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the text book for corporate finance.financial managementdiscounted cashflow
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THIRD EDITION
CORE PRINCIPLES AND APPLICATIONSOF CORPORATE FINANCE
Stephen A. RossSloan School of ManagementMassachusetts Institute of Technology
Randolph W.WesterfieldMarshall School of BusinessUniversity of Southern California
Jeffrey R JaffeWharton School of BusinessUniversity of Pennsylvania
Bradford D.JordanGatton College of Business and EconomicsUniversity of Kentucky
McGraw-HillIrwin
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>PART ONE OVERVIEW
I
CHAPTER ONEIntroduction to Corporate Finance 35
1.1 What Is Corporate Finance? 35
The Balance Sheet Model of theFirm 36
The Financial Manager 37
1.2 The Corporate Firm 38
The Sole Proprietorship 38
CHAPTER TWO
Financial Statements and Cash Flow 54
2.1 The Balance Sheet 54
Accounting Liquidity 55
Debt versus Equity 56
Value versus Cost 56
2.2 The Income Statement 57
Generally Accepted AccountingPrinciples 58
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1
1.3
1.4
1.5
The Partnership 38
The Corporation 39
A Corporation by AnotherName... 41
The Importance of Cash Flows 41
The Goal of Financial Management 44
Possible Goals 44
The Goal of Financial Management 45
A More General Goal 46
The Agency Problem and Controlof the Corporation 46
Agency Relationships 47
2.3
2.4
2.5
2.6
Noncash Items 58
Time and Costs 59
Taxes 59
Corporate Tax Rates 60
Average versus Marginal Tax Rates 60
Networking Capital 62
Financial Cash Flow 62
The Accounting Statement of CashFlows 65
Cash Flow from OperatingActivities 65
Cash Flow from InvestingActivities 66
Management Goals 47
Do Managers Act in the Stockholders'Interests? 48
Stakeholders 49
1.6 Regulation 49
The Securities Act of 1933 andthe Securities Exchange Actof 1934 50
Summary and Conclusions 51Closing Case: East Coast Yachts 53
Cash Flow from Financing Activities 67
Summary and Conclusions 68Closing Case: Cash Flows at East CoastYachts 76
CHAPTER THREEFinancial Statements Analysis
and Financial Models 78
3.1 Financial Statements Analysis 78
Standardizing Statements 79
CONTENTS
Common-Size Balance Sheets 79
Common-Size Income Statements 80
3.2 Ratio Analysis 82
Short- Term Solvency or Liquidity Measures 82
Long-Term Solvency Measures 84
Asset Management or Turnover Measures 85
Profitability Measures 87
Market Value Measures 88
3.3 The Du Pont Identity 91
A Closer Look at ROE 91
Problems with Financial Statement Analysis 93
3.4 Financial Models 95
A Simple Financial Planning Model 95
The Percentage of Sales Approach 96
3.5 External Financing and Growth 100
EFN and Growth 101
Financial Policy and Growth 103
A Note about Sustainable Growth RateCalculations 106
3.6 Some Caveats Regarding Financial PlanningModels 107
Summary and Conclusions 108Closing Case: Ratios and Financial Planningat East Coast Yachts 115
PART TWO VALUATION AND CAPITAL BUDGETINGCHAPTER FOURDiscounted Cash Flow Valuation 1184.1 Valuation: The One-Period Case 118
4.2 The Multiperiod Case 122
Future Value and Compounding 122
The Power of Compounding: A Digression 125
Present Value and Discounting 126
The Algebraic Formula 130
4.3 Compounding Periods 131
Distinction between Stated Annual Interest Rateand Effective Annual Rate 133
Compounding over Many Years 135
Continuous Compounding 135
4.4 Simplifications 137
Perpetuity 137
Growing Perpetuity 138
Annuity 140Trick 1: A Delayed Annuity 142 -^Trick 2: Annuity Due 143Trick 3: The Infrequent Annuity 144Trick 4: Equating Present Value of TwoAnnuities 144
Growing Annuity 145
4.5 Loan Types and Loan Amortization 147
Pure Discount Loans 147
Interest-Only Loans 147
Amortized Loans 148
4.6 What Is a Firm Worth? 151
Summary and Conclusions 153Closing Case: The MBA Decision 165
CHAPTER FIVEInterest Rates and Bond Valuation 1675.1 Bonds and Bond Valuation 167
Bond Features and Prices 168
Bond Values and Yields 168
Interest Rate Risk 171
Finding the Yield to Maturity: More Trial and Error 173
5.2 More on Bond Features 175
Long-Term Debt: The Basics 177The Indenture 178
Terms of a Bond 178Security 179Seniority 179Repayment 179The Call Provision 180Protective Covenants 180
5.3 Bond Ratings 181
5.4 Some Different Types of Bonds 182
Government Bonds 182
Zero Coupon Bonds 183
Floating-Rate Bonds 184
Other Types of Bonds 185
CONTENTS
5.5 Bond Markets 185
How Bonds Are Bought and Sold 186Bond Price Reporting 186A Note on Bond Price Quotes. 189
5.6 Inflation and Interest Rates 189
Real versus Nominal Rates 189
The Fisher Effect 190
5.7 Determinants of Bond Yields 191
The Term Structure of Interest Rates 191
Bond Yields and the Yield Curve: Putting It AllTogether 193Conclusion 195
Summary and Conclusions 195Closing Case: Financing East Coast Yachts' ExpansionPlans with a Bond Issue 200
CHAPTER SIXStock Valuation 202
r
6.1 The Present Value of Common Stocks 202Dividends versus Capital Gains 202
Valuation of Different Types of Stocks 204Case 1 (Zero Growth) 204Case 2 (Constant Growth) 204Case 3 (Differential Growth) 205
6.2 Estimates of Parameters in the Dividend DiscountModel 207
Where Does g Come From? 207Where Does R Come From? 208
A Healthy Sense of Skepticism 210
Total Payout 211
6.3 Growth Opportunities 211
Growth in Earnings and Dividendsversus Growth Opportunities 213The No-Payout Firm 213
6.4 Price-Earnings Ratio 214
6.5 Some Features of Common and PreferredStocks 216Common Stock Features 216
Shareholder Rights 216Proxy Voting 217Classes of Stock 217
Other Rights 218Dividends 218
Preferred Stock Features 219Stated Value 219Cumulative and Noncumulative Dividends 219Is Preferred Stock Really Debt? 219
6.6 The Stock Markets 220
Dealers and Brokers 220
Organization of the NYSE 220Members 220Operations 221Floor Activity 221
NASDAQ Operations 222ECNs 223
Stock Market Reporting 223Summary and Conclusions 226Closing Case: Stock Valuation at Ragan Engines 231
CHAPTER SEVENNet Present Value and Other InvestmentRules 2337.1 Why Use Net Present Value? 233
7.2 The Payback Period Method 236
Defining the Rule 236Problems with the Payback Method 237
Problem 1: Timing of Cash Flows within the PaybackPeriod 237Problem 2: Payments after the PaybackPeriod 237Problem 3: Arbitrary Standard for PaybackPeriod 238
Managerial Perspective, 238Summary of Payback 238
7.3 The Discounted Payback Period Method 239
7.4 The Average Accounting Return Method 239Defining the Rule 239
Step 1: Determining Average Net Income 240Step 2: Determining Average Investment 241Step 3: Determining AAR 241
Analyzing the Average Accounting Return Method 2417.5 The Internal Rate of Return 241
7.6 Problems with the IRR Approach 244
CONTENTS
Definition of Independent and Mutually ExclusiveProjects 244Two General Problems Affecting Both Independentand Mutually Exclusive Projects 245
Problem 1: Investing or Financing? 246Problem 2: Multiple Rates of Return 246NPV Rule 247Modified IRR 247The Guarantee against Multiple IRRs 248General Rules 248
Problems Specific to Mutually Exclusive Projects 249The Scale Problem 249The Timing Problem 251
Redeeming Qualities of IRR 253
A Test 253
7.7 The Profitability Index 254
Calculation of Profitability Index 254Application of the Profitability Index 254
7.8 The Practice of Capital Budgeting 256
Summary and Conclusions 258Closing Case: Bullock Gold Mining 269
CHAPTER EIGHTMaking Capital Investment Decisions 2708.1 Incremental Cash Flows 270
Cash FlowsNot Accounting Income 270
Sunk Costs 271
Opportunity Costs 271
Side Effects 272
Allocated Costs 272
8.2 The Baldwin Company: An Example 273
An Analysis of the Project 274Investments 274Income and Taxes 275Salvage Value 276Cash Flow 277Net Present Value 277
Which Set of Books? 277
A Note on Net Working Capital 277
A Note on Depreciation 278
Interest Expense 279
8.3 Inflation and Capital Budgeting 279
Discounting: Nominal or Real? 280
8.4 -' Alternative Definitions of Operating Cash
Flow 282
The Bottom-Up Approach 283
The Top-Down Approach 283
The Tax Shield Approach 283
Conclusion 2848.5 Investments of Unequal Lives: The Equivalent Annual
Cost Method 284
The General Decision to Replace 286
Summary and Conclusions 288Closing Cases: Expansion at East Coast Yachts 299
Bethesda Mining Company 299
CHAPTER NINERisk Analysis, Real Options, and CapitalBudgeting 3019.1 Decision Trees 301
Warning 303
9.2 Sensitivity Analysis, Scenario Analysis, andBreak-Even Analysis 303
Sensitivity Analysis and Scenario Analysis 304Revenues 304Costs 305
Break-Even Analysis 307Accounting Profit 307Present Value 309
9.3 Monte Carlo Simulation 310Step 1: Specify the Basic Model 310Step 2: Specify a Distribution for Each Variablein the Model 310Step 3: The Computer Draws OneOutcome 312Step 4: Repeat the Procedure 312Step 5: Calculate NPV 312
9.4 Real Options 313
The Option to Expand 313
The Option to Abandon 314
Timing Options 316
Summary and Conclusions 317Closing Case: Bunyan Lumber, LLC 325
CONTENTS
PART THREE RISK AND RETURNCHAPTER TENRisk and Return Lessons from MarketHistory 32710.1 Returns 327
Dollar Returns 327
Percentage Returns 329
10.2 Holding Period Returns 331
10.3 Return Statistics 33710.4 Average Stock Returns and Risk-Free
Returns 338
10.5 Risk Statistics 340
Variance 340
Normal Distribution and Its Implicationsfor Standard Deviation 341
10.6 The U.S. Equity Risk Premium: Historical andInternational Perspectives 342
10.7 2008: A Year of Financial Crisis 345
10.8 More on Average Returns 346
Arithmetic versus Geometric Averages 346
Calculating Geometric Average Returns 347
Arithmetic Average Return or GeometricAverage Return? 348
Summary and Conclusions 349Closing Case: A Job at East Coast Yachts,Parti 353
CHAPTER ELEVENReturn and Risk: The Capital Asset PricingModel (CAPM) 35511.1 Individual Securities 355
11.2 Expected Return, Variance, and Covariance 356
Expected Return and Variance 356
Covariance and Correlation 357
11.3 The Return and Risk for Portfolios 360
The Expected Return on a Portfolio 360Variance and Standard Deviation of a Portfolio 361
The Variance 361Standard Deviation of a Portfolio 361The Diversification Effect 362An Extension to Many Assets 363
11.4 The Efficient Set 363
The Two-Asset Case 363
The Efficient Set for Many Securities 367
11.5 Riskless Borrowing and Lending 368
The Optimal Portfolio 370
11.6 Announcements, Surprises, and Expected Returns 372
Expected and Unexpected Returns 372
Announcements and News 373
11.7 Risk: Systematic and Unsystematic 374
Systematic and Unsystematic Risk 374
Systematic and Unsystematic Componentsof Return 374
11.8 Diversification and Portfolio Risk 375
The Effect of Diversification: Another Lesson 'from Market History 375
The Principle of Diversification 375
Diversification and Unsystematic Risk 377
Diversification and Systematic Risk 377
11.9 Market Equilibrium 378
Definition of the Market Equilibrium Portfolio 378
Definition of Risk When Investors Holdthe Market Portfolio 379
The Formula for Beta 381
A Test 383
11.10 Relationship between Risk and ExpectedReturn (CAPM) 383Expected Return on Market 383
Expected Return on Individual Security 384
Summary and Conclusions 386Closing Case: A Job at East Coast Yachts, Part 2 395
CHAPTER TWELVERisk, Cost of Capital, and Capital Budgeting 39712.1 The Cost of Equity Capital 397
12.2 Estimating the Cost of Equity Capital with the CAPM 398
The Risk-Free Rate 401
Market Risk Premium 401Method 1: Using Historical Data 401Method 2: Using the Dividend Discount Model(DDM) 401
CONTENTS
12:3 Estimation of Beta 402
Real-World Betas 403
Stability of Beta 403
Using an Industry Beta 404
12.4 Beta and Covariance 406
Beta and Covariance 406
12.5 Determinants of Beta 407
Cyclicality of Revenues 407
Operating Leverage 407
Financial Leverage and Beta 407
12.6 Dividend Discount Model 409
Comparison of DDM and CAPM 409
Can a Low-Dividend or a No-Dividend StockHave a High Cost of Capital? 410
12.7 Cost of Capital for Divisions and Projects 41112.8 Cost of Fixed Income Securities 412
Cost of Debt 412
Cost of Preferred Stock 413
12.9 The Weighted Average Cost of Capital 414
12.10 Estimating Eastman Chemical's Cost of Capital 417
Eastman's Cost of Equity 417
Eastman's Cost of Debt 418
Eastman's WACC 419
12.11 Flotation Costs and the Weighted Average Costof Capital 419
The Basic Approach 419
Flotation Costs and NPV 420
Internal Equity and Flotation Costs 421
Summary and Conclusions 421Closing Case: The Cost of Capital for GoffComputer, Inc. 428
IPART FOUR CAPITAL STRUCTURE
AND DIVIDEND POLICY
CHAPTER THIRTEENEfficient Capital Markets and BehavioralChallenges 42913.1 Can Financing Decisions Create Value? 429
13.2 A Description of Efficient Capital Markets 431
Foundations of Market Efficiency 433Rationality 433
Independent Deviations from Rationality 433Arbitrage 434
13.3 The Different Types of Efficiency 434
777e Weak Form 434
The Semistrong and Strong Forms 435
Some Common Misconceptions aboutthe Efficient Market Hypothesis 436
The Efficacy of Dart Throwing 437Price Fluctuations 437Stockholder Disinterest 437
13.4 The Evidence 437
The Weak Form 438
The Semistrong Form 439Event Studies 440The Record of Mutual Funds 441
77je Strong Form 44213.5 The Behavioral Challenge to Market
Efficiency 443Rationality 443Independent Deviations fromRationality 443
Arbitrage 444
13.6 Empirical Challenges to Market Efficiency 444
13.7 Reviewing the Differences 450
Representativeness 450
Conservatism 450
13.8 Implications for Corporate Finance 451
/. Accounting Choices, Financial Choices,and Market Efficiency 451
2. The Timing Decision 451
3. Speculation and Efficient Markets 454
4. Information in Market Prices 454
Summary and Conclusions 456Closing Case: Your 401 (k) Account at East CoastYachts 462
CHAPTER FOURTEENCapital Structure: Basic Concepts 464
14.1 The Capital Structure Question and the PieTheory 464
14.2 Maximizing Firm Value versus MaximizingStockholder Interests 465
CONTENTS
14.3 Financial Leverage and Firm Value: An Example 467Leverage and Returns to Shareholders 467The Choice between Debt and Equity 469A Key Assumption 471
14.4 Modigliani and Miller: Proposition II (No Taxes) 471Risk to Equityholders Rises with Leverage 471Proposition II: Required Return to EquityholdersRises with Leverage 472MM: An Interpretation 477
14.5 Taxes 478
The Basic Insight 478Present Value of the Tax Shield 480Value of the Levered Firm 480
Expected Return and Leverage under CorporateTaxes 482
The Weighted Average Cost of Capital RWACCand Corporate Taxes 483Stock Price and Leverage under Corporate Taxes 483
Summary and Conclusions 485Closing Case: Stephenson Real EstateRecapitalization 492
CHAPTER FIFTEENCapital Structure: Limits to the Use of Debt 493
15.1 Costs of Financial Distress 493 .>Direct Bankruptcy Costs 494Indirect Bankruptcy Costs 494Agency Costs 495
Summary of Selfish Strategies 49715.2 Can Costs of Debt Be Reduced? 498
Protective Covenants 498Consolidation of Debt 499
15.3 Integration of Tax Effects and FinancialDistress Costs 499Pie Again 499
15.4 Signaling 50215.5 Shirking, Perquisites, and Bad Investments: A Note
on Agency Cost of Equity 503Effect of Agency Costs of Equity onDebt-Equity Financing 505Free Cash Flow 505
15.6 The Pecking-Order Theory 506Rules of the Pecking Order 507
Rule #1 Use Internal Financing 507Rule #2 Issue Safe Securities First 508
Implications 508
15.7 Growth and the Debt-Equity Ratio 509
No Growth 509
Growth 509
15.8 How Firms Establish Capital Structure 511
15.9 A Quick Look at the Bankruptcy Process 515
Liquidation and Reorganization 516Bankruptcy Liquidation 516Bankruptcy Reorganization 517
Financial Management and the BankruptcyProcess 517
Agreements to Avoid Bankruptcy 518
Summary and Conclusions 518Closing Case: McKenzie Corporation's CapitalBudgeting 523
CHAPTER SIXTEENDividends and Other Payouts 524
16.1 Different Types of Dividends 524
16.2 Standard Method of Cash DividendPayment 525
16.3 The Benchmark Case: An Illustration of theIrrelevance of Dividend Policy 527
Current Policy: Dividends Set Equal to CashFlow 527
Alternative Policy: Initial Dividend Is Greater than CashFlow 528
The Indifference Proposition 528
Homemade Dividends 528
A Test 530
Dividends and Investment Policy 531
16.4 Repurchase of Stock 531
Dividend versus Repurchase: ConceptualExample 532
Dividends versus Repurchases: Real-WorldConsiderations 533
1. Flexibility 5332. Executive Compensation 533
CONTENTS
3. Offset to Dilution 5344. Repurchase as Investment 5345. Taxes 534
16.5 Personal Taxes, Issuance Costs, and Dividends 534
Firms without Sufficient Cash to Pay a Dividend 535
Firms with Sufficient Cash to Pay a Dividend 536
Summary on Personal Taxes 537
16.6 Real-World Factors Favoring a High-DividendPolicy 537
Desire for Current Income 537
Behavioral Finance 538
Agency Costs 539
Information Content of Dividends and DividendSignaling 540
16.7 The Clientele Effect: a Resolution of Real-WorldFactors? 541
16.8 What We Know and Do Not Know about DividendPolicy 542
Dividends and Dividend Payers 542
Corporations Smooth Dividends 544
Payouts Provide Information to the Market 545
Putting It All Together 545
Some Survey Evidence on Dividends 548
16.9 Stock Dividends and Stock Splits 549
Some Details on Stock Splits and Stock Dividends 549Example of a Small Stock Dividend 549Example of a Stock Split 550Example of a Large Stock Dividend 550
Value of Stock Splits and Stock Dividends 5501 The Benchmark Case 550
Popular Trading Range 551
Reve'rse Splits 551
Summary and Conclusions 552Closing Case: Electronic Timing, Inc. 559
PART FIVE SPECIAL TOPICS
CHAPTER SEVENTEENOptions and Corporate Finance 56117.1 Options 561
17.2 Call Options 562
The Value of a Call Option at Expiration 562
17.3 Put Options 563
The Value of a Put Option at Expiration 563
17.4 Selling Options 565
17.5 Option Quotes 566
17.6 Combinations of Options 567
17.7 Valuing Options 570
Bounding the Value of a Call 570Lower Bound 570Upper Bound 570
The Factors Determining Call Option Values 570Exercise Price 570Expiration Date 571Stock Price 571The Key Factor: The Variability of theUnderlying Asset 572The Interest Rate 573
A Quick Discussion of Factors DeterminingPut Option Values 573
17.8 An Option Pricing Formula 574
A Two-State Option Model 575Determining the Delta 575Determining the Amount of Borrowing 576Risk-Neutral Valuation 576
The Black-Scholes Model 577
17.9 Stocks and Bonds as Options 581
The Firm Expressed in Terms of Call Options 582The Stockholders 582The Bondholders 583
The Firm Expressed in Terms of Put Options 584The Stockholders 584The Bondholders 584
A Resolution of the Two Views 584
A Note on Loan Guarantees 586
17.10 Options and Corporate Decisions: SomeApplications 586
Mergers and Diversification 587
Options and Capital Budgeting 588
17.11 Investment in Real Projects and Options 590Summary and Conclusions 592Closing Case: Exotic Cuisines Employee StockOptions 601
CONTENTS
CHAPTER EIGHTEENShort-Term Finance and Planning 60218.1 Tracing Cash and Networking Capital 60318.2 The Operating Cycle and the Cash Cycle 604
Defining the Operating and Cash Cycles 605The Operating Cycle 605The Cash Cycle 605
The Operating Cycle and the Firm's OrganizationChart 607
Calculating the Operating and Cash Cycles 608The Operating Cycle 608The Cash Cycle 609
Interpreting the Cash Cycle 61018.3 Some Aspects of Short-Term Financial Policy 611
The Size of the Firm's Investment in CurrentAssets 611
Alternative Financing Policies for Current Assets 612An Ideal Case 612Different Policies for Financing Current Assets 614
Which Financing Policy Is Best? 616Current Assets and Liabilities in Practice 617
18.4 The Cash Budget 617
Sales and Cash Collections 617Cash Outflows 618The Cash Balance 619
18.5 Short-Term Borrowing 619Unsecured Loans 620
Compensating Balances 620f Cost of a Compensating Balance 620
Letters of Credit 621Secur-ed Loans 621
Accounts Receivable Financing 621Inventory Loans 622
Commercial Paper 622
Trade Credit 622Understanding Trade Credit Terms 622Cash Discounts 623
18.6 A Short-Term Financial Plan 624
Summary and Conclusions 625Closing Case: Keafer Manufacturing Working CapitalManagement 633
CHAPTER NINETEENRaising Capital 63519.1 The Financing Life Cycle of a Firm: Early-Stage
Financing and Venture Capital 636Venture Capital 636
Some Venture Capital Realities 637
Choosing a Venture Capitalist 637Conclusion 637
19.2 Selling Securities to the Public: The BasicProcedure 637
19.3 Alternative Issue Methods 640
19.4 Underwriters 641
Choosing an Underwriter 641
Types of Underwriting 641Firm Commitment Underwriting 641Best Efforts Underwriting .,641Dutch Auction Underwriting 642
The Green Shoe Provision 642The Aftermarket 643
Lockup Agreements 643The Quiet Period 643
19.5 IPOs and Underpricing 643Evidence on Underpricing 644IPO Underpricing: The 1999-2000 Experience 645Why Does Underpricing Exist? 648
19.6 What CFOs Say aboutthe IPO Process 650
19.7 CEOs and the Value of the Firm 651
19.8 The Cost of Issuing Securities 65219.9 Rights 656
The Mechanics of a Rights Offering 656Subscription Price 657
Number of Rights Needed to Purchase aShare 657
Effect of Rights Offering on Price of Stock 657
Effects on Shareholders 659
The Underwriting Arrangements 659The Rights Puzzle 660
19.10 Dilution 660
Dilution of Proportionate Ownership 660
CONTENTS 5)
Dilution of Value: Book versus Market Values 660A Misconception 661The Correct Arguments 662
19.11 Issuing Long-Term Debt 66219.12 Shelf Registration 663Summary and Conclusions 664Closing Case: East Coast Yachts Goes Public 668
CHAPTER TWENTYInternational Corporate Finance 67020.1 Terminology 67120.2 Foreign Exchange Markets and Exchange
Rates 672
Exchange Rates 673Exchange Rate Quotations 673Cross-Rates and Triangle Arbitrage 675Types of Transactions 676
20.3 Purchasing Power Parity 677Absolute Purchasing Power Parity 677Relative Purchasing Power Parity 679
The Basic Idea 679The Result 679Currency Appreciation and Depreciation 681
20.4 Interest Rate Parity, Unbiased Forward Rates, and theInternational Fisher Effect 681
Covered Interest Arbitrage 681Interest Rate Parity 682
Forward Rates and Future Spot Rates 683
f Putting It All Together 684Uncovered Interest Parity 684The International Fisher Effect 684I
20.5 International Capital Budgeting 685Method 1: The Home Currency Approach 686Method 2: The Foreign Currency Approach 686Unremitted Cash Flows 687
20.6 Exchange Rate Risk 687Short-Run Exposure 687Long-Run Exposure 688Translation Exposure 689
Managing Exchange Rate Risk 690
20.7 Political Risk 690
Summary and Conclusions 691Closing Case: East Coast Yachts GoesInternational 696
CHAPTER TWENTY-ONEMergers and Acquisitions 69721.1 The Legal Forms of Acquisitions 698
Merger or Consolidation 698Acquisition of Stock 698Acquisition of Assets 699
Acquisition Classifications 699
A Note on Takeovers 700
Alternatives to Merger 700
21.2 Taxes and Acquisitions 701
21.3 Accounting for Acquisitions 701777e Purchase Method 701
Pooling of Interests 702More on Goodwill 703
21.4 Gains from Acquisition 703Synergy 703
Revenue Enhancement 704Marketing Gains 704Strategic Benefits 704Market Power 705
Cost Reductions 705Economies of Scale 705Economies of Vertical Integration 706Complementary Resources 706
Lower Taxes 706Net Operating Losses 706Unused Debt Capacity 706Surplus Funds 706
Reductions in Capital Needs 707
Avoiding Mistakes 707A Note on Inefficient Management 708
21.5 Some Financial Side Effects of Acquisitions 708
EPS Growth 708
Diversification 709
21.6 The Cost of an Acquisition 710
S 3 CONTENTS
Case I: Cash Acquisition 710 APPENDIX ACase ii: stock Acquisition 711 Mathematical Tables 725
Cash versus Common Stock 711 APPENDIX B217 Defensive Tactics 712 Using the HP 10B and Tl BA II Plus Financial
Calculators 734The Corporate Charter 712
Repurchase and Standstill Agreements 712 NAME INDEX 739
Poison Pills and Share Rights Plans 712 COMPANY .NDEX 741Going Private and Leveraged Buyouts 714
SUBJECT INDEX 743Other Devices and Jargon of CorporateTakeovers 714
21.8 Some Evidence on Acquisitions: Does M&A Pay? 715
21.9 Divestitures and Restructurings 716Summary and Conclusions 716Closing Case: The East Coast Yachts-West CoastSailboats Merger 723
CONTENTS 0
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