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Managerial Finance GLOBAL
E D I T1
Thirteenth Edition
Lawrence J. Gitman San Diego State University
Chad J. Zutter University of Pittsburgh
Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi
Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo
Managerial Finance GLOBAL
EBITf
Thirteenth Edition
Lawrence J. Gitman San Diego State University
Chad J. Zutter University of Pittsburgh
Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi
Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo
Contents About the Authors Preface
xxxv
xxxvii
Supplements to the Thirteenth Edition Acknowledgments To the Student
xh
xlvii
li
Introduction to Managerial Finance 1 The Role of Managerial Finance page 2
facebook Facebook—In No Hurry To
RBI Finance and Business 4 What is Finance? 4 Career Opportunities in Finance 4 Legal Forms of Business Organization Focus on Practice: Professional Certifications in Finance 5
Why Study Managerial Finance? 9 * REVIEW aUESTIONS 9
Go Public page 3
U 3 Goal of the Firm 10 Maximize Shareholder Wealth 10 Maximize Profit? 11 What about Stakeholders? 13 The Role of Business Ethics 13 •* REVIEW aUESTIONS
Relationship to Accounting
17
Primary Activities of the Financial Manager 19 •> REVIEW aUESTIONS
19
Bfil Governance and Agency 20 Corporate Governance 20 The Agency Issue 21 •» REVIEW QUESTIONS
Summary
Opener-in-Review Self-Test Problem
25 25
Warm-Up Exercises Problems
24
24
26
27
Spreadsheet Exercise
29
14
Focus on Ethics: Will Google Live Up to Its Motto? 15
U S ! Managerial Finance Function 15 Organization of the Finance Function 16 Relationship to Economics 16
XV
xvi
Contents
The Financial Market Environment page 30
Financial Institutions and Markets 32
E S I Regulation of Financial Institutions 44
Financial Institutions 32
Regulations Governing Financial Institutions 44
Commercial Banks, Investment Banks, and the Shadow Banking System 33 Financial Markets 34 The Relationship between Institutions and Markets 34
-» REVIEW QUESTIONS
The Money Market 35
E & l Business Taxes
The Capital Market 35
Ordinary Income 46
M Focus on Practice: Berkshire Hathaway—Can Buffett Be Replaced? 37 JPMorgan Chase & Co.— Cut to the Chase page 31
Regulations Governing Financial Markets 45
fjjf°g°BBSll Focus on Ethics: The Ethics of Insider Trading 40 * REVIEW QUESTIONS
40
45
46
Capital Gains 48 -» REVIEW QUESTIONS 49 Summary 49 Opener-in-Review 50 Self-Test Problem 51 Warm-Up Exercises 51
E f i l The Financial Crisis
41
Financial Institutions and Real Estate Finance 41 Falling Home Prices and Delinquent Mortgages 41 Crisis of Confidence in Banks 42 Spillover Effects and the Great Recession 43 •» REVIEW QUESTIONS
E U The Stockholders' Report 58 The Letter to Stockholders
-> REVIEW QUESTIONS
58
O ^ ^ J ^ Global Focus: More Countries Adopt International Financial Reporting Standards 58 The Four Key Financial Statements
59
fiBMSffiSSlI Focus on Ethics: Taking Earnings Reports at Face Value 59 Notes to the Financial Statements
Aberaombie & Fitch— The Value of Casual Luxury page 57
E&3 Profitability Ratios 79 Common-Size Income Statements Gross Profit Margin Net Profit Margin
65
E 8 9 Using Financial Ratios 67 67
Types of Ratio Comparisons
67
Cautions about Using Ratio Analysis 70
80
Earnings Per Share (EPS)
70
72
•• REVIEW QUESTIONS
73
Average Payment Period Total Asset Turnover •> REVIEW QUESTION
83
E B A Complete Ratio 84
74
92
Self-Test Problems
92
75
76
77 78
Problems
90
90
Opener-in-Review Warm-Up Exercises
75
Times Interest Earned Ratio
82 83
Summary
KSa Debt Ratios 76 Debt Ratio
Price/Earnings (P/E) Ratio Market/Book (M/B) Ratio
Dupont System of Analysis
73
Average Collection Period
B f i l Market Ratios 82
•» REVIEW QUESTIONS
E S I Activity Ratios 73 Inventory Turnover
70
82
Summarizing All Ratios
7i
Quick (Acid-Test) Ratio
81
Analysis 84
E f i l Liquidity Ratios 71 Current Ratio
81
Return on Total Assets (ROA)
•> REVIEW QUESTION
Categories of Financial Ratios •> REVIEW QUESTIONS
80
Return on Common Equity (ROE)
66
79
79
-* REVIEW QUESTIONS
Interested Parties
78
79
Operating Profit Margin
Consolidating International Financial Statements 65 •* REVIEW QUESTIONS
Fixed-Payment Coverage Ratio
93
94 .
Spreadsheet Exercise
110
85
82
xviii
Contents
Cash Flow and Financial Planning page 1 13
Analyzing the Firm's Cash Flow 115
• S I Profit Planning: Pro Forma Statements 135
Depreciation 115
Preceding Year's Financial Statements 135
Depreciation Methods" 116 Developing the Statement of Cash Flows 117
Sales Forecast 135 "• REVIEW QUESTION
135
Free Cash Flow 122 J Focus on Practice: Free Cash Flow at Cisco Systems 123
Apple—Investors Want Apple to Take a Bite Out of Its Cash Hoard page 1 14
E S 3 Preparing the Pro Forma Income Statement 137
•• REVIEW QUESTIONS 124
Considering Types of Costs and Expenses 137
E S The Financial Planning Process 124
•> REVIEW QUESTIONS
Long-Term (Strategic) Financial Plans 124
E 2 d Preparing the Pro Forma Balance Sheet 139
Short-Term (Operating) Financial Plans 125
•• REVIEW QUESTIONS
(8B/gBSStBg# Focus on Ethics: How Much Is a CEO Worth? 125 •> REVIEW QUESTIONS
127
139
141
mam Evaluation of Pro Forma Statements 141 •> REVIEW QUESTIONS 141 Summary 142
S S I Cash Planning: Cash Budgets 127
Opener-in-Review 143
The Sales Forecast 127
Warm-Up Exercises 145
Self-Test Problems 144
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 •» REVIEW QUESTIONS 135
xix
Contents
5 Time Value of Money page 159
ESI The Role of Time Value in Finance 161 Future Value versus Present Value Computational Tools
161
162
Basic Patterns of Cash Flow •> REVIEW QUESTIONS
163
164
E S I Single Amounts 164 Future Value of a Single Amount Present Value of a Single Amount Eli Lilly and Company—
•• REVIEW QUESTIONS
164 168
170
A General Equation for Compounding More Frequently Than Annually 183 Using Computational Tools for Compounding More Frequently Than Annually 184 Continuous Compounding 184 Nominal and Effective Annual Rates of Interest 185 g B § Focus on Ethics: How Fair Is "Check into Cash"? 187 REVIEW QUESTIONS
187
ESI Special Applications of Time Value 188
Riding the Pipeline page 160
E S I Annuities 171 Types of Annuities 171
Determining Deposits Needed to Accumulate a Future Sum 188
Finding the Future Value of an Ordinary Annuity 172 Finding the Present Value of an Ordinary Annuity 173
Loan Amortization
189
Focus on Practice: New Century Brings Trouble for Subprime Mortgages 191
Finding the Future Value of an Annuity Due 175
Finding Interest or Growth Rates
Finding the Present Value of an Annuity Due 176 Finding the Present Value of a Perpetuity 178
•» REVIEW QUESTIONS
•* REVIEW QUESTIONS
Finding an Unknown Number of Periods 192 Summary
178
Future Value of a Mixed Stream Present Value of a Mixed Stream •» REVIEW QUESTION
179 180
181
ESI Compounding Interest More Frequently Than Annually 181 Semiannual Compounding 181 Quarterly Compounding 182
Opener-in-Review
195
Self-Test Problems
196
Warm-Up Exercises
ESI Mixed Streams 178
Problems
194
194
197
198
Spreadsheet Exercise
214
Integrative Case 2 Track Software, Inc. 215
191
XX
Contents
> Valuation of Securities 219 Interest Rates and Bond Valuation page 220
Interest Rates and Required Returns 222 Interest Rate Fundamentals
222
6BffS333IEiE Focus on Practice: Bond's Valuation and Interest Rate Risk 225 Term Structure of Interest Rates
226
Asian Development Bank— Renminbi-Denominated
Legal Aspects of Corporate Bonds Cost of Bonds to the Issuer Bond Yields
234
Bond Prices
234
Bond Ratings
232
233
General Features of a Bond Issue
Basic Valuation Model
240
•» REVIEW QUESTIONS
241
Basic Bond Valuation
242
Bond Value Behavior
243
233
235
* REVIEW QUESTIONS
251
Self-Test Problems
252
236
International Bond Issues
237
•* REVIEW QUESTIONS 238
Problems
249
250
Opener-in-Review Warm-Up Exercises
I 1 S B @ Focus on Ethics: Can We Trust the Bond Raters? 236
247
Semiannual Interest and Bond Values 248 Summary
Common Types of Bonds
241
Yield to Maturity (YTM)
E S I Corporate Bonds 231
Finally Out page 221
239
Bond Fundamentals
230
International Bonds Are
Key Inputs
E S I Bond Valuation 241
Risk Premiums: Issuer and Issue Characteristics 229 •* REVIEW QUESTIONS
E S I Valuation Fundamentals 239
252
254
Spreadsheet Exercise
263
Contents
Stock Valuation
I f i l Differences between Debt and Equity 266
page 264
Voice in Management 266
Air Asia—Jewel in the Skies? page 265
Other Approaches to Common Stock Valuation 287 Focus on Ethics: Psst—Have You Heard Any Good Quarterly Earnings Forecasts Lately? 288
Claims on Income and Assets 266 Maturity 267 Tax Treatment 267
•» REVIEW QUESTIONS
•* REVIEW QUESTION
Kfil Decision Making and Common Stock Value 290
267
289
EE1 Common and Preferred Stock 267
Changes in Expected Dividends 290
Common Stock 268
Combined Effect 291
Preferred Stock
•> REVIEW QUESTIONS
271
xxi
Changes in Risk 291
Issuing Common Stock
272
Summary 292
•• REVIEW QUESTIONS
276
Opener-in-Review 294
292
Self-Test Problems 294
• n i l Common Stock Valuation 277 Market Efficiency 277 The Efficient-Market Hypothesis 278 O ' i S i i B l § Focus on Practice: Understanding Human Behavior Helps Us Understand Investor Behavior 279 Basic Common Stock Valuation Equation 279 Free Cash Flow Valuation Model 284
Warm-Up Exercises 295 Problems 296 Spreadsheet Exercise 303 Integrative Case 3 Encore International 304
xxii
Contents
Risk and the Required Rate of Return 307 Risk and Return
l i U Risk and Return Fundamentals 310
page 308
Risk Defined
310
W Focus on Ethics: If It Seems Too Good to Be True Then It Probably Is 310 Return Defined
311
Risk Preferences Mutual Funds—Fund's Returns
313
Not Even Close to Average page 309
E S I Risk of a Single Asset 313 Risk Assessment Risk Measurement
313
Portfolio Return and Standard Deviation 321 323
International Diversification
327
International Flavor to Risk Reduction 328 328
E S I Risk and Return: The Capital Asset Pricing Model (CAPM) 329 Types of Risk
329 330
•* REVIEW QUESTIONS 320
E S I Risk of a Portfolio 321
Correlation
Correlation, Diversification, Risk, and Return 326
The Basic Concept 358 $ Focus on Ethics: The Ethics of Profit 358 •> REVIEW QUESTIONS 360 360
Net Proceeds 360 General Electric—Falling Short of Expectations page 357
"• REVIEW QUESTIONS
369
B E I Weighted Average Cost of Capital 369
Sources of Long-Term Capital 359
KEfl Cost of Long-Term Debt Before-Tax Cost of Debt 361
Calculating Weighted Average Cost of Capital (WACC) 369 Focus on Practice: Uncertain Times Make for an Uncertain Weighted Average Cost of Capital 371
After-Tax Cost of Debt 363
Weighting Schemes 372
"• REVIEW QUESTIONS 364
•> REVIEW QUESTIONS 373
Summary 373 K S I Cost of Preferred Stock
364
Opener-in-Review 374
Preferred Stock Dividends 364
Self-Test Problem 374
Calculating the Cost of Preferred Stock 364
Warm-Up Exercises
* REVIEW QUESTION 365
Spreadsheet Exercise 383
ISSI Cost of Common Stock Finding the Cost of Common Stock Equity 365
xxiii
375 -
Problems 376
365
Integrative Case 4 Eco Plastics Company 385
XXIV
Contents
Long-Term Investment Decisions 387 Capital Budgeting Techniques page 388
Overview of Capital Budgeting 390 Motives for Capital Expenditure 390 Steps in the Process 390 Basic Terminology 391 Capital Budgeting Techniques 392 •> REVIEW QUESTION
Treats—Waffles and More, Cairo—Capital Budgeting Techniques Work a Treat page 389
393
KBU Payback Period Decision Criteria 393
393
Pros and Cons of Payback Analysis 394 B B f t Focus on Practice: Limits on Payback Analysis 395 •> REVIEW QUESTIONS
397
U!SI Net Present Value (NPV) 397 Decision Criteria 397 NPV and the Profitability Index 399 NPV and Economic Value Added 400 •> REVIEW QUESTIONS
401
li!SI Internal Rate of Return (IRR)
401
Decision Criteria 401 Calculating the IRR 402 •» REVIEW QUESTIONS
404
U ! £ ] Comparing NPV and IRR Techniques 404 Net Present Value Profiles 404 Conflicting Rankings 406 Which Approach Is Better? 409 feliStSigi Focus on Ethics: Nonfinancial Considerations in Project Selection 411 •» REVIEW QUESTIONS
l l f l l Relevant Cash Flows 428 Major Cash Flow Components
428
$3is%sS8!£k Focus on Ethics: A Question of Accuracy 428
Interpreting the Term Incremental
Sunk Costs and Opportunity Costs 429
Proceeds from Sale of Assets Taxes on Sale of Assets
441
443
443
Change in Net Working Capital •• REVIEW QUESTION
444
445
431
@ j 2 3 s ^ & Global Focus: Changes May Influence Future Investments in China 432
Installed Cost of New Asset
433
•» REVIEW QUESTION
447 448
Self-Test Problems
449
Problems
Change in Net Working Capital
436
Calculating the Initial Investment
437
438
U t t l Finding the Operating Cash Inflows 438 438
447
Opener-in-Review Warm-Up Exercises
After-Tax Proceeds from Sale of Old Asset 433
Interpreting the Term After-Tax
1183 Summarizing the Relevant Cash Flows 445 Summary
UEJ Finding the Initial Investment 432
•> REVIEW QUESTIONS
439
-> REVIEW QUESTIONS 443
Finding the Terminal Cash Flow 443
* REVIEW QUESTIONS Project Inventory page 427
Interpreting the Term Cash Inflows
Expansion versus Replacement Decisions 429
International Capital Budgeting and Long-Term Investments 430 ExxonMobil—Maintaining Its
XXV
449
450
Spreadsheet Exercise
461
xxvi
Contents
Risk and Refinements in Capital Budgeting page 463
HSU Introduction to Risk in Capital Budgeting 465
Portfolio Effects
•• REVIEW QUESTION
* REVIEW QUESTIONS
465
RADRs in Practice
478 480
IE£i Behavioral Approaches for Dealing with Risk 466
EEsi Capital Budgeting Refinements 480
Risk and Cash Inflows
Comparing Projects with Unequal Lives 480
Scenario Analysis Simulation
466
467
468
S Focus on Practice: The Monte Carlo Method: The Forecast Is for Less Uncertainty 470 BP—Worst Case Scenario
478
• REVIEW QUESTIONS
470
page 464
USSI International Risk Considerations 470 •> REVIEW QUESTION
471
IESI Risk-Adjusted Discount Rates 472 Determining Risk-Adjusted Discount Rates (RADRs) 472 § Focus on Ethics: Ethics and the Cost of Capital 475 Applying RADRs
475
Recognizing Real Options 483 Capital Rationing 485 •• REVIEW QUESTIONS Summary
Opener-in-Review
489
Self-Test Problems
490
Warm-Up Exercises Problems
487
488
490
492
Spreadsheet Exercise
502
Integrative Case 5 Lasting Impressions Company 503
Contents
Long-Term Financial Decisions 505
13
IE8I Leverage
Leverage and Capital Structure
Breakeven Analysis
page 506
508 509
Operating Leverage 513 CSigjjfeifBs^ Focus on Practice: Adobe's Leverage 515 Financial Leverage Total Leverage
516
•* REVIEW QUESTION
•* REVIEW QUESTIONS
Equity for Debt page 5 0 7
540
520
§> Focus on Ethics: Repo 1 0 5 522
Genzyme Corp.—Trading
Comparing Alternative Capital Structures 539 Considering Risk in EBIT-EPS Analysis 539 Basic Shortcoming of EBIT-EPS Analysis 540
523
Ufifl The Firm's Capital Structure 523 Types of Capital 523 External Assessment of Capital Structure 524 Capital Structure of Non-U.S. Firms 525
U f i l Choosing the Optimal Capital Structure 540 Linkage 540 Estimating Value 541 Maximizing Value versus Maximizing EPS 543 Some Other Important Considerations 543 •> REVIEW QUESTIONS
544
Summary 544 Opener-in-Review 546
Capital Structure Theory 526 Optimal Capital Structure 535
Warm-Up Exercises 547
•» REVIEW QUESTIONS 536
Problems 548
Self-Test Problems 546
Spreadsheet Exercise 558
IES1 EBIT-EPS Approach to Capital Structure 537 Presenting a Financing Plan Graphically 537
xxvii
xxviii
Contents
Payout Policy page 559
Policy
IE&1 Factors Affecting Dividend
The Basics of Payout 561
Policy
Elements of Payout Policy 561 Trends in Earnings and Dividends
Legal Constraints 574 562
Trends in Dividends and Share Repurchases 563 W Focus on Ethics: Are Buybacks Really a Bargain? 564 •> REVIEW QUESTIONS Global Investment House— The Payback Time page 560
574
565
• £ £ ] The Mechanics of Payout Policy 565 Cash Dividend Payment Procedures 565 Share Repurchase Procedures 567 Tax Treatment of Dividends and Repurchases 568 ® Focus on Practice: Capital Gains and Dividend Tax Treatment Extended to 2010 569
15 Working Capital and Current Assets Management page 598
Net Working Capital Fundamentals 600 Working Capital Management 600 Net Working Capital 601 Trade-Off between Profitability and Risk 601 •> REVIEW QUESTIONS
Calculating the Cash Conversion Cycle 604 Funding Requirements of the Cash Conversion Cycle 605 Strategies for Managing the Cash Conversion Cycle 607 •» REVIEW QUESTIONS
UsSsI Management of Receipts and Disbursements 624 Float 624 Speeding Up Collections 625 Slowing Down Payments 625 §f> Focus on Ethics: Stretching Accounts Payable—Is It a Good Policy? 626
608
IfiSI Inventory Management
623
Cash Concentration
608
626
Zero-Balance Accounts 627 Investing in Marketable Securities 629
Differing Viewpoints about Inventory •* REVIEW QUESTIONS 630 Level 608 Summary 630 Common Techniques for Managing Opener-in-Review 632 Inventory 609 Focus on Practice: RFID: The Self-Test Problems 632 Wave of the Future7 613 Warm-Up Exercises 633 Problems 634
International Inventory Management 614 •* REVIEW QUESTIONS
IfiSI Secured Sources of Short-Term Loans 657 Characteristics of Secured Short-Term Loans 657 Use of Accounts Receivable as Collateral 658 Use of Inventory as Collateral
