subject index - mcgraw hill...

Adelphia Communications, 20–21, 47Adjusted-present-value (APV) method,

617–619all-equity value, 626debt effects, 626example of, 625–628flow-to-equity method vs., 618–619formula for, 616, 618guidelines for, 616–617non-market-rate financing, 628tax subsidy to debt, 616–617weighted-average-cost-of-capital vs.,

620–621Advance commitments, 868–869A Forward Rate Agreement (FRA), 944Agency costs, 16, 585–588, 595

of convertibles and warrants, 804debt-equity financing and, 596of equity, 594–597free cash flow and, 596–597high-dividend policy and, 658selfish strategies, 585–588

Agency problem, 15Agency relationships, 16Agency theory, 1018, 1019, 1023Aging schedule, 969Agreement of merger, 991AIG International, 536, 829–830All-equity firms, cost of capital for, 556Allocated cost, 198–199Alternative asset class, 1046Alternative Investment Markets (AIM),

1062, 1080Amazon, 315, 896, 1038American depository receipt (ADR),

1062

Accounts payable, 893, 909Accounts payable period, 895Accounts receivable, 26, 925

days’ sales in receivables ratio, 609, 898

receivables turnover ratio, 66, 898Accounts receivable financing, 911Accounts receivable period, 895Acid-test ratio, 64ACP; see Average collection periodAcquisitions; see also Divestitures;

Leveraged buyouts; Mergers; Takeovers

accounting for, 1021–1022asset acquisition, 990basic forms of, 988–991classification scheme, 990conglomerate acquisition, 990consolidations, 947defensive tactics, 1010–1013diversification and, 1000earnings growth, 998–999going private, 991, 1022–1024horizontal or vertical, 990Japanese keiretsu, 979as market for corporate control, 994merger or consolidation, 988–989NPV of a merger, 993–1007purchase method accounting, 1022stock acquisition, 989synergy from, 991–992takeovers, 991–992tax forms of, 1020–1021tax-free transaction, 1020taxable transaction, 1021

AABC approach, 971–972ABN AMBRO, 272Abnormal returns (ARs), 496,

1014–1015cumulative (CARs), 497–498new issues, 703

Absolute priority rule (APR), 1043, 1044, 1050

Absolute purchasing power parity, 1070–1071

Accelerated depreciation, 322Accenture, Ltd., 457Accounting

for acquisitions, 1021completed contract method, 510efficient markets and, 510–511generally accepted principles of, 12,

29–31leasing and, 728–732manager’s choices in, 510–511P/E ratios and, 323percentage-of-completion method,

322, 510purchase method, 1021

Accounting incomecompared to cashflows, 195–196leasing and, 745–746

Accounting Standard 3, 36Accounting statements

balance sheet; see Balance sheetcash flows statement; see Statement

of cash flowscommon-size; see Common-size

statementsincome statement; see Income

statement

Subject Index

CF_SubjectIndex.indd 1099 4/14/2014 12:57:20 PM

1100 Subject Index

cash flows for, 199, 202–203depreciation, 200, 204–205income and taxes, 202incremental cash flows, 201interest expense, 206investments, 201–202net present value, 203net working capital, 199, 203–204operating revenues and costs, 200salvage value and, 202tax vs. stockholders’ books, 203

Balloon payment, 141, 534Bank of America, 25, 57, 327, 993Bank loans, 536

lines of credit, 536syndicated loans, 536

BankBoston, 1019Banker’s acceptances, 911, 956Bankruptcy, 547, 580; see also Financial

distressabsolute priority rule (APR),

1043–1044, 1050largest in U.S., 1040liquidation, 1042–1043predicting, 1053–1055prepackaged, 1052–1053priority of claims in, 1043private workout vs., 1050–1052reorganization, 1044–1050Section 363 stalking horse, 1047Z-score model, 1053–1056

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 1044

Bankruptcy code, 1041–1042, 1047Bankruptcy costs, 581–582

bankruptcy risk vs., 580–582Bankruptcy Reform Act of 1978,

1043–1044Banks, credit information from, 968–969Bargain purchase price option, 730Barnes & Noble, 896, 1038BASF, 447Beachhead, 993Bearer form, 532Beazer Homes USA, 25Behavioral finance

arbitrage, 501critics of, 508–509cyclical patterns, 492file drawer problem, 508–509high-dividend policy and, 657–658independent deviations from

rationality, 500market efficiency and, 500–502market prices and, 509rationality in, 500–501

Asked prices, 285, 326Asset beta, 457–458Asset management ratios, 66–67

days’ sales in inventory, 66days’ sales in receivables, 66–67inventory turnover, 66payables turnover, 67, 899receivables turnover, 66total asset turnover, 67

Asset pricing; see also Capital asset pricing model (CAPM)

empirical models, 436–438style portfolios, 437–438

Asset restructurings, 1013Assets, 25; see also Current assets

acquisition of, to acquire company, 989

book value of, 29current, 3efficient set for two assets, 388–393fixed, 3, 28matching with liabilities, 874–876restructuring, 1013risky, excess return on, 359

Assigned recievables, 911AT&T, 988, 990–991Automated clearinghouse (ACH), 936Availability delay, 930Available balance, 928Average collection period (ACP), 67,

898, 953, 956cash discounts and, 955–961monitoring, 969

Average (of distribution), 357Average returns, 362–365

arithmetic vs. geometric averages, 362–365

calculating, 358geometric averages, calculating,

363–365stock returns, 359

Average tax rate, 33Avis Budget Group, 423

BBackdoor equity, 843Balance sheet, 25–30

accounting definition, 25common-size, 58–59debt vs. equity on, 28example of, 28liquidity, 28–29model of the firm, 2–4percentage of sales approach, 79–81under FAS 16 (leases), 729value vs. cost, 29–30

Baldwin Company case, 198–200analysis of project, 200–203

American option, 757factors affecting value, 769

AmeriGas Partners, 305AmeriServe Food Distribution Inc., 282Amortization

partial amortization, 141–142spreadsheet application, 142

Amortization schedule, 140Amortized loan, 139–143Angel investors (angels), 686Announcements

earnings surprises, 503–504of new equity, 702–703

Annual compounding, 125, 129Annual percentage rate (APR), 125–126Annuity, 129, 132–139

annuity in arrears, 136delayed annuity, 135–136formula for present value of, 132growing annuity, 138–139infrequent, 137ordinary, 136present value of two annuities,

137–138spreadsheet applications, 135

Annuity in arrears, 136Annuity due, 136Anomalies, 502Antitrust law, 1013–1014AOL, 1006–1007, 1019Appellate Authority for Industrial

and Financial Reconstruction (AAIFR), 1049

Apple Computers, 6–7, 159Appraisal rights, 989Appraised value, 1019APT (arbitrage pricing theory), 434–436APV; see Adjusted present value (APV)

approachArbitrage, 491, 501

behavioral finance and, 501–502conversion value and, 836covered interest arbitrage, 1073–1074limits to, 501–504market efficiency and, 491, 502–504triangular, 1067–1068

Arbitrage pricing theory (APT), 434–436

Arbitrage profit, 766Arbitrageurs, 432Arithmetic average return, 363Arrearage, 529Ars; see Abnormal returnsArticles of incorporation, 7Arvind Mills Limited, 72, 103, 104, 105,

1058Ashok Leyland Finance (ALF), 966


Subject Index 1101

Borrowingin option pricing model, 772riskless, 399–400

Brackets, 692Break-even analysis, 238–242

accounting profit, 238–240credit policies, 963present value, 238–242

Brokerage costs, 905Brokers, 326Brooke Bond Lipton India Limited, 20Bubble theory, 506Build Own Operate Transfer (BOOT),

239Bulldog bonds, 537Bullet payment, 141Burger King, 282Business ethics, 15Business organization; see also

Corporationspartnerships, 6–7sole proprietorships, 4

CCall options, 757–758, 810

on bonds, 534bounding value of call, 766–767covered-call strategy, 765exercise price, 767expiration date, 767factors determining value, 767–769firm expressed as, 779–780hockey-stick diagram of values, 758lower bound, 766–767payoffs on, 758, 760preferred stock, 529put-call parity, 764stock price, 768–769stockholders and, 779upper bound, 767valuation of, 814–815value at expiration, 757–758variability of underlying asset, 768warrants vs., 830–833

Call premium, 534Call protected, 534Call provision, on bonds, 536Campbell Soup Co., 423Capacity, 968Capital, 968CAPM, 377, 409, 434–436, 1000Capital asset pricing model (CAPM),

377, 409, 434–436arbitrage pricing theory and, 434–436DDM compared to, 459–460estimating cost of capital with,

448–450

Board out clause, 1011Boeing Company, 896Bombay Stock Exchange (BSE), 331Bond interest rates, Fisher effect,

291–293Bond markets, 282–288

bond price quotes, 288buying/selling bonds, 282–283reporting of, 284–288

Bond prices, 266–275Bond ratings, 281–282Bond valuation

face value, 267par value, 267valuation summary, 273yields and, 267–270

Bond yields, 295–296Bondholders, 29

call options and, 779–780loan guarantees and, 782–783

Bonds, 266, 530; see also Corporate bonds; Government bonds; Maturity of bonds

bearer form, 532buying/selling of, 282–283call provisions, 534convertible, 535debenture, 533discount, 278features of, 266–267floating-rate, 535income bonds, 535international bonds, 537junk bonds, 282premium, 269price reporting of, 284–288put bond, 536repayment of, 533security, 533sinking fund, 533–534terms of, 531–533types of, 535–536warrants on, 535yield curve on, 295–297zero-coupon, 274

Book balance, 928Book equity, 29Book value, 29

dilution of, 712–714market value vs., 29, 541

Bookbuilding, 695BOP (best, optimistic, and pessimistic)

analysis, 237Borders Group, 580, 1038Borrower, 530

risk and, 509self-control and, 657

BellSouth, 272Benchmark, 438Berkshire Hathaway, 527Best efforts, 695Beta, 362, 399, 405, 424, 426–427

arbitrage and, 431–432asset beta, 458–459company betas, 453cyclicality of revenues, 457–458definition, 406determinants of, 457–458equity, 458estimation of, 452–456examples, computer software

industry, 456expected return, 409, 431–432financial leverage and, 457–458formula for, 406–407industry beta, use of, 455–457leverage and, 629–630linear relationship, 431–432operating leverage and, 457project evaluation and, 449real-world betas, 453stability of, 454–455systematic risk and, 424–426unlevered, 630

Bid, 285Bid-ask spread, 285Bid price, 216–217, 326Bidders, 991

returns to, in mergers, 1015–1016Binomial model, 809–815; see Two-state

option modelbenefits of approach, 826business contract valuation, 811–812extension to many dates, 814–815risk-neutral probabilities, 810three-date example, 811–812two-date example, 809–812

Binomial tree, gold prices, 818Black’s Law Dictionary, 1039Black-Scholes model, 770–771

duplicating strategy in, 777for executive stock options, 804formula for, 774not amenable to simulation, 821start-up valuation, 806–808two-state model compared, 815–816valuation of start-up company,

807–808warrant pricing, 833–834

Blanket inventory lien, 911Board for Industrial and Financial

Reconstruction (BIFR), 1048-1050


1102 Subject Index

accounting profit vs., 12accounting statement of, 40–41between firms and financial markets,

11distributable cash flow, 40dividend equal to, 644financial cash flow, 37–40flow-based insolvency, 1040free cash flow, 30, 596–597from financing activities, 41from granting credit, 952from investing activities, 41from operating activities, 36, 37,

39–41identification of, 11importance of, 10–13inflation and, 208–209initial dividend greater than, 643–644of leasing, 732–735levered cash flow (LCF), 618matching, convertible issues and, 842net present value and, 162nominal vs. real, 208–209operating cash flow, 39optimal debt levels and, 736paid to creditors, 38payback period and, 163perpetuity, 129–130present value of riskless, 735–736risk of, 13riskless, 735–736timing of, 11to stockholders, 39total, 39

Cash flow management, 41–46Cash flow time line, 896Cash management, 926; see also Float

investing idle cash, 940–943liquidity management vs., 927–928lockboxes and concentration banks

in, 937reasons for holding cash, 926–928

Cash manager, 897Cash offer, 694Cash-out, 903Cash outflow, 909Cash ratio, 64Cash reserves, 906Cash surpluses, 941–950Cash transaction, 854CBS, 17Certificate Of Deposit (CD), 944Certificates of deposit (CDs), 951Chambal Fertilisers & Chemicals

Limited (CFCL), 309Change in net working capital, 36

Cash; see also Cash offeractivities that increase/decrease,

893–894compensating balance, 927holding costs, 927investing idle cash, 941–943in NPV of mergers, 1003–1004planned/possible expenditures, 942reasons for holding, 926–928seasonal cash demands, 941sources and uses of, 894speculative and precautionary

motives for holding, 926–927tracing cash and net working

capital, 893–894transaction motive, 927

Cash balances, 909, 928Cash budgeting, 907–909

cash balance, 909cash outflow, 909

Cash collection and disbursement, 908–910, 934–939

accelerating collections, 937–939components of collection time,

934–935disbursement float, 939–940lockboxes, 935–936zero-balance accounts, 940

Cash concentration, 935–937Cash coverage ratio, 65Cash cow, 316Cash cycle, 896, 899; see also Operating

cyclecalculating, 897–898defined, 895–896interpreting of, 900operating cycle and, 900–901in various industries, 900–901

Cash disbursements, 909, 939–940; see also Cash collection and disbursement

Cash discounts, 955–961Cash dividends

chronology of payment, 641firms with cash for, 653–656firms without cash for, 652–653kinds of, 640payment of, 640–642standard payment method, 641–642taxes on, 649, 655

Cash equivalents, 927Cash flow, 25, 36; see also Financial

statements; Flotation costs; Incremental cash flows; Statement of cash flows

accounting income vs., 195–196

linearity of, 410–411portfolios and, 410–411

Capital budgeting, 4, 159, 449; see also Internal rate of return (IRR); International capital budgeting; Investment rules; Net present value

equivalent annual cost method, 218–219

frequency of use, 182international, 1077–1081for levered firms, 616net present value, 159–162options and, 785–786practice of, 180–181value creation and, 486

Capital expenditures, 909Capital gain/loss, 344–345, 347

dividends vs., 305–306yield on, 313

Capital gains yield, 313Capital intensity ratio, 79Capital market line (CML), 411Capital markets, historical returns, 351Capital One Corporation, 803–804Capital rationing, 179Capital spending, 38Capital structure, 4, 547; see also

Financial distressbasic concepts of, 547debt vs. equity, 547, 552–554effect of personal taxes on, 600–603establishment of, 602–607financial leverage and firm value,

550–553firm value vs. shareholder interests,

548–549limits to use of debt, 680MM Proposition I on, 552, 571MM Proposition II and, 571pie model, 547recent trends in, 540–541shareholders and, 540–541target debt-equity ratios, 606taxes and, 563–565value of the firm, 548–549

CAPM; see Capital asset pricing model (CAPM)

Caps, 879Captive finance company, 965, 966Carbon Everflow, 999-1000CARE, 282, 942, 943Carrying costs, 903–904

in credit costs, 964of inventory, 973

Carrying value, 29Carve-out, 1025


Subject Index 1103

conversion policy, 844conversion value, 836–837free lunch/expensive lunch flaw,

840–841matching cash flows, 842option value, 836–837reasons for issuing, 839–843risk synergy, 842straight bond value, 835straight debt vs., 839value of, 836–837

Corporate bonds, 266, 278–281, 530–534

basics of, 530–531call provision, 534equity securities compared, 530expected return, 278indenture, 531–534promised yield, 278protective covenants, 534repayment, 533–534security, 533seniority, 533terms of, 532–533types of, 535–536yields on, 279

Corporate charters, 1010–1011classified board, 1010supermajority provisions, 1011

Corporate Debt Restructuring (CDR), 1048-1049

Corporate discount rate, 461Corporate finance; see also

International corporate financebalance sheet model, 2–5efficient markets and, 509–517financial manager, 4–5goal of financial management, 14nature of, 2–6

Corporate financial planning; see Financial planning

Corporate firm, 4–10corporation, 7–10goals of, 121partnership, 6–7sole proprietorship, 4

Corporate focus, 1013Corporate long-term debt; see

Corporate bonds; Long-term debtCorporate strategy analysis

break-even analysis, 237–242decision trees, 252–254Monte Carlo simulation, 242–247

Corporate tax rates, 33Corporate taxes; see also Personal taxes;

Taxesbasic insight, 563–565

in NPV of mergers, 1005–1006other rights of, 528payoff of, 760present value of, 305–311proxy voting, 527shareholders’ rights, 526–527small-company, 352

Company betas, 453Compaq, 17Comparables approach, 320–325Compensating balances, 910, 927Competition Commission of India, 993Competition, 955Competitive offer, 697Complementary resources, 994Completed-contract method, 322, 510Compound growth, 116Compound interest, 114–115Compound value, 111Compounding, 119

annual, 129continuous, 127–129frequencies of, 126future value and, 114–117multiyear, 127over many years, 127power of, 117–118quarterly, 125semiannual, 125, 129

Compounding periods, 125–126Concentration banks, 935–936Conditions, 968Conglomerate acquisition, 990ConocoPhillips, 181Conservatism, 501, 505, 509Consideration, 991Consolidation, 944Consols, 129, 132Constant growth dividends, 307–310Consumer credit, 951Consumer demand, 954Continuous compounding, 127–129Contribution margin, 239Control of firm, 17

takeovers and, 1009Controlled disbursement account, 940Controller, 4, 897Conversion premium, 835Conversion price, 835Conversion ratio, 835Conversion value, 836–837Convertible bonds, 535, 834–835; see

also Warrantsagency cost, 843as backdoor equity, 843case for and against, 840common stock vs., 839–840

Changes in fixed assets, 37Chapter 7 bankruptcy, 1043–1044Chapter 7 of the Bankruptcy Reform

Act of 1978, 1041Chapter 11 bankruptcy, 580, 1038,

1041–1044Character, 968Characteristic line, 405, 453Check Clearing for the 21st Century

Act (Check 21), 933–934ChevronTexaco, 181Chicago Board Options Exchange, 829Chicago Board of Trade (CBT), 855Chicago Mercantile Exchange (CME),

855Chief financial officer, 4, 10Chrysler Corporation, 584, 782, 1019,

1047Cisco Systems, 250, 934CIT Group, 1052Citigroup, 536Classified board, 1010Clean price, 288Cleanup mergers, 1009Clearing, 928Clientele effect, 660–663Clienteles, 661CME Group, 855Coca-Cola, 57, 272, 860CoCo bonds, 536Coinsurance effect, 784, 1003Collars, 535Collateral, 533, 968Collateral value, 954Collected balance, 928Collection effort, 970–971Collection float, 929Collection policy, 925, 969–971

monitoring receivables, 969–970Collection time

accelerating collections, 937–939components of, 934–935

Comcast, 527, 980, 1011Commercial draft, 956Commercial paper, 911, 943Committed lines of credit, 910Common-size statements, 58

balance sheets, 59–60income statements, 59–61

Common stock, 525–529; see also Stock valuation

classes of, 527convertible debt vs., 839–840dividends, 528expected return on, 377features of, 525–528large-company, 352


1104 Subject Index

effects of, 961evaluating of, 962–964NPV of switching, 962–963optimal, 964–966proposed credit policy,

962–964Credit risk, 955Credit scoring, 968

five Cs of, 968Creditors (lenders), 29, 530

cash flow paid to, 38–39CRISIL, 282, 942, 943Cross-rates, 1062, 1066–1068Crown jewels, 1014Cumulative abnormal returns (CARs),

497–498Cumulative dividends (cum dividend),

497, 641Cumulative voting, 526Currency appreciation/depreciation, 947Currency swaps, 876–878Current assets, 3, 28, 893

alternative financing policies, 905–907financing strategies for, 902, 906–907ideal financial model, 903–906size of firm’s investment in, 902–905

Current income, 656–657Current liabilities, 3, 893Current ratio, 63Current yield, 273Customer type, 955Customer’s payment history, 968Cyclical activities, 941–942

DD. D. Ronnelly (DDR), 460–461Dabhol Power Plant, 250Daimler-Benz, 1019Date of payment, 641Date of record, 641Days’ sales in inventory, 66Days’ sales in receivables, 67, 898, 953DCF techniques, 254Dealers, 326Dean Witter, 1019Debentures, 530, 533Debt, 1; see also Bonds; Cost of debt;

Long-term debt; Optimal debt level

consolidation of, 590convertible vs. straight, 839cost of, 462–463equity vs., 28, 530, 532, 553–554issued of, 715–716optimal level and riskless cash flows,

736preferred stock as, 529protective covenants, 588–580

Costco, 330Costs; see also specific kinds of costs

allocated costs, 198–199of financial distress; see Financial

distress costsfixed or variable, 235–237inventory costs, 971period costs, 32related to safety reserves, 905shortage costs, 905, 971time and, 32value vs., 29–30

Coupon rate, 267Coupons, 267, 532Coupons on bonds, 267

semiannual, 269–270Covariance, 378, 380–382

calculation of, 380–382formula for, 386of securities’ return, 384

Covered call strategy, 765Covered interest arbitrage, 1073–1074Cram down procedure, 1047Credit

cash flows of, 952costs of, 955–956five C’s of, 969receivables and, 951–953

Credit analysis, 952, 961, 966–968credit information, 968–969one-time sale, 966repeat business, 967–968

Credit cost curve, 964Credit default swaps, 877, 878Credit evaluation and scoring, 968Credit function, 965Credit information, 968–969

banks, 969credit history reports, 968financial statements, 968payment history, 968

Credit instrument, 956Credit management

collection policy, 952credit analysis, 952, 961, 966–968terms of sale, 952

Credit manager, 897Credit period, 953–955

consumer demand, 954cost, profitability, and

standardization, 954–955perishability and collateral value, 954

Credit policy; see also Credit management

analysis of, 961–963break-even application, 964components of, 952–953

double taxation, 8expected return and leverage under,

567–569MM Proposition I, 566MM Proposition II and, 568optimal debt level and riskless cash

flow, 736present value of tax shield, 565PV of riskless cash flows, 736weighted average cost of capital, 569

Corporations, 7–10; see also Corporate firm; Firms

advantages of, 8agency problem and, 15–19articles of incorporation, 7characteristics of, 8control of, 15–19disadvantages of, 8partnerships vs., 9regulation of, 18–21

Correlation, 378, 380–383calculation of, 380–382negative, 382, 386positive, 382serial correlation, 494

Corus, 1007Cost of capital, 447–448, 461; see also

Discount rates; Required return; Weighted average cost of capital

all-equity firm, 556for divisions and projects,

461–463Eastman Chemical’s example,

469–472estimating

for all-equity firms, 556with CAPM, 448–452

for international firms, 1081security market line and, 461

Cost-cutting proposals, 214–215Cost of debt, 462–463

credit policy, 961Eastman example, 469–470embedded cost, 463

Cost effects, 961Cost of equity, 555

Eastman example, 469estimating cost of capital and, 449

Cost reduction, 993–994complimentary resources, 994economy of scale, 993elimination of inefficient

management, 994financing decisions, 487as source of synergy, 993–994technology transfer, 994vertical integration, 994


Subject Index 1105

carve-out, 1025sale, 1024spin-off, 1024–1025tracking stocks, 1025

Dividend discount model (DDM), 459–461

comparison with CAPM, 459–461discount rate, 313estimates of parameters, 310–316in estimating market risk premium,

451–452firm’s growth rate, 311–312low- or no-dividend stocks, 315–316retention ratio benefits, 312skepticism regarding, 314–315total return in, 313–314

Dividend payout, 641Dividend payout ratio, 79Dividend per share, 652Dividend policy; see also High-dividend

policybehavioral finance and, 656–658clientele effect, 660–663desire for current income and, 656dividend greater than cash flow,

643–644dividends equal to cash flow, 643fewer companies paying dividends,

663–665high-dividend policy, 656homemade dividends, 644–645indifference proposition, 644information content, 658–661investment policy and, 646irrelevance of policy, 643–646sensible, 669signaling and, 658–661as substantial, 662survey evidence about, 665–666sustainable growth, 88

Dividend signaling, 659Dividend yield, 313, 346, 640

preferences of investors for, 662Dividends, 528, 641; see also Cash

dividends; Dividend policy; Stock dividends

capital gains vs., 305–306cash payment method, 640–642characteristics of, 528choosing over repurchases, 648–649on common stock, 528discounting vs. earnings, 195earnings compared, 315fewer companies paying, 663–665firms with sufficient cash for, 653–656firms without cash to pay a dividend,

652–653

swaps contracts, 876–880Derived demand, 971Derived-demand inventories, 977Designated market makers (DMMs),

327Differential dividend growth, 309–310Dilution, 711

book value, 713–714by poison pills, 1011dividends vs. repurchases, 648–649earnings per share, 714of proportionate ownership, 712stock price dilution, 712–714

Direct leases, 726DIRECTV, 17, 305Dirty price, 296Disbursement float, 928–929

increasing of, 939–940Disbursements, controlling of, 940Discount

cash discount and ACP, 956trade discounts, 956

Discount bond, 268Discount rates, 111, 113, 448; see also

Cost of capitalcalculation of, 619corporate rate, 460estimated, valuation with, 623–625in growing perpetuity formula, 131lease vs. buy decision and, 736nominal vs. real, 209–211as opportunity cost, 162risk-adjusted, 450

Discounted cash flow valuation, 110, 196

cost-cutting proposals, 214–215multiperiod case, 113–117one-period case, 110–113special cases of, 214–219

Discounted payback period method, 165

Discounting, 119multiperiod, 120nominal vs. real, 209–211present value and, 118–121

Distributable cash flow, 40Distribution, 640Diversification, 395–399

acquisition and, 990–991essence of, 395–399information and, 396options and, 783–785portfolios and, 389, 429–430risk and, 396–397unsystematic risk, 429–430

Diversification effect, 386–387, 391Divestitures, 1023–1024; see also

Acquisitions; Mergers

reducing costs of, 588–589tax subsidy to, 616

Debt capacity, 995–997announcement of new equity and,

702increased debt capacity, 996unused, 996

Debt displacement, 737–741basic concept of, 737–739optimal debt level and, 739–741

Debt-equity ratio, 65debt displacement and, 540–543targeting of, 606

Debt financing, subsidies to, 617Debt securities, 529–530Debt service, 28, 38–39Debtor, 530Debtor in possession (DIP) debt, 1051Decision trees, 252–254, 788Declaration date, 641Deed of trust, 531Default risk, 942

on guaranteed loans, 782–783short-term securities, 942

Default risk premium, 296Defensive tactics, 1010–1013; see

Takeover defensesasset restructurings, 1013before being in play, 1010–1011corporate charters, 1010–1011exclusionary self-tenders, 1013greenmail and standstill agreements,

1011–1012Deferred call provision, 534Deferred Payment Guarantee, 961Deferred taxes, 32Delayed annuity, 135–136Deliverable instrument, 854Delta, 772Department of Economic Affairs

(DEA), 1014Dependent demand, 971Depository transfer check (DTC), 936Depreciation, 31, 510

accelerated, 510Baldwin case, 204–205straight-line, 322, 510

Depreciation tax shield, 213Derivatives, 853–854

actual use of, 880–881defined, 853duration hedging, 870–876exotics, 879–880forward contracts, 854–855futures contracts, 855–860hedging with, 861–863interest rate futures contracts,

863–870


1106 Subject Index

Empirical models, 436Enron, 20, 510, 583Enterprise value, 70Enterprise value multiples, 70Enterprise value ratios, 323–324Equity

backdoor equity, 843costs of; see Cost of equitydebt vs., 28, 530, 532, 552–554timing decision, 511

Equity-based compensation, 1019Equity capitalization, 29Equity financing; see also Securities;

StockEquity kickers, 829Equity multipler, 64Equity risk premium, 360Equity securities, 530; see also

Securities; StockEquity shares, 3Equivalent annual cost method,

218–219Erosion, 197Ethical issues, use of float, 933Euro Disney, 32, 250Eurobond, 536Eurocurrency, 1062European option, 756Event studies, 494, 497, 514, 1014

of semistrong form efficiency, 496–497

Ex-dividend date, 641Ex-rights date, 709Exchange offers, 593Exchange rate risk, 1081–1084

long-term exposure, 1082–1083managing risk, 1084short-term exposure, 1082translation exposure, 963–965

Exchange rates, 1064cross-rates, 1067–1068quotations, 1064–1065triangle arbitrage, 1067–1068types of transactions, 1068

Exclusionary self-tender, 1013Executive compensation, 2

dividends vs. repurchases, 648managerial compensation, 17–18valuing of, 803–805

Executive stock options, 801–805Black-Scholes model, 804reasons for use, 801–802top corporate grants, 802–803

Exercise price, 756call option values and, 767

Exercising the option, 756Exotics, 879

carrying costs, 974–976extensions to, 977inventory depletion, 973reorder points in, 977safety stocks in, 977storage costs, 974total costs, 975–976

Economy of scale, 993–994EDGAR database, 28EDI and Check 26, 933, 934Effective annual rate (EAR), 125, 955

stated annual interest rate vs., 126–127

Effective annual yield (EAY), 125Effective tax rate, 601Efficient capital markets, 488–491

behavioral challenge to, 500–502description of, 488–490event studies of, 494, 514

Efficient frontier, 391Efficient market hypothesis (EMH), 489

dart throwing misconception, 493–494

described, 488–490differing views on, 508–509efficacy of dart throwing, 493–494evidence on, 494–500foundations of, 490–491implications for corporate finance,

509–516implications for investors and firms,

489misconceptions about, 493–494price fluctuations misconception, 494semistrong form, 492–494stockholder disinterest, 494strong form, 492–493summary of, 517weak form, 491–492

Efficient markets; see also Market efficiency

accounting/financial choices and, 510–511

implications for corporate finance, 509–517

speculation and, 511–514stock prices and new information,

489Efficient set, 391–394

for many securities, 393–395for two assets, 388–393

Electronic communications networks (ECNs), 330

Electronic data interchange (EDI), 933–934

Electronic lockboxes, 935Embedded cost, 463

homemade, 644–645information content of, 658NVP compared to, 308–319payment procedure and chronology,

641price behavior around ex-dividend

date, 642pros and cons of, 665share repurchases vs., 647–649smoothing of, 665–666standard payment method, 641–642in stock valuation, 308as substantial in U.S. economy, 662summary of, 667–668survey evidence about, 665–666taxation of, 652, 655types of, 640

Dodd-Frank Wall Street Reform and Consumer Protection Act, 1

Dollar returns, 344–346Double taxation, 8Dribble method, 715Dun & Bradstreet, 968DuPont Corporation, 74, 994DuPont identity, 72–75

Yahoo! and Google example, 74Duration, 872–874Duration hedging

liability-asset matching, 874–876same maturity, different coupons,

871–880zero-coupon bonds, 870–871

Dutch auction, 647, 695Dynegy, 46

EEarnings

dividends and, 315measures of, 61

Earnings before interest and taxes (EBIT), 30, 61

Earnings growth, 312acquisitions and, 998–999

Earnings per share (EPS), 61, 316stock price and, 714

Earnings surprises, 503–504East Coast Yachts Goes International,

1090Eastman Chemical Co., 459, 469–472EBay, 315EBIT (Earnings before interest and

taxes), 30, 61EBITDA (earnings before interest,

taxes, depreciation, and amortization, 61, 65, 323–324

EBITDA margin, 68Economic order quantity (EOQ) model,

972–976


Subject Index 1107

Financial planning models, 51, 76–82caveats regarding, 90–91Monte Carlo simulation, 242–247percentage of sales approach, 78–82plug variable, 77–78pro forma statements, 76–77simple model, 76–78

Financial policy, as determinant of growth, 88

Financial ratios; see Ratio analysisFinancial slack, 600Financial statement analysis, 58–60

asset management or turnover measures, 66–67

common-size balance sheets, 58–59common-size income statements,

59–60DuPont identity, 73–75long-term solvency measures, 64–66market value measures, 69–72measures of earnings, 61problems with, 75–76profitability measures, 68–69ratio analysis; see Ratio analysisshort-term solvency or liquidity

measures, 62–63standardizing statements, 58–59

Financial statements, 25; see also Balance sheet; Income statement; Statement of cash flows

for credit analysis, 968as decision making tool, 57–58

Financingearly-stage financing, 686–687patterns of, 537–541stages of, 688–689venture capital and, 686–687

Financing decisions, 486–487; see also Short-term financial planning

pecking-order theory, 595–600timing of, 511value creation and, 486–488

Financing type project, 170Finished goods, 971Firm commitment, 695

economic rationale for, 698Firms; see also Corporate firm;

Corporations; Partnershipsall-equity firms, 556balance sheet model, 2–4as call option, 779–780cash flows with financial markets, 10choices with extra cash, 448control of firm, 17efficient market hypothesis (EMH)

and, 489operating cycle and organization

chart, 897

agency costs, 585–588bankruptcy risk vs. costs, 580–582as business impairment, 584–585complex capital structure, 1051costs of, 580–582, 617description of, 1038–1040direct costs, 582–584flow-based insolvency, 1040holdouts, 1051indirect costs, 584–585lack of information and, 1051largest U.S. bankruptcies, 1041legal and administrative costs,

582–584of marginal firms, 1051prediction models, 1046stock-based insolvency, 1039tax effects and, 590–592what happens in, 1041–1042

Financial distress costs, 582–588; see also Bankruptcy

agency costs, 585–586direct costs, 582–584indirect costs, 584–585pecking-order theory, 597–600signaling, 592–594

Financial EDI (FEDI), 933–934Financial Industry Regulatory

Authority (FINRA), 284Financial innovation, 488Financial leases, 727–728Financial leverage; see also Levered

firmsbeta and, 457–458debt vs. equity choice, 552–554key assumption regarding, 554MM Proposition II on, 554–555returns to shareholders and, 555–562risk to equity holders, 554–555value of the firm, 550–553

Financial leverage ratios; see Leverage ratios

Financial managementgoal of, 13–16payback method, 164

Financial managers, 4–5accounting/financial choices, 510–511compensation of, 17–18in efficient markets, 509–517inventory policy, 970skills needed, 10timing decision, 511–513

Financial planning“Procrustes approach” to, 91short-term; see Short-term financial

planningsimple models of, 76–82

Expected returnbeta and, 410individual securities, 377on individual security, 408–410leverage under corporate taxes,

567–569on market, 407–409on a portfolio, 383–385risk and, 407–411on securities, 448variance and, 378–380

Expenses payable, 893Expiration date

of call option, 756option values and, 767

External Commercial Borrowings (ECB), 297

External financing needed (EFN), 80

growth and, 82–89Extra cash dividend, 640–641ExxonMobil, 16, 181

FFace value, 267, 801

of bonds, 267Factor, 911Factor models, 427

portfolios and, 427–430Factored receivables, 911Fama-French three-factor model, 437FASB; see Financial Accounting

Standards BoardFeasible set, 390–391Federal budget deficit, 525Federal Reserve Board, 19Federal Trade Commission (FTC), 993,

1014Fidelity Magellan Fund, 361Field warehouse financing, 911FIFO (first in-first out), 322, 510File drawer problem, 508–509Financial Accounting Standards Board

(FASB), 29–30, 203Statement of Financial Accounting

Standards No. 13 (FAS 13) “Accounting for Leases,” 729

Statement of Financial Accounting Standards No. 52 (FASB 52), 1084

Financial cash flow, 36–40Financial crisis of 2008, 368–369Financial decision making; see also

specific kinds of decisionsin efficient capital markets, 510–511

Financial deficit, 537Financial distress, 1038–1040; see also

Bankruptcy


1108 Subject Index

Goldman, Sachs and Co., 8, 20Goodwill, 1021Google, 57, 75, 315, 321–322, 527, 697,

990Government bonds, 277–282

municipal (“munis”), 277Treasury bonds, 277yields on, 279

Government of India (GoI), 942Graphite India, 340-341, 999-1000Grasim, 1034-1036Green Shoe provision, 696, 704Greenmail, 1011–1012Gross spread, 695Growing annuity, 129, 138–139

present value formula, 138Growing perpetuity, 129, 131–132

present value of, 131Growth

determinants of, 88–89EFN and, 85–86financial policy and, 85–89internal growth rate, 85–86, 89sustainable growth rate, 86–89value vs., 506

Growth opportunities, 316–320earnings and dividends compared,

319–320NPVGO; see Net present value of

growth opportunity (NPVGO)of real-world companies, 318–319

Growth rates, in growing perpetuity formula, 131–132

Growth stocks, 505–506Growth stocks portfolio, 438

HHCA, 1023Hedge, 385Hedging, 854, 860–863

duration, 869–876in interest-rate futures, 866–869long hedge, 863maturity hedging, 906short hedge, 862

Hewlett Packard, 18, 321High-dividend policy

agency costs, 658behavioral finance, 656–658desire for current income and,

656–657dividend signaling, 659–660factors favoring, 656–660information content, 659

Hindalco Industries Limited, 331, 332Hindustan Unilever, 8, 20, 27, 42, 45,

46, 313, 322Hockey stick diagram, 758Holding period returns, 348–354

Forward exchange rate, 1068Forward rate, 1075–1076Forward trade, 1068Foster’s Group, 1061Fourth-round financing, 689Free cash flow, 39, 203–204Free cash flow hypothesis, 597

agency costs and, 596–597role in mergers, 997

Frequency distribution, 357Friendly takeovers, 1008–1010FTE; see Flow to equity (FTE)

approachFuture spot rates, 1075–1076Future value (FV), 111, 112

of an investment, 114compounding and, 114–117, 127

Futures contracts, 855–860, 865–866interest-rate, 863–869marked to the market, 858Treasury bonds, 863–864Wall Street Journal listed, 856–857

Futures hedging, 860–861FX swaps, 877–878

GGalleon Group, 19Gambling, 500–501The Gap, 496Garware Marine, 32General cash offer, 692General Electric (GE), 33, 75–76, 195General Motors, 58, 66, 584, 951, 994,

1025, 1040, 1047General partnership, 6General Theory of Employment, Interest,

and Money (Keynes), 926Generally accepted accounting

principles (GAAP), 12, 29–30income statement and, 31matching principle, 30

Geometric average return, 363arithmetic average return vs., 365calculation of, 363–364

Geometric series, 130Gilts, 1062Global Crossing, 510Global depository receipt (GDR), 1062Globalization, 1062Godrej Consumer Products, 8Godrej Group, 998Going on margin, 400–401Going private, 991, 1022–1023Going public case study, 704–707Gold mine valuation, 815–822

abandonment and opening decisions, 816–817

binomial tree for gold prices, 818Golden parachutes, 1011

as put option, 780–781valuation with WACC, 466–469value of; see Value of the firmwarrant holders and, 833

First-in, first-out (FIFO), 322, 510First-round financing, 689Fisher effect, 291–293

international Fisher effect, 1076–1078Fitch Ratings, 18Fitch, and ICRA, 282Five C’s of credit, 968Fixed assets, 3, 28

changes in, 37Fixed costs, 235, 457Fixed income securities, cost of,

462–463Flat-rate tax, 34Fleet Financial Group, 1020Flexibility, dividends vs. share

repurchases, 648Float, 928–934

collection float, 929cost of, 931–933disbursement float, 928–929EDI and Check 21, 933–934ethical and legal issues, 933management of, 930measuring, 930–931net float, 928steady-state float, 932

Float management, 930–933Floating-rate bonds (floaters), 535Floor activity, 328Floor brokers, 327Floors, 879Flotation costs, 626

basic approach, 472–473internal equity and, 474NPV and, 473–474weighted average cost of capital

(WACC), 472–474Flow-based insolvency, 1040Flow to equity (FTE) approach,

618–619calculating discount rate, 619calculating LCF, 618–619comparison to APV and WACC,

621–623valuation, 619

Ford Motor Company, 57–59, 527Ford Motor Credit (FMC), 966Foreign bonds, 537Foreign Currency Convertible Bonds

(FCCB), 297, 1080, 1091Foreign exchange markets, 1063–1069

exchange rates and, 1064–1065types of transactions, 1068

Forfaiting, 957Forward contracts, 854–855

pricing of, 863–864


Subject Index 1109

inflation and, 206–208, 288–290nominal vs. real, 206–208, 289–291real rate of interest, 207, 288–289solving for, 121stated annual interest rate, 125term structure of, 291–296

Interest-rate futures contracts, 863–869hedging in, 866–869short vs. long hedging, 868–869

Interest rate parity (IRP), 1074–1075Interest-rate risk, 270–272

risk premium, 293time to maturity, 271

Interest rate risk premium, 293Interest Rate Swap (IRS), 876–877, 944Interest rate swaps, 876–877Internal equity, flotation costs and, 474Internal growth rate, 85–86, 89Internal rate of return (IRR), 165–168

basic IRR rule, 166–167general rules summary, 172incremental, 174independent or mutually exclusive

projects, 167–172modified IRR (MIRR), 171multiple IRRs, 171–172multiple rates of return, 170NPV analysis compared, 167,

173–175problems with, 167–172redeeming qualities of, 177scale problem, 172–175spreadsheet application, 168timing problem, 175–177

Internal Revenue, 202, 203-205Internal Revenue Code (IRC), Section

Code 586, 655Internal Revenue Service (IRS), 203

Publication 949 How to Depreciate Property, 205–206

rules on leasing, 732International Accounting Standards

Board, 29International bonds, 537International capital budgeting,

1077–1081cost of capital, 1081foreign currency approach, 1079home currency approach,

1078–1079political risk and, 1084–1085unremitted cash flows, 1080–1081

International corporate financecapital budgeting, 1077–1081cost of capital, 1081covered interest arbitrage, 1073–1074cross-rates and triangle arbitrage,

1067–1068

Individual securitiescovariance and correlation, 378expected return on, 377, 408–411variance and standard deviation, 378

Indivisibilities, 180Industry beta, use of, 454–455Industry expected returns, 377Inefficient management, 994Inflation

capital budgeting and, 206–211cash flow and, 208–209interest rates and, 206–208, 288–291TIPS, 290–291year-by-year returns, 354

Inflation escalator clause, 860Inflation Indexed Bond, 292Inflation premium, 293Inflation rate, Fisher effect and,

291–293Inflation risk, 290

inflation-linked bonds, 289–291Information

on dividends, content of, 658–659in market prices, 492, 514–517new, reactions to, 489, 415random walk and, 492

Information content effect, 658Infosys Technologies, 8Infrastructure Leasing and Financial

Services Ltd. (IL&FS), 239, 240Infrequent annuity, 137Initial public offering (IPO), 686, 692

case study, 704–707Dutch auction underwriting, 695offering price, 698–699tech bubble in, 486timing decision of, 511–512underpricing, 698–702venture capital, 574–687

Inside quotes, 329Insider trading, 500Insolvency, 1040

defined, 1039flow-based, 1040stock-based, 1039

Intel, 159, 531Interest

compound, 114–115simple, 114–115

Interest coverage ratio, 65Interest expense, 206Interest on interest, 114–115, 125Interest rate

annual percentage rate, 125call-option values and, 770effective annual rate, 125Fisher effect and, 291–293

Home Depot, 71–72, 318, 423Homemade dividends, 644–645Homemade leverage, 552Homogeneous expectations, 403Honolulu Symphony Orchestra, 1038Horizon, 466Horizontal acquisition, 990Hostile takeover, 1009Hughes Aircraft, 994Hundi, 979Hybrid market, 326–327

IIbbotson SBBI 2012 Classic Yearbook,

348IBM, 321ICAI, 41ICICI Bank, 2Idiosyncratic risk, 397Immofinanz Group, 829, 835Income

accounting definition of, 29–30high-dividend policy and, 656–657

Income bonds, 535Income statement, 30–32

accounting definition, 29–30common-size, 59–61generally accepted accounting

principles, 30noncash items, 31percentage of sales approach, 78–79time and costs, 32

Income Tax Authorities, 995Incremental cash flows, 195

accounting income, 195–196allocated costs, 197–198Baldwin Company (example),

198–206as key to capital budgeting, 195–198opportunity cost and, 196–197side effects of, 197sunk costs and, 196

Incremental IRR, 174Indenture, 531–534

call provision, 534protective covenants, 534repayment, 533–534security, 533seniority, 533terms of bond, 532–533

Independent projects, 167problems with, 167profitability index and, 178

Indian Accounting Standards, 203Indian Companies Act 1956, 4Indian Companies Act, 2013, 7Indian Partnership Act, 1932, 6Indifference, to dividend policy, 644


1110 Subject Index

sales-type leasing, 726taxes and, 732types of, 726–728valuation of, 737–741

Leasingaccounting and, 729–732accounting income and, 745–746bad reasons for, 745–746buying vs., 727by manufacturers and third parties,

746cash flows of, 732–735debt displacement and, 737–739effects on debt, 746one hundred-percent financing, 745reasons for, 742–745reduction of uncertainty by, 744–745riskless cash flows and, 735–736tax advantages of, 742–744transaction costs of, 745

Ledger balance, 928Legal issues, use of float, 933Legislation

Sarbanes-Oxley Act of 2002, 20–21Securities Act of 1933, 19Securities Exchange Act of 1934, 19

Lehman Brothers’ bankruptcy, 583Lender, 530Lending, riskless, 399–400Lessee, reservation payment of, 743Lessors, reservation payment of, 744Letter of comment, 692Letter of credit, 957-959Letter of Guarantee, 959-960Level coupon bond, 267Leverage; see also Financial leverage;

Operating leveragebeta and, 629–631homemade leverage strategy, 552operating, beta and, 457return to shareholders and, 550–553valuation with, 623

Leverage ratios, 64–66cash coverage, 65–66times interest earned (TIE), 65total debt ratio, 64–65

Leveraged buyouts, 586, 1022–1023; see also Acquisitions

Leveraged lease, 728Leveraged recapitalization, 1013Leveraged syndicated loans, 536Levered firms, 457Liabilities, 25, 28, 30

matching with assets, 874–876Liens, 1044LIFO (last in-first out), 322Limited liability company (LLC), 8–9

Investments; see also Expected return; Returns

present value of, 119for retirement, 134

Investors; see also Portfolioefficient market hypothesis and, 489fooling of, 489preferences for dividend yield, 662

Invoice, 953Invoice date, 954Involuntary bankruptcy, 1043Iron Mountain, 1009IRR; see Internal rate of return (IRR)ISDEX, 486Issue costs, 703

JJacobs Engineering Group, 2JCPenney, 1011Jhunjhunwala’s Aircraft, 264Jindal Steel & Power Limited, 17John Deere, 57Joint stock companies, 10JP Morgan Chase & Co, 284Junk bonds, 282Just-in-time (JIT) inventory, 977

KK-factor model, 426–427Kanban systems, 977, 979Keiretsu, 979Kimberly-Clark, 972Kroger, 68

LLarsen & Toubro (L&T), 8, 1034-1036Last-in, first-out (LIFO), 510LBOs; see Leveraged buyoutsLease-or-buy decision, 736

discount rate and, 737NPV analysis of, 737, 740–741optimal debt level, 736present value of riskless cash flows,

736riskless cash flow, 735–736

Leases, 726assets frequently leased, 747basics of, 726capital leases, 729debt and, 735–736direct leases, 726financial leases, 727–728IRS concerns about, 732leveraged leases, 728offered by manufacturers/third

parties, 747operating leases, 727–728sale and leaseback, 728

exchange rate risk, 1081–1084exchange rates, 1064–1067foreign exchange markets, 1063–1064forward rates and future spot rates,

1074–1077interest rate parity, 1084–1085international Fisher effect, 1076–1077political risk, 1084–1085purchasing power parity, 1070–1073terminology for, 1062translation exposure, 1083–1084uncovered interest parity, 1076

International corporations, 7, 10, 1061top corporations, 9

International Financial Reporting Standards (IFRS), 29

International Fisher effect (IFE), 1076–1077

International Paper Co., 535Intrinsic value, 767Inventory, 28

accounting methods, 322, 510costs of holding, 973just-in-time inventory, 977

Inventory costs, 971Inventory loans, 911Inventory management, 951, 970–971

ABC approach to, 971–972derived-demand inventories, 977EOQ model, 973–977financial manger, 970inventory costs, 972inventory policy, 970just-in-time inventory, 977materials requirements planning

(MRP), 977techniques for, 972–977types of inventory, 970–972

Inventory period, 895, 898Inventory turnover, 66, 898Inverse floater, 879Investment banker, 695Investment banks, 694, 697–688; see

also UnderwritingInvestment decisions, dividends and,

648–658Investment grade, 715Investment rules, 159

discounted payback period method, 164

IRR method, 165–168NPV rule, 159–162payback period method, 162–165practice of capital budgeting and,

180–183profitability index, 178–180


Subject Index 1111

foundations of, 490–491rationality, 490, 500–501size and, 504–506stock prices and new information, 515types of efficiency, 491–494value vs. growth, 506

Market equilibrium portfolio, 403–407definition of, 403–404

Market history, equity risk premium, 357–360

Market model, 426–427Market portfolio, 404

definition of risk, 404–406expected return on, 407–409single factor and, 433–434

Market power, 993Market prices

behavioral finance and, 509information in, 514–516

Market risk, 397Market risk premium, 451–452

dividend discount model (DDM) and, 451–452

historical data, 451Market-to-book ratio, 59–60Market value, 29, 541

book value vs., 29, 540–542Market value ratios, 69–70

enterprise value, 70enterprise value multiples, 70market capitalization, 70market-to-book (M/B) ratio, 69–70price-earnings (P/E) ratio, 69

Marketability, 942Marketable claims, 592Marketing manager, 897Maruti Car, 231-232Matching principle, 30Materials requirements planning

(MRP), 977Matrix approach, 385Maturity, 267, 942

short-term securities, 942Maturity of bonds, 267Maturity hedging, 906McDonald’s, 347McGraw-Hill, 305Mean (of distribution), 357Members, 327Mentor Graphics, 18, 1009Merger premium, 1016–1017Mergers, 988; see also Acquisitions;

Divestitures; Leveraged buyouts; Takeovers

advantages/disadvantages of, 1001–1003

bad reasons for, 1001

repayment of, 533–534security, 533seniority, 533syndicated bank loans, 536terms of, 532–533types of, 535–536

Long-term financing, 525, 909; see also Bonds; Leasing

international bonds, 537long-term financial deficit, 539patterns of, 537–541syndicated bank loans, 536trends in capital structure and,

540–541Long-term solvency measures, 64–66

cash coverage, 65–66times interest earned, 65total debt ratio, 64–65

Lottery valuation, 132Lowe’s Companies, 71–72

MMACRS (Modified accelerated cost

recovery system), 202Mailing time, 930Making delivery, 854Malabar Gold Limited, 210Management, corporate

inefficient, elimination of, 994view of payback period method, 164

Management goals, 16–17Managerial information, 702–703Managers; see also Financial managers

agency theory, 1018bidding/target firms, 1018–1020compensation of, 17–18potential mergers and, 992shareholders’ interest and, 16–18

Mangalore Chemicals and Fertilizers Ltd, 18

Manpower, Inc., 64Marathon Oil, 991, 992Marginal tax rates, 33Marked to the market, 858Market bubbles, 486, 500–501, 506Market capitalization, 70Market for corporate control, 994Market crashes, 506Market efficiency

accounting/financial choices and, 510–512

arbitrage, 491, 501–504behavioral challenge to, 500–502crashes and bubbles, 506deviations from rationality, 490–491,

500earnings surprises, 503–504empirical challenges to, 502–508

Limited liability instrument, 758Limited Liability Partnership

Act 2008, 6Limited partnership, 6Line of credit, 910Linear interpolation, 777Linear relationship, 431–432Lines of credit, 536Liquidating dividend, 640Liquidation, 1043

by bankruptcy, 1043–1044priority of claims, 1043–1044straight liquidation, 1043

Liquidity, 28–29cash management vs., 927–928determinants of, 902–905

Liquidity measurescash ratio, 64current ratio, 63quick (acid-test) ratio, 64

Liquidity premium, 296Loan agreements, 3Loan covenants, 589Loan guarantees, 782–783Loans

amortization of, 139–143bank loans, 536inventory loan, 911“junk” loans, 536lines of credit, 536, 910secured, 910syndicated bank loans, 536unsecured, 910–911

Lockboxes, 935–937Lockheed Corporation, 782–783Lockups, 697London Interbank Offered Rate

(LIBOR), 536, 910swaps and, 876

London International Financial Futures and Options Exchange (LIFFE), 855

London Stock Exchange, Alternative Investment Market (AIM), 21

Long hedges, 863, 869short hedge compared to, 868–869

Long run, 32Long-term debt, 3, 530–534

basics of, 530–531call provision, 534equity vs., 530, 532features of, 531indenture, 531–534issue of bonds, 715–716junk bonds, 536patterns of, 537–541protective covenant, 534


1112 Subject Index

Multiperiod cash flow valuation, 123algebraic formula for, 124power of compounding, 117–118present value and discounting, 123

Multiples, 320Multiyear compounding, 127Municipal bonds, 266, 277–278Mutual funds, semistrong form

efficiency and, 497–500Mutually exclusive investments, 167Mutually exclusive projects, 168, 174

application of PI, 178–179problems with, 167–170, 172–177profitability index, 178–179scale problem, 172–175timing problem, 175–177

NNASDAQ, 328–329, 486National Association of Securities

Dealers Automated Quotations system (NASDAQ), 328–329, 486

National Stock Exchange (NSE), 331Nationally recognized statistical rating

organizations (NRSROs), 19NBC Universal, 990–991, 1011NCAA (No Coupon At All), 282Near-cash, 927Negative covenant, 534, 588Negotiated offer, 697Net float, 929Net income, 30–40, 61Net investment, 312Net operating losses (NOL), 995–996Net present value

attributes of, 162Baldwin case example, 203–204flotation costs and, 473–474formula for, 112, 124incremental cash flows, 174, 176–177internal rate of return vs.,

173–175of lease, calculating, 740–741lease-vs-buy decision, 736of merger, 1003–1007in Monte Carlo simulation, 247multiperiod case, 123–124nominal vs. real, 210–211in sensitivity analysis, 236spreadsheet applications, 159of switching credit policies, 962–963use of, 159–162

Net present value of growth opportunity (NPVGO), 316

cash cow firm, 316for real-world companies, 318–319

Net present value of a merger, 1003–1007

cash and, 1004–1005

Kaefer Manufacturing Working Capital Management, 924

The Leveraged Buyout of Cheek Products, Inc., 636–637

McKenzie Corporation’s Capital Budgeting, 612–613

The MBA decision, 157Ratios and Financial Planning at

East Coast Yachts, 100–102S&S Air’s Convertible Bond, 847–849Stephenson Real Estate

Recapitalization, 578Stock Valuation at Ragan Engines,

338–339Williamson Mortgage, Inc., 888Your 448(k) Account at East Coast

Yachts, 523–524Minimum variance portfolio, 388–390Minority shareholders, 524, 989MM Proposition I, 552–554

corporate taxes and, 566homemade leverage, 552key assumption, 554Proposition II compared (example),

557–561summary of, 569WACC in, 569

MM Proposition II, 554–561corporate taxes and, 568interpretation of, 561–563Proposition I compared (example),

557–561required return to equityholders,

555–561risk to equityholders, 555–649summary of, 571

Modified Accelerated Cost Recovery System (MACRS), 202

Modified IRR (MIRR), 171Modigliani-Miller thesis; see also MM

Proposition entrieson capital structure, 552–554corporate taxes and, 567interpretation of results, 561–564on stock vs. debt, 840summary (with taxes), 571summary (without taxes), 563value of firm, 552–553

Money market securities, 992–943Monopoly power, 993Monte Carlo simulation, 242–247Moody’s Investor Services, 19, 25, 281,

543Morgan Stanley, 1020Morningstar, 377Mortgage securities, 533Mortgage trust indenture, 533Multinationals, 1061

for cash consideration, 1003–1004cash vs. stock, 1006–1008for common stock, 1005–1006cost to shareholders, 1001–1003friendly vs. hostile takeovers, 1008–

1010Mergers of Equals (MOEs), 1019NPV analysis, 1003–1007NPV analysis of, 1003–1007options and, 783–785reduced capital requirements,

997–998returns to bidders, 1015stock-swap mergers, 1002value added by, 1014–1020

Mergers of equals (MOEs), 1019-1020Merrill Lynch, 327, 536Mesa Partners II, 1013–1014Mesa Petroleum, 994MIBOR, 1062-1063Michael C. Jensen, 994, 997Microsoft, 216Microsoft Corporation, 85, 250–251,

316, 327, 454Milking the property, 588Mini cases

Bethesda Mining Company, 230The Birdie Golf—Hybrid Golf

Merger, 1033–1034Bullock Gold Mining, 193Bunyan Lumber, LLC, 263–264Cash Flows at Warf Computers, Inc.,

53–54Cash Management at Richmond

Corporation, 947Clissold Industries Options, 798–799The Cost of Capital for Goff

Computer, Inc., 481–482Credit Policy at Braam Industries,

985The Decision to Lease or Buy at

Warf Computers, 751–752East Coast Yachts Goes

International, 1090–1091East Coast Yachts Goes Public,

722–723Electronic Timing, Inc., 680–681Exotic Cuisine’s’ Employee Stock

Options, 826The Fama-French Multifactor Model

and Mutual Fund Returns, 445Financing East Coast Yachts’s

Expansion Plans with a Bond Issue, 303–304

Goodweek Tires, Inc., 230–231A Job at East Coast Yachts, 373–375A Job at East Coast Yachts, Part 3,

420–422


Subject Index 1113

Options, 756; see also Call options; Option valuation; Put options

call options, 757–758capital budgeting and, 785–786combinations of, 763–766corporate decisions and, 783–786defined, 756investment in real projects and,

787–788loan guarantees and, 782–783mergers and diversification, 783–785natural resources and mining

industries, 815–823put-call parity, 764put options, 758–759quotes, 761selling of, 759–760stock and bonds as, 778–781synthetic stock, 764terminology for, 756valuation of, 766–770

Options (real options) analysis, 247–251option to abandon, 248–251option to expand, 247timing options, 251

Oracle, 990Orange County bankruptcy, 583Order costs, 905Order flow, 327Ordinary annuity, 136Organization chart, 5

operating cycle and, 897–900Over-subscription privilege, 710Over-the-counter collection, 935Overhead, 993Overreaction, 509Owners’ equity, 28–29Ownership interest, 530

PPAGALGUY, 948-949Palm, 503–504Par value, 267

of bonds, 267Partnerships, 6–7

corporation vs., 9–10general partnership, 4–6limited partnership, 4–6

Payables manager, 897Payables period, 899Payables turnover, 67, 899Payback period method, 162–165

arbitrary payback period standard, 163–164

defining the rule, 162–163discounted method, 165managerial perspective, 164payback period rule, 163payments after payback period, 163

market portfolio and, 433One-time sale, credit for, 966Open account, 956Open interest, 855Open market purchases, 646Operating cash flow (OCF), 213, 220Operating cash flow (OCF), 39–41

alternative definitions of, 211–213bottom-up approach to, 212–213tax shield approach to, 213–214top-down approach to, 212

Operating cycle, 895, 898; see also Cash cycle

calculating, 897–900cash cycle and, 899–900defined, 895–896firm’s organization chart, 897in various industries, 900–901

Operating leases, 727–728cancellation option, 728characteristics of, 726–728

Operating leverage, 457Opportunity cost, 162, 193, 197, 201

in credit costs, 964–965in equivalent annual cost method,

218–220in incremental cash flows, 196–197

Opportunity set, 390Optimal credit policy, 964–966

organizing the credit function, 965total credit cost curve, 964–965

Optimal debt levellease vs. buy decision and, 739–741riskless cash flows and, 736

Optimal portfolio, 401–409Option-pricing formula, 770–778

Black-Scholes model, 773–778borrowing amount, 772delta, 772risk-neutral valuation, 772–773two-state option model, 771–773

Option valuation, 766–770; see also Black-Scholes model; Option-pricing formula

binominal model; see Two-state option model

bounding call value, 766–767convertible bond, 837–838exercise price, 767expiration date, 767factors in call option values, 767–769factors in put option values, 770interest rate, 770lower bound, 766–767stock price, 768–769upper bound, 767–768variability of underlying asset,

768–769

cash vs. common stock, 1006–1007common stock, 1005–1006

Net present value rule, 160investment decisions and,

170–171Net price, 858Net working capital, 4, 36–37,

204–205, 892additions to, 38change in, 36–37defined, 4, 199tracing, 893–894

Net worth, 29New issues; see also Public issue

alternative issue methods, 694announcement and value of firm,

702–703cost of, 703–707

New York Mercantile Exchange (NYM), 855

New York Stock Exchange (NYSE), 327–329

classes of stock, 527floor activity, 328–329members of, 327–328operations, 327

No-dividend firm, 315–316Noida Toll Bridge Company Ltd.

(NTBCL), 239, 240Nominal cash flow, 208Nominal cash flow, 208, 209Nominal interest rate, 206–207, 288–291

Fisher effect and, 291–293Noncash items, 31Noncommitted line of credit, 910Noncumulative dividends, 528Nonmarketable claims, 592NoNo bonds, 536Nonpayment, probability of, 962Normal Bond, 292Normal distribution, 362–363Notes, 530, 534Notes payable, 893NPV; see Net present valueNPVGO; see Net present value of

growth opportunity modelNTPC, 8

OOff-balance sheet financing, 729Offered price, 326–327Offering price, 326–327, 698–699Oil & Natural Gas Corporation, 2Omnibus Budget Reconciliation Act

(1993), 33One-factor model, 428–433

expected return for individual stocks, 429


1114 Subject Index

return on equity, 69Project funding

cost of capital for, 460–461WACC and, 465–466

Projects not scale enhancing, 630–631Promissory note, 956Prospectus, 692Protective covenants, 534, 588

negative covenant, 534positive covenant, 534

Protective put, 763Proxy fight, 17, 527, 991, 1009Proxy voting, 527Public Companies Accounting

Oversight Board (PCAOB), 20Public issue, 691–692; see also Initial

public offering (IPO)alternative methods, 692–694cash offer, 694–697firm commitment offer, 695general cash offer, 692rights offer, 692

Public limited companies, 10Purchase method, 1021Purchase order financing, 911Purchasing manager, 897Purchasing power parity (PPP),

1068–1073absolute purchasing power parity,

1070–1071currency appreciation/depreciation,

1073relative purchasing power parity,

1071–1073Pure plays, 462Put bond, 536Put-call parity, 764Put options, 758–760

defined, 757factors determining values of, 770firm expressed as, 780payoff of, 759–760protective put, 763put-call parity, 781selling, 759–760stockholders and, 780–781value at expiration, 758–770

Put provision, 535

QQuick (acid-test) ratio, 63Quiet period, 697

RRagan Engines, Inc., 339Random walk, 492Ratio analysis, 60–73

acid-test ratio, 63asset management ratios, 66–67

Precautionary motives, 926Preemptive right, 528Preferred stock, 528–529

callable preferred, 529cost of, 464cumulative dividends, 528as debt, 530dividends, 528–530noncumulative dividends, 528stated value, 528

Premium bond, 269Present value (PV), 112

annuity, 132–133break-even point, 239–243common stock, 305–311consols, 129, 132continuous compounding and, 129discounting and, 118–121firm valuation, 143–144formula (one-period), 111of investment (multiperiod), 119levered cash flow, 619perpetuity, 130of riskless cash flow, 735–736spreadsheet applications, 144of tax shield, 565

Present value factor, 119Present value interest factor in annuities,

134Price-earnings (P/E) ratio, 57, 69,

320–322accounting methods, 322factors determining, 322

Price fluctuations, 494Primary dealers (PDs), 280Primary market, 326Principal value, 532Priority of claims, 1043–1044Private placements, 716Private workout, 1050–1051Pro forma statements, 76–77Processing delay, 930Procter & Gamble, 308, 314, 993Production costs, 457Production manager, 897Production setup costs, 905Profit margin, 68, 88Profit maximization, 14Profitability, 955Profitability index, 178–180

application of, 178–180capital rationing, 179independent projects, 178mutually exclusive projects, 178–179

Profitability ratiosEBITDA margin, 68profit margin, 68return on assets, 68

problem with, 163–164summary of, 164timing of cash flows, 163

Payback period rule, 163Payday loans, 126Payout ratio, 312Payouts, different types of, 640–641Peach Holdings, 21Pecking-order theory, 597

implications of, 599–600internal financing and, 599rules of, 598–599safe securities and, 599trade-off theory vs., 599

Percentage-of-completion methods, 322, 510

Percentage returns, 346–350Percentage of sales approach, 78–82

balance sheet, 79–81income statement and, 78–79

Period costs, 32Perishability, 955Perpetuity, 129–130, 618, 620

growing perpetuity, 131–132present value formula, 130

Perquisites, 594Personal taxes, 600–603; see also

Corporate taxes; Taxesbasics of, 600effect on capital structure, 600–603summary of, 655

Pfizer, 68Pie model, 547, 591Pioneer Distilleries, 46Playing the float, 939Plowback ratio, 79Poison pills, 1011Political risk, 1084Portfolio, 383

diversification and, 429–430diversification effect, 386–387expected return on, 384–385extension to many assets, 387factor models and, 427–430market equilibrium portfolio,

403–407matrix approach, 385minimum variance, 390optimal portfolio, 401–403risk and return for, 383–387standard deviation, 385–386style portfolios, 438–439variance, 385–386, 395

Portfolio riskfor equally weighted portfolio, 430riskless lending and, 399–400

POSCO, 159Positive covenant, 534, 588


Subject Index 1115

Revenue effects, 961Revenue enhancement, synergy of,

992–993Revenues

cyclicality of, 456–458estimates of, 235

Reverse split, 674Revolver, 536Richard Ruback, 994Richmond Corporation, 947Rights offer, 692, 707–611

effect on shareholders, 610–711effect on stock price, 708–709mechanics of, 707–709number of rights needed, 708rights puzzle, 711–712subscription price, 707underwriting arrangements, 710

Risk; see also Default risk; Derivatives; Hedging

behavioral finance and, 509beta and; see Betascredit risk, 955exchange-rate risk, 1084expected return and, 407–412hedging and, 853idiosyncratic, 397inflation risk, 290interest-rate risk, 270–273leverage and, 554–555market portfolio and, 403–406market risk, 397political risk, 1084project risk, 461–462systematic; see Systematic riskunsystematic; see Unsystematic risk

Risk-based models, 436Risk-free rate, 451Risk-free returns, 359Risk-neutral pricing, 810Risk-neutral probabilities, 810, 813Risk neutrality

probabilities in option valuation, 810in two-state option model, 772–773

Risk premiumsequity; see Equity risk premiumhistorical and international

perspectives, 365–369Risk and return

average returns; see Average returnsCAPM; see Capital asset pricing

modelequity risk premium; see Equity risk

premiumtrade-off for world stocks, 392

Risk statistics, 360–363normal distribution, 362–363

Regular cash dividends, 640Regulation, 18–21Regulation A, 692REI Agro, 1090-1093Relative purchasing power parity,

1071–1073basic ideas, 1071currency appreciation/depreciation,

69results of, 1071–1073

Reliance Industries Limited, 2, 10, 55, 989, 1007

Reliance Petroleum Limited (RPL), 1007

Rembrandt bonds, 537Reorder points, 977–978Reorganization, 582–584

bankruptcy reorganization, 1044–1048

Repayment of bonds, 533Repeat business, credit for, 966–968Representativeness, 500, 509Republic National Bank, 272Repurchase agreement (repos), 943Repurchases, 1013; see also Stock

repurchaseRequired return, 1013; see also Cost of

capital; Discount rateson equity, 555

Residual claim, 530Residual value, 744Retained earnings, 312Retention ratio, 79, 312Return on assets (ROA), 68

leasing and, 745Return on book assets, 69Return on book equity, 69Return on equity (ROE), 69, 312

DuPont identity and, 73expected, with leverage, 551in growth rate formula, 87–88

Return on net worth, 69Return on retained earnings, 312Returns; see also Expected return

average stock returns, 359, 363–365dollar returns, 344–346earnings surprises and, 503–505excess, 359holding-period returns, 348–354percentage returns, 346–350return statistics, 354–360risk-free returns, 359risk statistics, 360–362total annual returns (1926–2011), 3592008 financial crisis, 368–369U.S. equity risk premium, 365–369

capital intensity ratio, 68cash coverage, 65–66cash ratio, 64common financial ratios, 71current ratio, 63–64days’ sales in inventory, 66days’ sales in receivables, 66dividend payout ratio, 79DuPont identity and, 73–75EBITDA margin, 68enterprise value, 70, 323–324enterprise value multiples, 70inventory turnover, 66liquidity measures, 62–63long-term solvency measures, 64–66market capitalization, 70market-to-book ratio, 69–70market value measures, 69–70plowback ratio, 79price-earnings ratio, 69profit margin, 68profitability measures, 68–69quick ratio, 63receivables turnover, 66retention ratio, 79return on assets (ROA), 68return on equity (ROE), 69, 72–75short-term solvency, 62–64times interest earned, 65total asset turnover, 67total debt ratio, 54–65turnover measures, 66–67

Rationalitydeviations from, 490–491, 500market efficiency and, 490, 500–501

Raw materials, 971Raymond, 72, 73, 104, 105Real cash flow, 208, 209Real interest rate, 206–207, 288–290Real options, 247–252

option to abandon, 248–251option to expand, 247timing options, 251

Real Time Gross Settlement System (RTGS), 934, 937

Real-world betas, 453Recapitalizations, 1013Recaps, 1013–1014Receipt of goods, 954Receivables, 951–952

investment in, 952–953monitoring of, 969–970

Receivables period, 898, 953Receivables turnover, 67, 898Red herring, 692Registered form, 532Registration statement, 691


1116 Subject Index

sources of funds, 911tracing cash and net working capital,

893–894unsecured loans, 910–911

Short-term securitiescharacteristics of, 942default risk, 942marketability, 942maturity, 942taxes, 942

Short-term solvency, 62–63cash ratio, 63current ratio, 63quick (acid-test) ratio, 63

Siemens India, 8Shortage costs, 903–904, 971, 974–975SICA (Sick Industrial Companies Act),

1048Sight draft, 956Signaling

debt signaling, 592–594dividend signaling, 659–660information content effect, 658

Simple interest, 114–115Single-factor model, of market

portfolio, 433–434Sinking fund, 529, 533–534Size factor

in average returns, 504–506optimal size of firm, 993

SJVN, 305SmithKline Beecham, 503SML; see Security market lineSociety for Worldwide Interbank

Financial Telecommunication (SWIFT), 937, 1063

Sole proprietorship, 4–7Sony, 1025Sources of cash, 894Southwest Airlines, 853Special economic zone, 36Special purpose vehicle (SPV), 239Specialists, 327Specific risk, 397Speculating, 853Speculation, efficient markets and,

511–514Speculative motives, 826Spin-off, 1024Spot-exchange rate, 1068Spot trade, 1068Spread, 326Spreading overhead, 993Spreadsheet applications

annuity present values, 135bond prices and yields, 275–276IRRs calculation, 167–168

Security Pacific, 993Seed money stage, 689Self-control, 657Sell-offs (divestitures), 1024Selling, general, and administrative

expenses, 32Semiannual coupons, 270–271Semiconductor industry, 159Semistrong-form efficiency, 492–493

event studies, 496–498evidence on, 496–500mutual funds record, 497–500tests of, 496–498

Seniority, 533Sensitivity analysis, 233–237Separation principle, 402Serial correlation coefficients, selected

companies (2010), 495Serial correlations, 494Settlement price, 855Share repurchases, 647–649

dividends vs., 647–648Share warrants, 707Shareholder interests

managers and, 16–18maximization of firm value vs.,

548–549Shareholder rights, 526–527

in common stock, 525–527Shareholders

as call option holders, 779coinsurance effect, 1003effect of rights offerings on, 710–11managerial behavior and, 1016–1018minority shareholders, 526, 990

Sharpe ratio, 361, 367Shelf registration, 715Shell Transport, 501–503Shirking, 594Short hedges, 862, 868Short run, 32Short-term financial planning, 4,

910–911alternative current asset policy,

905–908banker’s acceptance, 911cash cycle, 895–896commercial paper, 911different strategies for, 906–908financing of current assets, 902flexible vs. restrictive, 902–903managers who deal with, 897operating and cash cycles, 894–901operating cycle, 894–901secured loans, 910size of investment in current assets,

901–905

standard deviation, 362–363variance, 360–362

Risk synergy, 722Riskless borrowing and lending,

399–400portfolio risk and, 399–400

Riskless cash flowoptimal debt level and, 736present value of, 735–736

RJR Nabisco, 994Road show, 695Royal Dutch Petroleum, 501–503

SSABMiller, 1062Safety reserves, 905Safety stocks, 977–978Sagara Ships, 985Sale and leaseback, 728Sales-type leasing, 726Salvage value, 202Samsung Electronics, 159, 181Samurai bonds, 537Sarbanes-Oxley Act (SarbOx), 20–21Sardar Sarovar Narmada Nigam Ltd

(SSNNL), 282-283Scale problem, 172–175Scenario analysis, 237–238Scorched earth policy, 1014Seasonal activities, 941–942Seasoned equity offering (SEO),

510–512, 702Seasoned new issue, 692–694Second-round financing, 689Secondary market, 325–326Secured loans, 910Securities; see also Bonds; Expected

return; Returns; specific kinds of securities

costs of new issues, 617innovation in, 488methods of issuing, 695–696

Securities Act of 1933, 19Securities and Exchange Act of 1933,

690Securities and Exchange Board of

India, 1008-1010, 1018Securities Exchange Act of 1934, 19Securities and Exchange Commission

(SEC), 19, 690, 1008, 1024on insider trading, 498–500registration statements, 691–692Schedule 13D, 1008

Security market line (SML), 408–412, 494

cost of capital and, 461to estimate risk-adjusted discount

rate, 450


Subject Index 1117

Sustainable growth rate, 86–90Swap pricing, 879Swaps, 853, 876Swaps contracts, 876–880

credit default swap (CDS), 878currency swaps, 878exotics, 879–880interest rate swaps, 876–877

Syndicate, 695Syndicated loans, 536Synergy, 197, 991–992

cost reduction from, 993–994incremental cash flows and, 197market or monopoly power, 993marketing gains, 993revenue enhancement, 993risk synergy, 842sources of, 992–998strategic benefits, 993

Synthetic stock, 764Synthetic T-bill, 752Systematic risk, 397–398

betas and, 424–427diversification and, 122

TT-bills; see Treasury billsT-Mobile, 988, 990Takeover defenses, 1010–1014

after company is in play, 1011–1013asset restructuring, 1013before being in play, 1010–1011corporate charters as, 1010–1011exclusionary self-tenders, 1013golden parachutes as, 1011greenmail, 1011–1012poison pills, 1011recapitalization and repurchase,

1012–1013standstill agreements, 1012white knight and white squire, 1012

Takeovers, 18, 991–992; see also Acquisitions; Mergers

crown jewels, 11–12defensive tactics, 1010–1013friendly vs. hostile, 1008–1010golden parachutes and, 1011poison pill, 1011proxy contests, 991varieties of, 990

Target firms, 991managers of, 1019–1020value and merger premium,

1016–1018Target ratio, debt-equity ratios, 606Targeted repurchase, 647Tax advantage, of leasing, 742–744

reporting of, 330world stock market capitalization

(2011), 366Stock prices

call option price and, 767–769corporate taxes, 570–571dilution, 711–712effect of rights offering on, 708–709fluctuations, 494new information and, 489

Stock repurchase, 640, 646–647dividend payouts vs., 647–648executive compensation, 649flexibility of, 649reasons for, 648–649targeted repurchase, 647taxes and, 652, 655to offset dilution, 649–650undervaluation, 649

Stock splits, 510, 640, 670benchmark case, 673examples of, 671–673reverse split, 674stock dividends and, 670–673trading range and, 673–674

Stock valuationconstant growth stocks, 307–310different types of stocks, 306–311differential growth stocks,

310–311zero growth stocks, 307

Stockholders; see also Shareholderscash flow to, 38–39disinterest of, 494

Stockholders’ books, 203–204Stockholders’ equity, 25, 28Stockout, 905Straight bond value, 835Straight-line depreciation, 322Straight voting, 526Street sweep, 1009Strike price, 756Strong-form efficiency, 492–493

evidence on, 500Style portfolios, 438–439Subordinated debt, 533Subscription price, 707Subsidies, 617Sun Microsystems, 980Sun TV Limited, 17Sunk costs, 196Superfloaters, 879Superinverses, 879Supermajority provisions, 1011Supplemental liquidity providers

(SLPs), 327Surplus funds, 996

loan amortization, 142NPV calculation, 161PV with multiple future cash

flows, 144time value of money

calculations, 122Stafford loans, 142Stakeholders, 18–19Standard & Poor’s, 19, 266, 281, 452,

525, 543monthly returns (2008), 369S&P 500 Index, 57, 497

Standard deviation, 360, 377calculation of, 379formula, 380of historical risk premium, 367in portfolio of many assets, 394–395of portfolio’s return, 385, 387

Standardization, 955Standby fee, 710Standby underwriting, 710Standstill agreements, 1012Starbucks, 802Start-up stage, 689Start-up valuation, 806–808State Bank of India, 2, 8, 17, 57Stated annual interest rate (SAIR), 125

effective annual rate vs., 126–127Statement of cash flows, 36–38, 39–40

cash flow from financing activities, 40cash flow from investing activities, 41cash flow from operating activities,

36–41Static trade-off, 590Statutory liquidity Ratio (SLR), 280Stead-state float, 932Steel Authority of India Limited

(SAIL), 66, 99Stock; see also Common stock;

Expected return; Preferred stock; Returns; Stock prices

acquisition by, 989as options, 778–782repurchase of, 646–647synthetic stock, 764tracking stock, 1025valuation of; see Stock valuation

Stock-based insolvency, 1039Stock certificates, 3Stock dividends, 511, 640, 671

benchmark case, 673example of, 671–672stock splits, 670–674

Stock-for-stock merger, 1007Stock market

dealers and brokers, 326random walk, 492


1118 Subject Index

UUnbiased forward rates (UFR), 1075-

1076Uncovered interest parity (UIP), 1076Underlying asset, of derivatives, 853Underpricing, of new stock issues,

698–700Underwriting, 695

arrangements for rights offerings, 710“Dutch auction,” 695firm commitment offer, 695

Underwriting discount, 695Unfunded debt, 530Uniform price auction, 696Unilever PLC, 503U.S. Department of Commerce, 33U.S. Department of Justice, 993,

1013–1014U.S. Small Business Administration, 65U.S. Steel, 57, 991, 1000U.S. Treasury “bail outs,” 1040U.S. Treasury bills; see Treasury billsUnocal, 1013Unseasoned new issue, 692Unsecured loans, 909–911Unsystematic risk, 397–398, 1000

diversification and, 429–430Uses of cash, 894Utilization ratios, 66

VVA Linux, 486Valuation; see also Option valuation;

Stock valuationof convertible bonds, 835–838discount rate estimated, 623–625executive compensation/options,

803–805with leverage, 623lottery valuation, 133multiperiod case, 113–117, 123one-period case, 110–113risk-neutral, 772–773of start-up, 806–808uncertainty and, 113weighted-average-cost-of-capital

method, 465–469Value

cost vs., 28–30growth vs., 506

Value additivity, 160Value creation, 2

capital budgeting decisions, 486financing decisions and, 486–488

Value of the firm, 324–326debt and, 548–549debt-equity exchange and, 547defined, 547

Third-round financing, 6893Com, 503–504Time, costs and, 32Time draft, 956Time premium, 767Time value of money, spreadsheet

application, 122Time Warner, 1006–1007, 1020Times interest earned (TIE), 65Timing decision, 511–512Timing option, 250Toehold, 1008Tombstone, 692–693Total asset turnover, 67, 88Total cash flow of the firm, 39Total debt ratio, 64–65Total dollar return, 345Total returns, year-by-year (1926–2011),

354–356Toyota, 58Toys “R” Us, 941Tracking stocks, 1025Trade acceptance, 956Trade credit, 951Trade discounts, 956Trade-off, 590Trade Reporting and Compliance

Engine (TRACE), 284Trading costs, 905Trading range, 673Transaction costs, reducing, by leasing,

745Transaction motive, 927Translation exposure, 1083–1084Transparency, 283Treasurer, 6Treasury bills, 277, 942, 943, 944

risk-free returns, 451synthetic T-bill, 766

Treasury bonds, 277price quotes, 286–287pricing of, 863–864

Treasury inflation-protected securities (TIPS), 290–291

Treasury yield curve, 295Triangle arbitrage, 1067–1068Trust deed, 533Trust receipt, 533Turnover measures, 66Two-state option model, 771–773

amount of borrowing, 772determining delta, 772extension to many dates, 814–816heating oil example, 809–812risk-neutral valuation, 772–773three-date example of, 811–812

Tyco, 20, 46

Tax books, 203Tax deductible, 462Tax-free acquisition, 1020Tax-free transaction, 1020Tax gains, 994

debt capacity and, 995from acquisitions, 994–995net operating losses and, 995–996surplus funds and, 996

Tax ratesaverage vs. marginal, 33–35corporate, 33flat-rate tax, 34

Tax Reform Act of 1986, 33, 994Tax shield, present value of, 565Tax shield approach, 213–214Tax subsidies

APV used with, 627to debt financing, 616

Taxability premium, 296Taxable acquisition, 1020Taxable transaction, 1020Taxes, 33–35; see also Corporate taxes

acquisitions and, 1020–1021average vs. marginal rates, 33–35cash flow and, 564–565corporate tax rates, 33deferred, 32dividends and, 652double taxation, 8financial distress costs, 590–592leases and, 732personal, 600–603, 652–653short-term securities, 942taxable transaction, 1020

Tech bubble, 486Technology transfer, 994Temporary cash surpluses, 941–942Tender offer, 646, 989, 1008Term loans, 716Term structure, 906Term structure of interest rates, 291–293

graphing of, 294–295Terms of sale, 952, 953–961

average collection period, 956basic form, 953cash discounts, 955–956cost of credit, 955–956credit instruments, 955–956credit period, 953–954invoice date, 954length of credit period, 954–955trade discounts, 956

Texaco bankruptcy, 584–585The original equipment manufacturer

(OEM) market, 231The replacement market, 231


Subject Index 1119

Westinghouse, 860What-if analysis, 233White knight, 1012White squire, 1012Williams Act (1968), 1008Work-in-progress, 971Working capital management, 892WorldCom, 20, 510, 583Write-off, 25Written-Down Value Method, 206

XXerox, 510

YYahoo!, 74, 330Yankee bonds, 537Yield to maturity (YTC)

after-tax yields, 277of bonds, 267, 272–277, 279calculating, 275

Yield to maturity (YTM), 267

ZZ-score model, 1053–1056Zero-balance account, 940Zero-coupon bonds, 274–275

duration hedging, 870–871Z-score model, 1053Zero growth constant dividend, 307

Volkswagen, 616Vultures, 1046

WWACC; see Weighted average cost of

capital (WACC) methodWaiting period, 692The Wall Street Journal, 17, 330, 856Walmart, 64Walt Disney, 197, 272, 1025Warner Brothers, 233Warrants, 535, 829–830

Black-Scholes model, 833–835call options vs., 830–833gain from exercising, 833reasons for issuing, 839–843value of firm and, 831–833

Washington Public Power Supply System (WPPSS), 266

Weak-form efficiency, 491–492evidence on, 494–496

Weighted average cost of capital (WACC) method, 464–466, 620–621

APV and FTE approaches compared, 621–623

corporate taxes and, 569Eastman example, 470–472flotation costs, 472–474formula, 620

Weighted average flotation cost, 473

levered firm, 565–567marketable/nonmarketable claims,

592Modigliani-Miller thesis, 553net of debt, 853new equity announcement, 702–703optimal debt level, 591PV of future cash flows, 143–144shareholder interests vs., 548–549start-ups, 122warrants and, 831–833

Value Line Investment Survey, 314, 452, 456

Value portfolio, 438Value stocks, 506Vanguard 500 Index Fund, 497–498Vanguard High Yield Corporate Bond

Fund, 279Variable costs, 235Variance, 360, 378, 385

calculation of, 378–380expected return and, 378–380of portfolio, 385–386in portfolio of many assets, 394–395

Venture capital, 687–689economic conditions and, 690stages of financing, 689–690

Vertical acquisition, 990Vertical integration, 994Viacom, 17Volatility, 360


subject index - mcgraw hill...

Documents