Finance for Executives

Contents

Part I Introduction

• The Key Question: Will Your Decision Create Value? 2
• The Fundamental Finance Principle 5
• Applying the Fundamental Finance Principle 9
• The Role of Financial Markets 14
• The Business Cycle 18
• HLC's Financial Statements 20
• How Profitable is a Firm? 25
• How Much Cash Does a Firm Generate? 26
• How Risky is a Firm? 28
• Is Value Created? 30
• Summary 31
• Further Reading 32
• Review Problems 33

• Financial Accounting Statements 37
• The Balance Sheet 40
• The Income Statement 50
• Reconciling Balance Sheets and Income Statements 54
• The Structure of the Owners' Equity Account 56
• Summary 57
• Appendix 2.1 Specimen Financial Statements 60
• Polo Ralph Lauren's Balance Sheets and Income Statements 60
• Further Reading 65
• Review Problems 65

• The Managerial Balance Sheet 68
• The Components of Capital Employed 75
• The Matching Strategy 77
• A Measure of Liquidity Based on the Funding Structure of Working Capital Requirement 79
• Improving Liquidity Through Better Management of the Operating Cycle 81
• Traditional Measures of Liquidity 89
• Summary 91
• Appendix 3.1 Financing Strategies 93
• Appendix 3.2 Polo Ralph Lauren's Liquidity and Operational Efficiency 96
• Further Reading 102
• Review Problems 102

• Cash Flows and Their Sources 108
• Preparing a Detailed Cash Flow Statement 111
• Two Variations of the Cash Flow Statement 119
• Bankers' Cash Flow versus Net Operating Cash Flow 123
• Managerial Implications 124
• Summary 126
• Appendix 4.1 Obtaining the Net Operating Cahs Flow From Balance Sheet and Income Statement Accounts 127
• Appendix 4.2 Polo Ralph Lauren's Cash Flows 132
• Further Reading 137
• Review Problems 137

• Measures of Profitability 142
• Return on Equity 143
• Other Measures of Profitability 157
• Financial Leverage and Risk 158
• Self-Sustainable Growth 162
• Summary 167
• Appendix 5.1 Factors Affecting a Firm's Operating Profitability 169
• Appendix 5.2 The Relationship Between a Firm's Roe and Its Aftertax Roic 173
• Appendix 5.3 Polo Ralph Lauren's Profitability 174
• Further Reading 180
• Review Problems 180

• The Capital Investment Process 186
• Would You Buy this Parcel of Land? 188
• The Net Present Value Rule 190
• Applying the Net Present Value Rule to a Capital Investment Decision 196
• Why the NPV Rule is a Good Investment Rule 198
• Special Cases of Capital Budgeting 205
• Limitations of the Net Present Value Criterion 209
• Summary 213
• Appendix 6.1 Calculation of the Present Value of an Annuity and the Constant Annual-Equivalent Cash Flow of a Project's Cash-Flow Stream 215
• Further Reading 218
• Review Problems 218

• The Payback Period 222
• The Discounted Payback Period 226
• The Internal Rate of Return (IRR) 229
• The Profitability Index (PI) 236
• Summary 239
• Further Reading 239
• Review Problems 239

• The Actual Cash-Flow Principle 243
• The With/Without Principle 244
• The Designer Desk Lamp Project 246
• Identifying a Project's Relevant Cash Flows 249
• Estimating a Project's Relevant Cash Flows 255
• Should SMC Launch the New Product? 261
• Summary 263
• Further Reading 264
• Review Problems 265

• Estimating the Amount of Required External Funds 268
• The Financial System: Its Structure and Functions 272
• How Firms Issue Securities 279
• Debt Capital: Characteristics and Valuation 285
• Equity Capital: Characteristics and Valuation 299
• Summary 304
• Appendix 9.1 The Bond Valuation Formula 305
• Appendix 9.2 The Valuation Formula for the Constant Growth Dividend Model 307
• Further Reading 308
• Review Problems 308

• Identifying Proxy or Pure-Play Firms 313
• Estimating the Cost of Debt 313
• Estimating the Cost of Equity: The Divided Discount Model 315
• Estimating the Cost of Equity: The Capital Asset Pricing Model 317
• Estimating the Cost of Capital of a Firm 329
• Estimating the Cost of Capital of a Project 333
• Summary 343
• Further Reading 344
• Review Problems 345

• The Capital Structure Decision: No Corporate Taxes and No Financial Distress Costs 348
• Effect of Changes in Capital Structure on the Firm's Value: The Pizza Theory 353
• The Capital Structure Decision: Corporate Income Taxes and No Financial Distress Costs 359
• The Capital Structure Decision When Financial Distress is Costly 367
• Formulating a Capital Structure Policy 370
• Summary 382
• Further Reading 384
• Review Problems 384

• Alternative Valuation Methods 388
• Valuing a Firm's Equity Using Comparables 390
• Valuing a Firm's Assets and Equity Using the Discounted Cash Flow Approach 397
• Estimating the DCF Value of OS Distributers' Assets and Equity 402
• Estimating the Acquisition Value of OS Distributors 409
• Estimating the Leveraged Buyout Value of OS Distributors 419
• Summary 428
• Appendix 12.1 The Dividend Discount Model Approach to the Valuation of a Firm's Equity 431
• Further Reading 432
• Review Problems 433

• The Firm's Risk Exposure from Foreign Operations 436
• The Foreign Exchange Market 439
• Hedging Contractual Exposure to Currency Risk 442
• Hedging Long-Term Contractual Exposure to Currency Risk with Swaps 454
• The Relationships Among Exchange Rates, Inflation Rates, and Interest Rates 455
• Analyzing an International Investment Project 460
• Managing Country Risk 469
• Summary 471
• Appendix 13.1 Translating Financial Statements with the Monetary/Nonmonetary Method and the Current Method 473
• Appendix 13.2 The Parity Relations 477
• Further Reading 483
• Review Problems 484

• Measuring Value Creation 488
• Identifying the Drivers of Value Creation 495
• Linking Operating Performance and Remuneration to Value Creation 500
• Linking the Capital Budgeting Process to Value Creation 508
• Putting it all Together: The Financial Strategy Matrix 512
• Summary 515
• Appendix 14.1 Adjusting Book Values to Estimate the Amount of Invested Equity Capital and Operating Profit 517
• Appendix 14.2 Estimating Market Value Added (MVA) When Future Cash Flows are Expected to Grow at a Constant Rate in Perpetuity 520
• Further Reading 521
• Review Problems 522
• Glossary 527
• Answers to Review Problems 551
• Index