Corporate finance and investment : decisions & strategies

787 Pages·2006·9.317 MB·xxv, 759 p. : ill. (some col.)\787

by  Richard Pike, Bill Neale

0273695614_COVER 1/11/05 9:49 am Page 1
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“A book that meets the needs of students at many levels using straightforward clear explanations. Written in Richard Pike & Bill Neale
common-sense language that can be understood by students just beginning their studies, as well as offering N O
complex hypotheses to challenge the more advanced students. It frequently puts the difficult theories in context
by relating them to the practicalities of business examples students can relate to.”
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– Dr Ann Butchers, Senior Teaching Fellow, University of Warwick, UK
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O fifth edition
This popular text takes a practical approach to corporate finance, applying key concepts and techniques to a broad range of N
contemporary issues in the field of finance. Examining financial issues from a managerial standpoint the authors demonstrate
the role finance has to play in explaining and shaping business development, rather than concentrating on quantitative aspects. V R CORPORATE FINANCE
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Established distinctive features: S AND INVESTMENT
• Reliable and easy to read, the text’s clear and accessible style presents T E
maths using worked examples and diagrams to aid understanding and

highlight application; M
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• Practical, problem-solving approach blends theory and practice through a
wealth of real-world examples, mini-case studies and cameos, to help I
E N DECISIONS & STRATEGIES
students to learn how to apply their knowledge;
• Carefully thought-out features throughout the text to encourage learning N
and self-assessment; A
• Recommended by professional bodies such as CIMA and ACCA. T
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New for fifth edition:
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Corporate Finance and Investmentis • Key formulae printed inside cover for easy reference;
highly suitable for undergraduates • Increased emphasis given to international aspects by drawing
taking a course in corporate finance together relevant material into a new Part VI on International Finance;
as part of Accounting, Finance and
• New final chapter provides an overview of the ‘State of the Art’ and
Business Studies degrees, as well as
future direction in corporate financial management, including
those taking MBA and other
important perspectives from a behavioural finance view; fifth
postgraduate-level courses in
corporate finance. It is particularly • Revised and updated to include the latest thinking on modern topics edition
suitable for those aiming for such as EVA®, strategic options and the new EU Mergers Directive.
professional body qualifications, e.g.,
from CIMA, ACCA or ICAS.
Richard Pikeis a Chartered Accountant and Professor of Accounting and Finance at the Bradford University School of
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Management.
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Bill Nealeis Associate Reader in Financial Management at the University of Bournemouth Institute of Business & Law. He is
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an experienced teacher, consultant and writer, and is the co-author of the Pearson Education text Business Finance: A Value-

Based Approachwith Trefor McElroy. &

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“Provides a comprehensive coverage of the whole spectrum of corporate finance. Using e
simple but powerful examples, as well as a host of real world illustrations, this book carefully a
explains the principles, models and intuition financial managers need to have to successfully l
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create value for their business. What is really excellent is the way that the authors embed
the discussion within the company’s wider corporate strategic context. This is one reason
why I have long used this book as the required text for my corporate finance course.”
– Dr Peter Moles, Senior Lecturer in Finance, University of Edinburgh Management School, UK
Cover image: © Getty Images/The Image Bank
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CORPORATE FINANCE AND INVESTMENT
DECISIONS & STRATEGIES
Visit the Corporate Finance and Investment,fifth editionCompanion
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learning material including:
■ Summary of each chapter to aid revision
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CORPORATE FINANCE
AND INVESTMENT
DECISIONS & STRATEGIES
Fifth Edition
Richard Pike and Bill Neale
CFAI_A01.QXD 3/15/07 7:05 AM Page iv
Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
England
and Associated Companies throughout the world
Visit us on the World Wide Web at:
www.pearsoned.co.uk
First published 1993
Fifth edition published 2006
© Prentice Hall Europe 1993,1999
© Pearson Education Limited 2003,2006
The rights of Richard Pike and Bill Neale to be identified as authors of this work have been
asserted by them in accordance with the Copyright,Designs and Patents Act 1988.
All rights reserved.No part of this 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 of the publisher or a
licence permitting restricted copying in the united Kingdom issued by the Copyright
Licensing Agency Ltd,90 Tottenham Court Road,London W1T 4LP.
ISBN:978-0-273-69561-5
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
A catalogue record for this book is available from the Library of Congress
10 9 8 7 6 5 4 3 2
10 09 08 07

Typeset in 91/12 pt Palatino by 71.
2
Printed and bound by Graficas Estella,Spain.
The publisher’s policy is to use paper manufactured from sustainable forests.
CFAI_A01.QXD 3/15/07 7:05 AM Page v
To our wives, Carol and Jean
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Contents
List of figures and tables xiii 2.9 Taxation and financial decisions 46
Preface xvi Summary 47
Guided tour of the book xx Key points 47
Guided tour of the companion website xxii Further reading 47
Acknowledgements xxiii Appendix:Financial statement analysis 48
Publisher’s acknowledgements xxiv Questions 57
Part I Chapter 3
A FRAMEWORK FOR FINANCIAL Present values and financial arithmetic 60
DECISIONS
3.1 Introduction 61
3.2 Measuring wealth 61
Chapter 1
3.3 Time-value of money 62
An overview of financial management 3 3.4 Financial arithmetic for capital growth 63
1.1 Introduction 4 3.5 Present value 65
1.2 The finance function 5 3.6 Present value arithmetic 68
1.3 Investment and financial decisions 6 3.7 Valuing bonds 71
1.4 Cash – the lifeblood of the business 7 3.8 Net present value 73
1.5 The emergence of financial management 8 Summary 77
1.6 The finance department in the firm 9 Key points 77
1.7 The financial objective 10 Further reading 77
1.8 The agency problem 11 Appendix I:The term structure of interest rates
1.9 Managing the agency problem 12 and the yield curve 78
1.10 Social responsibility and shareholder wealth 13 Appendix II:The investment–consumption decision 79
1.11 The corporate governance debate 14 Appendix III:Present value formulae 84
1.12 The risk dimension 16 Questions 86
1.13 The strategic dimension 17
Summary 20 Chapter 4
Key points 20
Valuation of assets,shares
Further reading 21
and companies 88
Questions 22
4.1 Introduction 89
4.2 The valuation problem 89
Chapter 2
4.3 Valuation using published accounts 90
The financial environment 24 4.4 Valuing the earnings stream:P:E ratios 96
2.1 Introduction 25 4.5 EBITDA – a halfway house 98
2.2 Financial markets 25 4.6 Valuing cash flows 98
2.3 The financial services sector 27 4.7 The DCF approach 100
2.4 The London Stock Exchange (LSE) 30 4.8 Valuation of unquoted companies 103
2.5 Are financial markets efficient? 34 4.9 Valuing shares:the Dividend Valuation Model 104
2.6 A modern perspective – chaos theory 41 4.10 Problems with the Dividend Growth Model 106
2.7 Short-termism in the City 43 4.11 Shareholder value analysis 109
2.8 Reading the financial pages 44 4.12 Economic Value Added (EVA) 111
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viii Contents
Summary 112 7.3 Advanced manufacturing technology
Key points 113 (AMT) investment 178
Further reading 113 7.4 Environmental aspects of investment 180
Questions 114 7.5 The capital investment process 181
7.6 Post-auditing 188
Summary 190
Part II
Key points 190
INVESTMENT DECISIONS
Further reading 190
AND STRATEGIES
Questions 191
Chapter 5
Part III
Investment appraisal methods 121
5.1 Introduction 122 INVESTMENT RISK AND RETURN
5.2 Cash flow analysis 122
5.3 Investment techniques – net present value 123 Chapter 8
5.4 Internal rate of return 125
Analysing investment risk 195
5.5 Profitability index 127
5.6 Payback period 128 8.1 Introduction 196
5.7 Accounting rate of return 129 8.2 Expected net present value (ENPV):
5.8 Ranking mutually exclusive projects 130 Betterway plc 197
8.3 Attitudes to risk 197
5.9 Investment evaluation and capital rationing 134
8.4 The many types of risk 198
Summary 137
8.5 Measurement of risk 200
Key points 137
8.6 Risk description techniques 204
Further reading 138
8.7 Adjusting the NPV formula for risk 208
Appendix I:Modified IRR 138
8.8 Risk analysis in practice 210
Appendix II:Multi-period capital rationing
Summary 211
and mathematical programming 139
Key points 211
Questions 144
Further reading 212
Appendix:Multi-period cash flows and risk 212
Chapter 6
Questions 215
Project appraisal – applications 147
6.1 Introduction 148 Chapter 9
6.2 Incremental cash flow analysis 148
Relationships between investments:
6.3 Replacement decisions 151
portfolio theory 219
6.4 Inflation cannot be ignored 153
9.1 Introduction 220
6.5 Taxation is a cash flow 155
9.2 Portfolio analysis:the basic principles 221
6.6 Use of DCF techniques 157
9.3 How to measure portfolio risk 223
6.7 Traditional appraisal methods 159
9.4 Portfolio analysis where risk and return
Summary 163
differ 226
Key points 163
9.5 Different degrees of correlation 227
Further reading 164
9.6 Worked example:Gerrybild plc 228
Appendix:The problem of unequal lives:Allis plc 164
9.7 Portfolios with more than two components 231
Questions 166
9.8 Can we use this for project appraisal?
Some reservations 233
Chapter 7
Summary 234
Investment strategy and process 173
Key points 234
7.1 Introduction 174 Further reading 234
7.2 Strategic considerations 174 Questions 235
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Contents ix
Chapter 10 Chapter 12
Setting the risk premium:the Capital Asset Identifying and valuing options 296
Pricing Model 237 12.1 Introduction 297
10.1 Introduction 238 12.2 Share options 297
10.2 Security valuation and discount rates 238 12.3 Option pricing 304
10.3 Concepts of risk and return 239 12.4 Application of option theory to
10.4 The relationship between different equity corporate finance 309
markets 243 12.5 Capital investment options 311
10.5 Systematic risk 244 12.6 Why conventional NPV may not tell the
10.6 Completing the model 249 whole story 314
10.7 Using the CAPM:assessing the
Summary 315
required return 250
Key points 315
10.8 The underpinnings of the CAPM 254
Further reading 316
10.9 Portfolios with many components:
Appendix:Black–Scholes option pricing formula 316
the capital market line 255
Questions 318
10.10How it all fits together:the key
relationships 257
10.11Reservations about the CAPM 259 Part IV
10.12Testing the CAPM 260
SHORT-TERM FINANCING
10.13Factor models 261
AND POLICIES
10.14The Arbitrage Pricing Theory 262
10.15Issues raised by the CAPM:some food
Chapter 13
for managerial thought 263
Treasury management and working
Summary 266
capital policy 323
Key points 266
Further reading 266 13.1 Introduction 324
Appendix:Analysis of variance 267 13.2 The treasury function 324
Questions 269 13.3 Funding 326
13.4 How firms can use the yield curve 328
Chapter 11 13.5 Banking relationships 329
13.6 Risk management 330
The required rate of return on
13.7 Working capital management 337
investment and Shareholder
13.8 Predicting corporate failure 339
Value Analysis 271
13.9 Cash operating cycle 340
11.1 Introduction 272
13.10Working capital policy 342
11.2 The required return in all-equity firms:
13.11Overtrading problems 346
the DGM 272
Summary 348
11.3 The required return in all-equity firms:
Key points 348
the CAPM 276
Further reading and website 348
11.4 Using value drivers – Shareholder Value
Questions 349
Analysis (SVA) 278
11.5 Worked example:Safa plc 280
Chapter 14
11.6 Using ‘tailored’discount rates 283
11.7 Another problem:taxation and the CAPM 288 Short-term asset management 353
11.8 Problems with ‘tailored’discount rates 289 14.1 Introduction 354
11.9 A critique of divisional hurdle rates 290 14.2 Managing trade credit 354
Summary 291 14.3 Worked example:Pickles Ltd 361
Key points 291 14.4 Inventory management 362
Further reading 292 14.5 Cash management 367
Questions 293 14.6 Worked example:Mangle Ltd 370