managerial finance - gbv.de · parti introduction to managerial finance 1 the role of managerial...

Managerial FinanceSixth Edition

Lawrence J. GitmanSan Diego State University

Chad J. ZutterUniversity of Pittsburgh

Prentice Hall

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 xxxi

Preface xxxiii

Supplements to the Sixth Edition

Acknowledgments xliii

To the Student xlvii

Parti Introduction to Managerial Finance 1

The Role ofManagerialFinancepage 2

I I I Finance and Business 3What is Finance? 3

Career Opportunities in Finance 3

Legal Forms of Business Organization

Why Study Managerial Finance? 7

•> REVIEW QUESTIONS 8

Goal of the Firm 9Maximize Shareholder Wealth

Maximize Profit? 10 /

What about Stakeholders? 11

The Role of Business Ethics 12


@B/»g3g83g) Focus on Ethics: Will GoogleLive Up to Its Motto? 13

Managerial FinanceFunction 14Organization of the FinanceFunction 14

Relationship to Economics 14

Relationship to Accounting 15

Primary Activities of the FinancialManager 17

•* REVIEW QUESTIONS 17

Governance and Agency 18Corporate Governance 18

The Agency Issue 19

-» REVIEW QUESTIONS 22

Summary 22

Self-Test Problem 23

Warm-Up Exercises 24

Problems 25

Spreadsheet Exercise 27

X V

xvi Contents

2The FinancialMarketEnvironmentpage 28

Financial Institutions andMarkets 29Financial Institutions 29

Commercial Banks, Investment Banks,and the Shadow Banking System 30

Financial Markets 31

The Relationship between Institutionsand Markets 31

The Money Market 32

The Capital Market 32^) Focus on Practice: Berkshire

Hathaway—Can Buffett Be Replaced? 37

* REVIEW QUESTIONS 37

E S The Financial Crisis 37Financial Institutions and RealEstate Finance 37

Falling Home Prices and DelinquentMortgages 38

Crisis of Confidence in Banks 39

Spillover Effects and the GreatRecession 39

•» REVIEW QUESTIONS 40

E s l Regulation of FinancialInstitutions 40Regulations Governing FinancialInstitutions 40

Regulations Governing FinancialMarkets 41

•*• REVIEW QUESTIONS 42

E S I Business Taxes

Ordinary Income 42Capital Gains 44-> REVIEW QUESTIONS

Summary 45



Problems 47


42

45

Contents xvii

I Financial Tools 51

3FinancialStatements andRatio Analysispage 52

I U The Stockholders'Report 53The Letter to Stockholders 53

The Four Key Financial Statements 53§ Focus on Ethics: Taking

Earnings Reports at Face Value 54

Notes to the Financial Statements 60

Consolidating International FinancialStatements 61


E&l Using Financial Ratios 61Interested Parties 61

Types of Ratio Comparisons 62

Cautions about Using RatioAnalysis 64

Categories of Financial Ratios 65

+ REVIEW QUESTIONS 65

Bfil Liquidity Ratios 65Current Ratio 65

Quick (Acid-Test) Ratio 67


E & l Ac t i v i t y Ratios 68

Inventory Turnover 68

Average Collection Period 68

Average Payment Period 69

Total Asset Turnover 70

•> REVIEW QUESTION 70

E s l Profitability Ratios 73Common-Size Income Statements 73

Gross Profit Margin 74

Operating Profit Margin 75

Net Profit Margin 75

Earnings Per Share (EPS) 75

Return on Total Assets (ROA) 76

Return on Common Equity (ROE) 76


Market Ratios 77

Price/Earnings (P/E) Ratio 77

Market/Book (M/B) Ratio 77


Elsl A Complete RatioAnalysis 78Summarizing All Ratios 78

Dupont System of Analysis 82

+ REVIEW QUESTIONS 84Summary 85Self-Test Problems 86Warm-Up Exercises 87Problems 88Spreadsheet Exercise 104

70BBI Debt RatiosDebt Ratio 72

Times Interest Earned Ratio 72

Fixed-Payment Coverage Ratio 72


xviii Contents

Cash Flow andFinancial Planningpage 107

Analyzing the Firm'sCash Flow 108

Depreciation 108

Depreciation Methods 109

Developing the Statement ofCash Flows 110

Free Cash Flow 115

Flow at Cisco Systems

•> REVIEW QUESTIONS

|> Focus on Practice: Free Cash116

117

EBfl The Financial PlanningProcess 117

Long-Term (Strategic) FinancialPlans 117

Short-Term (Operating) FinancialPlans 118


ESSl Cash Planning:Cash Budgets 119

The Sales Forecast 119

Preparing the Cash Budget 120

Evaluating the Cash Budget 124

Coping with Uncertainty in theCash Budget 125

Cash Flow within the Month 126

• S I Profit Planning: Pro FormaStatements 127

Preceding Year's FinancialStatements 127

Sales Forecast 127

•* REVIEW QUESTION 129

E l i l Preparing the Pro FormaIncome Statement 129

Considering Types of Costs andExpenses 129


t l J Preparing the Pro FormaBalance Sheet 131


Evaluation of Pro FormaStatements 133


Summary 134

Self-Test Problems 135


Problems 138


REVIEW QUESTIONS 127

Contents xix

5Time Valueof Moneypage 151

The Role of Time Value inFinance 152Future Value versus Present Value 152

Computational Tools 153

Basic Patterns of Cash Flow 154

•• REVIEW QUESTIONS 155

E£fl Single Amounts 155

Future Value of a Single Amount 155

Present Value of a Single Amount 159

"> REVIEW QUESTIONS 161

E&l Annuities 162

Types of Annuities 162

Finding the Future Value of an OrdinaryAnnuity 163

Finding the Present Value of an OrdinaryAnnuity 164

Finding the Future Value of anAnnuity Due 166

Finding the Present Value of anAnnuity Due 167

Finding the Present Value of aPerpetuity 169

"* REVIEW QUESTIONS 169

E&l Mixed Streams 169

Future Value of a Mixed Stream 170

Present Value of a Mixed Stream 171


Quarterly Compounding 173

A General Equation for CompoundingMore Frequently Than Annually 174

Using Computational Tools forCompounding More Frequently ThanAnnually 175

Continuous Compounding 175

Nominal and Effective Annual Rates ofInterest 176


E S I Special Applications of TimeValue 178

Determining Deposits Needed toAccumulate a Future Sum 178

Loan Amortization 179

Finding Interest or Growth Rates 181

$) Focus on Practice: NewCentury Brings Trouble for SubprimeMortgages 181

Finding an Unknown Number ofPeriods 183


Summary 184Self-Test Problems 186Warm-Up Exercises 187Problems 188Spreqdsheet Exercise 204

EEI Compounding Interest MoreFrequently Than Annually 172

Semiannual Compounding 172

XX Contents

Valuation of Securities 205

Interest Rates andBond Valuationpage 206

Interest Rates and RequiredReturns 207Interest Rate Fundamentals 207

Term Structure of Interest Rates 210

Risk Premiums: Issuer and IssueCharacteristics 214


EEI Corporate Bonds 216Legal Aspects of Corporate Bonds 216

Cost of Bonds to the Issuer 217

General Features of a Bond Issue 218

Bond Yields 218

Bond Prices 219

Bond Ratings 219

@iM&M§ Focus on Ethics: Can WeTrust the Bond Raters? 220

Common Types of Bonds 221

International Bond Issues 222


Efil Valuation FundamentalsKey Inputs 223

Basic Valuation Model 224


E&l Bond Valuation 226Bond Fundamentals 226

Basic Bond Valuation 226

Bond Value Behavior 228

Yield to Maturity (YTM) 231

Semiannual Interest andBond Values 232


Summary 234



Problems 238


223

Contents xxi

Stock Valuationpage 247

Differences between Debtand Equity 248

Voice in Management 248

Claims on Income and Assets 248

Maturity 249

Tax Treatment 249

•» REVIEW QUESTION 249

Common and PreferredStock 249

Common Stock 250

Preferred Stock 253

Issuing Common Stock 254


Common StockValuation 259Market Efficiency 259

The Efficient-Market Hypothesis 260

Focus on Practice:

Basic Common Stock ValuationEquation 261

Free Cash Flow Valuation Model 266

Other Approaches to CommonStock Valuation 269


Hfil Decision Making andCommon Stock Value 271

Changes in Expected Dividends 271

Changes in Risk 272

Combined Effect 273


Summary 273



Problems 277


Understanding Human Behavior Helps UsUnderstand Investor Behavior 261

xxii Contents

Risk and the Required Rate of Return 285

Risk and Returnpage 286

Risk and ReturnFundamentals 287Risk Defined 287

$ Focus on Ethics: If ItSeems Too Good to Be True Then ItProbably Is 287

Return Defined 288

Risk Preferences 289


E&l Risk of a Single Asset 290Risk Assessment 290

Risk Measurement 292


E&l Risk of a Portfolio 298Portfolio Return and StandardDeviation 298

Correlation 300

Diversification 300

Correlation, Diversification, Risk,and Return 303

International Diversification 304

-> REVIEW QUESTIONS 305

E&l Risk and Return: The CapitalAsset Pricing Model (CAPM) 305Types of Risk 305

The Model: CAPM 306


Summary 315



Problems 319


Contents xxiii

The Cost of Capitalpage 332

MMM Overview of theCost of Capital 333The Basic Concept 333

Sources of Long-Term Capital 334


E Q Cost of Long-Term Debt 335Net Proceeds 335

Before-Tax Cost of Debt 335

After-Tax Cost of Debt 337


E&l Cost of Preferred Stock 338Preferred Stock Dividends 338

Calculating the Cost ofPreferred Stock 339

•• REVIEW QUESTION 339

IS&I Cost of Common Stock 339Finding the Cost of CommonStock Equity 339

Cost of Retained Earnings 342

Cost of New Issues ofCommon Stock 342


H 9 Weighted Average Costof Capital 344Calculating Weighted Average Cost ofCapital (WACC) 344

(3a;°g°iSfBgl) Focus on Practice: UncertainTimes Make for an Uncertain WeightedAverage Cost of Capital 345

Weighting Schemes 346


Summary 347



Problems 350


xxiv Contents

Long-Term Investment Decisions 359

Capital BudgetingTechniquespage 360

Overview of CapitalBudgeting 361

Motives for Capital Expenditure 361

Steps in the Process 361

Basic Terminology 362

Capital Budgeting Techniques 363

* REVIEW QUESTION 364

USE! Payback Period 364

Decision Criteria 364

Pros and Cons of PaybackAnalysis 365


USKI Net Present Value (NPV) 367


NPV and the Profitability Index 370

NPV and Economic Value Added 370


US&I Internal Rate of Return<IRR) 372


Calculating the IRR 372


Comparing NPV and IRRTechniques 374Net Present Value Profiles 375

Conflicting Rankings 376

Which Approach Is Better? 379

ffij Focus on Ethics: IMonfinancialConsiderations in Project Selection 381

• REVIEW QUESTIONS 381

Summary 382



Problems 385


Contents XXV

11Capital BudgetingCash Flows andRisk Refinementspage 396

Relevant IncrementalCash Flows 397Major Cash Flow Components 397

Expansion versus ReplacementDecisions 397

Focus on Ethics: A Questionof Accuracy 398

Sunk Costs and OpportunityCosts 398


D E I Finding the InitialInvestment 400Installed Cost of New Asset 400

After-Tax Proceeds from Sale ofOld Asset 400

Change in Net Working Capital

Calculating the Initial Investment


403

404

Finding the OperatingCash Inflows 405Interpreting the Term After-Tax 405

Interpreting the Term Cash Inflows 406

Interpreting the Term Incremental 408


Finding the TerminalCash Flow 410Proceeds from Sale of Assets 410

Taxes on Sale of Assets 410

Change in Net Working Capital 411


I1K1 Risk in Capital Budgeting(Behavioral Approaches) 412

Breakeven Analysis 413

Scenario Analysis 415

Simulation 416

"> REVIEW QUESTIONS 417

U l s l Risk-Adjusted DiscountRates 417Determining Risk-Adjusted DiscountRates (RADRs) 417

Applying RADRs 418

Portfolio Effects 421

RADRs in Practice 422


Capital BudgetingRefinements 423Comparing Projects withUnequal Lives 423

Recognizing Real Options 426

Capital Rationing 428


Summary 431



Problems 436


xxvi Contents

Long-Term Financial Decisions 453

12Leverage andCapital Structurepage 454

HSU Leverage 455Breakeven Analysis 456

Operating Leverage 460

|) Focus on Practice: Adobe's' Leverage 462

Financial Leverage 463

Total Leverage 467


IE&J The Firm's CapitalStructure 469Types of Capital 469

External Assessment of CapitalStructure 470

Capital Structure of Non-U.S.Firms 472

Capital Structure Theory 473

Optimal Capital Structure 481


U S I EBIT-EPS Approach toCapital Structure 484Presenting a Financing PlanGraphically 484

Comparing Alternative CapitalStructures 485

Considering Risk in EBIT-EPSAnalysis 486

Basic Shortcoming of EBIT-EPSAnalysis 487


l£&] Choosing the OptimalCapital Structure 487Linkage 487

Estimating Value 488

Maximizing Value versusMaximizing EPS 490

Some Other ImportantConsiderations 490


Summary 491



Problems 495


Contents xxvii

13Payout Policypage 506

The Basics of PayoutPolicy 507Elements of Payout Policy 507

Trends in Earnings and Dividends 508

Trends in Dividends and ShareRepurchases 509


EfiEI The Mechanics of PayoutPolicy 5iiCash Dividend PaymentProcedures 511

Share Repurchase Procedures 513

Tax Treatment of Dividends andRepurchases 514

(jSBJgStagBsij) Focus on Practice: CapitalGains and Dividend Tax TreatmentExtended to 2010 515

Dividend Reinvestment Plans 516

Stock Price Reactions to CorporatePayouts 516


IESI Relevance of PayoutPolicy 517Residual Theory of Dividends 517

The Dividend Irrelevance Theory 517

Arguments for Dividend Relevance 518


U&I Factors Affecting DividendPolicy 520Legal Constraints 520

Contractual Constraints 521

Growth Prospects 521

Owner Considerations 522

Market Considerations 522


Ufil Types of DividendPolicies 522Constant-Payout-Ratio DividendPolicy 523

Regular Dividend Policy 523

Low-Regular-and-Extra DividendPolicy 524


U U Other Forms ofDividends 525Stock Dividends 525

Stock Splits 527


Summary 528



Problems' 532


xxviii Contents

Short-Term Financial Decisions 541

Working Capitaland Current AssetsManagementpage 542

I E U Net Working Capital

Fundamentals 543

Working Capital Management 543

Net Working Capital 544Trade-Off between Profitabilityand Risk 544


l i & l Cash Conversion Cycle 546

Calculating the Cash ConversionCycle 547

Funding Requirements of the CashConversion Cycle 548

Strategies for Managing the CashConversion Cycle 550


IK&I inventory Management 551

Differing Viewpoints about InventoryLevel 551

Common Techniques for ManagingInventory 552

@B;°5!ggffig3) Focus on Practice: RFID: TheWave of the Future 556

International InventoryManagement 557


IS&I Accounts Receivable

Management 558

Credit Selection and Standards 558

Credit Terms 562

Credit Monitoring 565


l £ s l Management of Receiptsand Disbursements 567

Float 567

Speeding Up Collections 568

Slowing Down Payments 568

Cash Concentration 569

Zero-Balance Accounts 570

Investing in Marketable Securities 571


Summary 572



Problems 576


Contents xxix

15Cunent LiabilitiesManagementpage 582

IEU Spontaneous Liabilities 583Accounts Payable Management 583

Accruals 588

(BB/ga3aBgl) Focus on Ethics: AccrualsManagement 588


BiKl Unsecured Sources ofShort-Term Loans 589Bank Loans 589

Commercial Paper 595

International Loans 596


Appendix A-i

Glossary G-i

Index i-i

Is&l Secured Sources ofShort-Term Loans 597Characteristics of Secured Short-TermLoans 597

Use of Accounts Receivable asCollateral 598

Use of Inventory as Collateral 600


Summary 602



Problems 605


managerial finance - gbv.de · parti introduction to managerial finance 1 the role of managerial...

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