Corporate finance / Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University.
2017
HG4026 .B46 2017 (Map It)
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Details
Title
Corporate finance / Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University.
Published
[Boston, Massachusetts] : Pearson, [2017]
Call Number
HG4026 .B46 2017
Edition
Fourth edition.
ISBN
9780134083278
013408327X
9780134202648
0134202643
013408327X
9780134202648
0134202643
Description
xxxii, 1,136 pages : color illustrations ; 26 cm.
System Control No.
(OCoLC)951563151
Bibliography, etc. Note
Includes bibliographical references and index.
Series
Record Appears in
Added Author
Table of Contents
Part 1 Introduction
ch. 1
Corporation
2
1.1.
Four Types of Firms
3
Sole Proprietorships
3
Partnerships
4
Limited Liability Companies
5
Corporations
5
Tax Implications for Corporate Entities
6
Corporate Taxation Around the World
7
1.2.
Ownership Versus Control of Corporations
7
Corporate Management Team
7
Interview with David Viniar
8
Financial Manager
9
Global Financial Crisis: The Dodd-Frank Act
10
Goal of the Firm
10
Firm and Society
11
Ethics and Incentives within Corporations
11
Global Financial Crisis: The Dodd-Frank Act on Corporate Compensation and Governance
12
Citizens United v. Federal Election Commission
12
Airlines in Bankruptcy
14
1.3.
Stock Market
14
Primary and Secondary Stock Markets
15
Traditional Trading Venues
15
Interview with Frank Hatheway
16
New Competition and Market Changes
17
Dark Pools
18
MyFinanceLab
19
Key Terms
19
Further Reading
20
Problems
20
ch. 2
Introduction to Financial Statement Analysis
23
2.1.
Firms' Disclosure of Financial Information
24
Preparation of Financial Statements
24
International Financial Reporting Standards
24
Interview with Ruth Porat
25
Types of Financial Statements
26
2.2.
Balance Sheet
26
Assets
27
Liabilities
28
Stockholders' Equity
29
Market Value Versus Book Value
29
Enterprise Value
30
2.3.
Income Statement
30
Earnings Calculations
31
2.4.
Statement of Cash Flows
32
Operating Activity
33
Investment Activity
34
Financing Activity
34
2.5.
Other Financial Statement Information
35
Statement of Stockholders' Equity
35
Management Discussion and Analysis
36
Notes to the Financial Statements
36
2.6.
Financial Statement Analysis
37
Profitability Ratios
37
Liquidity Ratios
38
Working Capital Ratios
39
Interest Coverage Ratios
40
Leverage Ratios
41
Valuation Ratios
43
Common Mistake: Mismatched Ratios
43
Operating Returns
44
DuPont Identity
46
2.7.
Financial Reporting in Practice
48
Enron
48
WorldCom
48
Sarbanes-Oxley Act
49
Global Financial Crisis: Bernard Madoff's Ponzi Scheme
50
Dodd-Frank Act
50
MyFinanceLab
51
Key Terms
52
Further Reading
53
Problems
53
Data Case
60
ch. 3
Financial Decision Making and the Law of One Price
61
3.1.
Valuing Decisions
62
Analyzing Costs and Benefits
62
Using Market Prices to Determine Cash Values
63
When Competitive Market Prices Are Not Available
65
3.2.
Interest Rates and the Time Value of Money
65
Time Value of Money
65
Interest Rate: An Exchange Rate Across Time
65
3.3.
Present Value and the NPV Decision Rule
68
Net Present Value
68
NPV Decision Rule
69
NPV and Cash Needs
71
3.4.
Arbitrage and the Law of One Price
72
Arbitrage
72
Law of One Price
73
3.5.
No-Arbitrage and Security Prices
73
Valuing a Security with the Law of One Price
73
Old Joke
77
NPV of Trading Securities and Firm Decision Making
77
Valuing a Portfolio
78
Global Financial Crisis: Liquidity and the Informational Role of Prices
79
Arbitrage in Markets
80
Where Do We Go from Here?
81
MyFinanceLab
82
Key Terms
83
Further Reading
83
Problems
83
Appendix The Price of Risk
87
Risky Versus Risk-Free Cash Flows
87
Arbitrage with Transactions Costs
92
Part 2 Time, Money, And Interest Rates
ch. 4
Time Value of Money
98
4.1.
Timeline
99
4.2.
Three Rules of Time Travel
100
Rule 1: Comparing and Combining Values
100
Rule 2: Moving Cash Flows Forward in Time
101
Rule 3: Moving Cash Flows Back in Time
102
Rule of 72
103
Applying the Rules of Time Travel
104
4.3.
Valuing a Stream of Cash Flows
106
4.4.
Calculating the Net Present Value
109
Using Excel: Calculating Present Values in Excel
110
4.5.
Perpetuities and Annuities
111
Perpetuities
111
Historical Examples of Perpetuities
112
Common Mistake: Discounting One Too Many Times
114
Annuities
114
Formula for an Annuity Due
117
Growing Cash Flows
117
4.6.
Using an Annuity Spreadsheet or Calculator
122
4.7.
Non-Annual Cash Flows
124
4.8.
Solving for the Cash Payments
125
4.9.
Internal Rate of Return
128
Using Excel: Excel's IRR Function
131
MyFinanceLab
132
Key Terms
133
Further Reading
134
Problems
134
Data Case
140
Appendix Solving for the Number of Periods
141
ch. 5
Interest Rates
143
5.1.
Interest Rate Quotes and Adjustments
144
Effective Annual Rate
144
Common Mistake: Using the Wrong Discount Rate in the Annuity Formu- la
145
Annual Percentage Rates
146
5.2.
Application: Discount Rates and Loans
148
5.3.
Determinants of Interest Rates
149
Global Financial Crisis: Teaser Rates and Subprime Loans
150
Inflation and Real Versus Nominal Rates
150
Investment and Interest Rate Policy
151
Yield Curve and Discount Rates
152
Yield Curve and the Economy
154
Common Mistake: Using the Annuity Formula When Discount Rates Vary by Maturity
154
Interview with Kevin M. Warsh
156
5.4.
Risk and Taxes
157
Risk and Interest Rates
158
After-Tax Interest Rates
159
5.5.
Opportunity Cost of Capital
160
Common Mistake: States Dig a $3 Trillion Hole by Discounting at the Wrong Rate
161
MyFinanceLab
162
Key Terms
163
Further Reading
163
Problems
163
Data Case
168
Appendix Continuous Rates and Cash Flows
170
Discount Rates for a Continuously Compounded APR
170
Continuously Arriving Cash Flows
170
ch. 6
Valuing Bonds
173
6.1.
Bond Cash Flows, Prices, and Yields
174
Bond Terminology
174
Zero-Coupon Bonds
174
Global Financial Crisis: Negative Bond Yields
176
Coupon Bonds
177
6.2.
Dynamic Behavior of Bond Prices
179
Discounts and Premiums
179
Time and Bond Prices
180
Interest Rate Changes and Bond Prices
182
Clean and Dirty Prices for Coupon Bonds
183
6.3.
Yield Curve and Bond Arbitrage
185
Replicating a Coupon Bond
185
Valuing a Coupon Bond Using Zero-Coupon Yields
186
Coupon Bond Yields
187
Treasury Yield Curves
188
6.4.
Corporate Bonds
188
Corporate Bond Yields
189
Are Treasuries Really Default-Free Securities?
189
Bond Ratings
191
Corporate Yield Curves
192
6.5.
Sovereign Bonds
192
Global Financial Crisis: The Credit Crisis and Bond Yields
193
Global Financial Crisis: European Sovereign Debt Yields: A Puzzle
195
Interview with Carmen M. Reinhart
196
MyFinanceLab
197
Key Terms
198
Further Reading
199
Problems
199
Data Case
203
Case Study
204
Appendix Forward Interest Rates
206
Computing Forward Rates
206
Computing Bond Yields from Forward Rates
207
Part 3 Valuing Projects And Firms
ch. 7
Investment Decision Rules
212
7.1.
NPV and Stand-Alone Projects
213
Applying the NPV Rule
213
NPV Profile and IRR
213
Alternative Rules Versus the NPV Rule
214
Interview with Dick Grannis
215
7.2.
Internal Rate of Return Rule
216
Applying the IRR Rule
216
Pitfall #1: Delayed Investments
216
Pitfall #2: Multiple IRRs
217
Common Mistake: IRR Versus the IRR Rule
219
Pitfall #3: Nonexistent IRR
219
7.3.
Payback Rule
220
Applying the Payback Rule
220
Payback Rule Pitfalls in Practice
221
Why Do Rules Other Than the NPV Rule Persist?
222
7.4.
Choosing Between Projects
222
NPV Rule and Mutually Exclusive Investments
222
IRR Rule and Mutually Exclusive Investments
223
Incremental IRR
224
When Can Returns Be Compared?
225
Common Mistake: IRR and Project Financing
227
7.5.
Project Selection with Resource Constraints
227
Evaluating Projects with Different Resource Requirements
227
Profitability Index
228
Shortcomings of the Profitability Index
230
MyFinanceLab
230
Key Terms
231
Further Reading
231
Problems
231
Data Case
237
Appendix Computing the NPV Profile Using Excel's Data Table Function
238
ch. 8
Fundamentals of Capital Budgeting
239
8.1.
Forecasting Earnings
240
Revenue and Cost Estimates
240
Incremental Earnings Forecast
241
Indirect Effects on Incremental Earnings
243
Common Mistake: The Opportunity Cost of an Idle Asset
244
Sunk Costs and Incremental Earnings
245
Common Mistake: The Sunk Cost Fallacy
245
Real-World Complexities
246
8.2.
Determining Free Cash Flow and NPV
247
Calculating Free Cash Flow from Earnings
247
Calculating Free Cash Flow Directly
249
Calculating the NPV
250
Using Excel: Capital Budgeting Using a Spreadsheet Program
251
8.3.
Choosing Among Alternatives
252
Evaluating Manufacturing Alternatives
252
Comparing Free Cash Flows for Cisco's Alternatives
253
8.4.
Further Adjustments to Free Cash Flow
254
Global Financial Crisis: The American Recovery and Reinvestment Act of 2009
258
8.5.
Analyzing the Project
258
Break-Even Analysis
258
Sensitivity Analysis
259
Interview with David Holland
261
Scenario Analysis
262
Using Excel: Project Analysis Using Excel
263
MyFinanceLab
264
Key Terms
266
Further Reading
266
Problems
266
Data Case
273
Appendix MACRS Depreciation
275
ch. 9
Valuing Stocks
277
9.1.
Dividend-Discount Model
278
One-Year Investor
278
Dividend Yields, Capital Gains, and Total Returns
279
Mechanics of a Short Sale
280
Multiyear Investor
281
Dividend-Discount Model Equation
282
9.2.
Applying the Dividend-Discount Model
282
Constant Dividend Growth
282
Dividends Versus Investment and Growth
283
John Burr Williams' Theory of Investment Value
284
Changing Growth Rates
286
Limitations of the Dividend-Discount Model
288
9.3.
Total Payout and Free Cash Flow Valuation Models
288
Share Repurchases and the Total Payout Model
288
Discounted Free Cash Flow Model
290
9.4.
Valuation Based on Comparable Firms
294
Valuation Multiples
294
Limitations of Multiples
296
Comparison with Discounted Cash Flow Methods
297
Stock Valuation Techniques: The Final Word
298
Interview with Douglas Kehring
299
9.5.
Information, Competition, and Stock Prices
300
Information in Stock Prices
300
Competition and Efficient Markets
301
Lessons for Investors and Corporate Managers
303
Kenneth Cole Productions-What Happened?
305
Efficient Markets Hypothesis Versus No Arbitrage
306
MyFinanceLab
306
Key Terms
308
Further Reading
308
Problems
309
Data Case
314
Part 4 Risk And Return
ch. 10
Capital Markets and the Pricing of Risk
318
10.1.
Risk and Return: Insights from 89 Years of Investor History
319
10.2.
Common Measures of Risk and Return
322
Probability Distributions
322
Expected Return
322
Variance and Standard Deviation
323
10.3.
Historical Returns of Stocks and Bonds
325
Computing Historical Returns
325
Average Annual Returns
327
Variance and Volatility of Returns
329
Estimation Error: Using Past Returns to Predict the Future
330
Arithmetic Average Returns Versus Compound Annual Returns
332
10.4.
Historical Trade-Off Between Risk and Return
332
Returns of Large Portfolios
333
Returns of Individual Stocks
334
10.5.
Common Versus Independent Risk
335
Theft Versus Earthquake Insurance: An Example
335
Role of Diversification
336
10.6.
Diversification in Stock Portfolios
337
Firm-Specific Versus Systematic Risk
338
No Arbitrage and the Risk Premium
339
Global Financial Crisis: Diversification Benefits During Market Crashes
341
Common Mistake: A Fallacy of Long-Run Diversification
342
10.7.
Measuring Systematic Risk
343
Identifying Systematic Risk: The Market Portfolio
343
Sensitivity to Systematic Risk: Beta
343
10.8.
Beta and the Cost of Capital
346
Estimating the Risk Premium
346
Common Mistake: Beta Versus Volatility
346
Capital Asset Pricing Model
348
MyFinanceLab
348
Key Terms
350
Further Reading
350
Problems
350
Data Case
355
ch. 11
Optimal Portfolio Choice and the Capital Asset Pricing Model
357
11.1.
Expected Return of a Portfolio
358
11.2.
Volatility of a Two-Stock Portfolio
359
Combining Risks
359
Determining Covariance and Correlation
360
Common Mistake: Computing Variance, Covariance, and Correlation in Excel
362
Computing a Portfolio's Variance and Volatility
363
11.3.
Volatility of a Large Portfolio
365
Large Portfolio Variance
365
Diversification with an Equally Weighted Portfolio
366
Interview with John Powers
368
Diversification with General Portfolios
369
11.4.
Risk Versus Return: Choosing an Efficient Portfolio
369
Efficient Portfolios with Two Stocks
370
Effect of Correlation
372
Short Sales
373
Efficient Portfolios with Many Stocks
374
Nobel Prizes: Harry Markowitz and James Tobin
375
11.5.
Risk-Free Saving and Borrowing
377
Investing in Risk-Free Securities
377
Borrowing and Buying Stocks on Margin
378
Identifying the Tangent Portfolio
379
11.6.
Efficient Portfolio and Required Returns
381
Portfolio Improvement: Beta and the Required Return
381
Expected Returns and the Efficient Portfolio
383
11.7.
Capital Asset Pricing Model
385
CAPM Assumptions
385
Supply, Demand, and the Efficiency of the Market Portfolio
386
Optimal Investing: The Capital Market Line
386
11.8.
Determining the Risk Premium
387
Market Risk and Beta
387
Nobel Prize: William Sharpe on the CAPM
389
Security Market Line
390
Beta of a Portfolio
390
Summary of the Capital Asset Pricing Model
392
MyFinanceLab
392
Key Terms
395
Further Reading
395
Problems
396
Data Case
402
Appendix The CAPM with Differing Interest Rates
404
Efficient Frontier with Differing Saving and Borrowing Rates
404
Security Market Line with Differing Interest Rates
404
ch. 12
Estimating the Cost of Capital
407
12.1.
Equity Cost of Capital
408
12.2.
Market Portfolio
409
Constructing the Market Portfolio
409
Market Indexes
409
Value-Weighted Portfolios and Rebalancing
410
Market Risk Premium
411
12.3.
Beta Estimation
413
Using Historical Returns
413
Identifying the Best-Fitting Line
415
Using Linear Regression
416
Why Not Estimate Expected Returns Directly?
417
12.4.
Debt Cost of Capital
417
Debt Yields Versus Returns
417
Common Mistake: Using the Debt Yield as Its Cost of Capital
418
Debt Betas
419
12.5.
Project's Cost of Capital
420
All-Equity Comparables
420
Levered Firms as Comparables
421
Unlevered Cost of Capital
421
Industry Asset Betas
423
12.6.
Project Risk Characteristics and Financing
425
Differences in Project Risk
425
Common Mistake: Adjusting for Execution Risk
427
Financing and the Weighted Average Cost of Capital
427
Interview with Shelagh Glaser
428
Common Mistake: Using a Single Cost of Capital in Multi-Divisional Firms
429
12.7.
Final Thoughts on Using the CAPM
430
MyFinanceLab
431
Key Terms
433
Further Reading
433
Problems
434
Data Case
438
Appendix Practical Considerations When Forecasting Beta
439
Time Horizon
439
Market Proxy
439
Beta Variation and Extrapolation
439
Outliers
440
Common Mistake: Changing the Index to Improve the Fit
441
Using Excel: Estimating Beta Using Excel
442
Other Considerations
443
ch. 13
Investor Behavior and Capital Market Efficiency
445
13.1.
Competition and Capital Markets
446
Identifying a Stock's Alpha
446
Profiting from Non-Zero Alpha Stocks
447
13.2.
Information and Rational Expectations
448
Informed Versus Uninformed Investors
448
Rational Expectations
449
13.3.
Behavior of Individual Investors
450
Underdiversification and Portfolio Biases
450
Excessive Trading and Overconfidence
451
Individual Behavior and Market Prices
453
13.4.
Systematic Trading Biases
453
Hanging on to Losers and the Disposition Effect
453
Nobel Prize: Kahneman and Tversky's Prospect Theory
454
Investor Attention, Mood, and Experience
454
Herd Behavior
455
Implications of Behavioral Biases
455
13.5.
Efficiency of the Market Portfolio
456
Trading on News or Recommendations
456
Nobel Prize: The 2013 Prize: An Enigma?
458
Performance of Fund Managers
458
Winners and Losers
461
13.6.
Style-BasedTechniques and the Market Efficiency Debate
462
Size Effects
462
Interview with Jonathan Clements
464
Momentum
466
Market Efficiency and the Efficiency of the Market Portfolio
467
Implications of Positive-Alpha Trading Strategies
467
13.7.
Multifactor Models of Risk
469
Using Factor Portfolios
470
Selecting the Portfolios
471
Cost of Capital with Fama-French-Carhart Factor Specification
472
13.8.
Methods Used in Practice
474
Financial Managers
474
Investors
475
MyFinanceLab
476
Key Terms
478
Further Reading
478
Problems
479
Appendix Building a Multifactor Model
485
Part 5 Capital Structure
ch. 14
Capital Structure in a Perfect Market
488
14.1.
Equity Versus Debt Financing
489
Financing a Firm with Equity
489
Financing a Firm with Debt and Equity
490
Effect of Leverage on Risk and Return
491
14.2.
Modigliani-Miller I: Leverage, Arbitrage, and Firm Value
493
MM and the Law of One Price
493
Homemade Leverage
493
MM and the Real World
494
Market Value Balance Sheet
495
Application: A Leveraged Recapitalization
496
14.3.
Modigliani-Miller II: Leverage, Risk, and the Cost of Capital
498
Leverage and the Equity Cost of Capital
498
Capital Budgeting and the Weighted Average Cost of Capital
499
Common Mistake: Is Debt Better Than Equity?
502
Computing the WACC with Multiple Securities
502
Levered and Unlevered Betas
502
Nobel Prize: Franco Modigliani and Merton Miller
504
14.4.
Capital Structure Fallacies
505
Leverage and Earnings per Share
505
Global Financial Crisis: Bank Capital Regulation and the ROE Fallacy
507
Equity Issuances and Dilution
508
14.5.
MM: Beyond the Propositions
509
MyFinanceLab
510
Key Terms
511
Further Reading
511
Problems
512
Data Case
516
ch. 15
Debt and Taxes
519
15.1.
Interest Tax Deduction
520
15.2.
Valuing the Interest Tax Shield
522
Interest Tax Shield and Firm Value
522
Pizza and Taxes
523
Interest Tax Shield with Permanent Debt
523
Weighted Average Cost of Capital with Taxes
524
Repatriation Tax: Why Some Cash-Rich Firms Borrow
525
Interest Tax Shield with a Target Debt-Equity Ratio
526
15.3.
Recapitalizing to Capture the Tax Shield
528
Tax Benefit
528
Share Repurchase
529
No Arbitrage Pricing
529
Analyzing the Recap: The Market Value Balance Sheet
530
15.4.
Personal Taxes
531
Including Personal Taxes in the Interest Tax Shield
531
Valuing the Interest Tax Shield with Personal Taxes
534
Determining the Actual Tax Advantage of Debt
535
Cutting the Dividend Tax Rate
535
15.5.
Optimal Capital Structure with Taxes
536
Do Firms Prefer Debt?
536
Limits to the Tax Benefit of Debt
539
Interview with Andrew Belson
540
Growth and Debt
541
OtherTax Shields
542
Low Leverage Puzzle
542
Employee Stock Options
544
MyFinanceLab
544
Key Terms
545
Further Reading
545
Problems
546
Data Case
550
ch. 16
Financial Distress, Managerial Incentives, and Information
551
16.1.
Default and Bankruptcy in a Perfect Market
552
Armin Industries: Leverage and the Risk of Default
552
Bankruptcy and Capital Structure
553
16.2.
Costs of Bankruptcy and Financial Distress
554
Bankruptcy Code
555
Direct Costs of Bankruptcy
555
Indirect Costs of Financial Distress
556
Global Financial Crisis: The Chrysler Prepack
559
16.3.
Financial Distress Costs and Firm Value
560
Armin Industries: The Impact of Financial Distress Costs
560
Who Pays for Financial Distress Costs?
560
16.4.
Optimal Capital Structure: The Trade-Off Theory
562
Present Value of Financial Distress Costs
562
Optimal Leverage
563
16.5.
Exploiting Debt Holders: The Agency Costs of Leverage
565
Excessive Risk-Taking and Asset Substitution
565
Debt Overhang and Under-Investment
566
Global Financial Crisis: Bailouts, Distress Costs, and Debt Overhang
567
Agency Costs and the Value of Leverage
568
Leverage Ratchet Effect
569
Debt Maturity and Covenants
570
Why Do Firms Go Bankrupt?
570
16.6.
Motivating Managers: The Agency Benefits of Leverage
571
Concentration of Ownership
572
Reduction of Wasteful Investment
572
Excessive Perks and Corporate Scandals
573
Global Financial Crisis: Moral Hazard, Government Bailouts, and the Appeal of Leverage
574
Leverage and Commitment
575
16.7.
Agency Costs and the Trade-Off Theory
575
Optimal Debt Level
576
Debt Levels in Practice
577
16.8.
Asymmetric Information and Capital Structure
577
Leverage as a Credible Signal
577
Issuing Equity and Adverse Selection
579
Nobel Prize: The 2001 Nobel Prize in Economics
581
Implications for Equity Issuance
581
Implications for Capital Structure
582
16.9.
Capital Structure: The Bottom Line
585
MyFinanceLab
586
Key Terms
588
Further Reading
588
Problems
588
ch. 17
Payout Policy
597
17.1.
Distributions to Shareholders
598
Dividends
598
Share Repurchases
600
17.2.
Comparison of Dividends and Share Repurchases
601
Alternative Policy 1: Pay Dividend with Excess Cash
601
Alternative Policy 2: Share Repurchase (No Dividend)
602
Common Mistake: Repurchases and the Supply of Shares
604
Alternative Policy 3: High Dividend (Equity Issue)
604
Modigliani-Miller and Dividend Policy Irrelevance
605
Common Mistake: The Bird in the Hand Fallacy
606
Dividend Policy with Perfect Capital Markets
606
17.3.
Tax Disadvantage of Dividends
606
Taxes on Dividends and Capital Gains
607
Optimal Dividend Policy with Taxes
608
17.4.
Dividend Capture and Tax Clienteles
610
Effective Dividend Tax Rate
610
Tax Differences Across Investors
611
Clientele Effects
612
Interview with John Connors
613
17.5.
Payout Versus Retention of Cash
615
Retaining Cash with Perfect Capital Markets
616
Taxes and Cash Retention
617
Adjusting for Investor Taxes
618
Issuance and Distress Costs
619
Agency Costs of Retaining Cash
620
17.6.
Signaling with Payout Policy
622
Dividend Smoothing
622
Dividend Signaling
623
Royal & Sun Alliance's Dividend Cut
624
Signaling and Share Repurchases
624
17.7.
Stock Dividends, Splits, and Spin-Offs
626
Stock Dividends and Splits
626
Spin-Offs
628
Berkshire Hathaway's A & B Shares
629
MyFinanceLab
630
Key Terms
631
Further Reading
632
Problems
632
Data Case
636
Part 6 Advanced Valuation
ch. 18
Capital Budgeting and Valuation with Leverage
640
18.1.
Overview of Key Concepts
641
18.2.
Weighted Average Cost of Capital Method
642
Interview with Zane Rowe
643
Using the WACC to Value a Project
644
Summary of the WACC Method
645
Implementing a Constant Debt-Equity Ratio
646
18.3.
Adjusted Present Value Method
648
Unlevered Value of the Project
648
Valuing the Interest Tax Shield
649
Summary of the APV Method
650
18.4.
Flow-to-Equity Method
652
Calculating the Free Cash Flow to Equity
652
Valuing Equity Cash Flows
653
What Counts as "Debt"?
654
Summary of the Flow-to-Equity Method
654
18.5.
Project-Based Costs of Capital
655
Estimating the Unlevered Cost of Capital
656
Project Leverage and the Equity Cost of Capital
656
Determining the Incremental Leverage of a Project
658
Common Mistake: Re-Levering the WACC
658
18.6.
APV with Other Leverage Policies
660
Constant Interest Coverage Ratio
660
Predetermined Debt Levels
661
Comparison of Methods
663
18.7.
Other Effects of Financing
663
Issuance and Other Financing Costs
663
Security Mispricing
664
Financial Distress and Agency Costs
665
Global Financial Crisis: Government Loan Guarantees
666
18.8.
Advanced Topics in Capital Budgeting
666
Periodically Adjusted Debt
667
Leverage and the Cost of Capital
669
WACC or FTE Method with Changing Leverage
671
Personal Taxes
672
MyFinanceLab
674
Key Terms
676
Further Reading
676
Problems
677
Data Case
683
Appendix Foundations and Further Details
685
Deriving the WACC Method
685
Levered and Unlevered Cost of Capital
686
Solving for Leverage and Value Simultaneously
687
Residual Income and Economic Value Added Valuation Methods
689
ch. 19
Valuation and Financial Modeling: A Case Study
691
19.1.
Valuation Using Comparables
692
19.2.
Business Plan
694
Operational Improvements
694
Capital Expenditures: A Needed Expansion
695
Working Capital Management
696
Capital Structure Changes: Levering Up
696
19.3.
Building the Financial Model
697
Forecasting Earnings
697
Interview with Joseph L. Rice, III
698
Working Capital Requirements
700
Forecasting Free Cash Flow
701
Using Excel: Summarizing Model Outputs
703
Balance Sheet and Statement of Cash Flows (Optional)
704
Using Excel: Auditing Your Financial Model
706
19.4.
Estimating the Cost of Capital
707
CAPM-Based Estimation
707
Unlevering Beta
708
Ideko's Unlevered Cost of Capital
708
19.5.
Valuing the Investment
709
Multiples Approach to Continuation Value
710
Discounted Cash Flow Approach to Continuation Value
711
Common Mistake: Continuation Values and Long-Run Growth
713
APV Valuation of Ideko's Equity
713
Reality Check
714
Common Mistake: Missing Assets or Liabilities
714
IRR and Cash Multiples
715
19.6.
Sensitivity Analysis
716
MyFinanceLab
717
Key Terms
718
Further Reading
718
Problems
719
Appendix Compensating Management
721
Part 7 Options
ch. 20
Financial Options
724
20.1.
Option Basics
725
Understanding Option Contracts
725
Interpreting Stock Option Quotations
725
Options on Other Financial Securities
727
20.2.
Option Payoffs at Expiration
728
Long Position in an Option Contract
728
Short Position in an Option Contract
729
Profits for Holding an Option to Expiration
731
Returns for Holding an Option to Expiration
732
Combinations of Options
733
20.3.
Put-Call Parity
736
20.4.
Factors Affecting Option Prices
739
Strike Price and Stock Price
739
Arbitrage Bounds on Option Prices
739
Option Prices and the Exercise Date
739
Option Prices and Volatility
740
20.5.
Exercising Options Early
741
Non-Dividend-Paying Stocks
741
Dividend-Paying Stocks
743
20.6.
Options and Corporate Finance
745
Equity as a Call Option
745
Debt as an Option Portfolio
746
Credit Default Swaps
746
Global Financial Crisis: Credit Default Swaps
747
Pricing Risky Debt
748
Agency Conflicts
749
MyFinanceLab
750
Key Terms
751
Further Reading
751
Problems
751
Data Case
756
ch. 21
Option Valuation
757
21.1.
Binomial Option Pricing Model
758
Two-State Single-Period Model
758
Binomial Pricing Formula
760
Multiperiod Model
761
Making the Model Realistic
765
21.2.
Black-Scholes Option Pricing Model
766
Black-Scholes Formula
766
Interview with Myron S. Scholes
767
Implied Volatility
772
Global Financial Crisis: The VIX Index
773
Replicating Portfolio
774
21.3.
Risk-Neutral Probabilities
776
Risk-Neutral Two-State Model
776
Implications of the Risk-Neutral World
776
Risk-Neutral Probabilities and Option Pricing
777
21.4.
Risk and Return of an Option
779
21.5.
Corporate Applications of Option Pricing
781
Beta of Risky Debt
781
Common Mistake: Valuing Employee Stock Options
784
Nobel Prize: The 1997 Nobel Prize in Economics
785
Agency Costs of Debt
785
MyFinanceLab
786
Key Terms
788
Further Reading
788
Problems
788
ch. 22
Real Options
793
22.1.
Real Versus Financial Options
794
22.2.
Decision Tree Analysis
794
Representing Uncertainty
795
Real Options
796
Solving Decision Trees
796
22.3.
Option to Delay: Investment as a Call Option
797
Investment Option
797
Why Are There Empty Lots in Built-Up Areas of Big Cities?
800
Factors Affecting the Timing of Investment
801
Investment Options and Firm Risk
802
Global Financial Crisis: Uncertainty, Investment, and the Option to Delay
803
22.4.
Growth and Abandonment Options
804
Valuing Growth Potential
804
Option to Expand
806
Interview with Scott Mathews
807
Option to Abandon
808
22.5.
Investments with Different Lives
810
Equivalent Annual Benefit Method
811
22.6.
Optimally Staging Investments
812
22.7.
Rules of Thumb
815
Profitability Index Rule
816
Hurdle Rate Rule
816
II The Option to Repay a Mortgage
818
22.8.
Key Insights from Real Options
819
MyFinanceLab
819
Key Terms
821
Further Reading
821
Problems
821
Part 8 Long-Term Financing
ch. 23
Raising Equity Capital
828
23.1.
Equity Financing for Private Companies
829
Sources of Funding
829
Crowdfunding: The Wave of the Future?
830
Interview with Kevin Laws
831
Venture Capital Investing
834
Venture Capital Financing Terms
836
Common Mistake: Misinterpreting Start-Up Valuations
836
From Launch to Liquidity
838
Exiting an Investment in a Private Company
840
23.2.
Initial Public Offering
840
Advantages and Disadvantages of Going Public
840
Types of Offerings
841
Mechanics of an IPO
843
Google's IPO
843
23.3.
IPO Puzzles
848
Underpricing
848
Cyclicality
851
Global Financial Crisis: Worldwide IPO Deals in 2008-2009
852
Cost of an IPO
852
Long-Run Underperformance
853
23.4.
Seasoned Equity Offering
854
Mechanics of an SEO
854
Price Reaction
856
Issuance Costs
857
MyFinanceLab
857
Key Terms
858
Further Reading
859
Problems
860
Data Case
863
ch. 24
Debt Financing
865
24.1.
Corporate Debt
866
Public Debt
866
Private Debt
870
24.2.
Other Types of Debt
871
Sovereign Debt
871
Municipal Bonds
873
Detroit's Art Museum at Risk
873
Asset-Backed Securities
874
Global Financial Crisis: CDOs, Subprime Mortgages, and the Financial Crisis
874
24.3.
Bond Covenants
876
24.4.
Repayment Provisions
877
Call Provisions
877
New York City Calls Its Municipal Bonds
879
Sinking Funds
881
Convertible Provisions
881
MyFinanceLab 883a Key Terms
884
Further Reading
885
Problems
885
Data Case
886
ch. 25
Leasing
889
25.1.
Basics of Leasing
890
Examples of Lease Transactions
890
Lease Payments and Residual Values
891
Leases Versus Loans
892
Calculating Auto Lease Payments
893
End-of-Term Lease Options
893
Other Lease Provisions
895
25.2.
Accounting, Tax, and Legal Consequences of Leasing
895
Lease Accounting
896
Operating Leases at Alaska Air Group
897
Tax Treatment of Leases
898
Leases and Bankruptcy
899
Synthetic Leases
900
25.3.
Leasing Decision
900
Cash Flows for a True Tax Lease
901
Lease Versus Buy (An Unfair Comparison)
902
Lease Versus Borrow (The Right Comparison)
903
Evaluating a True Tax Lease
905
Evaluating a Non-Tax Lease
906
25.4.
Reasons for Leasing
906
Valid Arguments for Leasing
907
Interview with Mark Long
909
Suspect Arguments for Leasing
910
MyFinanceLab
911
Key Terms
912
Further Reading
912
Problems
913
Part 9 Short-Term Financing
ch. 26
Working Capital Management
918
26.1.
Overview of Working Capital
919
Cash Cycle
919
Firm Value and Working Capital
921
26.2.
Trade Credit
922
Trade Credit Terms
922
Trade Credit and Market Frictions
922
Managing Float
923
26.3.
Receivables Management
924
Determining the Credit Policy
924
Monitoring Accounts Receivable
925
26.4.
Payables Management
927
Determining Accounts Payable Days Outstanding
927
Stretching Accounts Payable
928
26.5.
Inventory Management
928
Benefits of Holding Inventory
929
Costs of Holding Inventory
929
26.6.
Cash Management
930
Motivation for Holding Cash
930
Alternative Investments
931
Hoarding Cash
931
MyFinanceLab
933
Key Terms
934
Further Reading
934
Problems
935
Data Case
938
ch. 27
Short-Term Financial Planning
941
27.1.
Forecasting Short-Term Financing Needs
942
Seasonalities
942
Negative Cash Flow Shocks
945
Positive Cash Flow Shocks
946
27.2.
Matching Principle
947
Permanent Working Capital
947
Temporary Working Capital
947
Financing Policy Choices
948
27.3.
Short-Term Financing with Bank Loans
949
Single, End-of-Period Payment Loan
949
Line of Credit
949
Bridge Loan
950
Common Loan Stipulations and Fees
950
27.4.
Short-Term Financing with Commercial Paper
952
Global Financial Crisis: Short-Term Financing in Fall 2008
953
27.5.
Short-Term Financing with Secured Financing
954
Accounts Receivable as Collateral
954
Seventeenth-Century Financing Solution
954
Inventory as Collateral
955
Loan Guarantees: The Ex-Im Bank Controversy
956
MyFinanceLab
957
Key Terms
958
Further Reading
958
Problems
959
Part 10 Special Topics
ch. 28
Mergers and Acquisitions
962
28.1.
Background and Historical Trends
963
Merger Waves
963
Types of Mergers
965
28.2.
Market Reaction to a Takeover
965
28.3.
Reasons to Acquire
966
Economies of Scale and Scope
967
Vertical Integration
967
Expertise
967
Monopoly Gains
968
Efficiency Gains
968
Tax Savings from Operating Losses
969
Diversification
970
Earnings Growth
970
Managerial Motives to Merge
971
28.4.
Valuation and the Takeover Process
972
Valuation
973
Offer
974
Merger "Arbitrage"
975
Tax and Accounting Issues
976
Board and Shareholder Approval
977
28.5.
Takeover Defenses
978
Poison Pills
978
Staggered Boards
979
White Knights
980
Golden Parachutes
981
Recapitalization
981
Other Defensive Strategies
981
Regulatory Approval
982
Weyerhaeuser's Hostile Bid for Willamette Industries
982
28.6.
Who Gets the Value Added from a Takeover?
983
Free Rider Problem
983
Toeholds
984
Leveraged Buyout
984
Leveraged Buyout of RJR-Nabisco by KKR
985
Freezeout Merger
987
Competition
988
MyFinanceLab
988
Key Terms
990
Further Reading
990
Problems
990
ch. 29
Corporate Governance
993
29.1.
Corporate Governance and Agency Costs
994
29.2.
Monitoring by the Board of Directors and Others
995
Types of Directors
995
Board Independence
995
Board Size and Performance
997
Other Monitors
997
29.3.
Compensation Policies
998
Stock and Options
998
Pay and Performance Sensitivity
998
29.4.
Managing Agency Conflict
1000
Direct Action by Shareholders
1000
Shareholder Activism at The New York Times
1001
Management Entrenchment
1002
Threat of Takeover
1003
29.5.
Regulation
1003
Sarbanes-Oxley Act
1004
Interview with Lawrence E. Harris
1005
Cadbury Commission
1006
Dodd-Frank Act
1007
Insider Trading
1007
Martha Stewart and ImClone
1008
29.6.
Corporate Governance Around the World
1008
Protection of Shareholder Rights
1008
Controlling Owners and Pyramids
1009
Stakeholder Model
1011
Cross-Holdings
1012
29.7.
Trade-Off of Corporate Governance
1013
MyFinanceLab
1013
Key Terms
1015
Further Reading
1015
Problems
1015
ch. 30
Risk Management
1017
30.1.
Insurance
1018
Role of Insurance: An Example
1018
Insurance Pricing in a Perfect Market
1018
Value of Insurance
1020
Costs of Insurance
1022
Insurance Decision
1024
30.2.
Commodity Price Risk
1024
Hedging with Vertical Integration and Storage
1025
Hedging with Long-Term Contracts
1025
Hedging with Futures Contracts
1027
Common Mistake: Hedging Risk
1029
Differing Hedging Strategies
1030
Deciding to Hedge Commodity Price Risk
1030
30.3.
Exchange Rate Risk
1031
Exchange Rate Fluctuations
1031
Hedging with Forward Contracts
1032
Cash-and-Carry and the Pricing of Currency Forwards
1033
Global Financial Crisis: Arbitrage in Currency Markets?
1035
Hedging with Options
1037
30.4.
Interest Rate Risk
1041
Interest Rate Risk Measurement: Duration
1041
Duration-Based Hedging
1043
Swap-Based Hedging
1046
Savings and Loan Crisis
1048
MyFinanceLab
1050
Key Terms
1052
Further Reading
1052
Problems
1053
ch. 31
International Corporate Finance
1059
31.1.
Internationally Integrated Capital Markets
1060
31.2.
Valuation of Foreign Currency Cash Flows
1061
WACC Valuation Method in Domestic Currency
1062
Using the Law of One Price as a Robustness Check
1064
31.3.
Valuation and International Taxation
1065
Single Foreign Project with Immediate Repatriation of Earnings
1066
Multiple Foreign Projects and Deferral of Earnings Repatriation
1066
31.4.
Internationally Segmented Capital Markets
1067
Differential Access to Markets
1067
Macro-Level Distortions
1068
Implications
1069
31.5.
Capital Budgeting with Exchange Risk
1070
Interview with Bill Barrett
1071
MyFinanceLab
1073
Key Terms
1074
Further Reading
1074
Problems
1075
Data Case
1077
Glossary
1079
Index
1099