Understanding Financial Management: A Practical Guide

List of Figures ix

List of Tables xi

About the Authors xiv

Preface xvi

Acknowledgments xx

Part I The Foundation 1

Chapter 1 Introduction to Financial Management 3

1.1 Financial Management and the Financial Manager 4

1.2 Corporate Form of Business Organization 8

1.3 The Goal of Financial Management 10

1.4 Accounting Profit versus Economic Profit 12

1.5 The Agency Relationship 14

1.6 Organization of the Book 15

Chapter 2 Interpreting Financial Statements 18

2.1 Basics of Annual Reports and Financial Statements 18

2.2 Balance Sheet 20

2.3 Income Statement 25

2.4 Statement of Cash Flows 31

2.5 Statement of Retained Earnings 35

2.6 Common-size Statements 35

2.7 Notes to Financial Statements 39

2.8 Quality of Earnings 40

2.9 Other Issues 41

Chapter 3 Interpreting Financial Ratios 45

3.1 Financial Ratio Analysis 46

3.2 Liquidity Ratios 47

3.3 Debt Management Ratios 52

3.4 Asset Management Ratios 56

3.5 Profitability Ratios 61

3.6 Market Value Ratios 66

3.7 Uses of Financial Ratios 69

3.8 Limitations of Financial Ratio Analysis 70

Chapter 4 The Time Value of Money 73

4.1 Central Concepts in Finance 74

4.2 Future Value of a Present Amount 75

4.3 Present Value of a Future Amount 80

4.4 Future Value of an Annuity 83

4.5 Present Value of an Annuity 86

4.6 Present Value of a Perpetuity 91

4.7 Compounding Frequencies 91

4.8 Nominal and Effective Interest Rates 94

4.9 Solving for an Unknown Interest Rate 95

4.10 Other Time Value Applications 98

Chapter 5 Valuation 103

5.1 Valuation Fundamentals 104

5.2 Bond Characteristics and Features 110

5.3 Bond Valuation 115

5.4 Bond Pricing Relationships 121

5.5 Interest Rate Risk 126

5.6 Bond Yields 129

5.7 Bond Trading and Price Reporting 134

5.8 Preferred Stock Features and Valuation 136

5.9 Common Stock Characteristics and Features 140

5.10 Common Stock Valuation 142

Part II Working Capital Management Decisions 155

Chapter 6 Working Capital Management 157

6.1 Introduction to Working Capital Management 158

6.2 Approaches to Working Capital Management 159

6.3 Operating and Cash Conversion Cycles 163

6.4 Cash Management 165

6.5 Accounts Receivable Management 177

6.6 Inventory Management 181

Part III Long-term Investment Decisions 189

Chapter 7 Capital Investments and Cash Flow Analysis 191

7.1 Capital Investment Decisions 192

7.2 Project Classifications 194

7.3 Capital Budgeting Process 195

7.4 Guidelines for Estimating Project Cash Flows 199

7.5 Cash Flow Components 205

7.6 Tax Effects of Selling Depreciable Assets 214

7.7 Applying Cash Flow Analysis 217

7.8 Capital Budgeting for the Multinational Corporation 221

Chapter 8 Capital Budgeting 227

8.1 Project Classifications and Analysis 228

8.2 Net Present Value 230

8.3 Profitability Index 235

8.4 Internal Rate of Return 238

8.5 Modified Internal Rate of Return 242

8.6 Payback Period 246

8.7 Discounted Payback Period 250

8.8 Summary of Capital Budgeting Techniques 252

8.9 Mutually Exclusive Project Decisions 254

8.10 Capital Rationing Decisions 269

8.11 Capital Budgeting Techniques in Theory and Practice 272

Chapter 9 Risk Analysis 278

9.1 Types of Risk in Capital Budgeting 279

9.2 Assessing Single-Project Risk 285

9.3 Assessing Market Risk 294

9.4 Adjusting for Risk 302

9.5 Risk Analysis in Multinational Corporations 313

9.6 Risk Analysis in Theory and Practice 315

Part IV Long-term Financing Decisions 321

Chapter 10 Raising Funds and Cost of Capital 323

10.1 Financial Markets 324

10.2 Investment Banks 327

10.3 The Decision to Go Public 328

10.4 Different Methods of Issuing New Securities 331

10.5 Public Offer 335

10.6 Private Placement 339

10.7 Costs of Issuing New Securities 341

10.8 Cost of Capital Concept 342

10.9 Cost of Capital Components 345

10.10 Weighted Average Cost of Capital 358

10.11 Marginal Cost of Capital 361

Chapter 11 Capital Structure 369

11.1 The Financing Mix 370

11.2 Understanding Financial Risk 371

11.3 Capital Structure and the Value of the Firm 375

11.4 Modigliani–Miller Theorem with Corporate Taxes 381

11.5 The Costs of Financial Distress 386

11.6 Tradeoff Theory of Optimal Capital Structure 388

11.7 Pecking Order Theory of Capital Structure 391

11.8 Stakeholder Theory of Capital Structure 394

11.9 Capital Structure in Practice 396

11.10 Bankruptcy 397

Chapter 12 Dividend Policy 401

12.1 Dividends and Dividend Policy 402

12.2 The Dividend Puzzle 407

12.3 Factors Influencing the Dividend Decision 417

12.4 Dividend Policies 423

12.5 Stock Repurchases 429

12.6 Cash Dividends versus Stock Repurchases 434

12.7 Dividend Reinvestment Plans 436

12.8 Stock Dividends 440

12.9 Stock Splits and Reverse Splits 446

Glossary 453

Index 469