BRIEF CONTENTS

Preface iii

Part 1 Introduction to Financial Management 1

Chapter 1 An Overview of Financial Management 2

Part 2 Fundamental Concepts in Financial Management 23

Chapter 2 Time Value of Money 24
Chapter 3 Financial Statements, Cash Flow, and Taxes 64
Chapter 4 Analysis of Financial Statements 100
Chapter 5 Financial Markets and Institutions 141

Part 3 Financial Assets 173

Chapter 6 Interest Rates 174
Chapter 7 Bonds and Their Valuation 207
Chapter 8 Risk and Rates of Return 244
Chapter 9 Stocks and Their Valuation 289

Part 4 Investing in Long-Term Assets: Capital Budgeting 327

Chapter 10 The Cost of Capital 328
Chapter 11 The Basics of Capital Budgeting 357
Chapter 12 Cash Flow Estimation and Risk Analysis 387
Chapter 13 Real Options and Other Topics in Capital Budgeting 415

Part 5 Capital Structure and Dividend Policy 435

Chapter 14 Capital Structure and Leverage 436
Chapter 15 Distributions to Shareholders: Dividends and Share Repurchases 478

xx
 Brief Contents xxi

Part 6 Working Capital and Financial Planning 511

Chapter 16 Working Capital Management 512
Chapter 17 Financial Planning and Forecasting 552

Part 7 Special Topics in Financial Management 577

Chapter 18 Derivatives and Risk Management 578
Chapter 19 Multinational Financial Management 615
Chapter 20 Hybrid Financing: Preferred Stock, Leasing, Warrants,
and Convertibles 648
Chapter 21 Mergers and Acquisitions 683

Appendixes
Appendix A Solutions to Self-Test Questions and Problems A-1
Appendix B Answers to Selected End-of-Chapter Problems A-27
Appendix C Selected Equations and Data A-30

Index I-1
 CONTENTS
PREFACE iii ■ Simple versus Compound Interest 27
3. Financial Calculators 28
4. Spreadsheets 28
Part 1
■ Hints on Using Financial Calculators 29
Introduction to Financial Management 1
Graphic View of the Compounding Process 30
Chapter 1 2.3 Present Values 31
An Overview of Financial Management 2 Graphic View of the Discounting Process 33

Striking the Right Balance 2 2.4 Finding the Interest Rate, I 34

2.5 Finding the Number of Years, N 35
PUTTING THINGS IN PERSPECTIVE 3
2.6 Annuities 35
1.1 Forms of Business Organization 4 2.7 Future Value of an Ordinary Annuity 36
1.2 Stock Prices and Shareholder Value 6 2.8 Future Value of an Annuity Due 38
1.3 Intrinsic Values, Stock Prices, and 2.9 Present Value of an Ordinary Annuity 39
Compensation Plans 8 2.10 Finding Annuity Payments, Periods, and
1.4 Some Important Trends 11 Interest Rates 40
■ Is Shareholder Wealth Maximization Finding Annuity Payments, PMT 40
a Worldwide Goal? 12 Finding the Number of Periods, N 41
Finding the Interest Rate, I 41
1.5 Business Ethics 12
What Companies Are Doing 13 2.11 Perpetuities 42
Consequences of Unethical Behavior 13 2.12 Uneven Cash Flows 44
How Should Employees Deal with Unethical
2.13 Future Value of an Uneven Cash Flow
Behavior? 14
Stream 46
■ Protection for Whistle-Blowers 15
2.14 Solving for I with Uneven
1.6 Conflicts between Managers and
Cash Flows 47
Stockholders 16
2.15 Semiannual and Other Compounding
1.7 The Role of Finance in the Organization 17
Periods 48
TYING IT ALL TOGETHER 18 2.16 Comparing Interest Rates 50
2.17 Fractional Time Periods 52
2.18 Amortized Loans 52
Part 2
Fundamental Concepts in Financial TYING IT ALL TOGETHER 54
Management 23 INTEGRATED CASE
First National Bank 62
Chapter 2
WEB APPENDIX 2A
Time Value of Money 24
Continuous Compounding and Discounting
Will You Be Able to Retire? 24

PUTTING THINGS IN PERSPECTIVE 24 Chapter 3

Financial Statements, Cash Flow,
2.1 Time Lines 25 and Taxes 64
2.2 Future Values 26 Doing Your Homework with Financial Statements 64
1. Step-by-Step Approach 27
2. Formula Approach 27 PUTTING THINGS IN PERSPECTIVE 65

xxii
 Contents xxiii

3.1 A Brief History of Accounting and 4.3 Asset Management Ratios 104
Financial Statements 65 Inventory Turnover Ratio 105
Days Sales Outstanding 106
3.2 Financial Statements and Reports 66
Fixed Assets Turnover Ratio 106
3.3 The Balance Sheet 68 Total Assets Turnover Ratio 107
3.4 The Income Statement 72 4.4 Debt Management Ratios 108
3.5 Net Cash Flow 75 Total Debt to Total Assets 110
Times-Interest-Earned Ratio 110
3.6 Statement of Cash Flows 75 EBITDA Coverage Ratio 111
■ Massaging the Cash Flow
4.5 Profitability Ratios 112
Statement 78
Profit Margin on Sales 112
3.7 Statement of Retained Earnings 78 ■ Global Perspectives: Global Accounting
3.8 Uses and Limitations of Financial Standards: Can One Size Fit All? 113
Statements 79 Return on Total Assets 114
■ Financial Analysis on the Internet 80 Basic Earning Power (BEP) Ratio 114
Return on Common Equity 115
3.9 Modifying Accounting Data for Investor
and Managerial Decisions 81 4.6 Market Value Ratios 115
Operating Assets and Operating Capital 81 Price/Earnings Ratio 116
Operating Cash Flows 84 Price/Cash Flow Ratio 116
Free Cash Flow 84 Market/Book Ratio 116

3.10 MVA and EVA 86 4.7 Trend Analysis 118

3.11 The Federal Income Tax System 87 4.8 Tying the Ratios Together: The Du Pont
Corporate Taxes 87 Equations 118
Personal Taxes 87 4.9 Comparative Ratios and
Interest Paid 87 “Benchmarking” 121
Interest Earned 88 ■ Looking for Warning Signs within
Dividends Paid 88 the Financial Statements 123
Dividends Received 88
Tax Loss Carry-Back and Carry-Forward 88 4.10 Uses and Limitations of Ratio Analysis 124
Capital Gains 88 4.11 Problems with ROE 125
Depreciation 89 ■ EVA and ROE 126
Small Businesses 89
4.12 Looking Beyond the Numbers 128
TYING IT ALL TOGETHER 89
TYING IT ALL TOGETHER 129
INTEGRATED CASE
INTEGRATED CASE
D’Leon Inc., Part I 95
D’Leon Inc., Part II 136
WEB APPENDIX 3A
The Federal Income Tax System
Chapter 5
Financial Markets and Institutions 141
Chapter 4 A Strong Financial System Is Necessary for a Growing
Analysis of Financial Statements 100 and Prosperous Economy 141
Lessons Learned from Enron and WorldCom 100
PUTTING THINGS IN PERSPECTIVE 142
PUTTING THINGS IN PERSPECTIVE 102
5.1 An Overview of the Capital Allocation
4.1 Ratio Analysis 102 Process 143
4.2 Liquidity Ratios 103 5.2 Financial Markets 145
Current Ratio 103 Types of Markets 145
Quick, or Acid Test, Ratio 104 Recent Trends 146
xxiv Contents

5.3 Financial Institutions 148 6.4 The Term Structure of Interest Rates 187
5.4 The Stock Market 153 6.5 What Determines the Shape of the Yield
■ Citigroup Built to Compete in a Changing Curve? 189
Environment 154 ■ The Links between Expected Inflation
The Physical Location Stock Exchanges 154 and Interest Rates: A Closer Look 192
■ The NYSE and Nasdaq Combine Forces with 6.6 Using the Yield Curve to Estimate Future
the Leading Online Trading Systems 155 Interest Rates 193
The Over-the-Counter and the Nasdaq Stock 6.7 Other Factors that Influence Interest Rate
Markets 156 Levels 196
5.5 The Market for Common Stock 157 Federal Reserve Policy 196
Types of Stock Market Transactions 157 Federal Budget Deficits or Surpluses 196
International Factors 197
5.6 Stock Markets and Returns 160
Business Activity 197
Stock Market Reporting 160
Stock Market Returns 162 ■ Global Perspectives: Measuring
Country Risk 198
5.7 Stock Market Efficiency 163
Levels of Market Efficiency 163 6.8 Investing Overseas 199
■ Measuring the Market 164 6.9 Interest Rates and Business
Implications of Market Efficiency 166 Decisions 199
Is the Stock Market Efficient? 167
TYING IT ALL TOGETHER 201
■ A Closer Look at Behavioral Finance
Theory 168 INTEGRATED CASE
Smyth Barry & Company, Part II 206
TYING IT ALL TOGETHER 169

INTEGRATED CASE Chapter 7

Smyth Barry & Company, Part I 170
Bonds and Their Valuation 207
Sizing Up Risk in the Bond Market 207

Part 3 PUTTING THINGS IN PERSPECTIVE 208

Financial Assets 173
7.1 Who Issues Bonds? 208
Chapter 6 7.2 Key Characteristics of Bonds 209
Par Value 210
Interest Rates 174
Coupon Interest Rate 210
Low Interest Rates Encourage Investment and Stimulate Maturity Date 210
Consumer Spending 174 Call Provisions 211
Sinking Funds 211
PUTTING THINGS IN PERSPECTIVE 175
Other Features 212
6.1 The Cost of Money 175 7.3 Bond Valuation 213
6.2 Interest Rate Levels 176 7.4 Bond Yields 216
Yield to Maturity 216
6.3 The Determinants of Market Interest
Yield to Call 217
Rates 180
Current Yield 218
The Real Risk-Free Rate of Interest, r* 181
The Nominal, or Quoted, Risk-Free Rate of 7.5 Changes in Bond Values Over Time 218
Interest, rRF 182 7.6 Bonds with Semiannual Coupons 222
Inflation Premium (IP) 182
7.7 Assessing a Bond’s Riskiness 223
Default Risk Premium (DRP) 183
Interest Rate Risk 223
■ An Almost Riskless Treasury Bond 184 Reinvestment Rate Risk 225
Liquidity Premium (LP) 186 Comparing Interest Rate and Reinvestment Rate
Maturity Risk Premium (MRP) 186 Risk 226
 Contents xxv

7.8 Default Risk 227 TYING IT ALL TOGETHER 280

Various Types of Corporate Bonds 228
INTEGRATED CASE
Bond Ratings 229
Merrill Finch Inc. 286
Bankruptcy and Reorganization 233
7.9 Bond Markets 234 WEB APPENDIX 8A
Calculating Beta Coefficients
TYING IT ALL TOGETHER 236

INTEGRATED CASE
Chapter 9
Western Money Management Inc. 243
Stocks and Their Valuation 289
WEB APPENDIX 7A
Searching for the Right Stock 289
Zero Coupon Bonds

WEB APPENDIX 7B PUTTING THINGS IN PERSPECTIVE 290

Bankruptcy and Reorganization
9.1 Legal Rights and Privileges of Common
Stockholders 290
Chapter 8 Control of the Firm 290
The Preemptive Right 291
Risk and Rates of Return 244
No Pain No Gain 244 9.2 Types of Common Stock 292
9.3 Common Stock Valuation 292
PUTTING THINGS IN PERSPECTIVE 245 Definitions of Terms Used in Stock Valuation
Models 293
8.1 Stand-Alone Risk 246 Expected Dividends as the Basis for Stock
Probability Distributions 247 Values 294
Expected Rate of Return 248
Measuring Stand-Alone Risk: The Standard 9.4 Constant Growth Stocks 296
Deviation 250 Illustration of a Constant Growth
Using Historical Data to Measure Risk 252 Stock 296
Measuring Stand-Alone Risk: The Coefficient Dividend and Earnings Growth 297
of Variation 254 When Can the Constant Growth Model
Risk Aversion and Required Returns 255 Be Used? 298

■ The Trade-Off between Risk and Return 256 9.5 Expected Rate of Return on a Constant
Growth Stock 299
8.2 Risk in a Portfolio Context 257
Expected Portfolio Returns, r^p 258 9.6 Valuing Stocks Expected to Grow at a
Portfolio Risk 259 Nonconstant Rate 300
■ The Benefits of Diversification Are More ■ Evaluating Stocks That Don’t Pay
Important Than Ever 263 Dividends 304
Diversifiable Risk versus Market Risk 263 9.7 Valuing the Entire Corporation 305
The Concept of Beta 266 The Corporate Valuation Model 306
■ Global Perspectives: The Benefits ■ Other Approaches to Valuing Common
of Diversifying Overseas 270 Stocks 308
8.3 The Relationship between Risk and Rates Comparing the Total Company and Dividend
of Return 271 Growth Models 308
■ Estimating the Market Risk Premium 272 9.8 Stock Market Equilibrium 310
The Impact of Inflation 275 Changes in Equilibrium Stock Prices 311
Changes in Risk Aversion 275 9.9 Investing in International Stocks 313
Changes in a Stock’s Beta Coefficient 277
9.10 Preferred Stock 315
8.4 Some Concerns about Beta and
■Global Perspectives: Investing in Emerging
the CAPM 277
Markets 316
8.5 Some Concluding Thoughts: Implications
for Corporate Managers and Investors 278 TYING IT ALL TOGETHER 316
xxvi Contents

INTEGRATED CASE Chapter 11

Mutual of Chicago Insurance Company 322 The Basics of Capital Budgeting 357
Competition in the Aircraft Industry 357
Part 4 PUTTING THINGS IN PERSPECTIVE 358
Investing in Long-Term Assets:
Capital Budgeting 327 11.1 Generating Ideas for Capital Projects 358
11.2 Project Classifications 359
Chapter 10 11.3 The Net Present Value (NPV) Criterion 360
The Cost of Capital 328
11.4 Internal Rate of Return (IRR) 363
Creating Value at GE 328
11.5 Comparison of the NPV and IRR
PUTTING THINGS IN PERSPECTIVE 329 Methods 364
NPV Profiles 364
10.1 An Overview of the Weighted Average Cost NPV Rankings Depend on the Cost of Capital 365
of Capital 329 Independent Projects 367
Mutually Exclusive Projects 367
10.2 Basic Definitions 331
11.6 Multiple IRRs 369
10.3 Cost of Debt, rd(1  T) 332
11.7 Modified Internal Rate of Return
10.4 Cost of Preferred Stock, rp 333
(MIRR) 371
■ Funny-Named Preferred-Like
Securities 334
11.8 Payback Period 373

10.5 Cost of Retained Earnings, rs 335 11.9 Conclusions on Capital Budgeting

The CAPM Approach 336 Methods 375
Dividend-Yield-plus-Growth-Rate, or Discounted 11.10 Decision Criteria Used in Practice 376
Cash Flow (DCF), Approach 336
11.11 Using Capital Budgeting Techniques in
Bond-Yield-plus-Risk-Premium Approach 339
Other Contexts 377
■ How Much Does It Cost to Raise External
Capital? 340
11.12 The Post-Audit 378

10.6 Cost of New Common Stock, re 340 TYING IT ALL TOGETHER 379
Add Flotation Costs to a Project’s Cost 341
Increase the Cost of Capital 341 INTEGRATED CASE
When Must External Equity Be Used? 342 Allied Components Company 385

10.7 Composite, or Weighted Average, Cost of

Capital, WACC 343
Chapter 12
10.8 Factors That Affect the WACC 344
Cash Flow Estimation and Risk Analysis 387
Factors the Firm Cannot Control 344
Factors the Firm Can Control 344 Home Depot Keeps Growing 387

■ Global Perspectives: Global Variations PUTTING THINGS IN PERSPECTIVE 388

in the Cost of Capital 345
10.9 Adjusting the Cost of Capital 12.1 Background on the Project 388
for Risk 346 12.2 Project Analysis 390
10.10 Some Other Problems with Cost of Capital Input Data, Part 1 390
Estimates 348 Depreciation Schedule, Part 2 390
Salvage Value Calculations, Part 3 391
TYING IT ALL TOGETHER 349 Projected Cash Flows, Part 4 392
Appraisal of the Proposed Project, Part 5 393
INTEGRATED CASE
12.3 Other Points on Cash Flow Analysis 394
Coleman Technologies Inc. 355
Cash Flow versus Accounting Income 394
WEB APPENDIX 10A Timing of Cash Flows 395
The Cost of New Common Stock and the WACC Incremental Cash Flows 395
 Contents xxvii

Replacement Projects 395 TYING IT ALL TOGETHER 426

Sunk Costs 395
Opportunity Costs 396 INTEGRATED CASE
Externalities 396 21st Century Educational Products 431

12.4 Estimating Project Risk 397

12.5 Measuring Stand-Alone Risk 398 Part 5
Sensitivity Analysis 398 Capital Structure and Dividend Policy 435
Scenario Analysis 400
Monte Carlo Simulation 401
Chapter 14
■ Global Perspectives: Capital Budgeting
Capital Structure and Leverage 436
Practices in the Asian/Pacific Region 402
Debt: Rocket Booster or Anchor? 436
12.6 Different Capital Structures 403
12.7 Incorporating Risk into Capital PUTTING THINGS IN PERSPECTIVE 437
Budgeting 403
14.1 The Target Capital Structure 437
TYING IT ALL TOGETHER 404 14.2 Business and Financial Risk 439
Business Risk 439
INTEGRATED CASE
Operating Leverage 441
Allied Food Products 409
Financial Risk 444
APPENDIX 12A
14.3 Determining the Optimal Capital
Tax Depreciation 413
Structure 450
WEB APPENDIX 12B WACC and Capital Structure Changes 450
Replacement Project Analysis The Hamada Equation 452
WEB APPENDIX 12C The Optimal Capital Structure 453
Refunding Operations 14.4 Capital Structure Theory 456
WEB APPENDIX 12D ■ Yogi Berra on the M&M Proposition 457
Using the CAPM to Estimate the Risk-Adjusted Cost The Effect of Taxes 457
of Capital The Effect of Potential Bankruptcy 458
WEB APPENDIX 12E Trade-Off Theory 459
Techniques for Measuring Beta Risk Signaling Theory 460
Using Debt Financing to Constrain Managers 461
14.5 Checklist for Capital Structure Decisions 462
Chapter 13
■ Global Perspectives: Taking a Look at Global
Real Options and Other Topics in
Capital Structures 465
Capital Budgeting 415
14.6 Variations in Capital Structures 465
Keeping Your Options Open 415
TYING IT ALL TOGETHER 466
PUTTING THINGS IN PERSPECTIVE 416
INTEGRATED CASE
13.1 Introduction to Real Options 416 Campus Deli Inc. 472
13.2 Abandonment/Shutdown Options 417 WEB APPENDIX 14A
13.3 Investment Timing Options 419 Degree of Leverage
13.4 Growth Options 420
13.5 Flexibility Options 421 Chapter 15
13.6 Comparing Mutually Exclusive Projects Distributions to Shareholders: Dividends
with Unequal Lives 422 and Share Repurchases 478
Replacement Chains 422
Microsoft Shifts Gears and Begins to Unload Part of Its
Equivalent Annual Annuities (EAA) 423
Vast Cash Hoard 478
Conclusions about Unequal Lives 424
13.7 The Optimal Capital Budget 424 PUTTING THINGS IN PERSPECTIVE 479
xxviii Contents

15.1 Dividends versus Capital Gains: What Do 16.1 Working Capital Terminology 513
Investors Prefer? 479 16.2 The Cash Conversion Cycle 513
Dividend Irrelevance Theory 480 Calculating the Targeted CCC 514
Reasons Some Investors Prefer Dividends 480 Calculating the Actual CCC 515
Reasons Some Investors May Prefer Capital
■ Some Firms Operate with Negative Working
Gains 481
Capital! 516
15.2 Other Dividend Policy Issues 482
16.3 Alternative Current Asset Investment
Information Content, or Signaling, Hypothesis 482
Clientele Effect 482
Policies 517

15.3 Establishing the Dividend Policy 16.4 Alternative Current Asset Financing
in Practice 483 Policies 518
Maturity Matching, or “Self-Liquidating,”
Setting the Target Payout Ratio: The Residual
Approach 519
Dividend Model 483
Aggressive Approach 519
■ Global Perspectives: Dividend Yields Around Conservative Approach 519
the World 488 Choosing between the Approaches 521
Earnings, Cash Flows, and Dividends 489
16.5 The Cash Budget 521
Payment Procedures 490
16.6 Cash and Marketable Securities 525
15.4 Dividend Reinvestment Plans 493
Currency 526
15.5 Summary of Factors Influencing Dividend Demand Deposits 526
Policy 494 Marketable Securities 527
Constraints 494 16.7 Inventories 528
Investment Opportunities 494
■ Supply Chain Management 529
Alternative Sources of Capital 495
Effects of Dividend Policy on rs 495 16.8 Accounts Receivable 530
Credit Policy 530
15.6 Stock Dividends and Stock Splits 495
Setting and Implementing the Credit Policy 531
Stock Splits 496
Monitoring Accounts Receivable 532
Stock Dividends 496
Effect on Stock Prices 497 16.9 Accounts Payable (Trade Credit) 534
15.7 Stock Repurchases 498 16.10 Bank Loans 537
The Effects of Stock Repurchases 498 Promissory Note 537
■ Stock Repurchases Soar in 2004 499 Line of Credit 538
Revolving Credit Agreement 538
Advantages of Repurchases 500
Costs of Bank Loans 539
Disadvantages of Repurchases 501
Conclusions on Stock Repurchases 501 16.11 Commercial Paper 541
16.12 Accruals (Accrued Liabilities) 542
TYING IT ALL TOGETHER 502
16.13 Use of Security in Short-Term Financing 542
INTEGRATED CASE
Southeastern Steel Company 508 TYING IT ALL TOGETHER 543
INTEGRATED CASE
WEB APPENDIX 15A
Ski Equipment Inc. 548
An Example: The Residual Dividend Model
WEB APPENDIX 16A
Inventory Management
Part 6 WEB APPENDIX 16B
Working Capital and Financial Planning 511 Short-Term Loans and Bank Financing

Chapter 16 Chapter 17
Working Capital Management 512 Financial Planning and Forecasting 552
Best Buy Successfully Manages Its Working Capital 512 Forecasting Apple’s Future 552

PUTTING THINGS IN PERSPECTIVE 512 PUTTING THINGS IN PERSPECTIVE 553

 Contents xxix

17.1 Strategic Planning 553 18.6 Forward and Futures Contracts 596
17.2 The Sales Forecast 555 18.7 Other Types of Derivatives 600
17.3 The AFN Equation 556 Swaps 600
Key Determinants of External Funds Structured Notes 601
Requirements 558 Inverse Floaters 602
Excess Capacity Adjustments 558 ■ Credit Instruments Create New
Opportunities and Risks 603
17.4 Forecasted Financial Statements 560
Initial Forecast: “Business as Usual” 560 18.8 Risk Management 603
An Approach to Risk Management 605
17.5 Using Regression to Improve Financial
Forecasts 563 ■ Microsoft’s Goal: Manage Every Risk! 606

17.6 Using Individual Ratios in the Forecasting 18.9 Using Derivatives to Reduce Risks 607
Process 565 Security Price Exposure 607
Modifying Accounts Receivable 565 Commodity Price Exposure 610
Modifying Inventories 566 The Use and Misuse of Derivatives 610
Other “Special Studies” 566
TYING IT ALL TOGETHER 611
TYING IT ALL TOGETHER 567
INTEGRATED CASE
INTEGRATED CASE Tropical Sweets Inc. 613
New World Chemicals Inc. 572

WEB APPENDIX 17A Chapter 19

Forecasting Financial Requirements When Financial
Multinational Financial Management 615
Ratios Change
U.S. Firms Look Overseas to Enhance Shareholder
Value 615
Part 7
PUTTING THINGS IN PERSPECTIVE 616
Special Topics in Financial
Management 577 19.1 Multinational or Global Corporations 616
19.2 Multinational versus Domestic Financial
Chapter 18
Management 619
Derivatives and Risk Management 578
19.3 The International Monetary System 621
Using Derivatives to Manage Risk 578 International Monetary Terminology 621
Current Monetary Arrangements 622
PUTTING THINGS IN PERSPECTIVE 579
19.4 Foreign Exchange Rate Quotations 623
18.1 Reasons to Manage Risk 579 Cross Rates 624
18.2 Background on Derivatives 582 Interbank Foreign Currency Quotations 625

■ Global Perspectives: Barings and Sumitomo 19.5 Trading in Foreign Exchange 626
Suffer Large Losses in the Derivatives Spot Rates and Forward Rates 626
Market 583 19.6 Interest Rate Parity 627
18.3 Options 584 19.7 Purchasing Power Parity 629
Option Types and Markets 584
19.8 Inflation, Interest Rates, and Exchange
Factors That Affect the Value of a
Rates 630
Call Option 586
Exercise Value versus Option Price 586 19.9 International Money and Capital
18.4 Introduction to Option Pricing Models 589 Markets 631
International Credit Markets 631
■ Expensing Executive Stock Options 590
■ Hungry for a Big Mac? Go to China! 632
18.5 The Black-Scholes Option Pricing Model
■ Stock Market Indices Around the World 634
(OPM) 592
OPM Assumptions and Equations 592 International Stock Markets 635
OPM Illustration 594 19.10 International Capital Budgeting 636
xxx Contents

19.11 International Capital Structures 638 INTEGRATED CASE

Fish & Chips, Inc., Part I 681
19.12 Multinational Working Capital
Fish & Chips, Inc., Part II 681
Management 639
Cash Management 639
Credit Management 640
Inventory Management 641 Chapter 21
Mergers and Acquisitions 683
TYING IT ALL TOGETHER 642 Procter & Gamble Acquires Gillette 683
INTEGRATED CASE
PUTTING THINGS IN PERSPECTIVE 684
Citrus Products Inc. 646
21.1 Rationale for Mergers 685
Synergy 685
Chapter 20
Tax Considerations 685
Hybrid Financing: Preferred Stock, Leasing, Purchase of Assets below Their Replacement
Warrants, and Convertibles 648 Cost 686
Taking a Wild Ride with Amazon’s Convertible Diversification 686
Debt 648 Managers’ Personal Incentives 686
Breakup Value 687
PUTTING THINGS IN PERSPECTIVE 649 21.2 Types of Mergers 687
20.1 Preferred Stock 650 21.3 Level of Merger Activity 687
Basic Features 650 21.4 Hostile versus Friendly Takeovers 689
Other Types of Preferred Stock 652
21.5 Merger Regulation 690
Advantages and Disadvantages of Preferred
Stock 652 21.6 Merger Analysis 691
Valuing the Target Firm 692
20.2 Leasing 653 Setting the Bid Price 695
Types of Leases 653
■ More Than Just Financial Statements 697
■ Funny-Named Preferred-Like
Securities 654 Post-Merger Control 698

Financial Statement Effects 656 21.7 Financial Reporting for Mergers 699
Evaluation by the Lessee 657 Purchase Accounting 699
Factors That Affect Leasing Decisions 660 Income Statement Effects 700

20.3 Warrants 661 ■ Tempest in a Teapot? 701

Initial Market Price of a Bond with 21.8 The Role of Investment Bankers 702
Warrants 662 Arranging Mergers 702
Use of Warrants in Financing 663 Developing Defensive Tactics 702
Wealth Effects and Dilution Due to Establishing a Fair Value 703
Warrants 664 Financing Mergers 703
The Component Cost of Bonds with Arbitrage Operations 704
Warrants 666 21.9 Do Mergers Create Value? The Empirical
Problems with Warrant Issues 666
Evidence 704
20.4 Convertibles 667 ■The Track Record of Recent Large
Conversion Ratio and Conversion Price 667 Mergers 705
The Component Cost of Convertibles 668
Use of Convertibles in Financing 672 21.10 Corporate Alliances 706
Convertibles and Conflicts of Interest 673 21.11 Leveraged Buyouts 706
20.5 A Final Comparison of Warrants 21.12 Divestitures 707
and Convertibles 673 Types of Divestitures 707
Divestiture Illustrations 707
20.6 Reporting Earnings When Warrants
or Convertibles Are Outstanding 674 ■ Global Perspectives: Governments Are
Divesting State-Owned Businesses to Spur
TYING IT ALL TOGETHER 675 Economic Efficiency 708
 Contents xxxi

TYING IT ALL TOGETHER 710 Cyberproblem CP7-1 BondsOnline Educated

INTEGRATED CASE
Investor Center
Smitty’s Home Repair Company 713 Cyberproblem CP8-1 Evaluating Portfolio
Risk and Return
WEB APPENDIX 21A
Holding Companies Cyberproblem CP9-1 Intrinsic Stock
Valuation—Emerson
Electric
Appendixes
Cyberproblem CP10-1 Estimating the WACC—
Appendix A Solutions to Self-Test
AT&T
Questions and Problems A-1
Cyberproblem CP11-1 Capital Expenditures
Appendix B Answers to Selected End-of-
and Investment—IBM
Chapter Problems A-27
Cyberproblem CP12-1 Cash Flow Estimation—
Appendix C Selected Equations and
Alcoa
Data A-30
Cyberproblem CP13-1 Real Options
WEB APPENDIX C Cyberproblem CP14-1 Applying the Hamada
Selected Equations and Data
Equation
Cyberproblem CP15-1 Dividend Reinvestment
Index I-1 Plans
Cyberproblem CP16-1 Cash Conversion
Cyberproblems Cycle
Cyberproblem CP1-1 Executive Compensation Cyberproblem CP17-1 Using Analyst Reports
Cyberproblem CP2-1 Online Financial and Forecasts
Calculators Cyberproblem CP18-1 Option Strategies
Cyberproblem CP3-1 Examining the Financial Cyberproblem CP19-1 Multinational Financial
Report—3M Management—
Cyberproblem CP4-1 Using Ratio Analysis as McDonald’s
a Tool—Brady Cyberproblem CP20-1 Lease Analysis
Corporation Cyberproblem CP21-1 Mergers—
Cyberproblem CP5-1 World Financial Markets CNNMoney.com
Cyberproblem CP6-1 Yield Curves and Top 25 Deals of
Interest Rates the Year