The Prentice Hall Series in Finance
The Prentice Hall Series in Finance
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Principles of Managerial Finance—
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Brief Edition*
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Consumer Economics: Issues and Behaviors
Fundamentals of Multinational International Financial Management
Haugen
Finance
Berk/DeMarzo
The Inefficient Stock Market: What
Corporate Finance*
Pays Off and Why
Nofsinger
Psychology of Investing Berk/DeMarzo
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Haugen
Understanding Financial Statements Berk/DeMarzo/Harford
The New Finance: Overreaction,
Complexity, and Uniqueness
Theory of Asset Pricing Boakes
Holden
Pennacchi
Fundamentals of Corporate Finance*
Excel Modeling and Estimation in
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Rejda
Reading and Understanding the Financial Times
Insurance Brooks
Holden
Principles of Risk Management and
Excel Modeling and Estimation in
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Seiler
Financial Management: Core Performing Financial Studies: Concepts*
A Methodological Cookbook Copeland/Weston/Shastri
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International Banking: Text and Cases
Hull
Shapiro
Financial Theory and Corporate Policy
Fundamentals of Futures and Options
Capital Budgeting and Investment
Markets
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Dorfman/Cather Introduction to Risk Management and
Hull
Sharpe/Alexander/Bailey
Investments Insurance
Options, Futures, and Other
Solnik/McLeavey Eiteman/Stonehill/Moffett Multinational Business Finance
Derivatives
Hull
Global Investments
Stretcher/Michael Fabozzi
Risk Management and Financial
Cases in Financial Management Bond Markets: Analysis and Strategies
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Keown
Financial Management: Principles Capital Markets: Institutions and
Personal Finance: Turning Money into
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Valuation: The Art and Science of Foundations of Financial Markets and
Foundations of Finance: The Logic
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Management*
Financial Management and Policy Financial Management for Public,
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Fundamentals of Financial
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Financial Derivatives
McDonald
Gitman/Zutter
Derivatives Markets
Principles of Managerial Finance*
Principles of
Managerial Finance
Thirteenth Edition
Lawrence J. Gitman
San Diego State University
Chad J. Zutter
University of Pittsburgh
Prentice Hall
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Library of Congress Cataloging-in-Publication Data
Gitman, Lawrence J. Principles of managerial finance/Lawrence J. Gitman, Chad J. Zutter.—13th ed. p. cm.—(The Prentice Hall series in finance) Includes index. ISBN 978-0-13-611946-3 (alk. paper)
1. Corporations—Finance. 2. Business enterprises—Finance. I. Zutter, Chad J. II. Title. HG4011.G52 2010 658.15—dc22
Prentice Hall
is an imprint of
ISBN-13: 978-0-13-611946-3
Dedicated to the memory of my mother, Dr. Edith Gitman, who instilled in me the importance
of education and hard work. LJG
Dedicated to my wonderful wife, Heidi Zutter, who unconditionally
supports my every endeavor. CJZ
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Our Proven Teaching and Learning System
sers of U Principles of Managerial Finance have praised the effectiveness of the
book’s Teaching and Learning System, which they hail as one of its hall- marks. The system, driven by a set of carefully developed learning goals, has been retained and polished in this thirteenth edition. The “walkthrough” on the pages that follow illustrates and describes the key elements of the Teaching and Learning System. We encourage both students and instructors to acquaint them- selves at the start of the semester with the many useful features the book offers.
Six Learning Goals at the start of the chapter highlight the most important con- cepts and techniques in the chapter. Students
The Role of Managerial
are reminded to think about the learning
Finance goals while working through the chapter by
strategically placed learning goal icons .
Every chapter opens with a feature, titled
Learning Goals
Why This Chapter Matters to You
Why This Chapter Matters to You , that
LG 1 managerial finance function. Define finance and the
In your professional life
helps motivate student interest by high-
LG 2 Describe the legal forms of
ACCOUNTING You need to understand the relationships between the
business organization.
accounting and finance functions within the firm; how decision makers rely on the financial statements you prepare; why maximizing a firm’s
lighting both professional and personal
LG 3 Describe the goal of the firm, and
value is not the same as maximizing its profits; and the ethical duty that you have when reporting financial results to investors and other
benefits from achieving the chapter
of the firm is an appropriate goal explain why maximizing the value
stakeholders.
learning goals.
for a business.
INFORMATION SYSTEMS mation is important to managers in all functional areas; the documenta- You need to understand why financial infor-
LG 4 Describe how the managerial finance function is related to
tion that firms must produce to comply with various regulations; and
Its first part, In Your Professional Life ,
economics and accounting.
how manipulating information for personal gain can get managers into serious trouble.
discusses the intersection of the finance
LG 5 Identify the primary activities of
MANAGEMENT You need to understand the various legal forms of a
the financial manager.
business organization; how to communicate the goal of the firm to
topics covered in the chapter with the con-
LG 6 Describe the nature of the
employees and other stakeholders; the advantages and disadvantages
principal–agent relationship
of the agency relationship between a firm’s managers and its owners;
between the owners and
managers and investors. and how compensation systems can align or misalign the interests of
cerns of other major business disciplines. It
managers of a corporation, and explain how various corporate
MARKETING or market share is not always a good thing; how financial managers You need to understand why increasing a firm’s revenues
encourages students majoring in accounting,
governance mechanisms attempt to manage agency problems.
evaluate aspects of customer relations such as cash and credit manage- value to investors. ment policies; and why a firm’s brands are an important part of its
information systems, management, mar-
keting, and operations to appreciate how
OPERATIONS You need to understand the financial benefits of
ting costs may not increase the firm’s value; and how managers act on increasing a firm’s production efficiency; why maximizing profit by cut-
financial acumen will help them achieve
behalf of investors when operating a corporation.
their professional goals.
In your personal life rial finance also apply to your per- Many of the principles of manage- manage your own money more effectively. sonal life. Learning a few simple financial principles can help you
The second part, In Your Personal Life , identifies topics in the chapter that will have particular application to personal finance. This feature also helps students appreciate the tasks performed in a busi- ness setting by pointing out that the tasks
are not necessarily different from those
Each chapter begins with a short opening vignette that describes
a recent real-company event related to the chapter topic. These Facebook
stories raise interest in the chapter
In No Hurry to Go Public
by demonstrating its relevance in
the business world. acebook founder and chief executive officer F
Mark Zuckerberg is in no hurry to go public, even though he concedes that it is an inevitable step in the evolution of his firm. The Facebook CEO is on record saying that “we’re going to go public eventually, because that’s the contract that we have with our investors and our employees. . . . [but] we are definitely in no rush.” Nearly all public firms were at one time privately held by relatively few shareholders, but at some point the firms’ managers decided to go public. The decision to go public is one of the most important decisions managers can make.
Private firms are typically held by fewer shareholders and are subject to less regulation than are public firms. So why do firms go public at all? Often it is to provide an exit strategy for its private investors, gain access to investment capital, establish a market price for the firm’s shares, gain public exposure, or all of the above. Going public helps firms grow, but that and other benefits of public ownership must be weighed against the costs of going public.
Although taking Facebook public would likely make Zuckerberg one of the richest persons in the world under the age of 30, it would also mean that his firm would become subject to the influences of outside investors and government regulators. A public firm’s managers work for and are responsible to the firm’s investors, and government regulations require firms to provide investors with frequent reports disclosing material information about the firm’s performance. The regulatory demands placed on managers of public firms can sometimes distract managers from important aspects of running their businesses. This chapter will highlight the tradeoffs faced by financial managers as they make decisions intended to maximize the value of their firms.
Learning goal icons tie chapter con-
tent to the learning goals and appear LG 1 LG 2 1.1 Finance and Business
next to related text sections and again in
The field of finance is broad and dynamic. Finance influences everything that
the chapter-end summary, end-of- firms do, from hiring personnel to building factories to launching new advertising
campaigns. Because there are important financial dimensions to almost any
chapter homework materials, and sup- aspect of business, there are many financially oriented career opportunities for
those who understand the basic principles of finance described in this textbook.
plements such as the Study Guide, Test
Even if you do not see yourself pursuing a career in finance, you’ll find that an understanding of a few key ideas in finance will help make you a smarter con-
Item File, and MyFinanceLab.
sumer and a wiser investor with your own money.
For help in study and review, boldfaced key terms Corporations and their definitions appear
An entity created by law. corporation
A corporation is an entity created by law. A corporation has the legal powers of
in the margin where they are first intro- an individual in that it can sue and be sued, make and be party to contracts, and
The owners of a corporation, stockholders
acquire property in its own name. Although only about 20 percent of all U.S.
duced. These terms are also boldfaced in
takes the form of either
whose ownership, or
equity,
businesses are incorporated, the largest businesses nearly always are; corpora-
tions account for nearly 90 percent of total business revenues. Although corpora-
the book’s index and appear in the end-
of-book glossary. largest portion of corporate business receipts and net profits. Table 1.1 lists the
common stock or preferred
tions engage in all types of businesses, manufacturing firms account for the
stock.
key strengths and weaknesses of corporations.
Matter of Fact boxes provide inter-
Matter of fact
esting empirical facts that add back-
Problems with P/E Valuation
ground and depth to the material
he P/E multiple approach is a fast and easy way to estimate a stock’s value. However, P/E T covered in the chapter. ratios vary widely over time. In 1980, the average stock had a P/E ratio below 9, but by the year 2000, the ratio had risen above 40. Therefore, analysts using the P/E approach in the
1980s would have come up with much lower estimates of value than analysts using the model 20 years later. In other words, when using this approach to estimate stock values, the estimate will depend more on whether stock market valuations generally are high or low rather than on whether the particular company is doing well or not.
In More Depth boxes point
students to additional material,
In more depth
P = D 0 Deriving the * (1 + g) 1 + D 0 * (1 + g) 2 * (1 + g) 0 q +Á+ D 0 q
available on MyFinanceLab,
To read about
(1 + r s ) 1 (1 + r s ) 2 (1 + r s )
Constant-Growth Model, go
intended to further highlight a
to www.myfinancelab.com If we simplify Equation 7.3, it can be rewritten as:
particular topic for students who want to explore a topic in greater detail.
Examples are an important component
Example 6.3 3 The nominal interest rates on a number of classes of long-term securities in May
2010 were as follows:
of the book’s learning system. Numbered
and clearly set off from the text, they
Security
Nominal interest rate
provide an immediate and concrete
U.S. Treasury bonds (average)
Corporate bonds (by risk ratings):
3.95 demonstration of how to apply financial
High quality (Aaa–Aa)
Medium quality (A–Baa)
8.97 concepts, tools, and techniques. Some Examples demonstrate time-value-
Speculative (Ba–C)
Because the U.S. Treasury bond would represent the risk-free, long-term security, we can calculate the risk premium of the other securities by subtracting the risk-
of-money techniques. These examples
free rate, 3.30%, from each nominal rate (yield):
often show the use of time lines, equa-
tions, financial calculators, and spread-
Security
Risk premium
sheets (with cell formulas).
Corporate bonds (by ratings):
High quality (Aaa–Aa)
3.95% - 3.30% = 0.65%
Medium quality (A–Baa)
4.98 - 3.30 = 1.68
Speculative (Ba–C)
8.97 - 3.30 = 5.67
Personal Finance Examples demon-
Personal Finance Example 5.7 3 Fran Abrams wishes to determine how much money she will
have at the end of 5 years if she chooses annuity A, the ordinary annuity. She will deposit $1,000 annually, at the end of each of the next 5 years,
strate how students can apply manage-
into a savings account paying 7% annual interest. This situation is depicted on the
rial finance concepts, tools, and
following time line:
techniques to their personal financial
decisions.
Time line for future value of
an ordinary annuity ($1,000
end-of-year deposit, earning
7%, at the end of 5 years)
$5,750.74 Future Value
Key equations appear in green boxes
The Equation for Present Value
The present value of a future amount can be found mathematically by solving amount, Equation 5.4 for
throughout the text to help readers iden-
FV n , to be received PV. In other words, the present value, PV, of some future n periods from now, assuming an interest rate (or opportunity cost) of
r, is calculated as follows:
tify the most important mathematical
relationships. The variables used in these
equations are, for convenience, printed on the back endpapers of the book.
Note the similarity between this general equation for present value and the equa-
Review Questions appear at the
6 end of each major text section. REVIEW QUESTIONS 5–14 These questions challenge readers What effect does compounding interest more frequently than annually
have on (a) future value and (b) the effective annual rate (EAR)? Why?
to stop and test their understanding
5–15 How does the future value of a deposit subject to continuous com-
of key concepts, tools, techniques,
pounding compare to the value obtained by annual compounding?
5–16 Differentiate between a and practices before moving on to nominal annual rate and an effective annual
rate (EAR). Define annual percentage rate (APR) and annual per-
the next section.
centage yield (APY).
In Practice boxes offer insights focus on into important topics in managerial ETHICS
finance through the experiences of
If It Seems Too Good to Be True Then It Probably Is
real companies, both large and
in practice For many years,
fraud. Madoff’s hedge fund, Ascot
Madoff’s arrest indicated that investors’
investors around the
Partners, turned out to be a giant Ponzi
accounts contained over $64 billion, in
small. There are three categories of aggregate. Many investors pursued
world clamored to invest with Bernard
scheme.
Madoff. Those fortunate enough to
Over the years, suspicions were
claims based on the balance reported
In Practice boxes: in these statements. However, a recent
invest with “Bernie” might not have
raised about Madoff. Madoff gener-
understood his secret trading system,
ated high returns year after year, seem-
court ruling permits claims up to the dif-
but they were happy with the double-
ingly with very little risk. Madoff
ference between the amount an investor
Focus on Ethics deposited with Madoff and the amount boxes in every
digit returns that they earned. Madoff
credited his complex trading strategy
was well connected, having been the
for his investment performance, but
they withdrew. The judge also ruled
chapter help readers understand that investors who managed to with-
chairman of the board of directors of
other investors employed similar strate-
the NASDAQ Stock Market and a
gies with much different results than
draw at least their initial investment
and appreciate important ethical before the fraud was uncovered are not
Securities Clearing Corporation. His focus on PRACTICE went as far as to submit a report to the eligible to recover additional funds. credentials seemed to be impeccable.
founding member of the International
Madoff reported. Harry Markopolos
issues and problems related to Total out-of-pocket cash losses as a
SEC three years prior to Madoff’s arrest
Is a Fraud” that detailed his concerns. a managerial finance. estimated at slightly over $20 billion.
However, as the old saying goes, if Limits on Payback Analysis titled “The World’s Largest Hedge Fund result of Madoff’s fraud were recently something sounds too good to be true,
it probably is. Madoff’s investors in practice In tough economic
in Barrington, Illinois. “The simplicity of
even more important than discounted
learned this lesson the hard way when,
times, the standard for
On June 29, 2009, Madoff was
sentenced to 150 years in prison. computing payback may encourage 3 What are some hazards of cash flow (NPV and IRR)—because it
on December 11, 2008, the U.S. a payback period is often reduced. Chief information officers (CIOs) are Madoff’s investors are still working to sloppiness, especially the failure to
allowing investors to pursue spotlights the risks inherent in lengthy IT
recover what they can. Fraudulent include all costs associated with an
claims based their most recent projects. “It should be a hard and fast
a periods of more than 2 years. “We account statements sent just prior to corporate focus that relates a busi- investment, such as training, mainte- nance, and hardware upgrade costs,” payback period greater than 3 years, start with payback period,” says says Douglas Emond, senior vice presi- unless it’s an infrastructure project you ness event or situation to a specific
Focus on Practice boxes take a
Securities and Exchange Commission
(SEC) charged Madoff with securities apt to reject projects with payback
accounts statements? rule to never take an IT project with a
Ron Fijalkowski, CIO at Strategic
dent and chief technology officer at
can’t do without,” Campbell says.
Distribution, Inc., in Bensalem,
Eastern Bank in Lynn, Massachusetts. Whatever the weaknesses of the
financial concept or technique.
Pennsylvania. “For sure, if the payback
For example, he says, “you may be
payback period method of evaluating
period is over 36 months, it’s not going
bringing in a hot new technology, but capital projects, the simplicity of the
to get approved. But our rule of thumb
uh-oh, after implementation you realize method does allow it to be used in
Global Focus conjunction with other, more sophisti- boxes look specifi-
is we’d like to see 24 months. And if
that you need a dot-net guru in-house,
it’s close to 12, it’s probably a no-
and you don’t have one.”
cated measures. It can be used to
cally at the managerial finance screen potential projects and winnow
brainer.”
But the payback method’s emphasis
While easy to compute and easy
on the short term has a special appeal them down to the few that merit more
experiences of international careful scrutiny with, for example, net
to understand, the payback periods sim-
for IT managers. “That’s because the
plicity brings with it some drawbacks.
history of IT projects that take longer present value (NPV).
companies. than 3 years is disastrous,” says
“Payback gives you an answer that tells
you a bit about the beginning stage of
Gardner. Indeed, Ian Campbell, chief 3 In your view, if the payback period
All three types of In Practice boxes the NPV method, should it be used
a project, but it doesn’t tell you much
research officer at Nucleus Research, method is used in conjunction with
about the full lifetime of the project,”
Inc., in Wellesley, Massachusetts, says
says Chris Gardner, a cofounder of
payback period is an absolutely essen- before or after the NPV evaluation?
end with one or more tial metric for evaluating IT projects— critical thinking questions to help readers
iValue LLC, an IT valuation consultancy
GLOBAL focus
broaden the lesson from the con-
An International Flavor to Risk Reduction
tent of the box.
in practice Earlier in this chapter
Staunton calculated the historical returns diversified portfolio of 2.07, slightly
(see Table 8.5 on
on a portfolio that included U.S. stocks lower than the 2.10 coefficient of
page 318), we learned that from
as well as stocks from 18 other coun- variation reported for U.S. stocks in
1900 through 2009 the U.S. stock
tries. This diversified portfolio produced Table 8.5.
market produced an average annual
returns that were not quite as high as
nominal return of 9.3 percent, but that
the U.S. average, just 8.6 percent per 3 International mutual funds do
return was associated with a relatively
year. However, the globally diversified not include any domestic assets
whereas global mutual funds include
per year. Could U.S. investors have
high standard deviation: 20.4 percent
annual standard deviation of 17.8 per- portfolio was also less volatile, with an both foreign and domestic assets.
done better by diversifying globally?
cent. Dividing the standard deviation How might this difference affect
The answer is a qualified yes. Elroy
by the annual return produces a coeffi- their correlation with U.S. equity
mutual funds? Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists: 101 Years of Global Investment Returns (Princeton University Press, 2002).
Dimson, Paul Marsh, and Mike
cient of variation for the globally
The end-of-chapter Summary con- sists of two sections. The first sec-
Summary
FOCUS ON VALUE Time value of money is an important tool that financial managers and other
tion, Focus on Value , explains
market participants use to assess the effects of proposed actions. Because firms have long lives and some decisions affect their long-term cash flows, the effective
how the chapter’s content relates to
application of time-value-of-money techniques is extremely important. These techniques enable financial managers to evaluate cash flows occurring at dif-
the firm’s goal of maximizing
ferent times so as to combine, compare, and evaluate them and link them to the firm’s overall goal of share price maximization. It will become clear in Chapters 6
owner wealth. The feature helps
and 7 that the application of time value techniques is a key part of the value determination process needed to make intelligent value-creating decisions.
reinforce understanding of the link between the financial manager’s actions and share value.
REVIEW OF LEARNING GOALS
LG 1 Discuss the role of time value in finance, the use of computational tools,
The second part of the Summary,
and the basic patterns of cash flow. Financial managers and investors use time-
the Review of Learning Goals ,
value-of-money techniques when assessing the value of expected cash flow streams. Alternatives can be assessed by either compounding to find future value
restates each learning goal and sum-
or discounting to find present value. Financial managers rely primarily on
marizes the key material that was
present value techniques. Financial calculators, electronic spreadsheets, and financial tables can streamline the application of time value techniques. The
presented to support mastery of the
cash flow of a firm can be described by its pattern—single amount, annuity, or
goal. This review provides students
mixed stream.
with an opportunity to reconcile what they have learned with the learning goal and to confirm their understanding before moving forward.
Opener-in-Review
An Opener-in-Review question at the
end of each chapter revisits the opening
In the chapter opener you learned that it costs Eli Lilly close to $1 billion to bring a
new drug to market, and by the time all of the R&D and clinical trials are completed, Lilly may have fewer than 10 years left to sell the drug under patent protection.
vignette and asks students to apply a
Assume that the $1 billion cost of bringing a new drug to market is spread out evenly over 10 years, and then 10 years remain for Lilly to recover their investment.
lesson from the chapter to that business
How much cash would a new drug have to generate in the last 10 years to justify the $1 billion spent in the first 10 years? Assume that Lilly uses a required rate of return
situation.
of 10%.
Self-Test Problems , keyed to the
Self-Test Problems (Solutions in Appendix)
learning goals, give readers an opportu-
LG 2 LG 5 ST5–1 Future values for various compounding frequencies she can deposit in any of three savings accounts for a 3-year period. Bank A com- Delia Martin has $10,000 that
nity to strengthen their understanding
pounds interest on an annual basis, bank B compounds interest twice each year, and bank C compounds interest each quarter. All three banks have a stated annual
of topics by doing a sample problem.
interest rate of 4%. a. What amount would Ms. Martin have at the end of the third year, leaving all
For reinforcement, solutions to the Self-
interest paid on deposit, in each bank? b. What effective annual rate (EAR) would she earn in each of the banks?
Test Problems appear in the appendix at
deal with? Why? c. On the basis of your findings in parts a and b, which bank should Ms. Martin
the back of the book.
d. If a fourth bank (bank D), also with a 4% stated interest rate, compounds interest continuously, how much would Ms. Martin have at the end of the third year? Does this alternative change your recommendation in part c? Explain why
or why not.
Warm-Up Exercises
follow the Self-
Warm-Up Exercises
All problems are available in
Test Problems. These short, numerical
LG 2 E5–1
Assume a firm makes a $2,500 deposit into its money market account. If this account is currently paying 0.7% (yes, that’s right, less than 1%!), what will the account balance be after 1 year?
exercises give students practice in
applying tools and techniques presented
LG 2 LG 5 E5–2 If Bob and Judy combine their savings of $1,260 and $975, respectively, and deposit
what will the account balance be after 4 years? this amount into an account that pays 2% annual interest, compounded monthly,
in the chapter.
Comprehensive Problems , keyed to the
Problems All problems are available in
learning goals, are longer and more
LG 1 P5–1
Using a time line
The financial manager at Starbuck Industries is considering an investment that requires an initial outlay of $25,000 and is expected to result in cash
complex than the Warm-Up Exercises.
inflows of $3,000 at the end of year 1, $6,000 at the end of years 2 and 3, $10,000 at the end of year 4, $8,000 at the end of year 5, and $7,000 at the end of year 6.
In this section, instructors will find mul-
Industries’ proposed investment. a. Draw and label a time line depicting the cash flows associated with Starbuck
tiple problems that address the impor-
future value can be used to measure all cash flows at the end of year 6. b. Use arrows to demonstrate, on the time line in part a, how compounding to find c. Use arrows to demonstrate, on the time line in part b, how discounting to find
tant concepts, tools, and techniques in
LG present value can be used to measure all cash flows at time zero.
the chapter.
5 P4–19 Integrative—Pro forma statements d Which of the approaches future value or present value do financial managers Red Queen Restaurants wishes to prepare
financial plans. Use the financial statements on page 155 and the other information provided below to prepare the financial plans.
A short descriptor identifies the essen- tial concept or technique of the problem. Problems labeled as Integrative tie together related topics.
Personal Finance Problems specifi-
Personal Finance Problem
LG 2 P5–7
Time value
You can deposit $10,000 into an account paying 9% annual interest
cally relate to personal finance situa-
either today or exactly 10 years from today. How much better off will you be at the end of 40 years if you decide to make the initial deposit today rather than 10 years
tions and Personal Finance Examples in
from today?
each chapter. These problems will help students see how they can apply the
LG 6 P5–62 ETHICS PROBLEM A manager at a “Check Into Cash” business (see Focus on Ethics box on page 192) defends his business practice as simply “charging what the
tools and techniques of managerial
market will bear.” “After all,” says the manager, “we don’t force people to come in the door.” How would you respond to this ethical defense of the payday-advance business?
finance in managing their own finances. The last item in the chapter Problems is
an Ethics Problem . The ethics problem gives students another opportunity to think about and apply ethics principles to managerial financial situations.
All exercises and problems are available in MyFinanceLab.
Every chapter includes a Spreadsheet
Spreadsheet Exercise
Exercise . This exercise gives students
You are interested in purchasing the common stock of Azure Corporation. The firm
an opportunity to use Excel software
recently paid a dividend of $3 per share. It expects its earnings—and hence its divi-
dends—to grow at a rate of 7% for the foreseeable future. Currently, similar-risk stocks have required returns of 10%.
to create one or more spreadsheets with which to analyze a financial problem. The spreadsheet to be created often is modeled on a table or Excel screenshot located in the chapter. Students can access working versions of the Excel screenshots in MyFinanceLab.
Integrative Case 1 An Integrative Case at the end of
Merit Enterprise Corp.
each part of the book challenges stu-
ara Lehn, chief financial officer of Merit Enterprise Corp., was reviewing her
dents to use what they have learned
S presentation one last time before her upcoming meeting with the board of direc-
was pushing for a dramatic expansion of Merit’s production capacity. Executing the tors. Merit’s business had been brisk for the last two years, and the company’s CEO
over the course of several chapters.
CEO’s plans would require $4 billion in capital in addition to $2 billion in excess cash that the firm had built up. Sara’s immediate task was to brief the board on options for raising the needed $4 billion.
Additional chapter resources, such as
Unlike most companies its size, Merit had maintained its status as a private company, financing its growth by reinvesting profits and, when necessary, borrowing
Chapter Cases, Group Exercises, Critical
from banks. Whether Merit could follow that same strategy to raise the $4 billion necessary to expand at the pace envisioned by the firm’s CEO was uncertain, though
Thinking Problems, and numerous online
it seemed unlikely to Sara. She had identified two options for the board to consider:
resources, intended to provide further means for student learning and assess-
Brief Contents
Detailed Contents xv About the Authors xxxv Preface xxxvii Supplements to the Thirteenth Edition xlv Acknowledgments xlvii To the Student li
Introduction to Managerial
12 Risk and Refinements in
Part 1 Finance 1 Capital Budgeting 463
1 The Role of Managerial Finance 2
2 The Financial Market Environment 30 Part 6 Long-Term Financial
Decisions 505
13 Leverage and Capital Structure 506 Part 2 Financial Tools 55 14 Payout Policy 559
3 Financial Statements and Ratio Analysis 56
4 Cash Flow and Financial Planning 113 Short-Term Financial
Part 7
5 Time Value of Money 159
Decisions 597
15 Working Capital and Current Assets
Management 598
Part 3 Valuation of Securities 219
16 Current Liabilities Management 640
6 Interest Rates and Bond Valuation 220 Special Topics in Managerial
7 Stock Valuation 264
Part 8
Finance 675
17 Hybrid and Derivative Securities 676 Risk and the Required Part 4
18 Mergers, LBOs, Divestitures, and Rate of Return 307
Business Failure 714
8 Risk and Return 308
19 International Managerial Finance 757
9 The Cost of Capital 356
Appendix A-1
Long-Term Investment Part 5 Decisions 387
Glossary G-1 Index I-1
10 Capital Budgeting Techniques 388
11 Capital Budgeting Cash Flows 426
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Contents
About the Authors xxxv Preface xxxvii Supplements to the Thirteenth Edition xlv Acknowledgments xlvii To the Student li
Part 1 Introduction to Managerial Finance 1
1 1.1 Finance and Business 4 Relationship to Accounting 17
The Role of What is Finance? 4 Primary Activities of the Financial Managerial
Manager 19
Finance Career Opportunities in Finance 4 6 REVIEW QUESTIONS
19 page 2
Legal Forms of Business Organization 5
in practice Focus on Practice:
1.4 Governance and Agency 20
Professional Certifications in Finance 5
Corporate Governance 20
Why Study Managerial Finance? 9
6 The Agency Issue 21
Facebook—In No Hurry To
REVIEW QUESTIONS 9 6
REVIEW QUESTIONS 24 Go Public page 3
1.2 Goal of the Firm 10 Summary 24
10 Opener-in-Review Maximize Shareholder Wealth 25 Self-Test Problem 25
Maximize Profit? 11
Warm-Up Exercises 26
What About Stakeholders? 13 Problems 27
The Role of Business Ethics 13 Spreadsheet Exercise 29
6 REVIEW QUESTIONS 14 in practice Focus on Ethics: Will Google
Live Up to Its Motto? 15 1.3 Managerial Finance
Function 15 Organization of the Finance
Function 16 Relationship to Economics 16 Function 16 Relationship to Economics 16
Contents
2.3 Regulation of Financial The Financial
2 2.1 Financial Institutions and
Markets 32 Institutions 44 Market
Financial Institutions 32 Regulations Governing Financial Environment Institutions 44 page 30
Commercial Banks, Investment Banks,
and the Shadow Banking System 33 Regulations Governing Financial Financial Markets 34 Markets 45
The Relationship Between Institutions 6 REVIEW QUESTIONS 45 and Markets 34
The Money Market 35 Business Taxes 46 The Capital Market 35 Ordinary Income 46
in practice Focus on Practice: Berkshire
Capital Gains 48 Hathaway—Can Buffett Be Replaced? 37 6 REVIEW QUESTIONS 49
JPMorgan Chase & Co.—
in practice Focus on Ethics: The Ethics
Summary 49
Cut to the Chase page 31
of Insider Trading 40 Opener-in-Review 50 6 REVIEW QUESTIONS 40 Self-Test Problem 51
Warm-Up Exercises 51
2.2 The Financial Crisis 41
Problems 51
Financial Institutions and Real
Spreadsheet Exercise 53
Estate Finance 41
Integrative Case 1 Merit Enterprise
Falling Home Prices and Delinquent
Corp. 54
Mortgages 41 Crisis of Confidence in Banks 42 Spillover Effects and the Great
Recession 43 6 REVIEW QUESTIONS 44
Contents
xvii
Part 2 Financial Tools 55
3 3.1 The Stockholders’ Report 58 Fixed-Payment Coverage Ratio 78
Financial The Letter to Stockholders 6 58 REVIEW QUESTIONS 79 Statements and
Ratio Analysis in practice Global Focus: More Countries
Profitability Ratios 79 page 56
Adopt International Financial Reporting
Standards 58 Common-Size Income Statements 79 The Four Key Financial Statements 59 Gross Profit Margin 79
in practice Focus on Ethics: Taking
Operating Profit Margin 80 Earnings Reports at Face Value 59 Net Profit Margin
Notes to the Financial Statements 65
Earnings Per Share (EPS) 81
Consolidating International Financial
Statements 65 Return on Total Assets (ROA) 81
6 REVIEW QUESTIONS 66 Return on Common Equity (ROE) 82 Abercrombie & Fitch— 6 REVIEW QUESTIONS 82
The Value of Casual Luxury
3.2 Using Financial Ratios 67
page 57
3.7 Market Ratios
Interested Parties 67
Types of Ratio Comparisons 67 Price/Earnings (P/E) Ratio 82
Cautions About Using Ratio
Market/Book (M/B) Ratio 83 Analysis 70 6 REVIEW QUESTION 83
Categories of Financial Ratios 70
A Complete Ratio
REVIEW QUESTIONS 70 Analysis
3.3 Liquidity Ratios 71 Summarizing All Ratios 84 Current Ratio 71 Dupont System of Analysis 85
Quick (Acid-Test) Ratio 6 72 REVIEW QUESTIONS 90
6 Summary REVIEW QUESTIONS 90 73
Opener-in-Review 92 3.4 Activity Ratios 73 Self-Test Problems 92 Inventory Turnover 73 Warm-Up Exercises 93 Problems 94
Average Collection Period 74
Spreadsheet Exercise 110
Average Payment Period 75 Total Asset Turnover 75
6 REVIEW QUESTION 76 3.5 Debt Ratios 76
Debt Ratio 77 Times Interest Earned Ratio 78 Debt Ratio 77 Times Interest Earned Ratio 78
Contents
4.4 Profit Planning: Pro Forma Cash Flow and
4 4.1 Analyzing the Firm’s
Statement 135 Financial Planning
Cash Flow 115
Preceding Year’s Financial page 113
Depreciation 115
Depreciation Methods 116
Statements 135
Developing the Statement of
Sales Forecast 135
Cash Flows 117
6 REVIEW QUESTION 135
Free Cash Flow 122
in practice
Focus on Practice: Free Cash
Preparing the Pro Forma
Flow at Cisco Systems 123
Income Statement 137
6 REVIEW QUESTIONS 124
Considering Types of Costs and Expenses 137
Apple—Investors Want Apple
4.2 The Financial Planning 6 REVIEW QUESTIONS 139
to Take a Bite Out of its Cash
Process 124
Hoard page 114
Long-Term (Strategic) Financial 4.6 Preparing the Pro Forma Plans 124
Balance Sheet 139 Short-Term (Operating) Financial 6 REVIEW QUESTIONS 141 Plans 125
in practice Focus on Ethics: How Much
4.7 Evaluation of Pro Forma
Is a CEO Worth? 125
Statements 141
6 REVIEW QUESTIONS 127
6 REVIEW QUESTIONS 141 Summary 142
4.3 Cash Planning:
Opener-in-Review 143
Cash Budgets 127
Self-Test Problems 144
The Sales Forecast 127
Warm-Up Exercises 145
Preparing the Cash Budget 128
Problems 146
Evaluating the Cash Budget 132
Spreadsheet Exercise 157
Coping with Uncertainty in the Cash Budget 133
Cash Flow within the Month 134 6 REVIEW QUESTIONS 135
Contents
xix
A General Equation for Compounding Time Value
5 5.1 The Role of Time Value in
More Frequently Than Annually 183 of Money
Finance 161
Using Computational Tools for page 159
Future Value versus Present Value 161
Compounding More Frequently Than
Computational Tools 162
Annually 184
Basic Patterns of Cash Flow 163
Continuous Compounding 184
6 REVIEW QUESTIONS 164
Nominal and Effective Annual Rates of Interest 185
5.2 Single Amounts 164
in practice Focus on Ethics: How Fair Is
Future Value of a Single Amount 164
“Check into Cash”? 187
Present Value of a Single Amount 6 168 REVIEW QUESTIONS 187
6 REVIEW QUESTIONS 170
Eli Lilly and Company—
5.6 Special Applications of Time
Riding the Pipeline page 160
5.3 Value Annuities 188 171
Determining Deposits Needed to
Types of Annuities 171
Accumulate a Future Sum 188
Finding the Future Value of an Ordinary
Loan Amortization 189
Annuity 172
in practice Focus on Practice: New
Finding the Present Value of an Ordinary
Century Brings Trouble for Subprime
Annuity 173
Mortgages 191
Finding the Future Value of an
Finding Interest or Growth Rates 191
Annuity Due 175
Finding an Unknown Number of
Finding the Present Value of an
Periods 192
Annuity Due 176
6 REVIEW QUESTIONS 194
Finding the Present Value of a
6 Opener-in-Review REVIEW QUESTIONS 195 178 Self-Test Problems 196
5.4 Mixed Streams 178
Warm-Up Exercises 197 Problems 198
Future Value of a Mixed Stream 179
Spreadsheet Exercise 214
Present Value of a Mixed Stream 180
6 Integrative Case 2 REVIEW QUESTION Track Software, 181
Inc. 215 5.5 Compounding Interest More
Frequently Than Annually 181 Semiannual Compounding 181 Quarterly Compounding 182 Frequently Than Annually 181 Semiannual Compounding 181 Quarterly Compounding 182
Contents
Part 3 Valuation of Securities 219
6.3 Valuation Fundamentals 239 Interest Rates and
6 6.1 Interest Rates and Required
Returns 222
Key Inputs 239
Bond Valuation
page 220 Basic Valuation Model 240
Interest Rate Fundamentals 222
in practice Focus on Practice: I-Bonds
6 REVIEW QUESTIONS
Adjust for Inflation
Term Structure of Interest Rates 226
6.4 Bond Valuation 241
Risk Premiums: Issuer and Issue
Bond Fundamentals 241
Characteristics 229
Basic Bond Valuation 242
6 REVIEW QUESTIONS
Bond Value Behavior 243
6.2 Corporate Bonds 231
Yield to Maturity (YTM) 247
The Federal Debt—A Huge
Legal Aspects of Corporate Bonds 232
Semiannual Interest and
Appetite for Money
Bond Values 248
Cost of Bonds to the Issuer 233
page 221
6 REVIEW QUESTIONS General Features of a Bond Issue 249
233 Summary 250 Bond Yields 234
Opener-in-Review 251
Bond Prices 234
Self-Test Problems 252
Bond Ratings 235
Warm-Up Exercises 252
in practice Focus on Ethics: Can We Trust the Bond Raters?
Problems 254
Spreadsheet Exercise 263
Common Types of Bonds 236 International Bond Issues 237
6 REVIEW QUESTIONS 238
Contents
xxi
Other Approaches to Common Stock Valuation
7 7.1 Differences between Debt
Stock Valuation 287 page 264
and Equity 266
in practice Voice in Management Focus on Ethics: Psst—Have
You Heard Any Good Quarterly Earnings
Claims on Income and Assets 266
Forecasts Lately? 288
Maturity 267
6 REVIEW QUESTIONS 289
Tax Treatment 267
6 REVIEW QUESTION 7.4 267 Decision Making and Common Stock Value 290
7.2 Common and Preferred
Changes in Expected Dividends 290
Stock 267
Changes in Risk 291
A123 Systems Inc.—Going
Common Stock 268
Combined Effect 291
Green to Find Value page 265
Preferred Stock 271
6 REVIEW QUESTIONS 292
Issuing Common Stock 272
Summary 292
6 REVIEW QUESTIONS 276
Opener-in-Review 294 Self-Test Problems 294
7.3 Common Stock
Warm-Up Exercises 295
Valuation 277
Problems 296
Market Efficiency 277
Spreadsheet Exercise 303
The Efficient-Market Hypothesis 278
Integrative Case 3 Encore International
in practice Focus on Practice:
Understanding Human Behavior Helps Us Understand Investor Behavior 279
Basic Common Stock Valuation Equation 279
Free Cash Flow Valuation Model 284 Free Cash Flow Valuation Model 284
Contents
Part 4 Risk and the Required Rate of Return 307
8.1 Diversification 8 323 Risk and Return
Risk and Return
Correlation, Diversification, Risk, page 308
Fundamentals 310
Risk Defined 310
and Return 326
in practice Focus on Ethics: If It
International Diversification 327
Seems Too Good to Be True Then It
in practice Global Focus: An
Probably Is 310
International Flavor to Risk
Return Defined 311
Reduction 328
Risk Preferences 6 312 REVIEW QUESTIONS 328
Mutual Funds—Fund’s Returns
6 REVIEW QUESTIONS 313
Not Even Close to Average
Risk and Return: The Capital
page 309
Asset Pricing Model (CAPM) 329
8.2 Risk of a Single Asset 313
Types of Risk 329
Risk Assessment 313
The Model: CAPM 330
Risk Measurement 315
6 REVIEW QUESTIONS 339
6 REVIEW QUESTIONS 320
Summary 339
8.3 Opener-in-Review Risk of a Portfolio 340 321 Self-Test Problems 341
Portfolio Return and Standard Deviation 321
Warm-Up Exercises 342
Correlation
Problems 323 343
Spreadsheet Exercise 355
Contents
xxiii
Cost of Retained Earnings 367 The Cost of Capital Cost of Capital 358
9 9.1 Overview of the
Cost of New Issues of page 356
The Basic Concept 358
Common Stock 368
in practice
Focus on Ethics: The Ethics 6 REVIEW QUESTIONS 369
of Profit 358
Sources of Long-Term Capital 359
Weighted Average Cost
6 of Capital REVIEW QUESTIONS 369 360
Calculating Weighted Average Cost of
9.2 Capital (WACC) Cost of Long-Term Debt 369 360
in practice Focus on Practice: Uncertain
Times Make for an Uncertain Weighted General Electric—Falling
Net Proceeds 360
Average Cost of Capital 371 Short of Expectations
Before-Tax Cost of Debt 361
After-Tax Cost of Debt
Weighting Schemes 372
page 357
6 REVIEW QUESTIONS 364
6 REVIEW QUESTIONS 373 Summary 373
9.3 Cost of Preferred Stock 364
Opener-in-Review 374
Preferred Stock Dividends 364
Self-Test Problems 374
Calculating the Cost of
Warm-Up Exercises 375
Preferred Stock 364
Problems 376
6 REVIEW QUESTION 365
Spreadsheet Exercise 383 Integrative Case 4 Eco Plastics
9.4 Cost of Common Stock 365
Company 385
Finding the Cost of Common Stock Equity 365 Finding the Cost of Common Stock Equity 365
Contents
Part 5 Long-Term Investment Decisions 387
10.4 Internal Rate of Return Capital Budgeting
10 10.1 Overview of Capital
Decision Criteria 401 page 388
Motives for Capital Expenditure 390
Steps in the Process 390
Calculating the IRR 402
Basic Terminology 391
6 REVIEW QUESTIONS 404
Capital Budgeting Techniques 392
6 REVIEW QUESTION 10.5 393 Comparing NPV and IRR Techniques 404
10.2 Payback Period 393
Net Present Value Profiles 404
Decision Criteria 393
Conflicting Rankings 406
Pros and Cons of Payback
Which Approach Is Better? 409
Genco Resources—The Gold
in practice Focus on Ethics: Nonfinancial Standard for Evaluating Gold
Analysis 394
Mines page 389
in practice Focus on Practice: Limits on
Considerations in Project Selection 411
Payback Analysis 395
6 REVIEW QUESTIONS 411
6 REVIEW QUESTIONS 397
Summary 412 Opener-in-Review 413
10.3 Net Present Value (NPV) 397
Self-Test Problems 414
Decision Criteria 397
Warm-Up Exercises 414
NPV and the Profitability Index 399
Problems 415
NPV and Economic Value Added 400
Spreadsheet Exercise 425
6 REVIEW QUESTIONS 401
Contents
xxv
Interpreting the Term Cash Inflows 439 Capital Budgeting
11 11.1 Relevant Cash Flows 428
Interpreting the Term Incremental 441 Cash Flows
Major Cash Flow Components 428
6 REVIEW QUESTIONS 443 page 426
in practice
Focus on Ethics: A Question
of Accuracy 428
Expansion versus Replacement
Finding the Terminal
Decisions 429
Cash Flow 443
Sunk Costs and Opportunity
Proceeds from Sale of Assets 443
Costs 429
Taxes on Sale of Assets 443
International Capital Budgeting and
Change in Net Working Capital 444
Long-Term Investments 430
6 REVIEW QUESTION 445
6 REVIEW QUESTIONS 431
ExxonMobil—Maintaining Its
in practice Global Focus: Changes
11.5 Summarizing the Relevant
Project Inventory page 427
May Influence Future Investments in
Cash Flows 445
China 432