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15e

Australia ● Brazil ● Mexico ● Singapore ● United Kingdom ● United States

EugEnE F. Brigham University of Florida

JoEl F. houston University of Florida

Fundamentals of FinanCial

managEmEnt

Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

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Printed in the United States of America Print Number: 01 Print Year: 2018

Fundamentals of Financial Management, Fifteenth edition Eugene F. Brigham and Joel F. Houston

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xii

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WHY IS THIS IMPORTANT TO ME? For many students, the idea of taking finance is intimidating. Beyond that, students report that they become more engaged with the course material when they see its relevance in business. The “Why is this important to me?” activity asks the student to complete a short self-assessment activity to demonstrate how they may already have personal knowledge about the important finance concepts they will learn in the chapter material. It is intended to help the student, especially the non-finance major, better understand the relevance in the financial concepts they will learn.

xiii

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xvi

Brief Contents

xvii

Preface xxviii About the Authors xxxviii

Part 1 Introduction to Financial Management 1 Chapter 1 An Overview of Financial Management 2 Chapter 2 Financial Markets and Institutions 27

Part 2 Fundamental Concepts in Financial Management 61 Chapter 3 Financial Statements, Cash Flow,

and Taxes 62 Chapter 4 Analysis of Financial Statements 105 Chapter 5 Time Value of Money 148

Part 3 Financial Assets 193 Chapter 6 Interest Rates 194 Chapter 7 Bonds and Their Valuation 228 Chapter 8 Risk and Rates of Return 270 Chapter 9 Stocks and Their Valuation 316

Part 4 Investing in Long-Term Assets: Capital Budgeting 355 Chapter 10 The Cost of Capital 356 Chapter 11 The Basics of Capital Budgeting 385 Chapter 12 Cash Flow Estimation and Risk Analysis 417 Chapter 13 Real Options and Other Topics in Capital

Budgeting 453

Part 5 Capital Structure and Dividend Policy 473 Chapter 14 Capital Structure and Leverage 474 Chapter 15 Distributions to Shareholders: Dividends

and Share Repurchases 517

Part 6 Working Capital Management and Financial Forecasting 551 Chapter 16 Working Capital Management 552 Chapter 17 Financial Planning and Forecasting 592

Part 7 Special Topics in Financial Management 619 Chapter 18 Derivatives and Risk Management 620 Chapter 19 Multinational Financial Management 664

xviii Brief Contents

Chapter 20 Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles 700

Chapter 21 Mergers and Acquisitions 734

Appendixes APPENDIX A Solutions to Self-Test Questions

and Problems A-1 APPENDIX B Answers to Selected

End-of-Chapter Problems B-1 APPENDIX C Selected Equations and Tables C-1

Index I-1

xix

Contents Preface xxviii About the Authors xxxviii

Part 1 Introduction to Financial Management 1

ChaPtEr 1 an overview of Financial management 2 Striking the Right Balance 2

PUTTING THINGS IN PERSPECTIVE 4 1-1 What Is Finance? 4

1-1A Areas of Finance 4 1-1B Finance Within an Organization 5 1-1C Finance Versus Economics and

Accounting 5 1-2 Jobs in Finance 6 1-3 Forms of Business Organization 7 1-4 The Main Financial Goal: Creating Value

for Investors 9 1-4A Determinants of Value 9 1-4B Intrinsic Value 10 1-4C Consequences of Having a Short-Run

Focus 12 1-5 Stockholder–Manager Conflicts 13

1-5A Compensation Packages 13 1-5B Direct Stockholder Intervention 13 Are CEOs Overpaid? 14 1-5C Managers’ Response 15

1-6 Stockholder–Debtholder Conflicts 16 1-7 Balancing Shareholder Interests and the

Interests of Society 18 Investing In Socially Responsible Funds 18

1-8 Business Ethics 20 1-8A What Companies Are Doing 21 1-8B Consequences of Unethical Behavior 21 1-8C How Should Employees Deal With

Unethical Behavior? 23

TYING IT ALL TOGETHER 24

ChaPtEr 2 Financial markets and institutions 27 The Economy Depends on a Strong Financial System 27

PUTTING THINGS IN PERSPECTIVE 28 2-1 The Capital Allocation Process 29 2-2 Financial Markets 31

2-2A Types of Markets 31 2-2B Recent Trends 32

2-3 Financial Institutions 37 Lower Fees Motivate Investors to Move Toward Index Funds 40

Securitization Has Dramatically Transformed the Banking Industry 43

2-4 The Stock Market 43 2-4A Physical Location Stock Exchanges 44 Global Perspectives: The NYSE and NASDAQ Go Global 45 2-4B Over-the-Counter (OTC) and the Nasdaq

Stock Markets 45 2-5 The Market for Common Stock 46

2-5A Types of Stock Market Transactions 47 Initial Buzz Surrounding IPOs Doesn’t Always Translate Into Long-Lasting Success 48

2-6 Stock Markets and Returns 49 2-6A Stock Market Reporting 49 Measuring the Market 51 2-6B Stock Market Returns 52

2-7 Stock Market Efficiency 52 2-7A Behavioral Finance Theory 54 2-7B Conclusions About Market Efficiency 56

TYING IT ALL TOGETHER 57

intEgratED CasE smyth Barry & Company 58

Part 2 Fundamental Concepts in Financial Management 61

ChaPtEr 3 Financial statements, Cash Flow, and taxes 62 Unlocking the Valuable Information in Financial Statements 62

PUTTING THINGS IN PERSPECTIVE 63 3-1 Financial Statements and Reports 64

Global Perspectives: Global Accounting Standards: Will It Ever Happen? 65

3-2 The Balance Sheet 65 3-2A Allied’s Balance Sheet 67 The Balance Sheet of an Average American Household 72

3-3 The Income Statement 73 3-4 Statement of Cash Flows 75 3-5 Statement of Stockholders’ Equity 79

xx Contents

3-6 Uses and Limitations of Financial Statements 80

3-7 Free Cash Flow 81 Free Cash Flow Is Important for Businesses Both Small and Large 83

3-8 MVA and EVA 84 3-9 Income Taxes 86

Congress Considers Significant Changes to the Tax Code 86 3-9A Individual Taxes 87 3-9B Corporate Taxes 90

TYING IT ALL TOGETHER 94

intEgratED CasE D’leon inc., Part i 101

taking a Closer look Exploring Dunkin’ Brands Group’s Financial Statements 104

ChaPtEr 4 analysis of Financial statements 105 Can You Make Money Analyzing Stocks? 105

PUTTING THINGS IN PERSPECTIVE 106 4-1 Ratio Analysis 107 4-2 Liquidity Ratios 108

4-2A Current Ratio 108 Financial Analysis on the Internet 109 4-2B Quick, or Acid Test, Ratio 110

4-3 Asset Management Ratios 111 4-3A Inventory Turnover Ratio 111 4-3B Days Sales Outstanding 112 4-3C Fixed Assets Turnover Ratio 113 4-3D Total Assets Turnover Ratio 113

4-4 Debt Management Ratios 114 4-4A Total Debt to Total Capital 116 4-4B Times-Interest-Earned Ratio 116 Household Debt Burdens have Declined in Recent Years 117

4-5 Profitability Ratios 118 4-5A Operating Margin 118 4-5B Profit Margin 118 4-5C Return on Total Assets 119 4-5D Return on Common Equity 119 4-5E Return on Invested Capital 119 4-5F Basic Earning Power (BEP) Ratio 120

4-6 Market Value Ratios 121 4-6A Price/Earnings Ratio 121 4-6B Market/Book Ratio 122 4-6C Enterprise Value/EBITDA Ratio 123

4-7 Tying the Ratios Together: The DuPont Equation 124 Microsoft Excel: A Truly Essential Tool 125

4-8 Potential Misuses of ROE 126 Economic Value Added (EVA) Versus Net Income 127

4-9 Using Financial Ratios to Assess Performance 128

4-9A Comparison to Industry Average 128 4-9B Benchmarking 128 4-9C Trend Analysis 130

4-10 Uses and Limitations of Ratios 131 Looking for Warning Signs within the Financial Statements 133

4-11 Looking Beyond the Numbers 133

TYING IT ALL TOGETHER 135

intEgratED CasE D’leon inc., Part ii 144

taking a Closer look Conducting A Financial Ratio Analysis on HP Inc. 147

WEB aPPEnDiX 4a Common Size and Percent Change Analyses

ChaPtEr 5 time Value of money 148 Will You Be Able to Retire? 148

PUTTING THINGS IN PERSPECTIVE 149 5-1 Time Lines 150 5-2 Future Values 151

5-2A Step-By-Step Approach 152 5-2B Formula Approach 152 Simple Versus Compound Interest 152 5-2C Financial Calculators 153 5-2D Spreadsheets 153 5-2E Graphic View of the Compounding

Process 155 5-3 Present Values 157

5-3A Graphic View of the Discounting Process 159

5-4 Finding the Interest Rate, I 160 5-5 Finding the Number of Years, N 161 5-6 Annuities 161 5-7 Future Value of an Ordinary Annuity 162 5-8 Future Value of an Annuity Due 165 5-9 Present Value of an Ordinary Annuity 166

5-10 Finding Annuity Payments, Periods, and Interest Rates 168 5-10A Finding Annuity Payments, PMT 168 5-10B Finding the Number of Periods, N 169 5-10C Finding the Interest Rate, I 169

5-11 Perpetuities 170 5-12 Uneven Cash Flows 171 5-13 Future Value of an Uneven

Cash Flow Stream 173 5-14 Solving for I with Uneven Cash Flows 174 5-15 Semiannual and Other

Compounding Periods 175 5-16 Comparing Interest Rates 177 5-17 Fractional Time Periods 180 5-18 Amortized Loans 180

xxiContents

TYING IT ALL TOGETHER 182

intEgratED CasE First national Bank 190

WEB aPPEnDiX 5a Continuous Compounding and Discounting

WEB aPPEnDiX 5B Growing Annuities

Part 3 Financial Assets 193

ChaPtEr 6 interest rates 194 The Fed Contemplates an Increase in Interest Rates as the U.S. Economy Shows Signs of a Strong Rebound 194

PUTTING THINGS IN PERSPECTIVE 195 6-1 The Cost of Money 196 6-2 Interest Rate Levels 197 6-3 The Determinants of Market

Interest Rates 201 6-3A The Real Risk-Free Rate of Interest, r* 201 Global Perspectives: European Banks Confront the Reality of Negative Interest Rates 202 6-3B The Nominal, or Quoted, Risk-Free Rate

of Interest, rRF 5 r* 1 IP 203 6-3C Inflation Premium (IP) 203 6-3D Default Risk Premium (DRP) 204 6-3E Liquidity Premium (LP) 204 6-3F Interest Rate Risk and the Maturity

Risk Premium (MRP) 205 An Almost Riskless Treasury Bond 206

6-4 The Term Structure of Interest Rates 208 6-5 What Determines the Shape of the Yield

Curve? 210 The Links Between Expected Inflation and Interest Rates: A Closer Look 212

6-6 Using the Yield Curve to Estimate Future Interest Rates 214

6-7 Macroeconomic Factors that Influence Interest Rate Levels 217 6-7A Federal Reserve Policy 217 6-7B Federal Budget Deficits or Surpluses 217 6-7C International Factors 218 6-7D Business Activity 218

6-8 Interest Rates and Business Decisions 219

TYING IT ALL TOGETHER 220

intEgratED CasE morton handley & Company 226

taking a Closer look Using the New York Times Bond Market Page to Understand Interest Rates 227

ChaPtEr 7 Bonds and their Valuation 228 Sizing Up Risk in the Bond Market 228

PUTTING THINGS IN PERSPECTIVE 229 7-1 Who Issues Bonds? 230 7-2 Key Characteristics of Bonds 231

7-2A Par Value 231 7-2B Coupon Interest Rate 231 7-2C Maturity Date 232 7-2D Call Provisions 232 7-2E Sinking Funds 233 7-2F Other Features 234

7-3 Bond Valuation 234 7-4 Bond Yields 238

7-4A Yield to Maturity 239 7-4B Yield to Call 240

7-5 Changes in Bond Values over Time 242 7-6 Bonds with Semiannual Coupons 245 7-7 Assessing a Bond’s Riskiness 247

7-7A Price Risk 248 7-7B Reinvestment Risk 249 7-7C Comparing Price Risk and Reinvestment

Risk 250 7-8 Default Risk 252

7-8A Various Types of Corporate Bonds 252 7-8B Bond Ratings 253 7-8C Bankruptcy and Reorganization 258

7-9 Bond Markets 259 Accrued Interest and the Pricing of Coupon Bonds 260

TYING IT ALL TOGETHER 262

intEgratED CasE Western money management inc. 268

taking a Closer look Using Online Resources to Understand the Impact of Interest Rates on Bond Valuation 269

WEB aPPEnDiX 7a Zero Coupon Bonds

WEB aPPEnDiX 7B Bond Risk and Duration

WEB aPPEnDiX 7C Bankruptcy and Reorganization

ChaPtEr 8 risk and rates of return 270 Managing Risk in Difficult Times 270

PUTTING THINGS IN PERSPECTIVE 271 8-1 The Risk-Return Trade-Off 272 8-2 Stand-Alone Risk 274

8-2A Statistical Measures of Stand-Alone Risk 275

xxii Contents

8-2B Measuring Stand-Alone Risk: The Standard Deviation 277

8-2C Using Historical Data to Measure Risk 279 8-2D Other Measures of Stand-Alone Risk: The

Coefficient of Variation and the Sharpe Ratio 280

8-2E Risk Aversion and Required Returns 281 The Historical Trade-Off Between Risk and Return 282

8-3 Risk in a Portfolio Context: The CAPM 283 8-3A Expected Portfolio Returns, r⁄p 284 8-3B Portfolio Risk 285 Adding More Stocks Doesn’t Always Reduce The Risk of Your Portfolio 289 8-3C Risk in a Portfolio Context: The Beta

Coefficient 289 Global Perspectives: The Benefits of Diversifying Overseas 294

8-4 The Relationship between Risk and Rates of Return 295 Estimating The Market Risk Premium 298 8-4A The Impact of Expected Inflation 298 8-4B Changes in Risk Aversion 300 8-4C Changes in a Stock’s Beta Coefficient 302

8-5 Some Concerns about Beta and the CAPM 303

8-6 Some Concluding Thoughts: Implications for Corporate Managers and Investors 303

TYING IT ALL TOGETHER 305

INTEGRATED CASE Merrill Finch Inc. 312

Taking a Closer Look Using Past Information to Estimate Required Returns 314

WEb AppENDIx 8A Calculating Beta Coefficients

ChApTER 9 Stocks and Their Valuation 316 Searching for the Right Stock 316

PUTTING THINGS IN PERSPECTIVE 317 9-1 Legal Rights and Privileges of Common

Stockholders 317 9-1A Control of the Firm 317 9-1B The Preemptive Right 319

9-2 Types of Common Stock 319 9-3 Stock Price versus Intrinsic Value 320

Are “Smart Beta” Funds A Smart Idea? 321 9-3A Why Do Investors and Companies

Care about Intrinsic Value? 322 9-4 The Discounted Dividend Model 323

9-4A Expected Dividends as the Basis for Stock Values 325

9-5 Constant Growth Stocks 326 9-5A Illustration of a Constant Growth Stock 327

9-5B Dividends Versus Growth 328 9-5C Which is Better: Current Dividends or

Growth? 330 9-5D Required Conditions for the Constant

Growth Model 330 9-6 Valuing Nonconstant Growth Stocks 331

Evaluating Stocks That Don’t Pay Dividends 335 9-7 Enterprise-Based Approach

to Valuation 335 9-7A The Corporate Valuation Model 336 9-7B Comparing the Corporate Valuation

and Discounted Dividend Models 339 Other Approaches to Valuing Common Stocks 340

9-8 Preferred Stock 341

TYING IT ALL TOGETHER 342

INTEGRATED CASE Mutual of Chicago Insurance Company 348

Taking a Closer Look Estimating Exxon Mobil Corporation’s Intrinsic Stock Value 349

AppENDIx 9A Stock Market Equilibrium 351

Part 4 Investing in Long-Term Assets: Capital Budgeting 355

ChApTER 10 The Cost of Capital 356 Creating Value at Disney 356

PUTTING THINGS IN PERSPECTIVE 357 10-1 An Overview of the Weighted Average

Cost of Capital (WACC) 358 10-2 Basic Definitions 359 10-3 Cost of Debt, rd(12T) 361 10-4 Cost of Preferred Stock, rp 362 10-5 Cost of Retained Earnings, rs 363

10-5A CAPM Approach 364 10-5B Bond-Yield-Plus-Risk-Premium

Approach 365 10-5C Dividend-Yield-Plus-Growth-Rate,

or Discounted Cash Flow (DCF), Approach 366

10-5D Averaging the Alternative Estimates 367 10-6 Cost of New Common Stock, re 368

10-6A Add Flotation Costs to a Project’s Cost 368 10-6B Increase the Cost of Capital 369 10-6C When Must External Equity Be

Used? 370 10-7 Composite, or Weighted Average,

Cost of Capital, WACC 371

xxiiiContents

10-8 Factors that Affect the WACC 371 10-8A Factors the Firm Cannot Control 371 Some Real-World Estimates of the WACC 372 10-8B Factors the Firm Can Control 373

10-9 Adjusting the Cost of Capital for Risk 373

10-10 Some Other Problems with Cost of Capital Estimates 375

TYING IT ALL TOGETHER 376

intEgratED CasE Coleman technologies inc. 382

taking a Closer look Calculating 3M’s Cost of Capital 383

WEB aPPEnDiX 10a The Cost of New Common Stock and WACC

ChaPtEr 11 the Basics of Capital Budgeting 385 Competition in the Aircraft Industry: Airbus versus Boeing 385

PUTTING THINGS IN PERSPECTIVE 386 11-1 An Overview of Capital Budgeting 386 11-2 Net Present Value (NPV) 388 11-3 Internal Rate of Return (IRR) 392

Why NPV Is Better Than IRR 395 11-4 Multiple Internal Rates of Return 395 11-5 Reinvestment Rate Assumptions 397 11-6 Modified Internal Rate of Return

(MIRR) 398 11-7 NPV Profiles 402 11-8 Payback Period 405 11-9 Conclusions on Capital Budgeting

Methods 407 11-10 Decision Criteria Used in Practice 408

TYING IT ALL TOGETHER 409

intEgratED CasE allied Components Company 415

ChaPtEr 12 Cash Flow Estimation and risk analysis 417 Home Depot Carefully Evaluates New Investments 417

PUTTING THINGS IN PERSPECTIVE 418 12-1 Conceptual Issues in Cash Flow

Estimation 418

12-1A Free Cash Flow Versus Accounting Income 419

12-1B Timing of Cash Flows 420

12-1C Incremental Cash Flows 420 12-1D Replacement Projects 420 12-1E Sunk Costs 420 12-1F Opportunity Costs Associated With

Assets the Firm Owns 421 12-1G Externalities 421

12-2 Analysis of an Expansion Project 423 12-2A Effect of Different Depreciation

Rates 426 12-2B Cannibalization 426 12-2C Opportunity Costs 426 12-2D Sunk Costs 426 12-2E Other Changes to the Inputs 427

12-3 Replacement Analysis 427 12-4 Risk Analysis in Capital Budgeting 430 12-5 Measuring Stand-Alone Risk 431

12-5A Sensitivity Analysis 431 12-5B Scenario Analysis 433 12-5C Monte Carlo Simulation 435

12-6 Within-Firm and Beta Risk 435 12-7 Unequal Project Lives 436

12-7A Replacement Chains 438 12-7B Equivalent Annual Annuities (EAA) 438 12-7C Conclusions about Unequal Lives 438

TYING IT ALL TOGETHER 439

intEgratED CasE allied Food Products 448

aPPEnDiX 12a Tax Depreciation 451

WEB aPPEnDiX 12B Refunding Operations

WEB aPPEnDiX 12C Using the CAPM to Estimate the Risk-Adjusted Cost of Capital

WEB aPPEnDiX 12D Techniques for Measuring Beta Risk

ChaPtEr 13 real options and other topics in Capital Budgeting 453 Anheuser-Busch Used Real Options to Enhance Its Value 453

PUTTING THINGS IN PERSPECTIVE 454 13-1 Introduction to Real Options 454 13-2 Growth (Expansion) Options 455 13-3 Abandonment/Shutdown Options 458 13-4 Investment Timing Options 460 13-5 Flexibility Options 462 13-6 The Optimal Capital Budget 463 13-7 The Post-Audit 466

TYING IT ALL TOGETHER 467

xxiv Contents

intEgratED CasE 21st Century Education Products 471

Part 5 Capital Structure and Dividend Policy 473

ChaPtEr 14 Capital structure and leverage 474 Debt: Rocket Booster or Anchor? Caterpillar Inc. 474

PUTTING THINGS IN PERSPECTIVE 475 14-1 Book, Market, or “Target” Weights? 475

14-1A Measuring the Capital Structure 476 14-1B Capital Structure Changes Over Time 478

14-2 Business and Financial Risk 478 14-2A Business Risk 479 14-2B Factors That Affect Business Risk 480 14-2C Operating Leverage 481 14-2D Financial Risk 485

14-3 Determining the Optimal Capital Structure 490 14-3A WACC and Capital Structure

Changes 490 14-3B The Hamada Equation 490 14-3C The Optimal Capital Structure 494

14-4 Capital Structure Theory 495 Yogi Berra on the MM Proposition 496 14-4A The Effect of Taxes 497 14-4B The Effect of Potential Bankruptcy 498 14-4C Trade-off Theory 498 14-4D Signaling Theory 499 14-4E Using Debt Financing to Constrain

Managers 500 14-4F Pecking Order Hypothesis 501 14-4G Windows of Opportunity 502

14-5 Checklist for Capital Structure Decisions 502 14-6 Variations in Capital Structures 505

TYING IT ALL TOGETHER 506

intEgratED CasE Campus Deli inc. 513 taking a Closer look Exploring the Capital Structures for Four Restaurant Companies 516

WEB aPPEnDiX 14a Degree of Leverage

ChaPtEr 15 Distributions to shareholders: Dividends and share repurchases 517 Apple Shifts Gears and Begins to Unload Part of Its Vast Cash Hoard 517

PUTTING THINGS IN PERSPECTIVE 518

15-1 Dividends versus Capital Gains: What Do Investors Prefer? 519 15-1A Dividend Irrelevance Theory 519 15-1B Reasons Some Investors Prefer

Dividends 520 15-1C Reasons Some Investors Prefer Capital

Gains 520 15-2 Other Dividend Policy Issues 521

15-2A Information Content, or Signaling, Hypothesis 521

15-2B Clientele Effect 522 15-3 Establishing the Dividend Policy

in Practice 523 15-3A Setting the Target Payout Ratio: The

Residual Dividend Model 523 15-3B Earnings, Cash Flows, and

Dividends 528 Global Perspectives: Dividend Yields around the World 530 15-3C Payment Procedures 532

15-4 Dividend Reinvestment Plans 533 15-5 Summary of Factors Influencing Dividend

Policy 535 15-5A Constraints 535 15-5B Investment Opportunities 535 15-5C Alternative Sources of Capital 536 15-5D Effects of Dividend Policy on rs 536

15-6 Stock Dividends and Stock Splits 536 15-6A Stock Splits 537 15-6B Stock Dividends 537 15-6C Effect on Stock Prices 538

15-7 Stock Repurchases 539 15-7A The Effects of Stock Repurchases 539 15-7B Advantages of Repurchases 541 15-7C Disadvantages of Repurchases 541 15-7D Conclusions on Stock Repurchases 542

TYING IT ALL TOGETHER 543

intEgratED CasE southeastern steel Company 548

taking a Closer look Apple’s Dividend Policy 549

WEB aPPEnDiX 15a The Residual Dividend Model: An Example

Part 6 Working Capital Management and Financial Forecasting 551

ChaPtEr 16 Working Capital management 552 Successful Firms Efficiently Manage Their Working Capital 552

xxvContents

PUTTING THINGS IN PERSPECTIVE 553 16-1 Background on Working Capital 553 16-2 Current Assets Investment Policies 554 16-3 Current Assets Financing Policies 556

16-3A Maturity Matching, or “Self- Liquidating,” Approach 556

16-3B Aggressive Approach 556 16-3C Conservative Approach 558 16-3D Choosing Between the

Approaches 558 16-4 The Cash Conversion Cycle 559

16-4A Calculating the Targeted CCC 559 16-4B Calculating the CCC from Financial

Statements 560 Some Real-World Examples of the Cash Conversion Cycle 561

16-5 The Cash Budget 563 16-6 Cash and Marketable Securities 567

16-6A Currency 567 16-6B Demand Deposits 567 16-6C Marketable Securities 569

16-7 Inventories 570 16-8 Accounts Receivable 571

16-8A Credit Policy 571 16-8B Setting and Implementing the Credit

Policy 572 16-8C Monitoring Accounts Receivable 573

16-9 Accounts Payable (Trade Credit) 574 A Difficult Balancing Act 576

16-10 Bank Loans 577 16-10A Promissory Note 577 16-10B Line of Credit 578 16-10C Revolving Credit Agreement 579 16-10D Costs of Bank Loans 579

16-11 Commercial Paper 581 16-12 Accruals (Accrued Liabilities) 582 16-13 Use of Security in Short-Term

Financing 582

TYING IT ALL TOGETHER 583

intEgratED CasE ski Equipment inc. 589

WEB aPPEnDiX 16a Inventory Management

WEB aPPEnDiX 16B Short-Term Loans and Bank Financing

ChaPtEr 17 Financial Planning and Forecasting 592 Effective Forecasting is an Important Component of Strong Performance 592

PUTTING THINGS IN PERSPECTIVE 593 17-1 Strategic Planning 593 17-2 The Sales Forecast 595 17-3 The AFN Equation 597

17-3A Excess Capacity Adjustments 599 17-4 Forecasted Financial Statements 602

17-4A Part I. Inputs 604 17-4B Part II. Forecasted Income

Statement 604 17-4C Part III. Forecasted Balance Sheet 605 17-4D Part IV. Ratios and EPS 605 17-4E Using the Forecast to Improve

Operations 606 17-5 Using Regression to Improve

Forecasts 606 17-6 Analyzing the Effects of Changing

Ratios 608 17-6A Modifying Accounts Receivable 608 17-6B Modifying Inventories 608 17-6C Other “Special Studies” 608

TYING IT ALL TOGETHER 609

intEgratED CasE new World Chemicals inc. 615

taking a Closer look Forecasting the Future Performance of Abercrombie & Fitch 617

WEB aPPEnDiX 17a Forecasting Financial Requirements When Financial Ratios Change

Part 7 Special Topics in Financial Management 619

ChaPtEr 18 Derivatives and risk management 620 Using Derivatives to Manage Risk 620

PUTTING THINGS IN PERSPECTIVE 621 18-1 Reasons to Manage Risk 622

CFOs Assess the Costs and Benefits of Risk Management 624

18-2 Background on Derivatives 625 18-3 Options 627

18-3A Option Types and Markets 627 18-3B Factors that Affect the Value of a Call Option 629 18-3C Exercise Value Versus Option Price 629

18-4 Introduction to Option Pricing Models 632 Expensing Executive Stock Options 635

18-5 The Black–Scholes Option Pricing Model (OPM) 635 18-5A OPM Assumptions and Equations 635 18-5B OPM Illustration 637 Using the Vix as a Measure of Investors’ Fears 638

18-6 Forward and Futures Contracts 640

xxvi Contents

18-7 Other Types of Derivatives 644 18-7A SWAPS 644 Credit Instruments Create New Opportunities and Risks 645 18-7B Structured Notes 645 18-7C Inverse Floaters 647

18-8 Using Derivatives to Reduce Risks 647 18-8A Security Price Exposure 647 18-8B Futures 648 18-8C SWAPS 649 18-8D Commodity Price Exposure 650 18-8E The Use and Misuse of Derivatives 650

18-9 Risk Management 651 18-9A An Approach to Risk Management 652 PWC’s Guide for Assessing and Managing Risk 653

TYING IT ALL TOGETHER 655

intEgratED CasE tropical sweets inc. 659

taking a Closer look NETFLIX, Inc.: Call and Put Option Pricing and Interest Rate Futures 660

aPPEnDiX 18a Valuation of Put Options 662

ChaPtEr 19 multinational Financial management 664 U.S. Firms Look Overseas to Enhance Shareholder Value 664

PUTTING THINGS IN PERSPECTIVE 665 19-1 Multinational, or Global,

Corporations 665 Corporate Inversions Have Attracted Increased Criticism 669

19-2 Multinational versus Domestic Financial Management 669

19-3 The International Monetary System 671 19-3A International Monetary Terminology 671 19-3B Current Monetary Arrangements 672 Brexit Shakes Europe 673

19-4 Foreign Exchange Rate Quotations 674 19-4A Cross Rates 674 19-4B Interbank Foreign Currency

Quotations 675 19-5 Trading in Foreign Exchange 676

19-5A Spot Rates and Forward Rates 677 19-6 Interest Rate Parity 678 19-7 Purchasing Power Parity 680

Hungry for a Big Mac? Go to Hong Kong! 682 19-8 Inflation, Interest Rates, and Exchange

Rates 684 19-9 International Money and Capital

Markets 685 19-9A International Credit Markets 685

19-9B International Stock Markets 686 Stock Market Indexes around the World 687

19-10 Investing Overseas 688 Global Perspectives: Measuring Country Risk 688

Global Perspectives: Investing in International Stocks 689

19-11 International Capital Budgeting 691 19-12 International Capital Structures 692

TYING IT ALL TOGETHER 694

intEgratED CasE Citrus Products inc. 698

taking a Closer look Using the Internet to Follow Exchange Rates and International Indexes 699

ChaPtEr 20 hybrid Financing: Preferred stock, leasing, Warrants, and Convertibles 700 Tesla’s Investors Love the Convertible 700

PUTTING THINGS IN PERSPECTIVE 701 20-1 Preferred Stock 701

20-1A Basic Features 701 Preferred Stock: Does It Make Sense for Individual Investors? 702 20-1B Adjustable-Rate Preferred Stock 704 20-1C Advantages and Disadvantages

of Preferred Stock 704 20-2 Leasing 705

20-2A Types of Leases 705 Changes to the Financial Reporting of Leases Coming Soon 706 20-2B Financial Statement Effects 707 20-2C Evaluation by the Lessee 709 20-2D Other Factors that Affect Leasing

Decisions 712 20-3 Warrants 713

20-3A Initial Market Price of a Bond with Warrants 713

20-3B Use of Warrants in Financing 714 20-3C The Component Cost of Bonds with

Warrants 715 20-3D Problems with Warrant Issues 716

20-4 Convertibles 717 20-4A Conversion Ratio and Conversion

Price 717 20-4B The Component Cost of Convertibles 718 20-4C Use of Convertibles in Financing 721 20-4D Convertibles Can Reduce Agency

Costs 722 20-5 A Final Comparison of Warrants

and Convertibles 723 20-6 Reporting Earnings When Warrants

or Convertibles Are Outstanding 724

TYING IT ALL TOGETHER 724

xxvii Contents

intEgratED CasE Fish & Chips inc., Part i 730 Fish & Chips inc., Part ii 731

taking a Closer look Using the Internet to Follow Hybrid Securities 732

ChaPtEr 21 mergers and acquisitions 734 Amazon Announces Plans to Acquire Whole Foods 734

PUTTING THINGS IN PERSPECTIVE 735 21-1 Rationale for Mergers 736

21-1A Synergy 736 21-1B Tax Considerations 736 21-1C Purchase of Assets Below Their

Replacement Cost 737 21-1D Diversification 737 21-1E Managers’ Personal Incentives 737 21-1F Breakup Value 738

21-2 Types of Mergers 738 21-3 Level of Merger Activity 738 21-4 Hostile Versus Friendly Takeovers 740 21-5 Merger Analysis 741

21-5A Valuing the Target Firm 741 21-5B Setting the Bid Price 745 More than just Financial Statements 747 21-5C Post-Merger Control 747

21-6 The Role of Investment Bankers 748 21-6A Arranging Mergers 748 21-6B Developing Defensive Tactics 749 21-6C Establishing a Fair Value 750 21-6D Financing Mergers 750 21-6E Arbitrage Operations 751

21-7 Do Mergers Create Value? The Empirical Evidence 751

The Track Record of Large Mergers 752 21-8 Corporate Alliances 753 21-9 Private Equity Investments 754

21-10 Divestitures 754 21-10A Types of Divestitures 754 21-10B Divestiture Illustrations 755

TYING IT ALL TOGETHER 757

intEgratED CasE smitty’s home repair Company 760

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