Southern Methodist

University, page 427

Smart Ethics VideoKent Womack, Dartmouth College,

page 437

Smart Practices VideoFrank Popoff, Chairman of the Board

(retired), Dow Chemical, page 438

Chapter 11: An Overview of Long-Term Financing 420Opening Focus: So You Think the U.S. Has a Stock Market-BasedCorporate Finance System? 420

421

431

11.1 The Basic Instruments of Long-Term Financing

Common Stock 422Preferred Stock 425Long-Term Debt 425

11.2 The Basic Choices in Long-Term Financing 430

The Need to Fund a Financial Deficit 430The Choice between Internal versus External FinancingOther Financing Choices 431

Comparative Corporate Finance: What Do Private Pension Fundsand Capital Markets Have in Common? 432

11.3 The Role of Financial Intermediaries in Funding CorporateInvestment 433

What Is a Financial Intermediary, and What Does It Do? 433The Role of Financial Intermediaries in U.S. Corporate FinanceThe Corporate Finance Role of Non-U.S. Financial

Intermediaries 434

11.4 The Expanding Role of Securities Markets in the GlobalEconomy 435

Overview of Securities Issues Worldwide 435The Worldwide Surge in Mergers and Acquisitions 438

434

CONTENTS

11.5 Law and Finance: The Importance of Corporate Governance 439

The Law and Finance Model 440

11.6 Summary 443

Chapter 12: Capital Structure: Theory and TaxesOpening Focus: Capital Structures of America'sMost Admired Companies 450

450

12.1 What Is Financial Leverage and What Are Its Effects? 451

12.2 Worldwide Capital Structure Patterns 454

12.3 An Overview of Capital Structure Theories 460

The Agency Cost/Tax-Shield Trade-off Model 460The Pecking-Order Model 460The Signaling Model 461The Market-Timing Model 461

12.4 The Modigliani & Miller Propositions 462

Assumptions of the M&M Capital Structure Model 462Proposition I 462Proposition II and the WACC 465

12.5 M&M and Taxes 468

The M&M Model with Corporate Taxes 468Determining the Present Value of Debt Tax Shields 469The M&M Model with Corporate and Personal Taxes 470Bond Market Equilibrium with Corporate and Personal Taxes 472

Comparative Corporate Finance: Is the State Withering Away?No, Based on Government Spending Levels 473

Other Tax-Based Models of Capital Structure 475

12.6 A Checklist of How Taxes Should Impact Capital Structure 476

12.7 Summary 477

Chapter 13: Capital Structure: Nontax Determinantsof Corporate Leverage 485Opening Focus: France Telecom Launches a $15 Billion Rights Offeringto Reduce Its Leverage 485

13.1 Costs of Bankruptcy and Financial Distress 486

The Importance of Bankruptcy Costs 488Asset Characteristics and Bankruptcy Costs 490Direct and Indirect Costs of Bankruptcy 492

Comparative Corporate Finance: How Important Is R&D Spendingto Modern Economies? 493

International Differences in Bankruptcy Costs 495

13.2 Agency Costs and Capital Structure 496Using Debt to Overcome the Agency Costs of Outside Equity 497Agency Costs of Outside Debt 498The Agency Cost/Tax Shield Trade-off Model of Corporate

Leverage 499

Smart Ideas VideoMitchell Petersen, NorthwesternUniversity, page 455

Smart Practices VideoKeith Woodward, Vice Presidentof Finance, General Mills, page 461


Smart Ideas VideoRobert Bruner, University of Virginia,page 490

Smart Ideas VideoSheridan Titman, University of Texasat Austin, page 491

CONTENTS

13.3 The Pecking-Order Hypothesis 500

Assumptions Underlying the Pecking-Order Hypothesis 500Limitations of the Pecking Order 502

13.4 Signaling and Market-Timing Models 502

How Signaling with Capital Structure Can Convey Information 502The Market-Timing Model 504

13.5 Developing a Checklist for Capital Structure DecisionMaking 504

Leverage and Firm- and Industry-Specific Operating and FinancialVariables 504

Leverage and Ownership Structure Variables 507Leverage and Macroeconomic and Country-Specific Variables 507

13.6 Summary 509

Chapter 14: The Link between Capital Structureand Capital Budgeting 516

Opening Focus 516

14.1 M&M, Capital Budgeting, and the WACC 517

14.2 The Adjusted Present Value Method 518

14.3 The Flow-to-Equity Method 52014.4 A Checklist for the Interactions between Investmentand Financing Decisions 522

14.5 Summary

Chapter 15: Dividend Policy 528Opening Focus: Microsoft Pays the World's Largest Dividend 528

15.1 Dividend Fundamentals 531

Cash Dividend Payment Procedures 531External Factors Affecting Dividend Policy 532Types of Dividend Policies 533Other Forms of Dividends 534

15.2 Patterns Observed in Payout Policies Worldwide 537

Payout Patterns Observed 537

Introduction to the Agency Cost Model of Dividends 543

15.3 Dividend Irrelevance in a World with Perfect Capital Markets 545

15.4 Real-World Influences on Dividend Policy 547Personal Income Taxes 548Trading and Other Transactions Costs 550The Residual Theory of Dividends 551Paying Dividends as a Means of Communicating Information 551Dividend Payments as Solutions to Agency Problems 553

15.5 A Checklist for Dividend Payments 553

CONTENTS

Comparative Corporate Finance: Dividend Policies of the 25 Most ValuableNon-U.S. Public Companies 554

Developing a Checklist for Dividend Policy 554

15.6 Summary 555

PART 5: LONG-TERM FINANCING 564

Chapter 16: Investment Banking and the Public Saleof Equity Securities 567Opening Focus: Google Tries—and Fails—to Change the Rulesof Initial Public Offerings 567

16.1 Investment Banking 568

An Overview of the Global Investment Banking Industry 568Key Investment Banking Activities 571The Investment Banker's Role in Equity Issues 572

16.2 Legal Rules Governing Public Security Salesin the United States 579

Material Covered in an Offering Prospectus 580Shelf Registration (Rule 415) 582Ongoing Regulatory Requirements for a Publicly Traded Firm 583

16.3 The U.S. Market for Initial Public Offerings 583

Patterns Observed in the U.S. IPO Market 583

Comparative Corporate Finance: The Widely Varying Importanceof Stock Market Finance in Developed Countries 586

Advantages and Disadvantages of an IPO 586Specialized Initial Public Offerings: ECOs, Spin-offs, Reverse LBOs,

and Tracking Stocks 588The Investment Performance of Initial Public Offerings 590

16.4 Seasoned Equity Offerings in the United States 593

Stock Price Reactions to Seasoned Equity Issue Announcements 594Rights Offerings 594

16.5 Private Placements in the United States 595

Traditional Private Placements versus Rule 144A Issues 596

16.6 International Common Stock Offerings

Non-U.S. Initial Public Offerings 596

596

International Common Stock IssuesShare Issue Privatizations 601

16.7 Summary 603

598

Chapter 17: Long-Term Debt and Leasing 610Opening Focus: Once Floated, WorldCom's Bonds Sink 610

17.1 Characteristics of Long-Term Debt Financing 611

The Choice between Public and Private Debt Issues 611Loan Covenants 612Cost of Long-Term Debt 613

Smart Practices VideoDavid Baum, Co-head of MGAfor Goldman Sachs in the Americas,page 572

Smart Practices VideoJay Goodgold, Managing Director,Equities Division, Goldman Sachs,page 575

Smart Ethics VideoJay Ritter, University of Florida,page 578



XIV CONTENTS

Smart Ideas VideoAnnette Poulsen, University of

Georgia, page 619

Smart Ideas VideoEd Altman, New York University,

17.2 Term Loans 615Characteristics of Term Loan Agreements 615Term Lenders 616

17.3 Corporate Bonds 616

Popular Types of Bonds 617Legal Aspects of Corporate Bonds 619Methods of Issuing Corporate Bonds 620General Features of a Bond Issue 620High-Yield Bonds 621

Comparative Corporate Finance: Islamic Finance: How Do You Sell BondsWhen You Cannot Charge Interest? 623

International Corporate Bond Financing 623Bond-Refunding Options 624

17.4 Syndicated Loans 629

Specialized Syndicated Lending 631

17.5 Leasing 631

Basic Types of Leases 632Lease Arrangements 633The Lease Contract 633The Lease-versus-Purchase Decision 634Effects of Leasing on Future Financing 637Advantages and Disadvantages of Leasing 638

page 621 17.6 Summary 639

Smart Ideas VideoMyron Scholes, Stanford University,

and Chairman of Oak Hill PlatinumPartners, page 653


Smart Ethics VideoJohn Eck, President of Broadcast andNetwork Operations, NBC, page 671


Smart Ideas VideoMyron Scholes, Stanford University,

and Chairman of Oak Hill PlatinumPartners, page 684

PART 6: OPTIONS, DERIVATIVES,AND INTERNATIONAL FINANCIALMANAGEMENT 648

Chapter 18: Options Basics 651Opening Focus: Fiat Accompli 651

18.1 Options Vocabulary 653Comparative Corporate Finance: International Derivatives Trading 654

18.2 Option Payoff Diagrams 658

Call Option Payoffs 658Put Option Payoffs 660Payoffs for Portfolios of Options and Other Securities 661Put-Call Parity 665

18.3 Qualitative Analysis of Option Pricing 671

Factors That Influence Option Values 671

18.4 Calculating Option Prices 676

The Binomial Option-Pricing Model 676The Risk-Neutral Method 682

18.5 Summary 684

CONTENTS xv

Chapter 19: Black and Scholes and Beyond 690Opening Focus: The Value of Amazon's Real Options 690

19.1 The Black and Scholes Model 691

Calculating Black and Scholes Options Values 691Comparative Corporate Financing: The Global Valueof Options Trading 692

Volatility 699

19.2 Options Embedded in Other Securities 701

Plain-Vanilla Stocks and Bonds 701Warrants 704Convertibles 706

19.3 Options Embedded in Capital Investments—Real Options

The Option Value of Drilling Rights 710Mini-Case: Real Options at McDonald's—McTreat Spot

709

711

19.4 Summary 715

Appendix 19A: Estimating Volatility for the Black and ScholesModel 722

Chapter 20: International Financial Management 725Opening Focus: Two Floods 725

20.1 Exchange Rate Fundamentals 726

Fixed versus Floating Exchange Rates 726Exchange Rate Quotes 727The Foreign Exchange Market 731

20.2 The Parity Conditions in International Finance 733

Forward-Spot Parity 734Purchasing Power Parity 735Interest Rate Parity 73 8Real Interest Rate Parity (the Fisher Effect) 740The Asset Market Model of Exchange Rates 742

20.3 Managing Financial, Economic, and Political Risk 743

Translation and Economic Risk 745Political Risk 746European Monetary Union and the Rise of Regional Trading Blocs

747The Long-Term Success of World Trade and Foreign Direct

Investment 747Comparative Corporate Finance: What Is Japan's Export-to-GDP Ratio? 750

20.4 Long-Term Investment Decisions 751

Capital Budgeting 751Cost of Capital 753

20.5 Short-Term Financial Decisions 754

Cash Management 754Credit and Inventory Management 756


Smart Practices VideoMyron Scholes, Stanford University,and Chairman of Oak Hill PlatinumPartners, page 700

Smart Ideas VideoMyron Scholes, Stanford University,and Chairman of Oak Hill PlatinumPartners, page 704

Smart Ideas VideoMichael Brennan, UCLA, page 710

Smart Ideas VideoAnjan Thakor, University of Michigan,page 715

Smart Practices VideoMyron Scholes, Stanford University,and Chairman of Oak Hill PlatinumPartners, page 722

20.6 Summary 757

CONTENTS

Smart Practices VideoJackie Sturm, Director of Finance

for Technology and Manufacturing,Intel Corp., page 770

Smart Practices VideoJohn Eck, President of Broadcast andNetwork Operations, NBC, page 778


Smart Practices VideoBeth Acton, Vice President and

Treasurer of Ford Motor Co. (former).Currently, Chief Financial Officer,

Comerica, page 786

PART 7: SHORT-TERM FINANCINGDECISIONS 766

Chapter 21: Strategic and Operational FinancialPlanning 769Opening Focus: GM's Challenges and Plans 769

21.1 Overview of the Planning Process 770Comparative Corporate Finance: Public versus Private Forecasts 771

Successful Long-Term Planning 772The Role of Finance in Long-Term Planning 772

21.2 Planning for Growth 773

Sustainable Growth 773Pro Forma Financial Statements

21.3 Planning and Control 783Short-Term Financing StrategiesThe Cash Budget 786

21.4 Summary 792

778

783

Smart Practices VideoVern LoForti, Chief Financial Officer,

Overland Storage Inc., page 805

Smart Practices VideoJackie Sturm, Director of Finance forTechnology and Manufacturing, Intel

Corp., page 805

Smart Ethics VideoKeith Woodward, Vice President

of Finance, General Mills, page 808


Smart Practices VideoVern LoForti, Chief Financial Officer,\ Overland Storage Inc., page 814


Intel Corp. (former). Currently, ChiefFinancial Officer, Xilinx Corp., page 826

Chapter 22: Cash Conversion, Inventory, and ReceivablesManagement 804Opening Focus: Effective Short-Term Financial Managementat Dell 804

80622.1 The Cash Conversion Cycle

Operating Cycle 806Cash Conversion Cycle 808Shortening the Cash Conversion Cycle 809

22.2 Cost Trade-offs in Short-Term Financial Management 810

22.3 Inventory Management 812

Investing in Inventory 812Techniques for Controlling Inventory 813

816

816

22.4 Accounts Receivable Standards and Terms

Effective Accounts Receivable ManagementCredit Standards 817

Comparative Corporate Finance: Trade Credit Practicesaround the World 818

Credit Terms 824

22.5 Collecting, Monitoring, and Applying Cash to Receivables

Collection Policy 826Credit Monitoring 826Cash Application 829

826

22.6 Summary 830

CONTENTS XVII

Chapter 23: Liquidity Management 842Opening Focus: The Electronic Payment Revolution? 842

23.1 Cash Management 843

Float 844Cash Position Management 845

23.2 Collections 846

Types of Collection Systems 846

Comparative Corporate Finance: Please Send Money

Lockbox Systems 849

847

Cash Concentration 850Funds Transfer Mechanisms 850

23.3 Accounts Payable and Disbursements 852

Overview of the Accounts Payable Process 852Cash Discounts 853Disbursement Products and Methods 854Developments in Accounts Payable and Disbursements 855

23.4 Short-Term Investing and Borrowing

Short-Term Investing 857Short-Term Borrowing 860

23.5 Summary 862

856

Smart Practices VideoDaniel Carter, Chief Financial Officerof Charlotte Russe, page 850



PART 8: SPECIAL TOPICS 870

Chapter 24: Mergers, Corporate Control, and CorporateGovernance 873Opening Focus: State-Controlled Chinese Oil Company Bidsagainst Chevron for Union Oil of California 873

24.1 Overview of Corporate Control Activities 874

Corporate Control Transactions 875LBOs, MBOs, and Dual-Class Recapitalizations 876Tender Offers, Acquisitions, and Proxy Fights 876Divestitures and Spin-offs 879

24.2 Horizontal, Vertical, and Conglomerate Mergers 880

Horizontal Mergers 880Vertical Mergers 881Conglomerate Mergers 882Other Concentration Classifications 883

88424.3 Merger and Acquisition Transaction CharacteristicsMethod of Payment 884Accounting Treatment 886Shareholder Wealth Effects and Transaction CharacteristicsReturns to Target and Bidding Firm Shareholders 887Returns to Other Security Holders 890International Mergers and Acquisitions 890

887

CONTENTS

24.4 Rationale and Motives for Mergers and Acquisitions 893

Value-Maximizing Motives 893Synergy, Market Power, and Strategic Mergers 894Cash Flow Generation and Financial Mergers 896Non-Value-Maximizing Motives 896

24.5 History and Regulation of Mergers and Acquisitions 898

The History of Merger Waves 898Regulation of Corporate Control Activities 899International Regulation of Mergers and Acquisitions 904

Comparative Corporate Finance: Searching for Effective CorporateGovernance and Value-Enhancing Mergers 905

24.6 Corporate Governance 906

Law and Finance: Capital Markets and National LegalSystems 906

Efficient Capital Markets Promote Rapid EconomicGrowth 907

Privatization's Impact on Stock and Bond MarketDevelopment 909

24.7 Summary 911

Chapter 25: Bankruptcy and Financial Distress 921Opening Focus: WorldCom Emerges from Bankruptcy witha New Name, New Management, and a New Capital Structure—and Is Soon Acquired 921

25.1 Business Failure Fundamentals 922

Types of Business Failure 922Major Causes of Business Failure 924

25.2 Voluntary Settlements 926

Voluntary Reorganization 926Voluntary Liquidation 926

25.3 Bankruptcy Law in the United States 927Comparative Corporate Finance: Companies Can DeclareBankruptcy—Why Not Countries? 929

25.4 Reorganization in Bankruptcy 930

Reorganization Procedures 931Reorganization Plan 932Subsidies to Firms That Reorganize 935Prepackaged Bankruptcies 936

25.5 Liquidation in Bankruptcy 937

Procedures 937Priority of Claims 937Final Accounting 940

25.6 Predicting Bankruptcy 940

25.7 Summary 942

CONTENTS

WEB CHAPTERS

Chapter 26: Entrepreneurial Finance and Venture CapitalOpening Focus: Amazon.com Redefines Electronic Commerceand Epitomizes Entrepreneurial Growth

26.1 The Challenges of Financing EntrepreneurialGrowth Companies

26.2 Venture Capital Financing in the United States

26.3 The Organization and Operations of U.S. VentureCapital Firms

26.4 International Markets for Venture Capital and Private Equity

26.5 Summary

Chapter 27: Risk Management and Financial EngineeringOpening Focus: Southwest Airlines Profits by Hedging Fuel Costs

27.1 Overview of Risk Management

27.2 Forward Contracts

27.3 Futures Contracts

27.4 Options and Swaps

27.5 Financial Engineering

27.6 Summary

Appendix A: Financial Tables T1

Appendix B: Cumulative Probabilities T13

Appendix C: Key Formulas F1

Bibliography B1

Glossary G1

Name Index 11

Company Index 13

Subject Index 16

CORPORATE FINANCE - · PDF fileChief Financial Officer, ... PART 1: INTRODUCTION 2 Chapter 1:...

Documents

Transcript of CORPORATE FINANCE - · PDF fileChief Financial Officer, ... PART 1: INTRODUCTION 2 Chapter 1:...