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Selected material from



Fundamentals of Corporate Finance
Third Edition
Richard A. Brealey
Bank of England and London Business School


Stewart C. Myers
Sloan School of Management
Massachusetts Institute of Technology


Alan J. Marcus
Wallace E. Carroll School of Management
Boston College



with additional material from

Fundamentals of Corporate Finance, Alternate Fifth Edition
Essentials of Corporate Finance, Second Edition

Stephen A. Ross, Massachusetts Institute of Technology
Randolph W. Westerfield, University of Southern California
Bradford D. Jordan, University of Kentucky




UNIVERSITY OF PHOENIX




Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. Louis
Bangkok Bogotá Caracas Lisbon London Madrid
Mexico City Milan New Delhi Seoul Singapore Sydney Taipei Toronto
Selected material from
FUNDAMENTALS OF CORPORATE FINANCE, Third Edition
with additional material from
FUNDAMENTALS OF CORPORATE FINANCE, Alternate Fifth Edition
ESSENTIALS OF CORPORATE FINANCE, Second Edition

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Printed in the United States of America. Ex-
cept as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distrib-
uted in any form or by any means, or stored in a data base retrieval system, without prior written permission of the pub-
lisher.

This book contains select material from:
Fundamentals of Corporate Finance, Third Edition by Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus. Copyright
© 2001, 1999, 1995, by The McGraw-Hill Companies, Inc.
Fundamentals of Corporate Finance, Alternate Fifth Edition by Stephen A. Ross, Randolph W. Westerfield, and Bradford D.
Jordan. Copyright © 2000, 1998, 1995, 1993, 1991 by The McGraw-Hill Companies, Inc.
Essentials of Corporate Finance, Second Edition by Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan.
Copyright © 1999 by The McGraw-Hill Companies, Inc. Previous edition © 1996 by Richard D. Irwin, a Times Mirror
Higher Education Group, Inc. company.
All reprinted with permission of the publisher.

ISBN 0-07-553109-7

Sponsoring Editor: Christian Perlee
Production Editor: Nina Meyer
Contents
1
SECTION 1
How to Value Perpetuities 50
The Firm and the Financial
How to Value Annuities 51
Manager 3 Annuities Due 54
Organizing a Business 4 Future Value of an Annuity 57
Sole Proprietorships 4
Inflation and the Time Value of Money 61
Partnerships 5
Real versus Nominal Cash Flows 61
Corporations 5
Inflation and Interest Rates 63
Hybrid Forms of Business Organization 6
Valuing Real Cash Payments 65
Real or Nominal? 67
The Role of the Financial Manager 7
The Capital Budgeting Decision 8 Effective Annual Interest Rates 67
The Financing Decision 9
Summary 69
Financial Institutions and Markets 10 Related Web Links 69
Financial Institutions 10 Key Terms 70
Financial Markets 11 Quiz 70
Other Functions of Financial Markets and Practice Problems 72
Institutions 12 Challenge Problems 75
Solutions to Self-Test Questions 77
Who Is the Financial Manager? 13
Minicase 79
Careers in Finance 15
Financial Planning 81
Goals of the Corporation 17
Shareholders Want Managers to Maximize What Is Financial Planning? 82
Market Value 17 Financial Planning Focuses on the Big Picture 83
Ethics and Management Objectives 19 Financial Planning Is Not Just Forecasting 84
Do Managers Really Maximize Firm Value? 21 Three Requirements for Effective Planning 84
Snippets of History 25
Financial Planning Models 86
Summary 25 Components of a Financial Planning Model 87
Related Web Links 28 An Example of a Planning Model 88
Key Terms 28 An Improved Model 89
Quiz 28
Planners Beware 93
Practice Problems 29
Pitfalls in Model Design 93
Solutions to Self-Test Questions 31
The Assumption in Percentage of Sales Models 94
The Time Value of Money 33 The Role of Financial Planning Models 95
Future Values and Compound Interest 34 External Financing and Growth 96
Present Values 38 Summary 100
Finding the Interest Rate 44 Related Web Links 101
Key Terms 101
Multiple Cash Flows 46
Quiz 101
Future Value of Multiple Cash Flows 46
Practice Problems 102
Present Value of Multiple Cash Flows 49
Challenge Problems 106
Level Cash Flows: Perpetuities and Annuities 50 Solutions to Self-Test Questions 106

iii
IV CONTENTS



109
APPENDIX A
Financial Statement Analysis 133
Accounting and Finance 111 Financial Ratios 134
Leverage Ratios 138
The Balance Sheet 112
Liquidity Ratios 139
Book Values and Market Values 115
Efficiency Ratios 141
The Income Statement 117
Profitability Ratios 143
Profits versus Cash Flow 118
The Du Pont System 145
The Statement of Cash Flows 119
Other Financial Ratios 146
Accounting for Differences 121
Using Financial Ratios 147
Choosing a Benchmark 147
Taxes 123
Corporate Tax 123
Measuring Company Performance 150
Personal Tax 125
The Role of Financial Ratios 151
Summary 126
Summary 153
Related Web Links 127
Related Web Links 155
Key Terms 127
Key Terms 155
Quiz 127
Quiz 155
Practice Problems 128
Practice Problems 157
Challenge Problem 131
Challenge Problem 158
Solutions to Self-Test Questions 131
Solutions to Self-Test Questions 159
Minicase 160


163
SECTION 2
Bank Loans 185
Working Capital Management and
Commercial Paper 186
Short-Term Planning 165
Secured Loans 186
Working Capital 167
The Cost of Bank Loans 187
The Components of Working Capital 167
Simple Interest 187
Working Capital and the Cash Conversion Cycle 168
Discount Interest 188
The Working Capital Trade-Off 171
Interest with Compensating Balances 189
Links between Long-Term and Short-Term
Summary 190
Financing 172
Related Web Links 191
Tracing Changes in Cash and Working Capital 175 Key Terms 191
Quiz 191
Cash Budgeting 177
Practice Problems 192
Forecast Sources of Cash 177
Challenge Problem 194
Forecast Uses of Cash 179
Solutions to Self-Test Questions 195
The Cash Balance 179
Minicase 197
A Short-Term Financing Plan 180
Cash and Inventory Management 201
Options for Short-Term Financing 180
Cash Collection, Disbursement, and Float 202
Evaluating the Plan 184
Float 203
Sources of Short-Term Financing 185
Valuing Float 204
CONTENTS V


Managing Float 205 Credit Analysis 232
Speeding Up Collections 206 Financial Ratio Analysis 233
Controlling Disbursements 209 Numerical Credit Scoring 233
Electronic Funds Transfer 210 When to Stop Looking for Clues 234

Inventories and Cash Balances 211 The Credit Decision 236
Credit Decisions with Repeat Orders 237
Managing Inventories 212
Some General Principles 238
Managing Inventories of Cash 215
Uncertain Cash Flows 216
Collection Policy 239
Cash Management in the Largest Corporations 217
Bankruptcy 240
Investing Idle Cash: The Money Market 218
Bankruptcy Procedures 241
Summary 219
The Choice between Liquidation and
Related Web Links 220
Reorganization 242
Key Terms 220
Summary 244
Quiz 220
Related Web Links 245
Practice Problems 221
Key Terms 245
Challenge Problem 224
Quiz 245
Solutions to Self-Test Questions 224
Practice Problems 246
Credit Management and Collection 227 Challenge Problems 248
Terms of Sale 229 Solutions to Self-Test Questions 249
Minicase 250
Credit Agreements 231


253
SECTION 3
Book Values, Liquidation Values, and Market
Valuing Bonds 255
Values 283
Bond Characteristics 256
Valuing Common Stocks 287
Reading the Financial Pages 257
Today™s Price and Tomorrow™s Price 287
Bond Prices and Yields 259 The Dividend Discount Model 288
How Bond Prices Vary with Interest Rates 260
Simplifying the Dividend Discount Model 291
Yield to Maturity versus Current Yield 261
The Dividend Discount Model with No Growth 291
Rate of Return 265
The Constant-Growth Dividend Discount Model 292
Interest Rate Risk 267
Estimating Expected Rates of Return 293
The Yield Curve 268
Nonconstant Growth 295
Nominal and Real Rates of Interest 268

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