Principles of Managerial Finance PDF

GlobAl edITIon Principles of Managerial Finance FoUrTeenTh edITIon Lawrence J. Gitman Chad J. Zutter  Use the Financial Calculator to solve math problems...

GlobAl edITIon Principles of Managerial Finance FoUrTeenTh edITIon Lawrence J. Gitman Chad J. Zutter  Use the Financial Calculator to solve math problems right in MyFinanceLab! The Financial Calculator is available as a smartphone application as well as on a computer and includes important functions such as future and present value. Fifteen helpful tutorials show instructors and students the many ways to use the Financial Calculator in MyFinanceLab. Tutorials include lessons on calculator functions such as IRR and bond valuation. Select end-of-chapter problems are now available in MyFinanceLab as simulated Excel problems. Each problem has algorithmically generated values and allows students to solve the problem as they would in Excel. Each problem is autograded and has both Excel and problem-specific Learning Aids. Did your textbook come with a MyFinanceLab Student Access Kit? If so, go to www.pearsonmylab.com to register using the code. If not, you can purchase access to MyFinanceLab online at www.pearsonmylab.com. This page is intentionally left blank. Principles of Managerial Finance Global Edition Fourteenth Edition Lawrence J. Gitman San Diego State University Chad J. Zutter University of Pittsburgh Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editor in Chief: Donna Battista Operations Specialist: Carol Melville Editorial Project Manager: Mary Kate Murray Media Production Manager, Global Editions: M. Vikram Kumar Editorial Assistant: Elissa Senra-Sargent Senior Production Controller, Global Editions: Trudy Kimber Head of Learning Asset Acquisition, Global Editions: Laura Dent Art Director: Jonathan Boylan Senior Acquisitions Editor, Global Editions: Steven Jackson Cover Designer: Lumina Datamatics Project Editor, Global Editions: Suchismita Ukil Cover Art: © David Crockett/Shutterstock Project Editor, Global Editions: Laura Thompson Content Lead, MyFinanceLab: Miguel Leonarte Executive Marketing Manager: Anne Fahlgren Senior Media Producer: Melissa Honig Managing Editor: Jeff Holcomb Permissions Associate Project Manager: Samantha Graham Production Project Manager: Alison Eusden Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on page C-1. Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsonglobaleditions.com © Pearson Education Limited 2015 The rights of Lawrence J. Gitman and Chad J. Zutter to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. Authorised adaptation from the United States edition, entitled Principles of Managerial Finance, 14th edition, ISBN 978-0-13-350769-0 by Lawrence J. Gitman and Chad J. Zutter, published by Pearson Education © 2015. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or oth- erwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trade- marks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A. and other countries. Screen shots and icons reprinted with permission from the Microsoft Corporation. This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation. ISBN 10: 1-292-01820-8 ISBN 13: 978-1-292-01820-1 (Print) ISBN 13: 978-1-292-07824-3 (PDF) British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 9 8 7 6 5 4 3 2 1 15 14 13 12 11 Typeset in 10/12 Sabon LT Std by Cenveo Publisher Services/Nesbitt Printed and bound by Courier Kendallville in the United States of America  Dedicated to the memory of my mother, Dr. Edith Gitman, who instilled in me the importance of education and hard work. LJG Dedicated to my wonderful children, Logan, Henry, Evelyn, and Oliver, who provide me with constant commotion, fun, and affection. CJZ This page is intentionally left blank. Our Proven Teaching and Learning System U sers of Principles of Managerial Finance have praised the effectiveness of the book’s Teaching and Learning System, which they hail as one of its hall- marks. The system, driven by a set of carefully developed learning goals, has been retained and polished in this fourteenth edition. The “walkthrough” on the pages that follow illustrates and describes the key elements of the Teaching and Learning System. We encourage both students and instructors to acquaint them- selves at the start of the semester with the many useful features the book offers. Six Learning Goals at the start of the chapter highlight the most important con- cepts and techniques in the chapter. Students 1 The Role of Managerial are reminded to think about the learning goals while working through the chapter by Finance strategically placed learning goal icons. Every chapter opens with a feature, titled Learning Goals Why This Chapter Matters to You LG 1 Define finance and the Why This Chapter Matters to You, that In your professional life managerial finance function. Accounting You need to understand the relationships between the accounting helps motivate student interest by high- LG 2 Describe the legal forms of business organization. and finance functions within the firm, how decision makers rely on the financial statements you prepare, why maximizing a firm’s value is not the same as maxi- lighting both professional and personal mizing its profits, and the ethical duty you have when reporting financial results to LG 3 Describe the goal of the firm, and explain why investors and other stakeholders. benefits from achieving the chapter learning informAtion SYStemS You need to understand why financial information is maximizing the value of the firm is an appropriate important to managers in all functional areas, the documentation that firms must goals. produce to comply with various regulations, and how manipulating information goal for a business. for personal gain can get managers into serious trouble. LG 4 Describe how the mAnAgement You need to understand the various legal forms of a business Its first part, In Your Professional Life, managerial finance organization, how to communicate the goal of the firm to employees and other function is related to economics and stakeholders, the advantages and disadvantages of the agency relationship between a firm’s managers and its owners, and how compensation systems can discusses the intersection of the finance accounting. align or misalign the interests of managers and investors. mArketing You need to understand why increasing a firm’s revenues or market topics covered in the chapter with the con- LG 5 identify the primary activities of the financial manager. share is not always a good thing, how financial managers evaluate aspects of customer relations such as cash and credit management policies, and why a cerns of other major business disciplines. It firm’s brands are an important part of its value to investors. LG 6 Describe the nature of operAtionS You need to understand the financial benefits of increasing a firm’s encourages students majoring in accounting, the principal–agent production efficiency, why maximizing profit by cutting costs may not increase relationship between the owners and managers of the firm’s value, and how managers act on behalf of investors when operating a information systems, management, mar- corporation. a corporation, and explain how various many of the principles of managerial finance keting, and operations to appreciate how In your personal life also apply to your personal life. Learning a corporate governance mechanisms attempt to few simple financial principles can help you manage your own money more financial acumen will help them achieve manage agency effectively. problems. their professional goals. The second part, In Your Personal Life, identifies topics in the chapter that will have particular application to personal finance. This feature also helps students appreciate 2 the tasks performed in a business setting by pointing out that the tasks are not neces- sarily different from those that are relevant in their personal lives. 7 Each chapter begins with a short opening vignette that describes a recent real-company event related to the chapter topic. These stories Tesla Motors raise interest in the chapter by demonstrating Going Green to Find Value its relevance in the business world. ne of the most “hotly” debated topics of our day O has been the issue of global warming and the benefits and costs of lower emissions. Many companies are investing in radical new technologies with the hope of capitalizing on the going green movement. On June 29, 2010, Tesla Motors raised $226 million in its initial public offering (IPO) of common stock. Tesla, whose shares trade on the Nasdaq stock exchange, was the first automaker to use lithium ion batteries to produce an all-electric vehicle with a range of more than 200 miles. Even though Tesla racked up losses of $279 million from 2006 to 2009 and had never been profitable, investors were enthusiastic about the IPO, and Tesla’s stock price rose from $17 to $24 on its first day of trading. Excitement about Tesla’s prospects was fueled in part by its mission to reduce carbon emissions and in part by its charismatic cofounder, Elon Musk, who had previously started several successful companies, including PayPal. It also helped that the federal government offered a tax subsidy of $7,500 to anyone who purchased an electric vehicle, and some states offered additional tax incentives. In its first 2 years as a public company, Tesla continued to struggle to become profitable, but its stock price gradually trended upward. In 2013, Tesla reported its first quarterly profit as well as its first quarter of positive cash flow. Just days after that news hit the markets, Consumer Reports announced that Tesla’s sedan, the Model S, was the best car it had ever tested, receiving the highest score in the magazine’s history, a 99 out of 100. From May 8 to May 13, the company’s stock rose 57 percent! In the long run, Tesla’s stock price will depend on its ability to generate positive cash flows, without the help of government subsidies, and convince the market of its ability to do so into the future. Owner receives all profits (and Can raise more funds than sole Owners have Low organizational costs Borrowing power enhanced by Income included and taxed on Can achieve large size via sale of More available brain power and Independence Ownership (stock) is readily Secrecy Income included and taxed on 271 Ease of dissolution Long life of firm Can hire professional Has better access to financing Owner has Owners have Taxes are generally higher be Learning goal icons tie chapter con- LG 2 LG 3 6.2 Corporate Bonds Limited fund-raising power Partnership is dissolved when a tent to the learning goals and appear MyFinancelab Video A corporate bond is a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future Proprietor must be jack-of-all- Difficult to liquidate or transfer More expensive to organize than next to related text sections and again in corporate bond under clearly defined terms. Most bonds are issued with maturities of 10 to A long-term debt instrument 30 years and with a par value, or face value, of $1,000. The coupon interest rate that indicating Difficult to give employees a corporation on a bondlong- Subject tobegreater government the chapter-end summary, end-of-chapter has borrowed a certain represents the percentage of the bond’s par value that will paid an- amount of money and promises nually, typically in two equal semiannual payments, as interest. The bondholders, to repay it in Lacks continuity the future under when propri who are payments the lenders, are promised the semiannual interest Lacks secrecy because and, at ma- regula homework materials, and supplements clearly defined terms. turity, repayment of the principal amount. such as the Study Guide, Test Item File, and MyFinanceLab. For help in study and review, boldfaced Corporations key terms and their definitions appear corporation An entity created by law. A corporation is an entity created by law. A corporation has the legal powers of an individual in that it can sue and be sued, make and be party to contracts, and in the margin where they are first intro- stockholders acquire property in its own name. Although only about 20 percent of all U.S. businesses are incorporated, the largest businesses nearly always are; corpora- duced. These terms are also boldfaced in The owners of a corporation, whose ownership, or equity, tions account for roughly 80 percent of total business revenues. Although corpo- the book’s index and appear in the end- takes the form of common stock rations engage in all types of businesses, manufacturing firms account for the or, less frequently, preferred largest portion of corporate business receipts and net profits. Table 1.1 lists the of-book glossary. stock. key strengths and weaknesses of corporations. The owners of a corporation are its stockholders, whose ownership, or eq- Matter of Fact boxes provide interesting empirical facts that add background Matter of fact and depth to the material covered in the Bond Yields Hit Record Lows chapter. O n July 25, 2012, the 10-year Treasury note and 30-year Treasury bond yields reached all-time lows of 1.43% and 2.46%. That was good news for the housing market. Many mortgage rates are linked to rates on Treasury securities. For example, the traditional 30-year mortgage rate is typically linked to the yield on 10-year Treasury notes. With mortgage rates reaching new lows, potential buyers found that they could afford more expensive homes, and existing homeowners were able to refinance their existing loans, lowering their monthly mort- gage payments and leaving them with more money to spend on other things. This kind of activ- ity is precisely what the Federal Reserve hoped to stimulate by keeping interest rates low during the economic recovery. 8  IRF Example 5.10 ▶ In Example 5.8 of Braden Company, we found the present value of Braden’s Examples are an important component $700, 5-year ordinary annuity discounted at 8% to be $2,794.90. If we now as- sume that Braden’s $700 annual cash flow occurs at the start of each year and is of the book’s learning system. Numbered thereby an annuity due. This situation is depicted on the following time line. and clearly set off from the text, they Time line for present value of an annuity due ($700 0 1 Beginning of Year 2 3 4 5 provide an immediate and concrete dem- beginning-of-year cash $700 $700 $700 $700 $700 onstration of how to apply financial con- flows, discounted at 8%, over 5 years) $ 700 cepts, tools, and techniques. 648.15 600.14 Some examples demonstrate time-value- 555.68 514.52 of-money techniques. These examples Present Value $3,018.49 often show the use of time lines, equa- We can calculate its present value using a calculator or a spreadsheet. tions, financial calculators, and spread- MyFinancelab financial Calculator use Before using your calculator to find the present value of an annuity calculator due, you must either switch it to BEGIN mode or use the DUE key, depending on the sheets (with cell formulas). specifics of your calculator. Then, using the inputs shown at the left, you will find the New! An IRF icon, which appears Note: Switch calculator to BEGIN mode. present value of the annuity due to be $3,018.49 (Note: Because we nearly always Input Function assume end-of-period cash flows, be sure to switch your calculator back to END 700 PMT mode when you have completed your annuity-due calculations.) with some examples, indicates that the 5 N 8 I Spreadsheet use The present value of the annuity due also can be calculated as shown on the following Excel spreadsheet. example can be solved using the interest CPT PV A B rate factors. The reader can access the Solution 1 2 PRESENT VALUE OF AN ANNUITY DUE Annual annuity payment $700 Interest Rate Factor Supplement at 23,018.49 3 4 Annual rate of interest Number of years 8% 5 MyFinanceLab. The Interest Rate Factor 5 Present value Entry in Cell B5 is =PV(B3,B4,B2,0,1). –$3,018.49 Supplement is a self-contained supple- The minus sign appears before the $3,018.49 in B5 because the annuity’s present value ment that explains how the reader should is a cost and therefore a cash outflow. use the interest rate factors and docu- ments how the in-chapter examples can be solved by using them. MyFinanceLab contains additional resources to demonstrate the examples. New! The MyFinanceLab Financial Calculator reference indicates that the reader can use the finance calculator tool in MyFinanceLab to find the solution for an example by inputting the keystrokes shown in the calculator screenshot. New! The MyFinanceLab Solution Video reference indicates that the reader can watch a video in MyFinanceLab of the author discussing or solving the example. New! The MyFinanceLab Video refer- ence indicates that the reader can watch a Fran Abrams wishes to determine how much money she will IRF Personal Finance Example 5.7 ▶ have at the end of 5 years if she chooses annuity A, the ordinary video on related core topical areas. annuity. She will deposit $1,000 annually, at the end of each of the next 5 years, into a savings account paying 7% annual interest. This situation is depicted on the following time line. Personal Finance Examples demon- Time line for future value of an ordinary annuity ($1,000 $1,310.80 1,225.04 strate how students can apply managerial end-of-year deposit, earning 7%, at the end of 5 years) 1,144.90 finance concepts, tools, and techniques to 1,070.00 1,000.00 their personal financial decisions. $5,750.74 Future Value $1,000 $1,000 $1,000 $1,000 $1,000 0 1 2 3 4 5 End of Year As the figure shows, at the end of year 5, Fran will have $5,750.74 in her ac- count. Note that because the deposits are made at the end of the year, the first 9 Key Equations appear in blue boxes PV = CF , r (5.7) throughout the text to help readers identify the most important mathematical relation- ships. The variables used in these equations are, for convenience, printed on the front endpapers of the book. Review Questions appear at the end of each major ➔ REVIEW QuESTIONS text section. These questions challenge readers to stop 5-10 What is the difference between an ordinary annuity and an annuity due? Which is more valuable? Why? 0 and test their understanding of key concepts, tools, 5-11 What are the most efficient ways to calculate the present value of an ordinary annuity? techniques, and practices before moving on to the next 5-12 How can the formula for the future value of an annuity be modified to find the future value of an annuity due? section. 5-13 How can the formula for the present value of an ordinary annuity be modified to find the present value of an annuity due? 5-14 What is a perpetuity? Why is the present value of a perpetuity equal to New! Excel Review Questions ask readers to com- the annual cash payment divided by the interest rate? plete problems using a simulated Excel spreadsheet in MyFinanceLab that resemble the examples dem- ➔ ExCEL REVIEW QuESTIONS MyFinancelab 5-15 Since tax time comes around every year you smartly decide to make onstrated in the corresponding section. These prob- equal contributions to your IRA at the end of every year. Based on the information provided at MFL, calculate the future value of annual IRA lems allow students to gain experience building Excel contributions grown until retirement. spreadsheet solutions and developing valuable business 5-16 You have just graduated from college, begun your new career, and now it is time to buy your first home. Based on the information pro- skill. vided at MFL, determine how much you can spend for your new dream home. 5-17 Rather than making contributions to an IRA at the end of each year, you decide to make equal contributions at the beginning of each year. Based on the information provided at MFL, solve for the future value of beginning-of-year annual IRA contributions grown until re- tirement. In Practice boxes offer insights into impor- focus on EThICS tant topics in managerial finance through If It Seems Too Good to Be True, It Probably Is the experiences of real companies, both large in practice For many years, inves- tors around the world Over the years, suspicions were reported in these statements. However, a raised about Madoff. He generated high court ruling only permits claims up to the and small. There are three categories of In clamored to invest with Bernard Madoff. Those fortunate enough to returns year after year, seemingly with very little risk. Madoff credited his com- difference between the amount an inves- tor deposited with Madoff and the invest with “Bernie” might not have plex trading strategy for his investment amount the investor withdrew. The judge Practice boxes: understood his secret trading system, but they were happy with the double- performance, but other investors employed similar strategies with much also ruled that investors who managed to withdraw at least their initial investment focus on PRACTICE digit returns that they earned. Madoff different results than Madoff reported. before the fraud was uncovered are not was well connected, having been the Harry Markopolos went as far as to sub- eligible to recover additional funds. Focus on Ethics boxes in every chapter help chairman of the board of directors of Limits on Payback Analysis the NASDAQ Stock Market and a mit a report to the SEC 3 years prior to Total out-of-pocket cash losses Madoff’s arrest, titled “The World’s Larg- as a result of Madoff’s fraud were readers understand and appreciate important founding member of the tough economicest Hedge in practice In International Fund Is a Fraud,” consultancy that in Barrington, times, the standard for simplicity of computing payback may the Securities Securities Clearing Corporation. His detailed his concerns. estimated Illinois. “The to metric 2013, be $17.5 billion. In early for evaluating Investor than more important IT projects—even Protec- discounted cash credentials a payback seemed often reduced. On June to beisimpeccable. period 29, 2009, encourage after a lengthy sloppiness, especiallytionthe Corporation flow reported (NPV and thatIRR)—because more it spot- ethical issues and problems related to mana- However, as the old saying goes, if trial and eventual conviction, Madoff Chief information officers (CIOs) are apt failure to include all costs associated something sounds too good to be true, it was sentenced to 150 years in prison. than 53 percent of the funds had lights the risks inherent in lengthy IT proj- either been returned or were in the to reject probably projectsinvestors is. Madoff’s with payback Madoff’swith learned periods an investment, investors suchtoas training, are still working ects. returned process of being “It shouldto be a hard-and-fast rule to Madoff’s gerial finance. this of more lesson payback December thethan hard2way 11,period,” years. 2008, the when, says “Weon start with U.S.Ron Securities maintenance, recover what account costs,” Fijalkowski, statementssays and hardware upgrade they can. Fraudulent sentDouglas just priorEmond, to never take an IT project with a payback defrauded customers. senior vice period greater than 3 years, unless it’s ▶ What are some hazards of andCIO at Strategic Exchange CommissionDistribution, (SEC) Inc., in Madoff’spresident and chief arrest indicated technology officer that investors’ an infrastructure project you can’t do allowing investors to pursue claims Bensalem, MadoffPennsylvania. “For sure, accounts if atcontained Eastern more Bankthanin Lynn, Massachusetts. without,” Campbell says. Focus on Practice boxes take a corpo- charged Madoff’s the payback with securities fraud. hedge fund, Ascotis Partners, period lion, in aggregate. over 36 months, sued claims For example, basedin Many onathe $64 bil- heinvestors says, “you based on their most recent account pur- may be statements? Whatever the weaknesses of the pay- turned it’s out nottogoing be a giant to get Ponzi scheme. But our approved. bringing hotbalance new technology, but back period method of evaluating capital rate focus that relates a business event or a rule of thumb is we’d like to see 24 www.sec.gov/news/studies/2009/oig-509/exhibit-0293.pdf uh-oh, after implementation you realize months. And if it’s close to 12, it’s prob- that you need a.Net guru in-house, projects, the simplicity of the method does allow it to be used in conjunction with situation to a specific financial concept or ably a no-brainer.” Although easy to compute and easy and you don’t have one.” But the payback method’s emphasis other, more sophisticated measures. It can be used to screen potential projects to understand, the payback period’s on the short term has a special appeal and winnow them down to the few that technique. simplicity brings with it some draw- for IT managers. “That’s because the merit more careful scrutiny with, for exam- backs. “Payback gives you an answer history of IT projects that take longer ple, net present value (NPV). that tells you a bit about the beginning than 3 years is disastrous,” says Gard- ▶ In your view, if the payback period Global Focus boxes look specifically at the stage of a project, but it doesn’t tell you much about the full lifetime of the proj- GLOBAL focus ner. Indeed, Ian Campbell, chief re- search officer at Nucleus Research, Inc., method is used in conjunction with the NPV method, should it be used ect,” says Chris Gardner, a cofounder in Wellesley, Massachusetts, says pay- managerial finance experiences of interna- of iValue LLC, an IT valuation An International Flavor to Risk Reduction back period is an absolutely essential before or after the NPV evaluation? tional companies. Source: Gary Anthes, “ROI Guide: Payback Period,” Computerworld.com (February 17, 2003), in practice Earlier in this chapter (see Table 8.5 on Staunton calculated the historical www.computerworld.com/s/article/78529/ROI_Guide_Payback_Period?taxono returns on a portfolio that.included U.S. globally diversified portfolio of 2.08, slightly lower than the 2.17 coefficient page 324), we learned that from stocks as well as stocks from 18 other of variation reported for U.S. stocks in 1900 through 2011, the U.S. stock countries. This diversified portfolio pro- Table 8.5. All three types of In Practice boxes end with market produced an average annual duced returns that were not quite as ▶ International mutual funds do not nominal return of 9.3 percent, but that high as the U.S. average, just 8.5 per- one or more critical thinking questions to return was associated with a relatively high standard deviation: 20.2 percent cent per year. However, the globally diversified portfolio was also less vola- include any domestic assets, whereas global mutual funds include both foreign and domestic assets. help readers broaden the lesson from the per year. Could U.S. investors have done better by diversifying globally? tile, with an annual standard deviation of 17.7 percent. Dividing the standard How might this difference affect their correlation with U.S. equity The answer is a qualified yes. Elroy deviation by the annual return pro- content of the box. Dimson, Paul Marsh, and Mike duces a coefficient of variation for the mutual funds? Source: Elroy Dimson, Paul Marsh, Mike Staunton, Paul McGinnie, and Jonathan Wilmot, Credit Suisse Global Investment Returns Yearbook 2012. 10 Summary The end-of-chapter Summary consists of two sections. The first FOCuS ON VALuE section, Focus on Value, explains Time value of money is an important tool that financial managers and other mar- ket participants use to assess the effects of proposed actions. Because firms have how the chapter’s content relates to long lives and some decisions affect their long-term cash flows, the effective appli- cation of time-value-of-money techniques is extremely important. These tech- the firm’s goal of maximizing owner niques enable financial managers to evaluate cash flows occurring at different times so as to combine, compare, and evaluate them and link them to the firm’s wealth. This feature helps reinforce understanding of the link between REVIEW OF LEARNING GOALS the financial manager’s actions and LG 1 share value. Discuss the role of time value in finance, the use of computational tools, and the basic patterns of cash flow. Financial managers and investors use time- The second part of the Summary, value-of-money techniques when assessing the value of expected cash flow streams. Alternatives can be assessed by either compounding to find future the Review of Learning Goals, value or discounting to find present value. Financial managers rely primarily restates each learning goal and on present value techniques. Financial calculators, electronic spreadsheets, and financial tables can streamline the application of time value techniques. The summarizes the key material that cash flow of a firm can be described by its pattern: single amount, annuity, or was presented to support mastery mixed stream. of the goal. This review provides students with an opportunity to rec- oncile what they have learned with the learning goal and to confirm their understanding before moving forward. Opener-in-Review questions at the Opener-in-Review end of each chapter revisit the opening Tesla Motors shares were initially offered to investors at $17. Three years later, the price was $90 per share. What was the compound annual return that Tesla vignette and ask students to apply les- investors owned over this period? Given that Tesla paid no dividends and was not expected to start paying dividends anytime soon, what method might ana- sons from the chapter to that business lysts have used to value the company’s shares in 2013? The company sold 13.3 million shares in its IPO with a par value of $0.001 per share. How much paid- situation. in capital did Tesla record on its balance sheet as a result of the IPO? Do you think that the highly favorable Consumer Reports review of the Model S boosted Tesla’s stock primarily because the review reduced the company’s risk Self-Test Problems, keyed to the or because it boosted expected cash flows? learning goals, give readers an oppor- tunity to strengthen their under- Self-Test Problems (Solutions in Appendix) standing of topics by doing a sample Ratio formulas and interpretations Without referring to the text, indicate for each LG 3 LG 4 ST3–1 of the following ratios the formula for calculating it and the kinds of problems, if problem. For reinforcement, solutions LG 5 any, the firm may have if that ratio is too high relative to the industry average. What if the ratio is too low relative to the industry average? Create a table similar to the to the Self-Test Problems appear in one that follows and fill in the empty blocks. the appendix at the back of the book. An IRF icon indicates that the Self- Test Problem can be solved using the interest rate factors. The reader can access the Interest Rate Factor Supplement at MyFinanceLab. Warm-up Exercises follow the Self- Warm-up Exercises All problems are available in MyFinancelab. Test Problems. These short, numerical E4–1 The installed cost of a new computerized controller was $65,000. Calculate the de- LG 1 preciation schedule by year assuming a recovery period of 5 years and using the ap- exercises give students practice in propriate MACRS depreciation percentages given in Table 4.2 on page 120. applying tools and techniques presented E4–2 Classify the following changes in each of the accounts as either an inflow or an out- LG 2 flow of cash. During the year (a) marketable securities increased, (b) land and build- in the chapter. ings decreased, (c) accounts payable increased, (d) vehicles decreased, (e) accounts receivable increased, and (f) dividends were paid. E4–3 Determine the operating cash flow (OCF) for Kleczka, Inc., based on the following 11  Comprehensive Problems, keyed to Problems All problems are available in MyFinancelab. the learning goals, are longer and more LG 1 P4–1 Depreciation On March 20, 2015, Norton Systems acquired two new assets. Asset A was research equipment costing $17,000 and having a 3-year recovery period. complex than the Warm-Up Exercises. Asset B was duplicating equipment having an installed cost of $45,000 and a 5-year recovery period. Using the MACRS depreciation percentages in Table 4.2 on page In this section, instructors will find mul- 120, prepare a depreciation schedule for each of these assets. tiple problems that address the impor- LG 1 P4–2 Depreciation In early 2015, Sosa Enterprises purchased a new machine for $10,000 to make cork stoppers for wine bottles. The machine has a 3-year recovery period tant concepts, tools, and techniques in and is expected to have a salvage value of $2,000. Develop a depreciation schedule the chapter. b. for this asset Discuss the using the MACRS financing changesdepreciation suggested bypercentages in Table the statement 4.2. in part a. prepared LG 5 P4–19 Integrative: Pro forma statements Red Queen Restaurants wishes to prepare finan- A short descriptor identifies the cial plans. Use the financial statements and the other information provided below to prepare the financial plans. essential concept or technique of the problem. Problems labeled as Integrative tie together related topics. Personal Finance Problem Personal Finance Problems specifi- Preparation of cash budget Sam and Suzy Sizeman need to prepare a cash budget LG 4 P4–10 for the last quarter of 2016 to make sure they can cover their expenditures during cally relate to personal finance situations the period. Sam and Suzy have been preparing budgets for the past several years and and Personal Finance Examples in each have been able to establish specific percentages for most of their cash outflows. These percentages are based on their take-home pay (that is, monthly utilities nor- chapter. These problems will help students mally run 5% of monthly take-home pay). The information in the following table can be used to create their fourth-quarter budget for 2016. see how they can apply the tools and LG 3 P4–21 ETHICS PROBLEM The SEC is trying to get companies to notify the investment techniques of managerial finance in man- community more quickly when a “material change” will affect their forthcoming financial results. In what sense might a financial manager be seen as “more ethical” aging their own finances. if he or she follows this directive and issues a press release indicating that sales will not be as high as previously anticipated? The last item in the chapter Problems is an Ethics Problem. The ethics problem gives students another opportunity to think about and apply ethics principles to managerial financial situations. All exercises and problems are available in MyFinanceLab. Spreadsheet Exercise Every chapter includes a Spreadsheet CSM Corporation has a bond issue outstanding at the end of 2015. The bond has Exercise. This exercise gives students an oppor- 15 years remaining to maturity and carries a coupon interest rate of 6%. Interest on the bond is compounded on a semiannual basis. The par value of the CSM bond is tunity to use Excel software to create one or $1,000, and it is currently selling for $874.42. more spreadsheets with which to analyze a financial problem. The spreadsheet to be created is often modeled on a table or Excel screen- shot located in the chapter. Students can access working versions of the Excel screenshots in MyFinanceLab. An Integrative Case at the end of each part Integrative Case 3 of the book challenges students to use what they Encore International have learned over the course of several chapters. Additional chapter resources, such as Chapter I n the world of trendsetting fashion, instinct and marketing savvy are prerequisites to success. Jordan Ellis had both. During 2015, his international casual-wear company, Encore, rocketed to $300 million in sales after 10 years in business. His fashion line covered the young woman from head to toe with hats, sweaters, Cases, Group Exercises, and numerous online dresses, blouses, skirts, pants, sweatshirts, socks, and shoes. In Manhattan, there was an Encore shop every five or six blocks, each featuring a different color. Some resources, intended to provide further means for shops showed the entire line in mauve, and others featured it in canary yellow. Encore had made it. The company’s historical growth was so spectacular student learning and assessment are available in that no one could have predicted it. However, securities analysts speculated that Encore could not keep up the pace. They warned that competition is fierce in the fashion industry and that the firm might encounter little or no growth in the MyFinanceLab at www.myfinancelab.com. future. They estimated that stockholders also should expect no growth in future dividends. Contrary to the conservative securities analysts, Jordan Ellis believed that the 12 Brief Contents Detailed Contents 15 About the Authors 35 Preface 37 Supplements to the Fourteenth Edition 41 Acknowledgments 43 Introduction to Managerial Part 1 Long-Term Financial Finance 47 Part 6 decisions 557 1 the role of managerial finance 48 2 the financial market environment 76 13 Leverage and capital Structure 558 14 payout policy 612 Part 2 Financial Tools 103 Short-Term Financial Part 7 decisions 651 3 financial Statements and ratio Analysis 104 4 cash flow and financial planning 162 15 Working capital and current Assets management 652 5 time Value of money 208 16 current Liabilities management 695 Part 3 Valuation of Securities 271 Special Topics in Managerial Part 8 Finance 729 6 interest rates and Bond Valuation 272 17 Hybrid and Derivative Securities 730 7 Stock Valuation 316 18 mergers, LBos, Divestitures, and Business failure 768 Risk and the Required Rate 19 international managerial finance 811 Part 4 of Return 359 8 risk and return 360 Appendix A-1 9 the cost of capital 408 Glossary G-1 Long-Term Investment Credits C-1 Part 5 decisions 439 Index I-1 10 capital Budgeting techniques 440 11 capital Budgeting cash flows 478 12 risk and refinements in capital Budgeting 515 13 This page is intentionally left blank. Contents About the Authors 35 Preface 37 Supplements to the Fourteenth Edition 41 Acknowledgments 43 Part 1 Introduction to Managerial Finance 47 1 1.1 Finance and Business 50 primary Activities of the The Role of financial manager 65 What is finance? 50 Managerial ➔ REVIEW QuESTIONS 65 Finance career opportunities in finance 50 page 48 Legal forms of Business organization 51 1.4 Governance and Agency 66 in practice Focus on Practice: Professional Certifications in Finance 51 corporate governance 66 Why Study managerial finance? 55 the Agency issue 67 ➔ REVIEW QuESTIONS 56 ➔ REVIEW QuESTIONS 70 Facebook—Not Much to “Like” about IPO page 49 Summary 70 1.2 Goal of the Firm 56 Opener-in-Review 71 Self-Test Problem 71 maximize Shareholder Wealth 56 Warm-Up Exercises 72 maximize profit? 57 Problems 73 What About Stakeholders? 59 Spreadsheet Exercise 75 the role of Business ethics 59 ethics and Share price 60 ➔ REVIEW QuESTIONS 60 in practice Focus on Ethics: Critics See Ethical Dilemmas in Google Glass? 61 1.3 Managerial Finance Function 61 organization of the finance function 62 relationship to economics 62 relationship to Accounting 63 15 16 Contents 2 2.1 Financial Institutions and 2.3 Regulation of Financial The Financial Markets 78 Institutions and Markets 90 Market regulations governing financial financial institutions 78 Environment commercial Banks, investment Banks, institutions 91 page 76 and the Shadow Banking System 79 regulations governing financial markets 91 financial markets 80 the relationship between institutions ➔ REVIEW QuESTIONS 92 and markets 80 2.4 Business Taxes 92 the money market 81 the capital market 81 ordinary income 92 in practice Focus on Practice: Berkshire capital gains 95 Hathaway: Can Buffett Be Replaced? 83 ➔ REVIEW QuESTIONS 95 A Crisis in Housing in practice Focus on Ethics: The Ethics Finance—Under Water in the Summary 95 of Insider Trading 86 Desert page 77 Opener-in-Review 97 ➔ REVIEW QuESTIONS 87 Self-Test Problem 97 2.2 Warm-Up Exercises 98 The Financial Crisis 87 Problems 98 financial institutions and real estate Spreadsheet Exercise 100 finance 87 Integrative Case 1 Merit Enterprise falling Home prices And Delinquent