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Fundamentals of Financial Management (12th edition) PDF

755 Pages·2009·47.91 MB·English
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F U N D A M E N T A L S O F F I N A N C I A L M A N A G E M E N T Twelfth Edition Eugene F. Brigham UNIVERSITY OF FLORIDA Joel F. Houston UNIVERSITY OF FLORIDA Australia•Brazil•Japan•Korea•Mexico•Singapore•Spain•UnitedKingdom•UnitedStates FundamentalsofFinancial ©2009,2007South-Western,apartofCengageLearning Management,12thedition ALLRIGHTSRESERVED.Nopartofthisworkcoveredbythecopyrighthereon EugeneF.Brigham,JoelF.Houston maybereproducedorusedinanyformorbyanymeans—graphic,electronic,or VicePresidentofEditorial,Business: mechanical,includingphotocopying,recording,taping,Webdistribution,information JackW.Calhoun storageandretrievalsystems,orinanyothermanner—exceptasmaybepermittedby thelicensetermsherein. Editor-in-Chief:AlexvonRosenberg ExecutiveEditor:MichaelR.Reynolds Forproductinformationandtechnologyassistance,contactusat DevelopmentEditor: CengageLearningCustomer&SalesSupport,1-800-354-9706 MichaelGuendelsberger ExecutiveMarketingManager: Forpermissiontousematerialfromthistextorproduct, submitallrequestsonlineatwww.cengage.com/permissions BrianJoyner Furtherpermissionsquestionscanbeemailedto MarketingManager:NathanAnderson [email protected] SeniorMarketingCommunications Manager:JimOverly ExamView®isaregisteredtrademarkofeInstructionCorp. MarketingCoordinator:SuellenRuttkay WebsiteProjectManager:BrianCourter ©2009CengageLearning.AllRightsReserved. FrontlistBuyer,Manufacturing: LibraryofCongressControlNumber:2008941113 KevinKluck ISBN13:978-0-324-59771-4 SeniorArtDirector:MichelleKunkler ContentProjectManager:JenniferA. ISBN10:0-324-59771-1 Ziegler StudentEditionISBN13:978-0-324-59770-7 DirectorofProduction:SharonSmith StudentEditionISBN10:0-324-59770-3 MediaEditor:ScottFidler SeniorEditorialAssistant:AdeleT. South-WesternCengageLearning Scholtz 5191NatorpBoulevard ProductionService:LittenEditing Mason,OH45040 andPublishing USA Compositor:MacmillanPublishing Solutions CengageLearningproductsarerepresentedinCanadaby Cover and InternalDesigner: NelsonEducation,Ltd. GrannanGraphicDesign PhotographyManager:SheriBlaney Foryourcourseandlearningsolutions,visitacademic.cengage.com Purchaseanyofourproductsatyourlocalcollegestoreoratour preferredonlinestorewww.ichapters.com Printed in the United States of America 1 2 3 4 5 6 7 12 11 10 09 08 P R E F A C E WhenthefirsteditionofFundamentalswaspublished31yearsago,wewantedto provide an introductory text that students would find interesting and easy to understand.Fundamentalsimmediatelybecametheleadingundergraduatefinance text,andithasmaintainedthatpositioneversince.Ourgoalwiththiseditionwas to produce a book and ancillary package that would maintain its lead and set a new standard for finance textbooks. Important changes in the financial environment have occurred since the last edition. New technology and increased globalization continue to transform practices and markets. Continued improvements in communications and transportation have made it easier for businesses to operate on a worldwide basis—a company can be headquarteredinNewYork,developproductsinIndia,manufacturetheminChina, and sell them anywhere in the world. This has led to major changes in the labor markets,especiallytoanincreaseinoutsourcing,whichhasresultedingenerallylower consumer prices; but it has caused job losses for some U.S. workers and gains for others.Therehavealsobeendramaticrisesandfallsinthestockmarket,andinterest rates have remained low even as energy prices continue to rise. Corporate scandals have led to important changes in the laws governing corporate management and financial reporting, as well as to equally important changes in managerial compen- sation. These issues are discussed in this edition of Fundamentals, where we analyze them from financial and ethical perspectives. Our target audience is undergraduate students taking their first, and often only, financecourse.Somestudentswilldecidetomajorinfinanceandgoontotakecourses in investments, money and capital markets, and advanced corporate finance. Others willchoosemarketing,management,orsomeothernonfinancemajor.Stillotherswill majorinareasotherthanbusinessandtakefinanceandafewotherbusinesscourses to gain information that will help them in law, real estate, and other fields. Ourchallengewastoprovideabookthatservesalloftheseaudienceswell.Our conclusion was that we should focus on the core principles of finance (i.e., on basic topics such as the time value of money, risk analysis, and valuation). Moreover, we concluded that we should address these topics from two points of view: (1) as an investor who is seeking to make intelligent investment choices and (2) as a business manager trying to maximize the value of his or her firm's stock. Note that both investors and managers need to know the same set of principles, so the core topics are important to students regardless of what they choose to do after they finish the course. THE FINANCIAL CRISIS OF 2008 As everyone knows, the financial markets experienced a meltdown in the fall of 2008. The average stock's price declined by about 50%, which wiped out trillions of dollars of savings. The (sick) joke was that 401 (k) retirement plans were becoming 201 (k) plans. These market losses delayed many retirements and also caused many retirees to go back to work. Housing construction virtually ceased, and home prices plunged by about 20% nationwide and by as much as 50% in some parts of the country, wiping out trillions more of savings. Millions of homeowners found that their mortgages exceeded the value of their homes, and defaults and foreclosures followed. This led to huge losses by banks and other lenders, which in turn led to bankruptcies, restructuring, and massive layoffs. Threeyearsago,thereweremanystrong,old,andindependentglobalinvestment banks. Today, all of those in the U.S. are gone—icons like Merrill Lynch and iii iv Preface MorganStanleyhaveeithergonebankrupt,soldoutatrockbottomprices,orbeen forced to convert into regulated banks that are partially owned by the federal government. The credit markets literally froze up. Banks needed to conserve their cash to meetwithdrawals;hencetheyrefusedtomakeloanseventostrongindustrialand retail companies, or home and auto purchasers. This quickly led to a severe slowdown in non-financial businesses, accompanied by still more bankruptcies and layoffs. This happened all over the world, and the specter of a 1930s type depressionwasonthemindsofcentralbankersandtreasuryofficialsworldwide. Asaresult,coordinatedgovernmentrescueplanswereputintooperationinmost developed nations. We don't know at this point what will happen next. The best bet is that a depression will be avoided but a bad recession will occur. Going forward, companies and individuals will recognize that an excessive use of debt was the root cause of the financial meltdown, hence there will be a smaller and more responsible use of debt in the future—at least until memories of 2008 fade. How should the 2008 Crisis affect the contents of this textbook? Here is our conclusion: l The fundamental concepts of finance are unchanged; hence all the concepts covered in the book are still applicable. l The problems of 2008 resulted largely because businesses, individuals, and government officialsdid not pay sufficient attention to the basic principles of finance as covered in the book. l Therefore, there is no reason to change most of the book. l We should, however, use the 2008 experience to illustrate the basic points made in the book. For example, we talk about risk, and 2008 can and should be used to drive home how risk can be measured and dealt with. The economic situation is fluid and dynamic. We may have a rapid recovery, whichwouldbegreat,but,wemighthavealong,deep,andpainfulrecession.We plantousetheInternetintheyearsahead,whilethebookisinuse,toupdatethe situationonachapter-by-chapterbasis.Aseventsrelatedtothedifferentchapters occur,wewillprovideupdatedvignettesandotherinformationonthebook'web site.Weanticipatemanyimportantdevelopments,hencealotofupdates.Still,the good news is that the basic, fundamental contents of the book will remain the same. ORGANIZATION OF THE CHAPTERS: A VALUATION FOCUS As we discuss in Chapter 1, in an enterprise system such as that of the United States, the primary goal of financial management is to help managers maximize their firms' values, subject to constraints such as not polluting the environment, not engaging in unfair labor practices, and not engaging in antitrust activities. Therefore, valuation underlies everything in Fundamentals. In Chapter 1, we dis- cuss the concept of valuation, explain how it depends on future cash flows and risk, and show why value maximization is good for society in general. The val- uation theme runs throughout the text. Values are not established in a vacuum—stock and bond values are deter- mined in the financial markets, so an understanding of those markets is essential to anyone involved with finance. Therefore, Chapter 2 covers the major types of financialmarkets,thereturnsthatinvestorshavehistoricallyearned,andtherisks inherent in different types of securities. This information is important for anyone working in finance. It is also important for anyone who has or hopes to own financial assets. Preface v Asset values depend in a fundamental way on earnings and cash flows as reported in the accounting statements. Therefore, we review those statements in Chapter3.TheninChapter4,weshowhowaccountingdatacanbeanalyzedand usedtomeasurehowwellacompanyhasoperatedinthepastandhowitislikely to perform in the future. Chapter 5 covers the time value of money (TVM), perhaps the most funda- mental concept in finance. The basic valuation model, which ties together cash flows, risk, and interest rates, is based on TVM concepts; and these concepts are used throughout the remainder of the book. Therefore, students should allocate plenty of time to Chapter 5. Chapter 6 deals with interest rates, a key determinant of asset values. We discuss how interest rates are affected by risk, inflation, liquidity, the supply of and demand for capital in the economy, and the actions of the Federal Reserve. ThediscussionofinterestratesleadsdirectlytobondsinChapter7andstocks in Chapters 8 and 9. We show how stocks and bonds (and all other financial assets) are valued using the basic TVM model. Chapters 1 through 9 provide background information that is essential to investors and corporate managers. These are “finance” topics, not “business” or “corporate finance” topics as those terms are commonly used. Thus, Chapters 1 through9discusstheconceptsandmodelsusedtoestablishvalues,andwegoon in Chapters 10 through 21 to discuss specific actions managers can take to max- imize their firms' values. Asnotedpreviously,mostbusinessstudentsdon'tplantospecializein finance, sotheymightnotthinkthe“businessfinance”chaptersarerelevanttothem.Thisis not true, and in the later chapters, we show that all important business decisions involveallofafirm'sdepartments—marketing,accounting,production,andsoforth. Thus, while capital budgeting can be thought of as a financial decision, marketing people provide input on likely unit sales and sales prices, manufacturing people provide inputs on costs, and so forth. Moreover, capital budgeting decisions influ- encethesizeofthefirm,itsproducts,anditsprofits;andthosefactorsaffectallthe firm's employees, from the CEO to the mail room staff. STRUCTURAL CHANGES We made two important structural changes in this new edition: 1. WemovedthematerialonfinancialmarketsandinstitutionsfromChapter5to Chapter 2. Markets and institutions follow naturally from Chapter 1, and this materialprovidesusefulbackgroundinformationfortheremainderofthebook. 2. Wemovedthetimevalueofmoney(TVM)chapterfromChapter2toChapter5. Under the previous structure, we covered TVM concepts, then covered the accounting and financial markets chapters before applying TVM concepts to bond and stock valuation. We liked the idea of covering TVM early, but we concluded that it was pedagogically better to cover TVM concepts and then immediately focus on applications, as we do now. These changes improve the flow of the text significantly—there is a much smoother transition from chapter to chapter in the first part of the book. OTHER CHANGES We made many other changes, but the following are the most significant: 1. Editing. We edit each new edition toimprove clarity, but we did more in this edition than ever before. We put the entire text on digital files, which vi Preface facilitated shifting things around to improve transitions and flow. Students will find it easier to read the book than in the past. 2. Beginning-of-Chapter Vignettes and Within-Chapter Boxes. Many events have transpired in the financial markets during the past three years—for example, in 2008 credit markets tightened almost to the point of collapse, the housing andautomarketsareinterribleshape,themajorinvestmentbanksallfailedor were forced to reorganize as regulated commercial banks, and the heads of a number ofmajorcorporations were fired. We usetheseevents asthe subjects ofmanyvignettesandboxes,andtheyillustrateverywellthepointsmadein the chapters. 3. Learning Objectives. To help students see what we expect them to take away from the chapters, we added a set of learning objectives at the beginning of each chapter. 4. Excel. Spreadsheets, especially Excel, are becoming increasingly important in business; and students who are familiar with Excel have a significant advantageinthejobmarketandlateronthejob.WeusedExcelintwoways. First, we worked all the in-text examples, end-of-chapter problems, and test bankproblemswithbothExcelandacalculator,usingthecalculatortomake suretheproblemwasworkablewithacalculatorandusingExceltocheckfor accuracy.Second,weusedExceltocreatemanyofthetablesandgraphsinthe text, we displayed them as Excel pictures, and we have made available the models we used. Students do not need to know how to use Excel to go through the book, but if they are somewhat familiar with this software, they will see how many common financial problems can be set up and solved efficiently with Excel. Students who are not familiar with Excel may also be motivated to learn something about it. 5. Tie-In between Self-Test Questions, End-of-Chapter Questions, and the Test Bank. Becausetestingisimportant,wespentagreatdealoftimeimprovingthetest bank. Every question and problem was reviewed for clarity, accuracy, and consistencywiththetext.Also,wesetupself-testquestionsattheendofeach majorsectionwithinthetexttoenablestudentstotakereal-timetestsontheir ownbeforemovingon.Theend-of-chapter(EOC)questionsandproblemsare similar to, but often go beyond, the self-test questions, and the test bank questionsandproblemsaresimilartotheEOCmaterials.Ifstudents readthe text, do the self-test questions as they go along, and then work a sampling of the EOC questionsand problems,they shoulddo well on examsdrawn from the test bank. 6. Accounting Statements and Free Cash Flow. Most students in the basic finance course arefamiliarwith balance sheetsand income statements, but many don't understand the statement of cash flows and its relationship to free cash flows. Reviewerstoldusthatinthelasteditionwetriedtodotoomanythings—such as present alternative ways to calculate free cash flow—and that we should delete some of those items and better explain what remained. We agreed, and this edition does a much better job in this regard. 7. Cash Flows and Risk in Capital Budgeting. In the last edition, the first two chapters on capital budgeting (Chapters 11 and 12) were not tied together very well. In that edition, we used relatively simple and straightforward illustrative projects in Chapter 11 but switchedto entirely different and more complex projects in Chapter 12. For this edition, we rewrote Chapter 12, continuing with the Chapter 11 examples. We also reordered materials to presenttheminamorelogicalsequence.Onereviewerstatedthatthischapter was the single biggest improvement in the twelfth edition. 8. Financial Forecasting. As we were rewriting Chapter 17, GE's chairman announced that heexpected toreport higherearnings shortly,but twoweeks laterheannouncedasignificantearningsdecline,whichledtoasharpdropin Preface vii GE'sstockprice.Weusedthisexampletoillustratetheimportanceofaccurate forecasts and to liven up our discussion of strategic financial planning. In addition, we used an improved Excel model to streamline our illustrative forecast and to make the forecasting process simpler and clearer to students. 9. Capital Budgeting. We moved the analysis of projects with unequal lives back from Chapter 13 to Chapter 12 because unequal life analysis is more closely related to the other topics in Chapter 12. An additional benefit is that Chapter 13 is now more streamlined and focuses on real options. 10. Derivatives. We rearranged some of the sections to improve the discussion in Chapter 18. More specifically, we moved the “Using Derivatives to Reduce Risk”sectionsothatitimmediatelyfollowsthediscussionof“OtherTypesof Derivatives,”Wealsoreceivedfeedbacksuggestingthatwefocusedtoomuch on call options. With that in mind, we added a new Appendix 18A entitled “Valuation of Put Options.” Finally, we added some problems related to option pricing using the riskless hedge approach. 11. Mergers. We eliminated the discussion of purchase/pooling accounting treatment from Chapter 21 since all mergers are now accounted for as pur- chases. We also moved the discussion of merger regulation to a Web Appendix to help streamline the chapter. We could continue to list changes in this edition, but these items provide instructors (particularly those familiar with the last edition) with a good idea of the kinds of revisions that were made to this text. It also lets students know how authors try to improve their texts. ACKNOWLEDGMENTS The book reflects the efforts of a great many people—those who worked on Fundamentals and our related books in the past and those who worked on this twelfthedition.First,wewouldliketothankDanaAberwaldClark,whoworked closely with us at every stage of the revision—her assistance was absolutely invaluable.Second,SusanWhitmanprovidedgreattypingandlogisticalsupport. Our colleagues Roy Crum, Jim Keys, Andy Naranjo, M. Nimalendran, Jay Ritter, Mike Ryngaert, Craig Tapley, and Carolyn Takeda gave us many useful suggestions regarding the ancillaries and many parts of the book, including the integrated cases. We also benefited from the work of Mike Ehrhardt and Phillip Daves of the University of Tennessee and Roy Crum of the University of Florida, who worked with us on companion books. Also, Christopher Buzzard did an outstanding job helping us develop the Excel models, the web site, and the PowerPoint® presentations. Next, we would like to thank the following professors who reviewed this edition in detail and provided many useful comments and suggestions: Rebecca Abraham—Nova Southeastern University Kavous Ardalan—Marist College Tom Arnold—University of Richmond Deborah Bauer—University of Oregon Gary Benesh—Florida State University Mark S. Bettner—Bucknell University Elizabeth Booth—Michigan State University Brian Boscaljon—Penn State University, Erie Rajesh Chakrabarti—Georgia Institute of Technology Brent Dalrymple—University of Central Florida Jim DeMello—Western Michigan University Anne M. Drougas—Dominican University viii Preface Scott Ehrhorn—Liberty University David Feller—Brevard Community College Jennifer Foo—Stetson University Partha Gangopadhyay—St. Cloud State University Sharon H. Garrison—University of Arizona Robert P. Hoffman—College of St. Scholastica Benjamas Jirasakuldech—University of the Pacific Ashok Kapoor—Augsburg College Howard Keen—Temple University Christopher J. Lambert, J.D.—Fairmont State University Alice Lee—San Francisco State University Denise Letterman—Robert Morris University Yulong Ma—California State University, Long Beach Barry Marchman—Florida A&M Brian Maris—Northern Arizona University Matthew Morey—Pace University Tom C. Nelson—Leeds School of Business, University of Colorado at Boulder Darshana Palkar—Minnesota State University, Mankato Narendar V. Rao—Northeastern Illinois University Charles R. Rayhorn—Northern Michigan University Oliver Schnusenberg—University of North Florida Dean S. Sommers—University of Delaware Michal Spivey—Clemson University Glenn L. Stevens—Franklin & Marshall College Lowell E. Stockstill—Wittenberg University Samantha Thapa—Western Kentucky University David O. Vang—University of St. Thomas Sheng Yang—Black Hills State University David Zalewski—Providence College Sijing Zong—California State University—Stanislaus We would also like to thank the following professors, whose reviews and comments on our earlier books contributed to this edition: Robert Adams Charles Geof Booth Alva Butcher Mike Adler Barngrover Waldo Born Bill Campsey Sharif Ahkam Sam Basu Steven Bouchard Bob Carlson Syed Ahmad Greg Bauer Kenneth Severin Carlson Ed Altman Bill Beedles Boudreaux David Cary Bruce Anderson Brian Belt Rick Boulware Steve Celec Ron Anderson MosheBen-Horim Helen Bowers Mary Chaffin Tom Anderson Bill Beranek Oswald Bowlin Charles Chan John Andrews Tom Berry Don Boyd Don Chance Bob Angell Will Bertin G. Michael Boyd Antony Chang Vince Apilado Scott Besley Pat Boyer Susan Chaplinsky Harvey Dan Best Joe Brandt K. C. Chen Arbalaez Roger Bey Elizabeth Jay Choi Henry Arnold Gilbert W. Brannigan S. K. Choudhary Bob Aubey Bickum Mary Broske Lal Chugh Gil Babcock Dalton Bigbee Christopher Maclyn Clouse Peter Bacon John Bildersee Brown Bruce Collins Kent Baker Laurence E. Blose David T. Brown Mitch Conover Robert Balik Russ Boisjoly Kate Brown Margaret Tom Bankston Bob Boldin Larry Brown Considine Babu Baradwaj Keith Boles Bill Brueggeman Phil Cooley Les Barenbaum Michael Bond Paul Bursik Joe Copeland Preface ix David Cordell Wafica Ghoul Narayanan Ileen Malitz Marsha Cornett Erasmo Jayaraman Bob Malko M. P. Corrigan Giambona Zhenhn Jin Phil Malone John Cotner Armand Gilinsky, Kose John Abbas Charles Cox Jr. Craig Johnson Mamoozadeh David Crary Philip Glasgo Keith Johnson Terry Maness John Crockett, Jr. Rudyard Goode Ramon Johnson Chris Manning Bill Damon Raymond Steve Johnson Surendra Morris Danielson Gorman Ray Jones Mansinghka Joel Dauten Walt Goulet Frank Jordan Timothy Manuel Steve Dawson Bernie Manuel Jose Terry Martell Sankar De Grablowsky Sally Joyner David Martin Fred Dellva Theoharry Alfred Kahl D. J. Masson Chad Denson Grammatikos Gus Kalogeras John Mathys James Owen Gregory Rajiv Kalra Ralph May Desreumaux Ed Grossnickle Ravi Kamath John McAlhany Bodie Dickerson John Groth John Kaminarides Andy Bernard Dill Alan Grunewald Michael Keenan McCollough Gregg Dimkoff Manak Gupta Bill Kennedy Ambrose McCoy Les Dlabay Darryl Gurley Peppi M. Kenny Thomas McCue Mark Dorfman Sam Hadaway Carol Kiefer Bill McDaniel Tom Downs Don Hakala Joe Kiernan John McDowell Frank Draper Gerald Richard Kish Charles Gene Drzycimski Hamsmith Robert Kleiman McKinney Dean Dudley William Hardin Erich Knehans Robyn David Durst John Harris Don Knight McLaughlin Ed Dyl Paul Hastings Ladd Kochman James McNulty Fred J. Ebeid Bob Haugen Dorothy Koehl Jeanette Daniel Ebels Steve Hawke Jaroslaw Medewitz- Richard Edelman Stevenson Komarynsky Diamond Charles Edwards Hawkey Duncan Kretovich Jamshid Mehran U. Elike Del Hawley Harold Krogh Larry Merville John Ellis Eric M. Haye Charles Kroncke Rick Meyer George Engler Robert Hehre Don Kummer Jim Millar Suzanne Erickson Kath Henebry Robert A. Kunkel Ed Miller Dave Ewert David Heskel Reinhold Lamb John Miller John Ezzell George Joan Lamm John Mitchell L. Franklin Fant Hettenhouse Larry Lang Carol Moerdyk Richard J. Fendler Hans Heymann David Lange Bob Moore Michael Ferri Kendall Hill P. Lange Scott Moore Jim Filkins Roger Hill Howard Lanser Barry Morris John Finnerty Tom Hindelang EdwardLawrence Gene Morris Robert Fiore Linda Hittle Martin Lawrence Dianne R. Susan Fischer Ralph Hocking Wayne Lee Morrison Peggy Fletcher J. Ronald Jim LePage Chris Muscarella Steven Flint Hoffmeister David E. David Nachman Russ Fogler Robert Hollinger LeTourneau Tim Nantell Jennifer Frazier Jim Horrigan Jules Levine Don Nast Dan French John Houston John Lewis Edward Nelling Michael John Howe Jason Lin Bill Nelson Garlington Keith Howe Chuck Linke Bob Nelson David Garraty Steve Isberg Bill Lloyd William Nelson Jim Garven Jim Jackson Susan Long Bob Niendorf Adam Gehr, Jr. Keith Jakob Judy Maese Bruce Niendorf Jim Gentry Vahan Janjigian Bob Magee Ben Nonnally, Jr.

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Most books are stored in the elastic cloud where traffic is expensive. For this reason, we have a limit on daily download.