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Managerial FinanceG L O B A L E D I T1

Thirteenth Edition

Lawrence J. GitmanSan Diego State University

Chad J. ZutterUniversity of Pittsburgh

Boston Columbus Indianapolis New York San Francisco Upper Saddle River

Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto

Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

Managerial FinanceG L O B A L E B I T f

Thirteenth Edition

Lawrence J. GitmanSan Diego State University

Chad J. ZutterUniversity of Pittsburgh

Boston Columbus Indianapolis New York San Francisco Upper Saddle River

Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto

Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

Contents

About the Authors xxxv

Preface xxxvii

Supplements to the Thirteenth Edition xh

Acknowledgments xlvii

To the Student li

Introduction to Managerial Finance 1

The Role ofManagerialFinancepage 2

facebookFacebook—In No Hurry To

Go Public page 3

RBI Finance and Business 4What is Finance? 4

Career Opportunities in Finance 4

Legal Forms of Business Organization

Focus on Practice:Professional Certifications in Finance 5

Why Study Managerial Finance? 9

* REVIEW aUESTIONS 9

U 3 Goal of the Firm 10Maximize Shareholder Wealth

Maximize Profit? 11

What about Stakeholders? 13

The Role of Business Ethics 13•* REVIEW aUESTIONS 14

10

Focus on Ethics: Will GoogleLive Up to Its Motto? 15

Relationship to Accounting 17

Primary Activities of the FinancialManager 19

•> REVIEW aUESTIONS 19

Bfil Governance and Agency 20Corporate Governance 20

The Agency Issue 21

•» REVIEW QUESTIONS 24

Summary 24

Opener-in-Review 25

Self-Test Problem 25

Warm-Up Exercises 26

Problems 27

Spreadsheet Exercise 29

U S ! Managerial FinanceFunction 15Organization of the FinanceFunction 16

Relationship to Economics 16

XV

xvi Contents

The FinancialMarketEnvironmentpage 30

JPMorgan Chase & Co.—

Cut to the Chase page 31

Financial Institutions andMarkets 32

Financial Institutions 32

Commercial Banks, Investment Banks,and the Shadow Banking System 33

Financial Markets 34

The Relationship between Institutionsand Markets 34

The Money Market 35

The Capital Market 35

M Focus on Practice: BerkshireHathaway—Can Buffett Be Replaced? 37

fjjf°g°BBSll Focus on Ethics: The Ethicsof Insider Trading 40

* REVIEW QUESTIONS 40

Efi l The Financial Crisis 41

Financial Institutions and RealEstate Finance 41

Falling Home Prices and DelinquentMortgages 41

Crisis of Confidence in Banks 42

Spillover Effects and the GreatRecession 43


E S I Regulation of FinancialInstitutions 44

Regulations Governing FinancialInstitutions 44

Regulations Governing FinancialMarkets 45

-» REVIEW QUESTIONS 45

46E&l Business Taxes

Ordinary Income 46

Capital Gains 48

-» REVIEW QUESTIONS 49

Summary 49

Opener-in-Review 50



Problems 51


Integrative Case 1 Merit EnterpriseCorp. 54

Contents xvii

Parti! Financial Tools 55

3FinancialStatements andRatio Analysispage 56

Aberaombie & Fitch—The Value of Casual Luxurypage 57

58E U The Stockholders' ReportThe Letter to Stockholders 58

O ^ ^ J ^ Global Focus: More CountriesAdopt International Financial ReportingStandards 58

The Four Key Financial Statements 59

fiBMSffiSSlI Focus on Ethics: TakingEarnings Reports at Face Value 59

Notes to the Financial Statements 65

Consolidating International FinancialStatements 65

•* REVIEW QUESTIONS 66

E 8 9 Using Financial Ratios 67Interested Parties 67

Types of Ratio Comparisons 67

Cautions about Using RatioAnalysis 70

Categories of Financial Ratios 70

•> REVIEW QUESTIONS 70

Efi l Liquidity Ratios 71Current Ratio 7i

Quick (Acid-Test) Ratio 72

•• REVIEW QUESTIONS 73

E S I Activity Ratios 73Inventory Turnover 73

Average Collection Period 74

Average Payment Period 75

Total Asset Turnover 75

•> REVIEW QUESTION 76

Fixed-Payment Coverage Ratio 78

-> REVIEW QUESTIONS 79

E&3 Profitability Ratios 79Common-Size Income Statements 79

Gross Profit Margin 79

Operating Profit Margin 80

Net Profit Margin 80

Earnings Per Share (EPS) 81

Return on Total Assets (ROA) 81

Return on Common Equity (ROE) 82

-* REVIEW QUESTIONS 82

Bfi l Market Ratios 82Price/Earnings (P/E) Ratio 82

Market/Book (M/B) Ratio 83


E B A Complete RatioAnalysis 84Summarizing All Ratios 84

Dupont System of Analysis 85


Summary 90

Opener-in-Review 92

Self-Test Problems 92


Problems 94 .


KSa Debt Ratios 76Debt Ratio 77

Times Interest Earned Ratio 78

xviii Contents

Cash Flow andFinancial Planningpage 1 13

Apple—Investors Want Apple

to Take a Bite Out of Its Cash

Hoard page 1 14

Analyzing the Firm'sCash Flow 115

Depreciation 115

Depreciation Methods" 116

Developing the Statement ofCash Flows 117

Free Cash Flow 122

J Focus on Practice: Free CashFlow at Cisco Systems 123


E S The Financial PlanningProcess 124Long-Term (Strategic) FinancialPlans 124

Short-Term (Operating) FinancialPlans 125

(8B/gBSStBg# Focus on Ethics: How MuchIs a CEO Worth? 125


S S I Cash Planning:Cash Budgets 127The Sales Forecast 127

Preparing the Cash Budget 128

Evaluating the Cash Budget 132

Coping with Uncertainty in theCash Budget 133

Cash Flow within the Month 134


• S I Profit Planning: Pro FormaStatements 135

Preceding Year's FinancialStatements 135

Sales Forecast 135

"• REVIEW QUESTION 135

ES3 Preparing the Pro FormaIncome Statement 137

Considering Types of Costs andExpenses 137


E2d Preparing the Pro FormaBalance Sheet 139


mam Evaluation of Pro FormaStatements 141


Summary 142

Opener-in-Review 143



Problems 146


Contents xix

5Time Valueof Moneypage 159

Eli Lilly and Company—

Riding the Pipeline page 160

ESI The Role of Time Value inFinance 161Future Value versus Present Value 161

Computational Tools 162

Basic Patterns of Cash Flow 163


ESI Single Amounts 164Future Value of a Single Amount 164

Present Value of a Single Amount 168


E S I Annuities 171Types of Annuities 171Finding the Future Value of an OrdinaryAnnuity 172

Finding the Present Value of an OrdinaryAnnuity 173

Finding the Future Value of anAnnuity Due 175

Finding the Present Value of anAnnuity Due 176

Finding the Present Value of aPerpetuity 178


ESI Mixed Streams 178Future Value of a Mixed Stream 179

Present Value of a Mixed Stream 180

•» REVIEW QUESTION 181

ESI Compounding Interest MoreFrequently Than Annually 181Semiannual Compounding 181

Quarterly Compounding 182

A General Equation for CompoundingMore Frequently Than Annually 183

Using Computational Tools forCompounding More Frequently ThanAnnually 184

Continuous Compounding 184

Nominal and Effective Annual Rates ofInterest 185

gB§ Focus on Ethics: How Fair Is187"Check into Cash"?

REVIEW QUESTIONS 187

ESI Special Applications of TimeValue 188Determining Deposits Needed toAccumulate a Future Sum 188

Loan Amortization 189

Focus on Practice: NewCentury Brings Trouble for SubprimeMortgages 191

Finding Interest or Growth Rates 191

Finding an Unknown Number ofPeriods 192


Summary 194




Problems 198


Integrative Case 2 Track Software,Inc. 215

XX Contents

> Valuation of Securities 219

Interest Rates andBond Valuationpage 220

Asian Development Bank—

Renminbi-Denominated

International Bonds Are

Finally Out page 221

Interest Rates and RequiredReturns 222Interest Rate Fundamentals 222

6BffS333IEiE Focus on Practice: Bond'sValuation and Interest Rate Risk 225

Term Structure of Interest Rates 226

Risk Premiums: Issuer and IssueCharacteristics 229


E S I Corporate Bonds 231Legal Aspects of Corporate Bonds 232

Cost of Bonds to the Issuer 233

General Features of a Bond Issue 233

Bond Yields 234

Bond Prices 234

Bond Ratings 235

I 1 S B @ Focus on Ethics: Can WeTrust the Bond Raters? 236

Common Types of Bonds 236

International Bond Issues 237


E S I Valuation Fundamentals 239Key Inputs 239

Basic Valuation Model 240


E S I Bond Valuation 241Bond Fundamentals 241

Basic Bond Valuation 242

Bond Value Behavior 243

Yield to Maturity (YTM) 247

Semiannual Interest andBond Values 248


Summary 250




Problems 254


Contents xxi

Stock Valuationpage 264

Air Asia—Jewel in the

Skies? page 265

I f i l Differences between Debtand Equity 266

Voice in Management 266

Claims on Income and Assets 266

Maturity 267

Tax Treatment 267

•* REVIEW QUESTION 267

EE1 Common and PreferredStock 267

Common Stock 268

Preferred Stock 271

Issuing Common Stock 272


• n i l Common StockValuation 277

Market Efficiency 277

The Efficient-Market Hypothesis 278O' iSi iB l§ Focus on Practice:Understanding Human Behavior Helps UsUnderstand Investor Behavior 279

Basic Common Stock ValuationEquation 279

Free Cash Flow Valuation Model 284

Other Approaches to CommonStock Valuation 287

Focus on Ethics: Psst—HaveYou Heard Any Good Quarterly EarningsForecasts Lately? 288


Kfil Decision Making andCommon Stock Value 290

Changes in Expected Dividends 290

Changes in Risk 291

Combined Effect 291


Summary 292




Problems 296


Integrat ive Case 3 Encore International304

xxii Contents

Risk and the Required Rate of Return 307

Risk and Returnpage 308

Mutual Funds—Fund's Returns

Not Even Close to Average

page 309

l i U Risk and ReturnFundamentals 310Risk Defined 310

W Focus on Ethics: If ItSeems Too Good to Be True Then ItProbably Is 310

Return Defined 311

Risk Preferences 312


E S I Risk of a Single Asset 313Risk Assessment 313

Risk Measurement 315


E S I Risk of a Portfolio 321Portfolio Return and StandardDeviation 321

Correlation 323

Diversification 323

Correlation, Diversification, Risk,and Return 326

International Diversification 327

International Flavor to RiskReduction 328


E S I Risk and Return: The CapitalAsset Pricing Model (CAPM) 329Types of Risk 329

The Model: CAPM 330


Summary 339




Problems 343


Contents xxiii

The Cost of Capitalpage 356

General Electric—FallingShort of Expectationspage 357

H a l Overview of theCost of Capital 358

The Basic Concept 358

$ Focus on Ethics: The Ethicsof Profit 358

Sources of Long-Term Capital 359


KEfl Cost of Long-Term Debt 360

Net Proceeds 360

Before-Tax Cost of Debt 361

After-Tax Cost of Debt 363

"• REVIEW QUESTIONS 364

KSI Cost of Preferred Stock 364

Preferred Stock Dividends 364

Calculating the Cost ofPreferred Stock 364

* REVIEW QUESTION 365

ISSI Cost of Common Stock 365

Finding the Cost of CommonStock Equity 365

Cost of Retained Earnings 367

Cost of New Issues ofCommon Stock 368


BEI Weighted Average Costof Capital 369

Calculating Weighted Average Cost ofCapital (WACC) 369

Focus on Practice: UncertainTimes Make for an Uncertain WeightedAverage Cost of Capital 371

Weighting Schemes 372


Summary 373



Warm-Up Exercises 375 -

Problems 376


Integrat ive Case 4 Eco PlasticsCompany 385

XXIV Contents

Long-Term Investment Decisions 387

Capital BudgetingTechniquespage 388

Treats—Waffles and More,

Cairo—Capital Budgeting

Techniques Work a Treat

page 389

Overview of CapitalBudgeting 390

Motives for Capital Expenditure 390

Steps in the Process 390

Basic Terminology 391

Capital Budgeting Techniques 392


393KBU Payback PeriodDecision Criteria 393

Pros and Cons of PaybackAnalysis 394

B B f t Focus on Practice: Limits onPayback Analysis 395


U!SI Net Present Value (NPV) 397

Decision Criteria 397

NPV and the Profitability Index 399

NPV and Economic Value Added 400


li!SI Internal Rate of Return(IRR) 401

Decision Criteria 401

Calculating the IRR 402


U!£] Comparing NPV and IRRTechniques 404

Net Present Value Profiles 404

Conflicting Rankings 406

Which Approach Is Better? 409feliStSigi Focus on Ethics: NonfinancialConsiderations in Project Selection 411


Summary 412Opener-in-Review 413Self-Test Problems 414Warm-Up Exercises 414Problems 415Spreadsheet Exercise 425

Contents XXV

11Capital BudgetingCash Flowspage 426

ExxonMobil—Maintaining Its

Project Inventory page 427

l l f l l Relevant Cash Flows 428Major Cash Flow Components 428

$3is%sS8!£k Focus on Ethics: A Questionof Accuracy 428

Expansion versus ReplacementDecisions 429

Sunk Costs and OpportunityCosts 429

International Capital Budgeting andLong-Term Investments 430


@j23s^& Global Focus: ChangesMay Influence Future Investments inChina 432

UEJ Finding the InitialInvestment 432Installed Cost of New Asset 433

After-Tax Proceeds from Sale ofOld Asset 433

Change in Net Working Capital 436

Calculating the Initial Investment 437


Interpreting the Term Cash Inflows 439

Interpreting the Term Incremental 441


443

Finding the TerminalCash Flow 443Proceeds from Sale of Assets

Taxes on Sale of Assets 443

Change in Net Working Capital 444

•• REVIEW QUESTION 445

1183 Summarizing the RelevantCash Flows 445•» REVIEW QUESTION 447

Summary 447




Problems 450


U t t l Finding the OperatingCash Inflows 438Interpreting the Term After-Tax 438

xxvi Contents

Risk andRefinements inCapital Budgetingpage 463

BP—Worst Case Scenario

page 464

HSU Introduction to Risk inCapital Budgeting 465•• REVIEW QUESTION 465

IE£i Behavioral Approaches forDealing with Risk 466Risk and Cash Inflows 466

Scenario Analysis 467

Simulation 468

S Focus on Practice: TheMonte Carlo Method: The Forecast Is forLess Uncertainty 470

• REVIEW QUESTIONS 470

USSI International RiskConsiderations 470•> REVIEW QUESTION 471

IESI Risk-Adjusted DiscountRates 472Determining Risk-Adjusted DiscountRates (RADRs) 472

§ Focus on Ethics: Ethics and475

Portfolio Effects 478

RADRs in Practice 478


EEsi Capital BudgetingRefinements 480Comparing Projects withUnequal Lives 480

Recognizing Real Options 483

Capital Rationing 485


Summary 488




Problems 492


Integrat ive Case 5 Lasting ImpressionsCompany 503

the Cost of Capital

Applying RADRs 475

Contents xxvii

Long-Term Financial Decisions 505

13Leverage andCapital Structurepage 506

Genzyme Corp.—Trading

Equity for Debt page 507

IE8I Leverage 508

Breakeven Analysis 509

Operating Leverage 513

CSigjjfeifBs^ Focus on Practice: Adobe'sLeverage 515

Financial Leverage 516

Total Leverage 520

§> Focus on Ethics:522Repo 105


Ufifl The Firm's CapitalStructure 523Types of Capital 523

External Assessment of CapitalStructure 524

Capital Structure of Non-U.S.Firms 525

Capital Structure Theory 526

Optimal Capital Structure 535


IES1 EBIT-EPS Approach toCapital Structure 537Presenting a Financing PlanGraphically 537

Comparing Alternative CapitalStructures 539

Considering Risk in EBIT-EPSAnalysis 539

Basic Shortcoming of EBIT-EPSAnalysis 540


U f i l Choosing the OptimalCapital Structure 540

Linkage 540

Estimating Value 541

Maximizing Value versusMaximizing EPS 543

Some Other ImportantConsiderations 543


Summary 544




Problems 548


xxviii Contents

Payout Policypage 559

Global Investment House—

The Payback Time page 560

The Basics of PayoutPolicy 561

Elements of Payout Policy 561

Trends in Earnings and Dividends

Trends in Dividends and ShareRepurchases 563

W Focus on Ethics: AreBuybacks Really a Bargain? 564


562

• £ £ ] The Mechanics of PayoutPolicy 565

Cash Dividend PaymentProcedures 565

Share Repurchase Procedures 567

Tax Treatment of Dividends andRepurchases 568

® Focus on Practice: CapitalGains and Dividend Tax TreatmentExtended to 2010 569

Dividend Reinvestment Plans 570

Stock Price Reactions to CorporatePayouts 570


| £ £ ] Relevance of PayoutPolicy 571

Residual Theory of Dividends 571

The Dividend Irrelevance Theory 572

Arguments for Dividend Relevance 573

"> REVIEW QUESTIONS 574

IE&1 Factors Affecting Dividend

Policy 574

Legal Constraints 574

Contractual Constraints 576

Growth Prospects 576

Owner Considerations 576

Market Considerations 576


EES Types of DividendPolicies 577

Constant-Payout-Ratio DividendPolicy 577

Regular Dividend Policy 578

Low-Regular-and-Extra DividendPolicy 579


EES Other Forms ofDividends 579

Stock Dividends 579

Stock Splits 581


Summary 583




Problems 586


Integrat ive Case 6 O'Grady ApparelCompany 594

Contents xxix

Short-Term Financial Decisions 597

15Working Capitaland Current AssetsManagementpage 598

Hing Yiap—Focusing on

Working Capital page 599

Net Working CapitalFundamentals 600Working Capital Management 600

Net Working Capital 601

Trade-Off between Profitabilityand Risk 601


UsEi Cash Conversion Cycle 603

Calculating the Cash ConversionCycle 604

Funding Requirements of the CashConversion Cycle 605

Strategies for Managing the CashConversion Cycle 607


IfiSI Inventory Management 608

Differing Viewpoints about InventoryLevel 608

Common Techniques for ManagingInventory 609

Focus on Practice: RFID: The613Wave of the Future7

International InventoryManagement 614

•* REVIEW QUESTIONS

IfsBJ Accounts ReceivableManagement 615

Credit Selection and Standards 615

Credit Terms 619

Credit Monitoring 622

-* REVIEW QUESTIONS 623

UsSsI Management of Receiptsand Disbursements 624

Float 624

Speeding Up Collections 625

Slowing Down Payments 625§f> Focus on Ethics: Stretching

Accounts Payable—Is It aGood Policy? 626

Cash Concentration 626

Zero-Balance Accounts 627

Investing in Marketable Securities 629


Summary 630




Problems 634


XXX Contents

16Current LiabilitiesManagementpage 640

Memorial Sloan-Kettering

Cancer Center—Reducing

Accounts Payable Expenses

page 641

Spontaneous Liabilities 642

Accounts Payable Management 642

Accruals 647

®a?°sasgisti Focus on Ethics: AccrualsManagement 647


IESI Unsecured Sources ofShort-Term Loans 648Bank Loans 648

Commercial Paper 654

(BMSZSslS&k Focus on Practice: The Ebband Flow of Commercial Paper 654

International Loans 655


IfiSI Secured Sources ofShort-Term Loans 657Characteristics of Secured Short-TermLoans 657

Use of Accounts Receivable asCollateral 658

Use of Inventory as Collateral 660


Summary 662




Problems 665


Integrative Case 7 Casa de Diseno 672

Contents xxxi

Special Topics in Managerial Finance 675

17Hybrid andDerivativeSecuritiespage 676

Boeing—"We'll Buy It,

You Fly It" page 677

U S 1 Overview of Hybrids andDerivatives 678•> REVIEW QUESTION 678

U S I Leasing 678Types of Leases 678

Leasing Arrangements 679

@3%SS@(83̂ Focus on Practice: Leases toAirlines End on a Sour Note 680

Lease-versus-Purchase Decision 681

Effects of Leasing on FutureFinancing 685

Advantages and Disadvantages ofLeasing 686


EQBJ Convertible Securities 687Types of Convertible Securities 687

General Features of Convertibles 688

Financing with Convertibles 689

Determining the Value of a ConvertibleBond 691


Implied Price of an AttachedWarrant 694

Values of Warrants 695


U f i l Options 698Calls and Puts 698

Options Markets 698

Options Trading 699

Role of Call and Put Options inFund Raising 700

(8a®3S&83& Focus on Ethics: OptionsBackdating 701

Hedging Foreign-Currency Exposureswith Options 701

+ REVIEW QUESTIONS 702

Summary 702




Problems 706


U H I Stock PurchaseWarrants 693Key Characteristics 693

xxxii Contents

Mergers, LBOs,Divestitures, andBusiness Failurepage 714

IMS Health, Inc.—Creating

Value by Going Private

page 715

Merger Fundamentals 716Terminology 716

Motives for Merging 718

Types of Mergers 720


UiSI LBOs and Divestitures 721Leveraged Buyouts (LBOs) 721

Divestitures 722


UsSI Analyzing and NegotiatingMergers 723Valuing the Target Company 724

Stock Swap Transactions 726

Merger Negotiation Process 731

Holding Companies 733

International Mergers 735

-» REVIEW QUESTIONS 736C 3 2 * 5 ^ D Global Focus: InternationalMergers 737

Ui&J Business FailureFundamentals 737Types of Business Failure 737

Major Causes of Business Failure 738

@iffS3giSg$i Focus on Ethics: Too Big toFail? 739

Voluntary Settlements 739


Uifil Reorganization andLiquidation in Bankruptcy 741Bankruptcy Legislation 741

Reorganization in Bankruptcy(Chapter 11) 742

Liquidation in Bankruptcy(Chapter 7) 744


Summary 745




Problems 749


Contents xxxiii

19InternationalManagerialFinancepage 757

General Electric—Establishinga Presence in China page758

I E U The Multinational Companyand Its Environment 759

Key Trading Blocs 759

GATT and the WTO 761

Legal Forms of BusinessOrganization 761

Taxes 762

Financial Markets 764

+ REVIEW QUESTIONS 765

liSSI Financial Statements 765

Subsidiary Characterization andFunctional Currency 766

Translation of Individual Accounts 766


IKfil Risk 767

Exchange Rate Risks 767

Political Risks 773


(HffliMfsisimsl Focus on Ethics: Chiquita'sSlippery Situation 775

IKfil Long-Term Investment andFinancing Decisions 775

Foreign Direct Investment 775

Investment Cash Flows andDecisions 776

Capital Structure 777

Global Focus: Take anOverseas Assignment to Take a Step Up theCorporate Ladder 778

Long-Term Debt 779

Equity Capital 780


USfisl Short-Term FinancialDecisions 781

Cash Management 783

Credit and Inventory Management 786


IKflsl Mergers and JointVentures 787

•» REVIEW QUESTION 788

Summary 788




Problems 791


Integrative Case 8 OrganicSolutions 795

Appendix A-i

Glossary G-i

Index i i

lawrence j. gitman - gbv · · 2011-07-04lawrence j. gitman san diego state university ......

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