Foreword ....................................................... xi
Acknowledgments ................................................ xv
About the CFA Institute Investment Series .................... xvii
CHAPTER 1
Corporate Governance ............................................ 1
Learning Outcomes ............................................ 1
1 Introduction ................................................. 1
2 Corporate Governance: Objectives and Guiding Principles ...... 2
3 Forms of Business and Conflicts of Interest .................. 3
3.1 Sole Proprietorships .................................... 4
3.2 Partnerships ............................................ 5
3.3 Corporations ............................................ 5
4 Specific Sources of Conflict: Agency Relationships ........... 6
4.1 Manager-Shareholder Conflicts ........................... 6
4.2 Director-Shareholder Conflicts ......................... 10
5 Corporate Governance Evaluation ............................. 10
5.1 The Board of Directors ................................. 11
5.2 Examples of Codes of Corporate Governance .............. 24
6 Environmental, Social, and Governance Factors ............... 37
7 Valuation Implications of Corporate Governance .............. 39
8 Summary ..................................................... 40
Problems .................................................... 42
CHAPTER 2
Capital Budgeting .............................................. 47
Learning Outcomes ........................................... 47
1 Introduction ................................................ 48
2 The Capital Budgeting Process ............................... 49
3 Basic Principles of Capital Budgeting ....................... 50
4 Investment Decision Criteria ................................ 52
4.1 Net Present Value ...................................... 52
4.2 Internal Rate of Return ................................ 53
4.3 Payback Period ......................................... 55
4.4 Discounted Payback Period .............................. 57
4.5 Average Accounting Rate of Return ...................... 58
4.6 Profitability Index .................................... 58
4.7 NPV Profile ............................................ 59
4.1 Ranking Conflicts between NPV and IRR .................. 61
4.9 The Multiple IRR Problem and the No IRR Problem ........ 65
4.10 Popularity and Usage of the Capital Budgeting Methods .. 68
5 Cash Flow Projections ....................................... 70
5.1 Table Format with Cash Flows Collected by Year ......... 70
5.2 Table Format with Cash Flows Collected by Type ......... 72
5.3 Equation Format for Organizing Cash Flows .............. 72
6 More on Cash Flow Projections ............................... 74
6.1 Straight-Line and Accelerated Depreciation Methods ..... 74
6.2 Cash Flows for a Replacement Project ................... 77
6.3 Spreadsheet Modeling ................................... 79
6.4 Effects of Inflation on Capital Budgeting Analysis ..... 81
7 Project Analysis and Evaluation ............................. 82
7.1 Mutually Exclusive Projects with Unequal Lives ......... 82
7.2 Capital Rationing ...................................... 84
7.3 Risk Analysis of Capital Investments-Standalone
Methods ................................................ 86
7.4 Risk Analysis of Capital Investments-Market Risk
Methods ................................................ 92
7.5 Real Options ........................................... 95
7.6 Common Capital Budgeting Pitfalls ...................... 99
8 Other Income Measures and Valuation Models ................. 101
8.1 The Basic Capital Budgeting Model ..................... 101
8.2 Economic and Accounting Income ........................ 102
8.3 Economic Profit, Residual Income, and Claims
Valuation ............................................. 106
9 Summary .................................................... 110
Problems ................................................... 113
CHAPTER 3
Cost of Capital ............................................... 127
Learning Outcomes .......................................... 127
1 Introduction ............................................... 128
2 Cost of Capital ............................................ 128
2.1 Taxes and the Cost of Capital ......................... 129
2.2 Weights of the Weighted Average ....................... 131
2.3 Applying the Cost of Capital to Capital Budgeting
and Security Valuation ................................ 133
3 Costs of the Different Sources of Capital .................. 135
3.1 Cost of Debt .......................................... 135
3.2 Cost of Preferred Stock ............................... 138
3.3 Cost of Common Equity ................................. 140
4 Topics in Cost of Capital Estimation ....................... 146
4.1 Estimating Beta and Determining a Project Beta ........ 146
4.2 Country Risk .......................................... 153
4.3 Marginal Cost of Capital Schedule ..................... 154
4.4 Flotation Costs ....................................... 157
4.5 What Do CFOs Do? ...................................... 160
5 Summary .................................................... 160
Problems ................................................... 163
CHAPTER 4
Measures of Leverage .......................................... 171
Learning Outcomes .......................................... 171
1 Introduction ............................................... 171
2 Leverage ................................................... 172
3 Business Risk and Financial Risk ........................... 173
3.1 Business Risk and Its Components ...................... 174
3.2 Sales Risk ............................................ 174
3.3 Operating Risk ........................................ 176
3.4 Financial Risk ........................................ 182
3.5 Total Leverage ........................................ 184
3.6 Breakeven Points and Operating Breakeven Points ....... 189
3.7 The Risks of Creditors and Owners ..................... 191
4 Summary .................................................... 194
Problems ................................................... 194
CHAPTER 5
Capital Structure ............................................. 199
Learning Outcomes .......................................... 199
1 Introduction ............................................... 199
2 The Capital Structure Decision ............................. 200
2.1 Proposition I without Taxes: Capital Structure
Irrelevance ........................................... 201
2.2 Proposition II without Taxes: Higher Financial
Leverage Raises the Cost of Equity .................... 203
2.3 Taxes, the Cost of Capital, and the Value of the
Company ............................................... 205
2.4 Costs of Financial Distress ........................... 210
2.5 Agency Costs .......................................... 211
2.6 Costs of Asymmetric Information ....................... 212
2.7 The Optimal Capital Structure According to the
Static Trade-Off Theory ............................... 213
3 Practical Issues in Capital Structure Policy ............... 216
3.1 Debt Ratings .......................................... 216
3.2 Evaluating Capital Structure Policy ................... 217
3.3 Leverage in an International Setting .................. 218
4 Summary .................................................... 222
Problems ................................................... 223
CHAPTER 6
Dividends and Share Repurchases: Basics ....................... 229
Learning Outcomes .......................................... 229
1 Introduction ............................................... 229
2 Dividends: Forms ........................................... 230
2.1 Regular Cash Dividends ................................ 231
2.2 Extra or Special (Irregular) Dividends ................ 232
2.3 Liquidating Dividends ................................. 234
2.4 Stock Dividends ....................................... 234
2.5 Stock Splits .......................................... 236
3 Dividends: Payment Chronology .............................. 238
3.1 Declaration Date ...................................... 238
3.2 Ex-Dividend Date ...................................... 238
3.3 Holder-of-Record Date ................................. 239
3.4 Payment Date .......................................... 239
3.5 Interval between Key Dates in the Dividend Payment
Chronology ............................................ 239
4 Share Repurchases .......................................... 241
4.1 Share Repurchase Methods .............................. 243
4.2 Financial Statement Effects of Repurchases ............ 245
4.3 Valuation Equivalence of Cash Dividends and Share
Repurchases: The Baseline ............................. 249
5 Concluding Remarks ......................................... 250
6 Summary .................................................... 251
Problems ................................................... 252
CHAPTER 7
Dividends and Share Repurchases: Analysis ..................... 257
Learning Outcomes .......................................... 257
1 Introduction ............................................... 258
2 Dividend Policy and Company Value: Theory .................. 258
2.1 Dividend Policy Does Not Matter ....................... 258
2.2 Dividend Policy Matters: The Bird-in-the-Hand
Argument .............................................. 260
2.3 Dividend Policy Matters: The Tax Argument ............. 260
2.4 Other Theoretical Issues .............................. 261
2.5 Dividend Theory: Summary .............................. 271
3 Factors Affecting Dividend Policy .......................... 271
3.1 Investment Opportunities .............................. 272
3.2 The Expected Volatility of Future Earnings ............ 272
3.3 Financial Flexibility ................................. 273
3.4 Tax Considerations .................................... 273
3.5 Flotation Costs ....................................... 276
3.6 Contractual and Legal Restrictions .................... 277
3.7 Factors Affecting Dividend Policy: Summary ............ 278
4 Payout Policies ............................................ 279
4.1 Types of Dividend Policies ............................ 279
4.2 The Dividend versus Share Repurchase Decision ......... 285
4.3 Global Trends in Payout Policy ........................ 291
5 Analysis of Dividend Safety ................................ 293
6 Summary .................................................... 297
Problems ................................................... 298
CHAPTER 8
Working Capital Management .................................... 303
Learning Outcomes .......................................... 303
1 Introduction ............................................... 304
2 Managing and Measuring Liquidity ........................... 305
2.1 Defining Liquidity Management ......................... 305
2.2 Measuring Liquidity ................................... 307
3 Managing the Cash Position ................................. 312
3.1 Forecasting Short-Term Cash Flows ..................... 313
3.2 Monitoring Cash Uses and Levels ....................... 315
4 Investing Short-Term Funds ................................. 316
4.1 Short-Term Investment Instruments ..................... 316
4.2 Strategies ............................................ 320
4.3 Evaluating Short-Term Funds Management ................ 322
5 Managing Accounts Receivable ............................... 323
5.1 Key Elements of the Trade Credit Granting Process ..... 324
5.2 Managing Customers' Receipts .......................... 326
5.3 Evaluating Accounts Receivable Management ............. 328
6 Managing Inventory ......................................... 330
6.1 Approaches to Managing Levels of Inventory ............ 331
6.2 Inventory Costs ....................................... 332
6.3 Evaluating Inventory Management ....................... 332
7 Managing Accounts Payable .................................. 334
7.1 The Economics of Taking a Trade Discount .............. 335
7.2 Managing Cash Disbursements ........................... 336
7.3 Evaluating Accounts Payable Management ................ 337
8 Managing Short-Term Financing .............................. 337
8.1 Sources of Short-Term Financing ....................... 337
8.2 Short-Term Borrowing Approaches ....................... 339
8.3 Asset-Based Loans ..................................... 340
8.4 Computing the Costs of Borrowing ...................... 341
9 Summary .................................................... 343
Problems ................................................... 344
CHAPTER 9
Financial Statement Analysis .................................. 347
Learning Outcomes .......................................... 347
1 Introduction ............................................... 347
2 Common-Size Analysis ....................................... 348
2.1 Vertical Common-Size Analysis ......................... 350
2.2 Horizontal Common-Size Analysis ....................... 353
3 Financial Ratio Analysis ................................... 356
3.1 Activity Ratios ....................................... 357
3.2 Liquidity Analysis .................................... 363
3.3 Solvency Analysis ..................................... 365
3.4 Profitability Analysis ................................ 369
3.5 Other Ratios .......................................... 383
3.6 Effective Use of Ratio Analysis ....................... 386
4 Pro Forma Analysis ......................................... 392
4.1 Estimating the Sales-Driven Relations ................. 395
4.2 Estimating the Fixed Burdens .......................... 396
4.3 Forecasting Revenues .................................. 397
4.4 Constructing Pro Forma Statements ..................... 397
5 Summary .................................................... 401
Problems ................................................... 402
CHAPTER 10
Mergers and Acquisitions ...................................... 407
Learning Outcomes .......................................... 407
1 Introduction ............................................... 408
2 Mergers and Acquisitions: Definitions and Classifications .. 410
3 Motives for Merger ......................................... 413
3.1 Synergy ............................................... 413
3.2 Growth ................................................ 413
3.3 Increasing Market Power ............................... 414
3.4 Acquiring Unique Capabilities and Resources ........... 414
3.5 Diversification ....................................... 414
3.6 Bootstrapping Earnings ................................ 415
3.7 Managers' Personal Incentives ......................... 416
3.8 Tax Considerations .................................... 416
3.9 Unlocking Hidden Value ................................ 416
3.10 Cross-Border Motivations .............................. 417
4 Transaction Characteristics ................................ 418
4.1 Form of Acquisition ................................... 419
4.2 Method of Payment ..................................... 420
4.3 Mind-Set of Target Management ......................... 422
5 Takeovers .................................................. 424
5.1 Pre-Offer Takeover Defense Mechanisms ................. 424
5.2 Post-Offer Takeover Defense Mechanisms ................ 426
6 Regulation ................................................. 429
6.1 Antitrust ............................................. 430
6.2 Securities Laws ....................................... 433
7 Merger Analysis ............................................ 434
7.1 Target Company Valuation .............................. 434
7.2 Bid Evaluation ........................................ 446
8 Who Benefits from Mergers? ................................. 450
9 Corporate Restructuring .................................... 451
10 Summary .................................................... 452
Problems ...................................................... 454
Glossary ...................................................... 463
References .................................................... 475
About the Authors ............................................. 481
About the CFA Program ......................................... 487
Index ......................................................... 489
|
