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Corporate Finance Demystified PDF

289 Pages·2005·14.44 MB·English
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CORPORATE FINANCE DEMYSTIFIED TROY A. ADAIR, Jr. McGraw-Hill New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. Manufactured in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher. 0-07-148678-X The material in this eBook also appears in the print version of this title: 0-07-145910-3. All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trade- marked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringe- ment of the trademark. Where such designations appear in this book, they have been printed with initial caps. McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs. For more information, please contact George Hoare, Special Sales, at [email protected] or (212) 904-4069. TERMS OF USE This is a copyrighted work and The McGraw-Hill Companies, Inc. (“McGraw-Hill”) and its licensors reserve all rights in and to the work. Use of this work is subject to these terms. Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior con- sent. You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply with these terms. THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTH- ERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. McGraw-Hill and its licen- sors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw-Hill has no responsibility for the con- tent of any information accessed through the work. Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause what- soever whether such claim or cause arises in contract, tort or otherwise. DOI: 10.1036/0071459103 To my daughter, Genevieve, for her love and support throughout the writing of this book. ABOUT THE AUTHOR Troy A. Adair, Jr., PhD, is the Coordinator for the undergraduate Introduction to Financial Management course at the University of Michigan, and has taught the introductory course to both undergraduates and graduate students over 60 times throughout his career. In addition to having served as a consultant on financial data information systems to a number of financial institutions, Dr. Adair has also written two books on integrating the use of Microsoft Excel into the practice of finance, Excel Applications for Corporate Finance and Excel Applications for Investments. iv Copyright © 2006 by The McGraw-Hill Companies. Click here for terms of use. For more information about this title, click here CONTENTS Acknowledgments Xi Introduction xii PART ONE INTRODUCTION 3 CHAPTER 1 What Is Corporate Finance? 4 What Is Finance? 6 The Subfields of Finance 8 The Parts of Corporate Finance 10 So, Why Is This So Complicated? 10 Why Are We Studying Corporate Finance? 11 Quiz CHAPTER 2 Setting the Stage 15 Basic Forms of Business Organization 15 Goal of the Financial Manager 17 Agency Relationships and Conflicts 17 Quiz 19 CHAPTER 3 Accounting Statements and Cash Flows 23 The Balance Sheet: Assets vs. Liabilities 23 The Balance Sheet: Short-Term vs. Long-Term Accounts 25 The Income Statement 26 Taxes 27 Cash Flow From Assets 28 Quiz 29 V Corporate Finance Demystified VI CHAPTER 4 Common-Size, Common-Base Year, and Ratio Analysis 33 The General Goal of Ratio Analysis: Summarization 34 "Good" and "Bad" Values for Ratios 35 An Additional Effect of Ratio Analysis: Standardization 36 Common-Size Statement Analysis 36 Common-Base Year Analysis 39 Liquidity Ratios 40 Leverage Ratios 43 Asset Utilization Ratios 45 Profitability Ratios 46 Quiz 47 PART TWO "I WILL GLADLY PAY YOU $2 TOMORROW FOR $1 TODAY": THE TIME VALUE OF MONEY CHAPTER 5 Present and Future Value 53 Using a Financial Calculator or a Spreadsheet Program 54 Time Lines 55 The TVM Formulas 57 Calculator Setup and Notational Conventions 60 Using the TVM Formulas 61 Example—Car Loan with Delayed First Payment 62 Example—Retirement Calculation 64 What About Annuities Due? 66 Quiz 68 CHAPTER 6 Compounding and Interest Rate Conversion: When What You've Got Isn't What You Need 71 Interest Rate Flavors 72 APRs Explained 73 Just Because You Have a New Toy Doesn't Mean You Have To Use It! 75 Dealing with Other Nominal Rates 76 CONTENTS • • Vll A Caution on Using Calculators or Textbook Formulas to Convert Rates 77 Quiz 79 CHAPTER 7 Payment Composition and Amortization Schedules 83 Calculating Payment Components for Pure Discount Loans 84 Calculating Payment Components for Interest-Only Loans 85 Amortized Loans: Constant-Payment Loans 86 Amortized Loans: Constant-Principal Loans 87 A Final Note on Amortized Loans 89 Quiz 90 PART THREE VALUATION CHAPTER 8 Valuing Bonds 95 The Conventions of Bond Quotations 95 The Mathematics of a Bond 97 There are Rates, and then there are Rates that aren't Really Rates... 97 Solving for Bond Price 100 Solving for Anything but Bond Price 101 The Parts ofYTM 102 Quiz 104 CHAPTER 9 Valuing Stocks 107 The Conventions of Stock Quotations 108 The Mathematics of a Stock: Constant Dividends 108 The Mathematics of a Stock: Constantly Growing Dividends 110 The Mathematics of a Stock: Constantly Shrinking Dividends 113 What g > r Really Means 113 The Mathematics of a Stock: Nonconstant Dividends 114 Corporate Finance Demystified • • • Vlll Dividend Yield and Expected Capital Gains Yields on Stocks 117 Quiz 118 CHAPTER 10 Valuing Projects: The Capital-Budgeting Decision Rules 121 Why Cash Flow Signs Matter Now 122 Notational Conventions, Part 2 123 Net Present Value 125 The Intuition behind NPV 126 Payback 127 Discounted Payback 129 A Comparison of the Intuitions in Payback and Discounted Payback 131 Average Accounting Return (AAR) 131 Internal Rate of Return (IRR) 132 The Intuition behind IRR 133 Problems with IRR 133 Modified IRR (MIRR) 137 Profitability Index (PI) 138 Repeated Projects: Equivalent Annual Cost 139 Quiz 140 PART FOUR WHERE DO INTEREST RATES COME FROM? RISK, RETURN, AND THE COST OF CAPITAL CHAPTER 11 Measuring Risk and Return 145 Using the Past to Predict the Future: Computing the Average and Standard Deviation of Historic Returns 146 Explicit Guessing: Calculating the Expected Return and Standard Deviation across Expected States of Nature 149 Choosing Which Method to Use for Average and Standard Deviation 151 Portfolio Averages and Standard Deviations 151 Quiz 153 CONTENTS IX CHAPTER 12 Calculating Beta 157 Beta Estimation Methodology 158 Choosing and Gathering the Necessary Data 159 Calculating the Beta 160 Portfolio Betas 161 Quiz 161 CHAPTER 13 Analyzing the Security Market Line 165 The Relationship between the Security Market Line and the CAPM Equation 166 Estimating the Intercept of the SML 166 Estimating the Slope of the SML 167 Estimating the/Variable, Beta 168 Bringing it All Together 169 Quiz 169 CHAPTER 14 The Weighted Average Cost of Capital 173 The WACC Formula 174 Calculating the Component Cost of Equity, R 175 E Calculating the Component Cost of Preferred Stock, R 176 p Calculating the Before-Tax Cost of Debt, R 176 D Calculating the WACC 177 A Note on Nominal vs. Effective Rates 177 Quiz 177 PART FIVE ADVANCED TOPICS IN CORPORATE FINANCE CHAPTER 15 Estimating Future Cash Flows 183 Sample Project 184 Calculating Total Cash Flow: The Formula 184 Guiding Principles for Calculating Total Cash Flow 185 Calculating Depreciation 186 Operating Cash Flow (OCF) 187 Net Capital Spending 188 Changes in NWC 189

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There's no easier, faster, or more practical way to learn the really tough subjectsCorporate Finance Demystified offers a comprehensive introduction to corporate finance principles, the time value of money, including present value, amortization schedules, and more. This self-teaching guide comes com
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