Finance for Executives · Managing for Value Creation, 4th Edition by Hawawini, Gabriel -- Read -- Imperial Library of Trantor

Index

PART I I NTRODUCTION

The Key Question: Will Your Decision Create Value?

The Importance of Managing for Value Creation The Saturn Story

The Fundamental Finance Principle

Measuring Value Creation with Net Present Value Only Cash Matters Discount Rates A Proposal’s Cost of Capital

Applying the Fundamental Finance Principle

The Capital Budgeting Decision The Capital Structure Decision The Business Acquisition Decision The Foreign Investment Decision

The Role of Financial Markets

The Equity Market The Vioxx Recall External versus Internal Financing

The Business Cycle HLC’s Financial Statements

The Balance Sheet A Variant of the Standard Balance Sheet: The Managerial Balance Sheet The Income Statement

How Profitable Is the Firm?

The Profitability of Equity Capital The Profitability of Invested Capital

How Much Cash Has the Firm Generated?

Sources and Uses of Cash The Statement of Cash Flows

How Risky Is the Firm? Has the Firm Created Value? Summary Further Reading Financial Accounting Statements The Balance Sheet

Current or Short-Term Assets Noncurrent or Fixed Assets Current or Short-Term Liabilities Noncurrent Liabilities Owners’ Equity

The Income Statement

Net Sales Gross Profit Operating Profit Special Items Earnings Before Interest and Tax (EBIT) Earnings Before Tax (EBT) Earnings After Tax (EAT)

Reconciling Balance Sheets and Income Statements The Structure of the Owners’ Equity Account Summary The Home Depot’s Balance Sheets and Income Statements The Home Depot’s Balance Sheets

Short-Term Investments Other Current Assets Capital Leases Notes Receivable and Other Assets Sales Taxes Payable and Income Taxes Payable Deferred Revenue Other Accrued Expenses Other Long-Term Liabilities Accumulated Other Comprehensive Income (Loss)

The Home Depot’s Income Statements

Other Earnings (Loss) from Discontinued Operations (Net of Tax)

Further Reading Self-Test Problems Review Problems

CHAPTER 1 Financial Management and Value Creation: An Overview CHAPTER 2 Understanding Balance Sheets and Income Statements A PPENDIX 2.1 Specimen Financial Statements

PART II F INANCIAL D IAGNOSIS AND M ANAGEMENT

The Managerial Balance Sheet

The Three Components of a Firm’s Invested Capital The Two Components of a Firm’s Capital Employed The Structure of the Managerial Balance Sheet

The Matching Strategy A Measure of Liquidity Based on the Funding Structure of Working Capital Requirement Improving Liquidity through Better Management of the Operating Cycle

The Effect of the Firm’s Economic Sector on Its Working Capital Requirement The Effect of Managerial Efficiency on Working Capital Requirement The Effect of Sales Growth on Working Capital Requirement

Traditional Measures of Liquidity

Net Working Capital The Current Ratio The Acid Test or Quick Ratio

Summary The Home Depot’s Managerial Balance Sheets The Home Depot’s Liquidity Position The Home Depot’s Management of the Operating Cycle Further Reading Self-Test Problems Review Problems Cash Flows and Their Sources Preparing a Detailed Cash-Flow Statement

Net Cash Flow from Operating Activities Net Cash Flow from Investing Activities Net Cash flow from Financing Activities The Cash-Flow Statement The Statement of Cash Flow According to the Financial Accounting Standards Board

Cash Flow from Assets or Free Cash Flow Managerial Implications Summary Measuring Cash Inflow from Operations Measuring Cash Outflow from Operations

Cash Outflow from Purchases Cash Outflow from SG&A and Tax Expenses

Net Operating Cash Flow Restructuring the Home Depot’s Cash-Flow Statements The Home Depot’s Cash Flows from Operating Activities The Home Depot’s Cash Flows from Investing Activities The Home Depot’s Cash Flows from Financing Activities Further Reading Self-Test Problems Review Problems Measures of Profitability Return on Equity

Measuring Return on Equity The Effect of Operating Decisions on Return on Equity The Effect of Financing Decisions on Return on Equity The Incidence of Taxation on Return on Equity Putting It A Together: The Structure of a Firm’s Profitability The Structure of Return on Equity Across Industries

Other Measures of Profitability

Earnings Per Share (EPS) The Price-to-Earnings Ratio (P/E) The Market-to-Book Ratio

Financial Leverage and Risk

How Does Financial Leverage Work? Two Related Caveats: Risk and the Ability to Create Value

Self-Sustainable Growth Summary The Home Depot’s Profitability Structure

The Effect of The Home Depot’s Operating Profitability on Its Return on Equity The Effect of Operating Margin on The Home Depot’s Operating Profitability The Effect of Invested Capital Turnover on The Home Depot’s Operating Profitability The Effect of The Home Depot’s Financial Policy on Its Return on Equity The Effect of Taxation on The Home Depot’s Return on Equity

Further Reading Self-Test Problems Review Problems

CHAPTER 3 Assessing Liquidity and Operational Efficiency A PPENDIX 3.1 Financing Strategies A PPENDIX 3.2 The Home Depot’s Liquidity and Operational Efficiency CHAPTER 4 Measuring Cash Flows A PPENDIX 4.1 Obtaining the Net Operating Cash Flow from Balance Sheet and Income Statement Accounts A PPENDIX 4.2 The Home Depot’s Cash Flows CHAPTER 5 Diagnosing Profitability, Risk, and Growth A PPENDIX 5.1 The Home Depot’s Profitability

PART III I NVESTMENT D ECISIONS

The Capital Investment Process Would You Buy This Parcel of Land?

The Alternative Investment The Opportunity Cost of Capital

The Net Present Value Rule

A One-Period Investment A Two-Period Investment without an Intermediate Cash Flow A Two-Period Investment with an Intermediate Cash Flow Multiple-Period Investments

Applying the Net Present Value Rule to a Capital Investment Decision Why the NPV Rule Is a Good Investment Rule

NPV Is a Measure of Value Creation NPV Adjusts for the Timing of the Project’s Cash Flows NPV Adjusts for the Risk of the Project’s Cash Flows NPV is Additive

Special Cases of Capital Budgeting

Comparing Projects of Unequal Size Comparing Projects with Unequal Life Spans

Limitations of the Net Present Value Criterion

Managerial or Real Options Embedded in Investment Projects Dealing with Managerial Options

Summary Present Value of an N -Period Annuity Present Value of an Infinite Annuity or Perpetuity Constant Annual-Equivalent Cash Flow Further Reading Self-Test Problems Review Problems The Payback Period

The Payback Period Rule Why Do Managers Use the Payback Period Rule?

The Discounted Payback Period

The Discounted Payback Period Rule The Discounted Payback Period Rule versus the Ordinary Payback Period Rule

The Internal Rate of Return

The IRR Rule The IRR Rule May Be Unreliable Why Do Managers Usually Prefer the IRR Rule to the NPV Rule?

The Profitability Index

The Profitability Index Rule Use of the Profitability Index Rule

The Average Accounting Return

The Average Accounting Return Rule

Summary Further Reading Self-Test Problems Review Problems The Actual Cash-Flow Principle The With/Without Principle The Designer Desk-Lamp Project Identifying a Project’s Relevant Cash Flows

Sunk Costs Opportunity Costs Costs Implied by Potential Sales Erosion Allocated Costs Depreciation Expense Tax Expense Financing Costs Inflation

Estimating a Project’s Relevant Cash Flows

Measuring the Cash Flows Generated by a Project Estimating the Project’s Initial Cash Outflow Estimating the Project’s Intermediate Cash Flows Estimating the Project’s Terminal Cash Flow

Should SMC Launch the New Product?

Sensitivity of the Project’s NPV to Changes in the Lamp Price Sensitivity of NPV to Sales Erosion

Summary Further Reading Self-Test Problems Review Problems

CHAPTER 6 Using the Net Present Value Rule to Make Value-Creating Investment Decisions A PPENDIX 6.1 Calculation of the Present Value of an Annuity and the Constant Annual-Equivalent Cash Flow of a Project’s Cash-Flow Stream CHAPTER 7 Alternatives to the Net Present Value Rule CHAPTER 8 Identifying and Estimating a Project’s Cash Flows

PART IV F INANCING D ECISIONS

Estimating the Amount of Required External Funds The Financial System: Its Structure and Functions

Direct Financing Indirect or Intermediated Financing Securities Markets

How Firms Issue Securities

Private Placement Public Offerings

Debt Capital: Characteristics and Valuation

Borrowing through Bank Loans Borrowing through Lease Agreements Borrowing by Issuing Short-Term Securities Borrowing by Issuing Corporate Bonds

Equity Capital: Characteristics and Valuation

The Valuation of Preferred Stocks The Valuation of Common Stocks Tracking Stock Equity Warrants Contingent Value Rights

Summary Further Reading Self-Test Problems Review Problems Identifying Proxy or Pure-Play Firms Estimating the Cost of Debt Estimating the Cost of Equity Using the Dividend Discount Model

Estimating the Cost of Equity when Dividends Grow at a Constant Rate Estimating the Cost of Equity: How Reliable Is the Dividend Discount Model?

Estimating the Cost of Equity Using the Capital Asset Pricing Model

Diversification Reduces Risk Measuring Systematic Risk with the Beta Coefficient The Effect of Borrowing on a Company’s Stock Beta The Capital Asset Pricing Model Using the CAPM to Estimate SMC’s Cost of Equity

Estimating the Cost of Capital of a Firm

What Is the Firm’s Cost of Capital? The Firm’s Target Capital Structure The Firm’s Costs of Debt and Equity Summary of the Firm’s WACC Calculations

Estimating the Cost of Capital of a Project

The Project’s Risk Is Similar to the Risk of the Firm The Project’s Risk Is Different from the Risk of the Firm Three Mistakes to Avoid when Estimating a Project’s Cost of Capital

Summary Further Reading Self-Test Problems Review Problems The Capital Structure Decision in a World without Taxes and Financial Distress Costs

Effects of Borrowing on the Firm’s Profitability (No Taxes and No Financial Distress Costs) The Trade-Off between Profitability and Risk Effect of Borrowing on the Value of the Firm’s Assets and Its Share Price (No Taxes and No Financial Distress Costs) Effect of Borrowing on the Firm’s Cost of Capital (No Taxes and No Financial Distress Costs)

The Capital Structure Decision in a World with Corporate Income Taxes but without Financial Distress Costs

Effect of Borrowing on the Value of a Firm’s Assets (with Corporate Income Taxes and No Financial Distress Costs) Effect of Borrowing on the Firm’s Market Value of Equity (with Corporate Income Taxes and No Financial Distress Costs) Effect of Borrowing on the Firm’s Share Price (with Corporate Income Taxes and No Financial Distress Costs) Effect of Borrowing on the Cost of Capital (with Corporate Income Taxes and No Financial Distress Costs)

The Capital Structure Decision When Financial Distress Is Costly Formulating a Capital Structure Policy

A Closer Look at the Trade-Off Model of Capital Structure Factors Other Than Taxes That May Favor Borrowing Factors Other Than Financial Distress Costs That May Discourage Borrowing Is There a Preference for Retained Earnings? Putting It All Together

Summary Further Reading Self-Test Problems Review Problems

CHAPTER 9 Raising Capital and Valuing Securities A PPENDIX 9.1 The Valuation Formula for the Constant Growth Dividend Model CHAPTER 10 Estimating the Cost of Capital CHAPTER 11 Designing a Capital Structure

PART V B USINESS D ECISIONS

Alternative Valuation Methods Valuing a Firm’s Equity Using Comparable Firms

Direct Estimation of a Firm’s Equity Value Based on the Equity Value of Comparable Firms Factors That Determine Earnings Multiples Indirect Estimation of a Firm’s Equity Value Based on the Enterprise Value of Comparable Firms

Valuing a Firm’s Business Assets and Equity Using the Discounted Cash-Flow Approach

Estimating the DCF Value of a Firm’s Business Assets (Its Enterprise Value) Estimating the DCF Value of a Firm’s Equity Estimating OS Distributors’ Enterprise and Equity Values Step 1: Estimation of the Cash Flow from Business Assets Step 2: Estimation of the Weighted Average Cost of Capital Step 3: Estimation of the DCF Value of Business Assets Step 4: Estimation of the DCF Value of Equity Comparison of DCF Valuation and Valuation by Comparables

Estimating the Acquisition Value of OS Distributors

Identifying the Potential Sources of Value Creation in an Acquisition Why Conglomerate Mergers Are Unlikely to Create Lasting Value through Acquisitions The Acquisition Value of OS Distributors’ Equity

Estimating the Leveraged Buyout Value of OS Distributors

Estimating the Leveraged Buyout Value of Business Assets Will OS Distributors Be Able to Service Its Debt?

Summary Further Reading Self-Test Problems Review Problems What Is Risk? Why Should Firms Manage Risk?

Risk Management Can Reduce Corporate Income Tax Payments Risk Management Can Lower the Cost of Protection against Risk Risk Management Can Lower Financial Distress Costs Risk Management Can Provide Clearer Information to Investors about the Firm’s Core Activities Risk Management Can Lower Agency Costs

Corporate Risk Management

Risk Netting Cost Savings Risk Policy Risk Learning

The Risk Management Process

Step 1: Risk Identification Step 2: Risk Measurement Step 3: Risk Prioritization Step 4: Risk Policy Step 5: Risk Monitoring

A Closer Look at Currency Risk

The Foreign-Exchange Market Spot Transactions versus Forward Contracts

Hedging Contractual Exposure to Currency Risk

Hedging with Forward Contracts Hedging with Futures Contracts Hedging with Option Contracts Selecting a Hedging Technique

Hedging Long-Term Contractual Exposure to Currency Risk with Swaps Summary Further Reading Self-Test Problems Review Problems The Firm’s Risk Exposure from Foreign Operations

Accounting, or Translation, Exposure Economic Exposure Country Risk

Factors Affecting Changes in Exchange Rates

How Differences in Inflation Rates Affect Exchange Rates: The Purchasing Power Parity Relation The Relationship between Inflation Rates and Interest Rates: The Fisher Effect How Differences in Interest Rates Affect Exchange Rates: The Interest-Rate Parity Relation The Relation between Forward Rates and Future Spot Rates Putting It All Together

Analyzing an International Investment Project

The Net Present Value Rule: A Brief Review Surf and Zap Cross-Border Alternative Investment Projects

Managing Country Risk

Invest in Projects with Unique Features Use Local Sourcing Choose a Low-Risk Financial Strategy Design a Remittance Strategy Consider Buying Insurance against Country Risk

Summary The Monetary/Nonmonetary Method The Current Method Which Method Is Better? The Law of One Price The Purchasing Power Parity Relation The International Fisher Effect The Interest-Rate Parity Relation

Strategy 1: Investment in U.S. Dollars Strategy 2: Investment in Euros

Further Reading Self-Test Problems Review Problems Measuring Value Creation

Estimating Market Value Added Interpreting Market Value Added A Look at the Evidence

Identifying the Drivers of Value Creation

Linking Value Creation to Operating Profitability, the Cost of Capital, and Growth Opportunities Linking Value Creation to Its Fundamental Determinants

Linking Operating Performance and Remuneration to Value Creation

Mr. Thomas Hires a General Manager Has the General Manager Achieved His Objectives? Economic Profits versus Accounting Profits Designing Compensation Plans That Induce Managers to Behave Like Owners

Linking the Capital Budgeting Process to Value Creation

The Present Value of an Investment’s Future EVA Is Equal to Its MVA Maximizing MVA Is the Same As Maximizing NPV

Putting It All Together: The Financial Strategy Matrix

The Business Is a Value Creator but Is Short of Cash The Business Is a Value Creator with a Cash Surplus The Business Is a Value Destroyer with a Cash Surplus The Business Is a Value Destroyer That Is Short of Cash

Summary Adjusting the Book Value of Equity Capital Adjusting Earnings Before Interest and Tax Further Reading Self-Test Problems Review Problems A NSWERS TO S ELF -T EST P ROBLEMS G LOSSARY I NDEX

CHAPTER 12 Valuing and Acquiring a Business A PPENDIX 12.1 The Direct Discounted Cash-Flow Valuation of a Firm’s Equity CHAPTER 13 Managing Risk CHAPTER 14 Making International Business Decisions A PPENDIX 14.1 Translating Financial Statements with the Monetary/Nonmonetary Method and the Current Method A PPENDIX 14.2 The Parity Relations CHAPTER 15 Managing for Value Creation A PPENDIX 15.1 Adjusting Book Values to Estimate the Amount of Invested Equity Capital and Operating Profit A PPENDIX 15.2 Estimating Market Value Added (MVA) when Future Cash Flows Are Expected to Grow at a Constant Rate in Perpetuity

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