Corporate Finance and Strategy

The following sections are included:

• Preface
• About the Authors
• Acknowledgments
• Contents in Brief
• Contents

The following sections are included:

• Introduction
• What is Finance?
  • Areas of finance
• Finance in the Organization Chart
  • The place of finance in the organization
  • The role of the financial analyst
  • Relationships between finance and the other business disciplines
• The Goal of a Firm
  • Measuring shareholder wealth
  • Why not measure performance by some other criterion?
  • What about ethics?
  • Criterion for nonpublic firms
• Corporate Governance
  • The principal-agent problem
  • Reducing agency problems
• Forms of Business Organizations
  • Proprietorship
  • Partnerships
  • Corporations
• Tax Rates
  • Average and marginal tax rates
• Outline of the Book
• Summary

The following sections are included:

• Introduction
• Economic Policies and Information
  • Monetary policy
  • Fiscal policy
  • Leading economic indicators (LEIs)
• Financial Market Information
  • The stock market
  • The bond market
  • The option market
  • Other markets
• Financial Statements: A Brief Review
  • Balance sheet
  • Statement of earnings
  • Statement of equity
  • Statement of cash flows
  • Interrelationship among four financial statements
  • Annual versus quarterly financial data
• Critique of Accounting Information
  • Criticism
  • Methods for improvement
• Static Ratio Analysis
  • Static determination of financial ratios
• Cost–Volume–Profit Analysis
  • Deterministic break-even analysis
  • Stochastic analysis
• Relationships among Economic, Financial, and Accounting Information
• Summary
• Appendix 2A — Calculate 27 Financial Ratios with Excel
  • Liquidity Ratio
  • Financial Leverage Ratio
  • Asset Efficiency Ratios
  • Profitability Ratios
  • Market Value Ratios
• Appendix 2B — Two Possible Methods to Estimate SGR
• Appendix 2C — How to Compute DOL, DFL, and DCL with Excel

The following sections are included:

• Introduction
• Overview of Financial Planning
• Forecasting Growth Rates and Outside Financing
  • Internal growth rate
  • Sustainable growth rate
  • Effects of unexpectedly higher (or lower) growth
• Forecasting External Financing Needs
• Percentage of Sales Method
  • Percentage of sales analysis of JNJ
• Risk Considerations
  • Ex-post return and risk for a single asset
• Types of Risk and Their Effect on Returns
  • Business risk
  • Degree of operating leverage
  • Financial risk
  • Degree of financial leverage
  • Total risk
  • The value of financial statement analysis
• Summary

The following sections are included:

• Introduction
• Basic Concepts of Present Values
• Foundation of NPV Rules
• Compounding and Discounting Processes
  • Single payment case — Future values
  • Continuous compounding
  • Single payment case — Present values
  • Annuity case — Present values
  • Annuity case — Future values
  • Annual percentage rate (APR)
• Present and Future Value Tables
  • Future value of a dollar at the end of t periods
  • Future value of a dollar continuously compounded
  • Present value of a dollar received t periods in the future
  • Present value of an annuity of a dollar per period
• Why Present Values are Basic Tools for Financial Management Decisions
  • Managing in the stockholders’ interest
  • Productive investments
• Liquidity Preference
• Summary
• Appendix 4A — Three Hypotheses about Inflation and the Firm’s Value
• Appendix 4B — Book Value, Replacement Cost, and Tobin’s q
• Appendix 4C — Continuous Compounding and Continuous Discounting
  • Continuous Compounding
  • Continuous Discounting
• Appendix 4D — Applications of Excel for Calculating Time Value of Money
  • Future Value of a Single Amount
  • Present Value of a Single Amount
  • Future Value of an Ordinary Annuity
  • Present Value of an Ordinary Annuity
• Appendix 4E — Tables of Time Value of Money
  • Future Value Table (Annually Compounded)
  • Future Value Table (Continuously Compounded)
  • Present Value Table — Present Value of a Dollar Received t Periods in the Future
  • Present Value Table — Present Value of an Annuity of a Dollar per Period

The following sections are included:

• Introduction
• Bond Valuation
  • Present value of future cash flows
  • Interest rate, yield to maturity, and bond price
  • Credit risk, interest rate risk, and reinvestment rate risk
  • Zero-coupon bonds
• Stock Valuation
  • Constant dividend growth rate model
  • Rate of return and required rate of return
  • Supernormal growth stocks
• Growth Rate Estimation and its Application
  • Compound-sum method
  • Regression method
  • One-period growth model
  • Two-period growth model
  • Three-period growth model
• Preferred Stock Valuation
• Risk, Return, and Market Efficiency
  • Historical returns and fluctuations
  • Efficient capital markets
  • Implications for financial managers
• Application Examples
• Summary
• Appendix 5A — Derivation of Dividend Discount Model
  • Summation of Infinite Geometric Series
  • Dividend Discount Model

The following sections are included:

• Introduction
• The Capital Budgeting Process
  • Identification phase
  • Development phase
  • Selection phase
  • Control Phase
• Cash-Flow Evaluation of Alternative Investment Projects
• Alternative Capital-Budgeting Methods
  • Accounting rate-of-return
  • Internal rate-of-return method
  • Payback method
  • NPV Method
  • Profitability index
• Comparison of the NPV and IRR Method
  • Theoretical criteria
  • Practical perspective
• Different Lives and Equivalent Annual Cost
  • Different lives
  • Equivalent annual cost
• Capital-Rationing Decision
  • Basic concepts of linear programming
  • Capital rationing
• Summary
• Appendix 6A — Managers’ View on Alternative Capital-Budgeting Methods
• Appendix 6B — Derivation of Crossover Rate
• Appendix 6C — Using Excel to Calculate NPV and IRR
• Appendix 6D — Solving the Linear Program Model for Capital Rationing

The following sections are included:

• Introduction
• Risk Classification
  • Business risk
  • Financial risk
  • Total risk
• Portfolio Analysis and Application
  • Expected rate of return on a portfolio
  • Variance and standard deviation of a portfolio
  • The two-asset case
  • The N-asset case
  • The efficient portfolios
  • Corporate application of diversification
• The Market Rate of Return and Market Risk Premium
  • The risk premium
• Determination of Commercial Lending Rates
• The Dominance Principle and Performance Evaluation
• Summary
• Appendix 7A — Estimation of Market Risks Premium
• Appendix 7B — The Normal Distribution
• Appendix 7C — Minimum-Variance Approach to Derive Optimal Weight
• Appendix 7D — Sharpe Performance Approach to Derive Optimal Weight
• Appendix 7E — Solving Example 7.1 with Excel

The following sections are included:

• Introduction
• Capital Market Line, Efficient-Market Hypothesis, and Capital Asset Pricing Model
  • Lending, borrowing, and the market portfolio
  • The capital market line
  • The efficient-market hypothesis
  • The capital asset pricing model
• The Market Model and Beta Estimation
• Empirical Evidence for the Risk-Return Relationship
• Why Beta is Important in Financial Management
• Systematic Risk Determination
  • Business risk and financial risk
  • Other financial variables
  • Capital labor ratio
  • Fixed costs and variable costs
  • Market-based versus accounting-based beta forecasting
• Some Applications and Implications of the Capital Asset Pricing Model
• Liquidity and Capital Asset Pricing Model
• Arbitrage Pricing Theory
• Summary
• Appendix 8A — Mathematical Derivation of the Capital Asset Pricing Model
  • Derivation of CAPM
  • Chain Rule and Its Application

The following sections are included:

• Introduction
• Sources of Uncertainty and Methods for Capital Budgeting Under Uncertainty
• Risk-Adjusted Discount Rate Method
• Certainty Equivalent Method
  • The CAPM approach to the certainty equivalent method
  • Risk-adjusted discount rate versus certainty equivalent method
• The Statistical Distribution Method
  • Statistical distribution of cash flow
• Simulation Methods
  • Simulation analysis and capital budgeting
• Inflationary Effects in the Capital Budgeting Decision
  • The implication of inflation for investment decisions
  • Calculating the NPV of real cash flows
• Summary
• Appendix 9A — Decision Tree Method for Investment Decisions
• Appendix 9B — Hillier’s Statistical Distribution Method for Capital Budgeting under Uncertainty

The following sections are included:

• Introduction
• Average Earnings Yield Method Versus Current Earnings Yield Method
• The Discounted Cash Flow Approach to Cost of Capital Determination
  • Gordon dividend model
  • Growth rate
• The Weighted Cost of Capital
  • Cost of debt
  • The cost of retained earnings and new equity
  • Cost of preferred stock
  • The logic and procedure of weighted cost of capital
• The Marginal Cost of Capital (MCC)
• The Chase Manhattan Model Approach to Cost of Equity Capital
  • The CAPM approach to cost of equity capital estimation
  • Levered beta (β_L) versus unlevered beta (β_U)
  • The chase approach to cost of equity capital estimation
• Summary
• Appendix 10A — M&M Propositions 1 and 2
• Appendix 10B — A Mathematical Approach to MCC

The following sections are included:

• Introduction
• Financial Leverage and Its Effects on Earnings per Share
  • Impact of capital structure on earnings per share
  • Financial leverage
• Tax and Debt
  • Modigliani and Miller Proposition 1 with taxes
  • Miller’s irrelevance argument
• Degree of Financial Leverage, Operating Leverage, and the Combined Effect
  • Degree of financial leverage
  • Operating leverage and the combined effect
  • The trade-off between business risk and financial risk
• Target Capital Structure
  • Cost of capital and target capital structure
  • Weighted average cost of capital
  • Capital structure and beta determination
• Possible Reasons for Optimal Capital Structure
  • The traditional approach of optimal capital structure
  • Bankruptcy costs
  • Agency costs
  • Imperfect markets
• Summary
• Appendix 11A — An Explanation of Modigliani and Miller Proposition 1

The following sections are included:

• Introduction
• How Dividends are Paid
  • Factors influencing dividend policy
  • Dividend forms and payment procedures
  • Stock repurchase
  • Inflation accounting and corporate dividends
• Dividend Payment Determination
  • Residual theory
  • Lintner’s model
  • Stable dividend policy
  • Information content of dividends — A synthesis
  • Double taxation
• Stock Dividends, Stock Splits, and Stock Repurchases
  • Stock dividends and stock splits
  • Stock repurchase
• The Capital Asset Pricing Model with Dividend Effects
  • Some empirical evidence
  • Determinants of dividend policy
• The Irrelevance of Dividend Policy
  • Homemade dividends
  • Assumptions used to obtain the conclusions of Modigliani and Miller
  • Clientele effects
  • Dividend information content — A synthesis
  • Short-run versus long-run dividend effects
• Critique on M&M Dividend Irrelevance of Dividend Policy
• Summary
• Appendix 12A — Partial Adjustment Dividend Payment Model — JNJ as Case Study

The following sections are included:

• Introduction
• Investment and Dividend Interactions
  • Internal financing
  • External financing
• Interactions between Dividend and Financing Policies
  • Cost of equity capital and dividend policy
  • Default risk and dividend policy
• Interactions between Financing and Investment Decisions
  • Risk-free debt case
  • Risky debt case
• Implications of Financing and Investment Interactions for Capital Budgeting
  • Equity-residual method
  • After-tax, weighted-average, cost-of-capital method
  • Arditti and Levy method
  • Myers adjusted-present-value method
• Debt Capacity and Optimal Capital Structure
• Implications of Different Policies on the Beta Coefficient
  • Impact of financing policy on beta coefficient determination
  • Impact of production policy on beta coefficient determination
  • Impact of dividend policy on beta coefficient determination
• Summary

The following sections are included:

• Introduction
• The Bond Contract
  • Secured bonds
  • Unsecured bonds
  • Rating agencies
• Provisions and Covenants of Bonds
  • Bond refunding
• Interest Rate Theory
  • Inflation and Fisher model
• Term of Structure and Yield to Maturity
• Alternative Hypothesis for Term Structure
  • The traditional-expectations hypothesis
  • Forward rates
  • The term-preference hypothesis
  • Market segmentation hypothesis
• Duration, Volatility, and Weighted-Average Term to Maturity
  • Duration and its implication
  • Weighted-average term to maturity and duration
  • WATM versus duration measure
• Innovations in the Bond Market
  • Deep discount and zero coupon bonds
  • Floating-rate notes
  • Extendable notes
  • Junk bonds
• Summary
• Appendix 14A — Yield to Maturity and Its Application
  • Yield to Maturity
  • The Macaulay Model

The following sections are included:

• Introduction
• Balance Sheet Accounts
• The Market for Common Stock
• Procedures for Issuing Common Stock
  • Rule 415 shelf registration
  • Preemptive right
  • Issuing stock with a preemptive right
• Corporate Control and Stock Repurchase
• Agency Theory
• Preferred Stock
  • Floating-rate preferred stock
• The Choice between Debt, Preferred Stock, and Equity
  • Identifying financing alternatives
  • Factors to consider about sources of financing
  • Ranking alternatives
  • Making the final decision
• Summary
• Appendix 15A — Inflation and the Value of Common Stock

The following sections are included:

• Introduction
• Hybrid Securities
• Warrants and Their Valuation
• Convertible Bonds and Their Valuation
• Cost of Capital for Convertibles and Impacts of Call and Conversion
  • Cost of capital for convertibles
  • Impacts of call and conversion
• Beta Coefficients for Convertible Bonds
• Earnings per Share (EPS) when Warrants and Convertibles are Issued
• Summary
• Appendix 16A — Market Value of Convertible Bond
• Appendix 16B — Option Approach to Evaluating Bonds and Stocks

The following sections are included:

• Introduction
• Reasons and Types of Leasing Arrangements
  • Direct leasing
  • Sale and leaseback
  • Leverage leasing
• Accounting for Leases
  • Capital lease treatment
  • Accounting for operating leases
  • Accounting for leases from the lessor’s standpoint
• Lease Accounting Updates
  • Key updates & changes to leasing standards under U.S. GAAP
  • Revised criteria for determination of operating versus capital lease
  • Updates to leasing standards under IFRS
  • Impacts of new leasing standards to financial statements & ratios
• Cash Flow Estimation and Present Value Analysis of Lease or Buy Alternatives
  • Present value — Lease
  • Present value — Buy
• Valuation of Riskless and Risky Cash Flows for the Lease or Buy Decision
• CAPM and the Lease of Buy Decision
• Options to Evaluate Salvage Values in Financial Leases
• Summary
• Appendix 17A — Derivation of Discount Rate for Riskless Cash Flows
• Appendix 17B — Application of APV Method for Leasing Decision

The following sections are included:

• Introduction
• The Components of Working Capital
• The Concept of Cash Flow
• Cash Flow versus Funds Flow
• Organizing for Short-term Financial Planning
• Short-term Financial Planning Principles
• The Cash Flow Cycle and Its Calculation
• Cash Flow Forecasting, Budgeting, and Planning
• The Cash Budget
• Demand-Driven, Capital-Driven, and Cost-Driven Cash Budgets
• Users of Cash Forecasts and Business Plans
• Planning Horizons and Time Intervals of Cash Budgets
• From Forecasting to Budgeting to Planning
• Summary
• Appendix 18A — Time-Series Components of Sales
  • The Contribution of Each Component
  • Interpretation

The following sections are included:

• Introduction
• Trade Credit
• The Cost of Trade Credit
  • The seller’s perspective
  • The buyer’s perspective
• Financial Ratios and Credit Analysis
  • Financial ratio analysis
  • Numerical credit scoring
  • Benefits of credit-scoring models
  • Outside sources of credit information
• Credit Decision and Collection Policies
  • Collection policy
  • Factoring and credit insurance
• Summary
• Appendix 19A — Two Methods to Estimate the Discriminant Function
  • Dummy Regression Method
  • The Eigenvalue Method

The following sections are included:

• Introduction
• The Baumol and Miller–Orr Models
  • Baumol’s EOQ model
  • Miller–Orr model
• Cash Management Systems
  • Cash collection and transference systems
  • Cash transference mechanism and scheduling
• Credit Lines and Bank Relations
  • Credit lines
  • Bank relations
• Marketable Securities Management
  • Investment criteria for surplus cash balances
  • Types of marketable securities
  • Hedging considerations
• Inventory Management
  • Inventory loans
  • Economic order quantity
• Summary
• Appendix 20A — Derivation of Eq. (20.1)

The following sections are included:

• Introduction
• Procedures for Financial Planning and Analysis
• The Algebraic Simultaneous Equations Approach to Financial Planning and Analysis
• Sensitivity Analysis
• The Linear Programming Approach to Financial Planning and Analysis
  • Profit maximization
  • Linear programming and capital rationing
  • Linear programming approach to financial planning
• The Econometric Approach to Financial Planning and Analysis
  • A dynamic adjustment of the capital budgeting model
  • Simplified Spies model
• Summary
• Appendix 21A — The Simplex Algorithm for Capital Rationing
• Appendix 21B — Description of Parameter Inputs Used to Forecast Johnson & Johnson’s Financial Statements and Share Price
• Appendix 21C — Procedure of Using Excel to Implement the FINPLAN Program
• Appendix 21D — Outline for a Project

The following sections are included:

• Introduction
• Futures Contracts and Hedging
  • Nature of contracts
  • Futures exchanges
  • Margin
  • Regulation
  • Hedging with futures
• Options
  • Basic concepts of options
  • Option terminology
  • Option exchanges
  • Option price information
  • Option valuation
  • Variables that influence call option value
• Option-Like Securities
  • Warrants
  • Convertible securities
  • Callable bonds
  • Risky corporate debt
  • Earnings per share with warrants and convertibles
• Swap Contracts and Hedging
  • Interest rate swaps
  • Currency swaps
• Risk Management
• Summary
• Appendix 22A — Single Stock Futures
  • Nature of SSF Contracts
  • Pricing Single Stock Futures
  • Advantages of Single Stock Futures
• Appendix 22B — The Black–Scholes Option Pricing Model

The following sections are included:

• Introduction
• Basic Concepts of Options
  • Option price information
• Factors Affecting Option Value
  • Determining the value of a call option before the expiration date
• Determining the Value of Options
  • Expected value estimation
  • The Black–Scholes option pricing model
  • Taxation of options
  • American options
• Option Pricing Theory and Capital Structure
  • Riskiness of business operations
• Warrants
• Summary

The following sections are included:

• Introduction
• Basic Concepts of Portfolio Insurance
• Strategies and Implementation of Portfolio Insurance
  • Stop-loss orders
  • Portfolio insurance with listed put options
  • Portfolio insurance with synthetic options
  • Portfolio insurance with dynamic hedging
• Comparison of Alternative Portfolio-Insurance Strategies
  • Synthetic options
  • Listed put options
  • Dynamic hedging and listed put options
• Empirical Studies of Portfolio Insurance
  • Leland (1985)
  • Asay and Edelsburg (1986)
  • Eizman (1986)
  • Rendleman and McEnally (1987)
  • Garcia and Gould (1987)
  • Zhu and Kavee (1988)
  • Perold and Sharpe (1988)
  • Rendleman and O’Brien (1990)
  • Loria, Pham, and Sim (1991)
  • Do and Faff (2004)
  • Cesari and Cremonini (2003)
  • Herold, Maurer, and Purschaker (2005)
  • Hamidi, Jurczenko, and Maillet (2007)
  • Ho, Cadle, and Theobald (2008)
• Summary

The following sections are included:

• Introduction
• Classification of Business Combinations
  • Classification by corporate structure
  • Classification by structure of economic and financial relationship
• Methods of Business Combination
  • Negotiation and determination of an exchange ratio
  • Exchange ratio
  • The tender offer
  • Holding companies
  • Leveraged buyout
  • Joint ventures
• Tax, Accounting, and Legal Considerations of Business Combinations
  • Tax and surplus fund motives
  • Accounting treatment
  • Legal considerations
• Theoretical Rationale and Evidence
  • Economies of scale
  • Market power
  • Diversification and debt capacity
  • Tax considerations
  • Undervalued assets
  • Agency problems
• Cost–Benefit Analysis of Business Combinations
  • Synergy
  • Source of synergy
• Divestiture and Spin-Offs
  • Accounting for divestiture and spin-offs
  • Tax consequences
  • Theory and evidence
  • Analysis of the divestment decision
• Summary
• Appendix 25A — Exchange Ratio
• Appendix 25B — Empirical Studies of the Beneficiaries of Business Combinations
• Appendix 25C — Effects of Divestiture on Firm Valuation

The following sections are included:

• Introduction
• What is Financial Distress and Failure?
  • Illiquidity
  • Insolvency
  • Kinds of insolvency
• Voluntary Restructuring and Corporate Focus
• Bankruptcy
  • Agency problems
  • Chapter 11
  • Liquidation
• Out-of-Court Settlement and Private Workout Arrangement
  • Extensions
  • Composition
  • Creditors’ committee
  • Private workout or bankruptcy
• Bankruptcy and Financial Distress Analysis
• Summary
• Appendix 26A — Bankruptcy and Financial Distress Analysis for Financial Institutions

The following sections are included:

• Introduction
• The Foreign Exchange Market
  • Foreign exchange spot rates
  • Foreign exchange forward rates
• The International Money Market
• The International Capital Market
• Accounting for Foreign Exchange Exposure
• Types of Exposure
• The International Investment and Financing Decision
• Political Risk and Exchange Rate Risk Dimension
• Currency Option Valuation Model
• Summary
• Appendix 27A — The Relationship between Exchange Rates and Interest Rates

The following sections are included:

• Appendix A: Projects
• Appendix B: Standard Normal Table (Z)
• Appendix C: Some Useful Formulas
• Appendix D: Solutions to Select End-of-Chapter Problems
• Author Index
• Subject Index