Summary Essentials of Corporate Finance- Bradford D Jordan, Stephen A. Ross PDF

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Summary Essentials of Corporate Finance Bradford D Jordan, Stephen A. Ross 4th Edition

Contents 1. Introduction to Financial Management .......................................................................................... 5 1.1. Finance: A quick look ................................................................................................................ 5 1.2. Business Finance and the Financial Manager ........................................................................ 6 1.3. Forms of Business Organization .............................................................................................. 6 1.4. The Goal of Financial Management ........................................................................................ 8 1.5. The Agency Problem and Control of the Corporation .......................................................... 9 1.6. Financial Markets and the Corporation ................................................................................ 10 2. Financial Statements, Taxes and Cash Flow................................................................................ 12 2.1. The Balance Sheet ................................................................................................................... 12 2.2. The Income Statement ............................................................................................................ 13 2.3. Taxes ......................................................................................................................................... 14 2.4. Cash Flow ................................................................................................................................. 15 3. Working with Financial Statements ............................................................................................. 17 3.1. Standardized Financial Statements ....................................................................................... 17 3.2. Ratio Analysis ........................................................................................................................... 18 3.3. The Du Pont Identity............................................................................................................... 22 3.4. Internal and Sustainable Growth ........................................................................................... 23 3.5. Using Financial Statement Information ................................................................................ 24 4. Introduction to Valuation: The Time Value of Money ............................................................... 26 4.1. Future Value and Compounding ............................................................................................ 26 4.2. Present Value and Discounting.............................................................................................. 27 4.3. More on Present and Future Values ..................................................................................... 28 5. Discounted Cash Flow Valuation .................................................................................................. 29 5.1. Future Values of Multiple Cash Flows .................................................................................. 29 5.2. Valuing Level Cash Flows: Annuities and Perpetuities ....................................................... 29 5.3. Comparing rates: The Effect of Compounding Periods ...................................................... 30 5.4. Loan Types and Loan Amortization....................................................................................... 31 6. Interest Rates and Bond Valuation ............................................................................................... 33 6.1. Bonds and Bond Valuation ..................................................................................................... 33 6.2. More on Bond Features .......................................................................................................... 34 6.3. Bond Ratings ............................................................................................................................ 36 6.4. Some Different Types of Bonds ............................................................................................ 36 6.5. Bond Markets ........................................................................................................................... 37 © StuDocu.com

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6.6. Inflation and Interest Rates .................................................................................................... 38 6.7. Determinants of Bond Yields ................................................................................................. 38 7. Equity Markets and Stock Valuations .......................................................................................... 42 7.1. Common Stock Valuation ....................................................................................................... 42 7.2. Some Features of Common and Preferred Stock................................................................ 44 7.3. The Stock Markets................................................................................................................... 45 8. Net Present Value and Other Investment Criteria ..................................................................... 47 8.1. Net Present Value ................................................................................................................... 47 8.2. The Payback Rule .................................................................................................................... 48 8.3. The Average Accounting Return ........................................................................................... 48 8.4. The Internal Rate of Return.................................................................................................... 49 8.5. The Profitability Index ............................................................................................................. 53 8.6. The Practice of Capital Budgeting ......................................................................................... 53 9. Making Capital Investment Decisions .......................................................................................... 54 9.1. Project Cash Flows: A First Look ........................................................................................... 54 9.2. Incremental Cash Flows .......................................................................................................... 54 9.3. Pro Forma Financial Statements and Project Cash Flows .................................................. 55 9.4. More on Project Cash Flows .................................................................................................. 56 9.5. Evaluating NPV Estimates ...................................................................................................... 57 9.6. Scenario and Other What-If Analyses .................................................................................. 57 9.7. Additional Consideration in Capital Budgeting .................................................................... 58 10. Some Lessons from Capital Market History ............................................................................. 59 10.1. Returns ................................................................................................................................... 59 10.2. The Historical Record ........................................................................................................... 59 10.3. Average Returns: The First Lesson ..................................................................................... 60 10.4. The Variability of Returns: The Second Lesson................................................................. 60 10.5. More on Average Returns .................................................................................................... 61 10.6. Capital Market Efficiency ..................................................................................................... 62 11. Risk and Return ............................................................................................................................. 64 11.1. Expected Returns and Variances......................................................................................... 64 11.2. Portfolios ................................................................................................................................ 64 11.3. Announcements, Surprises, and Expected Returns .......................................................... 65 11.4. Risk: Systematic and Unsystematic..................................................................................... 65 11.5. Diversification and Portfolio Risk........................................................................................ 66 11.6. Systematic Risk and Beta ..................................................................................................... 67 © StuDocu.com

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11.7. The Security Market Line ..................................................................................................... 67 11.8. The SML and the Cost of Capital: A Preview .................................................................... 69 12. Cost of Capital .............................................................................................................................. 70 12.1. The Cost of Capital: Some Preliminaries ............................................................................ 70 12.2. The Cost of Equity ................................................................................................................ 70 12.3. The Cost of Debt and Preferred Stock ............................................................................... 71 12.4. The Weighted Average Cost of Capital.............................................................................. 71 12.5. Divisional and Project Cost of Capital ................................................................................ 72 13. Leverage and Capital Structure .................................................................................................. 75 13.2. The Effect of Financial Leverage ......................................................................................... 75 13.3. Capital Structure and the Cost of Equity Capital .............................................................. 77 13.4. Corporate Taxes and Capital Structure .............................................................................. 78 13.6. Optimal Capital Structure .................................................................................................... 80 13.7. Observed Capital Structures ................................................................................................ 82 13.8. A Quick Look at the Bankruptcy Process........................................................................... 82 13.1. The Capital Structure Question ........................................................................................... 84 13.5. Bankruptcy Costs .................................................................................................................. 84 14. Dividends and Dividend Policy ................................................................................................... 85 14.1. Cash Dividends and Dividend Payment ............................................................................. 85 14.2. Does Dividend Policy Matter? ............................................................................................. 86 14.3. Stock Repurchase: An Alternative to Cash Dividends ...................................................... 86 14.4. What We Know and Do Not Know about Dividend and Payout Policies ..................... 87 14.5. Stock Dividends and Stock Split .......................................................................................... 88 15. Raising Capital............................................................................................................................... 90 15.1. The Financing Life Cycle of a Firm: Early-Stage Financing and Venture Capital .......... 90 15.2. Selling Securities to the Public: The Basic Procedure....................................................... 91 15.3. Alternative Issue Methods ................................................................................................... 91 15.4. Underwriters .......................................................................................................................... 92 15.5. IPOs and Underpricing ......................................................................................................... 93 15.6. New Equity Sales and the Value of the Firm ..................................................................... 94 15.7. The Cost of Issuing Securities.............................................................................................. 94 15.8. Issuing Long-Term Debt ....................................................................................................... 94 15.9. Shelf Registration .................................................................................................................. 95 16. Short-Term Financial Planning.................................................................................................... 97 16.1. Tracing Cash and Net Working Capital .............................................................................. 97 © StuDocu.com

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16.2. The Operating Cycle and the Cash Cycle........................................................................... 98 16.3. Some Aspects of Short-Term Financial Policy................................................................. 101 16.4. The Cash Budget ................................................................................................................. 104 16.5. Short-Term Borrowing........................................................................................................ 105 17. Working Capital Management .................................................................................................. 106 17.1. Float and Cash Management ............................................................................................. 106 17.2. Cash Management: Collection, Disbursement, and Investment ................................... 107 17.3. Credit and Receivables ....................................................................................................... 109 17.4. Inventory Management ...................................................................................................... 113 17.5. Inventory Management Techniques ................................................................................. 113 18. International Aspects of Financial Management .................................................................... 117 18.1. Terminology ......................................................................................................................... 117 18.2. Foreign Exchange Markets and Exchange Rates ............................................................ 118 18.3. Purchasing Power Parity .................................................................................................... 119 18.4. Exchange Rates and Interest Rates ................................................................................... 120 18.5. Exchange Rate Risk ............................................................................................................. 120 18.6. Political Risk ......................................................................................................................... 121

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1. Introduction to Financial Management Business finance has three main areas of concern: capital budgeting, capital structure and working capital management. The goal of financial management within business finance is to make decisions that increase the value of the company's equity. There are various types of organizations and in the remaining of the book we deal with the corporate form. This is superior when it comes to raising money and transferring ownership interest but has the disadvantage of double taxation. In the corporation there exists the possibility of conflicts of interest between stockholders and management, called the agency problems.

1.1. Finance: A quick look There are four areas within finance: corporate finance, investments, financial institutions and international finance. The study of finance is not only applicable to people with a finance career but the knowledge can be used in other areas (marketing, accounting etc.) as well. Financial topics are traditionally grouped into four main areas: 1. Corporate Finance 2. Investments: deals with financial assets such as stocks and bonds. This area deals with questions such as what determines the price of a share? What are the potential risks related to the investment? What is the best mixture of types of assets to hold? 3. Financial Institutions: businesses that deal primarily in financial matters (banks and insurance companies) 4. International Finance: is more of a specialization within the areas described above. Even if you are not planning a finance career, having working knowledge is essential. If you are interested in marketing you need to know finance to understand how to get the greatest payoff from marketing expenditures. On top of this the finance industry also needs marketers that have sufficient knowledge of what is going on.

Also accountants, particularly in smaller businesses have to make financial decisions. Financial knowledge helps accountants recognize what types of information are particularly valuable and how it is actually used in practice. One of the key learning points in finance is how to create value. This knowledge may

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be used in the field of management and strategy as well. Finally, you will also have to make financial decisions of your own, that are important to you personally.

1.2. Business Finance and the Financial Manager There are four areas within finance: corporate finance, investments, financial institutions and international finance. The study of finance is not only applicable to people with a finance career but the knowledge can be used in other areas (marketing, accounting etc.) as well. Business finance (or Corporate Finance) is concerned with the following questions: 1. What long-term investments should you take on? 2. Where will you get the long-term finance to pay for the investments? 3. How will you manage your everyday financial activities?

The Chief Financial Officer (CFO) coordinates the activities of the controller (responsible for the accounting, tax payments and management information systems) and the treasurer (managing the cash and credit, financial planning and capital expenditures). The first question above refers to the process of planning and managing a firm’s longterm investment, which is called capital budgeting. The managers tries to generate cash flows from an asset that exceed the cost of this asset. This requires evaluation of size, timing and risk of future cash flows. The second question concerns the capital structure, the specific mixture of long-term debt and equity the firm uses to finance its operations. This requires assessment of the amount and the source of funding. In addition the manager has to decide how and where exactly to raise the money. Finally, the last question concerns working capital. This refers to a firm’s short-term assets and short-term liabilities. Questions to be answered are: how much cash and inventory to keep on hand? Should we sell on credit? How it’ll be obtain short-term financing?

1.3. Forms of Business Organization There are three main forms of organization: sole proprietorship, partnership and the corporation.

A sole proprietorship is a business owned by one person. The owner keeps all benefits but has also unlim...