Confirming Pages
Table of Contents
Preface
xv
Part 1
Overview
2.2
1
Chapter 1
Introduction to Corporate Finance
Executive Summary
1.1
What Is Corporate Finance?
The Balance-Sheet Model of the Firm
Capital Structure
The Financial Manager
Identification of Cash Flows
Timing of Cash Flows
Risk of Cash Flows
1.2
Corporate Securities as Contingent Claims
on Total Firm Value
1.3
The Corporate Firm
The Sole Proprietorship
The Partnership
The Corporation
The Income Trust
1.4
Goals of the Corporate Firm
Agency Costs and the Set-of-Contracts Perspective
Managerial Goals
Separation of Ownership and Control
In Their Own Words: B. Espen Eckbo on
Corporate Governance
1.5
Financial Institutions, Financial Markets, and
the Corporation
Financial Institutions
Money Versus Capital Markets
Primary Versus Secondary Markets
Listing
Foreign Exchange Market
1.6
Trends in Financial Markets and Management
1.7
Outline of the Text
Appendix 1A Taxes
1
1
2
2
3
4
5
7
7
8
9
9
10
11
12
13
13
14
14
16
18
18
20
20
22
22
23
24
26
Chapter 2
Accounting Statements and Cash Flow
Executive Summary
2.1
The Balance Sheet
Liquidity
Debt Versus Equity
Value Versus Cost
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30
30
31
31
32
The Income Statement
Generally Accepted Accounting Principles (GAAP)
Non-cash Items
Time and Costs
2.3
Net Working Capital
2.4
Financial Cash Flow
2.5
Summary and Conclusions
Minicase: Cash Flows at Warf Computers Inc.
Appendix 2A Financial Statement Analysis
Appendix 2B Statement of Cash Flows
33
33
34
34
35
36
39
42
43
53
Chapter 3
Financial Planning and Growth
Executive Summary
3.1
What Is Financial Planning?
3.2
A Financial Planning Model: The Ingredients
3.3
The Percentage Sales Method
The Income Statement
The Balance Sheet
3.4
What Determines Growth?
In Their Own Words: Robert C. Higgins on
Sustainable Growth
Some Caveats on Financial Planning Models
3.5
Summary and Conclusions
Minicase: Ratios and Financial Planning at East
Coast Yachts
Part 2
Value and Capital Budgeting
58
58
58
59
60
62
63
65
68
69
70
73
75
Chapter 4
Financial Markets and Net Present Value:
First Principles of Finance
75
Executive Summary
4.1
The Financial Market Economy
The Anonymous Market
Market Clearing
4.2
Making Consumption Choices Over Time
4.3
The Competitive Market
How Many Interest Rates Are There in a
Competitive Market?
4.4
The Basic Principle
4.5
Practising the Principle
A Lending Example
A Borrowing Example
75
76
77
77
78
81
81
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83
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4.6
4.7
4.8
Illustrating the Investment Decision
Corporate Investment Decision Making
Summary and Conclusions
86
89
92
Chapter 5
The Time Value of Money
Executive Summary
5.1
The One-Period Case
5.2
The Multiperiod Case
Future Value and Compounding
The Power of Compounding: A Digression
Present Value and Discounting
The Algebraic Formula
5.3
Compounding Periods
Compounding Over Many Years
Continuous Compounding (Advanced)
5.4
Simplifications
Perpetuity
Growing Perpetuity
Annuity
Mortgages
Using Annuity Formulas
Growing Annuity
5.5
What Is a Firm Worth?
5.6
Summary and Conclusions
Minicase: The MBA Decision
95
95
95
98
98
102
103
106
107
108
109
111
111
112
114
116
117
121
122
124
130
Chapter 6
How to Value Bonds and Stocks
Executive Summary
6.1
Definition and Example of a Bond
6.2
How to Value Bonds
Pure Discount Bonds
Level-Coupon Bonds
A Note on Bond Price Quotes
Consols
6.3
Bond Concepts
Interest Rates and Bond Prices
Yield to Maturity
Holding-Period Return
6.4
The Present Value of Common Stocks
Dividends Versus Capital Gains
Valuation of Different Types of Stocks
6.5
Estimates of Parameters in the Dividend
Discount Model
Where Does g Come From?
Where Does r Come From?
A Healthy Sense of Skepticism
6.6
Growth Opportunities
Growth in Earnings and Dividends Versus
Growth Opportunities
Dividends or Earnings: Which to Discount?
The No-Dividend Firm
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132
132
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133
135
136
136
136
137
137
138
138
139
142
143
144
145
145
147
148
148
6.7
The Dividend Growth Model and the
NPVGO Model (Advanced)
The Dividend Growth Model
The NPVGO Model
Summation
6.8
Price–Earnings Ratio
6.9
Stock Market Reporting
6.10 Summary and Conclusions
Minicase: Stock Valuation at Ragan
Thermal Systems
Appendix 6A The Term Structure of Interest Rates
149
149
150
151
151
153
154
160
161
Chapter 7
Net Present Value and Other
Investment Rules
171
Executive Summary
171
7.1
Why Use Net Present Value?
171
7.2
The Payback Period Rule
173
Defining the Rule
173
Problems With the Payback Method
174
Managerial Perspective
175
Summary of Payback
176
7.3
The Discounted Payback Period Rule
176
7.4
The Average Accounting Return (AAR)
177
Defining the Rule
177
Analyzing the Average Accounting Return
Method
178
7.5
The Internal Rate of Return (IRR)
179
7.6
Problems with the IRR Approach
182
Definition of Independent and Mutually
Exclusive Projects
182
Two General Problems Affecting Both
Independent and Mutually Exclusive Projects
182
Problems Specific to Mutually Exclusive Projects 187
Redeeming Qualities of the IRR
191
A Test
191
7.7
The Profitability Index (PI)
192
7.8
The Practice of Capital Budgeting
194
7.9
Summary and Conclusions
196
Minicase: Gold Mining Corp.
203
Chapter 8
Net Present Value and Capital
Budgeting
Executive Summary
8.1
Incremental Cash Flows
Cash Flows—Not Accounting Income
Sunk Costs
Opportunity Costs
Side Effects
Allocated Costs
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204
204
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8.2
The Majestic Mulch and Compost Company:
An Example
207
An Analysis of the Project
210
Which Set of Books?
211
A Note on Net Working Capital
211
Interest Expense
212
8.3
Inflation and Capital Budgeting
212
Interest Rates and Inflation
212
Cash Flow and Inflation
214
Discounting: Nominal or Real?
215
8.4
Alternative Definitions of Operating Cash Flow 217
The Bottom-Up Approach
218
The Top-Down Approach
218
The Tax Shield Approach
218
Conclusion
219
8.5
Applying the Tax Shield Approach to the Majestic
Mulch and Compost Company Project
219
Present Value of the Tax Shield on CCA
220
Total Project Cash Flow Versus Tax Shield
Approach
221
8.6
Investments of Unequal Lives: The Equivalent
Annual Cost Method
222
The General Decision to Replace (Advanced)
224
8.7
Summary and Conclusions
226
Minicase: I.Q. Inc.
233
Minicase: Jimmy’s Hot Dog Stands
233
Appendix 8A Capital Cost Allowance
234
Appendix 8B Derivation of the Present Value
of CCA Tax Shield Formula
238
Chapter 9
Risk Analysis, Real Options, and
Capital Budgeting
Executive Summary
9.1
Decision Trees
9.2
Sensitivity Analysis, Scenario Analysis, and
Break-Even Analysis
Sensitivity Analysis and Scenario Analysis
Break-Even Analysis
Break-Even Analysis, EAC, and Capital Cost
Allowance
9.3
Monte Carlo Simulation
Step 1: Specify the Basic Model
Step 2: Specify a Distribution for Each
Variable in the Model
Step 3: The Computer Draws One Outcome
Step 4: Repeat the Procedure
Step 5: Calculate NPV
9.4
Real Options
The Option to Expand
The Option to Abandon
Timing Options
9.5
Summary and Conclusions
Minicase: Bunyan Lumber LLC
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240
240
242
243
245
249
250
250
250
253
253
254
254
255
255
257
258
265
Part 3
Risk
266
Chapter 10
Risk and Return: Lessons from
Market History
266
Executive Summary
10.1 Returns
Dollar Earnings
Percentage Returns or Rate of Return
10.2 Holding-Period Returns
10.3 Return Statistics
10.4 Average Stock Returns and Risk-Free Returns
10.5 Risk Statistics
Variance and Standard Deviation
Normal Distribution and Its Implications for
Standard Deviation
Value at Risk
Further Perspective on Returns and Risk
10.6 More on Average Returns
Arithmetic Versus Geometric Averages
Calculating Geometric Average Returns
Arithmetic Average Return or Geometric
Average Return?
10.7 Summary and Conclusions
Minicase: A Job at Deck Out My Yacht
Corporation
Appendix 10A The Historical Market Risk Premium:
The Very Long Run can be accessed on the book’s
website at www.mcgrawhill.ca/olc/ross
266
267
267
268
270
273
275
277
277
278
278
279
280
280
281
282
283
286
Chapter 11
Risk and Return: The Capital Asset
Pricing Model (CAPM)
Executive Summary
11.1 Individual Securities
11.2 Expected Return, Variance, and Covariance
Expected Return and Variance
Covariance and Correlation
11.3 The Risk and Return for Portfolios
The Example of Supertech and Slowpoke
The Expected Return on a Portfolio
Variance and Standard Deviation of a Portfolio
11.4 The Efficient Set for Two Assets
Application to International Diversification
11.5 The Efficient Set for Many Securities
Variance and Standard Deviation in a Portfolio
of Many Assets
11.6 Diversification: An Example
Risk and the Sensible Investor
288
288
288
289
289
291
294
294
295
296
299
302
303
305
306
309
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11.7
Riskless Borrowing and Lending
The Optimal Portfolio
11.8 Market Equilibrium
Definition of the Market Equilibrium Portfolio
Definition of Risk When Investors Hold the
Market Portfolio
The Formula for Beta
A Test
11.9 Relationship Between Risk and Expected
Return (CAPM)
Expected Return on Market
Expected Return on Individual Security
11.10 Summary and Conclusions
Minicase: A Job at Deck Out My Yacht, Part 2
Appendix 11A Is Beta Dead? can be accessed on
the book’s website at www.mcgrawhill.ca/olc/ross
310
312
314
314
318
318
318
321
328
329
330
331
332
335
337
340
340
341
342
342
342
344
344
345
346
351
Chapter 13
Executive Summary
13.1 The Cost of Equity Capital
13.2 Estimation of Beta
Beta Estimation in Practice
Stability of Beta
Using an Industry Beta
13.3 Determinants of Beta
Cyclicality of Revenues
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13.4
Extensions of the Basic Model
The Firm Versus the Project: Vive la Différence
The Cost of Debt
The Cost of Preferred Stock
The Weighted Average Cost of Capital
The Capital Structure Weights
Taxes and Weighted Average Cost of Capital
363
363
365
365
365
366
366
13.5
Estimating the Cost of Capital for Rogers
Communications
369
13.6
Reducing the Cost of Capital
What Is Liquidity?
Liquidity, Expected Returns, and the Cost of
Capital
Liquidity and Adverse Selection
What the Corporation Can Do
371
371
Summary and Conclusions
Minicase: AlliedProducts
374
379
13.7
An Alternative View of Risk and Return:
The Arbitrage Pricing Theory
329
Risk, Return, and Capital Budgeting
360
362
315
316
317
Chapter 12
Executive Summary
12.1 Factor Models: Announcements, Surprises,
and Expected Returns
12.2 Risk: Systematic and Unsystematic
12.3 Systematic Risk and Betas
12.4 Portfolios and Factor Models
Portfolios and Diversification
12.5 Betas and Expected Returns
The Linear Relationship
The Market Portfolio and the Single Factor
12.6 The Capital Asset Pricing Model and the
Arbitrage Pricing Theory
Differences in Pedagogy
Differences in Application
12.7 Parametric Approaches to Asset Pricing
Empirical Models
Style Portfolios
12.8 Summary and Conclusions
Minicase: The Fama–French Multifactor Model
and Mutual Fund Returns
Operating Leverage
Financial Leverage and Beta
352
352
353
355
357
358
359
360
360
Appendix 13A Economic Value Added and the
Measurement of Financial Performance
Part 4
Capital Structure and Dividend Policy
372
372
373
380
385
Chapter 14
Corporate Financing Decisions and
Efficient Capital Markets
Executive Summary
14.1 Can Financing Decisions Create Value?
14.2 A Description of Efficient Capital Markets
Foundations of Market Efficiency
14.3 The Different Types of Efficiency
The Weak Form
The Semistrong and Strong Forms
Some Common Misconceptions About the
Efficient Market Hypothesis
14.4 The Evidence
The Weak Form
The Semistrong Form
The Strong Form
14.5 The Behavioural Challenge to Market Efficiency
14.6 Empirical Challenges to Market Efficiency
14.7 Reviewing the Differences
Representativeness
Conservatism
The Academic Viewpoints
In Their Own Words: A Random Talk with
Burton Malkiel
14.8 Implications for Corporate Finance
Accounting and Efficient Markets
385
385
385
387
388
391
391
392
393
395
395
396
399
400
402
406
407
407
407
408
409
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Contents
14.9
The Timing Decision
Speculation and Efficient Markets
Information in Market Prices
Summary and Conclusions
Minicase: Your Retirement Plan at Deck Out
My Yacht
410
411
413
415
420
16.5
Chapter 15
Long-Term Financing: An Introduction 421
Executive Summary
15.1 Common Stock
Authorized Versus Issued Common Stock
Retained Earnings
Market Value, Book Value, and Replacement Value
Shareholders’ Rights
Dividends
Classes of Shares
In Their Own Words: Bombardier Didn’t
Heed Teachers on Share Structure
15.2 Corporate Long-Term Debt: The Basics
Interest Versus Dividends
Is It Debt or Equity?
Basic Features of Long-Term Debt
Different Types of Debt
Repayment
Seniority
Security
Indenture
15.3 Preferred Shares
Stated Value
Cumulative and Noncumulative Dividends
Are Preferred Shares Really Debt?
Preferred Shares and Taxes
Beyond Taxes
15.4 Income Trusts
Income Trust Income and Taxation
15.5 Patterns of Long-Term Financing
15.6 Summary and Conclusions
421
421
422
422
423
423
425
425
426
427
428
428
428
429
429
430
430
430
431
431
431
432
432
433
434
434
435
437
Chapter 16
Capital Structure: Basic Concepts
Executive Summary
16.1 The Capital Structure Question and the Pie
Theory
16.2 Maximizing Firm Value Versus Maximizing
Shareholder Interests
16.3 Financial Leverage and Firm Value: An Example
Leverage and Returns to Shareholders
The Choice Between Debt and Equity
A Key Assumption
16.4 Modigliani and Miller: Proposition II (No Taxes)
Risk to Equityholders Rises with Leverage
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439
439
439
440
442
442
443
446
447
447
16.6
Proposition II: Required Return to
Equityholders Rises with Leverage
Example Illustrating Proposition I and
Proposition II
MM: An Interpretation
In Their Own Words: In Professor Miller’s
Words . . .
Taxes
The Basic Insight
Taxation of Corporate Income
Present Value of the Tax Shield
Value of the Levered Firm
Expected Return and Leverage Under
Corporate Taxes
The Weighted Average Cost of Capital,
rWACC, and Corporate Taxes
Stock Price and Leverage Under Corporate
Taxes
Summary and Conclusions
Minicase: Danielson Real Estate
Recapitalization
448
450
454
455
456
456
457
458
458
460
462
463
465
471
Chapter 17
Capital Structure: Limits to the Use
of Debt
Executive Summary
17.1 Costs of Financial Distress
Bankruptcy Risk or Bankruptcy Cost?
17.2 Description of Costs
Direct Costs of Financial Distress: Legal and
Administrative Costs of Liquidation or
Reorganization
Indirect Costs of Financial Distress
Agency Costs
17.3 Can Costs of Debt Be Reduced?
Protective Covenants
Consolidation of Debt
17.4 Integration of Tax Effects and Financial
Distress Costs
Pie Again
17.5 Signalling
17.6 Shirking, Perquisites, and Bad Investments:
A Note on Agency Cost of Equity
Effect of Agency Costs of Equity on
Debt–Equity Financing
Free Cash Flow
17.7 The Pecking-Order Theory
Rules of the Pecking Order
Implications
17.8 Growth and the Debt–Equity Ratio
No-Growth
Growth
17.9 Personal Taxes
The Miller Model
472
472
472
472
475
475
476
477
479
479
480
481
483
484
486
488
488
489
491
491
492
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17.10 How Firms Establish Capital Structure
Case Study: The Decision to Use More Debt:
The Case of Campeau Corporations’s
Acquisition of Federated
17.11 Summary and Conclusions
Minicase: Two-Line Pass Inc.’s
Capital Budgeting
Appendix 17A Some Useful Formulas of Financial
Structure can be accessed on the book’s website at
www.mcgrawhill.ca/olc/ross
Appendix 17B The Miller Model and the Graduated
Income Tax can be accessed on the book’s website at
www.mcgrawhill.ca/olc/ross
500
503
504
510
Chapter 18
Valuation and Capital Budgeting for
the Levered Firm
Executive Summary
18.1 Adjusted Present Value (APV) Approach
18.2 Flow to Equity (FTE) Approach
Step 1: Calculating Levered Cash Flow (LCF)
Step 2: Calculating rS
Step 3: Valuation
18.3 Weighted Average Cost of Capital (WACC)
Method
18.4 A Comparison of the APV, FTE, and WACC
Approaches
A Suggested Guideline
18.5 Capital Budgeting When the Discount Rate
Must Be Estimated
18.6 APV Example
All-Equity Value
Additional Effects of Debt
18.7 Beta and Leverage
The Project Is Not Scale-Enhancing
18.8 Summary and Conclusions
Minicase: The Leveraged Buyout of Miku
Products Group Inc.
Appendix 18A The Adjusted-Present-Value Approach
to Valuing Leveraged Buyouts can be accessed on the
book’s website at www.mcgrawhill.ca/olc/ross
511
511
511
513
513
514
514
514
515
517
519
521
521
521
523
525
526
532
Executive Summary
19.1 Different Types of Dividends
19.2 Standard Method of Cash Dividend Payment
19.3 The Benchmark Case: An Illustration of the
Irrelevance of Dividend Policy
Current Policy: Dividends Set Equal to Cash Flow
Alternative Policy: Initial Dividend is Greater
Than Cash Flow
The Indifference Proposition
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Part 5
Long-Term Financing
539
540
541
541
542
543
545
545
546
548
548
550
551
551
552
553
554
556
558
558
559
559
560
561
561
563
568
569
Chapter 20
Chapter 19
Dividends and Other Payouts
Homemade Dividends
A Test
Dividends and Investment Policy
19.4 Repurchase of Stock
Dividend Versus Repurchase: Conceptual Example
Dividends Versus Repurchases: Real-World
Considerations
19.5 Personal Taxes, Issuance Costs, and Dividends
Firms Without Sufficient Cash to Pay a Dividend
Firms With Sufficient Cash to Pay a Dividend
Summary on Personal Taxes
19.6 Expected Return, Dividends, and Personal Taxes
Some Evidence on Dividends and Taxes in
Canada
19.7 Real-World Factors Favouring a
High-Dividend Policy
Desire for Current Income
Behavioural Finance
Agency Costs
Information Content of Dividends and
Dividend Signalling
19.8 The Clientele Effect: A Resolution of
Real-World Factors?
19.9 What We Know and Do Not Know About
Dividend Policy
Corporate Dividends Are Substantial
In Their Own Words: Why Cognos
Incorporated Pays No Dividend; Why
Rogers Communications Pays Dividends
Fewer Companies Pay Dividends
Corporations Smooth Dividends
Payouts Provide Information to the Market
A Sensible Dividend Policy
19.10 Summary and Conclusions
Minicase: Electronic Timing Inc.
Appendix 19A Stock Dividends and Stock Splits
can be accessed on the book’s website at
www.mcgrawhill.ca/olc/ross
533
533
533
534
536
537
537
538
Issuing Equity Securities to the Public
Executive Summary
20.1 The Public Issue
20.2 The Basic Procedure for a New Issue
The POP System
20.3 The Cash Offer
Types of Underwriting
The Selling Period
The Overallotment Option
Investment Dealers
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571
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573
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574
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20.4
20.5
20.6
20.7
20.8
The Offering Price and Underpricing
The Decision to Go Public
Pricing IPOs
In Their Own Words: Jay R . Ritter on IPO
Underpricing Around the World
Underpricing: A Possible Explanation
The Announcement of New Equity and the
Value of the Firm
The Cost of Issuing Securities
Rights
The Mechanics of a Rights Offering
Subscription Price
Number of Rights Needed to Purchase a Share
The Value of a Right
Ex-Rights
Value of Rights After Ex-Rights Date
The Underwriting Arrangements
Effects on Shareholders
Cost of Rights Offerings
The Private Equity Market
Private Placement
The Private Equity Firm
Suppliers of Venture Capital
Stages of Financing
Summary and Conclusions
Minicase: Deck Out My Yacht Goes Public
575
576
576
577
578
579
580
581
582
582
583
583
585
586
586
587
587
588
588
588
589
590
591
594
Chapter 21
Long-Term Debt
Executive Summary
21.1 Long-Term Debt: A Review
21.2 The Public Issue of Bonds
The Basic Terms
Security
Seniority
Protective Covenants
The Sinking Fund
The Call Provision
21.3 Bond Refunding
Should Firms Issue Callable Bonds?
Calling Bonds: When Does It Make Sense?
Canada Plus Call
21.4 Bond Ratings
Junk Bonds
21.5 Some Different Types of Bonds
Zero-Coupon Bonds
Floating-Rate Bonds
Financial Engineering and Bonds
21.6 Direct Placement Compared to Public Issues
21.7 Long-Term Syndicated Bank Loans
21.8 Summary and Conclusions
Minicase: Financing the Expansion of East
Coast Yachts with a Bond Issue
ros65315_fm_i-xxii.indd xi
596
596
596
597
598
599
600
600
601
601
602
602
605
608
608
610
612
612
614
615
616
617
619
622
Chapter 22
Leasing
Executive Summary
22.1 Types of Leases
The Basics
Operating Leases
Financial Leases
22.2 Accounting and Leasing
22.3 Taxes and Leases
22.4 The Cash Flows of Financial Leasing
The Incremental Cash Flows
22.5 A Detour on Discounting and Debt Capacity
with Corporate Taxes
Present Value of Riskless Cash Flows
Optimal Debt Level and Riskless Cash Flows
(Advanced)
22.6 NPV Analysis of the Lease-Versus-Buy Decision
The Discount Rate
Asset Pool and Salvage Value
22.7 Debt Displacement and Lease Valuation
The Basic Concept of Debt Displacement
(Advanced)
Optimal Debt Level in the TransCanada
Example (Advanced)
22.8 Does Leasing Ever Pay? The Base Case
22.9 Reasons for Leasing
Good Reasons for Leasing
Bad Reasons for Leasing
Leasing Decisions in Practice
22.10 Some Unanswered Questions
Are the Uses of Leases and of Debt
Complementary?
Why Are Leases Offered by Both
Manufacturers and Third-Party Lessors?
Why Are Some Assets Leased More
Commonly Than Others?
22.11 Summary and Conclusions
Minicase: The Decision to Lease or Buy at
USB 2.0 Computers
Appendix 22A APV Approach to Leasing can
be accessed on the book’s website at
www.mcgrawhill.ca/olc/ross
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623
623
623
624
625
626
628
628
629
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631
632
632
633
633
634
634
635
638
639
639
642
643
643
643
644
644
644
647
Part 6
Options, Futures, and Corporate Finance 648
Chapter 23
Options and Corporate Finance: Basic
Concepts
Executive Summary
23.1 Options
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23.2
23.3
23.4
23.5
23.6
23.7
23.8
23.9
23.10
23.11
23.12
23.13
Contents
Call Options
The Value of a Call Option at Expiration
Put Options
The Value of a Put Option at Expiration
Selling Options
Stock Option Quotations
LEAPS
Combinations of Options
Valuing Options
Bounding the Value of an American Call
The Factors Determining Call Option Values
A Quick Discussion of Factors Determining
Put Option Values
An Option Pricing Formula
A Two-State Option Model
The Black–Scholes Model
Stocks and Bonds as Options
The Firm Expressed in Terms of Call Options
The Firm Expressed in Terms of Put Options
A Resolution of the Two Views
A Note on Loan Guarantees
Capital Structure Policy and Options
Selecting High-Risk Projects
Mergers and Options
Investment in Real Projects and Options
Summary and Conclusions
Minicase: Big Red Dog Manufacturing Options
649
649
651
651
652
653
655
655
658
658
659
662
663
664
667
671
672
674
675
675
677
677
678
681
683
689
25.2
25.3
25.4
25.5
25.6
25.7
25.8
25.9
The Difference Between Warrants and Call
Options
How the Firm Can Hurt Warrant Holders
Warrant Pricing and the Black–Scholes
Model (Advanced)
Convertible Bonds
The Value of Convertible Bonds
Straight Bond Value
Conversion Value
Option Value
Reasons for Issuing Warrants and
Convertibles
Convertible Debt Versus Straight Debt
Convertible Debt Versus Common Stock
The “Free Lunch” Story
The “Expensive Lunch” Story
A Reconciliation
Why Are Warrants and Convertibles Issued?
Matching Cash Flows
Risk Synergy
Agency Costs
Backdoor Equity
Conversion Policy
Summary and Conclusions
Minicase: S&S Air’s Convertible Bond
Options and Corporate Finance:
Extensions and Applications
Executive Summary
24.1 Executive Stock Options
Why Options?
In Their Own Words: Janet McFarland and
Paul Waldie on RIM Options Backdating
Valuing Executive Compensation
24.2 Valuing a Start-Up
24.3 More on the Binomial Model
Heating Oil
24.4 Shutdown and Reopening Decisions
Valuing a Gold Mine
The Abandonment and Opening Decisions
Valuing the Simple Gold Mine
24.5 Summary and Conclusions
Minicase: Exotic Cuisine Employee Stock Options
690
690
691
691
693
694
697
700
700
707
707
707
708
712
715
Chapter 25
Warrants and Convertibles
Executive Summary
25.1 Warrants
ros65315_fm_i-xxii.indd xii
716
716
716
720
721
722
722
723
724
725
725
726
727
728
728
728
729
729
729
730
730
732
736
Chapter 26
Derivatives and Hedging Risk
Chapter 24
717
720
Executive Summary
Derivatives, Hedging, and Risk
26.1 Forward Contracts
26.2 Futures Contracts
26.3 Hedging
Hedging with Futures Versus Hedging with
Options
26.4 Interest Rate Futures Contracts
Pricing of Government of Canada Bonds
Pricing of Forward Contracts
Futures Contracts
Hedging in Interest Rate Futures
26.5 Duration Hedging
The Case of Zero-Coupon Bonds
The Case of Two Bonds with the Same
Maturity but with Different Coupons
Duration
Matching Liabilities with Assets
Duration in Practice
26.6 Swap Contracts
Interest-Rate Swaps
Currency Swaps
Credit Default Swaps
Exotics
26.7 Actual Use of Derivatives
737
737
737
738
739
744
746
747
747
747
749
750
754
754
755
756
758
760
761
761
763
764
764
765
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Confirming Pages
xiii
Contents
26.8
Summary and Conclusions
Minicase: Williamson Mortgage Inc.
766
771
28.5
Part 7
Financial Planning and Short-Term
Finance
772
Executive Summary
27.1 Tracing Cash and Net Working Capital
27.2 Defining Cash in Terms of Other Elements
The Sources and Uses of Cash Statement
27.3 The Operating Cycle and the Cash Cycle
Interpreting the Cash Cycle
27.4 Some Aspects of Short-Term Financial Policy
The Size of the Firm’s Investment in Current
Assets
Alternative Financing Policies for Current
Assets
Current Assets and Liabilities in Practice
27.5 Cash Budgeting
Cash Outflow
The Cash Balance
27.6 The Short-Term Financial Plan
Short-Term Planning and Risk
Short-Term Borrowing
27.7 Summary and Conclusions
Minicase: Keafer Manufacturing Working
Capital Management
772
772
772
773
775
776
778
779
779
782
784
785
786
787
788
788
788
792
799
Chapter 28
Cash Management
Executive Summary
28.1 Reasons for Holding Cash
28.2 Determining the Target Cash Balance
The Baumol Model
The Miller–Orr Model
Other Factors Influencing the Target Cash
Balance
28.3 Managing the Collection and Disbursement
of Cash
Electronic Data Interchange: The End of Float?
Accelerating Collections
Controlling Disbursements
Ethical and Legal Questions
28.4 Investing Idle Cash
In Their Own Words: Geoff Martin on Online
Billing
Seasonal or Cyclical Activities
Planned Expenditures
ros65315_fm_i-xxii.indd xiii
800
800
801
801
802
805
807
808
811
812
815
815
816
817
817
818
818
820
821
824
Chapter 29
Credit Management
Chapter 27
Short-Term Finance and Planning
Characteristics of Short-Term Securities
Some Different Types of Money-Market Securities
Summary and Conclusions
Minicase: Cash Management at Richmond
Corporation
Executive Summary
29.1 Terms of the Sale
Why Trade Credit Exists
The Basic Form
Credit Period
Cash Discounts
Credit Instruments
29.2 The Decision to Grant Credit: Risk and
Information
The Value of New Information About Credit Risk
Future Sales
29.3 Optimal Credit Policy
Credit Insurance
29.4 Credit Analysis
Credit Information
Credit Evaluation and Scoring
29.5 Collection Policy
Average Collection Period
Aging Schedule
Collection Effort
29.6 Other Aspects of Credit Policy
Factoring
How to Finance Trade Credit
In Their Own Words: Ken Hitzig on Keeping
Business Liquid Through Factoring
29.7 Summary and Conclusions
Minicase: Credit Policies at Braam Industries
Part 8
Special Topics
825
825
825
826
827
827
827
829
830
832
832
833
834
836
836
836
837
837
838
838
839
839
839
840
840
844
845
Chapter 30
Mergers and Acquisitions
Executive Summary
30.1 The Basic Forms of Acquisitions
Merger or Consolidation
Acquisition of Stock
Acquisition of Assets
A Classification Scheme
A Note on Takeovers
30.2 The Tax Forms of Acquisitions
Determinants of Tax Status
Taxable Versus Tax-Free Acquisitions
845
845
845
846
846
847
847
847
849
849
850
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Confirming Pages
xiv
Contents
30.3
Accounting for Acquisitions
The Purchase Method
30.4 Determining the Synergy From an Acquisition
30.5 Sources of Synergy From Acquisitions
Revenue Enhancement
Cost Reduction
Tax Gains
The Cost of Capital
30.6 Calculating the Value of the Firm After an
Acquisition
Avoiding Mistakes
30.7 A Cost to Shareholders from Reduction
in Risk
The Base Case
The Case Where One Firm Has Debt
How Can Shareholders Reduce Their Losses
From the Coinsurance Effect?
30.8 Two “Bad” Reasons for Mergers
Earnings Growth
Diversification
30.9 The NPV of a Merger
Cash
Common Stock
Cash Versus Common Stock
Defensive Tactics
Divestitures
The Control Block and the Corporate Charter
Standstill Agreements
Exclusionary Offers and Nonvoting Stock
Going Private and Leveraged Buyouts
Other Defensive Devices
30.10 Some Evidence on Acquisitions
Do Acquisitions Benefit Shareholders?
The Managers Versus the Shareholders
In Their Own Words: Claude Lamoureux on
Corporate Governance
Real Productivity
30.11 Summary and Conclusions
Minicase:The Birdie Golf–Hybrid Golf Merger
Appendix 30A Campeau Corp.’s Acquisition of
Federated Department Stores can be accessed on the
book’s website at www.mcgrawhill.ca/olc/ross
850
850
851
852
852
853
855
856
856
858
858
858
859
Executive Summary
31.1 What Is Financial Distress?
31.2 What Happens in Financial Distress?
31.3 Bankruptcy Liquidation and Reorganization
Bankruptcy Liquidation
Bankruptcy Reorganization
Agreements to Avoid Bankruptcy
ros65315_fm_i-xxii.indd xiv
Current Issues in Financial Distress
Private Workout or Bankruptcy: Which Is Best?
Holdouts
Complexity
Lack of Information
Prepackaged Bankruptcy
31.5 The Decision to Seek Court Protection: The
Case of Olympia & York
31.6 Summary and Conclusions
Appendix 31A Predicting Corporate Bankruptcy:
The Z-Score Model can be accessed on the book’s
website at www.mcgrawhill.ca/olc/ross
878
879
880
885
887
887
887
889
890
891
893
895
895
895
896
896
896
896
897
899
Chapter 32
International Corporate Finance
860
860
860
861
862
862
864
865
866
866
868
869
869
870
871
872
872
876
Chapter 31
Financial Distress
31.4
901
Executive Summary
32.1 Terminology
32.2 Foreign Exchange Markets and Exchange Rates
Exchange Rates
Types of Transactions
32.3 The Law of One Price and Purchasing Power
Parity
32.4 Interest Rates and Exchange Rates: Interest
Rate Parity
The Dollar Investment
The Euro Investment
The Forward Discount and Expected Spot Rates
Exchange Rate Risk
More Advanced Short-Term Hedges
The Hedging Decision in Practice
32.5 International Capital Budgeting
Foreign Exchange Conversion
Unremitted Cash Flows
The Cost of Capital for International Firms
32.6 International Financing Decisions
Short-Term and Medium-Term Financing
International Bond Markets
32.7 Reporting Foreign Operations
32.8 Political Risk
32.9 Summary and Conclusions
Minicase: Jackman Grills Goes International
901
901
903
903
905
Appendix A Mathematical Tables
Appendix B Answers to Selected End-of-Chapter
Problems can be accessed on the book’s website at
www.mcgrawhill.ca/olc/ross
Glossary
Index
926
905
907
908
908
909
910
911
911
912
912
913
914
916
917
918
920
921
921
925
941
958
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