page i

Essentials of Corporate Finance

Eleventh Edition
Stephen A. Ross

Randolph W. Westerfield
University of Southern California

Bradford D. Jordan
University of Kentucky
 page xxii

Brief Contents

PART ONE OVERVIEW OF FINANCIAL

MANAGEMENT
1 Introduction to Financial Management 1

PART TWO UNDERSTANDING FINANCIAL

STATEMENTS AND CASH FLOW
2 Financial Statements, Taxes, and Cash Flow 24
3 Working with Financial Statements 52

PART THREE VALUATION OF FUTURE CASH

FLOWS
4 Introduction to Valuation: The Time Value of Money 100
5 Discounted Cash Flow Valuation 125

PART FOUR VALUING STOCKS AND BONDS

6 Interest Rates and Bond Valuation 169
7 Equity Markets and Stock Valuation 210

PART FIVE CAPITAL BUDGETING

8 Net Present Value and Other Investment Criteria 242
9 Making Capital Investment Decisions 279
 PART SIX RISK AND RETURN
10 Some Lessons from Capital Market History 315
11 Risk and Return 355

PART SEVEN LONG-TERM FINANCING

12 Cost of Capital 395
13 Leverage and Capital Structure 430
14 Dividends and Dividend Policy 463
15 Raising Capital 493

PART EIGHT SHORT-TERM FINANCIAL

MANAGEMENT
16 Short-Term Financial Planning 527
17 Working Capital Management 559

PART NINE TOPICS IN BUSINESS FINANCE

18 International Aspects of Financial Management 595

APPENDICES
A Mathematical Tables 622
B Key Equations 630
C Answers to Selected End-of-Chapter Problems 633
D Using the HP-10B and TI BA II Plus Financial
Calculators 637
Glossary 640
Name Index 645
Subject Index 646
 page xxiii

Contents

PART ONE OVERVIEW OF FINANCIAL

MANAGEMENT

1 Introduction to Financial Management 1

1.1 Finance: A Quick Look 2
The Five Basic Areas 2
Corporate Finance 2
Investments 2
Financial Institutions 3
International Finance 3
Fintech 3
Why Study Finance? 3
Marketing and Finance 3
Accounting and Finance 3
Management and Finance 4
Technology and Finance 4
You and Finance 5
1.2 Business Finance and the Financial Manager 6
What Is Business Finance? 6
The Financial Manager 6
 Financial Management Decisions 6
Capital Budgeting 6
Capital Structure 7
Working Capital Management 7
Conclusion 8
1.3 Forms of Business Organization 8
Sole Proprietorship 8
Partnership 8
Corporation 9
A Corporation by Another Name . . . 10
Benefit Corporation 10
1.4 The Goal of Financial Management 11
Profit Maximization 11
The Goal of Financial Management in a Corporation 11
A More General Financial Management Goal 12
Sarbanes-Oxley Act 13
1.5 The Agency Problem and Control of the Corporation 3
Agency Relationships 14
Management Goals 14
Do Managers Act in the Stockholders’ Interests? 14
Managerial Compensation 14
Control of the Firm 16
Conclusion 16
Stakeholders 16
1.6 Financial Markets and the Corporation 17
 Cash Flows to and from the Firm 17
Primary versus Secondary Markets 18
Primary Markets 18
Secondary Markets 18

Summary and Conclusions 19

Critical Thinking and Concepts Review 20
What’s on the Web? 22
CHAPTER CASE: The McGee Cake Company 23

PART TWO UNDERSTANDING FINANCIAL

STATEMENTS AND CASH FLOW

2 Financial Statements, Taxes, and Cash Flow

2.1 The Balance Sheet 25
Assets: The Left-Hand Side 25
Liabilities and Owners’ Equity: The Right-Hand Side 25
Net Working Capital 26
Liquidity 27
Debt versus Equity 27
Market Value versus Book Value 28
2.2 The Income Statement 29
GAAP and the Income Statement 30
Noncash Items 30
Time and Costs 31
Earnings Management 32
2.3 Taxes 33
Corporate Tax Rates 33
Average versus Marginal Tax Rates 34
2.4 Cash Flow 35
Cash Flow from Assets 36
Operating Cash Flow 36
Capital Spending 37
Change in Net Working Capital 37
Conclusion 37
A Note on “Free” Cash Flow 38

page xxiv

Cash Flow to Creditors and Stockholders 38

Cash Flow to Creditors 38
Cash Flow to Stockholders 38
Conclusion 39
An Example: Cash Flows for Dole Cola 39
Operating Cash Flow 39
Net Capital Spending 40
Change in NWC and Cash Flow from Assets 40
Cash Flow to Creditors and Stockholders 40

Summary and Conclusions 41

Chapter Review and Self-Test Problem 42
Answer to Chapter Review and Self-Test Problem 43
Critical Thinking and Concepts Review 44
 Questions and Problems 45
What’s on the Web? 49
Excel Master It! Problem 50
CHAPTER CASE: Cash Flows and Financial Statements
at Sunset Boards, Inc. 51

3 Working with Financial Statements 52

3.1 Standardized Financial Statements 53
Common-Size Balance Sheets 54
Common-Size Income Statements 55
3.2 Ratio Analysis 56
Short-Term Solvency, or Liquidity, Measures 57
Current Ratio 57
Quick (or Acid-Test) Ratio 58
Cash Ratio 58
Long-Term Solvency Measures 59
Total Debt Ratio 59
Times Interest Earned 59
Cash Coverage 60
Asset Management, or Turnover, Measures 60
Inventory Turnover and Days’ Sales in Inventory 60
Receivables Turnover and Days’ Sales in Receivables 61
Total Asset Turnover 62
Profitability Measures 62
Profit Margin 62
 Return on Assets 63
Return on Equity 63
Market Value Measures 63
Price-Earnings Ratio 63
Price-Sales Ratio 64
Market-to-Book Ratio 65
Enterprise Value-EBITDA Ratio 65
3.3 The DuPont Identity 67
An Expanded DuPont Analysis 68
3.4 Internal and Sustainable Growth 70
Dividend Payout and Earnings Retention 70
ROA, ROE, and Growth 71
The Internal Growth Rate 71
The Sustainable Growth Rate 71
Determinants of Growth 72
A Note on Sustainable Growth Rate Calculations 74
3.5 Using Financial Statement Information 74
Why Evaluate Financial Statements? 74
Internal Uses 75
External Uses 75
Choosing a Benchmark 75
Time-Trend Analysis 75
Peer Group Analysis 76
Problems with Financial Statement Analysis 82

Summary and Conclusions 83

 Chapter Review and Self-Test Problems 84
Answers to Chapter Review and Self-Test Problems 86
Critical Thinking and Concepts Review 87
Questions and Problems 88
What’s on the Web? 96
Excel Master It! Problem 97
CHAPTER CASE: Ratios and Financial Planning at S&S
Air, Inc. 98

PART THREE VALUATION OF FUTURE CASH

FLOWS

4 Introduction to Valuation: The Time Value of

Money 100
4.1 Future Value and Compounding 101
Investing for a Single Period 101
Investing for More Than One Period 101
4.2 Present Value and Discounting 107
The Single-Period Case 108
Present Values for Multiple Periods 108
4.3 More on Present and Future Values 111
Present versus Future Value 111
Determining the Discount Rate 112
Finding the Number of Periods 115

Summary and Conclusions 118

 Chapter Review and Self-Test Problems 119
Answers to Chapter Review and Self-Test Problems 119
Critical Thinking and Concepts Review 120
Questions and Problems 121
What’s on the Web? 124
Excel Master It! Problem 124

page xxv

5 Discounted Cash Flow Valuation 125

5.1 Future and Present Values of Multiple Cash Flows 126
Future Value with Multiple Cash Flows 126
Present Value with Multiple Cash Flows 129
A Note on Cash Flow Timing 133
5.2 Valuing Level Cash Flows: Annuities and Perpetuities
134
Present Value for Annuity Cash Flows 135
Annuity Tables 136
Finding the Payment 137
Finding the Rate 139
Future Value for Annuities 140
A Note on Annuities Due 140
Perpetuities 141
5.3 Comparing Rates: The Effect of Compounding Periods
143
Effective Annual Rates and Compounding 143
 Calculating and Comparing Effective Annual Rates 144
EARs and APRs 145
EARs, APRs, Financial Calculators, and Spreadsheets 147
5.4 Loan Types and Loan Amortization 148
Pure Discount Loans 148
Interest-Only Loans 148
Amortized Loans 149

Summary and Conclusions 153

Chapter Review and Self-Test Problems 154
Answers to Chapter Review and Self-Test Problems 155
Critical Thinking and Concepts Review 157
Questions and Problems 157
What’s on the Web? 165
Excel Master It! Problem 166
CHAPTER CASE: S&S Air’s Mortgage 167

PART FOUR VALUING STOCKS AND BONDS

6 Interest Rates and Bond Valuation 169

6.1 Bonds and Bond Valuation 170
Bond Features and Prices 170
Bond Values and Yields 170
Interest Rate Risk 173
Finding the Yield to Maturity: More Trial and Error 175
6.2 More on Bond Features 179
 Is It Debt or Equity? 180
Long-Term Debt: The Basics 180
The Indenture 181
Terms of a Bond 182
Security 182
Seniority 183
Repayment 183
The Call Provision 183
Protective Covenants 184
6.3 Bond Ratings 184
6.4 Some Different Types of Bonds 186
Government Bonds 186
Zero Coupon Bonds 187
Floating-Rate Bonds 188
Other Types of Bonds 189
Sukuk 189
6.5 Bond Markets 191
How Bonds Are Bought and Sold 191
Bond Price Reporting 191
A Note on Bond Price Quotes 194
6.6 Inflation and Interest Rates 194
Real versus Nominal Rates 194
The Fisher Effect 195
6.7 Determinants of Bond Yields 196
The Term Structure of Interest Rates 196
 Bond Yields and the Yield Curve: Putting It All Together 199
Conclusion 200

Summary and Conclusions 200

Chapter Review and Self-Test Problems 201
Answers to Chapter Review and Self-Test Problems 201
Critical Thinking and Concepts Review 202
Questions and Problems 203
What’s on the Web? 207
Excel Master It! Problem 208
CHAPTER CASE: Financing S&S Air’s Expansion Plans
with a Bond Issue 209

7 Equity Markets and Stock Valuation 210

7.1 Common Stock Valuation 211
Cash Flows 211
Some Special Cases 212
Zero Growth 213
Constant Growth 213
Nonconstant Growth 216

page xxvi

Components of the Required Return 218

Stock Valuation Using Comparables, or Comps 219
7.2 Some Features of Common and Preferred Stock 221
Common Stock Features 221
 Shareholder Rights. 221
Proxy Voting 223
Classes of Stock 223
Other Rights 224
Dividends 224
Preferred Stock Features 224
Stated Value 225
Cumulative and Noncumulative Dividends 225
Is Preferred Stock Really Debt? 225
7.3 The Stock Markets 225
Dealers and Brokers 226
Organization of the NYSE 226
Members 226
Operations 227
Floor Activity 228
Nasdaq Operations 229
ECNs 229
Stock Market Reporting 232

Summary and Conclusions 233

Chapter Review and Self-Test Problems 233
Answers to Chapter Review and Self-Test Problems 234
Critical Thinking and Concepts Review 234
Questions and Problems 235
What’s on the Web? 240
Excel Master It! Problem 240
 CHAPTER CASE: Stock Valuation at Ragan, Inc. 241

PART FIVE CAPITAL BUDGETING

8 Net Present Value and Other Investment Criteria

242
8.1 Net Present Value 243
The Basic Idea 243
Estimating Net Present Value 244
8.2 The Payback Rule 247
Defining the Rule 247
Analyzing the Rule 248
Redeeming Qualities of the Rule 249
Summary of the Rule 250
8.3 The Average Accounting Return 250
8.4 The Internal Rate Of Return 253
Problems with the IRR 256
Nonconventional Cash Flows 256
Mutually Exclusive Investments 258
Redeeming Qualities of the IRR 260
The Modified Internal Rate of Return (MIRR) 260
Method 1: The Discounting Approach 260
Method 2: The Reinvestment Approach 261
Method 3: The Combination Approach 261
MIRR or IRR: Which Is Better? 261
8.5 The Profitability Index 262
8.6 The Practice Of Capital Budgeting 263

Summary and Conclusions 265

Chapter Review and Self-Test Problems 266
Answers to Chapter Review and Self-Test Problems 266
Critical Thinking and Concepts Review 267
Questions and Problems 270
What’s on the Web? 276
Excel Master It! Problem 276
CHAPTER CASE: Bullock Gold Mining 278

9 Making Capital Investment Decisions 279

9.1 Project Cash Flows: A First Look 280
Relevant Cash Flows 280
The Stand-Alone Principle 280
9.2 Incremental Cash Flows 281
Sunk Costs 281
Opportunity Costs 281
Side Effects 282
Net Working Capital 282
Financing Costs 282
Other Issues 283
9.3 Pro Forma Financial Statements and Project Cash
Flows 283
Getting Started: Pro Forma Financial Statements 283
 Project Cash Flows 284
Project Operating Cash Flow 284
Project Net Working Capital and Capital Spending 285
Projected Total Cash Flow and Value 285
The Tax Shield Approach 286
9.4 More on Project Cash Flow 287
A Closer Look at Net Working Capital 287
Depreciation 288

page xxvii

Modified ACRS (MACRS) Depreciation 289

Bonus Depreciation 290
Book Value versus Market Value 290
An Example: The Majestic Mulch and Compost Company
(MMCC) 291
Operating Cash Flows 292
Changes in NWC 292
Capital Spending 293
Total Cash Flow and Value 293
Conclusion 295
9.5 Evaluating NPV Estimates 295
The Basic Problem 295
Forecasting Risk 296
Sources of Value 297
9.6 Scenario and Other What-If Analyses 297
 Getting Started 297
Scenario Analysis 298
Sensitivity Analysis 300
9.7 ADDITIONAL CONSIDERATIONS IN CAPITAL
BUDGETING 301
Managerial Options and Capital Budgeting 301
Contingency Planning 302
Strategic Options 303
Conclusion 303
Capital Rationing 304
Soft Rationing 304
Hard Rationing 304

Summary and Conclusions 305

Chapter Review and Self-Test Problems 305
Answers to Chapter Review and Self-Test Problems 306
Critical Thinking and Concepts Review 307
Questions and Problems 308
Excel Master It! Problem 313
CHAPTER CASE: Conch Republic Electronics 314

PART SIX RISK AND RETURN

10 Some Lessons from Capital Market History 315

10.1 Returns 316
Dollar Returns 316
 Percentage Returns 318
10.2 The Historical Record 320
A First Look 321
A Closer Look 321
10.3 Average Returns: The First Lesson 326
Calculating Average Returns 326
Average Returns: The Historical Record 326
Risk Premiums 326
The First Lesson 327
10.4 The Variability of Returns: The Second Lesson 328
Frequency Distributions and Variability 328
The Historical Variance and Standard Deviation 328
The Historical Record 331
Normal Distribution 332
The Second Lesson 333
2008: The Bear Growled and Investors Howled 334
Using Capital Market History 336
More on the Stock Market Risk Premium 336
10.5 More on Average Returns 339
Arithmetic versus Geometric Averages 339
Calculating Geometric Average Returns 339
Arithmetic Average Return or Geometric Average Return?
341
10.6 Capital Market Efficiency 342
Price Behavior in an Efficient Market 342
 The Efficient Markets Hypothesis 343
Some Common Misconceptions about the EMH 344
The Forms of Market Efficiency 345

Summary and Conclusions 346

Chapter Review and Self-Test Problems 346
Answers to Chapter Review and Self-Test Problems 347
Critical Thinking and Concepts Review 347
Questions and Problems 348
What’s on the Web? 352
Excel Master It! Problem 352
CHAPTER CASE: A Job at S&S Air 353

11 Risk and Return 355

11.1 Expected Returns and Variances 356
Expected Return 356
Calculating the Variance 358
11.2 Portfolios 360
Portfolio Weights 360
Portfolio Expected Returns 360
Portfolio Variance 362
11.3 Announcements, Surprises, and Expected Returns 363
Expected and Unexpected Returns 363
Announcements and News 364

page xxviii
11.4 Risk: Systematic and Unsystematic 365
Systematic and Unsystematic Risk 366
Systematic and Unsystematic Components of Return 366
11.5 Diversification and Portfolio Risk 367
The Effect of Diversification: Another Lesson from Market
History 367
The Principle of Diversification 368
Diversification and Unsystematic Risk 369
Diversification and Systematic Risk 369
11.6 Systematic Risk and Beta 370
The Systematic Risk Principle 370
Measuring Systematic Risk 370
Portfolio Betas 373
11.7 The Security Market Line 374
Beta and the Risk Premium 374
The Reward-to-Risk Ratio 375
The Basic Argument 376
The Fundamental Result 377
The Security Market Line 379
Market Portfolios 379
The Capital Asset Pricing Model 379
11.8 The SML and the Cost of Capital: a Preview 381
The Basic Idea 381
The Cost of Capital 382

Summary and Conclusions 382

 Chapter Review and Self-Test Problems 383
Answers to Chapter Review and Self-Test Problems 384
Critical Thinking and Concepts Review 385
Questions and Problems 387
What’s on the Web? 391
Excel Master It! Problem 392
CHAPTER CASE: The Beta for FLIR Systems 394

PART SEVEN LONG-TERM FINANCING

12 Cost of Capital 395

12.1 The Cost of Capital: Some Preliminaries 396
Required Return versus Cost of Capital 396
Financial Policy and Cost of Capital 397
12.2 The Cost of Equity 398
The Dividend Growth Model Approach 398
Implementing the Approach 398
Estimating g 398
Advantages and Disadvantages of the Approach 399
The SML Approach 400
Implementing the Approach 400
Advantages and Disadvantages of the Approach 401
12.3 The Costs of Debt and Preferred Stock 401
The Cost of Debt 402
The Cost of Preferred Stock 402
12.4 The Weighted Average Cost of Capital 403
The Capital Structure Weights 403
Taxes and the Weighted Average Cost of Capital 404
Solving the Warehouse Problem and Similar Capital
Budgeting Problems 406
Calculating the WACC for Eastman Chemical 407
Eastman’s Cost of Equity 409
Eastman’s Cost of Debt 410
Eastman’s WACC 413
12.5 Divisional and Project Costs of Capital 413
The SML and the WACC 414
Divisional Cost of Capital 415
The Pure Play Approach 415
The Subjective Approach 416
12.6 Company Valuation With The WACC 417

Summary and Conclusions 420

Chapter Review and Self-Test Problems 420
Answers to Chapter Review and Self-Test Problems 420
Critical Thinking and Concepts Review 421
Questions and Problems 422
What’s on the Web? 428
Excel Master It! Problem 428
CHAPTER CASE: Cost of Capital for Master Tools 429

13 Leverage and Capital Structure 430

13.1 The Capital Structure Question 431
13.2 The Effect of Financial Leverage 432
The Impact of Financial Leverage 432
Financial Leverage, EPS, and ROE: An Example 432
EPS versus EBIT 433
Corporate Borrowing and Homemade Leverage 435
13.3 Capital Structure and The Cost of Equity Capital 437
M&M Proposition I: The Pie Model 437
The Cost of Equity and Financial Leverage: M&M Proposition
II 437
Business and Financial Risk 439
13.4 Corporate Taxes and Capital Structure 440
The Interest Tax Shield 440
Taxes and M&M Proposition I 441
Conclusion 441

page xxix

13.5 Bankruptcy Costs 443

Direct Bankruptcy Costs 443
Indirect Bankruptcy Costs 443
13.6 Optimal Capital Structure 444
The Static Theory of Capital Structure 444
Optimal Capital Structure and the Cost of Capital 445
Capital Structure: Some Managerial Recommendations 447
Taxes 447
 Financial Distress 447
13.7 Observed Capital Structures 448
13.8 A Quick Look at The Bankruptcy Process 450
Liquidation and Reorganization 450
Bankruptcy Liquidation 450
Bankruptcy Reorganization 451
Financial Management and the Bankruptcy Process 452
Agreements to Avoid Bankruptcy 454

Summary and Conclusions 455

Chapter Review and Self-Test Problems 455
Answers to Chapter Review and Self-Test Problems 456
Critical Thinking and Concepts Review 456
Questions and Problems 457
What’s on the Web? 461
Excel Master It! Problem 461
CHAPTER CASE: Stephenson Real Estate
Recapitalization 462

14 Dividends and Dividend Policy 463

14.1 Cash Dividends and Dividend Payment 464
Cash Dividends 464
Standard Method of Cash Dividend Payment 465
Dividend Payment: A Chronology 465
More on the Ex-Dividend Date 466
14.2 Does Dividend Policy Matter? 468
 An Illustration of the Irrelevance of Dividend Policy 468
Current Policy: Dividends Set Equal to Cash Flow 468
Alternative Policy: Initial Dividend Greater Than Cash
Flow 468
A Test 469
Some Real-World Factors Favoring a Low Payout 469
Taxes 469
Flotation Costs 470
Dividend Restrictions 470
Some Real-World Factors Favoring a High Payout 470
Desire for Current Income 470
Tax and Legal Benefits from High Dividends 471
Clientele Effects: A Resolution of Real-World Factors? 471
14.3 Stock Repurchases: An Alternative to Cash Dividends
472
Cash Dividends versus Repurchase 474
Real-World Considerations in a Repurchase 475
Share Repurchase and EPS 476
14.4 What We Know And Do Not Know About Dividend and
Payout Policies 477
Dividends and Dividend Payers 477
Corporations Smooth Dividends 480
Putting It All Together 480
Some Survey Evidence on Dividends 482
14.5 Stock Dividends and Stock Splits 483
Value of Stock Splits and Stock Dividends 484
 The Benchmark Case 484
Popular Trading Range 484
Reverse Splits 484

Summary and Conclusions 485

Chapter Review and Self-Test Problems 486
Answer to Chapter Review and Self-Test Problem 487
Critical Thinking and Concepts Review 487
Questions and Problems 488
What’s on the Web? 491
CHAPTER CASE: Electronic Timing, Inc. 492

15 Raising Capital 493

15.1 The Financing Life Cycle of A Firm: Early-Stage
Financing and Venture Capital 494
Entrepreneurship 494
Venture Capital 494
Stages of Financing 495
Some Venture Capital Realities 497
Venture Capital Firms 498
Crowdfunding 499
Initial Coin Offerings 500
Conclusion 500
15.2 Selling Securities to the Public: The Basic Procedure
501
15.3 Alternative Issue Methods 503
15.4 Underwriters 504
Choosing an Underwriter 504
Types of Underwriting 504
Firm Commitment Underwriting 504
Best Efforts Underwriting 505
Dutch Auction Underwriting 505
The Green Shoe Provision 506
The Aftermarket 506
Lockup Agreements 506
The Quiet Period 507
Direct Listing 507
Special-purpose acquisition companies 507

page xxx

15.5 IPOs and Underpricing 508

Evidence on Underpricing 508
IPO Underpricing: The 1999–2000 Experience 510
The Partial Adjustment Phenomenon 513
Why Does Underpricing Exist? 514
15.6 New Equity Sales and the Value of The Firm 516
15.7 The Cost of Issuing Securities 516
15.8 Issuing Long-Term Debt 519
15.9 Shelf Registration 519

Summary and Conclusions 520

 Chapter Review and Self-Test Problems 521
Answer to Chapter Review and Self-Test Problem 521
Critical Thinking and Concepts Review 522
Questions and Problems 524
What’s on the Web? 525
CHAPTER CASE: S&S Air Goes Public 526

PART EIGHT SHORT-TERM FINANCIAL

MANAGEMENT

16 Short-Term Financial Planning 527

16.1 Tracing Cash and Net Working Capital 528
16.2 The Operating Cycle and the Cash Cycle 530
Defining the Operating and Cash Cycles 530
The Operating Cycle 530
The Cash Cycle 531
The Operating Cycle and the Firm’s Organizational Chart
531
Calculating the Operating and Cash Cycles 532
The Operating Cycle 533
The Cash Cycle 533
Interpreting the Cash Cycle 534
16.3 Some Aspects of Short-Term Financial Policy 536
The Size of the Firm’s Investment in Current Assets 536
Alternative Financing Policies for Current Assets 538
Which Financing Policy Is Best? 540
 Current Assets and Liabilities in Practice 541
16.4 The Cash Budget 542
Sales and Cash Collections 542
Cash Outflows 543
The Cash Balance 543
16.5 Short-Term Borrowing 545
Unsecured Loans 545
Secured Loans 545
Accounts Receivable Financing 545
Other Sources 546
16.6 A Short-Term Financial Plan 547

Summary and Conclusions 548

Chapter Review and Self-Test Problems 548
Answers to Chapter Review and Self-Test Problems 549
Critical Thinking and Concepts Review 550
Questions and Problems 551
What’s on the Web? 557
Excel Master It! Problem 557
CHAPTER CASE: Piepkorn Manufacturing Working
Capital Management, Part 1 558

17 Working Capital Management 559

17.1 Float and Cash Management 559
Reasons for Holding Cash 560
The Speculative and Precautionary Motives 560
 The Transaction Motive 560
Benefits of Holding Cash 560
Understanding Float 561
Disbursement Float 561
Collection Float and Net Float 561
Float Management 562
Ethical and Legal Questions 563
Electronic Data Interchange and Check 21: The End of
Float? 563
17.2 Cash Management: Collection, Disbursement, and
Investment 564
Cash Collection and Concentration 564
Components of Collection Time 564
Cash Collection 565
Lockboxes 565
Cash Concentration 565
Managing Cash Disbursements 566
Increasing Disbursement Float 566
Controlling Disbursements 567
Investing Idle Cash 568
Temporary Cash Surpluses 568
Characteristics of Short-Term Securities 569
Some Different Types of Money Market Securities 570
17.3 Credit and Receivables 571
Components of Credit Policy 571
Terms of Sale 572
 The Basic Form 572
The Credit Period 572

page xxxi

Cash Discounts 573

Optimal Credit Policy 575
The Total Credit Cost Curve 575
Organizing the Credit Function 575
Credit Analysis 576
Credit Information 576
Credit Evaluation and Scoring 577
Collection Policy 577
Monitoring Receivables 577
Collection Effort 578
17.4 Inventory Management 579
The Financial Manager and Inventory Policy 579
Inventory Types 579
Inventory Costs 580
17.5 Inventory Management Techniques 580
The ABC Approach 580
The Economic Order Quantity Model 581
Inventory Depletion 582
Carrying Costs 582
Shortage Costs 583
Total Costs 583
 Extensions to the EOQ Model 585
Safety Stocks 585
Reorder Points 585
Managing Derived-Demand Inventories 585
Materials Requirements Planning 586
Just-in-Time Inventory 586

Summary and Conclusions 588

Chapter Review and Self-Test Problems 588
Answers to Chapter Review and Self-Test Problems 589
Critical Thinking and Concepts Review 589
Questions and Problems 591
What’s on the Web? 593
CHAPTER CASE: Piepkorn Manufacturing Working
Capital Management, Part 2 594

PART NINE TOPICS IN BUSINESS FINANCE

18 International Aspects of Financial Management

595
18.1 TERMINOLOGY 596
18.2 FOREIGN EXCHANGE MARKETS AND EXCHANGE
RATES 597
Exchange Rates 598
Exchange Rate Quotations 599
Cross-Rates and Triangle Arbitrage 599
Types of Transactions 601
18.3 PURCHASING POWER PARITY 602
Absolute Purchasing Power Parity 602
Relative Purchasing Power Parity 604
The Basic Idea 604
The Result 605
Currency Appreciation and Depreciation 606
18.4 EXCHANGE RATES AND INTEREST RATES 606
Covered Interest Arbitrage 606
Interest Rate Parity 607
18.5 EXCHANGE RATE RISK 608
Short-Run Exposure 609
Long-Run Exposure 609
Translation Exposure 610
Managing Exchange Rate Risk 611
18.6 POLITICAL RISK 611
The Tax Cuts and Jobs Act 612
Managing Political Risk 612

Summary and Conclusions 613

Chapter Review and Self-Test Problems 614
Answers to Chapter Review and Self-Test Problems 614
Critical Thinking and Concepts Review 615
Questions and Problems 617
What’s on the Web? 619
Excel Master It! Problem 620
CHAPTER CASE: S&S Air Goes International 621
Appendix A Mathematical Tables 622
Appendix B Key Equations 630
Appendix C Answers to Selected End-of-Chapter
Problems 633
Appendix D Using the HP-10B and TI BA II Plus Financial
Calculators 637

Glossary 640
Name Index 645
Subject Index 646