PDF Finance and the Firm, An introduction to Corporate Finance, Edward W. Davis, John Pointon, Oxford Un

Finance and the Firm, An introduction to Corporate Finance, Edward W. Davis, John Pointon, Oxford University Press
453 pages

 

CONTENTS
Part I. Introduction
1. Introduction 3
How do we choose between alternative investments? 3
The Investment process 4
The concept of an investor’s required rate of return 4
How does risk affect investment criteria? 5
Can the choice of finance affect the value of the firm? 6
Recommendations for further reading 7
References 7
Part II. Investment Appraisal
Introduction to Part II 10
2. Compound Interest and Present Value
Introduction 11
The time value of money 11
Capital growth 12
Present values 13
How to determine the rate of interest 15
The investment period 15
Annuities 16
Discounting monthly, daily, and continuously 17
Conclusion 19
Exercises 19
Appendix 21
3. Net Present Value and Internal Rate of Return
Capital projects and the separation theorem 23
Example 24
Net present value and internal rate of return for a single-period investment 25
The net present value method in a multi-period setting 27
The internal rate of return in a multi-period setting 30
Multiple solutions and imaginary roots 32
Ranking problems 33
Summary 35
Recommendations for further reading 36
References 36
Exercises 37
4. Relevant Cash Flows
Introduction 38
The difference between profit and cash flow 38
Depreciation 39
Working capital 39
Accounting rate of return 44
How does this relate to the internal rate of return? 45
Cash flows beyond the payback period 46
Cash flows from lost opportunities 49
The irrelevance of sunk costs 50
Relevant cash flows when comparing assets with different life
spans 51
Summary 54
Recommendations for further reading 55
References 55
Exercises 56
Appendix 58
5. Inflation in Project Appraisal
Introduction 59
Specific inflation, general inflation, and the discount rate 59
Discounting the money cash flows 62
Discounting the real cash flows 63
Uniform rates of inflation 65
Conclusion 67
Recommendations for further reading 68
References 68
Exercises 68
6. Capital Rationing
Introduction 70
One-period constraint 71
Multi-period constraints 71
Extensions to the basic programming model 73
Summary 75
Recommendations for further reading 75
References 75
Exercises 76
7. Introduction to Risk Analysis
Introduction 78
The mean return of the project 78
The standard deviation of the project’s return 79
The risk of insolvency 81
The mean net present value and its standard deviation 83
Decision trees: how to calculate net present values when there
are sequential decisions 85
Risk-adjusted discount rates and certainty equivalents 88
Summary 90
Recommendations for further reading 91
References 91
Exercises 91
8. Risk within a Portfolio Framework
Introduction 93
The combined risk of two projects 93
Correlation between two projects 95
Finding the minimum variance of a portfolio of two securities 97
The variance of a large portfolio 98
Systematic and unsystematic risk 99
The efficient market portfolio 102
The capital asset pricing model 103
The use of the capital asset pricing model in multi-period
investments 107
Converting cash flows into certainty equivalents using the
capital asset pricing model (CAPM) 110
Limitations of the capital asset pricing model in project
appraisal 111
The traditional capital asset pricing model 112
What happens if we relax some of the assumptions? 112
Should we ignore tax? 113
Multi-period problems 113
An efficient market portfolio 113
Arbitrage pricing 114
For managers or shareholders: which risk matters? 114
Summary 115
Recommendations for further reading 117
References 117
Exercises 118
Appendices 120
9. Taxation and Project Appraisal
Introduction 122
The general effects of tax upon investment and finance 123
A cash flow tax system 124
Taxation and risk 128
Corporation tax in the UK 132
Capital allowances 132
Working capital 134
The imputation system 136
Project interactions and financing methods 138
Conclusion 138
Recommendations for further reading 139
References 140
Exercises 140
Appendix 143
10. Conclusion on Investment Appraisal
Why do we use the net present value rule? 144
Which cash flows are relevant to the project? 144
Perfect and imperfect capital markets 145
How do we take account of risk? 146
Does the theory hold in practice? 146
Part III. Financial Policy
Introduction to Part III 150
I I. Valuation of Stocks and Shares
Introduction 151
The basic share valuation model 152
A constant dividend valuation model 154
Constant growth in dividends 155
Split growth in dividends 156
Dividend growth versus capital gains 157
Earnings valuation models 158
Taxation and the cost of equity capital 162
Debenture stock: nominal and current yields 164
Summary 167
Recommendations for further reading 167
Exercises 167
Appendices . 169
12. Capital Structure
Introduction 170
The weighted average cost of capital 171
The marginal cost of capital and investment criteria 171
Should the firm’s overall cost of capital be dependent upon
its capital structure? 172
Modigliani’s and Miller’s argument upon the relevance of
debt capital 173
Capital structure and the capital asset pricing model 177
Tax and capital structure 178
Do the potential costs of bankruptcy offset the tax advantages
of debt? 183
Capital structure under imperfect markets and uncertainty:
How valid is the assumption of a perfect market? 185
Managerial motives and the use of debt 188
Agency costs arising from the reaction of capital suppliers 188
Information signalling 189
Conclusion 189
Recommendations for further reading 190
References 191
Exercises 192
13. Dividend Policy and Valuation
Introduction 194
Dividends and retained earnings: The neo-classical approach 195
Dividend policy under uncertainty: The behavioural approach 199
Dividends, taxation, and the value of the firm 200
Dividends and valuation under uncertainty: Information
signals 204
Summary 206
Recommendations for further reading 206
References 207
Exercises 207
Appendices 209
14. Conclusion on Financial Policy
Cost of capital 210
Capital structure 210
Taxation distortions in capital structure decisions 211
Other imperfections 211
Dividend policy 212
Taxation implications of dividend policy 212
Management communication 212
Part IV. Sources of Finance
Introduction to Part IV 214
15. Financial Intermediaries and Markets
Introduction 215
The creation of financial claims 216
The nature of financial transactions 217
Intermediation and asset transformation 218
An outline of financial markets 219
Forward, futures, and options markets 222
The term structure of interest rates 223
Conclusion 227
Recommendations for further reading 228
References 228
Exercises 229
16. Maturity Choice and Hedging Strategies
Introduction 230
Cash flows and capital requirements 231
Hedging policies: Maturity matching of assets and liabilities 232
Interest rate risk exposure 234
The substitution effect in corporate financing policy 235
The use of financial futures to hedge interest rate risk
exposure 236
Summary 239
Recommendations for further reading 240
References 240
Exercises 240
17. International Finance: Management of Exchange Risk
Introduction 242
Definitions of currency risk 242
The generation of transaction exposure through trade 244 Influence of interest rates and inflation upon exchange rates 246 Financial instruments available to manage transaction risk:
The use of forward currency markets 250
The significance of currency options 252
Currency options trading 254
Conclusion 259
Recommendations for further reading 260
References 260
Exercises 261
Appendix 263
18. Short-Term Borrowing
Introduction 264
Trade credit 265
Bill finance and acceptance credits 267
Money market borrowing: Commercial paper and
inter-company loans 268
Loans and overdrafts 269
Effective interest rates 270
The negotiation of ‘excess’ credit facilities 273
Hard-core overdraft borrowing 274
Factoring 275
Security 278
Summary 279
Recommendations for further reading 280
References 280
Exercise 280
19. Medium-Term Finance
Introduction 281
Term loans 281
Advantages to the borrower 283
Hire-purchase 285
Leasing 285
Operating leases 286
Contract hire 286
Financial leasing 286
Rental payment schedules 287
Rental costs 289
Leasing rentals in an equilibrium framework 290
The discount rate 291
Tax losses 292
Capital allowances 293
Residual values 296
The lessor’s implicit interest rate and the lessee’s finance
charges 296
The net present value to the lessee 296
The net present value to the lessor 297
Summary 298
Recommendations for further reading 299
References 299
Exercises 300
Appendices 301
20. Longer-Term Debt
Introduction 303
Loan capital 303
Interest costs 306
Credit rating 306
Syndicated loans and Euro-bond issues 309
Junk bonds and leveraged buy-outs 310
Preference shares 311
Conclusion 313
Recommendations for further reading 314
References 314
Exercises 314
21. Equity Capital and the Stock Exchange
Introduction 315
Ordinary shares 315
The ownership of quoted ordinary shares 318
Market channelling efficiency 319
The efficient markets theory 320
Summary 321
Recommendations for further reading 322
References 322
Exercises 323
22. Equity Finance: The New Issue Market
Introduction 324
Stock Exchange admission requirements 325
The issuing process 326
Markets in ‘unlisted’ securities 328
Method of issue 329
Underwriting 331
Costs of issue 331
Summary 336
Recommendations for further reading 337
References 337
Exercises 338
23. Rights Issues
Introduction 339
Effect on shareholder net wealth 342
Underwriting and the cost of capital 345
Capitalization issues and stock splits 348
Scrip dividends 349
Summary 350
Recommendations for further reading 350
References 350
Exercises 351
24. Convertibles and Share Options
Introduction 352
Convertibles 353
Setting the value of a convertible 353
Option pricing 356
Summary 362
Recommendations for further reading 363
References 363
Exercises 364
Part V. Mergers and Conclusion
25. Mergers and Take-overs
Introduction 369
Economic/strategic definitions of mergers and take-overs 369
Shareholder wealth maximization motives 372
Synergy 373
Market power 375
Finance for acquisitions 376
What form of consideration should be offered in making an acquisition? 378
What are the implications of financing an acquisition? 379
Take-over procedures and control in the UK 381
Summary 383
Recommendations for further reading 383
References 384
Exercises 384
26. Conclusion
Introduction 386
Assumptions of the theory of finance 386
Implications of the theory 387
Imperfections in the real world 388
Business finance and investment: The relevance of equilibrium analysis 390
Concluding remarks 391
References 392
Appendices
Appendix I 395
Appendix II 397
Appendix III 399
Appendix IV 401
Appendix V 403
Author Index 419
Subject Index 423