Write Apple Inc company's profitability, liquidity, leverage and the common stock as an investment.

xxv

Chapter 1 Goals and Governance of the Corporation 2 1.1 Investment and Financing Decisions 4

The Investment (Capital Budgeting) Decision 6

The Financing Decision 6

1.2 What Is a Corporation? 8

Other Forms of Business Organization 9

1.3 Who Is the Financial Manager? 10

1.4 Goals of the Corporation 12

Shareholders Want Managers to Maximize Market Value 12

1.5 Agency Problems, Executive Compensation, and Corporate Governance 15

Executive Compensation 16

Corporate Governance 17

1.6 The Ethics of Maximizing Value 18

1.7 Careers in Finance 21

1.8 Preview of Coming Attractions 22

1.9 Snippets of Financial History 23

Summary 25

Questions and Problems 26

Chapter 2 Financial Markets and Institutions 32 2.1 The Importance of Financial Markets

and Institutions 34

2.2 The Flow of Savings to Corporations 35

The Stock Market 37

Other Financial Markets 38

Financial Intermediaries 40

Financial Institutions 42

Total Financing of U.S. Corporations 44

2.3 Functions of Financial Markets and Intermediaries 45

Transporting Cash across Time 45

Risk Transfer and Diversification 45

Liquidity 46

The Payment Mechanism 47

Information Provided by Financial Markets 47

2.4 The Crisis of 2007–2009 49

Summary 51

Questions and Problems 52

Chapter 3 Accounting and Finance 56 3.1 The Balance Sheet 58

Book Values and Market Values 61

3.2 The Income Statement 63

Income versus Cash Flow 64

3.3 The Statement of Cash Flows 67

Free Cash Flow 69

3.4 Accounting Practice and Malpractice 70

3.5 Taxes 73

Corporate Tax 73

Personal Tax 74

Summary 75

Questions and Problems 76

Chapter 4 Measuring Corporate Performance 86 4.1 How Financial Ratios Relate to Shareholder

Value 88

4.2 Measuring Market Value and Market Value Added 89

4.3 Economic Value Added and Accounting Rates of Return 91

Accounting Rates of Return 93

Problems with EVA and Accounting Rates of Return 95

4.4 Measuring Efficiency 96

4.5 Analyzing the Return on Assets: The Du Pont System 98

The Du Pont System 98

4.6 Measuring Financial Leverage 100

Leverage and the Return on Equity 102

4.7 Measuring Liquidity 103

4.8 Interpreting Financial Ratios 104

4.9 The Role of Financial Ratios 108

Summary 109

Questions and Problems 110

Minicase 116

Part One Introduction

Contents

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xxvi Contents

Part Two Value

Chapter 5 The Time Value of Money 118 5.1 Future Values and Compound Interest 120

5.2 Present Values 123

Finding the Interest Rate 127

5.3 Multiple Cash Flows 128

Future Value of Multiple Cash Flows 128

Present Value of Multiple Cash Flows 129

5.4 Reducing the Chore of the Calculations: Part 1 131

Using Financial Calculators to Solve Simple Time-Value-of-Money Problems 131

Using Spreadsheets to Solve Simple Time-Value-of-Money Problems 132

5.5 Level Cash Flows: Perpetuities and Annuities 135

How to Value Perpetuities 135

How to Value Annuities 136

Future Value of an Annuity 140

Annuities Due 143

5.6 Reducing the Chore of the Calculations: Part 2 144

Using Financial Calculators to Solve Annuity Problems 144

Using Spreadsheets to Solve Annuity Problems 145

5.7 Effective Annual Interest Rates 145

5.8 Inflation and the Time Value of Money 147

Real versus Nominal Cash Flows 147

Inflation and Interest Rates 149

Valuing Real Cash Payments 151

Real or Nominal? 152

Summary 152

Questions and Problems 153

Minicase 164

Chapter 6 Valuing Bonds 166 6.1 The Bond Market 168

Bond Characteristics 168

6.2 Interest Rates and Bond Prices 170

How Bond Prices Vary with Interest Rates 172

Interest Rate Risk 174

6.3 Yield to Maturity 174

Calculating the Yield to Maturity 176

6.4 Bond Rates of Return 176

6.5 The Yield Curve 178

Nominal and Real Rates of Interest 181

6.6 Corporate Bonds and the Risk of Default 182

Protecting against Default Risk 185

Not All Corporate Bonds Are Plain Vanilla 187

Summary 187

Questions and Problems 188

Chapter 7 Valuing Stocks 196 7.1 Stocks and the Stock Market 198

Reading Stock Market Listings 199

7.2 Market Values, Book Values, and Liquidation Values 201

7.3 Valuing Common Stocks 203

Valuation by Comparables 203

Price and Intrinsic Value 204

The Dividend Discount Model 206

7.4 Simplifying the Dividend Discount Model 209

Case 1: The Dividend Discount Model with No Growth 209

Case 2: The Dividend Discount Model with Constant Growth 209

Case 3: The Dividend Discount Model with Nonconstant Growth 214

7.5 Valuing a Business by Discounted Cash Flow 218

Valuing the Concatenator Business 218

Repurchases and the Dividend Discount Model 219

7.6 There Are No Free Lunches on Wall Street 220

Random Walks and Efficient Markets 221

7.7 Market Anomalies and Behavioral Finance 224

Market Anomalies 224

Bubbles and Market Efficiency 226

Behavioral Finance 227

Summary 228

Questions and Problems 229

Minicase 236

Chapter 8 Net Present Value and Other Investment Criteria 238 8.1 Net Present Value 240

A Comment on Risk and Present Value 241

Valuing Long-Lived Projects 242

Choosing between Alternative Projects 244

8.2 The Internal Rate of Return Rule 245

A Closer Look at the Rate of Return Rule 246

Calculating the Rate of Return for Long-Lived Projects 246

A Word of Caution 248

Some Pitfalls with the Internal Rate of Return Rule 248

8.3 The Profitability Index 253

Capital Rationing 254

Pitfalls of the Profitability Index 254

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Contents xxvii

8.4 The Payback Rule 255

Discounted Payback 256

8.5 More Mutually Exclusive Projects 256

Problem 1: The Investment Timing Decision 257

Problem 2: The Choice between Long- and Short-Lived Equipment 258

Problem 3: When to Replace an Old Machine 260

8.6 A Last Look 261

Summary 262

Questions and Problems 263

Minicase 270

Appendix: More on the IRR Rule 271

Using the IRR to Choose between Mutually Exclusive Projects 271

Using the Modified Internal Rate of Return When There Are Multiple IRRs 271

Chapter 9 Using Discounted Cash-Flow Analysis to Make Investment Decisions 274 9.1 Identifying Cash Flows 276

Discount Cash Flows, Not Profits 276

Discount Incremental Cash Flows 278

Discount Nominal Cash Flows by the Nominal Cost of Capital 281

Separate Investment and Financing Decisions 282

9.2 Corporate Income Taxes 283

9.3 An Example—Blooper Industries 283

Forecasting Blooper’s Cash Flows 284

Calculating the NPV of Blooper’s Mine 287

Further Notes and Wrinkles Arising from Blooper’s Project 288

Summary 293

Questions and Problems 294

Minicase 302

Chapter 10 Project Analysis 304 10.1 How Firms Organize the Investment Process to Draw on

Their Competitive Strengths 306

The Capital Budget 306

Problems and Some Solutions 307

10.2 Reducing Forecast Bias 307

10.3 Some “What-If” Questions 308

Sensitivity Analysis 309

Scenario Analysis 312

10.4 Break-Even Analysis 312

Accounting Break-Even Analysis 313

NPV Break-Even Analysis 314

Operating Leverage 317

10.5 Real Options and the Value of Flexibility 319

The Option to Expand 319

A Second Real Option: The Option to Abandon 321

A Third Real Option: The Timing Option 321

A Fourth Real Option: Flexible Production Facilities 322

Summary 323

Questions and Problems 324

Minicase 330

Part Three Risk

Chapter 11 Introduction to Risk, Return, and the Opportunity Cost of Capital 332 11.1 Rates of Return: A Review 334

11.2 A Century of Capital Market History 335

Market Indexes 335

The Historical Record 335

Using Historical Evidence to Estimate Today’s Cost of Capital 338

11.3 Measuring Risk 340

Variance and Standard Deviation 340

A Note on Calculating Variance 343

Measuring the Variation in Stock Returns 343

11.4 Risk and Diversification 345

Diversification 345

Asset versus Portfolio Risk 346

Market Risk versus Specific Risk 352

11.5 Thinking about Risk 353

Message 1: Some Risks Look Big and Dangerous but Really Are Diversifiable 353

Message 2: Market Risks Are Macro Risks 354

Message 3: Risk Can Be Measured 355

Summary 356

Questions and Problems 357

Chapter 12 Risk, Return, and Capital Budgeting 362 12.1 Measuring Market Risk 364

Measuring Beta 364

Betas for Ford and PG&E 367

Total Risk and Market Risk 367

12.2 What Can You Learn from Beta? 369

Portfolio Betas 369

The Portfolio Beta Determines the Risk of a Diversified Portfolio 372

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