INSEAD Library

Includes bibliographical references and index and glossary

Digitized

Corporate Finance A Practical Approach Contents Foreword Acknowledgments Introduction CHAPTER 1 Corporate Governance Learning Outcomes 1. Introduction 2. Corporate Governance: Objectives and Guiding Principles 3. Forms of Business and Conflicts of Interest 3.1. Sole Proprietorships 3.2. Partnerships 3.3. Corporations 4. Specific Sources of Conflict: Agency Relationships 4.1. Manager-Shareholder Conflicts 4.2. Director-Shareholder Conflicts 5. Corporate Governance Evaluation 5.1. The Board of Directors 5.1.1. Board Composition and Independence 5.1.2. Independent Chair of the Board 5.1.3. Qualifications of Directors 5.1.4. Annual Election of Directors 5.1.5. Annual Board Self-Assessment 5.1.6. Separate Sessions of Independent Directors 5.1.7. Audit Committee and Audit Oversight 5.1.8. Nominating Committee 5.1.9. Compensation Committee 5.1.10. Board's Independent Legal and Expert Counsel 5.1.11. Statement of Governance Policies 5.1.12. Disclosure and Transparency 5.1.13. Insider or Related-Party Transactions 5.1.14. Responsiveness of Board of Directors to Shareholder Proxy Votes xiii xv xvii 1 1 2 3 3 4 5 5 6 7 10 10 11 12 13 14 15 15 16 17 18 19 21 21 22 23 24 5.2. Examples of Codes of Corporate Governance 5.2.1. General Electric: Governance Principles 5.2.2. Monetary Authority of Singapore: Guidelines and Regulations on Corporate Governance 5.2.3. Organisation for Economic Co-Operation and Development: OECD Principles of Corporate Governance 6. Environmental, Social, and Governance Factors 7. Valuation Implications of Corporate Governance 8. Summary Practice Problems 24 24 31 32 36 38 40 41 CHAPTER 2 Capital Budgeting Learning Outcomes 1. Introduction 2. The Capital Budgeting Process 3. Basic Principles of Capital Budgeting 4. Investment Decision Criteria 4.1. Net Present Value 4.2. Internai Rate of Return 4.3. Payback Period 4.4. Discounted Payback Period 4.5. Average Accounting Rate of Return 4.6. Profitability Index 4.7. NPV Profile 4.8. Ranking Conflicts Between NPV and IRR 4.9. The Multiple IRR Problem and the No IRR Problem 4.10. Popularity and Usage of the Capital. Budgeting Methods 5. Cash Flow Projections 5.1. Table Format with Cash Flows Collected by Year 5.2. Table Format with Cash Flows Collected by Type 5.3. Equation Format for Organizing Cash Flows 6. More on Cash Flow Projections 6.1. Straight-Line and Accelerated Depreciation Methods 6.2. Cash Flows for a Replacement Project 6.3. Spreadsheet Modeling 6.4. Effects of Inflation on Capital Budgeting Analysis 7. Project Analysis and Evaluation 7.1. Mutually Exclusive Projects with Unequal Lives 7.1.1. Least Common Multiple of Lives Approach 7.1.2. Equivalent Annual Annuity Approach 7.2. Capital Rationing 7.3. Risk Analysis of Capital Investments--Stand-Alone Methods 7.3.1. Sensitivity Analysis 7.3.2. Scenario Analysis 7.3.3. Simulation (Monte Carlo) Analysis 7.4. Risk Analysis of Capital Investments--Market Risk Methods 7.5. Real Options 7.6. Common Capital Budgeting Pitfalls 47 47 48 49 50 52 52 54 55 57 57 58 59 60 65 68 69 70 71 72 74 74 77 79 79 81 81 82 83 83 85 86 87 88 91 95 99 8. Other Income Measures and Valuation Models 8.1. The Basic Capital Budgeting Model 8.2. Economic and Accounting Income 8.3. Economic Profit, Residual Income, and Claims Valuation 8.3.1. Economic Profit 8.3.2. Residual Income 8.3.3. Claims Valuation 9. Summary Practice Problems 100 101 102 105 105 106 108 109 112 CHAPTER 3 Cost of Capital Learning Outcomes 1. Introduction 2. Cost of Capital 2.1. Taxes and the Cost of Capital 2.2. Weights of the Weighted Average 2.3. Applying the Cost of Capital to Capital Budgeting and Security Valuation 133 3. Costs of the Different Sources of Capital 3.1. Cost of Debt 3.1.1. Yield-to-Maturity Approach 3.1.2. Debt-Rating Approach 3.1.3. Issues in Estimating the Cost of Debt 3.1.3.1. Fixed-Rate Debt Versus Floating-Rate Debt 3.1.3.2. Debt with Optionlike Features 3.1.3.3. Nonrated Debt 3.1.3.4. Leases 3.2. Cost of Preferred Stock 3.3. Cost of Common Equity 3.3.1. Capital Asset Pricing Model Approach 3.3.2. Dividend Discount Model Approach 3.3.3. Bond Yield Plus Risk Premium Approach 4. Topics in Cost of Capital Estimation 4.1. Estimating Beta and Determining a Project Beta 4.2. Country Risk 4.3. Marginal Cost of Capital Schedule 4.4. Flotation Costs 4.5. What Do Chief Financial Officers Do? 5. Summary Practice Problems 127 127 128 128 130 131 135 135 135 136 137 137 137 137 137 138 139 140 144 145 146 146 153 155 158 160 161 163 CHAPTER 4 Capital Structure and Leverage Learning Outcomes 1. Introduction 2. Leverage 171 171 172 173 3. Business Risk and Financial Risk 3.1. Business Risk and Its Components 3.2. Sales Risk 3.3. Operating Risk 3.4. Financial Risk 3.5. Total Leverage 3.6. Breakeven Rates and Expected Return 3.7. The Risks of Creditors and Owners 4. The Capital Structure Decision 4.1. Proposition I Without Taxes: Capital Structure Irrelevance 4.2. Proposition II Without Taxes: Higher Financial Leverage Raises the Cost of Equity 4.3. Taxes, the Cost of Capital, and the Value of the Company 4.4. Costs of Financial Distress 4.5. Agency Costs 4.6. Costs of Asymmetric Information 4.7. The Optimal Capital Structure According to the Static Trade-Off Theory 5. Practical Issues in Capital Structure Policy 5.1. Debt Ratings 5.2. Evaluating Capital Structure Policy 5.3. Leverage in an International Setting 5.3.1. Institutional and Legal Environment 5.3.2. Financial Markets and Banking Sector 5.3.3. Macroeconomic Environment 5.3.4. Conclusions 6. Summary Practice Problems 175 175 175 176 182 185 187 191 193 194 195 197 200 201 202 203 205 205 206 207 208 209 210 210 211 213 CHAPTER 5 Dividends and Dividend Policy Learning Outcomes 1. Introduction 2. Forms of Dividends 2.1. Regular Dividends 2.1.1. Dividend Reinvestment Plans (DRIPs) 2.2. Extra (or Special) Dividends 2.3. Liquidating Dividends 2.4. Stock Dividends 2.5. Stock Splits 2.6. Share Repurchases 2.7. Repurchase Methods 2.8. Dividend Forms Outside the United States 3. Dividend Payment Chronology 3.1. Declaration Date 3.2. Ex-dividend Date 3.3. Holder-of-Record Date 3.4. Payment Date 219 219 220 221 221 221 222 222 222 224 225 229 230 230 230 230 231 231 3.5. Interval Between Key Dates in the Dividend Payment Chronology 3.5.1. Impact on Indirect Shareholders 4. Factors Affecting Dividend Payout Policy 4.1. Taxation of Dividends 4.1.1. Taxation Methods 4.1.2. Shareholder Preference for Current Income Versus Capital Gains 4.2. Flotation Costs on New Issues Versus Retaining Earnings 4.3. Restrictions on Dividend Payments 4.4. Clientele Effect 4.5. Signaling Effect: The Information Content of Dividends 4.5.1. Cross-Country Differences in Signaling Content 4.6. Conclusion 5. Dividend Policies 5.1. Residual Dividend Approach 5.2. Stable Dividend Policy 5.3. Target Payout Ratio 5.4. Share Repurchase 5.4.1. Reasons for Share Repurchase 5.5. Are Dividend Policies Changing? 6. The Dividend Controversy: Do Dividends Matter? 6.1. Dividends Are Irrelevant 6.2. Dividends Matter: Investors Prefer Dividends 6.3. Dividends Matter: Investors Are Tax Averse to Dividends 7. Valuation Implications of Dividends 8. Summary Practice Problems 231 232 232 233 233 234 235 236 236 237 239 240 240 241 243 243 245 246 249 251 251 251 253 253 255 256 CHAPTER 6 Working Capital Management Learning Outcomes 1. Introduction 2. Managing and Measuring Liquidity 2.1. Defining Liquidity Management 2.1.1. Primary Sources of Liquidity 2.1.2. Secondary Sources of Liquidity 2.1.3. Drags and Pulls on Liquidity 2.2. Measuring Liquidity 3. Managing the Cash Position 3.1. Forecasting Short-Term Cash Flows 3.1.1. Minimum Cash Balances 3.1.2. Identifying Typical Cash Flows 3.1.3. Cash Forecasting Systems 3.2. Monitoring Cash Uses and Levels 4. Investing Short-Term Funds 4.1. Short-Term Investment Instruments 4.1.1. Computing Yields on Short-Term Investments 4.1.2. Investment Risks 263 263 264 265 265 265 266 266 267 272 273 274 274 274 275 276 276 279 280 4.2. Strategies 4.3. Evaluating Short-Term Funds Management 5. Managing Accounts Receivable 5.1. Key Elements of the Trade Credit-Granting Process 5.2. Managing Customers' Receipts 5.3. Evaluating Accounts Receivable Management 5.3.1. Accounts Receivable Aging Schedule 5.3.2. The Number of Days of Receivables 6. Managing Inventory 6.1. Approaches to Managing Levels of Inventory 6.2. Inventory Costs 6.3. Evaluating Inventory Management 7. Managing Accounts Payable 7.1. The Economics of Taking a Trade Discount 7.2. Managing Cash Disbursements 7.3. Evaluating Accounts Payable Management 8. Managing Short-Term Financing 8.1. Sources of Short-Term Financing 8.2. Short-Term Borrowing Approaches 8.3. Asset-Based Loans 8.4. Computing the Costs of Borrowing 9. Summary Practice Problems 280 284 284 285 287 289 289 291 291 292 293 294 295 297 298 298 299 299 301 302 303 305 306 CHAPTER 7 Financial Statement Analysis Learning Outcomes 1. Introduction 2. Common-Size Analysis 2.1. Vertical Common-Size Analysis 2.2. Horizontal Common-Size Analysis 3. Financial Ratio Analysis 3.1. Activity Ratios 3.1.1. Turnover Ratios 3.1.2. The Operating Cycle and lis Components 3.1.3. Turnover and the Numbers of Days 3.2. Liquidity Analysis 3.2.1. Measures of Liquidity 3.3. Solvency Analysis 3.3.1. Component-Percentage Solvency Ratios 3.3.2. Coverage Ratios 3.4. Profitability Analysis 3.4.1. Margins 3.4.2. Return-on-Investment Ratios 3.4.3. DuPont Analysis 311 311 311 313 314 317 320 321 322 324 327 327 328 329 329 331 333 333 334 336 3.5. Other Ratios 3.6. Effective Use of Ratio Analysis 3.6.1. Company Description, Industry, and Major Factors 3.6.2. Activity 3.6.3. Liquidity 3.6.4. Solvency 3.6.5. Profitability 3.6.6. Returns 3.6.7. Other Analysis and Factors 3.6.8. Comparables 4. Pro Forma Analysis 4.1. Estimating the Sales-Driven Relations 4.2. Estimating the Fixed Burdens 4.3. Forecasting Revenues 4.4. Constructing Pro Forma Statements 5. Summary Practice Problems 345 348 349 349 349 350 350 351 353 353 354 357 357 358 359 362 363 CHAPTER 8 Mergers and Acquisitions Learning Outcomes 1. Introduction 2. Mergers and Acquisitions: Definitions and Classifications 3. Motives for Merger 3.1. Synergy 3.2. Growth 3.3. Increasing Market Power 3.4. Acquiring Unique Capabilities and Resources 3.5. Diversification 3.6. Bootstrapping Earnings 3.7. Managers' Personal Incentives 3.8. Tax Considerations 3.9. Unlocking Hidden Value 3.10. Cross-Border Motivations 3.10.1. Exploiting Market Imperfections 3.10.2. Overcoming Adverse Government Policy 3.10.3. Technology Transfer 3.10.4. Product Differentiation 3.10.5. Following Clients 4. Transaction Characteristics 4.1. Form of Acquisition 4.2. Method of Payment 4.3. Mind-Set of Target Management 4.3.1. Friendly Mergers 4.3.2. Hostile Mergers 367 367 368 370 373 373 374 374 374 374 375 376 376 376 377 377 377 377 377 377 379 379 380 382 382 383 5. Takeovers 5.1. Pre-Offer Takeover Defense Mechanisms 5.1.1. Poison Pills 5.1.2. Poison Puts 5.1.3. Incorporation in a State with Restrictive Takeover Laws (United States) 5.1.4. Staggered Board of Directors 5.1.5. Restricted Voting Rights 5.1.6. Supermajority Voting Provisions 5.1.7. Fair Price Amendments 5.1.8. Golden Parachutes 5.2. Post-Offer Takeover Defense Mechanisms 5.2.1. "Just Say No" Defense 5.2.2. Litigation 5.2.3. Greenmail 5.2.4. Share Repurchase 5.2.5. Leveraged Recapitalization 5.2.6. "Crown Jewel" Defense 5.2.7. "Pac-Man" Defense 5.2.8. White Knight Defense 5.2.9. White Squire Defense 6. Regulation 6.1. Antitrust 6.2. Securities Laws 7. Merger Analysis 7.1. Target Company Valuation 7.1.1. Discounted Cash Flow Analysis 7.1.2. Comparable Company Analysis 7.1.3. Comparable Transaction Analysis 7.2. Bid Evaluation 8. Who Benefits from Mergers? 9. Corporate Restructuring 10. Summary Practice Problems 384 384 384 385 385 386 386 386 386 386 387 387 387 387 387 388 388 388 388 388 390 390 393 394 394 394 401 404 407 412 413 414 416 Glossary References About the Authors About the CFA Program Index 421 431 435 439 441