Corporate Finance FUNDAMENTALS OF GLOBAL EDITION. Jonathan Berk Peter DeMarzo Jarrad Harford

Transcription

1 FUNDAMENTALS OF Corporate Finance GLOBAL EDITION Jonathan Berk Peter DeMarzo Jarrad Harford STANFORD UNIVERSITY STANFORD UNIVERSITY UNIVERSITY OF WASHINGTON Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

2 Introduction 1 CHAPTER 2 Introduction to Financial Statement Analysis 23 CHAPTER 1 Corporate Finance and the Financial Manager 2 I INTERVIEW WITH Leslie Tlllqulst, PA Consulting Group Why Study Finance? The Types of Firms 4 Sole Proprietorships 4 Partnerships 5 Limited Liability Companies 6 Features of Corporations 6 Tax Implications for Corporate Entities 7 I Corporate Taxation Around the World The Financial Manager 9 Making Investment Decisions 9 Making Financing Decisions 10 Cash for Treasury Management 10 The Goal of the Firm 10 I Shareholder Value Versus Stakeholder Value The Financial Manager's Place in the Corporation 11 The Corporate Management Team 11 Ethics and Incentives in Corporations The Stock Market 14 The Largest Stock Markets 14 Primary and Secondary Markets 14 _ NYSE 15 Over-the-Counter Stock Markets 15 Listing Standards 16 I NYSE, AMEX, DJIA, S&P 500: Awash in Acronyms 16 Other Financial Markets Financial Institutions 17 The Financial Cycle 17 Types of Financial Institutions18 Role of Financial Institutions18 limynnancelflb] Summary 19 I Problems 21 I INTERVIEW WITH Hiral Tolia, CBIZ Valuation Group, LLC Firms' Disclosure of Financial Information 25 Preparation of Financial Statements 25 Types of Financial Statements 25 I International Financial Reporting Standards The Balance Sheet 26 Assets 27 Liabilities 28 Shareholders'Equity Balance Sheet Analysis 30 Market-to-Book Ratio 30 Debt-Equity Ratio 30 Enterprise Value 31 Other Balance Sheet Information The Income Statement 33 Earnings Calculations Income Statement Analysis 35 Profitability Ratios 35 Asset Efficiency 36 Working Capital Ratios 36 EBITDA 37 Leverage (Gearing) Ratios 37 Investment Returns 37 The DuPont Identity 38 Valuation Ratios 39 I COMMON MISTAKE Mismatched Ratios The Statement of Cash Flows 42 Operating Activity 42 Investment Activity 44 Financing Activity Other Financial Statement Information 45 Management Discussion and Analysis 45 Statement of Changes in Shareholders' Equity 46 Notes to the Financial Statements Financial Reporting in Practice 46 Enron 46 The Sarbanes-OxleyAct 47

3 ix CHAPTER 3 I Practitioner INTERVIEW WITH Sue Frleden, Ernst & Young 48 The Financial Statements: A Useful Starting Point 49 l Summary 49 I Critical Thinking 52» Problems 52 I Data Case 58 Interest Rates and Valuing Cash Flows 61 Time Value of Money: An Introduction 62 I INTERVIEW WITH Nicole Wickswat, Intel Corporation 63 > Using a Financial Calculator: Solving for Present and Future Values of Cash Flow Streams Perpetuities 89 Perpetuities 89 > Historical Examples of Perpetuities 91» COMMON MISTAKE Discounting One Too Many Times Annuities 92 Present Value of an Annuity 92 Future Value of an Annuity Growing Cash Flows 96 Growing Perpetuity 96 Growing Annuity 98 CHAPTER Cost-Benefit Analysis 64 Role of the Financial Manager 64 Quantifying Costs and Benefits 64» When Competitive Market Prices Are Not Available Market Prices and the Valuation Principle 66 The Valuation Principle 67 Why There Can Be Only One Competitive Price for a Good 67 Your Personal Financial Decisions The Time Value of Money and Interest Rates 68 The Time Value of Money 69 The Interest Rate: Converting Cash Across Time 70 Timelines Valuing Cash Flows at Different Points in Time 73 Rule 1: Comparing and Combining Values 73» COMMON MISTAKE Summing Cash Flows Across Time 74 Rule 2: Compounding 74 ft Rule of Rule 3: Discounting 76 ft Using a Financial Calculator 78 Summary 78 I Critical Thinking 80 6 Problems 80 Time Value of Money: Valuing Cash Flow Streams 83 I INTERVIEW WITH Gregory Goin, McFee Financial Group Valuing a Stream of Cash Flows 85 Applying the Rules of Valuing Cash Flows to a Cash Flow Stream Solving for Variables Other Than Present Value or Future Value 99 Solving for the Cash Flows 100 Rate of Return 102 Solving for the Number of Periods 104 Summary 106 > Critical Thinking 1081 Problems 108» Data Case 113 CHAPTER 4 APPENDIX Using a Financial Calculator 114 Specifying Decimal Places 114 Toggling Between the Beginning and End of a Period 114 Set the Number of Periods per Year 114 General TVM Buttons 114 Solving for the Future Value of an Annuity (Example 4,5) 115 Solving for the Rate of Return 115 CHAPTER 5 Interest Rates 117» INTERVIEW WITH Jason Moore, Bradford &Marzec,LLC Interest Rate Quotes and Adjustments 119 The Effective Annual Rate 119 Adjusting the Discount Rate to Different Time Periods 120 Annual Percentage Rates 121 ft COMMON MISTAKE Using the EAR in the Annuity Formula Application: Discount Rates and Loans 124 Computing Loan Payments 124 Computing the Outstanding Loan Balance The Determinants of Interest Rates 127 Inflation and Real Versus Nominal Rates 127 Investment and Interest Rate Policy 128

4 I How Is Inflation Actually Calculated? 130 The Yield Curve and Discount Rates 130 I Practitioner INTERVIEW WITH Frederic S. Mishkin, Columbia University 132 I COMMON MISTAKE Using the Annuity Formula When Discount Rates Vary 133 The Yield Curve and the Economy The Opportunity Cost of Capital 136 I Interest Rates, Discount Rates, and the Cost of Capital 137 i^niyflnancelab] Summary 138 I Critical Thinking 139 I Problems 140 CHAPTER 6 Bonds 144 ft INTERVIEW WITH Andrew DeWitt, PIMCO Bond Terminology Zero-Coupon Bonds 147 Zero-Coupon Bond Cash Flows 148 Yield to Maturity of a Zero-Coupon Bond 148 Risk-Free Interest Rates Coupon Bonds 151 Coupon Bond Cash Flows The U.S. Treasury Market 152 Yield to Maturity of a Coupon Bond Finding Bond Prices on the Web 154 Coupon Bond Price Quotes Why Bond Prices Change 156 Interest Rate Changes and Bond Prices 156 Time and Bond Prices 158 Interest Rate Risk and Bond Prices 160 I Clean and Dirty Prices for Coupon Bonds 162 Bond Prices in Practice Corporate Bonds 164 Credit Risk 164 I Practitioner INTERVIEW WITH Lisa Black, Teachers Insurance and Annuity Association 165 Corporate Bond Yields 166 Bond Ratings 166 Corporate Yield Curves 166» The Credit Crisis and Bond Yields 168 Summary 170 ft Critical Thinking 171 I Problems Data Case 175 CHAPTER 6 APPENDIX A Solving for the Yield to Maturity of a Bond Using a Financial Calculator 177 CHAPTER 6 APPENDIX B The Yield Curve and the Law of One Price 178 CHAPTER 7 Stock Valuation 182 ft INTERVIEW WITH Christopher Ellis-Ferrara, AllianceBernstein Stock Basics 184 Stock Market Reporting: Stock Quotes 184 Common Stock 185 Preferred Stock The Mechanics of Stock Trades The Dividend-Discount Model 188 A One-Year Investor 188 Dividend Yields, Capital Gains, and Total Returns 189 A Multiyear Investor 190 Dividend-Discount Model Equation Estimating Dividends in the Dividend-Discount Model 192 Constant Dividend Growth 192 Dividends Versus Investment and Growth 193 Changing Growth Rates 195 I COMMON MISTAKE Forgetting to "Grow" This Year's Dividend 196 Value Drivers and the Dividend-Discount Model Limitations of the Dividend-Discount Model 198 Uncertain Dividend Forecasts 198 Non-Dividend-Paying Stocks Share Repurchases and the Total Payout Model Putting It All Together 201 j Summary 202 D Critical Thinking 204 & Problems 204 PART 2 INTEGRATIVE CASE 207 Valuation and the Firm 209 CHAPTER 8 Investment Decision Rules 210» INTERVIEW WITH Scott Ladner, Parsons Brinckerhoff The NPV Decision Rule 212 Net Present Value 212 The NPV Decision Rule Using the NPV Rule 214 Organizing the Cash Flows and Computing the NPV 214 The NPV Profile 215 Measuring Sensitivity with IRR 216 Alternative Rules Versus the NPV Rule 216

5 xi CHAPTER Alternative Decision Rules 216 I USING EXCEL Computing NPV and IRR 217 The Payback Rule 218 The Internal Rate of Return Rule 219 I COMMON MISTAKE IRR Versus the IRR Rule 223 Modified Internal Rate of Return 223 I Why Do Rules Other Than the NPV Rule Persist? Choosing Between Projects 226 Differences in Scale 227 ft Practitioner INTERVIEW WITH Dick Grannis, QUALCOMM 230 Timing of the Cash Flows Evaluating Projects with Different Lives 232 Important Considerations When Using the Equivalent Annual Annuity Choosing Among Projects When Resources Are Limited 235 Evaluating Projects with Different Resource Requirements Putting It All Together 238 l^myfmanceiabl Summary 239 I Critical Thinking 240 I Problems 241 B Data Case 246 Fundamentals of Capital.Budgeting 247 ft INTERVIEW WITH Kelly Cox, Boeing Corporation The Capital Budgeting Process Forecasting Incremental Earnings 250 Operating Expenses Versus Capital Expenditures 250 Incremental Revenue and Cost Estimates 251 Taxes 252 Incremental Earnings Forecast Determining Incremental Free Cash Flow 254 Converting from Earnings to Free Cash Flow 255 Calculating Free Cash Flow Directly 258 Calculating the NPV Other Effects on Incremental Free Cash Flows 260 Opportunity Costs 260 I COMMON MISTAKE The Opportunity Cost of an Idle Asset 260 Project Externalities 260 Sunk Costs 261 COMMON MISTAKE The Sunk Cost Fallacy 261 Adjusting Free Cash Flow 262 Replacement Decisions Analyzing the Project 265 Sensitivity Analysis 265 Break-Even Analysis 267 ft Practitioner INTERVIEW WITH David Holland, Sports and Entertainment Solutions 268 Scenario Analysis Real Options in Capital Budgeting 270 Option to Delay 270 Option to Expand 270 Option to Abandon 270 [g$myfuiance)ab] Summary 271 D Critical Thinking 273 I Problems 273 I Data Case 279 CHAPTER 9 APPENDIX MACRS Depreciation 280 CHAPTER 10 Stock Valuation: A Second Look 282 ft INTERVIEW WITH David Mandell, William Blair & Company The Discounted Free Cash Flow Model 284 Valuing the Enterprise 284 Implementing the Model 285 Connection to Capital Budgeting Valuation Based on Comparable Firms 288 Valuation Multiples 288 Limitations of Multiples 293 Comparison with Discounted Cash Flow Methods 294 Stock Valuation Techniques: The Final Word 294 ft Practitioner INTERVIEW WITH Marilyn Fedak, AllianceBernstein Information, Competition, and Stock Prices 296 Information in Stock Prices 296 Competition and Efficient Markets 298 Forms of Market Efficiency 298 Lessons for Investors and Corporate Managers 300 The Efficient Markets Hypothesis Versus No Arbitrage Individual Biases and Trading 302 Excessive Trading and Overconfidence 302 Hanging On to Losers and the Disposition Effect 302 ' Investor Attention, Mood, and Experience 303

6 xii Detailed Contents Summary 305 ft Critical Thinking 306 ft Problems 306 ft Data Case 310 PART 3 INTEGRATE CASE 312 Risk and Return CHAPTER 11 Risk and Return in Capital Markets 316 ft INTERVIEW WITH Sunita S. Mohanty, Absolute Return for Kids A First Look at Risk and Return Historical Risks and Returns of Stocks 320 Computing Historical Returns 321 Average Annual Returns 323 ft Arithmetic Average Returns Versus Compound Annual Returns 325 The Variance and Volatility of Returns 326 ft COMMON MISTAKE Mistakes When Computing Standard Deviation 328 ft USING EXCEL Computing the Standard Deviation of Historical Returns 328 The Normal Distribution The Historical Tradeoff Between Risk and Return 331 The Returns of Large Portfolios 331 The Returns of Individual Stocks Common Versus Independent Risk 332 Theft Versus Earthquake Insurance: An Example 332 Types of Risk Diversification in Stock Portfolios 334 Unsystematic Versus Systematic Risk 334 Diversifiable Risk and the Risk Premium 337 The Importance of Systematic Risk 337 ft COMMON MISTAKE A Fallacy of Long-Run Diversification 339 Summary 339 ft Critical Thinking 341 ft Problems 342 CHAPTER 12 Systematic Risk and the Equity Risk Premium 345 ft INTERVIEW WITH Alexander Morgan, Pantheon Ventures The Expected Return of a Portfolio 347 Portfolio Weights 347 Portfolio Returns 347 Expected Portfolio Return The Volatility of a Portfolio 350 Diversifying Risks 350 Measuring Stocks' Co-movement: Correlation 352 i USING EXCEL Calculating the Correlation Between Two Sets of Returns 354 Computing a Portfolio's Variance and Standard Deviation 354 The Volatility of a Large Portfolio 356 ft NOBEL PRIZE Harry Markowitz Measuring Systematic Risk 358 Role of the Market Portfolio 358 Stock Market Indexes as the Market Portfolio 359 Market Risk and Beta 359 ft Index Funds 360 I COMMON MISTAKE Mixing Standard Deviation and Beta 362 Estimating Beta from Historical Returns 363 ft USING EXCEL Calculating a Stock's Beta Putting It All Together: The Capital Asset Pricing Model 366 The CAPM Equation Relating Risk to Expected Return 366 ft Why Not Estimate Expected Returns Directly? 367 ft NOBEL PRIZE William Sharpe The Security Market Line 368 The CAPM and Portfolios 370 Summary of the Capital Asset Pricing Model 371 The Big Picture 371 Summary 372 I Critical Thinking 373 ft Problems 373 CHAPTER 12 APPENDIX Alternative Models of Systematic Risk 378 CHAPTER 13 The Cost of Capital 381» INTERVIEW WTTH John Drum, KPMG IIP A First Look at the Weighted Average Cost of Capital 383 The Firm's Capital Structure 383 Opportunity Cost and the Overall Cost of Capital 384 Weighted Averages and the Overall Cost of Capital 384 Weighted Average Cost of Capital Calculations 384

7 XIII 13.2 The Firm's Costs of Debt and Equity Capital 386 Cost of Debt Capital 386 ft COMMON MISTAKE Using the Coupon Rate as the Cost of Debt 387 Cost of Preferred Stock Capital 388 Cost of Common Stock Capital A Second Look at the Weighted Average Cost of Capital 390 WACC Equation 391 Weighted Average Cost of Capital in Practice 391 Methods in Practice Using the WACC to Value a Project 394 Key Assumptions 394 WACC Method Application: Extending the Life of a DuPont Facility 395 Summary of the WACC Method Project-Based Costs of Capital 396 Cost of Capital for a New Acquisition 397 Divisional Costs of Capital 397 ft Practitioner INTERVIEW WITH Shelagh Glaser, Intel When Raising External Capital Is Costly 399 Summary 401 I Critical Thinking 402 I Problems 403 ft Data Case 406 PART 4 INTEGRATIVE CASE 408 Long-Term Financing 409 CHAPTER 14 Raising Equity Capital ft INTERVIEW WITH Sandra Pfeiler, Goldman Sachs Equity Financing for Private Companies 412 Sources of Funding 412 Securities and Valuation 414 Exiting an Investment in a Private Company Taking Your Firm Public: The Initial Public Offering 416 Advantages and Disadvantages of Going Public 416 Primary and Secondary IPO Offerings 417 Other IPO Types 422 ft Google's IPO IPO Puzzles 425 Underpriced IPOs 425 "Hot".and "Cold" IPO Markets 427 I : A Very Cold IPO Market 427 High Cost of Issuing an IPO 428 Poor Post-IPO Long-Run Stock Performance Raising Additional Capital: The Seasoned Equity Offering 429 SEO Process 429 SE0 Price Reaction 431 SEO Costs 432 ^myflnancelab Summary 433 I Critical Thinking 434 ft Problems 434 CHAPTER 15 Debt Financing 438 ft INTERVIEW WITH Eric Hassberger, Strategic Hotels & Resorts Corporate Debt 440 Private Debt 440 ft Debt Financing at Hertz: Bank Loans 440 ft Debt Financing at Hertz: Private Placements 441 Public Debt 441 ft Debt Financing at Hertz: Public Debt Bond Covenants 445 Types of Covenants 445 Advantages of Covenants 445 Application: Hertz's Covenants Repayment Provisions 446 Call Provisions 446 Sinking Funds 449 Convertible Provisions 449 l^myrinancelab] Summary 452 I Critical Thinking 453 I Problems 453 CHAPTER 15 APPENDIX Using a Financial Calculator to Calculate Yield to Call 455 PART 5 INTEGRATIVE CASE 456 Capital Structure and Payout Policy 459 CHAPTER 16 Capital Structure I INTERVIEW WITH Christopher Cvijic, Morgan Stanley Capital Structure Choices 462 Capital Structure Choices Across Industries 462 Capital Structure Choices Within Industries 462

8 16.2 Capital Structure in Perfect Capital Markets 464 Application: Financing a New Business 465 Leverage and Firm Value 466 The Effect of Leverage on Risk and Return 467 Homemade Leverage 469 Leverage and the Cost of Capital 469 ft COMMON MISTAKE Capital Structure Fallacies 470 MM and the Real World 472 ft NOBEL PRIZE Franco Modigliani and Merton Miller Debt and Taxes 473 The Interest Tax Deduction and Firm Value 473 Value of the Interest Tax Shield 474 The Interest Tax Shield with Permanent Debt 476 Leverage and the WACC with Taxes 477 Debt and Taxes: The Bottom Line The Costs of Bankruptcy and Financial Distress 479 Direct Costs of Bankruptcy 479 ft Bankruptcy Can Be Expensive 479 Indirect Costs of Financial Distress Optimal Capital Structure: The Tradeoff Theory 480 Differences Across Firms 481 Optimal Leverage Additional Consequences of Leverage: Agency Costs and Information 482 Agency Costs 483 ft Airlines Use Financial Distress to Their Advantage 483 ft Financial Distress and Rolling the Dice, Literally 484 Debt and Information Capital Structure: Putting It All Together 487 Emyfuiancelab] Summary 488 I Critical Thinking 490 I Problems 490 CHAPTER 16 APPENDIX The Bankruptcy Code 497 CHAPTER 17 Payout Policy 498 ft INTERVIEW WITH Nit in Garg, Intuit Cash Distributions to Shareholders 500 Dividends 501 Share Repurchases Dividends Versus Share Repurchases in a Perfect Capital Market 503 Alternative Policy 1: Pay a Dividend with Excess Cash 504 Alternative Policy 2: Share Repurchase (No Dividend) 504» COMMON MISTAKE Repurchases and the Supply of Shares 506 Alternative Policy 3: High Dividend (Equity Issue) 506 Modigliani-Miller and Dividend Policy Irrelevance 507 k COMMON MISTAKE The Bird in the Hand Fallacy 508 Dividend Policy with Perfect Capital Markets The Tax Disadvantage of Dividends 509 Taxes on Dividends and Capital Gains 509 Optimal Dividend Policy with Taxes 509 Tax Differences Across Investors Payout Versus Retention of Cash 514 Retaining Cash with Perfect Capital Markets 514 Retaining Cash with Imperfect Capital Markets Signaling with Payout Policy 518 Dividend Smoothing 518 Dividend Signaling 519 I Royal & SunAlliance's Dividend Cut 520 Signaling and Share Repurchases 520 ft Practitioner INTERVIEW WITH John Connors, Microsoft (Retired) Stock Dividends, Splits, and Spin-Offs 522 Stock Dividends and Splits 522 I Berkshire Hathaway's A and B Shares 523 Spin-Offs Advice for the Financial Manager 524 Kniyflnancelabj Summary 525 I Critical Thinking 527 I Problems 527 S Data Case 529 PART 6 INTEGRATIVE CASE 531 Financial Planning and Forecasting 533 CHAPTER 18 Financial Modeling and Pro Forma Analysis 534 ft INTERVIEW WITH David Hollon, Goldman Sachs Goals of Long-Term Financial Planning 536 Identify Important Linkages 536 Analyze the Impact of Potential Business Plans 536 Plan for Future Funding Needs 536

9 xv 18.2 Forecasting Financial Statements: The Percent of Sales Method 537 Percent of Sales Method 537 Pro Forma Income Statement 538 Pro Forma Balance Sheet 539 I COMMON MISTAKE Confusing Stockholders' Equity with Retained Earnings 540 Making the Balance Sheet Balance: Net New Financing 540 Choosing a Forecast Target Forecasting a Planned Expansion 542 KMS Designs' Expansion: Financing Needs 543 KMS Designs' Expansion: Pro Forma Income Statement 544 I COMMON MISTAKE Treating Forecasts as Fact 546 Forecasting the Balance Sheet Growth and Firm Value 547 Sustainable Growth Rate and External Financing Valuing the Expansion 551 Forecasting Free Cash Flows 551 I COMMON MISTAKE Confusing Total and Incremental Net Working Capital 553 KMS Designs' Expansion: Effect on Firm Value 553 Optimal Timing and the Option to Delay 556 l^myflnancelab] Summary 557 / I Critical Thinking 558 ft Problems 558 CHAPTER 18 APPENDIX The Balance Sheet and Statement of Cash Flows 562 CHAPTER 19 Working Capital Management 564 ft INTERVIEW WITH Waleed Husain, Comcast Overview of Working Capital 566 The Cash Cycle 566 Working Capital Needs by Industry 568 Firm Value and Working Capital Trade Credit 570 Trade Credit Terms 571 Trade Credit and Market Frictions 571 I COMMON MISTAKE Using APR Instead of EAR to Compute the Cost of Trade Credit 572 Managing Float Receivables Management 574 Determining the Credit Policy The 5 C's of Credit 574 Monitoring Accounts Receivable Payables Management 578 Determining Accounts Payable Days Outstanding 578 Stretching Accounts Payable Inventory Management 580 Benefits of Holding Inventory 580 Costs of Holding Inventory 581 I Inventory Management Adds to the Bottom Line at Gap, Cash Management 582 Motivation for Holding Cash 582 Alternative Investments Cash Balances 584 l^myfinancelabl Summary 584 & Critical Thinking 586 II Problems 586 & Data Case 589 CHAPTER 20 Short-Term Financial Planning 591 ft INTERVIEW WITH Teresa Wendt, Lockheed Martin Forecasting Short-Term Financing Needs 593 Application: Springfield Snowboards, Inc. 593 Negative Cash Flow Shocks 594 Positive Cash Flow Shocks 594 Seasonalities 595 The Cash Budget The Matching Principle 598 Permanent Working Capital 598 Temporary Working Capital 598 Permanent Versus Temporary Working Capital 598 Financing Policy Choices Short-Term Financing with Bank Loans 601 Single, End-of-Period Payment Loan 601 Line of Credit 601 Bridge Loan 602 Common Loan Stipulations and Fees Short-Term Financing with Commercial Paper 604 I Short-Term Financing and the Financial Crisis of the Fall of Short-Term Financing with Secured Financing 606 Accounts Receivable as Collateral 606 I A Seventeenth-Century Financing Solution 606 Inventory as Collateral Putting It All Together: Creating a Short-Term Financial Plan 609

10 xvi Detailed Contents Summary 610 ft Critical Thinking 611 ft Problems 612 PART 7 INTEGRATIVE CASE 616 Special Topics 621 CHAPTER 21 Option Applications and Corporate Finance 622 ft INTERVIEW WITH Deniz Gulunay, BP Option Basics 624 Option Contracts 624 Stock Option Quotations 625 Options on Other Financial Securities 627 I Options Are for More Than Just Stocks Option Payoffs at Expiration 627 The Long Position in an Option Contract 628 The Short Position in an Option Contract 629 Profits for Holding an Option to Expiration 631 Returns for Holding an Option to Expiration Factors Affecting Option Prices 634 Strike Price and Stock Price 634 Option Prices and the Exercise Date 634 Option Prices and the Risk-Free Rate 635 Option Prices and Volatility The Black-Scholes Option Pricing Formula Put-Call Parity 638 Portfolio Insurance Options and Corporate Finance 641 ^Smyflnancelabl Summary 643 ft Critical Thinking 644 I Problems 644 ft Data Case 646 CHAPTER 22 Mergers and Acquisitions 648 ft INTERVIEW WITH Kyle Finegan, CroftS Bender LLC Background and Historical Trends 650 Merger Waves 650 Types of Mergers Market Reaction to a Takeover Reasons to Acquire 653 Economies of Scale and Scope 653 Vertical Integration 654 Expertise 654 Monopoly Gains 654 Efficiency Gains 655 Tax Savings from Operating Losses 655 Diversification 656 Earnings Growth 657 Managerial Motives to Merge The Takeover Process 659 Valuation 659 The Offer 660 Merger "Arbitrage" 662 Tax and Accounting Issues 663 Board and Shareholder Approval Takeover Defenses 665 Poison Pills 665 Staggered Boards 666 White Knights 667 Golden Parachutes 667 Recapitalization 667 Other Defensive Strategies 667 Regulatory Approval 668 ft Weyerhaeuser's Hostile Bid for Willamette Industries Who Gets the Value Added from a Takeover? 669 The Free Rider Problem 669 Toeholds 670 The Leveraged Buyout 670 ft The Leveraged Buyout of RJR-Nabisco by KKR 672 The Freezeout Merger 673 Competition 673 ganiyfinancelabl Summary 674 I Critical Thinking 676 I Problems 676 CHAPTER 23 International Corporate Finance 679 ft INTERVIEW WITH Rob Harvey, Cisco Systems Foreign Exchange 681 The Foreign Exchange Market 682 Exchange Rates Exchange Rate Risk 683 Exchange Rate Fluctuations 684 Hedging with Forward Contracts 686 Cash-and-Carry and the Pricing of Currency Forwards 687 Hedging Exchange Rate Risk with Options Internationally Integrated Capital Markets 692 ft COMMON MISTAKE Forgetting to Flip the Exchange Rate 694

11 XVII 23.4 Valuation of Foreign Currency Cash Flows 694 Application: Ityesi, Inc. 695 The Law of One Price as a Robustness Check Valuation and International Taxation 698 A Single Foreign Project with Immediate Repatriation of Earnings 699 Multiple Foreign Projects and Deferral of Earnings Repatriation 699 CHAPTERS ON THE WEB These Web Chapters are on MyFinanceLab at WEB CHAPTER 1 Leasing WEB CHAPTER 2 Insurance and Risk Management WEB CHAPTER 3 Corporate Governance 23.6 Internationally Segmented Capital Markets 700 Differential Access to Markets 700 Macro-Level Distortions 700 Implications of Internationally Segmented Capital Markets Capital Budgeting with Exchange Rate Risk 703 Application: Ityesi, Inc. 703 Conclusion 705 ^tnylinancriab] Summary 705 I Critical Thinking 707 D Problems Data Case 711