Tenth Edition
FUNDAMENTALS OFCORPORATE FINANCE
Stephen A. RossMassachusetts Institute of Technology
Randolph W. WesterfieldUniversity of Southern California
Bradford D.JordanUniversity of Kentucky
McGraw-HillIrwin
CHAPTER!
INTRODUCTION TO CORPORATE FINANCE 1
1.1 Corporate Finance and the Financial Manager 2What Is Corporate Finance? 2The Financial Manager 2Financial Management Decisions 2
Capital Budgeting 2Capital Structure 3Working Capital Management 4Conclusion 4
1.2 Forms of Business Organization 4Sole Proprietorship 4Partnership 5Corporation 5A Corporation by Another Name . . . 7
1.3 The Goal of Financial Management 7Possible Goals 8The Goal of Financial Management 8A More General Goal 9Sarbanes-Oxley 9
1.4 The Agency Problem and Controlof the Corporation 10Agency Relationships 10Management Goals 10Do Managers Act in the Stockholders! Interests? 11
Managerial Compensation 11Control of the Firm 12Conclusion 12
Stakeholders 121.5 Financial Markets and the Corporation 13
Cash Flows to and from the Firm 14Primary versus Secondary Markets 14
Primary Markets 14Secondary Markets 15
1 Dealer versus Auction Markets 15Trading in Corporate Securities 15Listing 16
1.6 Summary and Conclusions 16
CHAPTER 2
FINANCIAL STATEMENTS, TAXES,AND CASH FLOW 20
2.1 The Balance Sheet 21Assets: The Left Side 21Liabilities and Owners' Equity: The Right Side 21Net Working Capital 22Liquidity 23Debt versus Equity 24Market Value versus Book Value 24
2.2 The Income Statement 25GAAP and the Income Statement 26Noncash Items 27Time and Costs 27
2.3 Taxes 29Corporate Tax Rates 30Average versus Marginal Tax Rates 30
2.4 Cash Flow 32Cash Flow from Assets 32
Operating Cash Flow 33Capital Spending 33Change in Net Working Capital 34Conclusion 34A Note about "Free" Cash Flow 35
Cash Flow to Creditors and Stockholders 35Cash Flow to Creditors 35Cash Flow to Stockholders 35
An Example: Cash Flows for Dole Cola 37Operating Cash Flow 37Net Capital Spending 38Change in NWC and Cash Flow from Assets 38Cash Flow to Stockholders and Creditors 38
2.5 Summary and Cohclusions 39
CHAPTER 3
WORKING WITH FINANCIAL STATEMENTS 48
3.1 Cash Flow and Financial Statements:A Closer Look 49Sources and Uses of Cash 49The Statement of Cash Flows 51
3.2 Standardized Financial Statements 53Common-Size Statements 53
Common-Size Balance Sheets 53Common-Size Income Statements 54Common-Size Statements of Cash Flows 55
Common-Base Year Financial Statements:Trend Analysis 55Combined Common-Size and Base Year Analysis 55
xxxi
3.3 Ratio Analysis 56Short-Term Solvency, or Liquidity, Measures 57
Current Ratio 57The Quick (or Acid-Test) Ratio 58Other Liquidity Ratios 59
Long-Term Solvency Measures 59Total Debt Ratio 59A Brief Digression: Total Capitalization versusTotal Assets 60Times Interest Earned 60Cash Coverage 61
Asset Management, or Turnover, Measures 61Inventory Turnover and Days' Sales in Inventory 61Receivables Turnover and Days' Sales in-Receivables 62Asset Turnover Ratios 63
Profitability Measures 63Profit Margin 64Return on Assets 64Return on Equity 64
Market Value Measures 65Price-Earnings Ratio 65Price-Sales Ratio 65Market-to-Book Ratio 66Enterprise Value-EBITDA Ratio 66
Conclusion 673.4 The DuPont Identity 68
A Closer Look at ROE 68An Expanded DuPont Analysis 69
3.5 Using Financial Statement Information 71Why Evaluate Financial Statements? 71
Internal Uses 72External Uses 72
Choosing a Benchmark 72Time Trend Analysis 72Peer Group Analysis 72
Problems with Financial Statement Analysis 773.6 Summary and Conclusions 78
CHAPTER 4
LONG-TERM FINANCIAL PLANNINGAND GROWTH 90
4.1 What Is Financial Planning? 92Growth as a Financial Management Goal 92Dimensions of Financial Planning 92What Can Planning Accomplish? 93
Examining Interactions 93Exploring Options 93Avoiding Surprises 93Ensuring Feasibility and Internal Consistency 94Conclusion 94
4.2 Financial Planning Models: A First Look 94A Financial Planning Model: The Ingredients 94
Sales Forecast 94Pro Forma Statements 95Asset Requirements 95Financial Requirements 95The Plug 95
Economic Assumptions 96A Simple Financial Planning Model 96
4.3 The Percentage of Sales Approach 97The Income Statement 97The Balance Sheet 98A Particular Scenario 700An Alternative Scenario 707
4.4 External Financing and Growth 704EFN and Growth 704Financial Policy and Growth 706
The Internal Growth Rate 106The Sustainable Growth Rate 107Determinants of Growth 108
A Note about Sustainable Growth RateCalculations 7 70
4.5 Some Caveats regarding FinancialPlanning Models 7 7 7
4.6 Summary and Conclusions 712
CHAPTER 5
INTRODUCTION TO VALUATION: THE TIMEVALUE OF MONEY 722
5.1 Future Value and Compounding 723Investing for a Single Period 723Investing for More Than One Period 723A Note about Compound Growth 729
5.2 Present Value and Discounting 730The Single-Period Case 730Present Values for Multiple Periods 737
5.3 More about Present and Future Values 733Present versus Future Value 734Determining the Discount Rate, 734Finding the Number of Periods 738
5.4 Summary and Conclusions 747
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CHAPTER 6
DISCOUNTED CASH FLOW VALUATION 747
6.1 Future and Present Values of Multiple Cash Flows 748Future Value with Multiple Cash Flows 748Present Value with Multiple Cash Flows 757A Note about Cash Flow Timing 754
6.2 Valuing Level Cash Flows: Annuities andPerpetuities 755Present Value for Annuity Cash Flows 755
Annuity Tables 156Finding the Payment 158Finding the Rate 159
Future Value for Annuities 767A Note about Annuities Due -162Perpetuities 763Growing Annuities and Perpetuities 765
6.3 Comparing Rates: The Effect of Compounding 765Effective Annual Rates and Compounding 766Calculating and Comparing Effective Annual Rates 766EARS and APRS 768
Taking It to the Limit: A Note about ContinuousCompounding 770
6.4 Loan Types and Loan Amortization 7 77Pure Discount Loans 7 77Interest-Only Loans 7 72Amortized Loans 7 72
6.5 Summary and Conclusions 7 77
CHAPTER 7
INTEREST RATES AND BOND VALUATION 792
7.1 Bonds and Bond Valuation 793Bond Features and Prices 193Bond Values and Yields 793Interest Rate Risk 797Finding the Yield to Maturity: More Trial and Error 798
7.2 More about Bond Features 203Is It Debt or Equity? 203Long-Term Debt: The Basics 203The Indenture 205
Terms of a Bond 205Security 206Seniority 206Repayment 206The Call Provision 207Protective Covenants 207
7.3 Bond Ratings 2087.4 Some Different Types of Bonds 209
Government Bonds 209Zero Coupon Bonds 270Floating-Rate Bonds 27 7
Other Types of Bonds 272Sukuk 274
7.5 Bond Markets 275How Bonds Are Bought and Sold 276Bond Price Reporting 276A Note about Bond Price Quotes 277
7.6 Inflation and Interest Rates 279Real versus Nominal Rates 279The Fisher Effect 220Inflation and Present Values 227
7.7 Determinants of Bond Yields 222The Term Structure of Interest Rates 222Bond Yields and the Yield Curve: Putting It AllTogether 223Conclusion 225
7.8 Summary and Conclusions 226
CHAPTER 8
STOCK VALUATION 234
8.1 Common Stock Valuation 235Cash Flows 235Some Special Cases 237
Zero Growth 237Constant Growth 237Nonconstant Growth 240Two-Stage Growth 242
Components of the Required Return 243Stock Valuation Using Multiples 244
8.2 Some Features of Common and PreferredStocks 246Common Stock Features 246
Shareholder Rights 246Proxy Voting 247Classes of Stock 247Other Rights 248Dividends 248
Preferred Stock Features 249Stated Value 249Cumulative and Noncumulative Dividends 249Is Preferred Stock Really Debt? 249
8.3 The Stock Markets 250Dealers and Brokers 250Organization of the NYSE 257
Members 251Operations 252Floor Activity 252
NASDAQ Operations 253ECNs 254
Stock Market Reporting 2548.4 Summary and Conclusions 256
CHAPTER 9
NET PRESENT VALUE AND OTHER INVESTMENTCRITERIA 266
9.1 Net Present Value 267The Basic Idea 267Estimating Net Present Value 268
9.2 The Payback Rule 277Defining the Rule 277Analyzing the Rule 272Redeeming Qualities of the Rule 273Summary of the Rule 274
9.3 The Discounted Payback 2749.4 The Average Accounting Return 2779.5 The Internal Rate of Return 279
Problems with the IRR 283Nonconventional Cash Flows 283Mutually Exclusive Investments 285Investing or Financing? 287
Redeeming Qualities of the IRR 288The Modified Internal Rate of Return (MIRR) 289
Method # 7; The Discounting Approach 289Method #2: The Reinvestment Approach 289Method #3: The Combination Approach 289MIRR or IRR: Which Is Better? 290
9.6 The Profitability Index 2909.7 The Practice of Capital Budgeting 2979.8 Summary and Conclusions 294
CHAPTER 10
MAKING CAPITAL INVESTMENT DECISIONS 305
10.1 Project Cash Flows: A First Look 306Relevant Cash Flows 306The Stand-Alone Principle 306
10.2 Incremental Cash Flows 307Sunk Costs 307Opportunity Costs 307Side Effects 308Net Working Capital 308Financing Costs 308Other Issues 309
10.3 Pro Forma Financial Statements and ProjectCash Flows 309Getting Started: Pro Forma Financial Statements 309Project Cash Flows 370
Project Operating Cash Flow 310Project Net Working Capital and Capital Spending 311
Projected Total Cash Flow and Value 37 7
10.4 More about Project Cash Flow 372A Closer Look at Net Working Capital 372Depreciation 375
Modified ACRS Depreciation (MACRS) 315Book Value versus Market Value 316
An Example: The Majestic Mulch and CompostCompany (MMCC) 378
Operating Cash Flows 318Change in NWC 318Capital Spending 321Total Cash Flow and Value 321Conclusion 321
10.5 Alternative Definitions of Operating Cash Flow 322The Bottom-Up Approach 323The Top-Down Approach 323The Tax Shield Approach 323Conclusion 324
10.6 Some Special Cases of DiscountedCash Flow Analysis 324Evaluating Cost-Cutting Proposals 324Setting the Bid Price 326Evaluating Equipment Options with Different Lives 328
10.7 Summary and Conclusions 330
CHAPTER 11
PROJECT ANALYSIS AND EVALUATION 343
11.1 Evaluating NPV Estimates 344The Basic Problem 344Projected versus Actual Cash Flows 344Forecasting Risk 344Sources of Value 345
11.2 Scenario and Other What-lf Analyses 346Getting Started 346Scenario Analysis 347Sensitivity Analysis 349Simulation Analysis 350
11.3 Break-Even Analysis 357Fixed and Variable Costs 357
Variable Costs 351Fixed Costs 353Total Costs 353
Accounting Break-Even 354Accounting Break-Even: A Closer Look 355Uses for the Accounting Break-Even 356
11.4 Operating Cash Flow, Sales Volume, andBreak-Even 357Accounting Break-Even and Cash Flow 357
The Base Case 357
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Calculating the Break-Even Level 358Payback and Break-Even 358
Sales Volume and Operating Cash FlowCash Flow, Accounting, and FinancialBreak-Even Points 359
Accounting Break-Even Revisited 359Cash Break-Even 360Financial Break-Even 360Conclusion 360
358
11.5 Operating Leverage 362The Basic Idea 362Implications of Operating Leverage 362Measuring Operating Leverage 362Operating Leverage and Break-Even 364
11.6 Capital Rationing 364Soft Rationing 365Hard Rationing 365
11.7 Summary and Conclusions 365
CHAPTER 12 CHAPTER 13
SOME LESSONS FROM CAPITAL MARKET HISTORY 374 RETURN, RISK, AND THE SECURITY MARKET LINE 472
12.1 Returns 375Dollar Returns 375Percentage Returns 377
12.2 The Historical Record 379A First Look 379A Closer Look 387
12.3 Average Returns: The First Lesson 385Calculating Average Returns 385Average Returns: The Historical Record 385Risk Premiums 386
The First Lesson 38612.4 The Variability of Returns: The Second Lesson 387
Frequency Distributions and Variability 387The Historical Variance and Standard Deviation 388The Historical Record 390Normal Distribution 397The Second Lesson 3922008: The Bear Growled and Investors Howled 392Using Capital Market History 394More on the Stock Market Risk Premium 394
12.5 More about Average Returns 396Arithmetic versus Geometric Averages 396Calculating Geometric Average Returns 396Arithmetic Average Return or Geometric AverageReturn? 399
12.6 Capital Market Efficiency 400Price Behavior in an Efficient Market 400The Efficient Markets Hypothesis 407Some Common Misconceptions about the EMH 402The Forms of Market Efficiency 403
12.7 Summary and Conclusions 404
13.1 Expected Returns and Variances 473Expected Return 473Calculating the Variance 475
13.2 Portfolios 476Portfolio Weights 477Portfolio Expected Returns 47 7Portfolio Variance 478
13.3 Announcements, Surprises, and ExpectedReturns 420Expected and Unexpected Returns 420Announcements and News 420
13.4 Risk: Systematic and Unsystematic 422Systematic and Unsystematic Risk 422Systematic and Unsystematic Components ofReturn 422
13.5 Diversification and Portfolio Risk 423The Effect of Diversification: Another Lessonfrom Market History 423The Principle of Diversification 424Diversification and Unsystematic Risk 425Diversification and Systematic Risk 426
13.6 Systematic Risk and Beta 426The Systematic Risk Principle 427Measuring Systematic Risk 427Portfolio Betas 429
13.7 The Security Market Line 430Beta and the Risk Premium 430 ——
The Reward-to-Risk Ratio 431The Basic Argument 432The Fundamental Result 434
The Security Market Line 435Market Portfolios 435The Capital Asset Pricing Model 435
13.8 The SML and the Cost of Capital: A Preview 438The Basic Idea 438The Cost of Capital 438
13.9 Summary and Conclusions 439
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CHAPTER 14
COST OF CAPITAL 449
14.1
14.2
14.3
14.4
14.5
14.6
14.7
The Cost of Capital: Some Preliminaries 450Required Return versus Cost of Capital 450Financial Policy and Cost of Capital 457The Cost of Equity 457The Dividend Growth Model Approach 457
Implementing the Approach 451Estimating g 452Advantages and Disadvantages of the Approach 453
The SML Approach 453Implementing the Approach 454Advantages and Disadvantages of the Approach 454
The Costs of Debt and Preferred Stock 455The Cost of Debt 455The Cost of Preferred Stock 456The Weighted Average Cost of Capital 457The Capital Structure Weights 457Taxes and the Weighted Average Cost of Capital 458Calculating the WACC for Eastman Chemical 459
Eastman's Cost of Equity 459Eastman's Cost of Debt 461Eastman's WACC 462
Solving the Warehouse Problem and Similar CapitalBudgeting Problems 462Performance Evaluation: Another Use of the WACC 465Divisional and Project Costs of Capital 466The SML and the WACC 467Divisional Cost of Capital 468The Pure Play Approach 468The Subjective Approach 469Flotation Costs and the Weighted Average Cost ofCapital 470Tfye Basic Approach 477
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Summary and Conclusions 474
Flotation Costs and NPVInternal Equity and Flotation Costs
CHAPTER 15
RAISING CAPITAL 483
15.1 The Financing Life Cycle of a Firm: Early-StageFinancing and Venture Capital 484Venture Capital 484Some Venture Capital Realities 485Choosing a Venture Capitalist 485Conclusion 486
15.2 Selling Securities to the Public: The BasicProcedure 486
15.3 Alternative Issue Methods 48715.4 Underwriters 489
Choosing an Underwriter 490Types of Underwriting 490
Firm Commitment Underwriting 490Best Efforts Underwriting 491Dutch Auction Underwriting 491
The Aftermarket 497The Green Shoe Provision 492Lockup Agreements 492The Quiet Period 492
15.5 IPOs and Underpricing 493IPO Underpricing: The 1999-2000 Experience 493Evidence on Underpricing 493Why Does Underpricing Exist? 498
15.6 New Equity Sales and the Value of the Firm 49915.7 The Costs of Issuing Securities 500
The Costs of Selling Stock to the Public 500The Costs of Going Public: A Case Study 504
15.8 Rights 504The Mechanics of a Rights Offering 504Number of Rights Needed to Purchase a Share 505The Value of a Right 506Ex Rights 508The Underwriting Arrangements 509Effects on Shareholders 509
15.9 Dilution 570Dilution of Proportionate Ownership 570Dilution of Value: Book versus Market Values 570
A Misconception 511The Correct Arguments 512
15.10 Issuing Long-Term Debt 57215.11 Shelf Registration 57315.12 Summary and Conclusions 574
CHAPTER 16
FINANCIAL LEVERAGE AND CAPITALSTRUCTURE POLICY 527
16.1 The Capital Structure Question 522Firm Value and Stock Value: An Example 522Capital Structure and the Cost of Capital 523
16.2 The Effect of Financial Leverage 524The Basics of Financial Leverage 524
Financial Leverage, EPS, and ROE: An Example 524EPS versus EBIT 525
Corporate Borrowing and Homemade Leverage 52716.3 Capital Structure and the Cost of Equity Capital 528
M&M Proposition I: The Pie Model 528
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The Cost of Equity and Financial Leverage: M&MProposition II 529Business and Financial Risk 537
16.4 M&M Propositions I and II with Corporate Taxes 532The Interest Tax Shield 533Taxes and M&M Proposition I 533Taxes, the WACC, and Proposition II 534Conclusion 535
16.5 Bankruptcy Costs 537Direct Bankruptcy Costs 538Indirect Bankruptcy Costs 538
16.6 Optimal Capital Structure 539The Static Theory of Capital Structure 539Optimal Capital Structure and the Cost of Capital 540Optimal Capital Structure: A Recap 547Capital Structure: Some ManagerialRecommendations 543
Taxes 543Financial Distress 543
16.7 The Pie Again 543The Extended Pie Model 544Marketed Claims versus Nonmarketed Claims 545
16.8 The Pecking-Order Theory 545Internal Financing and the Pecking Order 545Implications of the Pecking Order 546
16.9 Observed Capital Structures 54716.10 A Quick Look at the Bankruptcy Process 549
Liquidation and Reorganization 549Bankruptcy Liquidation 549Bankruptcy Reorganization 550
Financial Management and the BankruptcyProcess ,557Agreements to Avoid Bankruptcy 552
16.11 Summary and Conclusions 553
CHAPTER 17
t DIVIDENDS AND PAYOUT POLICY 560
17.1 /Cash Dividends and Dividend Payment 567Cash Dividends 567Standard Method of Cash Dividend Payment 567Dividend Payment: A Chronology 562More about the Ex-Dividend Date 562
17.2 Does Dividend Policy Matter? 564An Illustration of the Irrelevance of Dividend Policy 564
Current Policy: Dividends Set Equal to Cash Flow 565Alternative Policy: Initial Dividend Greater Than CashFlow 565
Homemade Dividends 565A Test 566
17.3 Real-World Factors Favoring a Low DividendPayout 567Taxes 567Flotation Costs 567Dividend Restrictions 567
17.4 Real-World Factors Favoring a High DividendPayout 568Desire for Current Income 568Tax and Other Benefits from High Dividends 569
Corporate Investors 569Tax-Exempt Investors 569
Conclusion 56917.5 A Resolution of Real-World Factors? 569
Information Content of Dividends 569The Clientele Effect 577
17.6 Stock Repurchases: An Alternative to Cash• Dividends 577
Cash Dividends versus Repurchase 573Real-World Considerations in a Repurchase 574Share Repurchase and EPS 575
17.7 What We Know and Do NotKnow about Dividend and Payout Policies 575Dividends and Dividend Payers 575Corporations Smooth Dividends 578Putting It All Together 578Some Survey Evidence on Dividends 580
17.8 Stock Dividends and Stock Splits 582Some Details about Stock Splits and StockDividends 582
Example of a Small Stock Dividend 582Example of a Stock Split 583Example of a Large Stock Dividend 583
Value of Stock Splits and Stock Dividends 583The Benchmark Case 584Popular Trading Range 584
Reverse Splits 58417.9 Summary and Conclusions 585
CHAPTER 18 19-2
SHORT-TERM FINANCE AND PLANNING 593
18.1 Tracing Cash and Net Working Capital 59418.2 The Operating Cycle and the Cash Cycle 595
Defining the Operating and Cash Cycles 596The Operating Cycle 596The Cash Cycle 596
The Operating Cycle and the Firm's OrganizationalChart 597Calculating the Operating and Cash Cycles 598 19.3
The Operating Cycle 599The Cash Cycle 600
Interpreting the Cash Cycle 60718.3 Some Aspects of Short-Term Financial Policy 607
The Size of the Firm's Investment in Current Assets 602Alternative Financing Policies for Current Assets 603 19.4
An Ideal Case 603Different Policies for Financing Current Assets 603
Which Financing Policy Is Best? 606Current Assets and Liabilities in Practice 607
18.4 The Cash Budget 608 19.5Sales And Cash Collections 608Cash Outflows 609The Cash Balance 609
18.5 Short-Term Borrowing 670Unsecured Loans 67 7
Compensating Balances 611Cost of a Compensating Balance 611Letters of Credit 612
Secured Loans 672
Accounts Receivable Financing 612 19.6Inventory Loans 613 19A
Other Sources 673*18.6 A, Short-Term Financial Plan 67418.7 Summary and Conclusions 675
CHAPTER 19
CASH AND LIQUIDITY MANAGEMENT 626
19.1 Reasons for Holding Cash 627
The Speculative and Precautionary Motives 627The Transaction Motive 627Compensating Balances 627Costs of Holding Cash 627Cash Management versus Liquidity Management 628
Understanding Float 628Disbursement Float 628Collection Float and Net Float 629Float Management 630
Measuring Float 630Some Details 631Cost of the Float 631Ethical and Legal Questions 633
Electronic Data Interchange and Check 21: TheEnd of Float? 634Cash Collection and Concentration 635Components of Collection Time 635Cash Collection 635Lockboxes 635Cash Concentration 637Accelerating Collections: An Example 638Managing Cash Disbursements 639Increasing Disbursement Float 639Controlling Disbursements 640
Zero-Balance Accounts 640Controlled Disbursement Accounts 641
Investing Idle Cash 647Temporary Cash Surpluses 647
Seasonal or Cyclical Activities 641Planned or Possible Expenditures 641
Characteristics of Short-Term Securities 642Maturity 642Default Risk 642Marketability 642Taxes 642
Some Different Types of Money Market Securities 643Summary and Conclusions 644Determining the Target Cash Balance 649The Basic Idea 649The BAT Model 650
The Opportunity Costs 651The Trading Costs 652The Total Cost 652The Solution 652Conclusion 654
The Miller-Orr Model: A More General Approach 654The Basic Idea 654Using the Model 654
Implications of the BAT and Miller-Orr Models 655Other Factors Influencing the Target Cash Balance 656
CHAPTER 20
CREDIT AND INVENTORY MANAGEMENT 659
20.1 Credit and Receivables 660Components of Credit Policy 660The Cash Flows from Granting Credit 660The Investment in Receivables 667
20.2 Terms of the Sale 667The Basic Form 662The Credit Period 662
The Invoice Date 662Length of the Credit Period 662
Cash Discounts 663Cost of the Credit 664Trade Discounts 664The Cash Discount and the ACP 664
Credit Instruments 66520.3 Analyzing Credit Policy 665
Credit Policy Effects 665Evaluating a Proposed Credit Policy 666
NPV of Switching Policies 666A Break-Even Application 668
20.4 Optimal Credit Policy 668The Total Credit Cost Curve 668Organizing the Credit Function 669
20.5 Credit Analysis 670When Should Credit Be Granted? 670
A One-Time Sale 670Repeat Business 671
Credit Information 672Credit Evaluation and Scoring 672
20.6 Collection Policy 673Monitoring Receivables 673Collection Effort 674
20.7 Inventory Management 674The Financial Manager and Inventory PolicyInventory Types 675Inventory Costs 675
20.8 Inventory Management Techniques 676The ABC Approach 676The Economic Order Quantity Model 676
Inventory Depletion 678The Carrying Costs 678The Restocking Costs 679The Total Costs 679
Extensions to the EOQ Model 687Safety Stocks 681Reorder Points 681
Managing Derived-Demand Inventories 687Materials Requirements Planning 683Just-in-Time Inventory 683
20.9 Summary and Conclusions 68320A More about Credit Policy Analysis 690
Two Alternative Approaches 690The One-Shot Approach 690The Accounts Receivable Approach 691
Discounts and Default Risk 692NPV of the Credit Decision 693A Break-Even Application 693
674
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CHAPTER 21
INTERNATIONAL CORPORATE FINANCE 697
21.1 Terminology 69821.2 Foreign Exchange Markets and Exchange Rates 699
Exchange Rates 700Exchange Rate Quotations 700Cross-Rates and Triangle Arbitrage 701Types of Transactions 703
21.3 Purchasing Power Parity 704Absolute Purchasing Power Parity 704Relative Purchasing Power Parity 706
The Basic Idea 706The Result 706Currency Appreciation and Depreciation 707
21.4 Interest Rate Parity, Unbiased Forward Rates, andthe International Fisher Effect 708Covered Interest Arbitrage 708Interest Rate Parity 709Forward Rates and Future Spot Rates 770Putting It All Together 770
Uncovered Interest Parity 711 "~The International Fisher Effect 711
21.5 International Capital Budgeting 772Method 1: The Home Currency Approach 772Method 2: The Foreign Currency Approach 773Unremitted Cash Flows 774
21.6 Exchange Rate Risk 774Short-Run Exposure 774Long-Run Exposure 775
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Translation Exposure 776Managing Exchange Rate Risk 77 7
21.7 Political Risk 77721.8 Summary and Conclusions 778
APPENDIX A
MATHEMATICAL TABLES A-1
APPENDIX B
KEY EQUATIONS B-1
APPENDIX C
ANSWERS TO SELECTED END-OF-CHAPTERPROBLEMS C
APPENDIX D
USING THE HP 10B AND Tl BA IIPLUS FINANCIAL CALCULATORS D
Index /