Appendix A: Mathematical Tables Appendix B: Solutions to Selected End−of−Chapter Problems Glossary Name Index Subject Index End Papers

Finance

McGraw−Hill Primis

ISBN: 0−390−32000−5

Text: Corporate Finance, Sixth EditionRoss−Westerfield−Jaffe

Corporate Fiance

David Whitehurst

UMIST

Volume 2

McGraw-Hill/Irwin��

Finance

http://www.mhhe.com/primis/online/Copyright ©2003 by The McGraw−Hill Companies, Inc. All rights reserved. Printed in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without prior written permission of the publisher. This McGraw−Hill Primis text may include materials submitted to McGraw−Hill for publication by the instructor of this course. The instructor is solely responsible for the editorial content of such materials.

111 FINA ISBN: 0−390−32000−5

This book was printed on recycled paper.

Finance

Volume 2

Ross−Westerfield−Jaffe • Corporate Finance, Sixth Edition

Back Matter 903

Appendix A: Mathematical Tables 903Appendix B: Solutions to Selected End−of−Chapter Problems 919Glossary 923Name Index 939Subject Index 942End Papers 959

iii

Ross−Westerfield−Jaffe: Corporate Finance, Sixth Edition

Back Matter Appendix A: Mathematical Tables

903© The McGraw−Hill Companies, 2002

Mathematical Tables

AP

PE

ND

IXA



904 © The McGraw−Hill Companies, 2002

898 Appendix A Mathematical Tables

� TABLE A.1 Present Value of $1 to Be Received after T Periods � 1/(1 � r)T

Interest Rate

Period 1% 2% 3% 4% 5% 6% 7% 8% 9%

1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.91742 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.84173 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.77224 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.70845 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499

6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.59637 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.54708 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.50199 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604

10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224

11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.387512 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.355513 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.326214 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.299215 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745

16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.251917 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.231118 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.212019 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.194520 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784

21 0.8114 0.6598 0.5375 0.4388 0.3589 0.2942 0.2415 0.1987 0.163722 0.8034 0.6468 0.5219 0.4220 0.3418 0.2775 0.2257 0.1839 0.150223 0.7954 0.6342 0.5067 0.4057 0.3256 0.2618 0.2109 0.1703 0.137824 0.7876 0.6217 0.4919 0.3901 0.3101 0.2470 0.1971 0.1577 0.126425 0.7798 0.6095 0.4776 0.3751 0.2953 0.2330 0.1842 0.1460 0.1160

30 0.7419 0.5521 0.4120 0.3083 0.2314 0.1741 0.1314 0.0994 0.075440 0.6717 0.4529 0.3066 0.2083 0.1420 0.0972 0.0668 0.0460 0.031850 0.6080 0.3715 0.2281 0.1407 0.0872 0.0543 0.0339 0.0213 0.0134

*The factor is zero to four decimal places.




Appendix A Mathematical Tables 899

� TABLE A.1 (concluded)

Interest Rate

10% 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%

0.9091 0.8929 0.8772 0.8696 0.8621 0.8475 0.8333 0.8065 0.7813 0.7576 0.73530.8264 0.7972 0.7695 0.7561 0.7432 0.7182 0.6944 0.6504 0.6104 0.5739 0.54070.7513 0.7118 0.6750 0.6575 0.6407 0.6086 0.5787 0.5245 0.4768 0.4348 0.39750.6830 0.6355 0.5921 0.5718 0.5523 0.5158 0.4823 0.4230 0.3725 0.3294 0.29230.6209 0.5674 0.5194 0.4972 0.4761 0.4371 0.4019 0.3411 0.2910 0.2495 0.2149

0.5645 0.5066 0.4556 0.4323 0.4104 0.3704 0.3349 0.2751 0.2274 0.1890 0.15800.5132 0.4523 0.3996 0.3759 0.3538 0.3139 0.2791 0.2218 0.1776 0.1432 0.11620.4665 0.4039 0.3506 0.3269 0.3050 0.2660 0.2326 0.1789 0.1388 0.1085 0.08540.4241 0.3606 0.3075 0.2843 0.2630 0.2255 0.1938 0.1443 0.1084 0.0822 0.06280.3855 0.3220 0.2697 0.2472 0.2267 0.1911 0.1615 0.1164 0.0847 0.0623 0.0462

0.3505 0.2875 0.2366 0.2149 0.1954 0.1619 0.1346 0.0938 0.0662 0.0472 0.03400.3186 0.2567 0.2076 0.1869 0.1685 0.1372 0.1122 0.0757 0.0517 0.0357 0.02500.2897 0.2292 0.1821 0.1625 0.1452 0.1163 0.0935 0.0610 0.0404 0.0271 0.01840.2633 0.2046 0.1597 0.1413 0.1252 0.0985 0.0779 0.0492 0.0316 0.0205 0.01350.2394 0.1827 0.1401 0.1229 0.1079 0.0835 0.0649 0.0397 0.0247 0.0155 0.0099

0.2176 0.1631 0.1229 0.1069 0.0930 0.0708 0.0541 0.0320 0.0193 0.0118 0.00730.1978 0.1456 0.1078 0.0929 0.0802 0.0600 0.0451 0.0258 0.0150 0.0089 0.00540.1799 0.1300 0.0946 0.0808 0.0691 0.0508 0.0376 0.0208 0.0118 0.0068 0.00390.1635 0.1161 0.0829 0.0703 0.0596 0.0431 0.0313 0.0168 0.0092 0.0051 0.00290.1486 0.1037 0.0728 0.0611 0.0514 0.0365 0.0261 0.0135 0.0072 0.0039 0.0021

0.1351 0.0926 0.0638 0.0531 0.0443 0.0309 0.0217 0.0109 0.0056 0.0029 0.00160.1228 0.0826 0.0560 0.0462 0.0382 0.0262 0.0181 0.0088 0.0044 0.0022 0.00120.1117 0.0738 0.0491 0.0402 0.0329 0.0222 0.0151 0.0071 0.0034 0.0017 0.00080.1015 0.0659 0.0431 0.0349 0.0284 0.0188 0.0126 0.0057 0.0027 0.0013 0.00060.0923 0.0588 0.0378 0.0304 0.0245 0.0160 0.0105 0.0046 0.0021 0.0010 0.0005

0.0573 0.0334 0.0196 0.0151 0.0116 0.0070 0.0042 0.0016 0.0006 0.0002 0.00010.0221 0.0107 0.0053 0.0037 0.0026 0.0013 0.0007 0.0002 0.0001 * *0.0085 0.0035 0.0014 0.0009 0.0006 0.0003 0.0001 * * * *





� TABLE A.2 Present Value of an Annuity of $1 per Period for T Periods � [1 � 1/(1 � r)T]/r

Interest Rate

1% 2% 3% 4% 5% 6% 7% 8% 9%

1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.91742 1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.75913 2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.53134 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.23975 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897

6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.48597 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.03308 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.53489 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952

10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177

11 10.3676 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.805212 11.2551 10.5753 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.160713 12.1337 11.3484 10.6350 9.9856 9.3936 8.8527 8.3577 7.9038 7.486914 13.0037 12.1062 11.2961 10.5631 9.8986 9.2950 8.7455 8.2442 7.786215 13.8651 12.8493 11.9379 11.1184 10.3797 9.7122 9.1079 8.5595 8.0607

16 14.7179 13.5777 12.5611 11.6523 10.8378 10.1059 9.4466 8.8514 8.312617 15.5623 14.2919 13.1661 12.1657 11.2741 10.4773 9.7632 9.1216 8.543618 16.3983 14.9920 13.7535 12.6593 11.6896 10.8276 10.0591 9.3719 8.755619 17.2260 15.6785 14.3238 13.1339 12.0853 11.1581 10.3356 9.6036 8.950120 18.0456 16.3514 14.8775 13.5903 12.4622 11.4699 10.5940 9.8181 9.1285

21 18.8570 17.0112 15.4150 14.0292 12.8212 11.7641 10.8355 10.0168 9.292222 19.6604 17.6580 15.9369 14.4511 13.1630 12.0416 11.0612 10.2007 9.442423 20.4558 18.2922 16.4436 14.8568 13.4886 12.3034 11.2722 10.3741 9.580224 21.2434 18.9139 16.9355 15.2470 13.7986 12.5504 11.4693 10.5288 9.706625 22.0232 19.5235 17.4131 15.6221 14.0939 12.7834 11.6536 10.6748 9.8226

30 25.8077 22.3965 19.6004 17.2920 15.3725 13.7648 12.4090 11.2578 10.273740 32.8347 27.3555 23.1148 19.7928 17.1591 15.0463 13.3317 11.9246 10.757450 39.1961 31.4236 25.7298 21.4822 18.2559 15.7619 13.8007 12.2335 10.9617

Number ofPeriods






Interest Rate

10% 12% 14% 15% 16% 18% 20% 24% 28% 32%

0.9091 0.8929 0.8772 0.8696 0.8621 0.8475 0.8333 0.8065 0.7813 0.75761.7355 1.6901 1.6467 1.6257 1.6052 1.5656 1.5278 1.4568 1.3916 1.33152.4869 2.4018 2.3216 2.2832 2.2459 2.1743 2.1065 1.9813 1.8684 1.76633.1699 3.0373 2.9137 2.8550 2.7982 2.6901 2.5887 2.4043 2.2410 2.09573.7908 3.6048 3.4331 3.3522 3.2743 3.1272 2.9906 2.7454 2.5320 2.3452

4.3553 4.1114 3.8887 3.7845 3.6847 3.4976 3.3255 3.0205 2.7594 2.53424.8684 4.5638 4.2883 4.1604 4.0386 3.8115 3.6046 3.2423 2.9370 2.67755.3349 4.9676 4.6389 4.4873 4.3436 4.0776 3.8372 3.4212 3.0758 2.78605.7590 5.3282 4.9464 4.7716 4.6065 4.3030 4.0310 3.5655 3.1842 2.86816.1446 5.6502 5.2161 5.0188 4.8332 4.4941 4.1925 3.6819 3.2689 2.9304

6.4951 5.9377 5.4527 5.2337 5.0286 4.6560 4.3271 3.7757 3.3351 2.97766.8137 6.1944 5.6603 5.4206 5.1971 4.7932 4.4392 3.8514 3.3868 3.01337.1034 6.4235 5.8424 5.5831 5.3423 4.9095 4.5327 3.9124 3.4272 3.04047.3667 6.6282 6.0021 5.7245 5.4675 5.0081 4.6106 3.9616 3.4587 3.06097.6061 6.8109 6.1422 5.8474 5.5755 5.0916 4.6755 4.0013 3.4834 3.0764

7.8237 6.9740 6.2651 5.9542 5.6685 5.1624 4.7296 4.0333 3.5026 3.08828.0216 7.1196 6.3729 6.0472 5.7487 5.2223 4.7746 4.0591 3.5177 3.09718.2014 7.2497 6.4674 6.1280 5.8178 5.2732 4.8122 4.0799 3.5294 3.10398.3649 7.3658 6.5504 6.1982 5.8775 5.3162 4.8435 4.0967 3.5386 3.10908.5136 7.4694 6.6231 6.2593 5.9288 5.3527 4.8696 4.1103 3.5458 3.1129

8.6487 7.5620 6.6870 6.3125 5.9731 5.3837 4.8913 4.1212 3.5514 3.11588.7715 7.6446 6.7429 6.3587 6.0113 5.4099 4.9094 4.1300 3.5558 3.11808.8832 7.7184 6.7921 6.3988 6.0442 5.4321 4.9245 4.1371 3.5592 3.11978.9847 7.7843 6.8351 6.4338 6.0726 5.4509 4.9371 4.1428 3.5619 3.12109.0770 7.8431 6.8729 6.4641 6.0971 5.4669 4.9476 4.1474 3.5640 3.1220

9.4269 8.0552 7.0027 6.5660 6.1772 5.5168 4.9789 4.1601 3.5693 3.12429.7791 8.2438 7.1050 6.6418 6.2335 5.5482 4.9966 4.1659 3.5712 3.12509.9148 8.3045 7.1327 6.6605 6.2463 5.5541 4.9995 4.1666 3.5714 3.1250





� TABLE A.3 Future Value of $1 at the End of T Periods � (1 � r)T

Interest Rate

Period 1% 2% 3% 4% 5% 6% 7% 8% 9%

1 1.0100 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.09002 1.0201 1.0404 1.0609 1.0816 1.1025 1.1236 1.1449 1.1664 1.18813 1.0303 1.0612 1.0927 1.1249 1.1576 1.1910 1.2250 1.2597 1.29504 1.0406 1.0824 1.1255 1.1699 1.2155 1.2625 1.3108 1.3605 1.41165 1.0510 1.1041 1.1593 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386

6 1.0615 1.1262 1.1941 1.2653 1.3401 1.4185 1.5007 1.5869 1.67717 1.0721 1.1487 1.2299 1.3159 1.4071 1.5036 1.6058 1.7138 1.82808 1.0829 1.1717 1.2668 1.3686 1.4775 1.5938 1.7182 1.8509 1.99269 1.0937 1.1951 1.3048 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719

10 1.1046 1.2190 1.3439 1.4802 1.6289 1.7908 1.9672 2.1589 2.3674

11 1.1157 1.2434 1.3842 1.5395 1.7103 1.8983 2.1049 2.3316 2.580412 1.1268 1.2682 1.4258 1.6010 1.7959 2.0122 2.2522 2.5182 2.812713 1.1381 1.2936 1.4685 1.6651 1.8856 2.1329 2.4098 2.7196 3.065814 1.1495 1.3195 1.5126 1.7317 1.9799 2.2609 2.5785 2.9372 3.341715 1.1610 1.3459 1.5580 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425

16 1.1726 1.3728 1.6047 1.8730 2.1829 2.5404 2.9522 3.4259 3.970317 1.1843 1.4002 1.6528 1.9479 2.2920 2.6928 3.1588 3.7000 4.327618 1.1961 1.4282 1.7024 2.0258 2.4066 2.8543 3.3799 3.9960 4.717119 1.2081 1.4568 1.7535 2.1068 2.5270 3.0256 3.6165 4.3157 5.141720 1.2202 1.4859 1.8061 2.1911 2.6533 3.2071 3.8697 4.6610 5.6044

21 1.2324 1.5157 1.8603 2.2788 2.7860 3.3996 4.1406 5.0338 6.108822 1.2447 1.5460 1.9161 2.3699 2.9253 3.6035 4.4304 5.4365 6.658623 1.2572 1.5769 1.9736 2.4647 3.0715 3.8197 4.7405 5.8715 7.257924 1.2697 1.6084 2.0328 2.5633 3.2251 4.0489 5.0724 6.3412 7.911125 1.2824 1.6406 2.0938 2.6658 3.3864 4.2919 5.4274 6.8485 8.6231

30 1.3478 1.8114 2.4273 3.2434 4.3219 5.7435 7.6123 10.063 13.26840 1.4889 2.2080 3.2620 4.8010 7.0400 10.286 14.974 21.725 31.40950 1.6446 2.6916 4.3839 7.1067 11.467 18.420 29.457 46.902 74.35860 1.8167 3.2810 5.8916 10.520 18.679 32.988 57.946 101.26 176.03

*FVIV � 99,999.






Interest Rate

10% 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%

1.1000 1.1200 1.1400 1.1500 1.1600 1.1800 1.2000 1.2400 1.2800 1.3200 1.36001.2100 1.2544 1.2996 1.3225 1.3456 1.3924 1.4400 1.5376 1.6384 1.7424 1.84961.3310 1.4049 1.4815 1.5209 1.5609 1.6430 1.7280 1.9066 2.0972 2.3000 2.51551.4641 1.5735 1.6890 1.7490 1.8106 1.9388 2.0736 2.3642 2.6844 3.0360 3.42101.6105 1.7623 1.9254 2.0114 2.1003 2.2878 2.4883 2.9316 3.4360 4.0075 4.6526

1.7716 1.9738 2.1950 2.3131 2.4364 2.6996 2.9860 3.6352 4.3980 5.2899 6.32751.9487 2.2107 2.5023 2.6600 2.8262 3.1855 3.5832 4.5077 5.6295 6.9826 8.60542.1436 2.4760 2.8526 3.0590 3.2784 3.7589 4.2998 5.5895 7.2058 9.2170 11.7032.3579 2.7731 3.2519 3.5179 3.8030 4.4355 5.1598 6.9310 9.2234 12.166 15.9172.5937 3.1058 3.7072 4.0456 4.4114 5.2338 6.1917 8.5944 11.806 16.060 21.647

2.8531 3.4785 4.2262 4.6524 5.1173 6.1759 7.4301 10.657 15.112 21.199 29.4393.1384 3.8960 4.8179 5.3503 5.9360 7.2876 8.9161 13.215 19.343 27.983 40.0373.4523 4.3635 5.4924 6.1528 6.8858 8.5994 10.699 16.386 24.759 36.937 54.4513.7975 4.8871 6.2613 7.0757 7.9875 10.147 12.839 20.319 31.691 48.757 74.0534.1772 5.4736 7.1379 8.1371 9.2655 11.974 15.407 25.196 40.565 64.359 100.71

4.5950 6.1304 8.1372 9.3576 10.748 14.129 18.488 31.243 51.923 84.954 136.975.0545 6.8660 9.2765 10.761 12.468 16.672 22.186 38.741 66.461 112.14 186.285.5599 7.6900 10.575 12.375 14.463 19.673 26.623 48.039 86.071 148.02 253.346.1159 8.6128 12.056 14.232 16.777 23.214 31.948 59.568 108.89 195.39 344.546.7275 9.6463 13.743 16.367 19.461 27.393 38.338 73.864 139.38 257.92 468.57

7.4002 10.804 15.668 18.822 22.574 32.324 46.005 91.592 178.41 340.45 637.268.1403 12.100 17.861 21.645 26.186 38.142 55.206 113.57 228.36 449.39 866.678.9543 13.552 20.362 24.891 30.376 45.008 66.247 140.83 292.30 593.20 1178.79.8497 15.179 23.212 28.625 35.236 53.109 79.497 174.63 374.14 783.02 1603.010.835 17.000 26.462 32.919 40.874 62.669 95.396 216.54 478.90 1033.6 2180.1

17.449 29.960 50.950 66.212 85.850 143.37 237.38 634.82 1645.5 4142.1 10143.45.259 93.051 188.88 267.86 378.72 750.38 1469.8 5455.9 19427. 66521. *117.39 289.00 700.23 1083.7 1670.7 3927.4 9100.4 46890. * * *304.48 897.60 2595.9 4384.0 7370.2 20555. 56348. * * * *





� TABLE A.4 Sum of Annuity of $1 per Period for T Periods � [(1 � r)T� 1]/r

Interest Rate

1% 2% 3% 4% 5% 6% 7% 8% 9%

1 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.00002 2.0100 2.0200 2.0300 2.0400 2.0500 2.0600 2.0700 2.0800 2.09003 3.0301 3.0604 3.0909 3.1216 3.1525 3.1836 3.2149 3.2464 3.27814 4.0604 4.1216 4.1836 4.2465 4.3101 4.3746 4.4399 4.5061 4.57315 5.1010 5.2040 5.3091 5.4163 5.5256 5.6371 5.7507 5.8666 5.9847

6 6.1520 6.3081 6.4684 6.6330 6.8019 6.9753 7.1533 7.3359 7.52337 7.2135 7.4343 7.6625 7.8983 8.1420 8.3938 8.6540 8.9228 9.20048 8.2857 8.5830 8.8932 9.2142 9.5491 9.8975 10.260 10.637 11.0289 9.3685 9.7546 10.159 10.583 11.027 11.491 11.978 12.488 13.021

10 10.462 10.950 11.464 12.006 12.578 13.181 13.816 14.487 15.193

11 11.567 12.169 12.808 13.486 14.207 14.972 15.784 16.645 17.56012 12.683 13.412 14.192 15.026 15.917 16.870 17.888 18.977 20.14113 13.809 14.680 15.618 16.627 17.713 18.882 20.141 21.495 22.95314 14.947 15.974 17.086 18.292 19.599 21.015 22.550 24.215 26.01915 16.097 17.293 18.599 20.024 21.579 23.276 25.129 27.152 29.361

16 17.258 18.639 20.157 21.825 23.657 25.673 27.888 30.324 33.00317 18.430 20.012 21.762 23.698 25.840 28.213 30.840 33.750 36.97418 19.615 21.412 23.414 25.645 28.132 30.906 33.999 37.450 41.30119 20.811 22.841 25.117 27.671 30.539 33.760 37.379 41.446 46.01820 22.019 24.297 26.870 29.778 33.066 36.786 40.995 45.762 51.160

21 23.239 25.783 28.676 31.969 35.719 39.993 44.865 50.423 56.76522 24.472 27.299 30.537 34.248 38.505 43.392 49.006 55.457 62.87323 25.716 28.845 32.453 36.618 41.430 46.996 53.436 60.893 69.53224 26.973 30.422 34.426 39.083 44.502 50.816 58.177 66.765 76.79025 28.243 32.030 36.459 41.646 47.727 54.865 63.249 73.106 84.701

30 34.785 40.568 47.575 56.085 66.439 79.058 94.461 113.28 136.3140 48.886 60.402 75.401 95.026 120.80 154.76 199.64 259.06 337.8850 64.463 84.579 112.80 152.67 209.35 290.34 406.53 573.77 815.0860 81.670 114.05 163.05 237.99 353.58 533.13 813.52 1253.2 1944.8

*FVIFA � 99,999.

Number ofPeriods






Interest Rate

10% 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%

1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.00002.1000 2.1200 2.1400 2.1500 2.1600 2.1800 2.2000 2.2400 2.2800 2.3200 2.36003.3100 3.3744 3.4396 3.4725 3.5056 3.5724 3.6400 3.7776 3.9184 4.0624 4.20963.6410 4.7793 4.9211 4.9934 5.0665 5.2154 5.3680 5.6842 6.0156 6.3624 6.72516.1051 6.3528 6.6101 6.7424 6.8771 7.1542 7.4416 8.0484 8.6999 9.3983 10.146

7.7156 8.1152 8.5355 8.7537 8.9775 9.4420 9.9299 10.980 12.136 13.406 14.7999.4872 10.089 10.730 11.067 11.414 12.142 12.916 14.615 16.534 18.696 21.12611.436 12.300 13.233 13.727 14.240 15.327 16.499 19.123 22.163 25.678 29.73213.579 14.776 16.085 16.786 17.519 19.086 20.799 24.712 29.369 34.895 41.43515.937 17.549 19.337 20.304 21.321 23.521 25.959 31.643 38.593 47.062 57.352

18.531 20.655 23.045 24.349 25.733 28.755 32.150 40.238 50.398 63.122 78.99821.384 24.133 27.271 29.002 30.850 34.931 39.581 50.895 65.510 84.320 108.4424.523 28.029 32.089 34.352 36.786 42.219 48.497 64.110 84.853 112.30 148.4727.975 32.393 37.581 40.505 43.672 50.818 59.196 80.496 109.61 149.24 202.9331.772 37.280 43.842 47.580 51.660 60.965 72.035 100.82 141.30 198.00 276.98

35.950 42.753 50.980 55.717 60.925 72.939 87.442 126.01 181.87 262.36 377.6940.545 48.884 59.118 65.075 71.673 87.068 105.93 157.25 233.79 347.31 514.6645.599 55.750 68.394 75.836 84.141 103.74 128.12 195.99 300.25 459.45 700.9451.159 64.440 78.969 88.212 98.603 123.41 154.74 244.03 385.32 607.47 954.2857.275 72.052 91.025 102.44 115.38 146.63 186.69 303.60 494.21 802.86 1298.8

64.002 81.699 104.77 118.81 134.84 174.02 225.03 377.46 633.59 1060.8 1767.471.403 92.503 120.44 137.63 157.41 206.34 271.03 469.06 812.00 1401.2 2404.779.543 104.60 138.30 159.28 183.60 244.49 326.24 582.63 1040.4 1850.6 3271.388.497 118.16 158.66 184.17 213.98 289.49 392.48 723.46 1332.7 2443.8 4450.098.347 133.33 181.87 212.79 249.21 342.60 471.98 898.09 1706.8 3226.8 6053.0

164.49 241.33 356.79 434.75 530.31 790.95 1181.9 2640.9 5873.2 12941. 28172.3442.59 767.09 1342.0 1779.1 2360.8 4163.2 7343.9 22729. 69377. * *1163.9 2400.0 4994.5 7217.7 10436. 21813. 45497. * * * *3034.8 7471.6 18535. 29220. 46058. * * * * * *





� TABLE A.5 Future Value of $1 with a Continuously Compounded Rate r for T Periods: Values of erT

Continuously Compounded Rate (r)

1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 1.0101 1.0202 1.0305 1.0408 1.0513 1.0618 1.0725 1.0833 1.0942 1.10522 1.0202 1.0408 1.0618 1.0833 1.1052 1.1275 1.1503 1.1735 1.1972 1.22143 1.0305 1.0618 1.0942 1.1275 1.1618 1.1972 1.2337 1.2712 1.3100 1.34994 1.0408 1.0833 1.1275 1.1735 1.2214 1.2712 1.3231 1.3771 1.4333 1.49185 1.0513 1.1052 1.1618 1.2214 1.2840 1.3499 1.4191 1.4918 1.5683 1.64876 1.0618 1.1275 1.1972 1.2712 1.3499 1.4333 1.5220 1.6161 1.7160 1.82217 1.0725 1.1503 1.2337 1.3231 1.4191 1.5220 1.6323 1.7507 1.8776 2.01388 1.0833 1.1735 1.2712 1.3771 1.4918 1.6161 1.7507 1.8965 2.0544 2.22559 1.0942 1.1972 1.3100 1.4333 1.5683 1.7160 1.8776 2.0544 2.2479 2.4596

10 1.1052 1.2214 1.3499 1.4918 1.6487 1.8221 2.0138 2.2255 2.4596 2.718311 1.1163 1.2461 1.3910 1.5527 1.7333 1.9348 2.1598 2.4109 2.6912 3.004212 1.1275 1.2712 1.4333 1.6161 1.8221 2.0544 2.3164 2.6117 2.9447 3.320113 1.1388 1.2969 1.4770 1.6820 1.9155 2.1815 2.4843 2.8292 3.2220 3.669314 1.1503 1.3231 1.5220 1.7507 2.0138 2.3164 2.6645 3.0649 3.5254 4.055215 1.1618 1.3499 1.5683 1.8221 2.1170 2.4596 2.8577 3.3201 3.8574 4.481716 1.1735 1.3771 1.6161 1.8965 2.2255 2.6117 3.0649 3.5966 4.2207 4.953017 1.1853 1.4049 1.6653 1.9739 2.3396 2.7732 3.2871 3.8962 4.6182 5.473918 1.1972 1.4333 1.7160 2.0544 2.4596 2.9447 3.5254 4.2207 5.0531 6.049619 1.2092 1.4623 1.7683 2.1383 2.5857 3.1268 3.7810 4.5722 5.5290 6.685920 1.2214 1.4918 1.8221 2.2255 2.7183 3.3201 4.0552 4.9530 6.0496 7.389121 1.2337 1.5220 1.8776 2.3164 2.8577 3.5254 4.3492 5.3656 6.6194 8.166222 1.2461 1.5527 1.9348 2.4109 3.0042 3.7434 4.6646 5.8124 7.2427 9.025023 1.2586 1.5841 1.9937 2.5093 3.1582 3.9749 5.0028 6.2965 7.9248 9.974224 1.2712 1.6161 2.0544 2.6117 3.3201 4.2207 5.3656 6.8210 8.6711 11.023225 1.2840 1.6487 2.1170 2.7183 3.4903 4.4817 5.7546 7.3891 9.4877 12.182530 1.3499 1.8221 2.4596 3.3204 4.4817 6.0496 8.1662 11.0232 14.8797 20.085535 1.4191 2.0138 2.8577 4.0552 5.7546 8.1662 11.5883 16.4446 23.3361 33.115540 1.4918 2.2255 3.3201 4.9530 7.3891 11.0232 16.4446 24.5235 36.5982 54.598245 1.5683 2.4596 3.8574 6.0496 9.4877 14.8797 23.3361 36.5982 57.3975 90.017150 1.6487 2.7183 4.4817 7.3891 12.1825 20.0855 33.1155 54.5982 90.0171 148.413255 1.7333 3.0042 5.2070 9.0250 15.6426 27.1126 46.9931 81.4509 141.1750 244.691960 1.8221 3.3201 6.0496 11.0232 20.0855 36.5982 66.6863 121.5104 221.4064 403.4288

Period(T)





� TABLE A.5 (continued)


11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21%

1.1163 1.1275 1.1388 1.1503 1.1618 1.1735 1.1853 1.1972 1.2092 1.2214 1.23371.2461 1.2712 1.2969 1.3231 1.3499 1.3771 1.4049 1.4333 1.4623 1.4918 1.52201.3910 1.4333 1.4770 1.5220 1.5683 1.6161 1.6653 1.7160 1.7683 1.8221 1.87761.5527 1.6161 1.6820 1.7507 1.8221 1.8965 1.9739 2.0544 2.1383 2.2255 2.31641.7333 1.8221 1.9155 2.0138 2.1170 2.2255 2.3396 2.4596 2.5857 2.7183 2.85771.9348 2.0544 2.1815 2.3164 2.4596 2.6117 2.7732 2.9447 3.1268 3.3201 3.52542.1598 2.3164 2.4843 2.6645 2.8577 3.0649 3.2871 3.5254 3.7810 4.0552 4.34922.4109 2.6117 2.8292 3.0649 3.3201 3.5966 3.8962 4.2207 4.5722 4.9530 5.36562.6912 2.9447 3.2220 3.5254 3.8574 4.2207 4.6182 5.0531 5.5290 6.0496 6.61943.0042 3.3201 3.6693 4.0552 4.4817 4.9530 5.4739 6.0496 6.6859 7.3891 8.16623.3535 3.7434 4.1787 4.6646 5.2070 5.8124 6.4883 7.2427 8.0849 9.0250 10.07443.7434 4.2207 4.7588 5.3656 6.0496 6.8210 7.6906 8.6711 9.7767 11.0232 12.42864.1787 4.7588 5.4195 6.1719 7.0287 8.0045 9.1157 10.3812 11.8224 13.4637 15.33294.6646 5.3656 6.1719 7.0993 8.1662 9.3933 10.8049 12.4286 14.2963 16.4446 18.91585.2070 6.0496 7.0287 8.1662 9.4877 11.0232 12.0871 14.8797 17.2878 20.0855 23.33615.8124 6.8210 8.0045 9.3933 11.0232 12.9358 15.1803 17.8143 20.9052 24.5325 28.78926.4883 7.6906 9.1157 10.8049 12.8071 15.1803 17.9933 21.3276 25.2797 29.9641 35.51667.2427 8.6711 10.3812 12.4286 14.8797 17.8143 21.3276 25.5337 30.5694 36.5982 43.81608.0849 9.7767 11.8224 14.2963 17.2878 20.9052 25.2797 30.5694 36.9661 44.7012 54.05499.0250 11.0232 13.4637 16.4446 20.0855 24.5325 29.9641 36.5982 44.7012 54.5982 66.6863

10.0744 12.4286 15.3329 18.9158 23.3361 28.7892 35.5166 43.8160 54.0549 66.6863 82.269511.2459 14.0132 17.4615 21.7584 27.1126 33.7844 42.0980 52.4573 65.3659 81.4509 101.494012.5535 15.7998 19.8857 25.0281 31.5004 39.6464 49.8990 62.8028 79.0436 99.4843 125.211014.0132 17.8143 22.6464 28.7892 36.5982 46.5255 59.1455 75.1886 95.5835 121.5104 154.470015.6426 20.0855 25.7903 33.1155 42.5211 54.5982 70.1054 90.0171 115.5843 148.4132 190.566327.1126 36.5982 49.4024 66.6863 90.0171 121.5104 164.0219 221.4064 298.8674 403.4288 544.571946.9931 66.6863 94.6324 134.2898 190.5663 270.4264 383.7533 544.5719 772.7843 1096.633 1556.19781.4509 121.5104 181.2722 270.4264 403.4288 601.8450 897.8473 1339.431 1998.196 2980.958 4447.067

141.1750 221.4064 347.2344 544.5719 854.0588 1339.431 2100.646 3294.468 5166.754 8103.084 12708.17244.6919 403.4288 665.1416 1096.633 1808.042 2980.958 4914.769 8103.084 13359.73 22026.47 36315.50424.1130 735.0952 1274.106 2208.348 3827.626 6634.244 11498.82 19930.37 34544.37 59874.14 103777.0735.0952 1339.431 2440.602 4447.067 8103.084 14764.78 26903.19 49020.80 89321.72 162754.8 296558.6







22% 23% 24% 25% 26% 27% 28%

1 1.2461 1.2586 1.2712 1.2840 1.2969 1.3100 1.32312 1.5527 1.5841 1.6161 1.6487 1.6820 1.7160 1.75073 1.9348 1.9937 2.0544 2.1170 2.1815 2.2479 2.31644 2.4109 2.5093 2.6117 2.7183 2.8292 2.9447 3.06495 3.0042 3.1582 3.3201 3.4903 3.6693 3.8574 4.05526 3.7434 3.9749 4.2207 4.4817 4.7588 5.0351 5.36567 4.6646 5.0028 5.3656 5.7546 6.1719 6.6194 7.09938 5.8124 6.2965 6.8210 7.3891 8.0045 8.6711 9.39339 7.2427 7.9248 8.6711 9.4877 10.3812 11.3589 12.4286

10 9.0250 9.9742 11.0232 12.1825 13.4637 14.8797 16.444611 11.2459 12.5535 14.0132 15.6426 17.4615 19.4919 21.758412 14.0132 15.7998 17.8143 20.0855 22.6464 25.5337 28.789213 17.4615 19.8857 22.6464 25.7903 29.3708 33.4483 38.091814 21.7584 25.0281 28.7892 33.1155 38.0918 43.8160 50.400415 27.1126 31.5004 36.5982 42.5211 49.4024 57.3975 66.686316 33.7844 39.6464 46.5255 54.5982 64.0715 75.1886 88.234717 42.0980 49.8990 59.1455 70.1054 83.0963 98.4944 116.745918 52.4573 62.8028 75.1886 90.0171 107.7701 129.0242 154.470019 65.3659 79.0436 95.5835 115.5843 139.7702 169.0171 204.383920 81.4509 99.4843 121.5104 148.4132 181.2722 221.4064 270.426421 101.4940 125.2110 154.4700 190.5663 235.0974 290.0345 357.809222 126.4694 157.5905 196.3699 244.6919 304.9049 379.9349 473.428123 157.5905 198.3434 249.6350 314.1907 395.4404 497.7013 626.406824 196.3699 249.6350 317.3483 403.4288 512.8585 651.9709 828.817525 244.6919 314.1907 403.4288 518.0128 665.1416 854.0588 1096.63330 735.0952 992.2747 1339.431 1808.042 2440.602 3294.468 4447.06735 2208.348 3133.795 4447.067 6310.688 8955.293 12708.17 18033.7440 6634.244 9897.129 14764.78 22026.47 32859.63 49020.80 73130.4445 19930.37 31257.04 49020.80 76879.92 120571.7 189094.1 296558.650 59874.14 98715.77 162754.8 268337.3 442413.4 729416.4 120260455 179871.9 311763.4 540364.9 936589.2 1623346 2813669 487680160 540364.9 984609.1 1794075 3269017 5956538 10853520 19776403

Period(T)





� TABLE A.6 Present Value of $1 with a Continuous Discount Rate r for T Periods: Values of e�rT

Continuous Discount Rate (r)

1% 2% 3% 4% 5% 6% 7%

1 0.9900 0.9802 0.9704 0.9608 0.9512 0.9418 0.93242 0.9802 0.9608 0.9418 0.9231 0.9048 0.8869 0.86943 0.9704 0.9418 0.9139 0.8869 0.8607 0.8353 0.81064 0.9608 0.9231 0.8869 0.8521 0.8187 0.7866 0.75585 0.9512 0.9048 0.8607 0.8187 0.7788 0.7408 0.70476 0.9418 0.8869 0.8353 0.7866 0.7408 0.6977 0.65707 0.9324 0.8694 0.8106 0.7558 0.7047 0.6570 0.61268 0.9231 0.8521 0.7866 0.7261 0.6703 0.6188 0.57129 0.9139 0.8353 0.7634 0.6977 0.6376 0.5827 0.5326

10 0.9048 0.8187 0.7408 0.6703 0.6065 0.5488 0.496611 0.8958 0.8025 0.7189 0.6440 0.5769 0.5169 0.463012 0.8869 0.7866 0.6977 0.6188 0.5488 0.4868 0.431713 0.8781 0.7711 0.6771 0.5945 0.5220 0.4584 0.402514 0.8694 0.7558 0.6570 0.5712 0.4966 0.4317 0.375315 0.8607 0.7408 0.6376 0.5488 0.4724 0.4066 0.349916 0.8521 0.7261 0.6188 0.5273 0.4493 0.3829 0.326317 0.8437 0.7118 0.6005 0.5066 0.4274 0.3606 0.304218 0.8353 0.6977 0.5827 0.4868 0.4066 0.3396 0.283719 0.8270 0.6839 0.5655 0.4677 0.3867 0.3198 0.264520 0.8187 0.6703 0.5488 0.4493 0.3679 0.3012 0.246621 0.8106 0.6570 0.5326 0.4317 0.3499 0.2837 0.229922 0.8025 0.6440 0.5169 0.4148 0.3329 0.2671 0.214423 0.7945 0.6313 0.5016 0.3985 0.3166 0.2516 0.199924 0.7866 0.6188 0.4868 0.3829 0.3012 0.2369 0.186425 0.7788 0.6065 0.4724 0.3679 0.2865 0.2231 0.173830 0.7408 0.5488 0.4066 0.3012 0.2231 0.1653 0.122535 0.7047 0.4966 0.3499 0.2466 0.1738 0.1225 0.086340 0.6703 0.4493 0.3012 0.2019 0.1353 0.0907 0.060845 0.6376 0.4066 0.2592 0.1653 0.1054 0.0672 0.042950 0.6065 0.3679 0.2231 0.1353 0.0821 0.0498 0.030255 0.5769 0.3329 0.1920 0.1108 0.0639 0.0369 0.021360 0.5488 0.3012 0.1653 0.0907 0.0498 0.0273 0.0150

Period(T)







8% 9% 10% 11% 12% 13% 14% 15% 16% 17%

1 0.9231 0.9139 0.9048 0.8958 0.8869 0.8781 0.8694 0.8607 0.8521 0.84372 0.8521 0.8353 0.8187 0.8025 0.7866 0.7711 0.7558 0.7408 0.7261 0.71183 0.7866 0.7634 0.7408 0.7189 0.6977 0.6771 0.6570 0.6376 0.6188 0.60054 0.7261 0.6977 0.6703 0.6440 0.6188 0.5945 0.5712 0.5488 0.5273 0.50665 0.6703 0.6376 0.6065 0.5769 0.5488 0.5220 0.4966 0.4724 0.4493 0.42746 0.6188 0.5827 0.5488 0.5169 .04868 0.4584 0.4317 0.4066 0.3829 0.36067 0.5712 0.5326 0.4966 0.4630 0.4317 0.4025 0.3753 0.3499 0.3263 0.30428 0.5273 0.4868 0.4493 0.4148 0.3829 0.3535 0.3263 0.3012 0.2780 0.25769 0.4868 0.4449 0.4066 0.3716 0.3396 0.3104 0.2837 0.2592 0.2369 0.2165

10 0.4493 0.4066 0.3679 0.3329 0.3012 0.2725 0.2466 0.2231 0.2019 0.182711 0.4148 0.3716 0.3329 0.2982 0.2671 0.2393 0.2144 0.1920 0.1720 0.154112 0.3829 0.3396 0.3012 0.2671 0.2369 0.2101 0.1864 0.1653 0.1466 0.130013 0.3535 0.3104 0.2725 0.2393 0.2101 0.1845 0.1620 0.1423 0.1249 0.109714 0.3263 0.2837 0.2466 0.2144 0.1864 0.1620 0.1409 0.1225 0.1065 0.092615 0.3012 0.2592 0.2231 0.1920 0.1653 0.1423 0.1225 0.1054 0.0907 0.078116 0.2780 0.2369 0.2019 0.1720 0.1466 0.1249 0.1065 0.0907 0.0773 0.065917 0.2567 0.2165 0.1827 0.1541 0.1300 0.1097 0.0926 0.0781 0.0659 0.055618 0.2369 0.1979 0.1653 0.1381 0.1153 0.0963 0.0805 0.0672 0.0561 0.046919 0.2187 0.1809 0.1496 0.1237 0.1023 0.0846 0.0699 0.0578 0.0478 0.039620 0.2019 0.1653 0.1353 0.1108 0.0907 0.0743 0.0608 0.0498 0.0408 0.033421 0.1864 0.1511 0.1225 0.0993 0.0805 0.0652 0.0529 0.0429 0.0347 0.028222 0.1720 0.1381 0.1108 0.0889 0.0714 0.0573 0.0460 0.0369 0.0296 0.023823 0.1588 0.1262 0.1003 0.0797 0.0633 0.0503 0.0400 0.0317 0.0252 0.020024 0.1466 0.1153 0.0907 0.0714 0.0561 0.0442 0.0347 0.0273 0.0215 0.016925 0.1353 0.1054 0.0821 0.0639 0.0498 0.0388 0.0302 0.0235 0.0183 0.014330 0.0907 0.0672 0.0498 0.0369 0.0273 0.0202 0.0150 0.0111 0.0082 0.006135 0.0608 0.0429 0.0302 0.0213 0.0150 0.0106 0.0074 0.0052 0.0037 0.002640 0.0408 0.0273 0.0183 0.0123 0.0082 0.0055 0.0037 0.0025 0.0017 0.001145 0.0273 0.0174 0.0111 0.0071 0.0045 0.0029 0.0018 0.0012 0.0007 0.000550 0.0183 0.0111 0.0067 0.0041 0.0025 0.0015 0.0009 0.0006 0.0003 0.000255 0.0123 0.0071 0.0041 0.0024 0.0014 0.0008 0.0005 0.0003 0.0002 0.000160 0.0082 0.0045 0.0025 0.0014 0.0007 0.0004 0.0002 0.0001 0.0001 0.0000

Period(T)







18% 19% 20% 21% 22% 23% 24% 25% 26% 27% 28%

0.8353 0.8270 0.8187 0.8106 0.8025 0.7945 0.7866 0.7788 0.7711 0.7634 0.75580.6977 0.6839 0.6703 0.6570 0.6440 0.6313 0.6188 0.6065 0.5945 0.5827 0.57120.5827 0.5655 0.5488 0.5326 0.5169 0.5016 0.4868 0.4724 0.4584 0.4449 0.43170.4868 0.4677 0.4493 0.4317 0.4148 0.3985 0.3829 0.3679 0.3535 0.3396 0.32630.4066 0.3867 0.3679 0.3499 0.3329 0.3166 0.3012 0.2865 0.2725 0.2592 0.24660.3396 0.3198 0.3012 0.2837 0.2671 0.2516 0.2369 0.2231 0.2101 0.1979 0.18640.2837 0.2645 0.2466 0.2299 0.2144 0.1999 0.1864 0.1738 0.1620 0.1511 0.14090.2369 0.2187 0.2019 0.1864 0.1720 0.1588 0.1466 0.1353 0.1249 0.1153 0.10650.1979 0.1809 0.1653 0.1511 0.1381 0.1262 0.1153 0.1054 0.0963 0.0880 0.08050.1653 0.1496 0.1353 0.1225 0.1108 0.1003 0.0907 0.0821 0.0743 0.0672 0.06080.1381 0.1237 0.1108 0.0993 0.0889 0.0797 0.0714 0.0639 0.0573 0.0513 0.04600.1154 0.1023 0.0907 0.0805 0.0714 0.0633 0.0561 0.0498 0.0442 0.0392 0.03470.0963 0.0846 0.0743 0.0652 0.0573 0.0503 0.0442 0.0388 0.0340 0.0299 0.02630.0805 0.0699 0.0608 0.0529 0.0460 0.0400 0.0347 0.0302 0.0263 0.0228 0.01980.0672 0.0578 0.0498 0.0429 0.0369 0.0317 0.0273 0.0235 0.0202 0.0174 0.01500.0561 0.0478 0.0408 0.0347 0.0296 0.0252 0.0215 0.0183 0.0156 0.0133 0.01130.0469 0.0396 0.0334 0.0282 0.0238 0.0200 0.0169 0.0143 0.0120 0.0102 0.00860.0392 0.0327 0.0273 0.0228 0.0191 0.0159 0.0133 0.0111 0.0093 0.0078 0.00650.0327 0.0271 0.0224 0.0185 0.0153 0.0127 0.0105 0.0087 0.0072 0.0059 0.00490.0273 0.0224 0.0183 0.0150 0.0123 0.0101 0.0082 0.0067 0.0055 0.0045 0.00370.0228 0.0185 0.0150 0.0122 0.0099 0.0080 0.0065 0.0052 0.0043 0.0034 0.00280.0191 0.0153 0.0123 0.0099 0.0079 0.0063 0.0051 0.0041 0.0033 0.0026 0.00210.0159 0.0127 0.0101 0.0080 0.0063 0.0050 0.0040 0.0032 0.0025 0.0020 0.00160.0133 0.0105 0.0082 0.0065 0.0051 0.0040 0.0032 0.0025 0.0019 0.0015 0.00120.0111 0.0087 0.0067 0.0052 0.0041 0.0032 0.0025 0.0019 0.0015 0.0012 0.00090.0045 0.0033 0.0025 0.0018 0.0014 0.0010 0.0007 0.0006 0.0004 0.0003 0.00020.0018 0.0013 0.0009 0.0006 0.0005 0.0003 0.0002 0.0002 0.0001 0.0001 0.00010.0007 0.0005 0.0003 0.0002 0.0002 0.0001 0.0001 0.0000 0.0000 0.0000 0.00000.0003 0.0002 0.0001 0.0001 0.0001 0.0000 0.0000 0.0000 0.0000 0.0000 0.00000.0001 0.0001 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.00000.0001 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.00000.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000







29% 30% 31% 32% 33% 34% 35%

1 0.7483 0.7408 0.7334 0.7261 0.7189 0.7118 0.70472 0.5599 0.5488 0.5379 0.5273 0.5169 0.5066 0.49663 0.4190 0.4066 0.3946 0.3829 0.3716 0.3606 0.34994 0.3135 0.3012 0.2894 0.2780 0.2671 0.2567 0.24665 0.2346 0.2231 0.2122 0.2019 0.1920 0.1827 0.17386 0.1755 0.1653 0.1557 0.1466 0.1381 0.1300 0.12257 0.1313 0.1225 0.1142 0.1065 0.0993 0.0926 0.08638 0.0983 0.0907 0.0837 0.0773 0.0714 0.0659 0.06089 0.0735 0.0672 0.0614 0.0561 0.0513 0.0469 0.0429

10 0.0550 0.0498 0.0450 0.0408 0.0369 0.0334 0.030211 0.0412 0.0369 0.0330 0.0296 0.0265 0.0238 0.021312 0.0308 0.0273 0.0242 0.0215 0.0191 0.0169 0.015013 0.0231 0.0202 0.0178 0.0156 0.0137 0.0120 0.010614 0.0172 0.0150 0.0130 0.0113 0.0099 0.0086 0.007415 0.0129 0.0111 0.0096 0.0082 0.0071 0.0061 0.005216 0.0097 0.0082 0.0070 0.0060 0.0051 0.0043 0.003717 0.0072 0.0061 0.0051 0.0043 0.0037 0.0031 0.002618 0.0054 0.0045 0.0038 0.0032 0.0026 0.0022 0.001819 0.0040 0.0033 0.0028 0.0023 0.0019 0.0016 0.001320 0.0030 0.0025 0.0020 0.0017 0.0014 0.0011 0.000921 0.0023 0.0018 0.0015 0.0012 0.0010 0.0008 0.000622 0.0017 0.0014 0.0011 0.0009 0.0007 0.0006 0.000523 0.0013 0.0010 0.0008 0.0006 0.0005 0.0004 0.000324 0.0009 0.0007 0.0006 0.0005 0.0004 0.0003 0.000225 0.0007 0.0006 0.0004 0.0003 0.0003 0.0002 0.000230 0.0002 0.0001 0.0001 0.0001 0.0001 0.0000 0.000035 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.000040 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.000045 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.000050 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.000055 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.000060 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Period(T)


Back Matter Appendix B: Solutions to Selected End−of−Chapter Problems


Solutions to SelectedEnd-of-Chapter Problems

AP

PE

ND

IXB

Chapter 22.1 Total assets � $128,000

Common stock � $ 88,000

2.2 Common stock � $110,000,000RE � $ 22,000,000

2.7 Total cash flow to investors � ($5,000)

2.8 a. $25b. � $25

Chapter 33.1 $65,000

3.2 $73,600

3.8 a. $11 millionb. ii. $11 million � ($5 million � 1.1) � $5.5 million

Chapter 44.1 a. $1,628.89

b. $1,967.15c. $2,653.30d. $628.89

4.4 $92.30

4.5 $187,780.23

4.6 a. PV1 � $10,000 PV2 � $20,000b. PV1 � $ 9,090.91 PV2 � $12,418.43c. PV1 � $ 8,333.33 PV2 � $ 8,037.55d. r � 18.921%

4.9 $6,714.61

4.10 $1,609,866.18

4.15 a. $1,259.71b. $1,265.32c. $1,270.24d. $1,271.25

4.19 P � $800

4.22 a. $10,000b. $ 4,545.45c. $20,000

4.28 NPV � $201.88

4.29 $16,834.884.31 9.0648%4.32 a. $4,347.26

b. $17,824.65

4.36 Option 1 value � $1,201,178.88Option 2 value � $1,131,897.47

4.38 18.921%

4.39 PV of both children’s education (today) � $14,880.44Required payment � $14,880.44/A15

15% �$2,544.80

4.42 $457,611.46

4.43 NPV � $282.87, purchase the machine

Chapter 55.2 a. $1,000.00

b. $828.41c. $1,231.15

5.6 a. 12.36%b. $748.48c. $906.15

5.16 2,754 Shares

5.19 $26.95

5.21 P � $23.75

Chapter 66.1 a. Project A

b. Project B

6.3 a. 56.25%

6.5 a.

6.7 For Project A: IRR1 � 0%;IRR2 � 100%

For Project B: IRR � 36.1944%

6.9 a. IRR (Project A) � 25.69%IRR (Project B) � 19.43%

e. 19.09%g. NPVA � $689.98

NPVB � $5,671.08Choose Project B




6.16 a. Project Ab. AAR (Sunday) � 22.22%

AAR (Saturday) � 19.05%

Chapter 77.4 E(Salary) � $295,000

PV � $1,594,825.68

7.6 EPS � $4NPVGO � $3

Price � $36.33

7.8 NPV � �$7,722.52, No

7.13 NPVA � $1,446.76NPVB � $119.17Choose Project A

7.15 $705,882.35

7.23 $150,100

7.31 Bang EAC � $47,456IOU EAC � $49,592

Chapter 88.5 350 units

8.6 a. 265,625 abalonesb. $28,600

Chapter 99.1 a. $1 per share

b. $1,500c. 8.11%

9.4 15.865%

9.6 E(R) � 14.7%

9.11 b. 8.49%

9.12 a. 0.088b. 0.03311

9.13 a. E(R) � 0.056b. Standard deviation � 3.137%

9.14 a. R�M � 15.3%b. R�T � 6.28%

Chapter 1010.1 a. R� � 10.57%

b. � � 7.20%

10.4 Weight of Atlas stock � 23

Weight of Babcock stock � 13

10.5 R�p � 16.2%

�p � 18.23%

10.14 b. 13.5%

10.19 a. 5.9375%b. xA � 2

3

xB � 13

c. �2p � 0. This is a riskless portfolio.

10.27 � � 1.4

Chapter 1111.4 a. RA � 10.5 � 1.2 � (RM � 14.2) � A

RB � 13.0� 0.98 � (RM � 14.2) � B

RC � 15.7 � 1.37 � (RM � 14.2) � C

b. Rp � 12.925 � 1.1435 � (RM � 14.2) � 0.30A

� 0.45B � 0.25C

c. Rp � 13.8398%

11.6 a. Var(R1p) � .0225Var(R2p) � .00225A risk-averse investor will prefer to invest in thesecond market.

b. Var(R1p) � .0585Var(R2p) � .0025A risk-averse investor will prefer to invest in thesecond market.

c. Var(R1p) � .0225Var(R2p) � .0225Indifferent between investing in the two markets.

d. Indifference implies that the variances of theportfolios in the two markets are equal.Corr (2i,2j) � Corr (1i,1j) � .5

Chapter 1212.5 a. R�T � 0.01633; �T � 1.0032

12.6 b. i. R�M � 0.18iii. �M � 0.01265

d. i. R�j � 0.2ii. �2

j � 0.00048e. Corr (Rm,Ri) � 0.635f. �j � 1.1

Chapter 1414.1 a. 67,715 shares

b. Average price � $5 per sharec. Book value � $40 per share

14.2 a. Common stock � $500Total � $150,500

Chapter 1515.3 0.125

15.7 a. 18%b. rs � 20%

15.9 a. Value � $300 millionb. Value � $300 millionc. rs � 10.14%

914 Appendix B Solutions to Selected End-of-Chapter Problems




15.15 a. VU � $1,530,000

b. $273,000

15.16 $2,800,000

Chapter 1616.11 a. Total cash flow to stakeholders:

Equity plan � $1,260,000Debt plan � $1,638,000

b. Taxes (Debt) � $1,362,000Taxes (Equity) � $1,740,000

c. VU � $ 6,300,000VL � $11,700,000

d. Total cash flow to stakeholders:Equity plan � $1,440,000

Debt plan � $1,399,500

16.14 a. Value � $15,000b. i. V � $15,000

ii. B � $7,500iii. S � $7,500

c. i. rs � 30%ii. ro � .20 � 20%

d. i. VL � $12,000e. i. $9,000 Debt no longer adds value to the firm.

ii. $6,500 Debt lowers the value of the firm.

Chapter 1717.1 a. I � $350,625.29

b. B/C NPV � $18,285.17APV � $40,005.51

c. I � $403,222.85

17.6 a. rs � 17.576%b. rB � 10%, pre-tax

After-tax cost of debt � 6.6%c. 13.917%

17.7 a. i. WACC � 0.1047ii. WACC � 0.1173iii. WACC � 0.1047

17.8 �S � 1.21; rS � 17.293%V � $84,000,000; WACC � 14.426%NPV � $3.084 million

Chapter 1818.5 a. P � $15

b. Each year you receive $4,613.38

18.6 a. Value � $1,412,000b. Ex-dividend price � $138c. ii. P � $136.95

Number of shares sold � 76.67

18.13 a. P0 � $19.17b. P0 � $20.00

18.15 a. 0.0891b. 11%c. Preferred Stock Debt

i. 8.91% 11.00%ii. 8.00% 7.26%

iii. 6.42% 7.92%

Chapter 1919.6 At $40, P � $40.00

At $20, P � $33.33At $10, P � $30.00

19.10 a. 800,000 sharesb. 3c. $15 and three rights

19.11 a. Ex-rights price � $24.55b. Value of a right � $0.45c. Value � $2,700,500

19.13 a. $36.25b. $ 8.75

Chapter 2020.6 a. P � $1,266.41

20.8 a. VNC � $1,164.61b. C � $77.63c. $130.12

20.10 NPV � $17,857,143

Chapter 2121.7 a. Lease vs. buy NPV � $3,177.78

c. $18,177.78

Chapter 2222.6 a. $5

b. $0

22.7 a. $0

b. $5

22.10 $42.36

22.16 $0.5974

22.19 C � $1.6122.21 a. C � $5.89

b. P � $11.28

Chapter 2323.3 NPV (Fixed Plant) � $12,382,644.67

NPV (Flexible Plant) � $8,759,346.74Choose Fixed Plant

23.4 The value of the option is worth $229,400. Mr. Lusk should reject the $500 offer

Appendix B Solutions to Selected End-of-Chapter Problems 915




Chapter 2424.4 a. $1,750

b. $514.29c. i. $3,640

iii. $5,440/3 � $1,813.33iv. Gain � $13.33

d. $20

24.5 a. Lower limit � $0Upper limit � $2

b. Lower limit � $.5Upper limit � $3

24.14 a. i. 28ii. $35.71

iii. 14.27%b. i. 28

ii. The conversion price is only meaningful if thebond is selling at par.

c. $875d. Method One � $931

Method Two � $931

24.16 $333.33

Chapter 2525.3 a. i. $5.10

ii. $5.00b. i. $4.98

ii. $5.00

25.11 a. C � $35,237.89

25.13 a. A � $900.90; B � $593.45; C � $352.18b. A � $877.19; B � $519.37; C � $269.74c. A � �2.63%; B � �12.48%; C � �23.41%

25.17 3.5315 years25.20 a. 2.943 years

b. 2.752 years25.21 a. 3.327 years

b. 2.434 years

Chapter 2626.3 a. 5.26%

26.5 a. 7.14%b. Increase dividend payout ratio to d � 1.

Chapter 2727.3 Total sources � $82,325

27.4 Total sources � $646,000

27.12 a. S � $42,857b. January � $44,143

February � $66,000March � $76,000

Chapter 2828.3 $2,631.6228.4 a. Retain $243,193 in cash.

b. 17 times

28.6 Z* � $34,536H* � $63,608

28.8 Reduction in float � $6,750,000Cost of lockbox � $107,375

28.9 N � 33.43

28.12 $5,793.12 in present value terms

Chapter 2929.1 PV(Old) � $26,948.12

T � 50 days (for customers not taking the discount)

29.2 $1,232,876.71

29.3 PV(New) � $29,110,225.07

29.4 a. NPV(Credit) � $3,029.13b. 99.57%

29.10 Accounts receivable � $384,247

Chapter 3030.6 b. Prob (Joint value � $200,000) � 0.01

Prob (Joint value � $600,000) � 0.40Prob (Debt value � $300,000) � 0.08Prob (Debt value � $400,000) � 0.91Prob (Stock value � $0) � 0.25

c. Value of each company � $290,000d. Total debt value before merger � $380,000

Total debt value after merger � $390,000

30.10 a. $7,500,000b. V � $27,500,000c. Cash: $15,000,000

Stock: $15,625,000

30.11 a. $14,815,385

30.13 NPV � �$21.2

Chapter 3232.1 a. In direct terms, $1.6317/£

In European terms, DM 1.8110/£e. £ 0.3384/DM

¥ 95.6813/SF

32.7 b. E[$/DM(1)] � $0.525/DME[$/DM(3)] � $0.5788/DM

NPV � $17,582

916 Appendix B Solutions to Selected End-of-Chapter Problems


Back Matter Glossary 923© The McGraw−Hill Companies, 2002

Glossary

AAR Average accounting return.

ACRS Accelerated cost recovery system.

APT Arbitrage pricing theory.

Absolute priority rule (APR) Establishes priority ofclaims under liquidation.

Accelerated cost recovery system (ACRS) A system usedto depreciate assets for tax purposes. The current system, en-acted by the 1986 Tax Reform Act, is very similar to theACRS established in 1981. The current system specifies thedepreciable lives (recovery periods) and rates for each of sev-eral classes of property.

Accounting insolvency Total liabilities exceed total assets.A firm with negative net worth is insolvent on the books.

Accounting liquidity The ease and quickness with whichassets can be converted to cash.

Accounts payable Money the firm owes to suppliers.

Accounts receivable Money owed to the firm by customers.

Accounts receivable financing A secured short-term loanthat involves either the assigning of receivables or the factor-ing of receivables. Under assignment, the lender has a lien onthe receivables and recourse to the borrower. Factoring in-volves the sale of accounts receivable. Then the purchaser,called the factor, must collect on the receivables.

Accounts receivable turnover Credit sales divided by av-erage accounts receivable.

Additions to net working capital Component of cash flowof firm, along with operating cash flow and capital spending.

Advance commitment A promise to sell an asset before theseller has lined up purchase of the asset. This seller can offsetrisk by purchasing a futures contract to fix the sales price.

Agency costs Costs of conflicts of interest among stock-holders, bondholders, and managers. Agency costs are thecosts of resolving these conflicts. They include the costs ofproviding managers with an incentive to maximize share-holder wealth and then monitoring their behavior, and the costof protecting bondholders from shareholders. Agency costsare borne by stockholders.

Agency theory The theory of the relationship betweenprincipals and agents. It involves the nature of the costs of re-solving conflicts of interest between principals and agents.

Aggregation Process in corporate financial planning wherebythe smaller investment proposals of each of the firm’s opera-tional units are added up and in effect treated as a big picture.

Aging schedule A compilation of accounts receivable bythe age of account.

American Depository Receipt (ADR) A security issued inthe United States to represent shares of a foreign stock, en-abling that stock to be traded in the United States.

American option An option contract that may be exercisedanytime up to the expiration date. A European option may beexercised only on the expiration date.

Amortization Repayment of a loan in installments.

Angels Individuals providing venture capital.

Annualized holding-period return The annual rate of re-turn that when compounded T times, would have given thesame T-period holding return as actually occurred from pe-riod 1 to period T.

Annuity A level stream of equal dollar payments that lastsfor a fixed time. An example of an annuity is the coupon partof a bond with level annual payments.

Annuity factor The term used to calculate the present valueof the stream of level payments for a fixed period.

Annuity in advance An annuity with an immediate initialpayment.

Annuity in arrears An annuity with a first payment onefull period hence, rather than immediately. That is, the firstpayment occurs on date 1 rather than on date 0.

Appraisal rights Rights of shareholders of an acquiredfirm that allow them to demand that their shares be purchasedat a fair value by the acquiring firm.

Arbitrage Buying an asset in one market at a lowerprice and simultaneously selling an identical asset in another market at a higher price. This is done with no costor risk.

Arbitrage pricing theory (APT) An equilibrium assetpricing theory that is derived from a factor model by usingdiversification and arbitrage. It shows that the expected re-turn on any risky asset is a linear combination of variousfactors.

Arithmetic average The sum of the values observed di-vided by the total number of observations—sometimes re-ferred to as the mean.

Assets Anything that the firm owns.

Assets requirements A common element of a financialplan that describes projected capital spending and the pro-posed uses of net working capital.


Back Matter Glossary924 © The McGraw−Hill Companies, 2002

Auction market A market where all traders in a certaingood meet at one place to buy or sell an asset. The NYSE isan example.

Autocorrelation The correlation of a variable with itselfover successive time intervals.

Availability float Refers to the time required to clear acheck through the banking system.

Average accounting return (AAR) The average projectearnings after taxes and depreciation divided by the averagebook value of the investment during its life.

Average collection period Average amount of time re-quired to collect an account receivable. Also referred to asdays sales outstanding.

Average cost of capital A firm’s required payout to thebondholders and the stockholders expressed as a percentageof capital contributed to the firm. Average cost of capital iscomputed by dividing the total required cost of capital by thetotal amount of contributed capital.

Average daily sales Annual sales divided by 365 days.

Balance sheet A statement showing a firm’s accountingvalue on a particular date. It reflects the equation, Assets �Liabilities � Stockholders’ equity.

Balloon payment Large final payment, as when a loan isrepaid in installments.

Banker’s acceptance Agreement by a bank to pay a givensum of money at a future date.

Bankruptcy State of being unable to pay debts. Thus theownership of the firm’s assets is transferred from the stock-holders to the bondholders.

Bankruptcy costs See Financial distress costs.

Bargain-purchase-price option Gives lessee the option topurchase the asset at a price below fair market value when thelease expires.

Basic IRR rule Accept the project if IRR is greater than thediscount rate; reject the project if IRR is less than the discountrate.

Bearer bond A bond issued without record of the owner’sname. Whoever holds the bond (the bearer) is the owner.

Best-efforts underwriting An offering in which an under-writer agrees to distribute as much of the offering as possibleand to return any unsold shares to the issuer.

Beta coefficient A measure of the sensitivity of a security’sreturn to movements in an underlying factor. It is a measuredsystematic risk.

Bidder A firm or person that has made an offer to take overanother firm.

Black-Scholes call pricing equation An exact formula forthe price of a call option. The formula requires five vari-ables: the risk-free interest rate, the variance of the underlyingstock, the exercise price, the price of the underlying stock, andthe time to expiration.

Blanket inventory lien A secured loan that gives the lendera lien against all the borrower’s inventories.

Bond A long-term debt of a firm. In common usage, theterm bond often refers to both secured and unsecured debt.

Book cash A firm’s cash balance as reported in its financialstatements. Also called ledger cash.

Book value per share Per-share accounting equity value ofa firm. Total accounting equity divided by the number of out-standing shares.

Borrow To obtain or receive money on loan with the prom-ise or understanding of returning it or its equivalent.

Break-even analysis Analysis of the level of sales at whicha project would make zero profit.

Bubble theory (of speculative markets) Security pricessometimes move wildly above their true values.

Business failure The risk that the firm’s stockholders bearif the firm is financed only with equity.

Buying the index Purchasing the stocks in the Standard &Poor’s 500 in the same proportion as the index to achieve thesame return.

CAPM Capital asset pricing model.

CAR Cumulative abnormal return.

Call option The right—but not the obligation—to buy afixed number of shares of stock at a stated price within a spec-ified time.

Call premium The price of a call option on common stock.

Call price of a bond Amount at which a firm has the rightto repurchase its bonds or debentures before the stated matu-rity date. The call price is always set at equal to or more thanthe par value.

Call protected Describes a bond that is not allowed to becalled, usually for a certain early period in the life of the bond.

Call provision A written agreement between an issuingcorporation and its bondholders that gives the corporation theoption to redeem the bond at a specified price before the ma-turity date.

Callable Refers to a bond that is subject to be repurchasedat a stated call price before maturity.

Capital asset pricing model (CAPM) An equilibrium as-set pricing theory that shows that equilibrium rates of ex-pected return on all risky assets are a function of their covari-ance with the market portfolio.

Capital budgeting Planning and managing expendituresfor long-lived assets.

Capital gains The positive change in the value of an asset.A negative capital gain is a capital loss.

Capital market line The efficient set of all assets, bothrisky and riskless, which provides the investor with the bestpossible opportunities.

Capital markets Financial markets for long-term debt andfor equity shares.

918 Glossary



Capital rationing The case where funds are limited to a fixeddollar amount and must be allocated among competing projects.

Capital structure The mix of the various debt and equitycapital maintained by a firm. Also called financial structure.The composition of a corporation’s securities used to financeits investment activities; the relative proportions of short-termdebt, long-term debt, and owners’ equity.

Capital surplus Amounts of directly contributed equitycapital in excess of the par value.

Carrying costs Costs that increase with increases in thelevel of investment in current assets.

Carrying value Book value.

Cash budget A forecast of cash receipts and disbursementsexpected by a firm in the coming year. It is a short-term fi-nancial planning tool.

Cash cow A company that pays out all earnings per share tostockholders as dividends.

Cash cycle In general, the time between cash disbursementand cash collection. In net working capital management, itcan be thought of as the operating cycle less the accountspayable payment period.

Cash discount A discount given for a cash purchase. Onereason a cash discount may be offered is to speed up the col-lection of receivables.

Cash flow Cash generated by the firm and paid to creditorsand shareholders. It can be classified as (1) cash flow fromoperations, (2) cash flow from changes in fixed assets, and(3) cash flow from changes in net working capital.

Cash flow after interest and taxes Net income plus depreciation.

Cash-flow time line Line depicting the operating activitiesand cash flows for a firm over a particular period.

Cash offer A public equity issue that is sold to all interestedinvestors.

Cash transaction A transaction where exchange is imme-diate, as contrasted to a forward contract, which calls for fu-ture delivery of an asset at an agreed-upon price.

Cashout Refers to situation where a firm runs out of cashand cannot readily sell marketable securities.

Certificates of deposit Short-term loans to commercialbanks.

Change in net working capital Difference between networking capital from one period to another.

Changes in fixed assets Component of cash flow that equalssales of fixed assets minus the acquisition of fixed assets.

Characteristic line The line relating the expected return ona security to different returns on the market.

Clearing The exchanging of checks and balancing of ac-counts between banks.

Clientele effect Argument that stocks attract clientelesbased on dividend yield or taxes. For example, a tax clientele

effect is induced by the difference in tax treatment of dividendincome and capital gains income; high tax-bracket individu-als tend to prefer low-dividend yields.

Coinsurance effect Refers to the fact that the merger of twofirms decreases the probability of default on either’s debt.

Collateral Assets that are pledged as security for paymentof debt.

Collateral trust bond A bond secured by a pledge of com-mon stock held by the corporation.

Collection float An increase in book cash with no immedi-ate change in bank cash, generated by checks deposited by thefirm that have not cleared.

Collection policy Procedures followed by a firm in at-tempting to collect accounts receivable.

Commercial draft Demand for payment.

Commercial paper Short-term, unsecured promissorynotes issued by corporations with a high credit standing. Theirmaturity ranges up to 270 days.

Common equity Book value.

Common stock Equity claims held by the “residual own-ers” of the firm, who are the last to receive any distribution ofearnings or assets.

Compensating balance Deposit that the firm keeps withthe bank in a low-interest or non-interest-bearing account tocompensate banks for bank loans or services.

Competitive offer Method of selecting an investmentbanker for a new issue by offering the securities to the under-writer bidding highest.

Composition Voluntary arrangement to restructure a firm’sdebt, under which payment is reduced.

Compound interest Interest that is earned both on the ini-tial principal and on interest earned on the initial principal inprevious periods. The interest earned in one period becomesin effect part of the principal in a following period.

Compound value Value of a sum after investing it over oneor more periods. Also called future value.

Compounding Process of reinvesting each interest pay-ment to earn more interest. Compounding is based on the ideathat interest itself becomes principal and therefore also earnsinterest in subsequent periods.

Concentration banking The use of geographically dis-persed collection centers to speed up the collection of ac-counts receivable.

Conditional sales contract An arrangement whereby thefirm retains legal ownership of the goods until the customerhas completed payment.

Conflict between bondholders and stockholders Thesetwo groups may have interests in the corporation that conflict.Sources of conflict include dividends, dilution, distortion ofinvestment, and underinvestment. Protective covenants workto resolve these conflicts.

Glossary 919



Conglomerate acquisition Acquisition in which the ac-quired firm and the acquiring firm are not related, unlike ahorizontal or a vertical acquisition.

Consol A bond that carries a promise to pay a coupon forever;it has no final maturity date and therefore never matures.

Consolidation A merger in which an entirely new firm iscreated.

Consumer credit Credit granted to consumers. Tradecredit is credit granted to other firms.

Contingent claim Claim whose value is directly dependenton, or is contingent on, the value of its underlying assets. Forexample, the debt and equity securities issued by a firm derivetheir value from the total value of the firm.

Contingent pension liability Under ERISA, the firm is li-able to the plan participants for up to 30 percent of the networth of the firm.

Continuous compounding Interest compounded continu-ously, every instant, rather than at fixed intervals.

Contribution margin Amount that each additional prod-uct, such as a jet engine, contributes to after-tax profit of thewhole project: (Sales price � Variable cost) � (1 � Tc),where Tc is the corporate tax rate.

Conversion premium Difference between the conversionprice and the current stock price divided by the current stockprice.

Conversion price The amount of par value exchangeablefor one share of common stock. This term really refers to thestock price and means the dollar amount of the bond’s parvalue that is exchangeable for one share of stock.

Conversion ratio The number of shares per $1,000 bond(or debenture) that a bondholder would receive if the bondwere converted into shares of stock.

Conversion value What a convertible bond would be worthif it were immediately converted into the common stock at thecurrent price.

Convertible bond A bond that may be converted into an-other form of security, typically common stock, at the optionof the holder at a specified price for a specified period of time.

Corporation Form of business organization that is createdas a distinct “legal person” composed of one or more actualindividuals or legal entities. Primary advantages of a corpora-tion include limited liability, ease of ownership, transfer, andperpetual succession.

Correlation A standardized statistical measure of the de-pendence of two random variables. It is defined as the covari-ance divided by the standard deviations of two variables.

Cost of equity capital The required return on the com-pany’s common stock in capital markets. It is also called theequity holders’ required rate of return because it is what eq-uity holders can expect to obtain in the capital market. It is acost from the firm’s perspective.

Coupon The stated interest on a debt instrument.

Covariance A statistical measure of the degree to whichrandom variables move together.

Credit analysis The process of determining whether acredit applicant meets the firm’s standards and what amountof credit the applicant should receive.

Credit instrument Device by which a firm offers credit,such as an invoice, a promissory note, or a conditional salescontract.

Credit period Time allowed a credit purchaser to remit thefull payment for credit purchases.

Credit scoring Determining the probability of defaultwhen granting customers credit.

Creditor Person or institution that holds the debt issued bya firm or individual.

Cross rate The exchange rate between two foreign curren-cies, neither of which is generally the U.S. dollar.

Crown jewels An antitakeover tactic in which major assets—the crown jewels—are sold by a firm when facedwith a takeover threat.

Cum dividend With dividend.

Cumulative abnormal return (CAR) Sum of differencesbetween the expected return on a stock and the actual returnthat comes from the release of news to the market.

Cumulative dividend Dividend on preferred stock thattakes priority over dividend payments on common stock.Dividends may not be paid on the common stock until all pastdividends on the preferred stock have been paid.

Cumulative probability The probability that a drawingfrom the standardized normal distribution will be below a par-ticular value.

Cumulative voting A procedure whereby a shareholdermay cast all of his or her votes for one member of the boardof directors.

Current asset Asset that is in the form of cash or that is ex-pected to be converted into cash in the next 12 months, suchas inventory.

Current liabilities Obligations that are expected to requirecash payment within one year or the operating period.

Current ratio Total current assets divided by total currentliabilities. Used to measure short-term solvency of a firm.

Date of payment Date that dividend checks are mailed.

Date of record Date on which holders of record in a firm’sstock ledger are designated as the recipients of either divi-dends or stock rights.

Dates convention Treating cash flows as being received onexact dates—date 0, date 1, and so forth—as opposed to theend-of-year convention.

Days in receivables Average collection period.

Days sales outstanding Average collection period.

De facto Existing in actual fact although not by officialrecognition.

920 Glossary



Dealer market A market where traders specializing in par-ticular commodities buy and sell assets for their own account.The OTC market is an example.

Debenture An unsecured bond, usually with maturity of 15 years or more. A debt obligation backed by the generalcredit of the issuing corporation.

Debt Loan agreement that is a liability of the firm. An obli-gation to repay a specified amount at a particular time.

Debt capacity Ability to borrow. The amount a firm canborrow up to the point where the firm value no longer increases.

Debt displacement The amount of borrowing that leasingdisplaces. Firms that do a lot of leasing will be forced to cutback on borrowing.

Debt ratio Total debt divided by total assets.

Debt service Interest payments plus repayments of princi-pal to creditors, that is, retirement of debt.

Decision trees A graphical representation of alternativesequential decisions and the possible outcomes of those decisions.

Declaration date Date on which the board of directorspasses a resolution to pay a dividend of a specified amount toall qualified holders of record on a specified date.

Dedicated capital Total par value (number of shares issuedmultiplied by the par value of each share). Also called dedi-cated value.

Deed of trust Indenture.

Deep-discount bond A bond issued with a very lowcoupon or no coupon and selling at a price far below parvalue. When the bond has no coupon, it is also called a pure-discount or original-issue-discount bond.

Default risk The chance that interest or principal will notbe paid on the due date and in the promised amount.

Defeasance A debt-restructuring tool that enables a firm toremove debt from its balance sheet by establishing an irrevo-cable trust that will generate future cash flows sufficient toservice the decreased debt.

Deferred call A provision that prohibits the company fromcalling the bond before a certain date. During this period thebond is said to be call protected.

Deferred nominal life annuity A monthly fixed-dollarpayment beginning at retirement age. It is nominal becausethe payment is fixed in dollar amount at any particular time,up to and including retirement.

Deferred taxes Noncash expense.

Deficit The amount by which a sum of money is less thanthe required amount; an excess of liabilities over assets, oflosses over profits, or of expenditure over income.

Deliverable instrument The asset in a forward contractthat will be delivered in the future at an agreed-upon price.

Denomination Face value or principal of a bond.

Depreciation A noncash expense, such as the cost of plantor equipment, charged against earnings to write off the cost ofan asset during its estimated useful life.

Depreciation tax shield Portion of an investment that canbe deducted from taxable income.

Dilution Loss in existing shareholders’ value. There are sev-eral kinds of dilution: (1) dilution of ownership, (2) dilution ofmarket value, and (3) dilution of book value and earnings, aswith warrants and convertible issues. Firms with significantamounts of warrants or convertible issues outstanding are re-quired to report earnings on a “fully diluted” basis.

Direct lease A lease under which a lessor buys equipmentfrom a manufacturer and leases it to a lessee.

Disbursement float A decrease in book cash but no imme-diate change in bank cash, generated by checks written by the firm.

Discount If a bond is selling below its face value, it is saidto sell at a discount.

Discount rate Rate used to calculate the present value offuture cash flows.

Discounted payback period rule An investment decisionrule in which the cash flows are discounted at an interest rateand the payback rule is applied on these discounted cash flows.

Discounting Calculating the present value of a futureamount. The process is the opposite of compounding.

Distribution A type of dividend paid by a firm to its own-ers from sources other than current or accumulated retainedearnings.

Diversifiable risk A risk that specifically affects a singleasset or a small group of assets. Also called unique or unsys-tematic risk.

Dividend Payment made by a firm to its owners, either incash or in stock. Also called the “income component” of thereturn on an investment in stock.

Dividend growth model A model wherein dividends areassumed to be at a constant rate in perpetuity.

Dividend payout Amount of cash paid to shareholders ex-pressed as a percentage of earnings per share.

Dividend yield Dividends per share of common stock di-vided by market price per share.

Dividends per share Amount of cash paid to shareholdersexpressed as dollars per share.

Double-declining balance depreciation Method of accel-erated depreciation.

DuPont system of financial control Highlights the factthat return on assets (ROA) can be expressed in terms of theprofit margin and asset turnover.

Duration The weighted average time of an asset’s cashflows. The weights are determined by present value factors.

EAC Equivalent annual cost.

Glossary 921



EBIT Earnings before interest and taxes.

EMH Efficient market hypothesis.

ERISA Employee Retirement Income Security Act of 1974.

Economic assumptions Economic environment in whichthe firm expects to reside over the life of the financial plan.

Effective annual interest rate The interest rate as if it werecompounded once per time period rather than several timesper period.

Efficient market hypothesis (EMH) The prices of se-curities fully reflect available information. Investors buy-ing bonds and stocks in an efficient market should expectto obtain an equilibrium rate of return. Firms should expectto receive the “fair” value (present value) for the securitiesthey sell.

Efficient set Graph representing a set of portfolios thatmaximize expected return at each level of portfolio risk.

End-of-year convention Treating cash flows as if they oc-cur at the end of a year (or, alternatively, at the end of a pe-riod), as opposed to the date convention. Under the end-of-year convention, the end of year 0 is the present, end of year1 occurs one period hence, and so on.

Equilibrium rate of interest The interest rate that clearsthe market. Also called market-clearing interest rate.

Equity Ownership interest of common and preferred stock-holders in a corporation. Also, total assets minus total liabili-ties, or net worth.

Equity kicker Used to refer to warrants because they usu-ally are issued in combination with privately placed bonds.

Equity share Ownership interest.

Equivalent annual cost (EAC) The net present value ofcost divided by an annuity factor that has the same life as theinvestment.

Equivalent loan The amount of the loan that makes leasingequivalent to buying with debt financing in terms of debt ca-pacity reduction.

Erosion Cash-flow amount transferred to a new projectfrom customers and sales of other products of the firm.

Eurobanks Banks that make loans and accept deposits inforeign currencies.

Eurobond An international bond sold primarily in coun-tries other than the country in whose currency the issue isdenominated.

Eurocurrency Money deposited in a financial center out-side of the country whose currency is involved.

Eurodollar A dollar deposited in a bank outside the UnitedStates.

Eurodollar CD Deposit of dollars with foreign banks.

European Currency Unit (ECU) An index of foreign ex-change consisting of about 10 European currencies, originallydevised in 1979.

European option An option contract that may be exercisedonly on the expiration date. An American option may be ex-ercised any time up to the expiration date.

Event study A statistical study that examines how the re-lease of information affects prices at a particular time.

Ex rights or ex dividend Phrases used to indicate that astock is selling without a recently declared right or dividend.The ex-rights or ex-dividend date is generally four businessdays before the date of record.

Exchange rate Price of one country’s currency for another’s.

Exclusionary self-tender The firm makes a tender offer fora given amount of its own stock while excluding targetedstockholders.

Ex-dividend date Date four business days before the dateof record for a security. An individual purchasing stock beforeits ex-dividend date will receive the current dividend.

Exercise price Price at which the holder of an option canbuy (in the case of a call option) or sell (in the case of a putoption) the underlying stock. Also called the striking price.

Exercising the option The act of buying or selling the un-derlying asset via the option contract.

Expectations hypothesis (of interest rates) Theory thatforward interest rates are unbiased estimates of expected fu-ture interest rates.

Expected return Average of possible returns weighted bytheir probability.

Expiration date Maturity date of an option.

Extension Voluntary arrangements to restructure a firm’sdebt, under which the payment date is postponed.

Extinguish Retire or pay off debt.

Face value The value of a bond that appears on its face.Also referred to as par value or principal.

Factor A financial institution that buys a firm’s accounts re-ceivables and collects the debt.

Factor model A model in which each stock’s return is gener-ated by common factors, called the systematic sources of risk.

Factoring Sale of a firm’s accounts receivable to a financialinstitution known as a factor.

Fair market value Amount at which common stock wouldchange hands between a willing buyer and a willing seller,both having knowledge of the relevant facts. Also called mar-ket price.

Feasible set Opportunity set.

Federal agency securities Securities issued by corpora-tions and agencies created by the U.S. government, such asthe Federal Home Loan Bank Board and GovernmentNational Mortgage Association (Ginnie Mae).

Field warehouse financing A form of inventory loan inwhich a public warehouse company acts as a control agent tosupervise the inventory for the lender.

922 Glossary



Financial Accounting Standards Board (FASB) The gov-erning body in accounting.

Financial distress Events preceding and including bank-ruptcy, such as violation of loan contracts.

Financial distress costs Legal and administrative costs ofliquidation or reorganization (direct costs); an impaired abil-ity to do business and an incentive toward selfish strategiessuch as taking large risks, underinvesting, and milking theproperty (indirect costs).

Financial intermediaries Institutions that provide the mar-ket function of matching borrowers and lenders or traders.Financial institutions may be categorized as depository, con-tractual savings, and investment-type.

Financial lease A long-term noncancelable lease, generallyrequiring the lessee to pay all maintenance fees.

Financial leverage Extent to which a firm relies on debt.Financial leverage is measured by the ratio of long-term debtto long-term debt plus equity.

Financial markets Markets that deal with cash flows overtime, where the savings of lenders are allocated to the financ-ing needs of borrowers.

Financial requirements In the financial plan, financingarrangements that are necessary to meet the overall corporateobjective.

Financial risk The additional risk that the firm’s stockholdersbear when the firm is financed with debt as well as equity.

Firm commitment underwriting An underwriting inwhich an investment banking firm commits to buy the entireissue and assumes all financial responsibility for any unsoldshares.

Firm’s net value of debt Total firm value minus value of debt.

First principle of investment decision making An invest-ment project is worth undertaking only if it increases therange of choices in the financial markets. To do this, it mustbe at least as desirable as what is available to shareholders inthe financial markets.

Fixed asset Long-lived property owned by a firm that is usedby a firm in the production of its income. Tangible fixed assetsinclude real estate, plant, and equipment. Intangible fixed as-sets include patents, trademarks, and customer recognition.

Fixed cost A cost that is fixed in total for a given period oftime and for given volume levels. It is not dependent on theamount of goods or services produced during the period.

Fixed-dollar obligations Conventional bonds for whichthe coupon rate is set as a fixed percentage of the par value.

Flat benefit formula Method used to determine a partici-pant’s benefits in a defined benefit plan by multiplyingmonths of service by a flat monthly benefit.

Float The difference between bank cash and book cash.Float represents the net effect of checks in the process of col-

lection, or clearing. Positive float means the firm’s bank cashis greater than its book cash until the check’s presentation.Checks written by the firm generate disbursement float, caus-ing an immediate decrease in book cash but no change in bankcash. In neutral float position, bank cash equals book cash.Checks written by the firm represent collection float, whichincreases book cash immediately but does not immediatelychange bank cash. The sum of disbursement float and collec-tion float is net float.

Floater Floating-rate bond.

Floating-rate bond A debt obligation with an adjustablecoupon payment.

Forced conversion If the conversion value of a convertibleis greater than the call price, the call can be used to force con-version.

Foreign bonds An international bond issued by foreignborrowers in another nation’s capital market and traditionallydenominated in that nation’s currency.

Foreign exchange market Market in which arrangementsare made today for future exchange of major currencies; usedto hedge against major swings in foreign exchange rates.

Forward contract An arrangement calling for future deliv-ery of an asset at an agreed-upon price.

Forward exchange rate A future day’s exchange rate be-tween two major currencies.

Forward trade An agreement to buy or sell based on ex-change rates established today for settlement in the future.

Frequency distribution The organization of data to showhow often certain values or ranges of values occur.

Fully diluted See Dilution.

Funded debt Long-term debt.

Future value Value of a sum after investing it over one ormore periods. Also called compound value.

Futures contract Obliges traders to purchase or sell an as-set at an agreed-upon price on a specified future date. Thelong position is held by the trader who commits to purchase.The short position is held by the trader who commits to sell.Futures differ from forward contracts in their standardization,exchange trading, margin requirements, and daily settling(market to market).

GAAP Generally Accepted Accounting Principles.

General cash offer A public issue of a security that is soldto all interested investors, rather than only to existing share-holders.

General partnership Form of business organization inwhich all partners agree to provide some portion of the workand cash and to share profits and losses. Each partner is liablefor the debts of the partnership.

Generally Accepted Accounting Principles (GAAP) Acommon set of accounting concepts, standards, and proce-dures by which financial statements are prepared.

Glossary 923



Geometric mean Annualized holding-period return.

Gilts British and Irish government securities.

Going-private transactions Publicly owned stock in a firmis replaced with complete equity ownership by a privategroup. The shares are delisted from stock exchanges and canno longer be purchased in the open market.

Golden parachute Compensation paid to top-level man-agement by a target firm if a takeover occurs.

Goodwill The excess of the purchase price over the sum ofthe fair market values of the individual assets acquired.

Greenmail Payments to potential bidders to cease un-friendly takeover attempts.

Green-shoe provision A contract provision that gives theunderwriter the option to purchase additional shares at the of-fering price to cover overallotments.

Growing perpetuity A constant stream of cash flows with-out end that is expected to rise indefinitely. For example, cashflows to the landlord of an apartment building might be ex-pected to rise a certain percentage each year.

Growth opportunity Opportunity to invest in profitableprojects.

Hedging Taking a position in two or more securities that arenegatively correlated (taking opposite trading positions) to re-duce risk.

High-yield bond Junk bond.

Holder-of-record date The date on which holders ofrecord in a firm’s stock ledger are designated as the recipientsof either dividends or stock rights. Also called date of record.

Holding period Length of time that an individual holds asecurity.

Holding-period return The rate of return over a given period.

Homemade dividends An individual investor can undocorporate dividend policy by reinvesting excess dividends orselling off shares of stock to receive a desired cash flow.

Homemade leverage Idea that as long as individuals borrow(and lend) on the same terms as the firm, they can duplicate theeffects of corporate leverage on their own. Thus, if levered firmsare priced too high, rational investors will simply borrow on per-sonal accounts to buy shares in unlevered firms.

Homogeneous expectations Idea that all individuals havethe same beliefs concerning future investments, profits, anddividends.

Horizontal acquisition Merger between two companiesproducing similar goods or services.

IPO Initial public offering.

IRR Internal rate of return.

Idiosyncratic risk An unsystematic risk.

Immunized Immune to interest-rate risk.

In the money Describes an option whose exercise wouldproduce profits. Out of the money describes an option whoseexercise would not be profitable.

Income bond A bond on which the payment of income iscontingent on sufficient earnings. Income bonds are com-monly used during the reorganization of a failed or failingbusiness.

Income statement Financial report that summarizes afirm’s performance over a specified time period.

Incremental cash flows Difference between the firm’scash flows with and without a project.

Incremental IRR IRR on the incremental investment fromchoosing a large project instead of a smaller project.

Indenture Written agreement between the corporate debtissuer and the lender, setting forth maturity date, interest rate,and other terms.

Independent project A project whose acceptance or rejec-tion is independent of the acceptance or rejection of otherprojects.

Inflation An increase in the amount of money in circula-tion, resulting in a fall in its value and rise in prices.

Inflation-escalator clause A clause in a contract providingfor increases or decreases in inflation based on fluctuations inthe cost of living, production costs, and so forth.

Information-content effect The rise in the stock price fol-lowing the dividend signal.

In-house processing float Refers to the time it takes the re-ceiver of a check to process the payment and deposit it in abank for collection.

Initial public offering (IPO) The original sale of a com-pany’s securities to the public. Also called an unseasoned new issue.

Inside information Nonpublic knowledge about a corpora-tion possessed by people in special positions inside a firm.

Instruments Financial securities, such as money market in-struments or capital market instruments.

Interest coverage ratio Earnings before interest and taxesdivided by interest expense. Used to measure a firm’s abilityto pay interest.

Interest on interest Interest earned on reinvestment of eachinterest payment on money invested.

Interest rate The price paid for borrowing money. It is therate of exchange of present consumption for future consump-tion, or the price of current dollars in terms of future dollars.

Interest rate on debt The firm’s cost of debt capital. Alsocalled return on the debt.

Interest-rate-parity theorem The interest rate differentialbetween two countries will be equal to the difference betweenthe forward-exchange rate and the spot-exchange rate.

Interest-rate risk The chance that a change in the interestrate will result in a change in the value of a security.

Interest subsidy A firm’s deduction of the interest pay-ments on its debt from its earnings before it calculates its taxbill under current tax law.

924 Glossary



Internal financing Net income plus depreciation minusdividends. Internal financing comes from internally generatedcash flow.

Internal rate of return (IRR) A discount rate at which thenet present value of an investment is zero. The IRR is amethod of evaluating capital expenditure proposals.

Inventory A current asset, composed of raw materials to beused in production, work in process, and finished goods.

Inventory loan A secured short-term loan to purchase in-ventory. The three basic forms are a blanket inventory lien, atrust receipt, and field warehouse financing.

Inventory turnover ratio Ratio of annual sales to averageinventory that measures how quickly inventory is producedand sold.

Investment bankers Financial intermediaries who performa variety of services, including aiding in the sale of securities,facilitating mergers and other corporate reorganizations, act-ing as brokers to both individual and institutional clients, andtrading for their own accounts.

Investment grade bond Debt that is rated BBB and aboveby Standard & Poor’s or Baa and above by Moody’s.

Invoice Bill written by a seller of goods or services and sub-mitted to the purchaser.

Irrelevance result The MM theorem that a firm’s capitalstructure is irrelevant to the firm’s value.

Junk bond A speculative grade bond, rated Ba or lower byMoody’s, or BB or lower by Standard & Poor’s, or an unratedbond. Also called a high-yield or low-grade bond.

LBO Leveraged buyout.

LIBOR London interbank offered rate.

Law of one price (LOP) A commodity will cost the sameregardless of what currency is used to purchase it.

Lease A contractual arrangement to grant the use of spe-cific fixed assets for a specified time in exchange for pay-ment, usually in the form of rent. An operating lease is gen-erally a short-term cancelable arrangement, whereas afinancial, or capital, lease is a long-term noncancelableagreement.

Ledger cash A firm’s cash balance as reported in its finan-cial statements. Also called book cash.

Legal bankruptcy A legal proceeding for liquidating or re-organizing a business.

Lend To provide money temporarily on the condition that itor its equivalent will be returned, often with an interest fee.

Lessee One that receives the use of assets under a lease.

Lessor One that conveys the use of assets under a lease.

Letter of comment A communication to the firm from theSecurities and Exchange Commission that suggests changesto a registration statement.

Level-coupon bond Bond with a stream of coupon pay-ments that are the same throughout the life of the bond.

Leveraged buyout Takeover of a company by using bor-rowed funds, usually by a group including some member ofexisting management.

Leveraged equity Stock in a firm that relies on financialleverage. Holders of leveraged equity face the benefits andcosts of using debt.

Leveraged lease Tax-oriented leasing arrangement that in-volves one or more third-party lenders.

Liabilities Debts of the firm in the form of financial claimson a firm’s assets.

Limited partnership Form of business organization thatpermits the liability of some partners to be limited by theamount of cash contributed to the partnership.

Limited-liability instrument A security, such as a call op-tion, in which all the holder can lose is the initial amount putinto it.

Line of credit A noncommitted line of credit is an informalagreement that allows firms to borrow up to a previously spec-ified limit without going through the normal paperwork. Acommitted line of credit is a formal legal arrangement and usu-ally involves a commitment fee paid by the firm to the bank.

Lintner’s observations John Lintner’s work (1956) sug-gested that dividend policy is related to a target level of divi-dends and the speed of adjustment of change in dividends.

Liquidating dividend Payment by a firm to its ownersfrom capital rather than from earnings.

Liquidation Termination of the firm as a going concern.Liquidation involves selling the assets of the firm for salvagevalue. The proceeds, net of transaction costs, are distributedto creditors in order of established priority.

Liquidity Refers to the ease and quickness of convertingassets to cash. Also called marketability.

Liquidity-preference hypothesis Theory that the forwardrate exceeds expected future interest rates.

Lockbox Post office box set up to intercept accounts re-ceivable payments. Lockboxes are the most widely used de-vice to speed up collection of cash.

London Interbank Offered Rate (LIBOR) Rate the mostcreditworthy banks charge one another for large loans ofEurodollars overnight in the London market.

Long hedge Protecting the future cost of a purchase by pur-chasing a futures contract to protect against changes in theprice of an asset.

Long run A period of time in which all costs are variable.

Long-term debt An obligation having a maturity of more thanone year from the date it was issued. Also called funded debt.

Low-grade bond Junk bond.

MM Proposition I A proposition of Modigliani and Miller(MM) which states that a firm cannot change the total valueof its outstanding securities by changing its capital structureproportions. Also called an irrelevance result.

Glossary 925



MM Proposition II A proposition by Modigliani andMiller (MM) which states that the cost of equity is a linearfunction of the firm’s debt-equity ratio.

Mail float Refers to the part of the collection and disburse-ment process where checks are trapped in the postal system.

Make a market The obligation of a specialist to offer tobuy and sell shares of assigned stocks. It is assumed that thismakes the market liquid because the specialist assumes therole of a buyer for investors if they wish to sell and a seller ifthey wish to buy.

Making delivery Refers to the seller’s actually turning overto the buyer the asset agreed upon in a forward contract.

Marked to market Describes the daily settlement of obli-gations on futures positions.

Market capitalization Price per share of stock multipliedby the number of shares outstanding.

Market clearing Total demand for loans by borrowersequals total supply of loans from lenders. The market clearsat the equilibrium rate of interest.

Market model A one-factor model for returns where the in-dex that is used for the factor is an index of the returns on thewhole market.

Market portfolio In concept, a value-weighted index of allsecurities. In practice, it is an index, such as the S&P 500, thatdescribes the return of the entire value of the stock market, orat least the stocks that make up the index. A market portfoliorepresents the average investor’s return.

Market price The current amount at which a security istrading in a market.

Market risk Systematic risk. This term emphasizes the factthat systematic risk influences to some extent all assets in themarket.

Market value The price at which willing buyers and sellerstrade a firm’s assets.

Marketability Refers to the ease and quickness of convert-ing an asset to cash. Also called liquidity.

Marketed claims Claims that can be bought and sold in fi-nancial markets, such as those of stockholders and bondholders.

Market-to-book (M/B) ratio Market price per share ofcommon stock divided by book value per share.

Maturity date The date on which the last payment on abond is due.

Merger Combination of two or more companies.

Minimum variance portfolio The portfolio of risky assetswith the lowest possible variance. By definition, this portfo-lio must also have the lowest possible standard deviation.

Money markets Financial markets for debt securities thatpay off in the short term (usually less than one year).

Money purchase plan A defined benefit contribution planin which the participant contributes some part and the firmcontributes at the same or a different rate. Also called an in-dividual account plan.

Mortgage securities A debt obligation secured by a mort-gage on the real property of the borrower.

Multiple rates of return More than one rate of return fromthe same project that make the net present value of the proj-ect equal to zero. This situation arises when the IRR methodis used for a project in which negative cash flows follow pos-itive ones.

Multiples Another name for price/earnings ratios.

Mutually exclusive investment decisions Investment deci-sions in which the acceptance of a project precludes the ac-ceptance of one or more alternative projects.

NPV Net present value.

NPVGO model A model valuing the firm in which netpresent value of new investment opportunities is explicitly ex-amined. NPVGO stands for net present value of growth op-portunities.

Negative covenant Part of the indenture or loan agreementthat limits or prohibits actions that the company may take.

Negotiated offer The issuing firm negotiates a deal withone underwriter to offer a new issue rather than taking com-petitive bidding.

Net cash balance Beginning cash balance plus cash re-ceipts minus cash disbursements.

Net float Sum of disbursement float and collection float.

Net investment Gross, or total, investment minusdepreciation.

Net operating losses (NOL) Losses that a firm can take ad-vantage of to reduce taxes.

Net present value (NPV) The present value of future cashreturns, discounted at the appropriate market interest rate, mi-nus the present value of the cost of the investment.

Net present value rule An investment is worth making if ithas a positive NPV. If an investment’s NPV is negative, itshould be rejected.

Net working capital Current assets minus current liabilities.

Netting out To get or bring in as a net; to clear as profit.

Neutral flat position See Float.

Nominal cash flow A cash flow expressed in nominal termsif the actual dollars to be received (or paid out) are given.

Nominal interest rate Interest rate unadjusted for inflation.

Noncash item Expense against revenue that does not di-rectly affect cash flow, such as depreciation and deferred taxes.

Nonmarketed claims Claims that cannot be easily boughtand sold in the financial markets, such as those of the govern-ment and litigants in lawsuits.

Normal annuity form The manner in which retirementbenefits are paid out.

Normal distribution Symmetric bell-shaped frequency dis-tribution that can be defined by its mean and standard deviation.

Note Unsecured debt, usually with maturity of less than 15 years.

926 Glossary



Odd lot Stock trading unit of less than 100 shares.

Off balance sheet financing Financing that is not shown asa liability on a company’s balance sheet.

One-factor APT A special case of the arbitrage pricing the-ory that is derived from the one-factor model by using diver-sification and arbitrage. It shows the expected return on anyrisky asset is a linear function of a single factor. The CAPMcan be expressed as one-factor APT in which a single factoris the market portfolio.

Open account A credit account for which the only formalinstrument of credit is the invoice.

Operating activities Sequence of events and decisions that create the firm’s cash inflows and cash outflows. Theseactivities include buying and paying for raw materials, manu-facturing and selling a product, and collecting cash.

Operating cash flow Earnings before interest and deprecia-tion minus taxes. It measures the cash generated from operations,not counting capital spending or working capital requirements.

Operating cycle The time interval between the arrival ofinventory stock and the date when cash is collected from re-ceivables.

Operating lease Type of lease in which the period of con-tract is less than the life of the equipment and the lessor paysall maintenance and servicing costs.

Operating leverage The degree to which a company’scosts of operation are fixed as opposed to variable. A firmwith high operating costs compared to a firm with a low op-erating leverage, and hence relatively larger changes in EBITwith respect to a change in the sales revenue.

Opportunity cost Most valuable alternative that is givenup. The rate of return used in NPV computation is an oppor-tunity interest rate.

Opportunity set The possible expected return—standarddeviation pairs of all portfolios that can be constructed from aset of assets. Also called a feasible set.

Option A right—but not an obligation—to buy or sell under-lying assets at a fixed price during a specified time period.

Original-issue-discount bond A bond issued with a dis-count from par value. Also called a deep-discount or pure-discount bond.

Out of the money Describes an option whose exercisewould not be profitable. In the money describes an optionwhose exercise would produce profits.

Oversubscribed issue Investors are not able to buy all theshares they want, so underwriters must allocate the sharesamong investors. This occurs when a new issue is underpriced.

Oversubscription privilege Allows shareholders to pur-chase unsubscribed shares in a rights offering at the subscrip-tion price.

Over-the-counter (OTC) market An informal network ofbrokers and dealers who negotiate sales of securities (not aformal exchange).

Par value The nominal or face value of stocks or bonds. Forstock, it is a relatively unimportant value except for book-keeping purposes.

Partnership Form of business organization in which two ormore co-owners form a business. In a general partnershipeach partner is liable for the debts of the partnership. Limitedpartnership permits some partners to have limited liability.

Payback period rule An investment decision rule whichstates that all investment projects that have payback periodsequal to or less than a particular cutoff period are accepted,and all of those that pay off in more than the particular cutoffperiod are rejected. The payback period is the number of yearsrequired for a firm to recover its initial investment required bya project from the cash flow it generates.

Payments pattern Describes the lagged collection patternof receivables, for instance the probability that a 72-day-oldaccount will still be unpaid when it is 73 days old.

Payout ratio Proportion of net income paid out in cashdividends.

Pecking order in long-term financing Hierarchy of long-term financing strategies, in which using internally generatedcash is at the top and issuing new equity is at the bottom.

Perfect markets Perfectly competitive financial markets.

Perfectly competitive financial markets Markets in whichno trader has power to change the price of goods or services.Perfect markets are characterized by the following conditions:(1) Trading is costless, and access to the financial markets isfree. (2) Information about borrowing and lending opportunitiesis freely available. (3) There are many traders, and no singletrader can have a significant impact on market prices.

Performance shares Shares of stock given to managers onthe basis of performance as measured by earnings per shareand similar criteria—a control device used by shareholders totie management to the self-interest of shareholders.

Perpetuity A constant stream of cash flows without end. A British consol is an example.

Perquisites Management amenities such as a big office, acompany car, or expense-account meals. “Perks” are agencycosts of equity, because managers of the firm are agents of thestockholders.

Pie model of capital structure A model of the debt-equityratio of the firms, graphically depicted in slices of a pie thatrepresents the value of the firm in the capital markets.

Plug A variable that handles financial slack in the finan-cial plan.

Poison pill Strategy by a takeover target company to makea stock less appealing to a company that wishes to acquire it.

Pooling of interests Accounting method of reporting ac-quisitions under which the balance sheets of the two compa-nies are simply added together item by item.

Portfolio Combined holding of more than one stock, bond,real estate asset, or other asset by an investor.

Glossary 927



Portfolio variance Weighted sum of the covariances andvariances of the assets in a portfolio.

Positive covenant Part of the indenture or loan agreementthat specifies an action that the company must abide by.

Positive float See Float.

Post Particular place on the floor of an exchange wheretransactions in stocks listed on the exchange occur.

Preemptive right The right to share proportionally in anynew stock sold.

Preferred stock A type of stock whose holders are given cer-tain priority over common stockholders in the payment of divi-dends. Usually the dividend rate is fixed at the time of issue.Preferred stockholders normally do not receive voting rights.

Premium If a bond is selling above its face value, it is saidto sell at a premium.

Present value The value of a future cash stream discountedat the appropriate market interest rate.

Present value factor Factor used to calculate an estimate ofthe present value of an amount to be received in a future period.

Price takers Individuals who respond to rates and prices byacting as though they have no influence on them.

Priced out Means the market has already incorporated in-formation, such as a low dividend, into the price of a stock.

Price-to-earnings (P/E) ratio Current market price ofcommon stock divided by current annual earnings per share.

Primary market Where new issues of securities are of-fered to the public.

Principal The value of a bond that must be repaid at matu-rity. Also called the face value or par value.

Principle of diversification Highly diversified portfolioswill have negligible unsystematic risk. In other words, unsys-tematic risks disappear in portfolios, and only systematicrisks survive.

Private placement The sale of a bond or other security di-rectly to a limited number of investors.

Pro forma statements Projected income statements, bal-ance sheets, and sources and uses statements for future years.

Profit margin Profits divided by total operating revenue.The net profit margin (net income divided by total operatingrevenue) and the gross profit margin (earnings before interestand taxes divided by the total operating revenue) reflect thefirm’s ability to produce a good or service at a high or low cost.

Profitability index A method used to evaluate projects. It isthe ratio of the present value of the future expected cash flowsafter initial investment divided by the amount of the initial in-vestment.

Promissory note Written promise to pay.

Prospectus The legal document that must be given to everyinvestor who contemplates purchasing registered securities inan offering. It describes the details of the company and theparticular offering.

Protective covenant A part of the indenture or loan agree-ment that limits certain actions a company takes during theterm of the loan to protect the lender’s interest.

Proxy A grant of authority by the shareholder to transfer hisor her voting rights to someone else.

Proxy contest Attempt to gain control of a firm by solicit-ing a sufficient number of stockholder votes to replace the ex-isting management.

Public issue Sales of securities to the public.

Purchase accounting Method of reporting acquisitions re-quiring that the assets of the acquired firm be reported at theirfair market value on the books of the acquiring firm.

Purchasing power parity (PPP) Idea that the exchange rateadjusts to keep purchasing power constant among currencies.

Pure discount bond Bonds that pay no coupons and onlypay back face value at maturity. Also referred to as “bullets”and “zeros.”

Put option The right to sell a specified number of shares ofstock at a stated price on or before a specified time.

Put provision Gives holder of a floating-rate bond the rightto redeem his or her note at par on the coupon payment date.

Put-call parity The value of a call equals the value of buy-ing the stock plus buying the put plus borrowing at the risk-free rate.

Q ratio or Tobin’s Q ratio Market value of firm’s assets di-vided by replacement value of firm’s assets.

Quick assets Current assets minus inventories.

Quick ratio Quick assets (current assets minus inventories)divided by total current liabilities. Used to measure short-term solvency of a firm.

R squared (R2) Square of the correlation coefficient pro-portion of the variability explained by the linear model.

Random walk Theory that stock price changes from day today are at random; the changes are independent of each otherand have the same probability distribution.

Real cash flow A cash flow is expressed in real terms if thecurrent, or date 0, purchasing power of the cash flow is given.

Real interest rate Interest rate expressed in terms of realgoods; that is, the nominal interest rate minus the expected in-flation rate.

Receivables turnover ratio Total operating revenues di-vided by average receivables. Used to measure how effec-tively a firm is managing its accounts receivable.

Red herring First document released by an underwriter ofa new issue to prospective investors.

Refunding The process of replacing outstanding bonds,typically to issue new securities at a lower interest rate thanthose replaced.

Registration statement The registration that discloses allthe pertinent information concerning the corporation thatwants to make the offering. The statement is filed with theSecurities and Exchange Commission.

928 Glossary



Regular cash dividend Cash payment by firm to its share-holders, usually four times a year.

Regulation A The securities regulation that exempts smallpublic offerings (those valued at less than $1.5 million) frommost registration requirements.

Relative purchasing power parity (RPPP) Idea that therate of change in the price level of commodities in one coun-try relative to the price level in another determines the rate ofthe exchange rate between the two countries’ currencies.

Reorganization Financial restructuring of a failed firm.Both the firm’s asset structure and its financial structure arechanged to reflect their true value, and claims are settled.

Replacement value Current cost of replacing the firm’s assets.

Replacement-chain problem Idea that future replacementdecisions must be taken into account in selecting amongprojects.

Repurchase agreement (repos) Short-term, often overnight,sales of government securities with an agreement to repurchasethe securities at a slightly higher price.

Repurchase of stock Device to pay cash to firm’s sharehold-ers that provides more preferable tax treatment for shareholdersthan dividends. Treasury stock is the name given to previouslyissued stock that has been repurchased by the firm.

Residual dividend approach An approach that suggeststhat a firm pay dividends if and only if acceptable investmentopportunities for those funds are currently unavailable.

Residual losses Lost wealth of the shareholders due to di-vergent behavior of the managers.

Residual value Usually refers to the value of a lessor’sproperty at the time the lease expires.

Restrictive covenants Provisions that place constraints on theoperations of borrowers, such as restrictions on working capital,fixed assets, future borrowing, and payment of dividend.

Retained earnings Earnings not paid out as dividends.

Retention ratio Retained earnings divided by net income.

Return Profit on capital investment or securities.

Return on assets (ROA) Income divided by average totalassets.

Return on equity (ROE) Net income after interest andtaxes divided by average common stockholders’ equity.

Reverse split The procedure whereby the number of out-standing stock shares is reduced; for example, two outstand-ing shares are combined to create only one.

Rights offer An offer that gives a current shareholder theopportunity to maintain a proportionate interest in the com-pany before the shares are offered to the public.

Risk averse A risk-averse investor will consider risky port-folios only if they provide compensation for risk via a riskpremium.

Risk class A partition of the universal set of risk measure sothat projects that are in the same risk class can be comparable.

Risk premium The excess return on the risky asset that isthe difference between expected return on risky assets and thereturn on risk-free assets.

Round lot Common stock trading unit of 100 shares ormultiples of 100 shares.

S&P 500 Standard & Poor’s Composite Index.

SEC Securities and Exchange Commission.

SML Security market line.

SMP Security market plane.

Safe harbor lease A lease to transfer tax benefits of own-ership (depreciation and debt tax shield) from the lessee, if thelessee could not use them, to a lessor that could.

Sale and lease-back An arrangement whereby a firm sellsits existing assets to a financial company which then leasesthem back to the firm. This is often done to generate cash.

Sales forecast A key input to the firm’s financial planningprocess. External sales forecasts are based on historical expe-rience, statistical analysis, and consideration of variousmacroeconomic factors; internal sales forecasts are obtainedfrom internal sources.

Sales-type lease An arrangement whereby a firm leases itsown equipment, such as IBM leasing its own computers,thereby competing with an independent leasing company.

Scale enhancing Describes a project that is in the same riskclass as the whole firm.

Scenario analysis Analysis of the effect on the project ofdifferent scenarios, each scenario involving a confluence of factors.

Seasoned new issue A new issue of stock after the com-pany’s securities have previously been issued. A seasonednew issue of common stock can be made by using a cash of-fer or a rights offer.

Secondary markets Already-existing securities are boughtand sold on the exchanges or in the over-the-counter market.

Security market line (SML) A straight line that shows the equilibrium relationship between systematic risk and ex-pected rates of return for individual securities. According tothe SML, the excess return on a risky asset is equal to the ex-cess return on the market portfolio multiplied by the beta co-efficient.

Security market plane (SMP) A plane that shows theequilibrium relationship between expected return and the betacoefficient of more than one factor.

Semistrong-form efficiency Theory that the market is effi-cient with respect to all publicly available information.

Seniority The order of repayment. In the event of bank-ruptcy, senior debt must be repaid before subordinated debtreceives any payment.

Sensitivity analysis Analysis of the effect on the projectwhen there is some change in critical variables such as salesand costs.

Glossary 929



Separation principle The principle that portfolio choicecan be separated into two independent tasks: (1) determina-tion of the optimal risky portfolio, which is a purely technicalproblem, and (2) the personal choice of the best mix of therisky portfolio and the risk-free asset.

Separation theorem The value of an investment to an in-dividual is not dependent on consumption preferences. All investors will want to accept or reject the same invest-ment projects by using the NPV rule, regardless of personalpreference.

Serial covariance The covariance between a variable andthe lagged value of the variable; the same as autocovariance.

Set of contracts perspective View of corporation as a setof contracting relationships among individuals who have con-flicting objectives, such as shareholders or managers. Thecorporation is a legal contrivance that serves as the nexus forthe contracting relationships.

Shareholder Holder of equity shares. The terms share-holders and stockholders usually refer to owners of commonstock in a corporation.

Shelf life Number of days it takes to get goods purchasedand sold, or days in inventory.

Shelf registration An SEC procedure that allows a firm tofile a master registration statement summarizing planned fi-nancing for a two-year period, and then file short statementswhen the firm wishes to sell any of the approved master state-ment securities during that period.

Shirking The tendency to do less work when the return issmaller. Owners may have more incentive to shirk if they issueequity as opposed to debt, because they retain less ownership in-terest in the company and therefore may receive a smaller return.Thus, shirking is considered an agency cost of equity.

Short hedge Protecting the value of an asset held by sellinga futures contract.

Short run That period of time in which certain equipment,resources, and commitments of them are fixed.

Short sale Sale of a security that an investor doesn’t ownbut has instead borrowed.

Shortage costs Costs that fall with increases in the level ofinvestment in current assets.

Short-run operating activities Events and decisions con-cerning the short-term finance of a firm, such as how much in-ventory to order and whether to offer cash terms or creditterms to customers.

Short-term debt An obligation having a maturity of oneyear or less from the date it was issued. Also called un-funded debt.

Short-term tax exempts Short-term securities issued bystates, municipalities, local housing agencies, and urban re-newal agencies.

Side effects Effects of a proposed project on other parts ofthe firm.

Sight draft A commercial draft demanding immediatepayment.

Signaling approach Approach to the determination of op-timal capital structure asserting that insiders in a firm have in-formation that the market does not; therefore the choice ofcapital structure by insiders can signal information to out-siders and change the value of the firm. This theory is alsocalled the asymmetric information approach.

Simple interest Interest calculated by considering only theoriginal principal amount.

Sinking fund An account managed by the bond trustee forthe purpose of repaying the bonds.

Small issues exemption Securities issues that involve lessthan $1.5 million are not required to file a registration state-ment with the Securities and Exchange Commission. Insteadthey are governed by Regulation A, for which only a brief of-fering statement is needed.

Sole proprietorship A business owned by a single individ-ual. The sole proprietorship pays no corporate income tax buthas unlimited liability for business debts and obligations.

Spot-exchange rate Exchange rate between two currenciesfor immediate delivery.

Spot-interest rate Interest rate fixed today on a loan that ismade today.

Spot trade An agreement on the exchange rate today forsettlement in two days.

Spread underwriting Difference between the under-writer’s buying price and the offering price. The spread is afee for the service of the underwriting syndicate.

Spreadsheet A computer program that organizes numericaldata into rows and columns on a terminal screen, for calculat-ing and making adjustments based on new data.

Stakeholders Both stockholders and bondholders.

Stand-alone principle Investment principle that states afirm should accept or reject a project by comparing it with se-curities in the same risk class.

Standard deviation The positive square root of the vari-ance. This is the standard statistical measure of the spread ofa sample.

Standardized normal distribution A normal distributionwith an expected value of 0 and a standard deviation of 1.

Standby fee Amount paid to an underwriter who agrees topurchase any stock that is not subscribed to the public investorin a rights offering.

Standby underwriting An agreement whereby an under-writer agrees to purchase any stock that is not purchased bythe public investor.

Standstill agreements Contracts where the bidding firm in atakeover attempt agrees to limit its holdings of another firm.

Stated annual interest rate The interest rate expressed as apercentage per annum, by which interest payment is determined.

930 Glossary



Static theory of capital structure Theory that the firm’scapital structure is determined by a trade-off of the value oftax shields against the costs of bankruptcy.

Stock dividend Payment of a dividend in the form of stockrather than cash. A stock dividend comes from treasury stock,increasing the number of shares outstanding, and reduces thevalue of each share.

Stock split The increase in the number of outstanding sharesof stock while making no change in shareholders’ equity.

Stockholder Holder of equity shares in a firm. The termsstockholder and shareholders usually refer to owners of com-mon stock.

Stockholders’ books Set of books kept by firm manage-ment for its annual report that follows Financial AccountingStandards Board rules. The tax books follow the IRS rules.

Stockholders’equity The residual claims that stockholdershave against a firm’s assets, calculated by subtracting total li-abilities from total assets; also net worth.

Stockout Running out of inventory.

Straight voting A shareholder may cast all of his or hervotes for each candidate for the board of directors.

Straight-line depreciation A method of depreciationwhereby each year the firm depreciates a constant proportionof the initial investment less salvage value.

Striking price Price at which the put option or call optioncan be exercised. Also called the exercise price.

Strong-form efficiency Theory that the market is efficientwith respect to all available information, public or private.

Subordinate debt Debt whose holders have a claim on thefirm’s assets only after senior debtholders’ claims have beensatisfied.

Subscription price Price that existing shareholders are al-lowed to pay for a share of stock in a rights offering.

Sum-of-the-year’s-digits depreciation Method of acceler-ated depreciation.

Sunk cost A cost that has already occurred and cannot beremoved. Because sunk costs are in the past, such costsshould be ignored when deciding whether to accept or rejecta project.

Super-majority amendment A defensive tactic that re-quires 80 percent of shareholders to approve a merger.

Surplus funds Cash flow available after payment of taxesin the project.

Sustainable growth rate The only growth rate possiblewith preset values for four variables: profit margin, payout ra-tio, debt-equity ratio, and asset utilization ratio, if the firm is-sues no new equity.

Swap Exchange between two securities or currencies.One type of swap involves the sale (or purchase) of a for-eign currency with a simultaneous agreement to repurchase(or sell) it.

Swap rate The difference between the sale (purchase) priceand the price to repurchase (resell) it in a swap.

Sweep account Account in which the bank takes all excessavailable funds at the close of each business day and investsthem for the firm.

Syndicate A group of investment banking companies thatagree to cooperate in a joint venture to underwrite an offeringof securities for resale to the public.

Systematic Common to all businesses.

Systematic risk Any risk that affects a large number of as-sets, each to a greater or lesser degree. Also called market riskor common risk.

Systematic risk principle Only the systematic portion ofrisk matters in large, well-diversified portfolios. Thus, the ex-pected returns must be related only to systematic risk.

T-bill Treasury bill.

T-period holding-period return The percentage returnover the T-year period an investment lasts.

Takeover General term referring to transfer of control of afirm from one group of shareholders to another.

Taking delivery Refers to the buyer’s actually assumingpossession from the seller of the asset agreed upon in a for-ward contract.

Target cash balance Optimal amount of cash for a firm tohold, considering the trade-off between the opportunity costs ofholding too much cash and the trading costs of holding too little.

Target firm A firm that is the object of a takeover by an-other firm.

Target payout ratio A firm’s long-run dividend-to-earningsratio. The firm’s policy is to attempt to pay out a certain per-centage of earnings, but it pays a stated dollar dividend and ad-justs it to the target as increases in earnings occur.

Targeted repurchase The firm buys back its own stockfrom a potential bidder, usually at a substantial premium, toforestall a takeover attempt.

Tax books Set of books kept by firm management for theIRS that follows IRS rules. The stockholders’ books followFinancial Accounting Standards Board rules.

Taxable acquisition An acquisition in which shareholdersof the acquired firm will realize capital gains or losses thatwill be taxed.

Taxable income Gross income less a set of deductions.

Tax-free acquisition An acquisition in which the sellingshareholders are considered to have exchanged their oldshares for new ones of equal value, and in which they have ex-perienced no capital gains or losses.

Technical analysis Research to identify mispriced securitiesthat focuses on recurrent and predictable stock price patterns.

Technical insolvency Default on a legal obligation of thefirm. For example, technical inventory occurs when a firmdoesn’t pay a bill.

Glossary 931



Tender offer Public offer to buy shares of a target firm.

Term structure Relationship between spot-interest ratesand maturities.

Terms of sale Conditions on which firm proposes to sell itsgoods and services for cash or credit.

Time value of money Price or value put on time. Timevalue of money reflects the opportunity cost of investing at arisk-free rate. The certainty of having a given sum of moneytoday is worth more than the certainty of having an equal sumat a later date because money can be put to profitable use dur-ing the intervening time.

Tobin’s Q Market value of assets divided by replacementvalue of assets. A Tobin’s Q ratio greater than 1 indicates thefirm has done well with its investment decisions.

Tombstone An advertisement that announces a public offer-ing of securities. It identifies the issuer, the type of security, theunderwriters, and where additional information is available.

Total asset-turnover ratio Total operating revenue dividedby average total assets. Used to measure how effectively afirm is managing its assets.

Total cash flow of the firm Total cash inflow minus totalcash outflow.

Trade acceptance Written demand that has been acceptedby a firm to pay a given sum of money at a future date.

Trade credit Credit granted to other firms.

Trading costs Costs of selling marketable securities andborrowing.

Trading range Price range between highest and lowestprices at which a security is traded.

Transactions motive A reason for holding cash that arisesfrom normal disbursement and collection activities of the firm.

Treasury bill Short-term discount debt maturing in lessthan one year. T-bills are issued weekly by the federal gov-ernment and are virtually risk free.

Treasury bond or note Debt obligations of the federal gov-ernment that make semiannual coupon payments and are soldat or near par value in denominations of $1,000 or more. Theyhave original maturities of more than one year.

Treasury stock Shares of stock that have been issued andthen repurchased by a firm.

Triangular arbitrage Striking offsetting deals amongthree markets simultaneously to obtain an arbitrage profit.

Trust receipt A device by which the borrower holds the in-ventory in “trust” for the lender.

Underpricing Issuing of securities below the fair marketvalue.

Underwriter An investment firm that buys an issue of se-curity from the firm and resells it to the investors.

Unfunded debt Short-term debt.

Unit benefit formula Method used to determine a partici-pant’s benefits in a defined benefit plan by multiplying yearsof service by the percentage of salary.

Unseasoned new issue Initial public offering (IPO).

Unsystematic What is specific to a firm.

Unsystematic risk See Diversifiable risk.

VA principle Value additivity principle.

Value additivity (VA) principle In an efficient market thevalue of the sum of two cash flows is the sum of the values ofthe individual cash flows.

Variable cost A cost that varies directly with volume and iszero when production is zero.

Variance of the probability distribution The expectedvalue of squared deviation from the expected return.

Venture capital Early-stage financing of young companiesseeking to grow rapidly.

Vertical acquisition Acquisition in which the acquiredfirm and the acquiring firm are at different steps in the pro-duction process.

WACC Weighted average cost of capital.

Waiting period Time during which the Securities andExchange Commission studies a firm’s registration statement.During this time the firm may distribute a preliminaryprospectus.

Warrant A security that gives the holder the right—but notthe obligation—to buy shares of common stock directly froma company at a fixed price for a given time period.

Wash Gains equal losses.

Weak-form efficiency Theory that the market is efficientwith respect to historical price information.

Weighted average cost of capital (WACC) The averagecost of capital on the firm’s existing projects and activities.The weighted average cost of capital for the firm is calculatedby weighting the cost of each source of funds by its propor-tion of the total market value of the firm. It is calculated on abefore- and after-tax basis.

Weighted average maturity A measure of the level ofinterest-rate risk calculated by weighting cash flows by thetime to receipt and multiplying by the fraction of total pres-ent value represented by the cash flow at that time.

Winner’s curse The average investor wins—that is, getsthe desired allocation of a new issue—because those whoknew better avoided the issue.

Wire transfer An electronic transfer of funds from onebank to another that eliminates the mailing and check-clearingtimes associated with other cash-transfer methods.

Yankee bonds Foreign bonds issued in the United States byforeign banks and corporations.

Yield to maturity The discount rate that equates the pres-ent value of interest payments and redemption value with thepresent price of the bond.

Zero-balance account (ZBA) A checking account inwhich a zero balance is maintained by transfer of funds froma master account in an amount only large enough to coverchecks presented.

932 Glossary


Back Matter Name Index 939© The McGraw−Hill Companies, 2002

Index I–1

Name IndexAggarwal, Reena, 560Agrawal, Anup, 449Ahn, D., 363nAllen, Franklin, 525Allen, Robert, 203Altinkilic, Oya, 545n, 560Altman, Edward I., 426–427, 574, 575, 576,

583, 855, 860, 868, 869n, 870, 871Amihud, Y., 324n, 326–327, 576nAmran, Martha, 671Anders, George, 867nAndrade, Gregor, 426–427Ang, J., 517, 605, 607Antikarov, Vladimir, 672Ariel, R. A., 355nArmstrong, Michael, 203Asquith, Paul, 514, 544, 576n, 690n, 691, 843

Bagwell, Laurie S., 506nBali, R., 497nBanz, R. W., 354nBarnea, A., 688nBar-Or, Yuval, 427Barry, Christopher, 557nBartov, Eli, 353nBaumol, William S., 773Bautista, A. J., 606Beatty, R., 540nBeranek, W., 864nBerens, J. L., 441n, 443nBerger, P. G., 835nBerkman, H., 725nBethal, Jennifer, F., 555Bhagat, S., 541n, 554Bhattacharya, S., 515nBiddle, G. C., 360Bierman, H., Jr., 812Billet, Matthew T., 839nBlack, Fischer, 68, 284n, 511, 645Block, S. B., 161Blume, M., 516Bodenheimer, Henry, 333Bodie, Zvi, 125, 570nBodnar, Gordon M., 724n, 725Boehmer, R., 864nBooth, 553Bosignore, Michael R., 651, 653Bourdain, Anthony, 161Bower, D. H., 302Bower, R. S., 302Bowman, R. G., 606Boyle, Barbara, 162Bradbury, M. E., 725nBradley, M., 844Brav, A., 363nBrealey, Richard, 681nBreen, William J., 284n

Brennan, Michael J., 215, 324n, 510–511,672, 691

Brigham, E. F., 687nBrumer, Robert, 178Bruno, A. V., 557Buckstein, Mark A., 856

Caesar, Julius, 74Campbell, Cynthia J., 690nCanter, M. S., 705nCarleton, W. T., 743Carter, R., 540nCaton, Gary L., 690nChambers, Donald, 341nChambers, John T., 651, 653Chan, Su Han, 202nChattergee, S., 865nChen, Hsuan-Chi, 545n, 560Chen, N., 299nChew, Donald H., Jr., 334n, 455, 513n, 516n,

579n, 580n, 691Childs, John, 516Chung, Kee H., 39nColler, M., 327Copeland, Tom, 189, 329, 450n, 531, 672Cornell, Bradford, 236, 579nCornett, M., 450nCowan, A. R., 690nCox, John C., 579n, 700nCrawford, P. J., 606Crockett, J., 516Crutchley, Claire, 544nCulp, C., 695n, 705nCuny, C. L., 441n, 443nCutler, David M., 427

DeAngelo, Harry, 376, 448n, 513, 839, 840nDeAngelo, Linda, 376, 513, 840mDeloof, Marc, 807Demetz, H., 531nDesai, A., 844Desai, J., 839nDeSantis, Georgio, 887nDescartes, René, 152nDevlin, Robert M., 651, 653Dhillon, U. S., 865nDick, C. L., Jr., 743Dill, D. A., 606Dirksen, Everett M., 430nDobrzynski, Judith H., 201nDolde, Walter, 725nDonaldson, Gordon G., 382, 738Donaldson. O., 16Dunsby, Adam, 506nDye, E., 214n

Easterbrook, Frank, 868Ebbers, Bernard J., 651, 653

Eberhart, Allan C., 864nEckbo, E. B., 363n, 825Ederington, Louis H., 690nEdwards, F. R., 705nEdwards, Robert Davis, 345nEllis, Katrina, 560Elton, N., 497Esrey, William T., 651, 653Ezzel, J. R., 323n, 329, 410n, 485

Fabozzi, Frank J., 584, 584n, 763Fabozzi, T. D., 584Fama, Eugene F., 63, 284, 329, 356, 357, 366,

440n, 511, 517, 518, 519, 525Fields, W. C., 700Fiorina, Carly S., 651, 653Fisher, Irving G., 63Flath, D., 603Fohrer, Alan J., 453, 520Fomon, Robert, 787Francis, J. C., 743Frank, M., 497nFranklin, Benjamin, 70Franks, J. R., 606French, Kenneth R., 284, 329, 356, 357, 358,

440n, 511, 517, 518, 519, 525Friend, I., 302, 516Frohman, Clay, 162

Garvey, Gerald T., 16nGault, Stanley, 467Géczy, C., 363n, 883Gerard, Bruno, 887nGerjsbeek, W. R., Jr., 160nGibbons, M. R., 355nGilson, Stuart G., 864n, 868Goetzmann, W. N., 236Golub, Harvey, 651, 653Gompers, P. A., 363nGordon, M., 512Gordon, R. H., 21Graham, John R., 160–161, 309n, 329, 447,

449n, 455Grimm, W. T., 826–827Gruber, M., 497Grundhofer, John, 651, 653

Haddad, M., 105nHammergree, John H., 651, 653Hamonoff, R., 778nHansen, Robert S., 513n, 540, 541n, 545n, 560Harper, C. P., 606Harris, M., 689nHarvey, Campbell R., 160–161, 309n, 329, 888Haugen, Robert A., 426n, 455, 544n, 688nHausman, W. H., 812Havokimian, Armen, 440n


Back Matter Name Index940 © The McGraw−Hill Companies, 2002

I–2 Name Index

Hayes, P. A., 581Hayt, Gregory S., 724n, 725Healey, P. M., 514, 845Helms, B. P., 105nHershman, A., 554Hess, Pat, 355n, 516nHiggins, Robert C., 739, 742Hilbert, Stephen C., 651, 653Hill, Ned C., 791, 812Hirschleifer, J., 63Hite, G. L., 497nHodges, S. D., 606Holthausen, Robert W., 572nHong, H., 360Hoshi, Takeo, 847nHowton, Shawn D., 724n, 725nHubbard, R. Glenn, 835nHull, John C., 628n, 645, 663nHunt Brothers, 701

Ibbotson, Roger G., 73, 139n, 225, 226, 227,228, 229, 231, 233, 236, 299, 541, 545n

Icahn, Carl, 856Ikenberry, David, 363, 509nIngersoll, John E., 579n, 689n, 700nInselbag, Isik, 474n, 485, 493n

Jacob, J., 839nJagannathan, R., 497nJain, P., 839nJamail, Joe, 427Jarrell, Gregg, 202nJarrow, R. A., 525, 541n, 868Jegers, Marc, 807Jensen, Michael C., 15n, 117, 284n, 435,

437n, 504, 826–827, 828n, 831,842–843, 868

Jobs, Steven, 521Joehnk, M. D., 572n, 581John, J., 839nJohn, Kose, 864n, 868Johnson, R. E., 606, 607Johnson, W. B., 353nJorion, P., 236

Kallberg, J. G., 763Kane, A., 125Kaplan, R. S., 359–360Kaplan, Steven L., 426–427, 868Kashyup, Anil K., 847nKaufold, Howard, 474n, 485, 489n, 493nKealy, Bill, 516nKeim, Donald B., 354, 364–365Kensinger, John, 202nKester, W. Carl, 845n, 847nKeynes, John Maynard, 433Khanna, Naveen, 541nKieso, D. E., 31Kim, E. H., 844Koller, T., 189, 329Koraczyk, Robert A., 284nKorwar, A. N., 544Kothari, S. P., 284n, 356Kraus, A., 569n, 570Krinsky, Itzhak, 353nKulatilaka, Nalin, 671Kumar, Raman, 513n

Lakonishok, Joseph, 363, 509nLang, Larry N. P., 437n, 864n, 868LaPorta, R., 21Lease, Ronald C., 376, 516, 517, 606, 866Lee, C. F., 743Lee, Inmoo, 545, 546, 547, 577Lee, Won Heum, 450nLee, Y. W., 812Leeson, Nicholas, 695Leftwich, Richard W., 572nLemmon, Michael, 455Levich, Richard M., 882Lewellen, W., 516, 517Lewis, Craig M., 688n, 689Lindahl, F. W., 360Lindberg, E. B., 39nLindenberg, Eric, 823nLindley, J. T., 105nLinn, S. G., 839Lins, Karl, 835nLintner, John, 273, 277, 285n, 518–520Litwak, Mark, 162nLitzenberger, Robert, 510–511, 516nLockhead, Scott, 545, 546, 547, 577Logue, D. E., 302, 541n, 839nLong, H., 214nLong, Michael S., 807, 812, 841nLopez-De-Silanes, F., 21Loughran, Tim, 355, 361, 362, 363, 844Luehrman, T. A., 485

MacBeth, James, 284nMackie-Mason, J. K., 21Madhavan, A., 364–365Magee, John, 345Magee, R. P., 353nMaier, J. B., 556Majd, S., 214Maksimovic, V., 525, 868Malatesta, P. H., 841n, 843Malitz, I. B., 807, 812Malkiel, Burton G., 348n, 357n, 359, 366Manaster, S., 540nMandelker, G., 360, 843nManess, Terry S., 791Marcus, A., 125Marden, Bernard, 867Markowitz, Harry, 259n, 277Marr, M. W., 554Marsh, P., 451nMarshall, John, 15nMarston, Richard, 724n, 725Martin, John, 202nMasonson, L. N., 763Masulis, R. W., 363n, 448n, 450n, 544Matsusaka, John, 835nMauer, D. C., 839nMazzeo, M. A., 690nMcColl, Hugh L., Jr., 651, 653McConnell, John J., 117, 201–202, 376, 580,

606, 607, 827, 839, 865n, 866McGuire, William W., 651, 653Meadows, W. C., 171–172Meeking, William, 15n, 435Mehra, Rajnish, 240–241Melicher, R. W., 581Mello, A. S., 705n

Mendelson, H., 324n, 326–327, 576nMian, Shehzad I., 807, 812Michaely, Roni, 514, 525, 560Mikkelson, W. H., 376, 544, 687nMiles, J. A., 323n, 329, 410n, 485Milken, Michael, 574Miller, I. M., 515nMiller, M., 21, 695n, 705nMiller, Merton H., 63, 340–341, 395–396,

405, 406, 417, 441n, 455, 462–463, 499,502, 511, 512, 513, 525, 776

Minton, Bernadette A., 726, 883Minuit, Peter, 74Modigliani, Franco, 395–396, 405, 406, 417,

499, 502, 512, 525Moore, W. T., 690nMork, Randall, 835nMoyer, R. C., 607Mullins, David W., Jr., 514, 544, 576n, 778nMurrin, J., 189, 329Muscarella, Chris J., 117, 201–202, 557n, 827Muzka, D., 556nMyers, Stewart C., 214, 382n, 438n, 439n,

440n, 606, 681n, 743, 778n, 825n, 835n

Nagarajan, Nandu J., 353n, 449Nance, D. R., 883nNayan, N., 690nNevitt, P. K., 584nNewman, H. A., 353nNorli, O., 363n

O’Brian, Thomas I., 887nOgden, J. P., 572nO’Hara, Maureen, 560O’Neill, Paul, 651, 653Opler, Tim, 440n, 756Orr, Daniel, 776Otek, E., 835n, 839n

Palepu, K. G., 514, 845Palia, Darius, 835nParkinson, K., 763Parsons, J. E., 541n, 705nPartch, M. M., 544Pastor, Lubos, 354Peavey, John W., III, 557nPenman, Stephen H., 360Perfect, Steven B., 724n, 725nPerlmutter, Isaac, 867Perry, K., 578Petersen, Mitchell A., 807Peterson, D., 517Peterson, P. P., 517, 605, 607Phillips, Stephen, 866nPickens, T. Boone, 827, 840Pinkowitz, Lee, 756Pogue, G. A., 743Porter, Michael E., 825Poterba, James M., 358Pratt, S. E., 554n, 556, 557Prescott, Edward C., 240–241Protopapadakis, A., 509nPruitt, Stephen W., 39n

Radhakrishnan, Suresh, 353nRagolski, Richard J., 688n, 689


Back Matter Name Index 941© The McGraw−Hill Companies, 2002

Name Index I–3

Rajan, Raghuram G., 455, 807Ramaswamy, K., 510–511Ramirez, G. G., 865nRanking, G., 532Rappaport, A., 738, 743Ravid, S. A., 807, 812Raviv, A., 541n, 689nReilly, F., 572nReinganum, M. R., 354nReinhart, U. E., 216Reishus, David, 868Rice, E. M., 839, 840nRitter, Jay R., 361, 362, 363, 538–539, 540n,

541, 542, 545, 546, 547, 560, 577Robichek, A., 214Rock, K., 515n, 543nRockefeller family, 556Rogowski, R., 554nRoll, Richard, 299n, 303, 353n, 359–360,

505n, 843Ross, Marc, 164Ross, Michael P., 823nRoss, Stephen A., 39n, 285n, 299n, 302, 515n,

579n, 700nRowell, D. R., 743Rozeff, Michael, 513nRuback, Richard S., 826–827, 842–843,

845, 868

Sartoris, William L., 791, 812Schall, L. D., 160n, 164, 607Schallheim, James S., 455, 606, 607Scharfstein, David, 847nScherr, F. C., 812Schipper, K., 843Schlarbaum, G. C., 516, 517, 580Scholes, Myron S., 284n, 364–365, 511, 513,

628, 645Schramm, Ronald M., 887nSchrand, C., 883Schwartz, E. S., 215, 691Senbet, Lemma, 426n, 455, 688n, 868Servaes, Henri, 835n, 865nSeward, James K., 688n, 689, 839n, 868Seyhun, H. N., 359nShah, K., 450Shanken, Jay, 284n, 356Shapiro, Alan, 466nSharpe, William F., 273, 277Shelton, J. R., 743Shiller, Robert S., 236Shivdasani, A., 363n

Shleifer, Andrei, 835nShleiter, A., 21Shome Dilip K., 513nShoven, John B., 506nSiegel, Jeremy, 241Sigler, Andrew, 201nSimpson, Ron, 162Singh, A. K., 690nSinquefield, Rex A., 73, 139n, 225, 226, 227,

228, 229, 231, 233, 236, 299Sirri, Drik R., 555Sivarama, K. V., 607Sloane, Richard G., 284n, 356, 360Smith, Adam, 435Smith, B., 864nSmith, Clifford W., Jr., 431, 551n, 552, 553,

605, 607, 807, 812, 883nSmith, Frederick, 428Smith, R., 553Smithson, C. W., 883nSolnik, B. H., 887Sorenson, E., 554nSorenson, O. W., 607Sousa, D., 839nStambaugh, Robert F., 354Stanley, K. L., 516, 517Stanley, M. T., 161Statman, Meir, 262Stein, J., 688nStern, Joel M., 334n, 513n, 516n, 579n,

580n, 691Stevenson, H., 556nStewart, G. B., 334nStice, Earl, 532Stillman, R., 825Stoll, H., 531nStowe, J. D., 812Stulz, René, 437n, 756, 887Suggitt, Heather J., 583Summers, Lawrence H., 427Sundem, G., 160n, 164Sunder, L. S., 440nSwan, Peter L., 16nSzewczyk, S. H., 352

Taggart, R. A., 451n, 570n, 578Tamarowski, C., 324nTashjian, Elizabeth, 866Thaler, R. H., 514Thompson, G. R., 554Thompson, R., 843Thornley, Anthony S., 454, 520

Timmons, J., 556nTitman, Sheridan, 440nTong, Wilson, 356Travlos, N., 450nTreynor, Jack, 285nTrigeorgis, L., 672Truman, Harry, 495Tsetsekos, George P., 352Tufano, Peter, 341n, 726Tyebjee, T. T., 557

Van Horne, James C., 214, 681nVarma, Raj, 341nVermaelen, Theo, 363, 509nVetsuypens, Michael R., 557nVijh, Anand M., 839n, 844Vishney, Robert W., 835n

Wakeman, L. M., 605, 607Walker, D., 556Walkling, R. A., 437n, 841nWalsh, J. P., 839nWang, Henry N., 887nWarner, J. B., 426, 431Warren, J. M., 743Wasserstein, Bruce, 848Weill, Sanford J., 651–654Weinstein, M., 572nWeiss, Lawrence A., 426, 863, 864n, 868Welch, John F., Jr., 651, 653Werners, R., 353nWetzel, W. E., 556–557Weygandt, J. J., 31White, M. J., 96, 426Willet, Joseph T., 516Williamson, O., 15Williamson, Rohan, 756Willliams, Vanessa, 93nWolff, Eric D., 576nWomack, K., 514Woolridge, J. Randall, 202Wozniak, Stephen, 521Wruck, Karen H., 854, 866n, 868

Yohn, T., 327

Zantout, Zaher, 352Zhang, Xiao-Jun, 360Zhao, Quanshui, 545, 546, 547, 577Ziemba, W. T., 525, 868Zietlow, John T., 791Zingales, Luigi, 455


Back Matter Subject Index942 © The McGraw−Hill Companies, 2002

Capital Structure andDividend Policy

Abandon, option to, 213Abnormal return, 351–352, 545Absolute priority rule, 859, 863, 864Accelerated depreciation, 123Accounting

for acquisitions, 820–823completed contract method, 123and efficient markets, 359–361and leasing, 589–590and P/E ratios, 122percentage-of-completion method, 123pooling-of-interests method, 822–823purchase method, 821–822

Accounting costs, 27Accounting income, 26

compared to cash flows, 169–170and leasing, 604

Accounting liquidity, 22–23measures of, 33

Accounting profit, break-even point, 211Accounts payable, 33, 760Accounts payable period, 751–753Accounts receivable financing, 762Accounts receivable period, 751–752Acquisitions; see also Leveraged buyouts;

Mergers; Takeoversaccounting for, 820–823by asset acquisition, 818avoiding mistakes, 830benefits to shareholders, 842–845case, 852–853classification scheme, 818consolidations, 817cost reductions from, 825–827defensive tactics, 838–841determining synergy, 823–824and diversification, 834–835for earnings growth, 833–834economic analysis, 831instead of dividends, 504–505as investment made under

uncertainty, 816Japanese keiretsu, 845–846long-run evidence on, 844–485as market for corporate control, 827mergers, 817pooling-of-interests method, 822–823purchase method accounting, 821–822real productivity in, 845reducing cost of capital, 829short-run evidence on, 842–844sources of synergy, 824–829by stock acquisition, 817–818strategic advantage, 825takeovers, 818–819tax forms of, 819–820

tax gains from, 827–829value of the firm after, 829–830

Activity ratios, 34–35Additions to net working capital, 28Adjustable-rate preferred stock, 793–794Adjusted basis, 172nAdjusted-present-value method, 468–470

compared to flow-to-equity method, 474compared to weighted-average-cost-of-

capital method, 473example of, 478–481formula, 485guidelines, 474–476for leasing, 608–610for leveraged buyouts, 489–494side effects, 468–469

Administrative expenses, 27, 425–426, 859Advance commitments, 712Adverse selection

costs of, 327and liquidity, 325–326

After-tax interest rate, 592, 609Agency costs, 15

case, 467of convertibles and warrants, 688and high-dividend policy, 513of leasing, 604selfish strategies, 427–430

Agency costs of equity, 435–437effect on debt-equity financing, 437and free cash flow hypothesis, 437

Aggregation, 733Aging schedule, 809–810Agreement of merger, 824nAlex. Brown and Sons, 540All-equity financing assumption, 473All-equity value, 478–479, 609Allied Products, case, 332–333Alternative minimum tax, 42American Airlines, 856American Depository Receipts, 872–873American option, 612

expiration date and value, 622factors affecting value, 625

American Research and Development, 556American Stock Exchange, 18, 365, 517Amortization, 378Analysts

security, 327technical, 345

Angels, 556Anheuser-Busch, 371, 372, 373, 375, 379Announcements

effect on markets, 286–288of new issue, 543–544

Annual compounding, 79, 82

Annual percentage rate, 79Annuity, 86–91

delayed, 88–89formula, 95growing, 91–93infrequent, 90tables, 900–901, 904–905

Annuity factor, 88Annuity in advance, 89–90Annuity in arrears, 90Apple Computer, 38, 556, 587

case, 521–523Appraisal rights, 817Appraisal value of assets, 819–820Appropriate discount rate, 75–76APT; see Arbitrage pricing theoryAPV; see Adjusted-present-value methodArbitrage, 52

and interest-rate parity, 879law of one price, 877triangular, 876

Arbitrage pricing theory, 220and capital asset pricing model, 285,

298–299in one-factor model, 297risk-based model, 300

Arbitrage profit, 621Arthur Rock and Company, 556Articles of incorporation, 12Asset acquisition, 818Asset-based receivables financing, 811Asset beta, 318–319Asset pricing

capital asset pricing model versus APT,298–299

empirical models, 300–301in factor models, 286–297style portfolios, 301

Asset requirementsin financial plan, 734financing of, 757

Assets, 3, 22appraisal value, 819–820and debt-equity ratio, 451economic value of, 26quick assets, 33

Assigned receivables, 762Asymmetric information, pecking-order

theory, 438Atlantis Casino, 426AT&T, 16, 107, 213, 839

case, 202–203Auction market, 18–19Auction-rate preferred stock, 794–795Authorized common stock, 372Availability float, 781

Subject Index


Back Matter Subject Index 943© The McGraw−Hill Companies, 2002

Average accounting returnanalysis of, 146definition, 144–145steps, 145–146

Average collection period, 34, 809Average daily float, 781–782Average daily sales, 809Average of distribution, 231–232Average receivables, 34Average return, 231–232Average stock returns, 232–233Average total assets, 34

Backdoor equity, 688–689Balance sheet

accounting definition, 22accounting liquidity, 22–23debt and equity on, 24defining cash on, 746–750market-value, 402values versus costs, 24

Balance sheet model, 3–4Baldwin Company, case, 171–177

analysis of bowling ball project, 172–175cash flows, 173depreciation, 174incremental cash flows, 174interest expense, 177operating revenues and costs, 173working capital, 176

Balloon payments, 568, 590Bank cash, 779Bank drafts, 787Banker’s acceptance, 762, 790, 802Bank of America, 825Bank of England, 105Bankruptcy, 375, 377

absolute priority rule, 859, 863case, 866–867direct costs of, 867economic analysis, 860–861expected, 426impaired ability to conduct business,

426–427involuntary, 859largest cases in U. S., 855and liquidation, 425–426Orange County, Calif., 425prepackaged, 865–866priority of claims in, 859versus private workout, 863–864and reorganization, 425–426Z-score model, 869–871

Bankruptcy costs, 422–425as claim to cash flow, 433–434and debt consolidation, 432of liquidation/reorganization, 425–426

Bankruptcy liquidation, 857–863Bankruptcy Reform Act of 1978, 858–860Bankruptcy reorganization, 862–863Bankruptcy risk, 422–425Banks, 47

credit information from, 808immunized, 719long-term loans, 581–583sales of foreign bonds, 890n

secured loans, 762sweep accounts, 788unsecured loans, 761–762zero-balance, 787

Barings Bank, 695Basic IRR rule, 147Baumol model, 773–776

implications of, 776Beachhead, 825Bearer bonds, 566, 890nBearer instruments, 47Benchmark, 301, 319Best-efforts cash offer, 537Best efforts offering, 538–539Beta, 220

asset, 318–319in capital asset pricing model, 273–274company, 312–313and cyclicality of revenues, 315–316of debt, 318definition, 270equity, 318–319estimation of, 310–315and expected return, 295–298and expected return on individual security, 273and financial leverage, 318–319formula, 271future of, 283–284global, 888illustration of, 269–270industry, 313–315and leverage, 481–484levered, 484and operating leverage, 316–317for pulp/paper industry, 323real-world, 312for selected stocks, 271stability of, 312–313and systematic risk, 288–291unlevered, 483–484

Beta coefficient, 289, 291Bid-ask spread, 325, 531Bidder, 818–819Billboard magazine, 2Binomial model

applications, 658–671function, 626–628

Black-Scholes model, 625–626, 628–633,650, 664

for executive stock options, 652–654formula, 629parameters, 629for valuing a start-up, 656–658warrant pricing, 679–680

Black’s Law Dictionary, 854Blanket inventory lien, 762Block trades, 364–365Boeing Company, 169, 177, 178Bondholders, 24

benefits of mergers, 830–833and cash flow of firm, 635effects of sinking fund, 568and loan guarantees, 638and put option terms, 636versus shareholders, 513

Bond market reporting, 107–108

Bond marketsinternational, 889–891top ten, 890

Bond prices, 104n, 105future estimation, 134–136and interest rates, 106

Bond ratings, 572–578Bonds, 2, 377

basic terms, 565–566bearer form, 566callable, 378, 569–572call provision, 563, 568collateral trust, 566consols, 105convertible, 680–690debenture, 567deep-discount, 579–580defaulted, 861definition, 102at discount, 102–103, 106dual-currency, 890duration concept, 716–718duration hedging, 714–716face value, 565–566features of, 564floating-rate, 578–579foreign, 874, 889–891income bonds, 580junk bonds, 572, 573–578level-coupon, 103–105long-term corporate, 225long-term government, 225maturity date, 102noncallable, 569as options, 633–638at premium, 106present value formula, 107protective covenants, 567public issue, 564–568pure discount, 102–103returns on, 232–233security of, 566–567sinking fund for, 567–568and term structure of interest rates, 130–139yield to maturity, 106–107zero-coupon, 102

Bonds registered, 890Book cash, 779Book-debt ratio, 386Book equity to market equity ratio, 511Book value, 24, 372, 373–374

versus market value, 386–387Bop analysis, 206Borrowers, 376–377Borrowing

example, 54–56in financial markets, 46–53in option pricing model, 627riskless, 264–268short-term, 758target cash balance, 778–779

Bounding value of a call, 621Break-even analysis, 209–212Break-even point, 211–212, 395Bridgestone Corporation, 845Brokerage costs, 754

Subject Index I–5



Brokerage fees, 325Bubble theory, 357–359Bulldog bonds, 874Bullet bond, 102Business appraiser, 94Business plans, 733Bylaws, 12

Cadence Design, 315Calculated average collection period, 809Call

delta of, 627floating-rate CDs, 796force conversion, 689gain on a, 679lower bound, 621in the money, 613out of the money, 613upper bound, 621

Callable bonds, 378, 569–572effect of interest rates, 569–572timing of, 572

Call optionson bonds, 689compared to warrants, 675–678definition, 613as derivatives, 695–696firms expressed in terms of, 624–635selling, 616–617value at expiration, 613–614

Call option valuesfactors determining, 622–624variables, 625

Call premium, 568Call price, 378Call protected bond, 568Call provision, 105, 563, 568

and interest-rate risk, 571merits of, 569–572and taxes, 571

Capital asset pricing model, 220, 296and arbitrage pricing theory, 285,

298–299empirical testing of, 283–284expected return on individual security,

273–274expected return on market, 272–273expected return under, 302formula, 273–274global, 887linearity, 274–275and portfolios, 275risk-based model, 300and security market line, 274–275

Capital budgeting, 4, 160–162adjusted-present-value method, 468–470,

478–481compared to performance measurement, 333comparison of methods, 473–476and cost of equity capital, 307–310equivalent annual cost method, 184–186estimating discount rate, 476–478firm versus project, 319–323flow-to-equity method, 470–471and inflation, 177–183international, 883–886

options in, 642–644projects versus dividends, 501with risky cash flows, 220and value creation, 339–341weighted-average-cost-of-capital method,

471–472Capital expenditures, 4, 760Capital gain

definition, 223versus dividends, 108–109, 512, 517–518dollar returns, 221–222percentage returns, 222–224

Capital gains tax, 42, 503Capital in excess of par, 372Capital lease, 589–590Capital loss, 223Capital market line, 275Capital markets, 18; see also Efficient capital

markets; Financial marketsreturn statistics, 231–232

Capital rationing, 159Capital structure, 4–5

alternatives, 390and dividend policy, 520–521equity versus debt, 395–398establishing, 448–452firm value versus shareholder interests,

391–393formula, 461–462and free cash flow hypothesis, 437interindustry differences, 451Miller model, 447–448MM Proposition I on, 395–397MM Proposition II on, 398–407Modigliani-Miller results, 405–407Modigliani-Miller thesis, 422optimal, 393–398and options, 639–640pecking-order theory, 438–440pie model, 390–391, 408, 433–434recent trends, 385–387static trade-off theory, 433and taxes, 408–416

Capital surplusCAPM; see Capital asset pricing modelCaps, 723–724Captive finance companies, 811Carrying costs, 754–756

in credit costs, 805–806Carrying value, 24Carter Hale, 865Cash

compensating balance, 772components of, 746–750economic definition, 772idle, 788–790liquidity of, 771in NPV of mergers, 835–837, 838reasons for holding, 771–772transactions motive, 772

Cash balances, 671, 772costs of, 773ethical and legal questions, 787in financial statements, 779opportunity cost of, 774target, 773–779

total cost of holding, 775–776trading costs, 775

Cash budgeting, 759–761cash balance, 761cash outflow, 760

Cash collection, 772, 779–787accelerating, 783–786process, 782

Cash cow, 115, 121Cash cycle, 750–753Cash disbursement, 772, 779–787

delaying, 786–787process, 786

Cash discounts, 800–801Cash dividends

kinds of, 495standard payment method, 496–497taxes on, 503

Cash equivalents, 772Cash flow, 27–30; see also Incremental cash

flows; Statement of cash flowscompared to net working capital, 28for different credit terms, 80, 800dividend equal to, 498financial claims to, 433–434in financial markets, 46–48from financing activities, 41between firms and financial markets, 8of granting credit, 799growing perpetuity, 84–86identification of, 5–7and inflation, 180–181initial dividend greater than, 498–499from investing activities, 41of leasing, 591–593levered, 470–471matching, 687and net present value, 141nominal versus real, 181–182from operating activities, 40–41from operations, 28, 30paid to creditors, 29paid to stockholders, 29within payback period, 142from perpetuity, 83–84and personal taxes, 444–445present value of, 78riskless, 593–594risk of, 8–9risky, 220seasonal or cyclical, 788from selling new debt, 29timing of, 7–8total, 30in U. S. 1999, 382unlevered, 470–471, 472, 473unremitted, 886

Cash flow management, 4Cash flow time line, 751Cash-for-stock transactions, 640Cash management

with adjustable-rate preferred stock, 793–794areas of, 731with auction-rate preferred stock, 794–795collection and disbursement, 779–787ethical and legal questions, 787

I–6 Subject Index



with floating-rate CDs, 796–797investing idle cash, 788–790steps, 771target cash balance, 773–779

Cash offer, 535, 537–543best efforts method, 538–539competitive, 541firm commitment, 538Green Shoe provision, 538and investment banks, 539–541negotiated, 541offering price, 541–543underpricing, 541–543

Cash-out, 754Cash outflow, 760Cash reserves, 758Cash surpluses, 788Cash transaction, 697CBS Records, 845Certificates of deposit

Eurodollar, 790floating-rate, 796–797

Certification, 540, 553Change in fixed assets, 28Change in net working capital, 27, 176Chapter 7 bankruptcy, 858–860Chapter 11 bankruptcy, 857, 862–863, 865–866Characteristic line, 269–270Charmin Paper Company, 825Check clearing, 780Chemical Venture Capital Corporation, 556Chicago Board of Trade, 703, 709Chicago Board Options Exchange, 613, 617, 676Chief financial officers, 7Chrysler Corporation, 426, 638Citibank, 578Citicorp Venture Capital, 556Citigroup, 380, 581, 652–654Clearing House Interbank Payments

System, 785Clearing of checks, 780Clientele, 515Clientele effect, 515–516Coca-Cola Company, 700Coinsurance effect, 833Collars, 793Collateral, 566–567Collateral trust bonds, 566Collected bank cash, 779Collection effect, 810Collection float, 780–781Collection policy, 798

aging schedule, 809–810average collection period, 809collection effort, 810factoring, 810

Columbia Pictures, 845Commercial aircraft market, 332–333Commercial draft, 802Commercial paper, 762, 790Committed lines of credit, 761Common stock, 371–376

authorized versus issued, 372book value, 373–374capital surplus, 372classes of, 375–376

constant growth, 109–111versus convertible debt, 685–686and convertibles, 674definition, 371differentiated growth, 111–112dividends, 375dividends versus capital gains, 108–109histogram of returns 1926-1999, 231holding period, 108large-company, 225market value, 373–374in NPV of mergers, 837–838par and no-par, 371present value of, 108–112replacement value, 373–374and retained earnings, 372–373shareholder rights, 374–375small-company, 225treasury stock, 373and warrants, 674zero-growth, 109–111

Company betas, 312–313Companywide growth rate, 732Compaq Computer, 320Compensating balance, 779Competitive firm cash offer, 537Competitive offer, 541Complementary resources, 826Completed contract method, 123Complicated financial structure, 867Compounding, 70–73

continuous, 81–82over many years, 81power of, 73–74

Compounding periods, 79–82Compound interest, 70–71Compound value, 66Concentration banking, 784Conditional sales contract, 802Conglomerate acquisition, 818Consideration, 818–819Consolidated Edison, 119Consolidations, 817Consols, 83, 105, 377Constant-growth stock, 109–111Consumer credit, 798Consumption choices, 48–51Contingent claims, 9–10Contingent value rights, 612, 640Continuation of returns, 349Continuous compounding, 81–82Contribution margin, 210Conversion policy, 689–690Conversion premium, 680–681Conversion price, 680–681Conversion ratio, 680–681Conversion value, 681–682Convertible bonds, 674

agency costs, 689as backdoor equity, 688–689case for and against, 685conversion policy, 689–690conversion value, 681–682definition, 680–681kinds of issues, 687–689option value, 682–684

reasons for issuing, 684–687risk synergy, 688–689straight bond value, 681

Convertible debtversus common stock, 685–686versus straight debt, 684–685

Convertible preferred stock, 680–681Corporate bond market, 107Corporate charter, 839Corporate discount rate, 319Corporate finance, 5–9; see also Financing;

International financebalance sheet model, 3–4basic concerns, 2capital structure, 4–5separation theorem, 56

Corporate financial planning; see Financialplanning

Corporate strategy analysisbreak-even analysis, 209–212decision trees, 203–206discounted cash flow and options, 213–215option to abandon, 213option to expand, 212–213and positive NPV, 200–203scenario analysis, 206–209sensitivity analysis, 206–209and stock market, 201–202

Corporate taxesdiscounts and debt capacity with, 592–595expected return and leverage under, 411–413MM Proposition I, 410–411stock prices and leverage under, 414–415valuation under, 445–448and weighted average cost of capital,

413–414Corporate tax rate, 42–43Corporate wealth, 17Corporations; see also Firms

agency costs, 15characteristics, 12–13compared to partnerships, 14federal tax rate, 42–43goals of, 14–17investment decisions, 60–62lowering trading costs, 327managerial goals, 15–16separation of ownership and control, 16–17set-of-contracts perspective, 15shareholders and managerial behavior, 17world’s largest, 16

Correlation, 245–247calculating, 246definition, 242–243formula, 246, 247

Correlation coefficient, 248Cost of capital, 319; see also Weighted

average cost of capitalfor all-equity firm, 399calculating, 476–477with debt, 320–323delay-adjusted, 781for international firms, 886–888at International Paper, 323–324liquidity and expected return, 325reduced by acquisitions, 829

Subject Index I–7



reducing, 324–327and security market line, 320

Cost of debt, 324Cost of debt capital, 423nCost of equity, 324, 399Cost of equity capital, 307–310

and determinants of beta, 315–319estimation of beta, 310–315

Cost of float, 781Cost reduction, 340

from complementary resources, 826economies of scale, 825economies of vertical integration, 826elimination of inefficient management,

826–827Costs, 207

of holding cash, 771, 773kinds of, 26–27of new securities issues, 544–547versus values, 24

Costs of financial distress; see Financialdistress

Coupon of floating-rate CDs, 796Coupon rate, 104Coupons, 103–105Covariance, 245–247, 250

calculating, 246definition, 242–243formula, 246, 247, 252

Covered-call strategy, 620Credit

five Cs of, 808line of, 761–762

Credit analysis, 731, 798credit information, 808credit scoring, 808

Credit instruments, 801–802Creditors, 4, 376Credit period, 799Credit policy

collections, 809–810components, 798credit analysis, 808and credit risk, 804and future sales, 804–805optimal, 805–807risk and information, 802–805terms of sale, 798–802trade credit financing, 811

Credit reports, 808Credit risk, 804Cross rate, 783Crown jewels, 841Crystal Oil Company, 865–866Cum dividend, 497Cumulative abnormal returns, 352Cumulative dividends, 380Cumulative probability, 630–632Cumulative voting, 374Currency swaps, 722–723, 874Current assets, 3, 746

different strategies in, 757–758financing of, 732, 756–759ideal financial model, 756–757size of investment in, 753–756

Current income, and stock price, 512

Current liabilities, 4, 747Current ratio, 33Current taxes, 26Cutoff rate, 319Cyclical activities, 788Cyclicality of revenues, 315–316

Dart-throwing efficiency, 348Data mining, 300Date of payment, 497Date of record, 496Dates convention, 86Days in receivables, 809Days’ sales outstanding, 809Dead-weight costs explanation, 580Dealer markets, 18–19Dean Witter Reynolds, 540Debenture, 377, 567Debt, 2

additional effects of, 609–610on balance sheet, 24beta of, 318as contingent claims, 9–10convertible versus straight, 684–685cost of, 324cost of capital with, 320–323definition, 376versus equity, 395–398and financial leverage, 35–36and free cash flow hypothesis, 437interest expense, 36payment in kind variety, 490npreferred stock as, 380pressures on firms from, 422–425reducing costs of, 430–432riskless, 439secured, 811subordinated, 378tax disadvantage, 408–410types of securities, 377

Debt-asset ratio, 448–449Debt capacity, 36, 433, 440, 544

with corporate taxes, 592–595purposes of, 598–599unused, 828

Debt consolidation, 432Debt displacement

basic concept of, 596–597definition, 598and lease valuation, 596–599and optimal debt level, 597–599

Debt-equity financing, 437Debt-equity ratio, 35, 407

choosing, 390–391and growth, 441–443in Japan, 432target, 735targeting, 451–452

Debt financing, 3–4, 403–405; see alsoBonds; Long-term debt

aversion to, 449case, 466–467case against, 454case for, 453versus equity, 381flotation costs, 479

leveraged buyouts, 489–494long-term, 376–377in Miller model, 447–448, 462–464nonmarket rate, 480–481subsidies, 469tax subsidy, 479–480

Debtor, 376–377Debtor-in-possession debt, 864Debt ratio, 35–36Debt securities, 17–18, 376Debt service, 24, 29Decision trees, 203–206, 644Declaration date, 496Dedicated capital, 371Deed of trust, 564Deep-discount bonds, 579–580Default, 375

futures contracts, 700on guaranteed loans, 638

Defaulted bonds, 861Default rate, 575, 576Default risk, 789Deferral accounting method, 360Deferred call, 568Deferred taxes, 26Delay-adjusted cost of capital, 781Delayed annuity, 88–89Deliverable instrument, 696Delta Air Lines, 856Delta of a call, 627Denomination of bond certificate, 103Denomination of bonds, 565Department of Justice, 825Depository transfer check, 785nDepreciation, 26, 145, 174–175, 359

classes of property, 199half-year convention, 199total investment equal to, 113

Derivatives, 255n, 695–696actual use of, 724–725case, 705–706duration hedging, 714–720exotics, 723–724financial, 695forward contracts, 696–697futures contracts, 697–702hedging with, 703–706interest rate futures, 606–713reasons for using, 696swap contracts, 721–723, 874

Deutsche Bank, 695Diageo PLC, 612, 640Differentiated growth stock, 111–112Digital Equipment Corporation, 556Dilution, 677–678Direct leases, 587Direct placement, 537

of bonds, 580–581Direct rights offer, 537Disbursement float, 780, 787Discount, 538

of banker’s acceptance, 802Discount bonds, 102–103Discounted cash flow analysis, 824

and corporate options, 213–215for positive NPV, 200

I–8 Subject Index



Discounted payback period rule, 143–144Discounting, 74–78

with corporate taxes, 592–595dividends versus earnings, 118

Discount rate, 69–70, 114–115appropriate, 75–76calculating, 471in capital budgeting, 476–478case, 93function of risk, 242in lease-or-buy decision, 596with levered beta, 484nominal versus real, 181–183and price-earnings ratios, 122risk-adjusted, 310with unlevered beta, 484

Discount selling, 106Distress prediction models, 861Distribution, 495

spread dispersion of, 234symmetric, 234

Diversifiable risk, 262–263Diversification, 834–835

lower cost of capital from, 886–887Diversification effect, 251–252, 254,

260–264, 293–295Divestiture, 838–839Dividend discount model, 108–109

estimates of parameters, 112–115versus growth model, 118

Dividend growth model, 119Dividend payout, 496Dividend per share, 496Dividend policy

case, 521–523clientele effect, 515–516current and alternative, 500factors favoring high dividends, 512–513homemade dividends, 500–501indifference proposition, 499irrelevance of, 498–503market information from, 520means of avoiding payment, 504–506Modigliani-Miller thesis, 506, 512parameters, 518–519purpose of, 495sensible, 520–521unknown factors in, 516–521

Dividendsalternatives to, 504–505versus capital gains, 108–109cash payment method, 496–497characteristics, 375cumulative or noncumulative, 380default on, 375dollar returns, 221–222expected returns, 509–511fewer companies paying, 517–518firms without sufficient cash for, 503–504firms with sufficient cash for, 504–506greater than cash flow, 498–499growth in, 117–118homemade, 500–501information content of, 514–515versus interest, 376–377and investment policy, 502

payment procedure, 496percentage returns, 222–224and personal taxes, 509–511present value of, 111–112pros and cons, 521ratio to aggregate earnings, 518set equal to cash flow, 498versus stock repurchase, 507taxation of, 444–445tax-disadvantages, 517–518taxes and issuance costs, 503–506types of, 495–496in U. S. economy, 516–518

Dividends-to-earnings ratio, 519–520Dividend valuation model, 309nDividend yield, 39, 114, 223, 496

definition, 510neffect on pretax expected returns, 510and marginal tax rate, 517

Dollar investment, 879Dollar returns, 221–222Downsizing, 826–827Down-state price, 661Draft, 787

commercial, 802sight, 802

Drexel Burnham Lambert, 556, 574–575Dribble method of new issuance, 554Dual-currency bonds, 890Due diligence, 540Dumb dentists, 557Du Pont system of financial control, 37Duration, 716–718

of assets and liabilities, 718–720formula, 717n

Duration hedging, 714–720Dutch auction, 794–795

E. F. Hutton, 787EAIR; see Effective annual interest rateEarly warning distress signal, 857Earnings

compared to cash flows, 169–170falling, 544growth in, 117–118ratio of dividends to, 518reporting of, 678short-term versus long-term, 201–202

Earnings before interest, 394–395Earnings before interest and taxes, 25, 316n,

410–411, 441–442Earnings growth, reasons for mergers,

833–834Earnings per share, 115, 394–395

and market value, 507Eastern Airlines, 856EBIT; see Earnings before interest and taxesEconomic assumptions in financial planning,

734–735Economic value added, 333–336

formula, 335Economies of scale, 825Edison International, 453, 520Effective annual interest rate, 80Effective annual yield, 80Effective tax rate, 503

Efficient capital markets, 123, 339,341–343

Efficient frontier, 255Efficient market hypothesis, 342–343, 344

contrary views, 354–359evidence on semistrong form, 350–359evidence on strong form, 359evidence on weak form, 349–350misconceptions about, 348–349semistrong form, 346–347strong form, 346–347summary of, 363weak form, 343–346

Efficient marketsand accounts, 359–361price-pressure effects, 364–365tests of, 353

Efficient setfor many securities, 257–260for two assets, 252–257

Electronic Data Systems, 839Electronics firms, 121–122Empirical models, 300–301End-of-the-year convention, 86English consols, 105Eo Company, 213Equilibrium rate of interest, 48, 49Equity, 2

agency costs of, 435–437on balance sheet, 22, 24as contingent claims, 9–10cost of, 324versus debt, 395–398dribble method of new issuance, 554international market, 890nmarket price, 38market risk premium, 240–241performance shares, 17private market, 554–558tax disadvantage, 408–410timing decision, 361–363trading in securities, 18–19

Equity beta, 318–319Equity contract, 15Equity curveout, 839Equity financing, 4, 402–403; see also

Securities; Stockversus debt, 381

Equity kicker, 674Equity multiplier, 35Equity premium puzzle, 240–241Equity risk premium puzzle, 240–241Equity securities, 17–18, 376; see also

Securities; StockEquivalent annual cost, 187, 211–212Equivalent annual cost method, 184–186Erosion of cash flows, 171Eurobanks, 889Eurobonds, 783Eurocurrency, 783Eurocurrency market, 889Eurodollar, 889Eurodollar CDs, 790Euroequities, 890nEuropean Currency Unit, 783European Monetary System, 783

Subject Index I–9



European option, 612, 622nEvent studies, 349, 351–352Excess return on the risky asset, 232Exchange-rate risk, 881–883Exchange rates, 875–876

and interest rates, 879–883and reporting foreign operations, 891table, 894–895

Exclusionary self-tenders, 840Ex-dividend date, 496Executive compensation

elements of, 650–651valuing, 652–655

Executive stock optionsBlack-Scholes model, 652–654reasons for, 650–652top 15 corporate grants, 651

Exercise price, 612and call-option values, 622

Exercising the option, 612Exotics, 723–724Expectations hypothesis, 137, 139Expected return, 286

and beta, 295–298under capital asset pricing model, 302definition, 242and dividends, 509–511in empirical models, 300equal to risk-free rate, 628on individual security, 273–274leverage under corporate taxes, 411–413liquidity and cost of capital, 325on market, 272–273on portfolios, 248–249on risky securities, 220

Expected spot rate, 881Expense preference, 15–16Expensive-lunch story, 686–687Expiration date, 612, 622Ex-rights date, 549External financing, 382External funds needed, 736–738Extinguished debt, 378Extra cash dividend, 495

Face valueof bonds, 102–103, 377, 565–566of options, 651

Factor, 810surprises and expected returns, 286–287

Factored receivables, 762Factoring, 810Factor models

betas and expected return, 295–298betas and systematic risk, 288–291CAPM versus APT, 298–299definition, 290–291for portfolios, 291–295

Fair market value, 38Feasible set, 255Federal agency securities, 790Federal Express, 428–429Federal Home Loan Bank Board, 790Federal Trade Commission, 825Fedwire, 785Field-warehousing financing, 762

FIFO (first-in, first-out) accounting, 122–123,359–360

Financial Accounting Standards Board, 175,589–590, 891

on pooling-of-interests method, 823nFinancial assets, purchase of, instead of

dividends, 505Financial break-even point, 212Financial distress

agency costs, 427–430bankruptcy, 860–861case, 467characteristics of, 854–855costs of, 422–425, 451, 469dealing with, 856–857direct costs, 425–426, 867indirect costs, 426–427integrating costs with tax effects, 432–434kinds of, 377prediction models, 861private workout versus bankruptcy, 863–864reducing costs of, 430–432and uncertain operating income, 451–452

Financial failure, 377Financial instruments, 2, 47–48; see also

Bonds; Stockderivatives, 695–696exotics, 723–724forward contracts, 696–697futures contracts, 697–702interest-rate futures contracts, 707–714main types in U. S., 225new, 340–341options, 612stock options, 650–655swaps contracts, 721–723warrants, 674–676

Financial intermediaries, 47Financial leases, 588Financial leverage, 35–36

and beta, 318–319effect on firm value, 450effects of corporate and personal taxes,

445–448MM Proposition II on, 399–401and returns to shareholders, 393–395and risk to equity holders, 398–399and value of the firm, 393–398

Financial managersin efficient markets, 339skills needed, 5–9

Financial markets, 5, 8anonymous, 47basic principles, 52–53borrowing, 54–56capital market, 18and consumption choices, 48–51exchange trading, 19functions, 46–47functions of, 17–19lending, 53–54listing, 19market clearing, 47–48money market, 18perfectly competitive, 51–52primary market, 18

secondary market, 18separation theorem, 62

Financial performance measures, 333–336Financial planning

accomplishments, 733basic policy elements, 732and determinants of growth, 738–741guidelines, 732long-term, 731nature of, 733purposes of, 731scenarios, 733short-term, 731

Financial planning modelcriticisms of, 741external funds needed, 736–738ingredients, 738

Financial ratios; see Ratio analysisFinancial slack, 440

case, 467Financial statement analysis

activity ratios, 34–35financial leverage, 35–36market value ratios, 38–40profitability, 36–38short-term solvency, 33sustainable growth rate, 38

Financial statements; see also Balance sheet;Income statement; Statement of cash flows

cash balances in, 779for credit analysis, 808pro forma, 359, 734

Financial structurecomplicated, 867formula, 461–462

Financing; see also International financeacquisitions, 816contingent value rights, 612first-round, 557forms of, 3–4off-balance-sheet, 589patterns of, 382–385by venture capitalists, 554, 556–558

Financing decisions, 1, 4equity versus debt, 395–398by nonfinancial corporations, 384pecking-order theory, 438–440role of options, 650timing of, 361–363and value creation, 339–341

Financing opportunities, 340–341Financing patterns

international 1991-1996, 385in U. S. 1979-1999, 383

Firestone Tire and Rubber, 845Firm commitment offering, 537, 538

economic rationale for, 540Firms; see also Corporations; Partnerships

balance sheet model, 3–4capital structure, 4–5expressed in terms of call options, 624–635expressed in terms of put options, 635–636financial managers, 5–9financing decisions, 1growth opportunities, 115–119growth rate formula, 113

I–10 Subject Index



kinds of, 10–14lowering trading costs, 327Modigliani-Miller results, 405–407no-dividend, 118–119stock repurchase, 506–509with sufficient cash for dividends, 504–506top option grants, 650–651, 653use of derivatives, 696without sufficient cash for dividends,

503–504Firm’s value net of debt, 679First Boston, 852–853First City Properties, 841First-dollar obligations, 578First principle of investment decision making,

52–53First-round financing, 557Five Cs of credit, 808Fixed assets, 3, 23

changes in, 28Fixed costs, 26–27, 207, 316Fixed dollar obligation, 578Float, 779–782Floated stock issue, 402Floating-rate bonds, 578–579Floating-rate CDs, 796–797Floating-rate preferred stock, 794Floor-and-ceiling provisions, 578Floors, 723–724Flotation costs, 479, 552Flow-based insolvency, 855–856Flow-to-equity method, 470–471, 473

compared to APV and CAPM, 474formula, 485

Force conversion, 689Ford Motor Company, 247, 375Forecasting

for financial planning, 738–739sales forecasts, 734

Foreign bonds, 874Foreign exchange conversion, 883–886Foreign exchange markets

description, 874–875Eurocurrency market, 889participants, 874–875types of transactions, 876

Foreign exchange risk, 881–882Foreign operations, reporting, 891Foreign political risks, 887–888Forward contracts, 696–697

compared to futures, 698flaws in, 700on mortgages, 709–712pricing of, 707–708

Forward discount rate, 881Forward exchange rate, 876, 879, 882Forward rate, 132–134

versus spot rate, 137Forward trade, 876Free cash flow, 30n, 828Free cash flow hypothesis, 437Free-lunch story, 686French Revolution, 357Frequency distribution, 231–232Fully diluted basis reporting of earnings, 678Funded debt, 377, 563

Future sales, 804Futures contracts, 697–702

hedging with, 703–705interest-rate, 707–714listed, 701–702marked to the market, 698–700trading in, 698Treasury bonds, 709

Future value, 59, 66case, 93and compounding, 70–73with compounding, 81formula, 71tables, 902–903, 906–908

GenenTech, 123General cash offer, 534–535General Electric, 123–124, 313, 314, 429General expenses, 27Generally accepted accounting principles

and balance sheet, 24and income statement, 26

General Mills, 612, 640–642General Motors, 213, 247, 266–267, 292, 349,

377, 379, 434, 436, 732, 733, 826, 839General partnership, 11General replacement decision, 187–188Geometric series, 83German bankruptcy code, 860–861Getty Oil, 427, 827Gibson Greeting Cards, 695Gilts, 874Ginnie Mae; see Government National

Mortgage AssociationGlobal betas, 888Globalization, 872Going on margin, 266nGoing private, 840–841Going-private transactions, 819Golden parachute, 841Goldman Sachs, 537, 541Goodweek Tires, Inc., case, 198–199Goodwill, 821–822Goodyear Tire and Rubber, 857

case, 466–467Government bailouts, 638Government National Mortgage

Association, 790Graduated income tax, 462–464Greenmail, 839Green Mountain Power, 270Green Shoe option, 538, 545Gross national product beta, 289–290Gross profit margin, 36Growing annuity, 91–93

formula, 95Growing perpetuity, 84–86

formula, 95Growth

and debt-equity ratio, 441–443determinants of, 738–741in earnings and dividends, 117–118

Growth opportunities, 115–119versus growth in earnings and dividends,

117–118and price-earnings ratios, 121–123

Growth rateactual versus sustainable, 742companywide, 732estimating, 112–115

Growth-rate equation, 739Growth rate formula, 113Growth stock, 301, 355–356Guide to Venture Capital, 556, 557

Head-and shoulders pattern, 345Hedge, 250Hedging, 695–696

case, 705–706definition, 696duration, 714–720exchange-rate risk, 882–883with forward contracts, 696–697with futures contracts, 697–702in interest-rate futures, 709–713kinds of, 703–705by matching liabilities with assets, 718–720with swaps, 721–723

Hewlett-Packard, 320High-dividend policy

agency costs, 513and desire for current income, 512rationale for, 516tax arbitrage, 513uncertainty resolution, 512

High-risk projects, 639–640Hockey-stick diagram, 613–614Holding period, 108Holding-period returns, 225–231Homemade dividends, 500–501Homemade leverage strategy, 396–397Homogeneous expectations, 268, 499Horizontal acquisition, 818Hughes Aircraft, 826Hurdle rate, 319Hybrid securities, 377

IBM, 38, 122, 247, 266–267, 320, 343, 350,587, 613, 732, 733

Idiosyncratic risk, 288Idle cash

investing, 788–790planned expenditures, 788–789seasonal or cyclical, 788

Illiquid assets, 398Immunization strategies, 720Immunized bank, 719Income

accounting versus taxable, 26and consumption choices, 48–51desire for, 512

Income bonds, 580Income statement

accounting definition, 25generally accepted accounting principles, 26noncash items, 26sections of, 25–26time and costs, 26–27

Incremental cash flowscase, 171–177compared to earnings, 169–170and erosion, 171

Subject Index I–11



net present value of, 157and opportunity cost, 170and sunk costs, 170

Incremental IRR, 154–155Indenture, 376, 378, 564

protective covenants, 430–431Independent projects, 149

and profitability index, 159Indifference proposition, 499Individual securities

covariance and correlation, 245–247expected return, 273–274expected return and variance, 243–245returns on, 286–287risk and return, 242–247

Industry betas, 313–315Inflation

and capital budgeting, 177–183and cash flow, 180–181and deep-discount bonds, 579–580and interest rates, 170–180and purchasing power parity, 878–879and year-by-year returns, 225, 229

Inflation beta, 289–290Inflation escalator clause, 700Inflation risk, 579Information content effect of dividends, 514–515Information sets, 346–347Infrequent annuity, 90In-house processing float, 781Initial public offerings, 361–362, 537

case, 558–559underpricing, 541–543by venture capitalists, 557–558

Innovation, 287Insolvency, 854–856Intangible assets, 3, 23Intel Corporation, 429Interest

compound, 70–71versus dividends, 376–377simple, 70–71

Interest coverage ratio, 36Interest expense, 36, 177Interest on interest, 70, 797Interest payment, 46Interest rate

after-tax, 592, 609annual percentage rate, 79and bond prices, 106and call-option values, 624caps and floors, 723–724in competitive markets, 51–52and consumption choices, 48–51effective annual, 80effect on callable bonds, 569–572equilibrium, 48, 49and exchange rates, 879–883expectations hypothesis, 137growing perpetuity, 86and inflation, 170–180market, 103nominal versus real, 179–180stated annual, 79term structure, 130–139

Interest rate arbitrage, 52

Interest-rate beta, 289–290Interest-rate forecasting, 571Interest-rate futures contracts

hedging in, 709–713pricing of forward contracts, 707–708pricing of Treasury bonds, 706–707

Interest-rate parity, 879–883Interest-rate parity theorem, 879–880Interest-rate risk, 789

and call provision, 571and duration hedging, 714–720and hedging, 710–711immune to, 719matching liabilities with assets, 718–720

Interest-rate swaps, 721–722, 874Internal financing, 382, 439Internal rate of return, 146–149, 155–157

basic rule, 147incremental, 154–155independent or mutually exclusive projects,

149–153problems with, 149–157redeeming qualities of, 157–158scale problem, 153–155

Internal Revenue Service, 175on auction-rate preferred stock, 794–795rules on leasing, 590–591

International bond markets, 889–891International capital budgeting

cost of capital, 886–888foreign exchange conversion, 883–886and political risk, 887–888unremitted cash flows, 886

International corporations, 872largest, 873

International equity market, 890nInternational finance

approaches, 872exchange-rate risk, 881–883exchange rates and interest rates,

879–883foreign exchange markets, 874–876law of one price, 877purchasing power parity, 878reporting foreign operations, 891terminology for, 872–874

International financial decisions, 888–891bond markets, 889–891medium-term financing, 889short-term financing, 889

International Paper, 323–324International price-earnings ratios, 122Internet stock purchases, 327In the money call, 613Intuit, 429Inventory, 23Inventory accounting, 122–123Inventory loan, 762Inventory period, 751–753Inventory turnover ratio, 35Inventory valuation, 359Inventory warehousing costs, 754Inverse floater, 723Investment banks

functions of, 539–541methods of issuing securities, 538–539

reputation capital, 540services of, 537

Investment decisions, 60–62average accounting return, 145–146discounted payback period rule, 143–144first principle of, 52–53illustration of, 56–60and IRR, 146–149net present value analysis, 140–141payback period rule, 141–143problems with IRR, 149–158and profitability index, 158–159separation principle, 267–268

Investment policy, and dividend policy, 502Investments; see also Expected return; Returns

efficient set for many securities, 257–260efficient set for two assets, 252–257goals of, 45of idle cash, 788–790made under uncertainty, 816in mutually exclusive projects, 149net present value of, 68–69net present value rule, 59–60present value, 74–78replacement-chain problem, 184–186stock repurchase, 508–509

Investors; see also Portfolioclientele effect, 515and efficient market hypothesis,

342–343, 344expectations hypothesis, 137fooling, 340homogeneous expectations, 268liquidity-preference hypothesis, 138–139and rights offerings, 547–551and risk, 263–264risk-neutral, 628and risky securities, 220tax brackets, 515

Invoice date, 798–799Involuntary bankruptcy, 859IRR. see Internal rate of returnIssued common stock, 372

Japandebt-equity ratios, 432high stock prices, 358

Japanese keiretsu, 845–846Japanese stock market, 122Junk bonds, 424, 572, 573–578

Kansas City Power and Light, 119Keiretsu, 845–847K-factor model, 290–291Kohlberg, Kravis and Roberts, 490–494, 675

L. L. Bean, 37Lambda Fund of Drexel Burnham Lambert, 556Large-company common stock, 225Law of one price, 877Lease-or-buy decision, 587

and discount rate, 596lessor view of, 600–601net present value analysis, 595–596net present value calculation, 599optimal debt level, 594–595




present value of riskless cash flows,592–594

riskless cash flow, 594–595Leases

basics of, 586–587capital lease, 589–590and debt, 605financial, 588offered by manufacturers, 605offered by third parties, 605operating, 587parties to, 586and taxes, 590–591types of assets preferred, 605

Leasingand accounting, 589–590and accounting income, 604adjusted-present-value method, 608–610cash flows of, 591–593and debt displacement, 596–599lessor view of, 600–601one hundred percent financing, 604reduction of uncertainty by, 603tax advantages, 601–603transaction costs, 603

Ledger cash, 779Lenders, 376

seniority, 378Lending

example, 53–54in financial markets, 46–53riskless, 264–268

Lessee, 586reservation payment, 602

Lessors, 586manufacturer, 605reservation payment, 603third-party, 605view of leases, 600–601

Letter of comment, 535Level-coupon bonds, 103–105Leverage; see also Financial leverage;

Operating leverageaversion to, 449and beta, 481–484under corporate taxes, 414–415expected return under corporate taxes,

411–413target amount of, 440

Leveraged buyouts, 436, 474; see alsoAcquisitions

adjusted-present value method, 489–494defense against takeovers, 840–841definition, 489–490with junk bonds, 575

Leveraged equity formula, 413Leveraged leases, 588Levered beta, 484Levered cash flow, 470–471Levered firm, 391

capital budgeting methods, 468–476value of, 410–411

Liabilities, 4, 22, 24dividends as, 496leases as, 589

Liability-to-equity ratio, 596–597

LIFO (last-in, first-out) accounting, 122–123,359–360

Limited liability, 13Limited-liability instrument, 613Limited partnership, 11, 555Linear interpolation, 631nLinearity, 274–275Line of credit, 761–762Liquid assets, 756Liquidating dividend, 495Liquidation, 377

by bankruptcy, 857–863legal and administrative costs, 425–426

Liquidity, 746–747and adverse selection, 325–326characteristics, 789and expected return, 325and futures contracts, 700optimal amount of, 771of stock, 325

Liquidity-preference hypothesis, 138–139Listing requirements, 19Loan covenants, 430–431Loan guarantees, 638Loans

in Eurocurrency market, 889secured, 762unsecured, 761–762

Lockboxes, 783–784Lockheed Corporation, 638London Interbank Offer Rate, 721, 723–724,

761, 796–797, 889definition, 874

Long hedge, 704–705, 712–713Long run, 26–27, 240–241Long-term corporate bonds, 225Long-term debt

bond ratings, 572–578bond refunding, 568–572direct placement versus public issue, 580–581features of, 377indenture, 378with junk bonds, 573–578kinds of bonds, 578–580overview, 563public issue of bonds, 564–568repayment, 378security, 378seniority, 378syndicated bank loans, 581–583types of, 377

Long-term financial planning, 731Long-term financing, 760; see also Leasing

with common stock, 371–376with debt, 376–377feature, 382–385pecking order, 384with preferred stock, 379–381private equity market, 554–558public issue of equities, 534–547rights issue of equities, 547–553with venture capital, 556–559

Long-term government bonds, 225Loss carrybacks, 43Loss carryforward, 43, 828Lower bound of option price, 621

MACRS; see Modified accelerated costrecovery system

Macy’s, 865Magnification factor, 270Mail and wire fraud, 787Mail float, 781Make a market, 19Making delivery, 696Management, inefficient, 826–827Management team, 15Managerial goals, 15–16Managerial information, 544Managers

and net present value rule, 62and shareholder control, 17

Manufacturer lessors, 605Manufacturers Hanover Venture Capital

Corporation, 556Marathon Oil, 824n

case, 852–853Marginal firm, 864Marginal tax rate, 517Marked to the market, 698–700Marketability, 789Market basket of goods, 878–879Market capitalization, 354Market clearing, 47–48Market-debt ratio, 387Marketed claims, 434Market efficiency, timing decision, 361–363Market-equilibrium portfolio, 268–272Market for corporate control, 827Market-impact costs, 325Marketing, 540Marketing gains, 824–825Market interest rate, 103Market model, 291Market portfolio, 268–269

definition of risk, 269–271and one-factor model, 297–298

Market power, from acquisitions, 825Market price, 38Market risk, 263, 288Market risk premium, 240–241Market-to-book value, 39–40, 374Market value, 24, 373–374

versus book value, 386–387and earnings per share, 507

Market-value balance sheet, 402Market value ratios, 38–40Market-value weights, 322Marshall Industries, 453Matching cash flows, 687Matching cycles, 184–185Matrix approach to portfolios, 250, 259, 261Maturity, 789

calculation of, 716–718of long-term debt, 563

Maturity date, 102–103, 377face value, 102

Maturity hedging, 758Maturity mismatching, 758McCaw Cellular Communications, 202–203McDonald’s Corporation, 118Mean of the distribution, 231–232Medium-term financing, 889




Medstone International, Inc., case, 558–559Meiji Mutual Life, 846Mergers; see also Acquisitions; Leveraged

buyouts; Takeoversbad reasons for, 833–835cost to shareholders, 830–833definition, 817NPV analysis, 835–838and options, 640–642

Merrill Lynch, 537Mesa Petroleum, 827, 840Metallgesellschaft AG, 695

case, 705–706Mezzanine financing, 575MG Refining and Marketing, 695

case, 705–706Microsoft Corporation, 617Middle South Utilities, 554Midland Company, 6–9Midwest Stock Exchange, 18Milking the property, 429Miller model

of capital structure, 447–448and graduated income tax, 462–464of personal taxes, 445–448

Miller-Orr model, 776–778implications of, 778

Miller-Scholes tax arbitrage strategy, 513Minimum variance portfolio, 255Mitsubishi Bank, 847Mitsubishi Group, 845Mitsubishi Motors, 846, 847Mitsubishi Trust and Banking, 846Mitsui, 845MM Proposition I, 395–397

under corporate taxes, 410–411definition, 397illustration, 401–405key assumptions, 397–398summary of, 407, 416

MM Proposition II, 398–407under corporate taxes, 411–413definition, 399and financial leverage, 399–401formula, 400illustration, 401–405summary of, 407, 416

Mobil Corporation, 852–853Modified accelerated cost recovery system, 199Modigliani-Miller thesis; see also MM

Proposition entrieson capital structure, 422with corporate taxes, 416on dividend policy, 499, 502, 506, 512interpretation of results, 405–407on stock versus debt, 685–686value of the firm, 432

Momenta International Corporation, 213Money management style, 301Money market, 18, 771, 788Money market banks, 18Money market securities, 789–790Monitoring, 540Monopoly power, from acquisitions, 825Moody’s Investors Service, 572–573, 789,

790, 793

Mortgage, 378, 709–713Mortgage-backed bonds, 890Mortgage securities, 566Mortgage-trust indenture, 566Motorola, 213Multinational corporations, 802

largest, 873Multiple rates of return, 151–153Multiples, 121Mutual funds, 531

record of, 353–354Mutually exclusive projects, 149, 427–428

and profitability index, 159replacement-chain problem, 184–186scale problem, 153–155timing problem, 155–157

NASDAQ, 18, 517National Association of Securities Dealers, 18NCR Corporation, case, 202–203Negative beta, 220, 270Negative correlation, 247Negative covariance, 246Negative covenant, 430, 567Negative inflation beta, 289Negative net present value, 117Negotiated offer, 541Net float, 780Net income, 30Net investment, 113Net operating losses, 827–828Net present value, 59, 66–95; see also

Positive NPVattributes, 141case, 175compared to internal rate of return,

146–149compounding periods, 79–82formula, 68, 307of investment, 68–69of lease-or-buy decision, 599multiperiod case, 70–78negative, 117one-period case, 66–70and problems with IRR, 149–157

Net present value analysisand break-even analysis, 209–212decision trees, 203–206and discounted cash flow analysis, 213–215of granting credit, 803–804international capital budgeting, 883–886of investment decisions, 140–141lease-or-buy decision, 595–596of mergers, 835–838option pricing, 626scenario analysis, 206–209sensitivity analysis, 206–209

Net present value of growth opportunitymodel, 116–117, 119–121

Net present value rule, 59–60versus average accounting return

method, 146in investment decisions, 60–62

Net profit margin, 36Netstockdirect.com, 327Netting-out process, 698

Net working capital, 4, 27, 172, 739, 772additions to, 28changes in, 176compared to cash flow, 28definition, 746tracing, 746–747

Neutral float position, 780New York Stock Exchange, 18–19, 225, 325,

364–365, 373, 517, 889bond market, 107market value of listed securities, 19

New York Times, 123Niagara Mohawk, 554No-dividend firms, 118–119No-growth condition, 441Nominal cash flow, 181–182Nominal interest rate, 179–180Noncallable bonds, 569Noncash items, N6Noncommitted lines of credit, 761Noncumulative dividends, 380Nonmarketed claims, 434Nonmarket-rate financing, 480–481Nontraditional cash offer, 537Nonventure equity markets, 555No-par value, 371Normal distribution, 234–235, 630Normal return, 286Notes, 377Notes payable, 33NPV; see Net present valueNPVGO; see Net present value of growth

opportunity model

Odd-lot form of securities, 530Off-balance-sheet financing, 589Offering price, 541–543One-factor model, 291, 292

expected return for individual stocks,296–297

and market portfolio, 297–298One hundred percent financing, 604One-year discount bonds, 102Open account, 801Open-end bond issue, 566Operating cash flow, 4, 28, 30, 40–41Operating cycle, 750–753Operating efficiencies, 830Operating income, uncertain, 451–452Operating leases, 587Operating leverage, and beta, 316–317Opportunity cost, 754

of cash balances, 774in credit costs, 805–806of float, 781in incremental cash flows, 170of lost interest, 772

Opportunity set, 255–257Optimal credit policy, 805–807Optimal debt level, 594–595, 597–599Optimal portfolio, 266–268Option-pricing formula, 625–633

binomial model, 658–671Black-Scholes model, 625–626, 628–633,

650, 652–654failure of NVP, 626




two-state option model, 626–628Options

call options, 613–614and capital structure policy, 639–640combinations of, 618–620covered-call strategy, 620definition, 612executive stock options, 650–655in financing decisions, 650and investment in real projects, 642–644and mergers, 640–642put-call parity, 619puts, 614selling, 616–617start-up valuation, 656–658stock and bond, 633–638terminology for, 612trading, 617valuing, 620–625variability of underlying asset, 623–624Wall Street Journal quotes, 617

Option to abandon, 213Option to buy, 547Option to expand, 212–213Option value of a bond, 682–684Oracle Corporation, 315Orange County, Calif., bankruptcy, 425, 695Order costs, 754Organizational independence, 17Organizational survival, 17Organization chart, 6Original equipment manufacturer, 198Original-issue discount bonds, 579Origination fee, 710Out of the money bond, 680, 689–690Out of the money call, 613Oversubscribing, 543Oversubscription privilege, 551Over-the-counter market, 18

bond sales, 107foreign exchange market, 874

Overvaluation, 838

Pacific Enterprises, 520Pacific Gas and Electric, 554Pan American Airways, 856Partnerships, 11–12

compared to corporations, 14Par value

of bonds, 565of long-term debt, 377of stock, 371

Payback period ruledefinition, 141–142discounted, 143–144managerial perspective, 143problems with, 142summary of, 143

Payment in kind debt, 490nPayment ratio, 114–115Payments pattern, 810Payout ratio, 38Pecking order, 384Pecking-order theory, 438–440

implications of, 440rules of, 439–440

Pennzoil, 427Percentage-of-completion method, 123Percentage returns, 222–224Perfectly competitive financial markets,

51–52Performance shares, 17Period costs, 27Perpetuity, 83–84

formula, 95Perquisites, 436Personal taxes, 422, 443–448

and dividends, 509–511Miller model, 445–448

Phillips Petroleum, 827PI decision rule, 159Pie model of capital structure, 390–391, 408,

433–434Pillsbury, 612, 640–642Piper Jaffrey, 695Plain-vanilla bonds, 578Planned expenditures, 788–789PLM International, Inc, case, 13–14Plug variable, 734Poison pills, 841Political risk, 887–888Pooling-of-interests accounting, 822–823Population distribution, 235–236Portfolio, 247

and CAPM, 275diversification effect, 251–252, 254,

260–264, 293–295efficient set for many securities,

257–260efficient set for two assets, 252–257expected return, 248–249factor models, 291–295growth stock, 301hedge, 250internationally diversified, 888investor risk, 263–264market-equilibrium, 268–272matrix approach, 250, 259, 261minimum variance, 255opportunity set, 255–257optimal, 266–268risk and return, 247–252risk-free securities, 264–266standard deviation, 250–252, 259–260value stock, 301variance, 249–252, 259–260, 261–262

Portfolio risk, 262–263for equally weighted portfolio, 295

Positive correlation, 247Positive covariance, 246Positive covenant, 430, 567Positive float, 779–780Positive NPV, 200

case, 202–203and corporate strategy analysis, 200–203creating, 201

Post, 19Preemptive right, 375Preference, 379Preferred stock

adjustable-rate, 793–794auction-rate, 794–795

as consol, 105convertible, 680–681as debt, 380definition, 379dividends, 380stated value, 379

Preferred stock puzzle, 381Premium, currency at, 879Premium selling, 106Prepackaged bankruptcy, 865–866Present value, 59

algebraic formula, 78of annuity, 86–91break-even point, 211–212of common stock, 108–112and discounting, 74–78of dividends, 111–112of firm, 94–95formula for bonds, 107formulas, 95of growing annuity, 91–93of growing perpetuity, 84–86of perpetuity, 83–84of projects, 469–470of pure discount bond, 103of riskless cash flow, 592–594tables, 898–901, 909–912of tax shield, 409–410, 492–493of two annuities, 90–91of unlevered cash flow, 492

Present value analysis, 67Present value factor, 765Price conversion, 689Price-earnings ratios, 38–39, 121–123

accounting methods, 122and discount rate, 122factors determining, 123international, 122Japanese stock market, 122

Price fluctuations, 348Price movements, 661Price-pressure effects, 364–365Price takers, 51Price-taking assumption, 51Primary basis report of earnings, 678Primary market, 18Principal, 103, 376, 377Principal repayment, 46Principal value, of bonds, 565Private equity firm, 555Private placement, 18

of bonds, 580–581equity securities, 554–555new securities, 537

Private workout, 857, 863–864Privileged subscription, 537Probability theory, 262Procter and Gamble, 695, 825Product costs, 27Production set-up costs, 745Profitability index, 158–159Profitability ratios, 36–38Profit margins, 36Pro forma financial statements, 359, 734Promissory note, 802Prospectus, 534–535




Protective covenants, 430–431, 563, 567; seealso Restrictive covenants

and investment opportunities, 571Proxy contests, 819Proxy fight, 375Proxy voting, 375Public issue

announcement and firm value, 543–544of bonds, 564–568, 580–581cash offer, 537–543costs of, 544–547kinds of, 535–537steps, 534–535

Purchase method of accounting, 821–822Purchase-sale arrangement, 538Purchasing power parity, 878–879Pure discount bonds, 102–103, 579Put, floating-rate CDs, 796Put-call parity, 619, 636Put options

definition, 614factors determining values, 624–625firms expressed in terms of, 635–636selling, 616–617value at expiration, 614–616

Put provision, 578

Q ratio, 39–40Qualcomm, 454, 520Quarterly compounding, 79Quartiles, 301Quick assets, 33Quick ratio, 33Quote, 325

Random walk, 344Random walk hypothesis, 349–350Ratio analysis

activity ratios, 34–35current ratio, 33debt ratio, 35–36dividend yield, 39interest coverage, 36inventory turnover, 35market price, 38market-to-book value ratio, 39–40market value ratios, 38–40payout ratio, 38price-earnings ratio, 38–39, 121–123profitability, 36–38profit margin, 36quick ratio, 33receivables turnover, 34retention ratio, 38return on assets, 37return on equity, 37sustainable growth rate, 38Tobin’s Q, 39–40total asset turnover, 34

Real cash flow, 181–182Real interest rate, 179–180Real-world betas, 312Receivables, assigned or factored, 762Receivables turnover ratio, 34Red herring, 534–535Refunding, 568–572

Registered bonds, 890Registration requirement, 18Registration statement, 534

for bonds, 564Regression, 312Regular cash dividends, 495Regulation A, 534Relative purchasing power parity, 878–879Rembrandt bonds, 874Reopening decision, 665–671Reorganization, 857–863, 862–863

legal and administrative costs, 425–426Repayment, 378Replacement-chain problem, 184–186Replacement market, 198Replacement value, 373–374Repurchase agreements, 790Repurchase of stock; see Stock repurchaseRepurchase standstill agreements, 839–840Reputation capital, 540Required return on equity, 399Reservation payment, 602–603Residual losses, 15Residual value, 603Restrictive covenants, 378, 431Restructuring, at TWA, 856–857Retained earnings, 113–114, 372–373Retention ratio, 38, 113–114Return and risk; see Risk and returnReturn on assets, 37

and economic value added, 334–335Return on equity, 37, 113Return on the retained earnings, 113–114Returns; see also Expected return; Risk-free

returnsabnormal, 351–352average stock returns, 232–233comparison of financial instruments, 233continuation of, 349and cost of capital, 325dollar returns, 221–222holding-period, 225–231on individual securities, 286–287and market capitalization, 354parameters for, 293percentage, 222–224reversal of, 349on risky securities, 220stock versus government securities, 240–241and temporal anomalies, 354–355value versus growth stocks, 355–356variability of, 834–835

Return statistics, 231–232Revco, 865

case, 866–867Revenue enhancement, 824–825Revenue recognition, 26Revenues, 206

cyclicality of, 315–316Reversal returns, 349Reverse split, 531Rights, 547, 548–549Rights offer, 535

definition, 547effect on stock price, 549–551effects on shareholders, 550–551

mechanics of, 547–548number of rights needed, 548–549subscription price, 548underwriting arrangements, 551

Rights puzzle, 551–553Risk; see also Derivatives; Hedging

in adjustable-rate preferred stock, 794in auction-rate preferred stock, 795of cash flow, 8–9in credit policy, 802–805with derivatives, 695–696diversifiable, 262–263market, 263and market portfolio, 269–271portfolio, 262–263and selfish investment strategy, 427–429and sensible investors, 263–264and separation principle, 267–268systematic and unsystematic, 287–288total, 262unsystematic, 262–263

Risk and return, 219and capital asset pricing model, 272–275CAPM versus APT, 298–299efficient set for two assets, 252–257frequency distribution, 233, 234for individual securities, 242–247market-equilibrium portfolio, 268–271in one-factor model, 296–297optimal portfolio, 266–268for portfolios, 247–252in U.S. capital markets, 225–231for world stocks, 257

Risk-averse investors, 138, 263, 423nRisk-based models, 300Risk exposure, 348Risk-free rate, 274, 628Risk-free returns, 232–233Risk-free securities, 264–266Riskless cash flow

optimal debt level and, 594–595present value of, 593–594

Riskless debt, 439Riskless tax shield, 482Risk-neutral investors, 138Risk-neutral pricing, 659Risk-neutral probabilities, 659–660, 662Risk-neutral valuation, 627–628Risk premium, 232–233, 272

historical, 240–241Risk statistics, 234–236, 242–247

covariance and correlation, 245–247expected return and variance, 243–245normal distribution, 234–235standard deviation, 234variance, 234

Risk synergy, 687–688Risky return, 286RJR Nabisco buyout, 490–494, 575Rolling, 795Roll over, 579Round lot, 530–531Rule 144A, 555

Saab automobiles, 212–213Safety reserves costs, 754




Safeway, Inc., 675SAIR; see Stated annual interest rateSale-and-lease-back, 588Sale-of-assets divestiture, 838–839Sales forecasts, 734Sales-type leasing, 587Salomon Smith Barney, 537Sampling error, 236Samurai bonds, 874Scale-enhancing project, 483–484Scale problem, 153–155Scenario analysis, 206–209Scorched earth strategy, 841Scoville, 841Seagate Technology, 680, 681–682Sears, 315Seasonal activities, 788Seasoned new issue, 537Secondary market, 18Secured debt, 811Secured loans, 762Securities; see also Bonds; Expected return;

Returns; Stockadjustable-rate preferred stock, 793–794American Depository Receipts, 872–873announcement of new issue, 543–544auction-rate preferred stock, 794–795bearer instruments, 47beta of, 269–271, 283–284cash management with floating-rate CDs,

796–797characteristic line, 269–270as contingent claims, 9–10costs of new issues, 469, 544–547creative view of, 340–341dribble method of new issuance, 554hybrid, 377kinds of, 2, 17–18marketing of, 18methods of issuing, 537money market, 789–790private equity market, 554–558private placement, 554–555public offerings, 534–535rights offering, 547–553risk-free, 264–266round lots, 530–531shelf registration, 553–554short-term marketable, 788–789tracking stock, 838–839trading, 534trading range, 530–531

Securities Act of 1933, 534, 889Securities and Exchange Commission, 359, 524

bond registration, 564letter of comment, 535on private placement, 554–555registration requirement, 18, 534Rule 144A, 555shelf registration, 553–554

Securities dealers, 18Securities Exchange Act of 1934, 534, 553Securitization, 811Security

of bonds, 566–567of debt, 378

Security analysts, 327Security market line, 274–275, 296–297

compared to dividend valuation model, 309nand cost of capital, 320to estimate risk-adjusted discount rate, 310

Seed-money, 557Selfish investment strategy

costs of, 430by firms, 427–428by shareholders, 428–429

Selling a covered call, 620Selling expenses, 27Semiannual compounding, 79, 82Semistrong-form efficiency, 346–347

event studies, 351–352evidence on, 350–354record of mutual funds, 353–354

Semivariance, 235nSempra Energy, 119Seniority, 378Sensitivity analysis, 206–209Separation of ownership and control, 12–13,

16–17Separation principle/theorem, 56, 62,

267–268Serial correlation, 349–350Serial correlation coefficients

largest U. S. companies, 350positive and negative, 349–350

Set-of-contracts viewpoint, 15Shareholder disinterest, 348–349Shareholder diversification, 887Shareholders, 4, 371

and acquisitions, 817appraisal rights, 817and bankruptcy costs, 424benefits of acquisitions, 842–845versus bondholders, 513and cash flow of firm, 634–635coinsurance effect, 833contingent value rights, 612, 640cost of mergers, 830–833effect of rights offering, 550–551interests of, versus value of the firm,

391–393leverage and returns to, 393–395and loan guarantees, 638and managerial behavior, 17and managerial goals, 15of preferred stock, 380and put option terms, 635–636and rights offerings, 547–551risk of financial leverage, 398–399

Shareholders’ books, 175Shareholders’ equity, 4, 22, 24Shareholders’ rights, 374–375Shares, 371Share warrants, 547Shelf cash offer, 537Shelf life, 35Shelf registration, 553–554Shirking, 435Shiva Corporation, 541Shortage costs, 754–756Short hedge, 703–704, 712Short run, 26–27

Short-run operating activities, 750–751Short-term borrowing, 758Short-term debt, 563Short-term financial planning, 731

banker’s acceptance, 762carrying costs, 754–756cash budgeting, 759–761cash cycle, 750–753commercial paper, 762financing current assets, 753, 756–759flexible versus restrictive, 753–754international, 889net working capital in, 746operating cycle, 750–753secured loans, 762shortage costs, 754–756and size of investment in current assets,

753–756tracing cash and working capital, 746–747unsecured loans, 761–762

Short-term marketable, 788–789Short-term solvency, 33Short-term tax-exempts, 790Shutdown decision, 665–671Sight draft, 802Simple interest, 70–71Singapore Airlines, 771Singer Asset Finance Company, case, 93Sinking fund, 378, 567–568Skewed distribution, 234Small-company common stock, 225Small-issues exemption, 534Smell-of-death explanation, 580Society for Worldwide Interbank Financial

Telecommunications, 874Sole proprietorship, 11Sony Corporation, 845Sources-and-uses-of-cash statement,

748–750Southern California Edison, 453Southern Company, 554South Sea Bubble, 357Specific risk, 287Speculating, 696Speculative markets, 357–359Spin-off divestiture, 838–839Spot exchange rate, 876

interest-rate parity, 879and law of one price, 877

Spot rate, 130–139expected, 881

Spot trades, 876Spread, 538, 544Spread discount, 544Spreading overhead, 825Spread of a distribution, 234Sprint PCS, 839Staggering, 374Staggering board elections, 839Standard and Poor’s Corporation, 572–573,

789, 790, 793, 889Standard and Poor’s 500 Index, 225, 299,

312, 313as benchmark, 301market portfolio, 268–269standard deviation, 252, 253




Standard deviation, 234calculating, 244definition, 242formula, 245implications of normal distribution,

234–236of portfolio, 250–252in portfolio of many assets, 259–260S&P 500 Index, 252, 253

Standardized normal distribution, 630–632Standby fee, 551Standby rights offer, 537Standby underwriting, 551Standstill agreements, 839–840Start-up, 557

valuing, 655–658Stated annual interest rate, 79

compared to effective rate, 80Stated liquidation value of share, 379Statement of cash flows, 27–30

cash flow from financing activities, 41cash flow from investing activities, 41cash flow from operating activities, 40–41

Statement of consolidated cash flows, 42Statements of Financial Accounting

StandardsNo. 13, 589–590No. 52, 891

Static trade-off theory, 433versus pecking-order theory, 440

Stock, 2; see also Expected return; Returnsabnormal returns, 351–352block trades, 364–365dribble method of new issuance, 554exchange trading, 19growth portfolios, 355–356information sources, 342–343issuance costs and dividends, 503–506issued to pay dividends, 504liquidity of, 325listings, 19as options, 633–638public issue, 524–527surprises and announcements, 286–287synthetic, 619tracking stock, 838–839value portfolios, 355–356

Stock acquisition, 817–818Stock-based insolvency, 855–856Stock dividends, 496, 529–532Stock exchanges, 18–19Stock-for-stock transactions, 640Stockholders; see ShareholdersStock market

bubble theory, 357–359and corporate strategy analysis, 201–202information from dividend policy, 520and price-earnings ratios, 122random walk, 344reaction to new issue announcement,

543–544returns on, 221–232

Stock market crash of 1929, 356–357Stock market crash of 1987, 356Stock market reporting, 123–124Stock options, 612

Stockpower.com, 327Stock prices

in binomial model, 626–628in Black-Scholes model, 628–633and call option price, 613and convertible bonds, 684–685under corporate taxes, 414–415and debt-equity ratio, 450–451effect of rights offering, 549–551fluctuations, 348and increase in dividends, 504information sets, 346–347and IPOs, 361–362in Japan, 358manipulation of, 201–202price-pressure effects, 364–365and stock issues, 361

Stock repurchase, 506–509versus dividend payouts, 507and earnings per share, 507exclusionary self-tenders, 840as investment, 508–509targeted, 508, 839–840and taxes, 508

Stock split, 326–327, 496, 529–532Straight bond value, 681Straight debt versus convertible debt,

684–685Straight-line depreciation, 26, 123, 145, 359Straight voting, 374Strategic benefits of acquisitions, 825Strategic fit, 830Strike price, 612

and call option values, 622–624Strong-form efficiency, 346–347

evidence on, 359Style portfolios, 301Subordinated debt, 378Subscription price, 548Subsidies, 340Sunk costs, 170Superfloaters, 723Superinverse floaters, 723Supermajority amendment, 839Surplus funds, 828–829Surprises, 287Sustainable growth, 731, 742Sustainable growth rate, 38, 739–741Swap rate, 876Swaps contracts, 874

currency swaps, 722–723interest-rate, 721–722

Sweep accounts, 788Symmetric distribution, 234–235Syndicate, 538Syndicated bank loans, 581–583Synergy, 816

determining, 823–824measuring, 845sources of, 824–829

Synthetic stock, 619Systematic risk, 287–288

and beta coefficient, 289and betas, 288–291of foreign stock investment, 887–888

Systematic variability, 834–835

Takeovers, 17, 818–819; see alsoAcquisitions; Mergers

crown jewels, 841defenses against, 838–841and golden parachutes, 841poison pill, 841

Taking delivery, 696Tangible fixed assets, 3, 23Target cash balance

Baumol model, 773–776and borrowing, 778–779compensating cash balance, 779Miller-Orr model, 776–778

Target debt-equity ratio, 735Targeted repurchase, 839Targeted stock repurchase, 508Taxability, 789Taxable acquisition, 819–820Taxable income, 26Tax arbitrage, 513Tax books, 175Tax code, quirk in, 408–409Tax deductibility

limited, 448unlimited, 447

Taxesbasics of, 408and call provision, 571current, 26and debt-equity ratio, 451deferred, 26and dividends, 375, 444–445, 503–506and financial distress costs, 432–434graduated income tax, 462–464and leases, 590–591personal, 443–448and preferred stock, 381quirk in tax code, 408–409and stock repurchase, 508value of leveraged firm, 410–411

Taxes advantages of leasing, 601–603Tax-free acquisition, 819–820, 838Tax gains

from acquisitions, 819–820, 827–829from mergers, 829

Tax operating loss, 43Tax rates, real-world, 447Tax Reform Act of 1986, 13, 175, 199,

794, 828nTax shield, 474

from debt, 410from flotation costs, 479and leasing, 609present value of, 409–410, 492–493riskless, 482

Tax subsidy, 479–480TCI, Inc., 203Technical analysis, 345Technical analysts, 345Temporal anomalies, 354–355Tender offer, 817–818Term loans, 580–581Terms of sale, 798–802

cash discounts, 800–801credit instruments, 801–802credit period, 799




Term structure of interest rates,130–139, 758

forward rate, 132–134Texaco, 427Texas State Court, 427Textron, 556Theoretical distribution, 235Third-party lessors, 605Time horizon, 138Time preference theory, 48–51Time value of money, 307

compounding periods, 79–82definition, 66future value and compounding, 70–73future value concept, 66power of compounding, 73–74present value and discounting, 74–78present value concept, 67–68

Timing assumption, 86Timing of decisions, 361–363Timing problem, 155–157Tobin’s Q, 39–40, 374Tokio Marine and Fire, 846Tokyo Stock Market, 122Tombstone advertisement, 535, 536Total annual return, 233Total asset turnover ratio, 34Total cash flow, 28, 30Total cost curve, 754–755Total cost of cash balances, 775–776Total-credit-cost curve, 806Total dollar return, 222Total investment, 113Total return, 223

year-by-year, 229–230Total risk, 262–263Toys “R” Us, 788Tracking stock, 838–839Trade credit, 798Trade credit financing, 811Trade-off theory; see Static trade-off

theoryTrading costs, 754, 772, 775Trading range, 530–531Transaction costs

of leasing, 603of reverse split, 531of stock splits and dividends, 531

Transactions motive, 772Trans World Airways, 856–857Treasury bills, 225, 789

returns on, 232–233Treasury bonds, 789

futures contracts, 709pricing of, 706–707

Treasury notes, 789Treasury stock, 373–374Triangular arbitrage, 876Triple tops pattern, 345True distribution, 235–236Trust deed, 566Trust receipt, 762Tulip craze, 357Two-state option model, 626–628

amount of borrowing, 627applications, 658–671

determining delta, 627risk-neutral valuation, 627–628

Two-year discount bonds, 102

Uncertain return, 286Uncertainty resolution, 512Underinvestment, 428–429Underlying asset

of derivatives, 695–696variability of, 623–624

Underpricing, 541–543, 545Undersubscription, 551Underwriters

of Eurobonds, 890functions, 540and rights offerings, 551, 553top U. S., 538

Underwriting discount, 544Underwriting risk, 540Underwriting syndicate, 18, 538Unfunded debt, 563Unique risk, 263United Airlines, 856United States

federal tax rates, 42–43historical financing patterns, 383largest bankruptcies, 855

United States Bankruptcy Code, 857United States government bonds, 232–233United States Steel, 359, 824n

case, 852–853Unlevered beta, 483–484Unlevered cash flow, 470–471, 472, 473

present value of, 492Unocal, 827, 840Unremitted cash flows, 886Unseasoned new issue, 537Unsecured loans, 761–762Unsystematic risk, 262–263, 287–288

in APT, 298in diversified portfolio, 296, 297

Unsystematic variability, 834–835Unused debt capacity, 828Upper bound of option price, 621Up-state price, 661USX Corporation, 359

Valuationadjusted-present-value method, 468–470,

478–481comparison of methods, 473–476of convertible bonds, 681–684of executive compensation, 652–655of executive stock options, 654–655flow-to-equity method, 470–471of leasing, 596–599in leveraged buyouts, 490–494of options, 620–625under personal/corporate taxes, 445–448risk-neutral, 627–628of start-up, 655–658weighted-average-cost-of-capital method,

471–472Value

of American options, 625of assets, 26

of bonds, 102–105of a call option, 613–614of cash cow, 121of common stock, 108–112versus cost, 24of put option, 614–616, 624–625

Value creation, 339–341Value Line Investment Survey, 332Value of levered firm, 410–411Value of the firm, 4, 28, 94–95

and acquisitions, 816after acquisition, 829–830and changes in financial leverage, 450and financial leverage, 393–398and growth rate, 112–115and marketed claims, 434in Miller model, 448Modigliani-Miller thesis, 432net of debt, 679and new issue announcement, 543–544versus shareholder interests, 391–393and taxes, 408–416

Value stock, 301, 355–356Variability of return, 834–835Variable costs, 26–27, 207, 316Variables

for call-option values, 625negatively correlated, 247plug, 734positively correlated, 247uncorrelated, 247

Variance, 234calculating, 244definition, 242formula, 250matrix approach, 250, 259of portfolio, 249–252, 261–262in portfolio of many assets, 259–260

Venture capitalcase, 558–559and IPOs, 557–558market for, 554stages of financing, 556–557suppliers of, 556–557

Vertical acquisition, 818Vertical integration, 826Video Product Company, 2

WACC; see Weighted average cost ofcapital

Wages, taxes, and other expenses, 760Waiting period, 534–535Walk-away-from option, 613Wall Street Journal, 104, 107, 123, 352n,

701–702Warrants, 674–676

Black-Scholes model, 679–680compared to call potions, 675–678kinds of issues, 687–689reasons for issuing, 684–687

Weak-form efficiency, 333–346evidence on, 349–353

Weighted average cost of capital, 321–323,324, 399, 401

and corporate taxes, 413–414determining, 484




Weighted-average-cost-of-capital method,471–472

compared to adjusted-present valuemethod, 473

compared to flow-to-equity method, 474formula, 485guidelines, 474–476for tax shield, 492–493

Weighted average of betas, 293Weighted average of expected returns, 248,

251, 293Weighted average of standard deviations,

251, 252

Weighted average of unsystematic risk, 293Westinghouse, 700What-if analysis, 206White knight, 853Winner’s curse, 543Wire transfers, 784–786Working capital, 176

Xerox Corporation, 122, 288

Yankee bonds, 874, 889–890Yield to maturity, 106–107, 130–139

Zero-balance account, 787Zero bond, 102Zero-coupon bonds, 102, 130–139, 579

duration hedging, 714Zero covariance, 247Zero-growth stock, 109–111Zero inflation beta, 289Zero-sum transactions, 723Z-score model, 869–871



Back Matter End Papers 959© The McGraw−Hill Companies, 2002

AR Abnormal return

APT Arbitrage pricing theory

CAPM Capital asset pricing model

CAR Cumulative abnormal return

Ct Cash flow at period t

Corr(x,y) Correlation between x and yor �xy

Cov(x,y) Covariance between x and yor �xy

d Dividend payout ratio

Dep Depreciation

Divt Dividend payment at period t

e 2,71828 (base for natural logarithms)

E Exercise price of option

EBIT Earnings before interest and taxes

EPS Earnings per share

g Growth rate

IRR Internal rate of return

Lt Lease payment in year t

NPV Net present value

Pt Price of stock at time t

PV Present value

Rm Return on market portfolio

Rp Return on portfolio P

rB Cost of debt

rB(1 �TC) After-tax cost of debt

rF Risk-free interest rate

rn Nominal interest rate

rr Real interest rate

rS Cost of equity

R� or E(R) Expected returns

R2 R squared

RP Risk premium

S£(t) Spot exchange rate between British pound and U.S. dollar at time t

SML Security market line

Tc Corporate income tax rate

VL Value of a levered firm

(VL � B � S)

VU Value of an unlevered firm (VU � S)

rWACC Weighted average cost of capital

� Beta; the slope of the market model; a measure of risk

�asset Asset beta or firm beta

�equity Equity beta

� Standard deviation

�2 Variance

� Inflation rate

� Sum of

Some Commonly Used Notations


Back Matter End Papers960 © The McGraw−Hill Companies, 2002

Some Useful Formulas

1 Present Value (Chapters 3 and 4)The discounted value of T future cash flows

PV � � � . . . � � �T

t � 1

2 Net Present Value (Chapters 3 and 4)Present value minus initial costsNPV � PV � CostCO � � Cost

NPV � CO � �T

t � 1

3 Perpetuity (Chapter 4)The value of C received each year, forever

PV �

4 Annuity (Chapter 4)The value of C received each year for T years

PV � [1 � 1/(l � r)t]

5 Growing Perpetuity (Chapter 4)The value of a perpetuity that grows at rate g, where the first payment is C

PV �

6 Growing Annuity (Chapter 4)The value of a T-period annuity that grows at the rate g, where the firstpayment is C

PV � C � � � � �T�7 Measures of Risk for Individual Assets (Chapter 10)

Var (RA) � �2A � Expected value of (RA � R�A)2

SD (RA) � �A � �V�ar� (�R�A)�Cov (RA,RB) � �AB � Expected value of [(RA �R�A) (RB � R�B)]

Corr (RA,RB) � AB � Cov (RARB)/�A�B

8 Expected Return on a Portfolio of Two Assets (Chapter 10)R�p � XAR�A � XBR�B

9 Variance of a Portfolio of Two Assets (Chapter 10)�2

p � X2A � �2

A � 2XAXB � �AB � X2B � �2

B

1 � g�l � r

1�r � g

1�r � g

C�r � g

C�r

C�r

Ct�(l � r)t

Ct�(1 � r)t

CT�(1 � r)T

C2�(1 � r)2

C1�1 � r


Back Matter End Papers 961© The McGraw−Hill Companies, 2002

10 Beta of a Security (Chapter 10)

�A �

11 Capital Asset Pricing Model (Chapter 10)R�A � RF � �A � (R�M � RF)

12 k-Factor Model (Chapter 11)Ri � RF � �i1F1 � �i2F2 � . . . � �ikFk � i

13 Leverage and the Cost of Equity (Chapter 12)Before tax:

rS � rO � (rO � rB)

After tax:

rS � � (1 � TC)( � rB)

14 Value of the Firm under Corporate Taxes (Chapter 15)VL � VU � TCB

15 Weighted Average Cost of Capital (Chapter 15)

� � rS � � � rB (1 � TC)

16 Equity Beta (Chapter 17)

No-tax case: �Unlevered firm � � �Equity

Corporate tax case: �Unlevered firm � � �Equity

17 Black-Scholes Model (Chapter 22)

C � SN(d1) � Ee�rt N(d2)

where d1 � [ln (S/E) � (r � 1⁄2�2)t]/��2�t�d2 � d1 � ��2�t�

18 Sustainable Growth (Chapter 26)

Growth �P � (1 � d ) � 1 � L)

��T � [P � (1 � d ) � (1 � L)]

Equity��Equity � (1 � TC) Debt

Equity��Debt � Equity

B�S � B

S�S � B

B�S

B�S

Cov (RA, RM)��

�2(RM)

Appendix A: Mathematical Tables Appendix B: Solutions to Selected End−of−Chapter Problems Glossary Name Index Subject Index End Papers

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