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    Lawrence J. Gitman - Finance - Principles of Managerial Finance-Prentice Hall (2009)

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    Lawrence J. Gitman - Finance - Principles of Managerial Finance-Prentice Hall (2009)

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    Lawrence J. Gitman - Finance - Principles of Managerial Finance-Prentice Hall (2009)

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    PRINCIPLES OF MANAGERIAL FINANCE The Prentice Hall Series in Finance ‘AanderStarpetaey ‘Pdamera ef sen ‘le Deere: Sree Bik Maragenen Borpocoee BexeOoaonade ear “re Make, nas Es ond ae Berketaren Corpor ane Gatporte Panes Te Core Blermaisniet “Pe Copal adn Dection Enon slo ierinen Pret Dodieerton/Cetoe "Brena one caewenal "Re ico an Practce of Prema! nc Mangement copeanarveon Stat "Paonia Thay and Corporat Paliy CormwatiVang ara "Bingroneral Paonia Mangan! covRabinss ‘pon Senko orton Trondcton Rs Manageme a inanance Dierich "Prana Series and atl Seton Habe Oman Theory Princes of Manager Fnace™ Pinca Meera Pane Bf (lamandocbak ‘Fanaa fete” (laman Madera Taredcton Farce GutreLemen ‘Matt of tr te nl Pre Haagen The fii Sick arb What Poe Oprant oso Inca Tory ro hw PnanessOvorcton Comply and Uae olden “Eel Modeling a Eaton i te undowenal of Corporate Fiance ‘Eel Modeling and Enna it fe Fandomowal ef rime ‘eel edelng ord Binaton brincamenr {a Corporte Panee oghesMacDonall Ba "aden of Peed Ott pon, Fuarc ond Oe Dreier ek Aanagemen ond Fant irene ai Serato! Puce Kenre alee "Set pane enn a tet Keorarttryseot iceman oe eee ns en ney Panera Fs of Fans: The apie Spe A enc Spe Un ene ae nxt a rapt tin 7m i ee nen pe eae mae einai Fr date oe ie or rate a Raoee ‘Mil emer a i elie et ME aty Tonle Pte ese Orite a Tecmo re Saenews Pana re ake cas neguee ese ae coor devotes sides \uratona Mone and Pct Panlel Mers ad Fetes Motte ‘Co nenatoral Pasco MotoeStnst Vien ‘enema tes! Peto oftnesine OpteFen10"Cossor Adonced Corpora Fiance Pransect cry af Ate Pig is ef ik Mogens Sehocatee Terrie and cing ani ‘Sten (Cacrie Fae Sater Peering Fcc Sus 1 Methods Cookie ipl ugg nd fst Jini StarpsaleranderBaaey “incinen SetaeeLeaey ‘Goal feos ‘se Fecal nego Tan Tae dr and Scene of Crp isnot Decors ‘Pena Pare Manat Findomevs nd Soon ‘Pra! Management end oly Fram! Merk as nd Plow Van Horne Wachowic: “Fndowera of Pani Management Vaggha “Fncncie! Pongo he Enno Weston rhe Marin Taare ‘nd Corporate Govonance Winger Fesea "Aisonel Ponce {Log onto worwinyfinancela.com to learn more PRINCIPLES OF MANAGERIAL FINANCE TWELFTH EDITION Editor-in-Chief: Denise Clinton Executive Editor: Donna Batista Development Editor: Ann Tarbert Project Menager/EA: Ming Kim Editoil Assistant: Keri McQueen ‘Managing Editor: Nancy Fenton ‘Senior Marketing Manager: Jodi Bassett ‘Senior Media Producer: Bethany Tdd ‘Supplements Editor: Heather McNally Permissions Editor Dana Weightman Project Coordination, Text Dasign, Art Studio, ‘and Electronic Page Makeup: Thompson Steele, Inc Design Manager: lye Wells ‘Cover Photograph: George Hammerstei/Solus Photography/Veer Senior Manufacturing Buyer: Carol Melle ‘edits: 55: Data from Dun & Bradstreet, “Industry Noms and Ratios, 2006"; 341: From The WallStreet Journal, 3/28/07; 339: © 2007 MetroPCS Wireless, nc All Rights Reserved; 563: © 2006 by Risk Management Associaton; 816: From David K. Geman, arthur ‘Stonehill and Michae! H, Moffet, Multinational Business Finance, 11th ed. (Boston, MA: Pearson Education, 2007), pp. 336-342. © 2007 Pearson Education. Reprinted with permis- sion; 816: From Oavid K. Seman, Arthur. Stoneil, and Michael H, Moet, Atukinedonal ‘Business Finance, 11th ed. Boston, MA: Pearson Education, 2007), p. 341. © 2007 Pearson Education. Reprinted with permission; 825: Fom Rita M. Rodriguez and E. Eugene Carer, International Fancal Management, 3rd ed. (Englewood Cis, Ni: Prentce-Hal, p. S12. Reprinted with permission. © 2009 by Lawrence 1. GAman Al cghts reserved. No part ofthis publication may be reproduced, stored ina retieval ‘system or ransmitted, in any form or by any means, elecronic, mechanical, photocopying, recording, or othernise, without the par written persion ofthe publisher For information on obtaring permission forthe use of material fom this work, please submit ¢ writen request to Pearson Education, Inc. Right and Contracts Department, 75 avington Steet, Suite 500, Boston, MA 02116 of fax your request t0 (617) 848-7047, Printed inthe United States, 1 you purchased this book within the United States or Canada you should be aware that it has been wrongfully imported without the approval ofthe Publisher or the Auto. (aN 0-391-55520-7 ISBN 9780521555281 25456789 10-cRK-A1 100908 Dedicated to the memory of my mother, Dr. Edith Gitman, who instilled in me the importance of education and hard work myfinancelab The Key to Your Success in Three Easy Steps! © ‘ake a Sample Test toassess your knowledge. ® Review your personalized ‘Study Plan to see where you need more work. © Use the Study Plan exercises ‘and step-by-step tutorials to get practice-and individualized feedback-where you need it. ‘The MyFinanceLab Course Home page makes it easy for you to stay on track by displaying dass announcements and automatic reminders of upcoming assignments. Did your textbook come bundled with 2 MyFinanceLab access code? If so, simply go to wwnn.myfinancelab.com to register using the code. If not, you can purchase access to MyFinancelab online at wwwumyfinancelab.com, Gitman’s Proven Teaching/Learning System U; by a sec of carefully developed learning ‘welfth edition. The “wallthrough” on. sess of Principles of Managerial Finance have praised the effectiveness ofthe book’s ‘eaching/learaing system, which they hall as one of it hallmarks. The system, driven i goals, has been retained and polished in this the pages that follow illustrates and describes the key elements ofthe teaching/learning system. We encourage both students and instruc tors to acquaine themselves atthe start book offers. Capital Budgeting Techniques ‘of che semester wich che many useful features the Six Learning Goals 2¢ the sac of the chapser anchor the most important concepts and techniques in the chaptec. The learning ‘goal icons reappeas next to related text sections and again inthe chapterend sum- ‘mary, end-of chapter homework materials, and supplements such as the Seady Guide, ‘Test Bank, and MyFiaanceLb, Every chapter opens with a feature, titled | Why This Chapter Matters to You, that ‘helps mocivare student interest Iss firs part, In Your Professional Life, cliscusses the intersection of the finance ropies covered inthe chaptec with the concerns of other major business disciplines. Ie enco ages students majoring in accounting, in sation syseems, management, marketing, sand operations to appreciat: the numerous ect interaction that rowel ‘The second part, In Your Personal Life, identifies topes in che chapter thar will hare ‘Particular application to personal finance Each chapter opens with a short ‘vignette that describes 2 recent real-company event related to the ‘chapter topic. These stores raise incecest inthe chaprer by demon- rating its relevance in the busi- ness word, A critical thinking question at the end of each vignette encourages readers to give additional thought to the story and its application to the chapter topic, Learning goal icons, which appear next ro firse-level text headings, ‘se chapter content to the learning goals. Forkelp ia study and review, key terms are printed in boldface type, and theie efintions appear in the margin where they are frst introduced. These terms are also boldfaced in the book's index and appear in the end-of-book glossary. Apple, Inc. Examples are an important compo- nent of the book's learning syste. (Cleary se off from the text, they pro- vide an immediate and conctete demon- stration of how to apply financial ‘concepts, tools, and techniques. Examples in certain chaprers demon- sate time value of money techniques. ‘These exarnples show the use of time lines, financial calculators, spzeadsheets (vith cell formulas), and factor tables ‘New! Personal Finance Examples demonstrate how students can apply managerial nance concepts, tools, and techniques to their personal finan- ial decisions, Key equations ace prince in biue throughout the tex to hel readers identify the most izporean mathemat- ‘cal rlaonships. The variables sed jn these equations aze, for convenience priaed on che rome endpaper: of the book ‘Marginal hints add useful ideas, ‘comments, and pieces of infoemation +0 entich the rextdiseustion and boost student learning Review Questions appeas ar the end of each major text section. Taese ques tions challenge readers to stop and eest their understanding of key concepts, tools, cechniques, and practices before ‘moving on to the next section. In Practice boxes offer insights {nto imporcant topics in mansgesial Finance through the experiences of real companies, both lage and small. Thece are thee categories of In Practice boxes: Focus on Ethics boxes in every chapter help readers understand and appreciate important ethical issues ‘and problems related ro managerial nance. Focus on Practice boxes take a ‘corporate focus that relates a busi- ness event or situation to a specific financial concept or technique. Global Focus boxes look specif cally at the managerial finance expe- Fences of iternational companies. All three sypes of in Practice boxes lend with a critical sinking question to help ceaders broaden the lesson com the content ofthe box. Guideline answers to these questions can be found at the book's Companion Website “The end-of-chaprer Summary consists of two sections. The firs section, Focus fon Value, explains how the chapter's content relates to the firm's goal of ‘maximizing owner wealth. The feature halps reinforce understanding of the link berweea the financial manager's actions and share value ‘The second part ofthe Summary, the Review of Leaning Goals, reseass cach leacning goal and summarizes the key material chat was presented co suppost mastery of that goal ow ate“ nat Ecos Una eof marina ce 5 ‘Warm-Up Exercises Problems ———S s= Sora Self-Test Problems, keyed to the learning goals, give readers aa opporta- nity to strengthen their understanding cof topics by doing 2 sample problem. For reinforcement, solutions co the Self ‘Test Problems appear in Appendix B at the back of the book. ‘Warm-Up Exercises follow the Self: ‘Test Problems. These short, numerical ‘ccercists give students practice in applying tools and techniques presented in the chapter. A blus box indicates the Exercises and Problems available in MyFinancelab. Compechensive Problems, keyed to the lesrning goals, are longer and more ‘complex chan the Warm-Up Exercises, In this section, insractors wil find ‘multiple problems char addzess the important concepts, tools, and tech niques in the chaprec ‘New! Personal Finance Problems specifically relate to personal finance situations and examples in each chapter ‘These new problems will help students see how they can apply the toole and techniques of managerial finance in ‘managing their own Aaances, A short descriptor identifies the ersential concept or technique ofthe problem. Problems labeled as Integrative tie together related topics. Guideline answers to selected end-of-chapter problems appear in Appendix C. ‘The last item inthe chapter Problems is an Ethics Problem. The ethics problem. Bives students another opportunity to think about and apply ethics principles to managerial financial situations, Chapter Cases cal for application of concepts and techniques to a moze ‘complex, realistic situation chan inthe regular Problems. These cases help stcengthen practical application of financial tools and techniques. Every chapter includes a Spreadsheet Exercise. This exercise gives stadents an opportunity to use Excel® sofoware to create one or more spreadsheess with which to analyze a financial problem. ‘The spreadsheet to be ereated often is modeled on a table ia the chapter or a spreadsheet cemplate that can be viewed atthe book's Companion Website, Every chapter offers a Group Exercise in which snudents work together ia the ‘context of an ongoing company. Each group will create 2 company and follow iethrough the various managecial finance topics and business activities preseated in the textbook. Now available online at the book’s ‘Companion Website, a Web Exercise for every chapter links the chapter topic to arelated ste on the Internet and asks seadents to use information found there to answer questions. These exercises captace student incerese while showing sources of finance information online Aa Integrative Case at the end of tach pare of te book challenges stu- dents to use what they have learned lover the course of several chapters. — |] ‘Chapter 2. Cage eng hn cigs peter be Rett Group Exercise | =o ~ BEEF Gece Integrative Case 1 Tack Sof e Supt metres a Brief Contents Detailed Contents xiv Preface xa Revised Content edi Supplements to the Twelth Edition conii Acknowledgments x! To the Student i PART ONE Introduction to Managerial Finance 1 1 The Role and Environment of Managerial Finance 2 2 Financial Statements and Analysis 42 3 Cash Flow and Financial Planning 108 PARTTWO Important Financial Concepts 159 4 Time Value of Money 160 5 Riskand Return 225 6 Interest Rates and Bond Valuation 280 7 Stock Valuation 328 8 Capital Budgeting Cash Flows 378 Capital Budgeting Techniques 422 10 Risk and Refinements in Capital Budgeting 456 PARTFOUR Long-Term Financial Decisions 501 11 The Cost of Capital 502 12 Leverage and Capital Structure 544 13 Dividend Policy 598 PART FIVE Short-Term Financial Decisions 635, 14 Working Capital and Current Assets Management 636 15 Current Liabilities Management 680 PART SIX Special Topics in Managerial Finance 719 16 Hybrid and Derivative Securities 720 17 Mergers, L80s, Divestitures, ‘and Business Failure 760 18 International Managerial Finance 806 APPENDIXES A Financial Tables A-1 B Solutions to Self-Test Problems B-1 © Answers to Selected End-of-Chapter Problems C-1 Web Chapter: Financial Markets and Institutions (on the book’s Companion Website wweprenhall.com/gitman Glossary G1 Index 1 Contents - Preface x Revised Content xx Supplements to the Twelfth Edition soi Acknowledgments xt Tothe Student xi PartOne | Chapter 1 ‘The Role and Environment of Managerial Finance page 2 Sura Tate fo Cet pees Introduction to Managerial Finance 1 2.1 Finance and Bu What is Finance? 4 aor reas and Opportunies Legal Fours of Business ‘Organization 5 Why Study Managerial Finance? & Review Questions $ ss 4 1.2. The Managerial Finance Function 9 Organization of the Finance Function 10 Relationship to Economies 10 Relationship to Accounting 11 Primary Activities ofthe Financial Manager 15, Review Questions 13 1.3 Goalofthe Firm 13 Maximize Profit? 14 Maximize Shareholder Wealth 15, Corporate Governance 16 ‘The Role of Business Ethics 17 IBL2RACTICE Focus on Eis: Ehis at 19, The Agency Issue 19 Review Questions 21 1.4 Financial Institutions and Markets 22 Financial Institutions 22 Financial Markets 25 ‘The Relationship between Institutions and Markets 25 ‘The Money Market 25 ‘The Capital Market 24 ‘LERACTIE Foca on Prccr Berishre Mathanay-can Ble e Repiscd? 20 Review Questions 29 1S Business Taxes 29 Ordinary tncome 29 Capital Gains 31 Review Questions 32 Summary 32 SelfTest Problem 54 Warm-Up Exercises 34 Problems 35 ‘Chapter 1 Case: Assessing ‘the Goal of Sports Products, Ine. 38 Spreadsheet Exercise 39 Group Exercise 40 Web Exercise 41 Chapter 2 Financial Statements and Analysis page 42 ‘el neh Re Te cong pases 2.1 The Stockholders’ Report 44 ‘The Letter to Stockholders. 44 The Four Key Financial ‘Statements 44 [BS2RAGTIGE Focus on Stix: Backto SehoolonEtses as Notes to the Financial Statements 51 Consolidating International Financial Statements 52 ALERAGKICE Fonus on Practice: ie Tne Se Ghange Som 55 Review Questions 53 2.2. Using Financial Ratios 53 Interested Parties 54 Types of Ratio Comparisons 54 Cautions about Using Ratio Analysis 56 Categories of Financial Ratios. 57 Review Questions 57 23 Liquidity Ratios 58 Current Ratio 58 Quick (Acd-Test) Ratio 59 Review Question 59 24 Activity Ratios 59 Inventory Turnover 60 ‘Average Collecion Period 60 ‘Average Payment Period 61 “otal Asset Turnover 62 Review Question 62 28 Debt Ratios 62 Debt Ratio 64 Times Interest €amed Ratio 64 Fxed-Payment Coverage Ratio 65 Review Questions 65 (CONTENTS Pa 2.6 Profitability Ratios 6s Common-Sze Income statements 66 Gross Profi Margin 67 Operating Proft Margin. 67 Net Prof Margin 67 Eamings per Share (EPS) 68 Return on Total Assets (ROA). 63 Retum on Comman Equity (OE) 69 Review Questions 69 2.7 Market Ratios 69 Price/Eamings (P/E) Ratio. 69 Matket/Book (M/B) Rao. 70 Review Queston 71 28 A Complete Ratio ‘Analysis. 71 Surmaviing Al Ratios 71 DuPont System of Analisis 75 Review Questions 77 Summay 73 Seles Problems 79 Warm-Up Exercises 80 Problems 81 Chapter 2 Cas: Assessing Martin Manufacturing’ Current Financial Position 96 Spreadsheet Exercise 100 Group Exercise 102 Web Exercise 105 xi CONTENTS Chapter 3 Cash Flow and Financial Planning page 104 3.4 Analyzing the Firm's Cask Fiow 106 Depreiation 106 Developing the Statement of Cech ows 108 Operating Cash How 122 Free CoshFlow 115, Iursacrcs foo on Pace: Aedetmew stay Te Review Questons 117 3.2 The Financial Planning Process 117 Longs (Sategi) Financial Plane 117 L2aAGEce ons on Bi: How Much ESS Won is ‘Short-Term (Operating) Financial Plan 118 Review Questions 120 3.3 Cash Planning: Cash Budgets 120 ‘The Sales Forecast 120 Preparing the Cash Budget 121 Evaluating the Cash Budget 125 Coping with Uncertainty inthe Cash Budget 127 Cash Flow within the Month 128 Review Questions 128 3.4 Profit Planning: Pro Forma Statements 128 Preceding Year's Financial ‘Statements 129 Sales Forecast 129 Review Question 129 3.5 Preparing the Fro Forma Income Statement 130 Considering Types of Costs ‘and Expenses. 131 Review Questions 132 3.6 Preparing the Pro Forma Balance Sheet 132 Review Questions 134 3.7 Evaluation of Pro Forma Statements 134 Review Questions 135 Summary 135 Self-Test Problems 137 Warm-Up Exercises 139 Problems 139 ‘Chapter 3 Case: Preparing Marin Manufacturing’ 2010 Fro Forma Financial Statements 150 Spreadsheet Exerise 151 Group Exercise 153 Web Exercise 153, Integrative Cese 1: Track Softwar ine 154 ‘conTENTS Part Two . | Chapter 4 Time Value of Money ‘Band Congany-ig weFaice page 11 Important Financial Concepts 159 4.1 The Role of time Value in Finance 162 Future Value versus Present Value 162 ‘Computational Tools 163 Basic Paterns of Cash Flow 165 Review Questions 165 4.2 SingleAmounts 166 Future Value of a Single ‘Amount 166 Present Value ofa Single ‘Amount 170 Comparing Present Value and Future Value 172 Review Questions 173 43° Annuities 173 Types of Annuities 174 Finding the Future Value ‘of an Ordinary Annuity 175 Finding the Present Value ‘of an Ordinary Annuity 176 Finding the Future Value ‘of an Annuity Due 178 Finding the Present Value of en Annuity Due 180 Finding the Present Value ofa Perpetuty 187 Review Questions 182 44 Mixed Steams 182 Future Value of a Mixed Stream 182 Present Value of a Mixed Stream 164 Review Question 185, 45° Compounding Interest ‘More Frequently Than Annually. 186 Semiannval Compounding 165, Quartery Compounding 186 ‘A General Equation for ‘Compounding More Frequently Then Annually 167 Using Computational Tools fet Compounding Move Frequently Than Annually 189 Continuous Compounding 190 Nominal and Effective “Annual Rates of Interest 191 RLPRACTICE Foes. on his: Hew fr {Sheek ine Cast? 192 Review Questions 193 4.6 Special Applications ofTime Value 193 Determining Deposits Needed to Accumulate a Future Sum 195 Loan Amortization 194 Finding interest or Growth Rates. 196 BUBRAGKICE Focus on Practice: ‘ew Century Brgs Taube for Subprime Moreages 157 Finding an Unknown Number ‘of Periods. 199 Review Questions 201 ‘Summary 201 Self-Test Problems 204 Warm-Up Exercises 205 Problems 206 CChopter 4 Case: Finding sil Moran's Retirement Annuity 222 Spreadsheet Exercise 222 Group Exercise 223 Web Exercise 225 vill ‘CONTENTS Chapter 5 Risk and Retum, page 228 secret You :. we Cling Sivsnscnu te ire peg? Chapter 6 Interest Rates and Bond Valuation page 280 5.1 RiskendRetum Fundamentals 228 Risk Defined 228 Return Defined 228 IRLERAGHICE Foes on Eis: What about fowl Rsk) 250 Risk Preferences 232 Review Questions 233, 5.2 Risk of a Single Asset 233 Risk Assessment 253 Risk Measurement 235, Review Questions 240 5.3 Riskofa Portfolio 241 Portfolio Return and Standard Deviation 241 Conelation 242 Diversification 243 Conelation, Diversification, Risk, ‘and Return 244 Intemational Diversification 247 5.1 Interest Rates and Required Returns 282 Interest Rate Fundamentals. 282 REERAGTICE Foaus on Praca: Bonds ‘absttoriision 235 Term Stucture of interest Rates 285, Risk Premiums: Issuer and Issue Characteristics 289 Review Questions 291 6.2 Corporate Bonds 291 Legal Aspects of Corporate Bonds 291 Cost of Bonds tothe Issuer 292 General Festures of a Bond ‘sue 295 Bond Yields 294 Bond Prices 254 Bond Ratings 295 LERACICE Foose on Bis Cn We ram the Bond Rate? 296 [RLERACTIGE Clobal Focus: An ntomatons Brorto Rak Reducion 248 Review Questions 248, 5.4 Risk and Retum: ‘The Capital Asset Pricing Model (CAPM) 249 Types of Risk 249 ‘The Model: CAPM 250 Review Questions 259 Summary 260 Self-Test Problems 262 Warm-Up Exercises 263 Problems 264 ‘Chapter 5 Case: Analyzing Risk and ‘Return on Chargers Products Investments 275 Spreadsheet Exercise 277 Group Exercise 277 Web Exercise 279 Popular Types of Bonds 296 Intemational Bond issues 297 Review Questions 298 6.3 Valuation Fundamentals 299 ey Inputs 299 Basic Valuation Model 300 Review Questions 501 6.4 Bond Valuation 301 Bond Fundamentals 302 Basic Bond Valuation 302 Bond Value Behavior 304 Yield to Maturity (YIM) 307 Semiannual Interest ‘and Bond Values 509 Review Questions 317 Summary 311 SelfTest Problems 314 Chapter 7 Stock Valuation Warm-Up Exercises 314 Problems 316 Chapter 6 Case: Evaluating Annie Hegg’s Proposed investment Aller Industies Bonds "324 7.1 Differences between Debt and Equity Capital 330, ‘Voice in Management 550 Gaaims on Income and Assets 350 Maturity 331 Tox Treatment 331 Review Question 351 72 Common and Preferred Stock 331 Common Steck 351 Preferred Stock 335 Issuing Common Stock 356 Interpreting Stock Quotations 341 Review Questions 342 7.3 Common Stock Valuation 342 Market Efficiency 342 Basic Common Stock Valuation Equation 345 RSPRACTIGE Foaus on Prseet UUncerstancing Hurran Bahavior Helps Us Undentan imesor Beaver 36 Free Cash Fiow Valuation ‘Model 351 Other Approaches to Common ‘Stock Valuation 354 ‘CONTENTS Spreadsheet Exercise 325 Group Exercise 326 Web Brerdse 327 [gLeaacrioe Focus o Bhi: stove ou Heard ry Good Quarterly Eanes Forecast atch 398 Review Questions 357 7A Decision Making and Common, Stock Value 357 CChangesin Expected Return 358 Changes in Risk 358 Combined Etfect 359 Review Questions 359 Summary 359 Self-Test Problems 363 Warm-Up Exercises 365 Problems 364 (Chapter 7 Case: Assessing the Impact of Suarez Manufacturing’s Proposed Risky Investment on Its ‘Stock Value 371 Spreadsheet Exercise 372 Group Exercise 373 Web Exercise 375 Integrative Case 2: Encore international 374 xx ‘CONTENTS Part Three | Chapter 8 Capital Budgeting Cash Flows page 378 Enontshi-triring Piet page ss Long-Term Investment Decisions 377 8.1 Capital Budgeting Decision Process 380 ‘Motives for Capital Expenditure 380 ‘Steps in the Process 380, Basic Terminology 382 Review Questions 384 8.2 Relevant Cash Flows 384 ‘Major Cash Flow Components 384 Expansion versus Replacement Decisions 384 WUPRAGTCE Foaus on Bhics ‘AQueston ese 305 Sunk Costs and Opportunity Costs 386 International Capital Budgeting ‘and Long-Term Investments 387 Review Questions 387 LnLexacrice GlbalFecs: changes Nay inuence Future Ivesonens fn China 388 8.3 Finding the Initial Investment 383 Installed Cost of New Asset 369 After Tax Proceeds from Sale ‘of Old Asset 369 ‘Change in Net Working Capital 392 Calculating the Initial Investment 395 Review Questions 394 84 Finding the Operating Cash Inflows 394 Interpeting the Term Aiter-Tox 384 Interpreting the Term Cash Inflows 395 Interpreting the Term Incremental 398 Review Questions 399 8.5 Finding the Terminal Cash Flow 399 Proceeds ftom Sale of Assets 399 Taxes on Sale of Assets 399 CChange in Net Working Capital 400 Review Question 401 8.6 Summarizing the Relevant Cash Flows 401, Review Question 403 Summary 405 Self-Test Problems 404 Warm-Up Exercises 405, Problems 408, Chapter 8 Case: Developing Relevant ‘Cash Flows for Clark Upholstery ‘Company's Machine Renewal or Replacement Decision 417 Spreadsheet Exerdse 419 Group Exercise 420 Web Exercise 421 Chapter 9 Capital Budgeting Techniques page 422 pig re—The Pane levees peo Chapter 10 Risk and Refinements in Capital Budgeting page 456 9.4 Overview of Gapital Budgeting ‘Techniques 424 ‘Bennet Company's Relevent Cash Fows 426 Review Question 425 9.2 Payback Period 425 Decision Criteria 425 Pros and Cons of Payback Periods 426 ‘RLEBACTICE Fors on Practce: UUs on Payback Anal 7 Review Questions 429 93 Net Present Value (ev) 429 Decision Criteria 450 Review Questions 431 9.4 Internal Rate of Retum GRR) 431 Decision Criteria 452 Caleulating the IRR 432 Review Questions 434 410.1 Introduction to ick in Capital Budgeting 458 Review Question 458 40.2 Behavioral Approaches for Dealing with Risk 459 Risk and Cash inflows 459 Scenario Analysis 461 Simulation 462 [BLERACTGE Focus on Practice: The Monte Caro tethod: The Freesat for Le Uncen 85 Review Questions 463, 10.3 International Risk Considerations 464 Review Question 465, ‘contents xxi 9.5 Comparing NPV and IRR Techniques 434 Net Present Value Profiles 435 Conflicting Rankings 435 Which Approach Is Better? 438 (QLeRAGTICE Focus on Ehes: Nonna Consderation in Projed selection 0 Review Questions 440 Summary 441 Self-Test Problem 443 WermUp Exercises 443 Problems 444 Chapter 9 Case: Making Norwich ‘To's Lathe Investment Decision 455 Spreadsheet Exerise 454 Group Exercise 455 Web Brerise 455, 10.4 Risk-Adjusted Discount Rates 465 Determining Risk-Adjusted Discount Rates (RADRs) 465 [RLPRAGTICE Foous on Ees: Erironartal Comparex: Honesty Sthe soa Poly 208 Apphing RADRS. 463 Portfolio ees 470 RADRSin Practice 472 Review Questions 475 4105 Capital Budgeting Refinements 473 Comparing Projects with Unequal tes 475 Recognising Real Options 477 ‘capital Rationing 479 Review Questions 482 CONTENTS. Summary 482 SelfTest Problem 484 Warm-Up Exercses 488 Problems 486 Chapter 10 Case: Evaluating Cherone Equipments Risky Plans for Increasing Its Production apacty 495 Spreadsheet Exercise 497 Group Brercise 498 Web Brerise 498 Integrative Case 3: Lasting ‘Impressions Company 499 Part Four | Chapter 11 ‘The Gost of Capital page 502 ‘Used ies Faing OF Asin ape ss Long-Term Financial Decisions 501 11.1 Overview of the Cost of Capital 504 Some Kay Assumptions 504 The Basic Concept 504 BCPRAGTICE Focus on tics: “he Rabestos Penal 505. Specific Sources of Capital 506 Review Questions S07 LL2 Cost of Long-Term. Debt 507 Net Proceeds 507 BeforeTax Cost of Debt 508 ‘Aftor-Tax Cost of Debt 510 Review Questions 511 113 Cost of Preferred Stock 511 Preferred Stock Dividends 511 Caleulating the Cost of Preferred Stock 511 Review Question 512 14 Cost of Common Stock 512 Finding the Cost of Common Stock Equity 512 Cost of Retained Eamings 515 Cost of New Issues of ‘Common Stock $15 Review Questions 517 1A.S Weighted Average Gost of Cepital ‘517 Calelating Weighted Average Cost ‘of Capital (ACC) 517 Weighting Schemes. 518 Review Questions 520 11.6 Marginal Cost and Investment Decisions 520 Weighted Marginal Cost ‘of Capital WMC) 520 RERRAGTICE Focus on Praie: Bide Creation “Sa Investment Opporturities Schedule 05) 524 Using the WMICC and 105 to ‘Make Fnancing/investment Decisions 524 Review Questions 526 ‘Summary 526 Self Test Problem 528 Chapter 12 Leverage and Capital Structure page 544 Warm-Up Exercises. 530 Problems 530 (Chapter 11 Case: Making Star Products Financing/lavestment Decision 539 12.1 Leverage 545 Breakeven Analysis 547 Operating Leverage 550 IRLzRAcTIcz Focus on Pacien Aécbes Lerenge 555 Financial Leverage 554 Total Leverage 557 ALERACTICE focus on hist ‘The Buyout Binge 560, Review Questions $60 12.2 The Firm’s Capital Structure 561 “Types of Capital 561 External Assessment of Capital Structure 562 Capital Stucture of Non-US. Firms 563 Capital Stucture Theory 564 ‘Optimal Capital Structure 572 Review Questions 574 12.3 EBIT-EPS Approach to Capital Structure 574 resenting a Financing Pian Graphically 575 Comparing altemative Capital ‘Souctures. 575 CONTENTS oii Spreadsheet Exercise 541 Group Exercise 542 Web Exercise 543 Considering Rsk in EBIT-EPS ‘Analysis 577 Basic Shortcoming of EBIT-EPS ‘Analysis 977 Review Question 577 12.4 Choosing the Optimal Capital Structure 578 Linkage 578 Estimetiig Value 578 Maximizing Value versus Maximizing EPS 579 Some Other Important Considerations 580 Review Questions. 580 Summary 581 Self-Test Problems 583 Warm-Up Exercises 584 Problems 585 (Chapter 12 Case: Evaluating ‘Tampa Manfacturng’s Capital Structure 595 Spreadsheet Exercise 596 Group Exercise $97 Web Exercise 597 xxiv CONTENTS Chapter 13 Dividend Policy page 598 aoa Caponion— Ghirgaeea be Suehedes pape 39 13.1 Dividend A Fundamentals 600 Cash Dividend Payment Procedures 600 Tax Teatment of Dividends 602 [RLRRAGHIGE Focus on Pace: apa aint and Oxtcend ae eaere Exended 2010" 602 Dividend Reinvestment Plens 605 Review Questions 603 13.2 Relevance of Dividend Policy 603, Residual Theory of Dividends 608 Arguments for Dividend Inelevance 606 Acguments for Dividend Relevance 607 Review Questions 607 13.3 Factors Affecting Dividend Policy” 607 Legal Constraints 608 Contractual Constraints 609 Intemal Constraints 609 Growth Prospects 609 (Owner Considerations 608 Market Considerations 610 Review Question 610 13.44 ‘Types of Dividend Policies 612 Constant-Payout-Rato Dividend Policy 611 Regular Dividend Policy 611 Low Regular-and-Edra Dividend Policy 612 Review Question 613 135 Other Forms of Dividends 613, Stock Dividends 615 Stock Spits 615 ‘Stock Repurchases 616 RLPRECTICE Focus on Bis Fee Buybacks Realy Bargain? 618 Review Questions 619 Summary 619 SelfTest Problems 62t Warm-Up Exercises 621 Problems 622 Chapter 13 Case: Establishing ‘General Access Company's Dividend Policy and inital Dividend 623 Spreadsheet Exercise 630 Group Brercise 631 Web Exercise 631 Integrative Case 4: O'Grady Apparel Company 632 ‘CONTENTS sow Part Five Chapter 14 Working Capital and Current Assets Management page 636 mrerounoucege recone nee Short-Term Financial Decisions 635 14.1 Net Working Capital Fundamentals 638 Short-Term Financial Management 638 Net Working Capital 638 ‘The Tradeoff between Profitability ‘and Risk 639) Review Questions 640 142 Cash Conversion Cycle 642 Calculating the Cash Conversion Cycle 641 Funding Requirements of the Cash Conversion Cycle 642 ‘Strategies for Managing the Cash Conversion Cycle 645. Review Questions 645 143 Inventory Management 645 Differing Viewpoints about laventory Level 645 Common Techniques for Managing Inventory 686 ‘aLeRacice Fees on race: RAD: The ave of ie Fuse 63) Intemational ventory ‘anagement 651 Review Questions 652 144 Accounts Receivable Management 652 Credit Selecion and Standards 652 Credit Terms 657 Credit Monitoring 659 Review Questions 661 145 Management of Receipts and Disbursements 661 Float 852 ‘Speeding Up Collections 662 Slowing Down Payments 663 ‘Cash Concentration 663 [RLBRACTICE Fons on Eki: Suetehing ‘ecounts Payables» Good Posey” 65% ero-Balance Accounts 665 Investing in Marketable ‘Securities 665 Review Questions 668 Summary 668 SelfTest Problems. 670 Warm-Up Exercises 671 Problems 671 (Chapter 14 Case: Assessing Roche Publishing Company's Cash ‘Management Eficency 677 Spreadsheet Exercise 678 Group Exercise 679 Web Bxerise 679 seo ‘CONTENTS Chapter 15 Current Liabilities Management page 680 eel Soiree Canes Cote Reaseng sur Pople pene ages) 15.1 Spontaneous Liabilities 682 ‘Accounts Payable Management 682 Accruals 686 Review Questions 687 15.2 Unsecured Sources of Short-Term Loans 687 Bank Loans 687 [BLEBACIIGE Focus on Ethics: ean ood eee Commercial Paper 693 RUBRACHICE Foais on Pract Commerc sper Beam t Conte ser Depressed Stato the Deeds 694 Intemational Loans 695, Review Questions 696 15.3 Secured Sources of Short-Term Loans 697 Characteristics of Secured Short-Term Loans 697 Use of Accounts Receivable Collateral 698 Use of Inventory ‘35 Collateral 700 Review Questions 702 Summary 702 SelfTest Problem 706 WemmUp Exercises. 705 Problems 707 (Chapter 15 Case: Selecting Kanton ‘Company's Financing Stategy and Unsecured Short-Term Borrowing Arrangement 713 Spreadsheet Exerise 716 Group Exercise 715 Web Beercise 715 Integrative Case 5: Casa deDiseno 716 CONTENTS xxvii Part Six | Special Topics in Managerial Finance 719 Chapter 16 16.1. Overview of Hybrids Value of warrants 740 Hybrid and and Derivatives 722 Review Questions 742 Derivative Review Question 722 : Securities : 16.5 Options 742 page 720 16.2 Leasing 722 Calls ond Puts 742 Types of Leases 722 Options Markets 748, Leasing Arangements 725 Options Wading 743, Lease-versus-Purchase Decision 724 Role of Call and Put Options IBzRACHIc focus on Pcie: Lees in Fund Raising 74, {Arline End on SourNote 3 Hedging Foreign-Curtency Bifects of Leasing on Future Exposures with Options 744 Financing 729 IRLBRAGRICE Focus on Bice Advantages and Disadvantages Spins Backstrg 735 ofleasing 730 Review Questions 746 Review Questions 750 Summary 746 Srurtmronesttnse 16:3 Convertible Selftest Problems 748 ae Securities 731 Wiarm-Up Exercises 749 Types of Convertible Secures 751 Problems 750 General Features i Cf converbs. 752 Chapa 8 Cae Fring Rai fencing ith Conese, 735 Sore par aes Determining the Value : ‘ofa Comertble Bond 735 ‘Spreadsheet Exercise 758 Review Questions 757 Group Exercise 758 Exestise 759 164 Stock Purchase _ Warrants 737 Key Characteristics 738 Implied Price of an Attached Warrant 739 sow ‘conTeNTS Chapter 17 Mergers, BOs, Divestitures, and Business Failure age 760 3 Merger iar Fundamentals 762 Teeminology. 762 Motives for Meging_764 Typer of Merges 766 Review Questons 787 47.2 LBOs and Divestitures 767 Leveraged Buyouts (L805). 767 Divesttures. 768 Review Questions 770 17.3 Analyzing and Negotiating Mergers 770 Valuing the Target Company 770 ‘Stock Swap Transactions 772 Merger Negotiation Process 778 Holding Companies 780 Intemational Mergers 762 Review Questions 783 LERAGIIGE clobal Fox Inceraional merges 788 174 Business Failure Fundamentals 784 Types of Business Failure 724 Major Causes of Business Filure 735 Voluntary Settlements 786 Review Questions 787 17.8 Reorganization and Liquidation in Bankruptcy 787 Bankruptcy Legislation 787 REBEAGRICE Foeus on Bes st (Uhl to Desare Snkrupey? "788 Reorganization in Bankruptcy (Chapter 11). 766 Lquidation in Bankruptey (Chapter?) 790 Review Questions 792 Summary 792 SelfTest Problems 794 WormUp Exercises 735 Problems 736 (Chapter 17 Case: Deciding Whether ‘to Acquire or Liguidate Procras, Corporation 802 Spreadsheet Exerise 804 Group Exercise 805 Web Exercise 805 Chapter 18 International ‘Managerial Finance page 806 Appendixes 18.1 The Multinational Company and its Environment 308 Key Trading Blocs 808 GATT andthe WTO. 810 Legal Forms of Business ‘Organization 810, Financial Markets 15 RCESACTICE Foaus on his Cadkng ‘Bown on aber for Business Review Questions 815 18.2 Financial Statements $15 Subsidiary Characterization ‘and Functional Currency 15 ‘Tanslation of individual ‘Accounts 816 Review Question 817 18.3 Risk 817 Exchange Rate Risks 817 Political Risks 822 Review Questions 824 18.4 Long-Term Investment and Financing Decisions 824 Direct investment 824 Investment Cash Flows ‘and Decisions 625 ‘A. Financial Tables AT B Solutions to Settest Problems- 8-1 C Answers to Selected End-of-Chapter Problems C1 ‘conrents xix Capital Stucture 826 LongTeim Debt 627 |RL2LAGTIGE Global Foevs Take an Sreseos Assignment Take 9 Step Up hecomportelaader £28 Equity Capital 628 Review Questions 830 18.5 Short-Term Financial Decisions 831 Cash Management @32 Credit and inventory Manegement 835 Review: Questions 836 18.6 Mergers and Joint Ventures #35 Review Question 837 Summary 858 Self-Test Problem 840, Warm-Up Exercises 840 Problems 841 Chapter 18 Case: Assessing a Direct Investment in Chile by US. Computer Corporation 843 Spreadsheet Exerise 844 Group Exercise 845 Web Brerise 845 Integrative Case 6: Organic ‘Solutions 846 ‘Web Chapter: Financial Markets and Insttutions ‘on the book's Companion Website vwerwprenhall.com/gitman Glossary G1 Index 1 Preface Tits to iti tne of Manacaril Finance cae ut of my experience teaching the introductory managerial finance course ealy in my cazeexLvras ‘ot very far removed from my own undergraduate studies and therefore could appreciate the difficulties some of my students were having with the textbook we used. They wanted a book that spoke to them in plain English, They wanted a book that tied concepts co reality. And they wanted not just description, but demonstration of concepts, tools, and techaiques. Recogaizing that, I deeded co ‘write an introductory finance text that would effectively resolve these concerns. Courses and students have changed since that initial book, but the goals of the text have not changed. The conversational tone and wide use of examples set off in the text stil characterize Principles of Managerial Finance. Building on ‘hose strengths, over 11 editions, numerous translations, and well ove half amil= lioa US. users, P've continued ro listen carefully to feedback froma both insteuc- tors and students, from adopters, nonadopters, and practitioners, ‘The Twelfth Edition Like the first edition, the twelfth edition sil uses plain English, tes concepts to reality, and demonstrates concepts, cools, and techniques. It incomporates a proven learning system, which integrates pedagogy with concepts and practical applications. Ir concentrates on the knowledge chat is needed to make keea finan- cial decisions in an increasingly competitive business environment. The strong pedagogy and generous use of exaples—including, new in this edition, personal finance examples—make the text an easily accessible resource for long-distance learning, online courses, and self-study programs. Tae book also has been well received in the core MBA course and in management developmeat and executive teaining programs. Organization ‘The texts organization, described in detail in dhe fllowing pages, conceptually links the fire's actions and its value as detecmined i the securities market. Each aajor decison area is preseaed in tems of both isle and rerum factors and theit potential impact on owes’ wealth. A Focts on Value clement atthe end ofeach chaps belps reinforce the seadene’s understanding ofthe lnk between the nan ial manager's serions and the Em's share value Is organizing each chaptes, I have adhered fo & managerial decision-making perspective, relating decisions tothe firm's overall goal of wealth maximization, Once a particular concepé has been developed, is application is ustated by an ‘example—a hallmark fearure of this book. Thete examples demonstace, and solidify inthe tudeot’s thought, financial decision-making considerations and their consequences. As described next, this edition expands this feature withthe addition of examples related wo personal france. PREFACE International Considerations “We live in a world where international considerations cannot be divorced from the study of business in general and finance in parscular. Asin prior editions, dis cussions of international dimensions of chapter tapies ace integrated throughout the book. A marginal icon of a globe highlighes chese discussions, and intecna- tional material is integrated into learning goals and ond-of-chapeer materials. Ja ‘addicio, for those who want to spend more rime addressing the topic, a separate ‘chapter On intemational managerial finance concludes the book. Personal Finance Linkages ‘The twelfth edicion has responded ro reviewers’ requests for more personal finance linkages and to calls for educacors o help improve the financial literacy of young people. Arche searrof each chaptes, the feature titled Why This Chapter Matters to You helps motivate srudent interest by discussing how the topic ofthe chapter relates to the concerns of other major business disciplines and ta personal finance ‘Within the chapter, Personal Finance Examples explicit link the concepts, tools, and techniques of each chapter to personal finance applications. Inthe homework acetal, che book has more chan 75 personal finance problems. The purpose of ‘hese personal finance materials isto demonstrate to students the usefulness of ‘managerial finance knowledge in both business and personal financial dealings. Ethical Issues ‘The need for ethics in business remains as important as ever. Sradents need to understand the ethical issues that financial managers face as they attempt to max. imize shareholder value and co solve busiaess problems. Thus, every chapter includes an In Practice box that focuses on ethical issues. Half of these ethics boxes are new inthis edition, and those that are aot new have been updated, Homework Opportunities Of course, practice is essential for students learning of managerial finance con- ‘cepts, tools, and techniques, To meet that seed, the book offers a rich and varied send of homework assignmencs: short, aumerical Warm-Up Exercises; a com- prebensve se of Problems, inclading more thar one problem for each important concept of technique and now also including personal finance problems; an Ethics Problem for each ehaprer; a Chapter Case; a Spreadsheet Exercises a ‘Group Exercise; an online Web Exercise; and atthe end of each part of che book, ‘an Integrative Case In addition, most ofthe end-of-chapter problems are aval. able in algorichmie form in ‘These materials (see pages xi chroagh xit for detailed descriptions) offer students solid earning opportunites, and eh ‘offer instructors opportunities 9 expand and ensich the classroom environment. From classroom to boardroom, the cwelfth edition of Principles of Managerial Finance can help users get to where they want to be. I believe that tis the best edi- sion yermore relevant, more accurate, and more efecrive than ever. hope you agree that Principles of Managerial Finence, Tweli Edition, isthe most effective introductory eianageral finance text for your suudents. Lawrence J. Gitman La Jolla, California Chapter 1 Chapter 2 Chapter 3 Revised Content AAs we made plans to publish the twelfth edition, we carefully assessed market feedback about content changes that would berter meet che needs of instructors teaching the course. ‘The chapter sequence remains the same as in the prior edition, Although the text content is sequential, instructors can assign almost any chaprer asa selé in your ordee Explain why tps could be viewed as similar o stcek options and why the delays and incorrect orders could cepresents case of agency costs. If tpt are gone forever, bow could Doaur Shop reduce these agency cost? [EEE Rescon, Inc., has asked your corporation, Pruro, Inc., for financial assistance. BS rpc rte ete sce eee dec ee ae eee ae aodsrncse erga gre ens od eR AS RED Problems atiuebox (a indicates problems available in ELE], Development Company. The firm has recency declared baakruprey and bss $60,000 in unpaid deb, Explain the narare of payments, if any, by Ms, Hagpec ia cach of the following situations. 4. Southwes: Development Company isa sole proprietorship owned by Ms. Harper b. Southwest Development Company isa 50-50 parmership of Ms. Harper ‘and Christopher Black. Southwest Development Company ie corporation g Piet Liability comparisons Merideth Harper has invested $25,000 in Southorest PARTONE Introduction to Managerial Finance Macgialcost-benei analysis an the goal ofthe frm Ken Alen, capital buds sing nals fr Bally Gear Inc bas been asked 0 erluns a propor The a2- sur ofthe aucomodiecvioabaces that replacing te oboucs ured onthe heavy rack gear ine wl prodace al benefits of $560,000 (nada lla) cove the nex 5 year, The exiting eobotios woul produce ene of $400,000 {ao in today’ dels) ovr tar sme ine periods An inal cask investment of $220,000 would be eqicd to insal the new equipment. The manage enizates that the etng robo canbe sold for $70,000, Show how Ken wl apply marginal cos-boreft analysis ecrigues 0 deeemine the flowing 2 The marian (add) bent ofthe proposed neve robods. The marginal faces) com ofthe propane ne robots Tae et beets of he proposed new robo. a |, What should Ken Allen recommend ther the company do? Why? ‘What factors besides the costs and benefits should be considered before the finsl decision i made? textbooks ro college and gniversyy bookstores. The books aze shipped with a prov ‘iso tha chey mutt be paid for within 30 days but xa be returned for fll refund ‘rede within 90 days, In 2009, Thomas shipped and billed book ttle toraling '$760,000. Collections, act of rerun cedis, during the yar totaled $690,000. ‘The company spent $300,000 acquiring the books that it shipped ‘a. Using acerval accounting aad the preceding values, how the fim’ ne profit for the past yeor Using cash accounting and the preceding values, show the fiem’s net cashflow for the past year ‘¢. Which of hese satement is more useful tothe financial manager? Why? 5 [EEEEY crus income ven cath Now for a pevod Thomas Book Sales, lnc, supplies Faso as Pow EEE Cash ows Icisrypical for Jane wo plan, moniror and assess her financial position sing ash flows over a given period, typically a month. Jane has a savings account, sand hee bank loans money at 6% per yeae while it offers shorv-term investcent ras of 5%, Jane's cash flows during August were as follows: fie nero ced ising ot Groeret Slacy 4500 ‘Ao payer 85 lies 280 Morse 1200 ae ‘ma Decermide Jue’ cota cas inflows and cash outflows. Decermine the net cashflow forthe month of August. If there isa shortage, what are 2 few options open to Jane? If chere isa surplus, what would be a pradent strategy for her to follow? pee CHAPTER 1 The Role and Environment of Managerial Finance 37 PI-S_ Identifying agency problems, costs and resolutions Explain why each ofthe follow ing siuationsis an agency problem and what costs to the firm migat esut omit. Sagges how the problem might be dealt wih shor of firing the individual(s) involved. ‘a The ironc desk reeeptonis routinely cakes an extra 20 minates of lanch to run personal ercnds, ', Division managers are padding cost extimate so as to show short-term efficiency gains when the costs come ia lower chan the extimates, «The fcm’s chit executive officer has secret talks with 2 competitor about the por- sSibiliy ofa merger in which (s)he would become the CEO ofthe combined fms. 4. A branch manager lays off experienced full-time employees and stafs curtomiee secvice positions with part-time or cemporary workers to lowec employment ‘costs and raise this year's branch profi. Tae manager’ bons is based on prof inal. P16 Corporate taxes Tantor Supply, loc, is small corporation acting asthe exclusive Aiscibutor of 2 major lin of sporting goods. During 2009 the firm eared $82,500 before taxes. 4. Calculate the firm's ex bile using the corporate tax rae schedule gvea in Table 1.4. », How much are Tantoe Supply's 2008 aftercax earnings? ‘e What asthe firm's average tae rate, based on yout findings in perc a? 44. Whats the firm's marginal tax rate, based on your findings in part a? Average corporate tax rates Using the corporate tax rate schedule given in Bere ee ee MEI a Bele rene cere ee EEEY Marginal corporate eaxeats Using the corporate ax rate scedale ive in Table 14, perform the following: 4 Fld che marginal wc we forthe folowing levels of conporteeamings before tsxe: $15,000; $60,005 $90,000; $200,000; $400,000; $1 milion nd 820 milion. Poche marginal tx rates ewatured onthe y ais) agains the pretax income levels (measured on the = ais). Explain the relaonship between these variables. TEE] tnceest versus dividend income Dang the yeas us ended, Sbtig Dieibtors Jac, bad pretax earings om operations of $490,000, In adton, daring he yeaz ic received $20,000 ia income from incest on bons i eld in Zig Maatlacrsing and recived $20,000 in income fom dividends on its 5% common stock balding in “Tank Indusies, Tac. Shoring is inthe 40% tax racer andi eligible fora 70% div idend exelsion on is Tank Industrie sock 2 Calculate the Sra’ axon is opecatng earings on bs. Find the eax andthe afeseax amount atibutable co the inteest income fom Zig Manafacrusng boods. Find the eax andthe afertax amount arubutable ro the dividend income from ‘he Tank Industries, ne, common sock. 38 PART ONE Introduction to Managerial nance 4. Compare, contrast, and discuss the aftertax amounts cesulting from the intecest income ard dividend income calculated in pars b and c. Wharf the fm’ oral ax ability forthe year? fonerese and eaxe 1 be $40,000 for this period. Assuming an ordinary ax rae of 40%, compare the firm’ earings afer taxes and eamings available for common stockholders (earnings after taxes and prefered stock dividends, if any) under the following conditions ‘a. The firm pays $10,000 in interest. bb. The frm pays $10,000 in prefered stock dividends. 3 TEBE sncerse versus dividend expease Michaels Corporation expects earings before OED epic gis aces Perkine Mancfcrsing i cosering he sl of vo nondete Cheats Xan Yes X sprue or 32000 wl soley or nso kar ¥ was pce 330000 wl be sl toy for 835900. Tae Ermitabjen tos 0% ex rteon copa pis Gada he anos of cpl uy ap eaced on ec of & Cinise utanone sof ase (Capital gains taxes. The following rable conains purchase ad sale prices forthe % noadeptecable capital asses of « major coeporation The frm paid taxes of 40% on «apical gains, ‘A £3,000 3 p00 e200 D> 4x00 B. 16500 a Determine che amouat of capital gain realized on each ofthe five asses i. Calculate the amount of tax paid on each ofthe assess, PI-13. ETHICS PROBLEM What docs it mean to say chat managers should maximize shareholder wealth “subjec o ethical constraints"? What ethical considerations ‘ght enter inra decisions thar eesult in cashflow and stock price effect chat ae less ‘haa they might otherwise have been? |e te a eR A SE Chapter 1 Case Assessing the Goal of Sports Products, Inc. “Loren Seguara and Dale Johnson both work foe Sports Feeds, Inc. & mor pro- ducer of boating equipment and aceessories. Loren works as clerical assistant inthe ‘Accounting Department, and Dale works 25 packager inthe Shipping Department. ‘CHAPTER 1. The Role and Environment of Managerial Finance 39 During their lunch break one day, they begaa talking abour the company. Dale com plsined cha he bad always worked hard trying not to waste packing materials and efficiently and cost-effectively performing his job. In spite of his efores and those of his co-workers in the department, the fem's stock price had declined nearly $2 pee share over che past 9 months. Loven indicated that she shared Dale’ fusteaton, par- ‘icoacly because che ficm's profits ad been rising. Nether could understand wiay the firm's stock peice was falling a profs rose ‘Locen indicated that she had seen documents desexibing the fa'sprof-sharing plan wader which all managers were parally compensated on the basis of the firm's profits. Ske suggested chat maybe ic was profit that was important to management, because i dizectly affected their pay: Dale said, “That doesn't make sense, because the stockholders own the firm. Shouldn't management do whacs best for stock: holders? Something's wrong!” Loren responded, “Well, maybe chat explains why the ‘company hasn't concerned itself with the stock price. Look, the only profits chat stockholders receive are in che form of cath dividends, and this fa bas neve paid dividends during its 20-year history. We a stockholders therefore don’ direc bea efit rom profits. The only way we berefitis forthe stock price to sis.” Dale chimed fi *That peobably explains why the firm is being sued by state and federal environ meatal officials for dumping pollatans inthe adjacent streamn. Why spend money for pollution control? Ir increases cos, lowers profits, and thesefore lowers menoge- smenc’scarnings!™ Loren and Dale realized that che lunch break had ended and they must quickly recur to work. Before leaving, they decided to meet the nex: day to continve thet discussion. ToDo ‘2 Whar should the management of Sports Products, ne, pursue as its overiding goal? Why? b. Does the firm appear to have an agency problem? Explain. ce Evaluate the firm’ approach to polation control. Does it seem so be ethical? ‘Why might incuring the expense ro control pollusioe bein che bes arrests of the firm's owners despite ics negative effect on profits? 4. Does the firm appeat to have an efecive corporate governance stricture? Explain any shortcomings ‘On che basis of ce information provided, whar specific recommendations would you offer the fra? (eee senescence Spreadsheet Exercise ‘Assume chat Monsaato Corporation is considering the renovation and/or replace- ‘ment of some of its older and outdated carpet-maaufscruing equipment. Is objective is to improve the efficiency of operations in terms of both epeed and seduction in the umber of defecs. The company’s finance department bes compiled pecrinent data ‘that will allow itto conduct a marginal cost-benefit analysis for the proposed equip ment replacement. ‘The cash outlay for new equipment would be approximately $600,000. The net book value ofthe old equipment and ics poreasal net selling prve is $250,000. The 40 PART ONE Introduction to Managerial Finance total benefits fom the gow equipment (measured in today's dollars) would be $900,000. The benefits of the old equipment over a similar period of ie (measzted in today’s dolacs) would be $300,000. ToDo (Ceeate a spreadeheet to conduct a marginal cost-benefit analysis for Monsanto Corpo: ration and determine the followings “The marginal (added) benefits ofthe proposed new equipment. >. The marginal (added) cos of the proposed aew equipment. “The net benefit ofthe proposed new equipment. 6. 4. Whar would you recommend thac the firm do? Why? cece tue a eee ESN RID Group Exercise ‘You may not cecll it, ur in kindergarten one yardstick of your development was summarized as “plays well with others.” As you moved through your school yeas, this explci characteristic was deleted, and you were graded based on your attain sment of moce concrete larning gouls such as addition, spelling, and, eventual, los ical thinking, Of cours, playing well—gering along with othert—is nota skill that Aisappenrs along with our baby tech. Homans are social animals, and as such we spend euch of our day in close proximity to other peopl. This is parculaly true in the workplace. Most jobs include ar least some component of teamwork. Working ‘well within groaps is necessary for succes in most fms. With this fact in mind, in each chapter you will be asked to complete a group assignment Linked tothe Learning goals of each chaptec The size ofthe groups is Ae ble, although groups of 3 to 5 students are probably most appropriate. These ase ‘ments willbe continuous inthe sense thatthe groups will be establishing frm and, fn each chapces, will arempt 10 simulate decisions made by corporations in their rormal course of fsancial management. The group assignments begin with chs cchaptes and each subsequear chapter will build on your previous work ‘Your group must fest form a Bettis partnership, Assume that this parnership has existed for several years and isin the proces of going public. This “frm-group” will continue throughout the semester. You will also follow a ceal, publily ‘ceded Firm dhroughout the semeste, which should be selted in some way t0 your fctious busines. ToDo 1. Name your fem, describe the business in, and state what advantages you (as management seein going public. b, Discuss the necessary managerial roles of your fictitious firm, and explaia the responsibilities for each within the fir. (Although individual roles could be sssigned here, che group is esponsble fr all pars of all assignment) & Choose a publicly taded corporation to act asa *shadow frm.” (1) Goo wumsmartmoney.com, the ste tun by the Wall Steet Journal, and look up the mor secent anntal financial reatereats for your shadow firm. (CHAPTER 1 The Role and Emiconment of Managerial Finance a1 (2) Find the exchange on which your femis stock trade, and fed the industry ea ~ ew Oh Bag Sea eae revenue—the roral dolla: amount of sales during the peciod—from which the cost of goods sold is dedacred. The resulting gross profits of $986,000 represent the amount remaining to sarsfy operating, financial, and tax coscs. Next, operating expenses, which include selling expease, general and adaniaistrative expense, lease expense, and depreciation expense, ate deducted from gross profits The resulting operating profits of $413,000 represent the profits earned from pro dasing and selling pcoducts; this amount does not consider financial and tax costs. (Operating profit is often called earnings before interest and taxes, of EBIT.) Next, the fisancial cost—interest expense—is subtacted from operating “SDepecon pn ca ad quent nid ic maura oven of ponds tw ire SEES MSV SME ae mins econ toes dividend per share (0P5) The dole amount of es,

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