Ninth Edition CORPORATE FINANCE Stephen A. Ross Massachusetts Institute of Technology Randolph W. Westerfieid University of Southern California University of Kentucky McGraw-HISI Brwin Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
CHAPTER! INTRODUCTION TO CORPORATE FINANCE 7 1.1 Corporate Finance and the Financial Manager 2 What Is Corporate Finance? 2 The Financial Manager 2 ( Financial Management Decisions 2 "'.;. Capital Budgeting 2 ' v, Capital Structure ;3, /.-, Working Capital Management 4 '..., Conclusion 4.., 1 1.2 Forms of Business Organization 4 Sole Proprietorship 4 v Partnership 5... Corporationl 5, A Corporation by Another Name... 7 1.3 The Goal of Financial Management 7 Possible Goals 8 The Goal of Financial Management 8 A More General Goal 9,.'.*_. Sarbanes-Oxley 9 1.4 The Agency Problem and Control of the ' Corporation 70... Agency Relationships 70 Management Goals 77' Do Managers Act in the'stockholders' Interests? 71. Managerial Compensation ' 11,\ " Control of the-firm 12.-" '.Conclusion 12 Stakeholders 72 1.5 Financial Markets and the Corporation 13 Cash Flows to and from the Firm 14 Primary versus Secondary Markets 74! Primary Markets 14,.-,-" Secondary Markets 15 Dealer versus Auction Markets 15 Trading in Corporate Securities 75 'Listing, 16 1.6 Summary and Conclusions 16 CHAPTER 2 FINANCIAL STATEMENTS, TAXES, AND CASH FLOW 79 2.1 The Balance Sheet 20 Assets The Left Side 20 Liabilities and Owners' Equity The Right Side 20 Net Working Capital 27 Liquidity 22 Debt versus Equity 23 Market Value versus Book Value 23 2.2 The Income Statement 24 GAAP and the Income Statement 25 Noncash Items 26 time and Costs 26 2.3 Taxes 28 Corporate Tax Rates 28 Average versus Marginal Tax Rates 29 2.4 Cash Flow 30 Gash Flow from Assets 31... Operating Cash Flow 31 Capital Spending 32 Change in Net Working Capital 32 Conclusion 33 A Note about "Free" Cash Flow 33 Cash Flow to Creditors and Stockholders 33 Cash Flow to Creditors 33 Cash Flow to Stockholders 33 An Example Cash Flows for Dole Cola 35 Operating Cash Flow 35 Net Capital Spending 36 Change in NWC and Cash Flow from Assets 36,. Cash Flow to Stockholders and Creditors 36 2.5 Summary and Conclusions 37 CHAPTER 3 WORKING WITH FINANCIAL STATEMENTS 46 3.1 ' Cash Flow and Financial Statements ; A Closer Look 47 Sources and Uses of Cash 47 The Statement of Cash Flows 49 3.2 Standardized Financial Statements 5 / Common-Size Statements 57 ^,. Common-Size Balance.;SheetS'51';,, ; Common-SizeIncome.StatementsK52. '. ; Common-Size StatemenisofCashFlows..- 53,, Common-Base Year Financial Statements Trend Analysis. 53 ' K - i/". ' XXXI
> Combined Common-Size and Base Year Analysis 53 ' 3.3 Ratio Analysis 54 Short-Term Solvency, or Liquidity, Measures 55 ' Current Ratio 55 The Quick (or Acid-Test) Ratio,56 Other Liquidity Ratios 57 Long-Term Solvency Measures 57 > Total Debt Ratio 57 A Brief Digression; Total Capitalization versus Total Assets 58 Times Interest Earned 58 Cash Coverage 59. ' ' ; Asset Management, or Turnover, Measures 59 Inventory Turnover and Days'Sales in Inventory 59.,., ReceivablesTurnoyer and Days'Sales, *, in Receivables. 60, '. *,., Asset Turnover Ratios 61 Profitability Measures 61 Profit Margin 62 " ; Return on Assets 62 Return on Equity 62 "_,', Market Value Measures 63 Price-Earnings Ratio 63, Price-Sales Ratio 63... Market-to-Book Ratio 64 Conclusion 64, 3.4 The Du Pont Identity 65 A Closer Look at ROE 65 An Expanded Du Pont Analysis 67 3.5 Using Financial Statement Information 69 Why Evaluate Financial Statements? 69 Internal Uses 69 External Uses.'69 Choosing a Benchmark 70 Time Trend Analysis 70. Peer Group Analysis 70 '. Problems with Financial Statement Analysis 74 3.6 Summary and Conclusions 76 CHAPTER 4 LONG-TERM FINANCIAL PLANNING AND GROWTH 87 4.1 What Is Financial Planning? 88 Growth as a Financial Management Goal 88 Dimensions of Financial Planning 89 What Can Planning Accomplish? 90, Examining Interactions 90 Exploring Options 90 Avoiding Surprises 90 Ensuring Feasibility and Internal Consistency 90 Conclusion '" 90 4.2 Financial Planning Models A First Look 97 A Financial Planning Model The Ingredients 97 Sales Forecast 91 Pro Forma Statements 97 Asset Requirements 92 ' '. Financial Requirements 92 The Plug 92 Economic Assumptions 92 A Simple Financial Planning Model 92 4.3 The Percentage of Sales Approach 94 The Income Statement 94 The Balance Sheet 95 A Particular Scenario 97 An Alternative Scenario 98 4.4 External Financing and Growth 99 EFN and Growth 99 Financial Policy and Growth 703 The Internal Growth Rate 103 The Sustainable Growth Rate 103 Determinants of Growth 105 A Note about Sustainable Growth Rate Calculations 706 4.5 Some Caveats Regarding Financial Planning Models 708 4.6 Summary and Conclusions 709 PART J Valuation of Future Cash Flow CHAPTERS.. ' ' / ' " ' ' INTRODUCTION TO VALUATION THE TIME VALUE OF MONEY 779, 5.1 Future Value and Compounding 720.' *.' Investing for a Single Period 720, Investing for More Than One Period.720 A Note about Compound Growth 726 5.2 5.3 5.4 Present Value and Discounting 727 The Single-Period Case 727 Present values for Multiple Periods 728 More about Present and Future values 737 Present versus Future Value 737 Determining the Discount Rate 732 Finding the Number of Periods 736 Summary and Conclusions 739
CHAPTER 6 DISCOUNTED,CASH FLOW VALUATION 144 6.1 Future and Present values of Multiple Cash Flows 745, ;' ;"., ", Future Value with Multiple Cash"Flows 745 " -Present Value with Multiple Cash Flows 748. A Note about Cash Flow Timing 757 6.2 Valuing Level Cash Flows Annuities and Perpetuities 752 ' ' ' Present,Value for Annuity Cash Flows 753 ".-*. Annuity Tables 154.., /. Finding the'payment_ 155 - /- Finding the Rate 157., ', Future Value for Annuities 759, - {A Note about Annuities Due 160 '.' ;!" Perpetuities 760- " -,. i Growing Ahnuitiesand Perpetuities 767 6.3 Comparing Rates The Effect of Compounding 763 '"'. Effective Annual Rates and Compounding 763 Calculating arid Comparing Effective " Annual Rates,764 ;.. "', EARs;and APRs- 766 ', ', * Taking It to the Limit A Note about Continuous ".. Cbrnpounding. 767.. -' 6.4 Loan Types and Loan Amortization 769..Pure Discount Loans 769, '.."'V--. Interest-Only Loans 169'L- ' - '..Amortized Loans 170 ;/ ',,, 6.5, Summary arid Conclusions 7 75 CHAPTER7 /. '.-,.; '..- " ' '', INTEREST RATES AND BOND VALUATION 790 71 Bonds and Bond Valuation 797 ". Bond Features and Prices 191,.Bond Values and Yields.797.,,, ; InterestRate Risk 795 Finding the Yield to Maturity More Trial and Error 796 7.2 More about Bond Features 207." Is It Debt or Equity? 207..'Long-TermDebt The Basics 207..'.-. The Indenture 203,. Terms~ofa Bond 203... ",,..-'. "., Security" 204, ' '.'.' ',Seniority 204 ' ' '.' ".Repayment 204 '. '.' '".'The Call Provision 205.,},[ Protective Covenants 205.. - 7.3 Bond Ratings 206 7.4 Some Different Types of Bonds 207, Government Bonds 207. '. Zero Coupon Bonds 208 Floating-Rate Bonds,,209,.,...,, Other Types of Bonds, 270 v' r-,',;, ; ; 7.5. Bond Markets 272 ;; ''. Y^; How Bonds Are Bought'apd Sold '212^''-. ;.'. " Bond.Price Reporting, 274,,, ; '"; ;.,;>,-" A Note about Bond Price Quotes,275,,.... ; 7.6 Inflation and Interest Rates 277 Real versus NominalrRates.277 ' " ; ",' "'. ; ; ; ' The Fisher Effect/'27'8;i;;;'/' V;';!';,\ ; A (*;,, ',''/ Inflation and Present Values.279... 7.7 Determinants of Bond Yields 220 ; The Term Structure of Interest;Rates-^ 220 1, Bond Yields and the 'Yield-, Curve,. Putting,.. -, It Air Together''22 7,,"; j ' '. ','.,',, ; ; \ ;' '. -.- 'Conclusion"-,223'f *,", ' ;' '' ;'.'--.* ", -.-,", 7.8 Summary andi Conclusions",224 ' CHAPTER-8 ;- >; ;- ; J y;-;'j',;* ;.>; '*-.\^'^ STOCK VALUATION^ 237 ' > ; ; ^ ; 8.1 Common Stock Valuation 232'' -, '.Cash Flows 232- } {'*,- /.. V 5 >v\-.^.'"'." ''' '.' ' Some Special Cases-.234,./;".",,.,./,,-., ' ''\ Zero Growth]23'4^-'-'''[, \,U *'',,., ' ;'"' ' ;. ' Constant Growth,,234 ;, ;;>' v '--.! r... ;,', NonconstantGrowth,237,- "' ' ' ' '. ' '- --, Two-Stage Growthy239\X; V; ','''-.', ; Components of the'required Return. 240 ;., 8.2 Some Features of Common and Preferred Stocks 242; ' CommonStbckFeatures 242' ;,... ; - " Shareholder -Rights; ^242.-.';. "",,' '. (\.' ', p r o x y V o t i n g ' ^ 2 4 3 '. ^, ;'; '; ' ' ',- ;-' ', /' "'.' - _,-, "Classes of.stock' 244 \ _'.'{; ;,,-,.'];",'. ' Other Rights 244 Vj",*''' ' ';,'V "'<;- _ ;.- ' " ';,;,. - '','.. -'Dividends'- 244 -.,!ll,y". ;,;,.f-,.^^y'.'-\- ; *-",. P r e f e r r e d S t d c k F e a t u r e s - > 2 4 5 ;,,;*;* ',.'., /",' StatedValue' 245'f./ fv' i^''.<. '" Jr., ',,' Cumulative"andNoncumulative,Dividends- 245.... ' ' te Preferred Stock Really, Debt?',245. ';' '';. 8.3 The Stock Marketsf)246 ' ' c Dealers and. Brokers -'246' ;',;,' ',, *,..Organization ofthe NYSE ;,247 ;;, ;.-;; ;; - J, ' ', Members ^247- '' '.,",/ - ;- ',]; /,,'",, '; v" ;,, - ' 'Operations 1 \248'-.'!'';.. v,"' ';; ''*'".],> V ' ' ',,, Floor Activity,,2$8' ;A,;.vJ',,,".'; ;,-, -, '' ' -.'. NASDAQ Operations^, ;2'49y -"~;[ ;. ; ;,,"" '?,.", " - -,'. ECNS '250;}..'--,, -/;T/J -V;',YV,- '-".',,'V Stock Market-Reporting'., "25p_".;' ;, "'",,.-'/ '"'' 8.4 SummaryandConclusions 252
CHAPTER* NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 260" ',,/" * ' ''' 9.1 Net Present Value 267 - The Basic Idea 267 - ;l Estimating Net Present Value 262 9.2 The Payback Rule 265 Defining the Rule 265 Analyzing the Rule 266 Redeeming Qualities of the Rule 267 Summary of the Rule 268 9.3 The Discounted Payback 268 9.4 The Average Accounting Return 277 9.5 The Internal Rate of Return 273_ ; Problems with the IRR 277 "' Nonconventional Cash Flows 277 Mutually Exclusive Investments.279.- Investing or Financing? 281. Redeeming Qualities of the IRR 282 The Modified Internal Rate of Return (MIRR) 283. Method #1 The Discounting Approach 283 Method #2 The Reinvestment Approach 283 ';..'-, Method #3 The Combination Approach 283,, MIRR or IRR Which Is Better? 284 9.6 The Profitability Index 284, ' ' '/ 9.7 The Practice of Capital Budgeting -285 9.8 Summary and Conclusions 288 CHAPTER 10 MAKING CAPITAL INVESTMENT DEdSIONS 298 10.1 Project Cash Flows A First Look 299.Relevant Cash Flows 299..'", The Stand-Alone Principle 299 ; 10.2 Incremental Cash Flows 299 Sunk Costs 300.- -, Opportunity Costs 300 ' Side Effects 300.,. '...-. - Net Working Capital 301,',' '' Financing Costs 307. Other Issues 307. ' '. 10.3 Pro Forma Financial Statements and Project Cash Flows 302 / Getting Started Pro Forma Financial Statements " 302 '-.. Project Cash Flows;.303, ' ; Project Operating Cash Flow. 303 Project Net Working Capital and Capital Spending 304 Projected total Cash Flow and Value *.304 10.4 More about Project Cash Flow 305. A Closer Look at Net Working Capital' 305 ;,' ;- ' '.' Depreciation 308'. ; ; - ; Modified ACRS Depreciation (MACRS)- 308 Book Value versus Market Value,; 309 An Example The Majestic Mulch and Compost ; Company (MMCC) 37 7 x.. ','.,. - ; Operating Cash Flows 311,,,. ' ; - ; - Change in NWC 311. - '.-,," Capital Spending 314... Total Cash Flow and Value 314 Conclusion 314.. - 10.5 Alternative Definitions of Operating Cash Flow 375, The Bottom-Up Approach 376 The Top-Down Approach 376.. The Tax Shield Approach.376 -,'".-, ; Conclusion 377., ' 10.6 Some Special Cases of Discounted Cash Flow Analysis 37 7 Evaluating Cost-Cutting Proposals '377 Setting the Bid Price 379...... Evaluating Equipment Options with Different Lives 327 10.7 Summary and Conclusions 323 CHAPTER 11 PROJECT ANALYSIS AND EVALUATION 335. 11.1 Evaluating NPV Estimates 336 The Basic Problem 336 Projected versus Actual Cash Flows 336 Forecasting Risk 336... Sources of Value 337.,,.-,' ',' 11.2 Scenario and Other What-lf Analyses 338, Getting Started 3 3 8 "'. ',. '..", Scenario Analysis 339 -'., "'',' ;. Sensitivity Analysis 347. '. -'.,'., Simulation Analysis 342...., *,.. 11.3 Break-Even Analysis 342 Fixed and Variable Costs 343 '. ' Variable Costs 343,......' Fixed Costs 344,., ;, Total Costs 344,.. '.' Accounting Break-Even 346 * Accounting Break-Even A Closer Look 346 Uses for the Accounting Break-Even. 348., ',. 11.4 Operating Cash Flow, Sales Volume, and < '. Break-Even 348 Accounting Break-Even and Cash Flow,349 The Base Case 349 >.'..,,-,-
Calculating the BreakrEven Level 349 " ; Payback and Break-Even 350 Sa es Volume arid Operating Cash Flow 350. -Cash Flow, Accounting, and Financial! Break-Even Points'- 350 ' ',,. "., Accounting Break-Even Revisited 351.', Cash Break-Even 351."" - '.; ',. '. {FinancialBreak-Even 352. '. Conclusion 352 ", 11.5 Operating Leverage 353 The Basic Idea 353. Implications of Operating Leverage 354 Measuring Operating Leverage 354. Operating Leverage and Break-Even 355 11.6 Capital Rationing 356 Soft Rationing 356 Hard Rationing 357 ;11.7 Summary and Conclusions 357 C H A P T E R 1 2 ' ',,. ;,.- --' /,'..".-. SOME LESSONS FROM CAPITAL MARKET HISTORY 365 12.1 12.2 12.3 12.4 12.5 12.6 12.7 Returns,366..,-,'...,.' -,".;...",..'-"''' " Dollar Returns" 366, ;, /,. Percentage Returns 368.' /....'., -, ' ; The Historical Record 370. ;,, A First Look,370. ; ' '. / '"_. [. -. A Closer Look 372,. Average Returns The First Lesson 376..... Calculating Average Returns 376,. Average Returns the Historical Record 376 Risk Premiums 377,,,. ',,, '.',,. - The First Lesson 377,-,' -, The Variability of Returns The Second Lesson 378. Frequency Distributions and Variability ^ 378 The Historical Variance and Standard Deviation 379 The Historical Record 387!. Normal Distribution 387 The Second Lesson 383;., ;. "... Using Capital Market History 383. More on the Stock Market Risk Premium.384 More about Average Returns,385, ;; Arithmetic versusi Geometric Averages 386. ' Calculating Geometric Average Returns 386 "; '-'Arithmetic Average Return or Geometric Average Return? 388, Capital Market Efficiency 389,. Price Behavior in an Efficient Market 389 The Efficient Markets Hypothesis 397 Sortie Commonr Misconceptions about the EMH 397. The Forms of Market Efficiency 393 Summary and Conclusions.394 CHAPTER13. RETURN, RISK, AND THE SECURITY MARKET LINE 407.13.-1 Expected Returns and Variances 402 ; - Expected Return 402 Calculating the Variance 404 1312 Portfolios 405 - ' Portfolio Weights 406 ^Portfolio Expected Returns 406 Portfolio Variance 407 13.3 Announcements, Surprises, and Expected Returns 409 Expected and Unexpected Returns 409 Announcements and News 409 13.4 Risk Systematic and Unsystematic 47 7 Systematic and Unsystematic Risk 47 7 * Systematic and Unsystematic Components, of Return 47 7 13.5 Diversification and Portfolio Risk 412 The Effect of Diversification Another Lesson from Market History 472 The Principle of Diversification 473 Diversification and Unsystematic Risk 414 Diversification and Systematic Risk 475 13.6 Systematic Risk and Beta 475 '. The Systematic Risk Principle 476 Measuring Systematic Risk 476 Portfolio Betas 477 13.7 The Security Market Line 479 '" ' Beta and the Risk Premium 479.-'.', The Reward-to-Risk Ratio 420, '."; The Basic Argument 421. ;'.' The Fundamental Result 423 The Security Market Line 424,',' v. t. Market Portfolios 424 The Capital Asset Pricing Model 424 13.8 The SML and the Cost of Capital A Preview 427 1 The Basic Idea 427 The Cost of Capital 427 13.9 Summary and Conclusions 428
PART 6 Cost or Capital and Lone-Term Financial Poll CHAPTER 14 COST OF CAPITAL 437 14.1 The Cost of Capital Some Preliminaries 438 Required Return versus Cost of Capital 438 Financial Policy and Cost of Capital 439 14.2 The Cost of Equity 439 The Dividend Growth Model Approach 439. Implementing the Approach 439 Estimating g 440 -,. Advantages and Disadvantages of the - Approach 441,.-.-.*,,,,,-'.. The SML Approach 447-,, ' I m p l e m e n t i n g t h e A p p r o a c h 4 4 2...,. Advantages and Disadvantages of the '. ' "' /'Approach 442 ".' '..'.',-...'..*.,. ' 14.3 The Costs of Debt and Preferred Stock 443 T h e C o s t of D e b t 4 4 3 ;. ',,\.,;'..,.' The Cost of Preferred Stock; 444 14.4 The Weighted Average Cost of Capital 445 The Capital Structure Weights; 445 ; v Taxes and the Weighted Average Cost of Capital 446 Calculating the WACC for Eastman Chemical 447 Eastman's Cost of Equity 447,''-' }<' ' ' /' Eastman's Cosf of Debt 449''. "'.-;, Eastman's WACC 450 "'?".('-.... ',, '. Solving the Warehouse Problem and Similar Capital Budgeting Problems 450.,'..;.,, '" ' Performance Evaluation Another Use of the v WACC 453 ''," ' ' " ' ; ';,' 14.5 Divisional and.project Costs of Capital 454 The SML and the WACC 455 Divisional Cost of Capital 456 The Pure Play Approach 456 The Subjective Approach 457 14.6 Flotation Costs and the Weighted Average Cost of Capital 458 The Basic Approach 459.., Flotation Costs and NPV 460 Internal Equity and Flotation Costs 462, 14.7 Summary and Conclusions 462 CHAPTER 15 RAISING CAPITAL 477.'?''/ 15.1 The Financing Life Cycle of a Firm Early-Stage Financing and Venture Capital 472, Venture Capital 472. Some Venture Capital Realities 473 Choosing a Venture Capitalist 473 Conclusion 474 15.2 Selling Securities to the Public The Basic Procedure 474 15.3 Alternative Issue Methods 475 15.4 Underwriters 477 Choosing an Underwriter 478 Types of Underwriting 478 Firm Commitment Underwriting 478 Best Efforts Underwriting 478 ' Dutch Auction Underwriting 479 The Aftermarket 479 The Green Shoe Provision 480 Lockup Agreements 480 The Quiet Period 480 15.5 IPOs and Underpricing 487 IPO Underpricing The 1999-2000 Experience 487 Evidence on Underpricing 487 Why Does Uriderpricing Exist? 484 15.6 New Equity Sales and the Value of the Firm 487 15.7 The Costs of Issuing Securities 488 The Costs of Selling Stock to the Public 488 The Costs of Going Public The Case of Symbion 490 15.8 Rights 492; ; The Mechanics of a Rights Offering 492 Number of Rights Needed to Purchase a Share 493 The Value of a Right 494,.,. Ex Rights.496 the Underwriting Arrangements 497 Effects on Shareholders 497 15.9 Dilution 498 Dilution of Proportionate Ownership 498 Dilution of Value Book versus Market Values 498, A Misconception 499,." The Correct Arguments 500 15.10 Issuing Long-Term Debt 500 15.11 Shelf Registration 507 15.12 Summary and Conclusions 502 CHAPTER16 FINANCIAL LEVERAGE AND CAPITAL STRUCTURE POLICY 508 16.1 The Capital Structure Question 509 Firm Value arid Stock Value An Example 509 Capital Structure and the Cost of Capital 570
16.2 The Effect of Financial Leverage 570 The Basics of Financial Leverage 57 7 Financial Leverage, EPS, and ROE An Example 511 EPS versus EBIT 512 Corporate Borrowing and Homemade Leverage 574 16.3 Capital Structure and the Cost of Equity Capital 575 M&M Proposition I The Pie Model 575 The Cost of Equity and Financial Leverage M&M Proposition II 576 Business and Financial Risk 578 16.4 M&M Propositions I and II with Corporate Taxes -579-.,, " -; -,',,; The Interest Tax Shield 520 Taxes and M&M Proposition 1. 520 Taxes, the WACC, and Proposition II 527.. Conclusion 522 16.5 Bankruptcy Costs 524 Direct Bankruptcy Costs 525 Indirect Bankruptcy Costs 525 16.6 Optimal Capital Structure 526 The Static Theory of Capital Structure 526 Optimal Capital Structure and the Cost of Capital 527 Optimal Capital Structure A Recap 528 Capital Structure Some Managerial Recommendations 530, Taxes 530 Financial Distress 530 16.7 The Pie Again 530 The Extended Pie Model 537 Marketed Claims versus Nonmarketed Claims 532 16.8 The Pecking-Order Theory 532 Internal Financing and the Pecking Order 532 Implications of the Pecking Order 533 16.9 Observed Capital Structures 534 16.10 A Quick Look at the Bankruptcy Process 536 Liquidation and Reorganization 536 Bankruptcy Liquidation 536 Bankruptcy Reorganization 537 Financial Managernent and the Bankruptcy Process 538 Agreements to Avoid Bankruptcy 539 16.11 Summary and Conclusions 539 CHAPTER 17 DIVIDENDS AND PAYOUT POLICY 546 17.2 17.3 17.4 17.5 17.6 17.7 17.8 17.1 Cash Dividends and Dividend Payment 547 Cash Dividends 547 17.9 Standard Method of Cash Dividend Payment 547 Dividend Payment A Chronology 547 More about the Ex-Dividend Date 548 Does Dividend Policy Matter? 550 An Illustration of the Irrelevance of Dividend Policy 550 Current Policy Dividends Set Equal to Cash Flow 551 Alternative Policy Initial Dividend Greater Than Cash Flow 551 Homemade Dividends 557,.-_.,..., v.%,.. Real-World,Factors Favoring a Low ; ','y- Dividend Payout 553, ; Taxes",'553.'"/'" '' ; - ";.;,' ;,; >.'"';- -'-V > -. ',;. " "' ".Flotation Costs' 553 ';',''.' ; / '/'.,.;,; ;"\.- ji" Dividend Restrictions* 553. -'_"'. ' '-._ ' ' <,..',.'. Real-World Factors Favoring a High - Dividend Payout 554, '; Desire for Current Income 554 ;,,. Tax and Other Benefits from High Dividends 555 Corporate Investors 555,,". Tax-Exempt Investors^ 555 <,.', ' Conclusion 555, /;!. ''- ' -,., - - ' A Resolution of Real-World Factors? 555 Information Content of Dividends 556 The Clientele Effect 557. '.." Stock Repurchases An Alternative to Cash Dividends 558. Cash Dividends versus Repurchase 559 Real-World Considerations in a Repurchase 560. V r Share Repurchase and EPS 567 What We Know and Do Not Know about Dividend and Payout Policies 567 Dividends and Dividend Payers 567 Corporations Smooth Dividends 564 Putting It All Together 564 Some Survey Evidence on Dividends 566- Stock Dividends and Stock Splits 568.' Some Details about Stock Splits and Stock Dividends 568, '.' ' ' ' -. Example of a Small Stock Dividend 568 Example of a Stock Split 569. - Example of,a Large Stock Dividend 569 Value of Stock Splits and Stock Dividends 569 The Benchmark Case- 570 ' Popular Trading.Range 570 Reverse Splits 570 ; ' - Summary arid Conclusions 577
f CHAPTER 18.. v,;v> '." ; { %,/.;/ ; ;' SHORT-TERM FINANCE AND PLANNING 579 18.1 Tracing Cash and Net Working Capital 580 18.2 The Operating Cycle and the Cash Cycle 587 Defining the Operating arid Cash Cycles 582 The Operating Cycle.582.,... The Cash Cycle,582 './ The Operating Cycle arid the Firm's Organizational '.',,'.' C h a r t " 5 8 3. - ' ^ - " i { " ' '.. ; " ' ; '.-'''. Calculatingthe Operating arid Cash Cycles 584,.'., The Operating Cycle 5 8 5 ;,. ^ '. ' ',.. -'." The.Cash Cycle 586*, ' ;' '.", ", -;.' '' ' Interpreting the Cash Cycle "587, 18.3 Some Aspects of Short-Term Financial Policy 587 The Size of the Firrn's Investment in Current ' ' ; A s s e t s 5 8 8 - ' " ' " _ '-. '-'. * '-' ' '." / Alternative Financing Policies for Current '" Assets 589, -,. ",> -\ '; An Ideal Case'589 '." ' Different'Policies for Financing Current Assets 589 Which Financing Policy Is Best? 592, Current Assets and Liabilities in Practice 593 18.4 The Cash Budget 594 Sales and Cash Collections; 594 ' Cash Outflows 595 J The Cash Balance 595 18.5 Short-Term Borrowing 596 Unsecured Loans 597 Compensating Balances 597 Cost of a Compensating Balance 597 Letters of Credit 598 Secured Loans 598 Accounts Receivable Financing 598 Inventory Loans 599 Other Sources 599 18.6 A Short-Term Financial Plan 600 18.7 Summary and Conclusions 607 CHAPTER 19 CASH AND LIQUIDITY MANAGEMENT 672 19.1 Reasons for Holding Cash 673 The Speculative and Precautionary Motives 673 The Transaction Motive 673 Compensating Balances 673 Costs of Holding Cash 613 Cash Management versus Liquidity Management 674 19.2 Understanding Float 674 Disbursement Float 674 Collection Float and Net Float 675 - Float Management 676.. ; Measuring Float 676 - Some Details, 67 7 Cost of the Float 617. Ethical and Legal Questions 619 Electronic Data Interchange and Check 21 The End of Float? 620-19.3 Cash Collection and Concentration 627 Components of Collection Time 627 Cash Collection 627 Lockboxes 627 Cash Concentration 623 Accelerating Collections An Example - 624 19.4 Managing Cash Disbursements 625 Increasing Disbursement Float 625 Controlling Disbursements 626 Zero-Balance Accounts 626 Controlled Disbursement Accounts 627 19.5 Investing Idle Cash 627 ".-' Temporary Cash Surpluses 627. Seasonal or Cyclical Activities 627 Planned or Possible Expenditures 627 Characteristics of Short-Term Securities 628 Maturity 628, Default Risk 628 Marketability 628 Taxes 628 Some Different Types of Money Market Securities 629 19.6 Summary and Conclusions 630 19A Determining the Target Cash Balance 634 The Basic Idea 634 The BAT Model 635 The Opportunity Costs 636 The Trading-Costs 637 The Total Cost 637 The Solution. 638 Conclusion' 639 The MiileHDrr Model A More General Approach 639. The Basicjdea 639 Using the'model 639 Implicatioris of the BAT and Miller-Orr Models,647>.,, Other Factors Influencing the Target Cash Balance 641.' ';,
CHAPTER 20 CREDIT AND INVENTORY MANAGEMENT 644 20.1 Credit and Receivables 645 Components of Credit Policy 645 The Cash Flows from Granting Credit 645 The Investment in Receivables 646 20.2 Terms of the Sale 646 The Basic Form 647 The Credit Period 647 The Invoice Date 647 Length of the Credit Period 647 Cash Discounts 648 Cost of the Credit 649.. ; trade Discounts 649 The Cash Discount and the ACP 649 Credit Instruments 650 20.3 Analyzing Credit Policy 650 Credit Policy Effects 650 Evaluating a Proposed Credit Policy 657 NPV of Switching Policies 651 ABreak-Even Application 653 20.4 Optimal Credit Policy 653, The Total Credit Cost Curve 653 Organizing the Credit Function 654 20.5 Credit Analysis 655 When Should Credit Be Granted? 655, A One-Time Sale 655. Repeat Business 656.. Credit Information 657. Credit Evaluation and Scoring 657... 20.6 Collection Policy 658 Monitoring Receivables 658 Collection Effort 659 20.7 Inventory Management 659 The Financial Manager and Inventory Policy 660 Inventory Types 660 Inventory Costs.660... 20.8 Inventory Management J, /, ;, Techniques 667 ',.,, The ABC Approach.667.,,,.'*; /,., ; The Economic Order Quantity Model 662'. Inventory Depletion 662;, "...., TheCarryingCosts 664 " '., The Shortage Costs.664 \ " ;,, -'. The Total Costs 664 '. " ','".".,,., Extensions to the EOQ Model 666.. " ;.", Safety.Stocks 666 '. }. '', ' '. '-. ' ' *. ' ',-,. Reorder Points 6 6 6. '" -; "" ' ' ','" ', Managing Derived-Demand Inventories 666 Materials Requirements Planning. 668 -. ' ",' Just-in-time Inventory...668' ". 20.9 Summary and Conclusions.668 20A More about Credit Policy Analysis 674 Two Altemative.Approaches 674.."',/;,.;.. ',,. The One-ShotApproach '.675. ;. >-.. ';.-... The Accounts Receivable Approach 675 Discounts and Default Risk 676 NPV of the Credit Decision 677 A Break-Even Application 678 CHAPTER21 INTERNATIONAL CORPORATE FINANCE 687 21.1 Terminology 682 / 21.2 Foreign Exchange Markets and Exchange ''Rates 683 ' /',. -. Exchange Rates 684 ;, ' ExchangeRate Quotations, 684 ';,.", Crdss-Rates and Triangle Arbitrage 685- - -.* Types of Transactions ' 687 '.,, > 21.3 Purchasing Power Parity 688 Absolute Purchasing Power Parity 688..,; Relative Purchasing,PowerParity 690 - ;. The Basic Idea, 690, '.. '; ";. The Result 690 ' Currency Appreciation and Depreciation 69,7 21.4 Interest Rate Parity, Unbiased Forward Rates, and the International Fisher Effect 692 Covered Interest Arbitrage 692 Interest Rate Parity 693 Forward Rates and Future Spot Rates 694 Putting It All Together 694 Uncovered Interest Parity 695 The International Fisher Effect 695 21.5 International Capital Budgeting 696 Method 1 The Home Currency Approach 696 Method 2 The Foreign Currency Approach 697 Unremitted Cash Flows 698 21.6 Exchange Rate Risk 698 Short-Run Exposure 698 Long-Run Exposure 699
Translation Exposure 700 Managing Exchange Rate Risk 707 21.7 Political Risk 707 21.8 Summary and Conclusions 702 APPENDIX C ANSWERS TO SELECTED END-OF-CHAPTER PROBLEMS C-1 '. '. APPENDIX A MATHEMATICAL TABLES APPENDIX B KEY EQUATIONS B-1 A-i Index i-1