Principles of managerial finance. [Fifteenth edition, Global edition] 9781292261515, 129226151X

Citation preview

New to This Global Edition • Tax Cuts and Jobs Act of 2017, which made sweeping changes to the American corporate and personal tax codes, has been included • Highlights on how tax changes may alter firms’ incentives in a variety of ways • Content and feature updates throughout the text and inclusion of global examples in the end-of-chapter homework assignments—from Britain, Scotland, Thailand, and Singapore—reflect global application in managerial finance • MyLab Finance now includes the following features ° New chapter introduction videos and animations that explain the importance of the chapter content within the context of managerial finance ° New and updated solution videos of the author discussing or solving in-chapter examples

Principles of Managerial Finance FIFTEENTH EDITION

Chad J. Zutter • Scott B. Smart

FIFTEENTH EDITION

This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the benefit of students outside the United States and Canada. If you purchased this book within the United States or Canada, you should be aware that it has been imported without the approval of the Publisher or Author.

Principles of Managerial Finance

Now in its fifteenth edition, Principles of Managerial Finance continues to help students develop a variety of skills—Excel modeling, ethical reasoning, and critical thinking—to succeed in a rapidly changing financial and managerial environment. A strong pedagogy and generous use of examples, including personal finance examples, make this text an easily accessible resource for in- and out-of-class learning.

GLOBAL EDITION

G LO B A L EDITION

GLOBAL EDITION

Pearson Global Edition

Zutter Smart

Zutter_15_129226151X_Final.indd 1

14/08/18 8:28 PM

Prepare, Apply, Confirm and Develop Employability Skills with MyLab Finance

86%

of students said it helped them earn higher grades on homework, exams, or the course *Source: 2016 Student Survey, n 1317

MyLabTM Finance is an online homework, tutorial, and assessment program constructed to work with this text to engage students and improve results. It was designed to help students develop and assess the skills and applicable knowledge that they will need to succeed in their courses and their future careers. See what more than 25,000 students had to say about MyLab Finance: “MyLab Finance offers assistance WHILE doing homework rather than relying on information from class to execute later.” — Anthony Wilent, Stockton University

Question Help MyLab homework and practice questions are correlated to the textbook, and generate algorithmically to give students unlimited opportunity for mastery of concepts. If students get stuck, Learning Aids including Help Me Solve This, View an Example, eText Pages, and a Financial Calculator walk them through the problem and identify helpful info in the text, giving them assistance when they need it most. “MyLab Finance’s primary benefit was that it helped me gain a better understanding of the subject matter. More than just doing calculations but true understanding.” — Robert Irish, Southern New Hampshire University

A01_ZUTT1515_15_GE_FM.indd 1

23/08/18 4:47 PM

Using proven, field-tested technology, auto-graded Excel Projects allow instructors to seamlessly integrate Microsoft Excel® content into their course without having to manually grade spreadsheets. Students have the opportunity to practice important finance skills in Excel, helping them to master key concepts and gain proficiency with the program.

93%

91%

93% Dynamic Study Modules help students study chapter topics effectively on their own by continuously assessing their knowledge application and performance in real time. These are available as graded assignments prior to class, and accessible on smartphones, tablets, and computers.

eText

Study Plan

Dynamic Study Modules

% of students who found learning tool helpful

Pearson eText enhances student learning—both in and outside the classroom. Take notes, highlight, and bookmark important content, or engage with interactive lecture and example videos that bring learning to life (available with select titles). Accessible anytime, anywhere via MyLab or the app.

The MyLab Gradebook offers an easy way for students and instructors to view course performance. Item Analysis allows instructors to quickly see trends by analyzing details like the number of students who answered correctly/incorrectly, time on task, and median time spend on a question by question basis. And because it’s correlated with the AACSB Standards, instructors can track students’ progress toward outcomes that the organization has deemed important in preparing students to be leaders.

88%

of students would tell their instructor to keep using MyLab Finance

For additional details visit: www.pearson.com/mylab/finance

A01_ZUTT1515_15_GE_FM.indd 2

23/08/18 4:47 PM

Principles of

Managerial Finance

A01_ZUTT1515_15_GE_FM.indd 1

23/08/18 4:47 PM

The Pearson Series in Finance Berk/DeMarzo Corporate Finance*† Corporate Finance: The Core*†

Holden Excel Modeling in Corporate Finance Excel Modeling in Investments

Rejda/McNamara Principles of Risk Management and Insurance†

Berk/DeMarzo/Harford Fundamentals of Corporate Finance*†

Hughes/MacDonald International Banking: Text and Cases

Smart/Gitman/Joehnk Fundamentals of Investing*†

Brooks Financial Management: Core Concepts*†

Hull Fundamentals of Futures and Options Markets† Options, Futures, and Other Derivatives†

Solnik/McLeavey Global Investments

Copeland/Weston/Shastri Financial Theory and Corporate Policy Dorfman/Cather Introduction to Risk Management and Insurance Eakins/McNally Corporate Finance Online Eiteman/Stonehill/Moffett Multinational Business Finance*† Fabozzi Bond Markets: Analysis and Strategies Foerster Financial Management: Concepts and Applications*† Frasca Personal Finance Haugen The Inefficient Stock Market: What Pays Off and Why Modern Investment Theory

Keown Personal Finance: Turning Money into Wealth* Keown/Martin/Petty Foundations of Finance: The Logic and Practice of Financial Management*† Madura Personal Finance* McDonald Derivatives Markets Fundamentals of Derivatives Markets

Titman/Keown/Martin Financial Management: Principles and Applications*† Titman/Martin Valuation: The Art and Science of Corporate Investment Decisions Weston/Mitchell/Mulherin Takeovers, Restructuring, and Corporate Governance Zutter/Smart Principles of Managerial Finance*† Principles of Managerial Finance— Brief Edition*†

Mishkin/Eakins Financial Markets and Institutions† Moffett/Stonehill/Eiteman Fundamentals of Multinational Finance*† Pennacchi Theory of Asset Pricing

* denotes titles with MyLab Finance:       Log onto www.pearson.com/mylab/finance to learn more. †

denotes Global Edition titles

A01_ZUTT1515_15_GE_FM.indd 2

23/08/18 4:47 PM

FIFTEENTH EDITION GLOBAL EDITION

Principles of

Managerial Finance Chad J. Zutter University of Pittsburgh

Scott B. Smart Indiana University

Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney • Dubai • Singapore • Hong Kong Tokyo • Seoul • Taipei • New Delhi • Cape Town • Sao Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan

A01_ZUTT1515_15_GE_FM.indd 3

23/08/18 4:48 PM

Vice President, Business, Economics, and UK Courseware: Donna Battista Director of Portfolio Management: Adrienne D’Ambrosio Senior Portfolio Manager: Kate Fernandes Editorial Assistant: Caroline Fenn Associate Acquisitions Editor, Global Edition: Ananya Srivastava Editor, Global Edition: Paromita Banerjee Assistant Project Editor, Global Edition: Jyotis Elizabeth Jacob Vice President, Product Marketing: Roxanne McCarley Product Marketer: Kaylee Carlson Product Marketing Assistant: Marianela Silvestri Manager of Field Marketing, Business Publishing: Adam Goldstein Executive Field Marketing Manager: Thomas Hayward Vice President, Production and Digital Studio, Arts and Business: Etain O’Dea Director of Production, Business: Jeff Holcomb Managing Producer, Business: Alison Kalil Content Producer: Meredith Gertz

Content Producer, Global Edition: Purnima Narayanan Senior Manufacturing Controller, Global Edition: Kay Holman Operations Specialist: Carol Melville Design Lead: Kathryn Foot Manager, Learning Tools: Brian Surette Content Developer, Learning Tools: Sarah Peterson Managing Producer, Digital Studio and GLP, Media Production and Development: Ashley Santora Managing Producer, Digital Studio: Diane Lombardo Digital Studio Producer: Melissa Honig Digital Studio Producer: Alana Coles Digital Content Team Lead: Noel Lotz Digital Content Project Lead: Miguel Leonarte Manager, Media Production, Global Edition: Vikram Kumar Project Manager: Kathy Smith, Cenveo® Publisher Services Interior Design: Cenveo® Publisher Services Cover Design: Lumina Datamatics Cover Art: Wayne0216/Shutterstock

Microsoft and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published as part of the services for any purpose. All such documents and related graphics are provided “as is” without warranty of any kind. Microsoft and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all warranties and conditions of merchantability, whether express, implied or statutory, fitness for a particular purpose, title and non-infringement. In no event shall Microsoft and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from the services. The documents and related graphics contained herein could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Microsoft and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time. Partial screen shots may be viewed in full within the software version specified. Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A. and other countries. This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation. Acknowledgments of third-party content appear on the appropriate page within the text. PEARSON, ALWAYS LEARNING, and MYLAB are exclusive trademarks owned by Pearson Education, Inc. or its affiliates in the U.S. and/or other countries. Pearson Education Limited KAO Two KAO Park Harlow CM17 9NA United Kingdom and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsonglobaleditions.com © Pearson Education Limited 2019 The rights of Chad J. Zutter and Scott B. Smart, to be identified as the author of this work, have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. Authorized adaptation from the United States edition, entitled Principles of Managerial Finance, 15th Edition, ISBN 978-0-13-447631-5 by Chad J. Zutter and Scott B. Smart, published by Pearson Education © 2019. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. For information regarding permissions, request forms, and the appropriate contacts within the Pearson Education Global Rights and Permissions department, please visit www.pearsoned.com/permissions/. ISBN 10: 1-292-26151-X ISBN 13: 978-1-292-26151-5 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 9 8 7 6 5 4 3 2 1 Typeset in Times NR MT Pro by Cenveo® Publisher Services Printed and bound by Vivar in Malaysia

A01_ZUTT1515_15_GE_FM.indd 4

23/08/18 4:48 PM

Dedicated to our good friend and mentor, Dr. Lawrence J. Gitman, who trusted us as coauthors and successors of Principles of Managerial Finance. CJZ SBS

A01_ZUTT1515_15_GE_FM.indd 5

23/08/18 4:48 PM

This page intentionally left blank

A01_MISH4182_11_GE_FM.indd 6

10/06/15 11:46 am

Brief Contents Contents  9 About the Authors  29 Preface  31 Acknowledgments  44

PART 1 Introduction to Managerial Finance  47

1 2

The Role of Managerial Finance  48 The Financial Market Environment  87

PART 2 Financial Tools  121

3 Financial Statements and Ratio Analysis  122 4 Long- and Short-Term Financial



5

Planning  188 Time Value of Money  235

PART 3 Valuation of Securities  301

6 7

Interest Rates and Bond Valuation  302 Stock Valuation  351

PART 4 Risk and the Required Rate of Return  391

8 9

PART 6 Long-Term Financial Decisions  597 13 Leverage and Capital Structure  598 14 Payout Policy  652

PART 7 Short-Term Financial Decisions  691 15 Working Capital and Current Assets Management  692 16 Current Liabilities Management  735

PART 8 Special Topics in Managerial Finance  771 17 Hybrid and Derivative Securities  772 18 Mergers, LBOs, Divestitures, and Business Failure  811 19 International Managerial Finance  855

Risk and Return  392 The Cost of Capital  442

PART 5 Long-Term Investment Decisions  475 10 Capital Budgeting Techniques  476 11 Capital Budgeting Cash Flows  517 12 Risk and Refinements in Capital Budgeting  555

Appendix  895 Glossary  927 Index  955

7

A01_ZUTT1515_15_GE_FM.indd 7

23/08/18 4:48 PM

This page intentionally left blank

A01_MISH4182_11_GE_FM.indd 6

10/06/15 11:46 am

Contents About the Authors  29 Preface  31 Acknowledgments  44

PART 1 Introduction to Managerial Finance  47

1

The Role of Managerial Finance  48

1.1 Finance and the Firm  50 What Is Finance?  50 What Is a Firm?  51 What Is the Goal of the Firm?  51 in practice

FOCUS ON ETHICS:

Do Corporate Executives Have a Social Responsibility?  52 The Role of Business Ethics  56 ➔ REVIEW QUESTIONS   57 ▲ Brookdale Senior Living––Is Brookdale’s Management About to Be Retired? 49

in practice

FOCUS ON PRACTICE:

Must Search Engines Screen Out Fake News?  58

1.4 Developing Skills for Your Career  78 Critical Thinking  79 Communication and Collaboration  79 Financial Computing Skills  79 Summary  79 Opener-In-Review  81 Self-Test Problem  81 Warm-Up Exercises  81 Problems  83 Spreadsheet Exercise  86

1.2 Managing the Firm  58 The Managerial Finance Function  59 ➔ REVIEW QUESTIONS   67

1.3 Organization Forms, Taxation, and the Principal-Agent Relationship  67 Legal Forms of Business Organization  67 Agency Problems and Agency Costs  74 Corporate Governance  75 ➔ REVIEW QUESTIONS   78

9

A01_ZUTT1515_15_GE_FM.indd 9

23/08/18 4:48 PM

10 Contents

2

The Financial Market Environment  87

▲ Airbnb––Billions of VC Funding Gives Airbnb Plenty of Room 88

2.1 Financial Institutions  89 Commercial Banks, Investment Banks, and the Shadow Banking System  89

Issuing Common Stock  103

➔ REVIEW QUESTIONS   91

➔ REVIEW QUESTIONS   111

2.2 Financial Markets  91 The Relationship Between Institutions and Markets  91 The Money Market  92 The Capital Market  93

2.5 Financial Markets in Crisis  111 Financial Institutions and Real Estate Finance  111 Spillover Effects and Recovery from the Great Recession  114

in practice

FOCUS ON PRACTICE:

Berkshire Hathaway: Can Buffett Be Replaced?  94 The Role of Capital Markets  98 in practice

FOCUS ON ETHICS:

Should Insider Trading Be Legal?  100 ➔ REVIEW QUESTIONS   101

2.3 Regulation of Financial Markets and Institutions  101

2.4 The Securities Issuing

Process  103

➔ REVIEW QUESTIONS   114

Summary  115 Opener-In-Review  116 Self-Test Problem  117 Warm-Up Exercises  117 Problems  118 Spreadsheet Exercise  119 INTEGRATIVE CASE 1 Merit Enterprise Corp.  120

Regulations Governing Financial Institutions  101 Regulations Governing Financial Markets  102 ➔ REVIEW QUESTIONS   102

A01_ZUTT1515_15_GE_FM.indd 10

23/08/18 4:48 PM

Contents 11

PART 2 Financial Tools  121

3

Financial Statements and Ratio Analysis  122

3.1 The Stockholders’ Report  124 The Letter to Stockholders  124 in practice

More Countries Adopt International Financial Reporting Standards  124 The Four Key Financial Statements  125 in practice

▲ Kroger––Ratios Point to Trouble at Kroger 123

GLOBAL FOCUS:

FOCUS ON ETHICS:

Earnings Shenanigans  125 Notes to the Financial Statements  131 Consolidating International Financial Statements  131 ➔ REVIEW QUESTIONS   132

3.2 Using Financial Ratios  133 Interested Parties  133 Types of Ratio Comparisons  133 Cautions About Using Ratio Analysis  136 ➔ REVIEW QUESTIONS   137

3.3 Liquidity Ratios  138 Current Ratio  138 Quick (Acid-Test) Ratio  140 ➔ REVIEW QUESTIONS   141

3.4 Activity Ratios  141 Inventory Turnover  141 Average Collection Period  142 Average Payment Period  144 Total Asset Turnover  144 ➔ REVIEW QUESTION   145

3.5 Debt Ratios  145 Debt Ratio  147 Debt-to-Equity Ratio  147

A01_ZUTT1515_15_GE_FM.indd 11

Times Interest Earned Ratio  148 Fixed-Payment Coverage Ratio  149 ➔ REVIEW QUESTIONS   149

3.6 Profitability Ratios  149 Common-Size Income Statements  149 Gross Profit Margin  150 Operating Profit Margin  152 Net Profit Margin  152 Earnings Per Share (EPS)  153 Return on Total Assets (ROA)  154 Return on Equity (ROE)  154 ➔ REVIEW QUESTIONS   156

3.7 Market Ratios  156 Price/Earnings (P/E) Ratio  157 Market/Book (M/B) Ratio  159 ➔ REVIEW QUESTION   160

3.8 A Complete Ratio Analysis  160 Summary of Whole Foods’ Financial Condition  160 DuPont System of Analysis  164 ➔ REVIEW QUESTIONS   167

Summary  167 Opener-In-Review  169 Self-Test Problems  169 Warm-Up Exercises  170 Problems  171 Spreadsheet Exercise  186

23/08/18 4:48 PM

12 Contents

4

Long- and ShortTerm Financial Planning  188

4.1 The Financial Planning

4.4 Profit Planning: Pro Forma

Process  190

Statements  211

Long-Term Strategic Financial Plans  190 Short-Term (Operating) Financial Plans  191

Preceding Year’s Financial Statements  212 Sales Forecast  212 ➔ REVIEW QUESTION   213

➔ REVIEW QUESTIONS   192

4.2 Measuring the Firm’s Cash

Flow  192 ▲ Netflix Inc.––Not Streaming at Netflix— Cash Flow 189

Depreciation  192 Depreciation Methods  193 Developing the Statement of Cash Flows  195 Free Cash Flow  200 in practice

FOCUS ON ETHICS:

Is Excess Cash Always a Good Thing?  201 in practice

FOCUS ON PRACTICE: Free Cash Flow at LinkedIn  202

➔ REVIEW QUESTIONS   203

4.3 Cash Planning: Cash

Budgets  203

The Sales Forecast  203 Preparing the Cash Budget  204 Evaluating the Cash Budget  209 Coping with Uncertainty in the Cash Budget  210 Cash Flow within the Month  211

4.5 Preparing the Pro Forma

Income Statement  213

Considering Types of Costs and Expenses  214 ➔ REVIEW QUESTIONS   215

4.6 Preparing the Pro Forma Balance Sheet  215 ➔ REVIEW QUESTIONS   217

4.7 Evaluation of Pro Forma

Statements  217

➔ REVIEW QUESTIONS   218

Summary  218 Opener-In-Review  220 Self-Test Problems  220 Warm-Up Exercises  222 Problems  222 Spreadsheet Exercise  233

➔ REVIEW QUESTIONS   211

A01_ZUTT1515_15_GE_FM.indd 12

23/08/18 4:48 PM

Contents 13

5

Time Value of Money  235

5.1 The Role of Time Value in

Finance  237

Future Value Versus Present Value  237 Computational Tools  238 Basic Patterns of Cash Flow  240 ➔ REVIEW QUESTIONS   240

▲ Mega Millions Jackpot–– Pay Me Now or Pay Me Later 236

5.2 Single Amounts  241 Future Value of a Single Amount  241 Present Value of a Single Amount  245 ➔ REVIEW QUESTIONS   248 ➔ EXCEL REVIEW QUESTIONS   248

5.3 Annuities  249 Types of Annuities  249 Finding the Future Value of an Ordinary Annuity  250 Finding the Present Value of an Ordinary Annuity  251 Finding the Future Value of an Annuity Due  253 Finding the Present Value of an Annuity Due  254 Finding the Present Value of a Perpetuity  256 ➔ REVIEW QUESTIONS   257 ➔ EXCEL REVIEW QUESTIONS   257

5.4 Mixed Streams  258 Future Value of a Mixed Stream  258 Present Value of a Mixed Stream  260 ➔ REVIEW QUESTION   261 ➔ EXCEL REVIEW QUESTION   261

A General Equation for Compounding  263 Using Computational Tools for Compounding  263 Continuous Compounding  264 Nominal and Effective Annual Rates of Interest  265 ➔ REVIEW QUESTIONS   267 in practice

FOCUS ON ETHICS:

Was the Deal for Manhattan a Swindle?  267

➔ EXCEL REVIEW QUESTIONS   268

5.6 Special Applications of

Time Value  268

Determining Deposits Needed to Accumulate a Future Sum  268 Loan Amortization  269 Finding Interest or Growth Rates  271 in practice

FOCUS ON PRACTICE:

New Century Brings Trouble for Subprime Mortgages  271 Finding an Unknown Number of Periods  274 ➔ REVIEW QUESTIONS   276

➔ EXCEL REVIEW QUESTIONS   276

Summary  276 Opener-In-Review  278 Self-Test Problems  278 Warm-Up Exercises  279 Problems  280 Spreadsheet Exercise  296 INTEGRATIVE CASE 2 Track Software, Inc.  297

5.5 Compounding Interest More

Frequently than Annually  261 Semiannual Compounding  261 Quarterly Compounding  262

A01_ZUTT1515_15_GE_FM.indd 13

23/08/18 4:48 PM

14 Contents

PART 3 Valuation of Securities  301

6

Interest Rates and Bond Valuation  302

6.1 Interest Rates and Required Returns  304 Interest Rate Fundamentals  304 Term Structure of Interest Rates  309 in practice

FOCUS ON PRACTICE: I-Bonds Adjust for Inflation  310

Risk Premiums: Issuer and Issue Characteristics  315 ➔ REVIEW QUESTIONS   316 ▲ Aston Martin Bond Issue––The Name Is Bond—Junk Bond 303

6.2 Government and Corporate Bonds  316 Legal Aspects of Corporate Bonds  317 Cost of Bonds to the Issuer  318 General Features of a Bond Issue  319 Bond Yields  320 Bond Prices  320 Bond Ratings  321 Common Types of Bonds  321 International Bond Issues  322 in practice

FOCUS ON ETHICS:

“Can Bond Ratings Be Trusted?”  323

6.3 Valuation Fundamentals  325 Key Inputs  325 Basic Valuation Model  326 ➔ REVIEW QUESTIONS   327

6.4 Bond Valuation  327 Bond Fundamentals  328 Bond Valuation  328 Semiannual Interest Rates and Bond Values  330 Changes in Bond Values  332 Yield to Maturity (YTM)  335 ➔ REVIEW QUESTIONS   337 ➔ EXCEL REVIEW QUESTIONS   337

Summary  337 Opener-In-Review  339 Self-Test Problems  340 Warm-Up Exercises  340 Problems  342 Spreadsheet Exercise  350

➔ REVIEW QUESTIONS   324

A01_ZUTT1515_15_GE_FM.indd 14

23/08/18 4:48 PM

Contents 15

7

7.1 Differences Between Debt

Stock Valuation  351 and Equity  353

Voice in Management  353 Claims on Income and Assets  353 Maturity  354 Tax Treatment  354 ➔ REVIEW QUESTION   354

7.2 Common and Preferred

Stock  354 ▲ Tesla Inc.––Stock Prices Are All About the Future 352

Common Stock  355 Preferred Stock  358 ➔ REVIEW QUESTIONS   360

7.3 Common Stock Valuation  360 Market Efficiency and Stock Valuation  360 Common Stock Dividend Valuation Model  362 in practice

FOCUS ON PRACTICE:

in practice

FOCUS ON ETHICS:

7.4 Decision Making and Common

Stock Value  374

Changes in Expected Dividends  375 Changes in Risk  375 Combined Effect  376 ➔ REVIEW QUESTIONS   376

Summary  376 Opener-In-Review  378 Self-Test Problems  379 Warm-Up Exercises  379 Problems  380 Spreadsheet Exercise  388 INTEGRATIVE CASE 3 Encore International  389

Understanding Human Behavior Helps Us Understand Investor Behavior  363 Free Cash Flow Valuation Model  367 Other Approaches to Common Stock Valuation  370 Index Funds and Corporate Governance  372 ➔ REVIEW QUESTIONS   374

A01_ZUTT1515_15_GE_FM.indd 15

23/08/18 4:48 PM

16 Contents

PART 4 Risk and the Required Rate of Return  391

8

Risk and Return  392

8.1 Risk and Return Fundamentals  394

8.4 Risk and Return: The Capital Asset Pricing Model (CAPM)  414

What Is Risk?  394 What Is Return?  394

Types of Risk  414 The Model: CAPM  415

in practice

FOCUS ON ETHICS:

If It Seems Too Good to Be True, It Probably Is  395 Risk Preferences  397 ▲ Legg Mason Global Asset Management–– Miller’s Time 393

➔ REVIEW QUESTIONS   398

8.2 Risk of a Single Asset  398 Risk Assessment  398 Risk Measurement  401

➔ REVIEW QUESTIONS   424

Summary  424 Opener-In-Review  426 Self-Test Problems  426 Warm-Up Exercises  427 Problems  428 Spreadsheet Exercise  440

➔ REVIEW QUESTIONS   406

8.3 Risk of a Portfolio  406 Portfolio Return and Standard Deviation  406 Correlation  408 Diversification  409 Correlation, Diversification, Risk, and Return  411 International Diversification  412 in practice

GLOBAL FOCUS:

An International Flavor to Risk Reduction  413 ➔ REVIEW QUESTIONS   414

A01_ZUTT1515_15_GE_FM.indd 16

23/08/18 4:48 PM

Contents 17

9

The Cost of Capital  442

9.1 Overview of the Cost of

Capital  444 in practice

FOCUS ON ETHICS: The Cost of Capital Also Rises  444

The Basic Concept  445 Sources of Long-Term Capital  447 ➔ REVIEW QUESTIONS   448 ▲ J&J––Exceeding Expectations 443

9.2 Cost of Long-Term Debt  448 Net Proceeds  448 Before-Tax Cost of Debt  449 After-Tax Cost of Debt  451 ➔ REVIEW QUESTIONS   452 ➔ EXCEL REVIEW QUESTION   452

9.3 Cost of Preferred Stock  452 Preferred Stock Dividends  453 Calculating the Cost of Preferred Stock  453

9.5 Weighted Average Cost

of Capital  458

Calculating Weighted Average Cost of Capital (WACC)  458 in practice

FOCUS ON PRACTICE:

Uncertain Times Make for an Uncertain Weighted Average Cost of Capital  460 Capital Structure Weights  461 ➔ REVIEW QUESTIONS   461

Summary  462 Opener-In-Review  463 Self-Test Problem  463 Warm-Up Exercises  464 Problems  465 Spreadsheet Exercise  472 INTEGRATIVE CASE 4 Eco Plastics Com