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Corporate Finance and Investment

Corporate Finance and Investment

Richard Pike | Bill Neale | Philip Linsley | Saeed Akbar

(2018)

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Book Details

Abstract

Corporate Finance and Investment

Table of Contents

Section Title Page Action Price
Cover Cover
Title Page iii
Copyright Page iv
Brief Contents v
Contents vii
List of figures and tables xii
Preface xv
Authors’ acknowledgements xix
Publisher’s acknowledgements xx
Part I A FRAMEWORK FOR FINANCIAL DECISIONS 1
Chapter 1 An overview of financial management 3
1.1 Introduction 4
1.2 The finance function 5
1.3 Investment and financial decisions 6
1.4 Cash – the lifeblood of the business 7
1.5 The emergence of financial management 8
1.6 The finance department in the firm 9
1.7 The financial objective 10
1.8 The agency problem 12
1.9 Managing the agency problem 12
1.10 Social responsibility and shareholder wealth 13
1.11 The corporate governance debate 14
1.12 The risk dimension 16
1.13 The strategic dimension 17
Summary 19
Key points 19
Further reading 20
Useful websites 20
Questions 21
Chapter 2 The financial environment 23
2.1 Introduction 24
2.2 Financial markets 24
2.3 The financial services sector 26
2.4 The London Stock Exchange (LSE) 31
2.5 Are financial markets efficient? 33
2.6 Reading the financial pages 38
2.7 Taxation and financial decisions 40
Summary 40
Key points 40
Further reading 41
Useful websites 41
Appendix: Financial statement analysis 41
Questions 50
Chapter 3 Present values, and bond and share valuation 53
3.1 Introduction 54
3.2 Measuring Wealth 54
3.3 Time-value of money 54
3.4 Financial arithmetic for capital growth 55
3.5 Present value 57
3.6 Present value arithmetic 61
3.7 Valuing bonds 64
3.8 Valuing shares: the dividend valuation model 67
3.9 Problems with the dividend growth model 69
Summary 71
Key points 71
Further reading 72
Useful websites 72
Appendix I: The term structure of interest rates and the yield curve 72
Appendix II: Present value formulae 75
Appendix III: The P:E ratio and the constant dividend valuation model 76
Questions 78
Part II INVESTMENT DECISIONS AND STRATEGIES 81
Chapter 4 Investment appraisal methods 83
4.1 Introduction 84
4.2 Cash-flow analysis 84
4.3 Net present value 85
4.4 Investment techniques – net present value 89
4.5 Internal rate of return 91
4.6 Profitability index 93
4.7 Payback period 94
4.8 Accounting rate of return 95
4.9 Ranking mutually exclusive projects 96
4.10 Investment evaluation and capital rationing 99
Summary 103
Key points 103
Further reading 104
Appendix I: Modified IRR 104
Appendix II: Multi-period capital rationing and mathematical programming 105
Questions 109
Chapter 5 Project appraisal – applications 112
5.1 Introduction 113
5.2 Incremental cash-flow analysis 113
5.3 Replacement decisions 116
5.4 Inflation cannot be ignored 118
5.5 Taxation is a cash flow 120
5.6 Use of DCF techniques 123
5.7 Traditional appraisal methods 125
Summary 129
Key points 129
Further reading 129
Appendix: The problem of unequal lives: Poulter plc 130
Questions 132
Chapter 6 Investment strategy and process 139
6.1 Introduction 140
6.2 Strategic considerations 140
6.3 Advanced manufacturing technology (AMT) investment 143
6.4 Environmental aspects of investment 146
6.5 The capital investment process 147
6.6 Post-auditing 152
Summary 154
Key points 154
Further reading 155
Questions 156
Part III VALUE, RISK AND THE REQUIRED RETURN 157
Chapter 7 Analysing investment risk 159
7.1 Introduction 160
7.2 Expected net present value (ENPV): Betterway plc 161
7.3 Attitudes to risk 161
7.4 Types of risk 163
7.5 Measurement of risk 164
7.6 Risk description techniques 168
7.7 Adjusting the NPV formula for risk 172
7.8 Risk analysis in practice 174
7.9 Capital investment options 175
Summary 179
Key points 179
Further reading 180
Appendix: Multi-period cash flows and risk 180
Questions 183
Chapter 8 Relationships between investments: portfolio theory 187
8.1 Introduction 188
8.2 Portfolio analysis: the basic principles 189
8.3 How to measure portfolio risk 190
8.4 Portfolio analysis where risk and return differ 193
8.5 Different degrees of correlation 195
8.6 Worked example: gerrybild plc 197
8.7 Portfolios with more than two components 199
8.8 Can we use this for project appraisal? some reservations 201
Summary 202
Key points 203
Further reading 203
Questions 204
Chapter 9 Setting the risk premium: the Capital Asset Pricing Model (CAPM) 206
9.1 Introduction 207
9.2 Security valuation and discount rates 207
9.3 Concepts of risk and return 208
9.4 International portfolio diversification 212
9.5 Systematic risk 215
9.6 Completing the model 219
9.7 Using the CAPM: assessing the required return 221
9.8 Worked example 226
9.9 The underpinnings of the CAPM 227
9.10 Portfolios with many components: the capital market line 228
9.11 How it all fits together: the key relationships 230
9.12 Reservations about the CAPM 232
9.13 Testing the CAPM 233
9.14 Factor models 234
9.15 The Arbitrage Pricing Theory 236
9.16 Fama and French’s three-factor model 237
9.17 The four- and five-factor models 238
9.18 Issues raised by the CAPM: some food for managerial thought 239
Summary 241
Key points 242
Further reading 242
Appendix: Analysis of variance 243
Questions 245
Chapter 10 The required rate of return on investment 247
10.1 Introduction 248
10.2 The required return in all-equity firms: the DGM 248
10.3 The required return in all-equity firms: the CAPM 252
10.4 Using ‘tailored’ discount rates 254
10.5 Worked example: Tieko plc 261
10.6 Another problem: taxation and the CAPM 262
10.7 Problems with ‘tailored’ discount rates 263
10.8 A critique of divisional hurdle rates 264
Summary 266
Key points 266
Further reading 266
Questions 267
Chapter 11 Enterprise value and equity value 270
11.1 Introduction 271
11.2 The valuation problem 271
11.3 Valuation using published accounts 272
11.4 Valuing the earnings stream: P:E ratios 278
11.5 EBITDA – a halfway house 280
11.6 Valuing cash flows 282
11.7 The DCF approach 284
11.8 Valuation of unquoted companies 287
11.9 Shareholder value analysis 288
11.10 Using value drivers 290
11.11 Worked example: Safa plc 291
11.12 Economic Value Added (EVA) 294
Summary 295
Key points 296
Further reading 296
Questions 297
Chapter 12 Identifying and valuing options 302
12.1 Introduction 303
12.2 Share options 303
12.3 Option pricing 311
12.4 Application of option theory to corporate finance 318
12.5 Capital investment options (real options) 319
12.6 Why conventional NPV may not tell the whole story 321
Summary 322
Key points 323
Further reading 323
Useful websites 323
Appendix: Black–scholes option pricing formula 324
Questions 325
Part IV SHORT-TERM FINANCING AND POLICIES 327
Chapter 13 Risk and treasury management 329
13.1 Introduction 330
13.2 The treasury function 330
13.3 Funding 332
13.4 How firms can use the yield curve 335
13.5 Banking relationships 336
13.6 Treasury risk management 337
13.7 Risk management 347
Summary 353
Key points 353
Further reading 353
Useful websites 353
Questions 354
Chapter 14 Working capital and short-term asset management 355
14.1 Introduction 356
14.2 Working capital management 356
14.3 Predicting corporate failure 357
14.4 Cash operating cycle 359
14.5 Working capital policy 360
14.6 Overtrading problems 364
14.7 Managing trade credit 366
14.8 Inventory management 374
14.9 Cash management 379
14.10 Worked example: mangle ltd 382
14.11 Cash management models 384
Summary 385
Key points 386
Further reading 386
Useful websites 386
Appendix: Miller–Orr cash management model 387
Questions 389
Chapter 15 Short- and medium-term finance 396
15.1 Introduction 397
15.2 Trade credit 397
15.3 Bank credit facilities 399
15.4 Invoice finance (or ‘asset-based finance’) 403
15.5 Using the money market: bill finance 406
15.6 Hire Purchase (HP) 408
15.7 Leasing 410
15.8 Lease evaluation: a simple case 413
15.9 Motives for leasing 416
15.10 Allowing for corporation tax in lease evaluation 418
15.11 Worked example of leasing to include taxation: Porlock plc 420
15.12 Policy implications: when should firms lease? 422
Summary 423
Key points 423
Further reading 424
Appendix: Financing international trade 424
Questions 428
Part V STRATEGIC FINANCIAL DECISIONS 431
Chapter 16 Long-term finance 433
16.1 Introduction 434
16.2 Guiding lights: corporate aims and corporate finance 434
16.3 How companies raise long-term finance in practice 436
16.4 Shareholders’ funds 436
16.5 How unquoted firms can raise equity finance 439
16.6 Worked example: YZ and VCI 443
16.7 Going public 446
16.8 Equity issues by quoted companies 449
16.9 Debt instruments: debentures, bonds and notes 457
16.10 Leasing and sale-and-leaseback (SAL) 470
16.11 Islamic finance 472
Summary 474
Key points 474
Further reading 475
Questions 476
Chapter 17 Returning value to shareholders: the dividend decision 480
17.1 Introduction 481
17.2 The strategic dimension 483
17.3 The legal dimension 484
17.4 The theory: dividend policy and firm value 484
17.5 Objections to dividend irrelevance 492
17.6 The information content of dividends: Dividend smoothing 497
17.7 Worked example 498
17.8 Alternatives to cash dividends 500
17.9 The dividend puzzle 505
17.10 Conclusions 507
Summary 509
Key points 509
Further reading 509
Appendix: Home-made dividends 510
Questions 512
Chapter 18 Capital structure and the required return 515
18.1 Introduction 516
18.2 Measures of gearing 517
18.3 Operating and financial gearing 522
18.4 Financial gearing and risk: Lindley plc 524
18.5 The ‘traditional’ view of gearing and the required return 528
18.6 The cost of debt 531
18.7 The overall cost of capital 533
18.8 Worked example: damstar plc 536
18.9 More on Economic Value Added (EVA) 539
18.10 Financial distress 539
18.11 Two more issues: signalling and agency costs 543
18.12 Conclusions 543
Summary 545
Key points 545
Further reading 545
Appendix: Credit ratings 546
Questions 547
Chapter 19 Does capital structure really matter? 551
19.1 Introduction 552
19.2 The Modigliani–Miller message 552
19.3 MM’s propositions 554
19.4 Does it work? Impediments to arbitrage 557
19.5 MM with corporate income tax 558
19.6 Capital structure theory and the CAPM 561
19.7 Linking the Betas: ungearing and re-gearing 564
19.8 MM with financial distress 565
19.9 Calculating the WACC 567
19.10 The Adjusted Present Value Method (APV) 570
19.11 Worked example: Rigton plc 571
19.12 Further issues with the APV 572
19.13 Which discount rate should we use? 573
19.14 Valuation of a geared firm 573
19.15 Performance evaluation in a geared firm: The EVA revisited 575
Summary 575
Key points 576
Further reading 577
Appendix I: Derivation of MM’s Proposition II 577
Appendix II: MM’s Proposition III: The cut-off rate for new investment 578
Appendix III: Allowing for personal taxation: Miller’s revision 578
Questions 580
Chapter 20 Acquisitions and re-structuring 585
20.1 Introduction 586
20.2 Takeover activity 587
20.3 Motives for takeover 592
20.4 Alternative bid terms 598
20.5 Evaluating a bid: the expected gains from takeovers 600
20.6 Worked example: ML plc and CO plc 601
20.7 The importance of strategy 603
20.8 The strategic approach 604
20.9 Post-merger activities 609
20.10 Assessing the impact of mergers 612
20.11 Value gaps 620
20.12 Corporate restructuring 623
20.13 Private equity 628
Summary 632
Key points 632
Further reading 633
Questions 634
Part VI INTERNATIONAL FINANCIAL MANAGEMENT 641
Chapter 21 Managing currency risk 643
21.1 Introduction 644
21.2 The structure of exchange rates: spot and forward rates 645
21.3 Foreign exchange exposure 647
21.4 Should firms worry about exchange rate changes? 650
21.5 Economic theory and exposure management 653
21.6 Exchange rate forecasting 658
21.7 Devising a foreign exchange management (FEM) strategy 661
21.8 Internal hedging techniques 664
21.9 Simple external hedging techniques 668
21.10 More complex techniques 670
21.11 More complex techniques: Futures and swaps 673
21.12 Conclusions 676
Summary 677
Key points 677
Further reading 678
Questions 679
Chapter 22 Foreign investment decisions 683
22.1 Introduction 684
22.2 Advantages of MNCS over national firms 686
22.3 Foreign market entry strategies 688
22.4 Additional complexities of foreign Investment 691
22.5 The discount rate for Foreign Direct Investment (FDI) 692
22.6 Evaluating FDI 694
22.7 Worked example: Sparkes plc and Zoltan kft 694
22.8 Exposure to foreign exchange risk 697
22.9 How MNCS manage operating exposure 701
22.10 Hedging the risk of foreign projects 703
22.11 Political and country risk 704
22.12 Managing political and country risk (PCR) 706
22.13 Financing FDI 708
22.14 The WACC for FDI 711
22.15 Applying the APV to FDI 711
22.16 Worked example: applying the APV 712
Summary 714
Key points 714
Further reading and website 715
Questions 716
Chapter 23 Key issues in modern finance: a review 719
23.1 Introduction 720
23.2 Understanding individual behaviour 721
23.3 Understanding corporate behaviour 722
23.4 Understanding how markets behave 726
23.5 Behavioural finance 733
Summary 741
Key points 742
Further reading 742
Appendices 743
A Solutions to self-assessment activities 743
B Solutions to selected questions 761
C Present value interest factor (PVIF) 793
D Present value interest factor for an annuity (PVIFA) 795
Glossary 797
A 797
B 797
C 798
D 800
E 800
F 801
G 802
H 802
I 803
J 803
L 804
M 804
N 805
O 805
P 806
Q 807
R 807
S 808
T 809
U 809
V 810
W 810
Y 810
Z 810
References 811
Index 827
A 827
B 828
C 829
D 832
E 833
F 834
G 836
H 836
I 837
J 838
K 839
L 839
M 839
N 841
O 841
P 842
Q 843
R 844
S 845
T 847
U 848
V 848
W 848
X 849
Y 849
Z 849
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