Corporate finance and investment : decisions & strategies

825 Pages·2009·10.88 MB·English

by  Richard Pike

Sixth
“A book that meets the needs of students at many levels using straightforward clear explanations. Edition
Written in common sense language that can be understood by students just beginning their
Sixth Edition
studies, as well as offering complex hypotheses to challenge the more advanced students.
It frequently puts the difficult theories in context by relating them to the practicalities of business D C
examples students can relate to.” e o CoRPoRaTE FiNaNCE
Dr Ann Butchers, Senior Teaching Fellow, University of Warwick, UK c R
i
s P aNd iNvEsTMENT
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o o
In these turbulent financial and economic times make sure the future of good business practice and sound investment
decisions lies in your own hands. Understand the importance of the financial decision-making process in business n R
today with the new sixth edition of this popular and well-established text book. s
a Decisions and Strategies

From classic cases of ownership versus control of a firm, to more recent events affecting the methods and financial a T
instruments used by companies to raise finance, Corporate Finance and Investment develops, explains and above all
n E
applies key concepts and techniques in finance to a broad range of contemporary management and business policy
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concerns and challenges.
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Richard Pike and Bill Neale
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Classic features: MyFinanceLab r
• A strategic focus A brand new online learning resource for this a a
• A practical approach edition available to users of this book, t N
www.myfinancelab.com e
• A clear and accessible style
An unrivalled online study and testing resource g C
• An international perspective
that generates a personalised study plan and i E
provides extensive practice questions exactly e
Take a look below to see what’s new:
where you need it. s a
• New chapter 12 Enterprise Value and Equity Value
• New greater focus on derivatives and interest rate Also available on the site: N
management in chapter 13 • Podcasts relate finance theory to topical
issues recently documented in the news d
• New section on Islamic Finance in chapter 16
• New section on private equity in chapter 20 • Videos relating to each part of the
book give you the opportunity to watch i
• New detailed worked examples in every chapter N
interviews with Managing Directors and
• New and improved further reading guides, which Finance Directors of global companies to
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focus on key empirical references, at the end of see how they run their business.
every chapter. E
• Audio animations guide you step-by-step
• New news articles in every chapter illustrate how through the key concepts in corporate s

theory is being used in practice. finance.
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• New statistics, figures, charts and tables have been
See the first page of this text for information on
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successfully updated to reflect the latest data.
how to register and start using the resources
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Corporate Finance and Investment is highly suitable for undergraduates taking a course in corporate finance as part of
Accounting, Finance and Business Studies degrees, as well as those taking MBA and other postgraduate-level courses T
in corporate finance. Recommended by CIMA and ACCA it is particularly suitable for those aiming for professional
body qualifications, e.g., from CIMA, ACCA, or ICAS
Pike
Richard Pike is a Chartered Accountant and Professor of Finance at the Bradford University School of Management.
Bill Neale is a freelance lecturer and writer, formerly of University of Bournemouth Neale
Institute of Business & Law. He is co–author, with Trefor McElroy, of the Pearson
Education text Business Finance: A Value-Based Approach.
www.pearson-books.com
an imprint of Front cover image: © Getty Images
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A01_PIKE5504_06_SE_FM.QXD 10/29/08 3:35 PM Page i
CORPORATE FINANCE AND INVESTMENT
The Power of Practice
With your purchase of a new copy of this textbook,you received a Student Access Kit for
MyFinanceLab for Corporate Finance and Investment,sixth edition.Follow the instructions on the
card to register successfully and start making the most of the resources.
Don’t throw it away!
The Power ofPractice:
MyFinanceLab is an online study and testing resource that puts you in control of your study, providing
extensive practice exactly where and when you need it.
MyFinanceLab gives you unrivalled resources:
■ Sample tests for each chapter allowing you to see how much you have learned and where you still
need practice
■ A personalised study plan, which constantly adapts to your strengths and weaknesses taking you to
exercises you can practice over and again with different variables every time
■ Guided solutions which break the problem into its component steps and guide you through with hints
■ Audio animations to guide you step by step through the key concepts in corporate finance.
■ Podcasts analysing topical issues and recent news items in finance.
■ Video clips of CEOs and Financial Directors from large companies explaining how they make financial
decisions for each part of the book.
■ E text
■ Online glossary which defines key terms and provides examples
See Using MyFinanceLab on page xxii for more details.
To activate your registration go to www.myfinancelab.com/registerand follow the instructions on screen
to register as a new user.
A01_PIKE5504_06_SE_FM.QXD 10/29/08 3:35 PM Page ii
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A01_PIKE5504_06_SE_FM.QXD 10/29/08 3:35 PM Page iii
CORPORATE FINANCE
AND INVESTMENT
DECISIONS & STRATEGIES
Sixth Edition
Richard Pike and Bill Neale
A01_PIKE5504_06_SE_FM.QXD 10/31/08 10:07 AM Page iv
To our wives, Carol and Jean
Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
and Associated Companies throughout the world
Visit us on the World Wide Web at:
www.pearsoned.com
First published 1993
Sixth edition published 2009
© Prentice Hall Europe 1993, 1999
© Pearson Education Limited 2003, 2009
The rights ofRichard Pike and Bill Neale to be identified as authors ofthis work have been
asserted by them in accordance with the Copyright, Designs and Patents Act 1988.
All rights reserved. No part ofthis publication may be reproduced, stored in a retrieval
system, or transmitted in any form or by any means, electronic, mechanical, photocopying,
recording or otherwise, without either the prior written permission ofthe publisher or a
licence permitting restricted copying in the United Kingdom issued by the Copyright
Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS
ISBN 978-0-273-71550-4
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Library ofCongress Cataloging-in-Publication Data
Pike, Richard (Richard H.)
Corporate finance and investment : decisions & strategies/Richard Pike and Bill Neale. — 6th ed.
p. cm.
ISBN 978-0-273-71550-4 (pbk.)
1. Corporations—Great Britain—Finance. 2. Investments—Great Britain.
3. Corporations—Europe—Finance. I. Neale, Bill. II. Title.
HG4135.P35 2009
658.150941—dc22
2008039373

10 9 8 7 6 5 4 3 2 1
13 12 11 10 09
Typeset in 9.5/12 Palatino by 73.
Printed and bound by Rotolito Lombarda, Italy.
The publisher’s policy is to use paper manufactured from sustainable forests.
A01_PIKE5504_06_SE_FM.QXD 10/29/08 3:35 PM Page v
Brief Contents
List of figures and tables xii
Preface xiv
Guided tour xviii
Using MyFinanceLab xx
Acknowledgements xxii
Publisher’s acknowledgements xxiii
Part I A FRAMEWORK FOR FINANCIAL DECISIONS 1
1 An overview of financial management 3
2 The financial environment 23
3 Present values, and bond and share valuation 53
Part II INVESTMENT DECISIONS AND STRATEGIES 81
4 Investment appraisal methods 83
5 Project appraisal – applications 113
6 Investment strategy and process 139
Part III VALUE, RISK AND THE REQUIRED RETURN 157
7 Analysing investment risk 159
8 Identifying and valuing options 184
9 Relationships between investments: portfolio theory 209
10 Setting the risk premium: the Capital Asset Pricing Model 227
11 The required rate of return on investment 262
12 Enterprise value and equity value 284
Part IV SHORT-TERM FINANCING AND POLICIES 315
13 Treasury management and working capital policy 317
14 Short-term asset management 349
15 Short- and medium-term finance 376
Part V STRATEGIC FINANCIAL DECISIONS 409

16 Long-term finance 411
17 Returning value to shareholders: the dividend decision 453
18 Capital structure and the required return 485
19 Does capital structure really matter? 520
20 Acquisitions and restructuring 550
Part VI INTERNATIONAL FINANCIAL MANAGEMENT 613
21 Managing currency risk 615
22 Foreign investment decisions 656
23 Key issues in modern finance: a review 692
Appendix A Solutions to self-assessment activities 711
Appendix B Solutions to selected questions 729
Appendix C Present value interest factor (PVIF) 761
Appendix D Present value interest factor for an annuity (PVIFA) 763
Glossary 765
References 774
Index 784
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Contents
List of figures and tables xii Chapter 3
Preface xiv
Present values, and bond and share
Guided tour xviii
valuation 53
Using MyFinanceLab xx
Acknowledgements xxii 3.1 Introduction 54
Publisher’s acknowledgements xxiii 3.2 Measuring wealth 54
3.3 Time-value of money 55
3.4 Financial arithmetic for capital growth 56
Part I
3.5 Present value 57
A FRAMEWORK FOR FINANCIAL 3.6 Present value arithmetic 61
DECISIONS 3.7 Valuing bonds 64
3.8 Valuing shares: the dividend valuation model 67
Chapter 1 3.9 Problems with the dividend growth model 69
An overview of financial management 3 Summary 72
Key points 72
1.1 Introduction 4
Further reading 73
1.2 The finance function 5
Appendix I: The term structure of interest rates
1.3 Investment and financial decisions 6
and the yield curve 73
1.4 Cash – the lifeblood of the business 7
Appendix II: Present value formulae 75
1.5 The emergence of financial management 8
Appendix III: The P:E ratio and the constant dividend
1.6 The finance department in the firm 9
valuation model 76
1.7 The financial objective 10
Questions 78
1.8 The agency problem 11
1.9 Managing the agency problem 12
Part II
1.10 Social responsibility and shareholder wealth 13
1.11 The corporate governance debate 14 INVESTMENT DECISIONS AND
1.12 The risk dimension 16 STRATEGIES
1.13 The strategic dimension 17
Summary 19 Chapter 4
Key points 19 Investment appraisal methods 83
Further reading 20
4.1 Introduction 84
Questions 21
4.2 Cash flow analysis 84
4.3 Net present value 85
Chapter 2
4.4 Investment techniques – net present value 89
The financial environment 23 4.5 Internal rate of return 90
2.1 Introduction 24 4.6 Profitability index 93
2.2 Financial markets 24 4.7 Payback period 94
2.3 The financial services sector 26 4.8 Accounting rate of return 95
2.4 The London Stock Exchange (LSE) 30 4.9 Ranking mutually exclusive projects 96
2.5 Are financial markets efficient? 33 4.10 Investment evaluation and capital rationing 100
2.6 Reading the financial pages 38 Summary 103
2.7 Taxation and financial decisions 40 Key points 104
Summary 40 Further reading 104
Key points 40 Appendix I: Modified IRR 104
Further reading 41 Appendix II: Multi-period capital rationing and
Appendix: Financial statement analysis 41 mathematical programming 106
Questions 50 Questions 110
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viii Contents
Chapter 5 Chapter 8
Project appraisal – applications 113 Identifying and valuing options 184
5.1 Introduction 114 8.1 Introduction 185
5.2 Incremental cash flow analysis 114 8.2 Share options 185
5.3 Replacement decisions 117 8.3 Option pricing 193
5.4 Inflation cannot be ignored 119 8.4 Application of option theory to corporate
5.5 Taxation is a cash flow 120 finance 199
5.6 Use of DCF techniques 123 8.5 Capital investment options 200
5.7 Traditional appraisal methods 125 8.6 Why conventional NPV may not tell
the whole story 204
Summary 129
Key points 129 Summary 205
Further reading 129 Key points 205
Appendix: The problem of unequal lives: Allis plc 130 Further reading 205
Questions 132 Appendix: Black–Scholes option pricing formula 206
Questions 207
Chapter 6
Investment strategy and process 139 Chapter 9
6.1 Introduction 140 Relationships between investments:
6.2 Strategic considerations 140 portfolio theory 209
6.3 Advanced manufacturing technology (AMT)
9.1 Introduction 210
investment 143
9.2 Portfolio analysis: the basic principles 211
6.4 Environmental aspects of investment 146
9.3 How to measure portfolio risk 212
6.5 The capital investment process 147
9.4 Portfolio analysis where risk and return differ 215
6.6 Post-auditing 153
9.5 Different degrees of correlation 217
Summary 155 9.6 Worked example: Gerrybild plc 218
Key points 155 9.7 Portfolios with more than two components 221
Further reading 155 9.8 Can we use this for project appraisal?
Questions 156 Some reservations 222
Summary 224
Part III
Key points 224
VALUE, RISK AND THE REQUIRED Further reading 224
RETURN Questions 225
Chapter 7 Chapter 10

Analysing investment risk 159 Setting the risk premium: the Capital
7.1 Introduction 160 Asset Pricing Model 227
7.2 Expected net present value (ENPV): 10.1 Introduction 228
Betterway plc 161 10.2 Security valuation and discount rates 228
7.3 Attitudes to risk 161 10.3 Concepts of risk and return 229
7.4 The many types of risk 163 10.4 The relationship between different equity
7.5 Measurement of risk 164 markets 232
7.6 Risk description techniques 168 10.5 Systematic risk 234
7.7 Adjusting the NPV formula for risk 172 10.6 Completing the model 238
7.8 Risk analysis in practice 174 10.7 Using the CAPM: assessing the required
Summary 176 return 239
Key points 176 10.8 Worked example 244
Further reading 176 10.9 The underpinnings of the CAPM 245
Appendix: Multi-period cash flows and risk 176 10.10 Portfolios with many components: the
Questions 180 capital market line 246
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Contents ix
10.11 How it all fits together: the key relationships 248
Part IV
10.12 Reservations about the CAPM 250
10.13 Testing the CAPM 250 SHORT-TERM FINANCING AND POLICIES
10.14 Factor models 252
10.15 The Arbitrage Pricing Theory 253 Chapter 13
10.16 Fama and French’s three-factor model 254 Treasury management and working
10.17 Issues raised by the CAPM: some food for
capital policy 317
managerial thought 255
13.1 Introduction 318
Summary 257
13.2 The treasury function 318
Key points 257
13.3 Funding 320
Further reading 258
13.4 How firms can use the yield curve 322
Appendix: Analysis of variance 258
13.5 Banking relationships 324
Questions 260
13.6 Risk management 324
13.7 Working capital management 334
Chapter 11
13.8 Predicting corporate failure 336
Therequiredrateof return 13.9 Cash operating cycle 337
oninvestment 262 13.10 Working capital policy 338
13.11 Overtrading problems 342
11.1 Introduction 263
11.2 The required return in all-equity firms: Summary 343
the DGM 263 Key points 343
11.3 The required return in all-equity firms: Further reading and website 344
the CAPM 267 Questions 345
11.4 Using ‘tailored’ discount rates 269
11.5 Worked example: Tieko plc 274 Chapter 14
11.6 Another problem: taxation and the CAPM 276 Short-term asset management 349
11.7 Problems with ‘tailored’ discount rates 277
14.1 Introduction 350
11.8 A critique of divisional hurdle rates 278
14.2 Managing trade credit 350
Summary 279 14.3 Inventory management 358
Key points 279 14.4 Cash management 363
Further reading 280 14.5 Worked example: Mangle Ltd 366
Questions 281 14.6 Cash management models 368
Summary 369
Chapter 12
Key points 369
Enterprise value and equity value 284 Further reading 370
12.1 Introduction 285 Appendix: Miller–Orr cash management model 370
12.2 The valuation problem 285 Questions 372
12.3 Valuation using published accounts 286
12.4 Valuing the earnings stream: P:E ratios 292 Chapter 15
12.5 EBITDA – a halfway house 294 Short- and medium-term finance 376
12.6 Valuing cash flows 294
15.1 Introduction 377
12.7 The DCF approach 296
15.2 Trade credit 377
12.8 Valuation of unquoted companies 300
15.3 Bank credit facilities 379
12.9 Shareholder value analysis 301
15.4 Invoice finance (or ‘asset-based finance’) 382
12.10 Using value drivers 302
15.5 Using the money market: bill finance 384
12.11 Worked example: Safa plc 303
15.6 Hire purchase (HP) 386
12.12 Economic value added (EVA) 306
15.7 Leasing 388
Summary 307 15.8 Lease evaluation: a simple case 390
Key points 308 15.9 Motives for leasing 393
Further reading 308 15.10 Allowing for Corporation Tax in lease
Questions 309 evaluation 395