8 questions total

total of 700-800 words for the entire posting

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finance 4e

page iii

finance 4e

Marcia Millon Cornett

Bentley University

Troy A. Adair Jr.

Harvard Business School

John Nofsinger

University of Alaska Anchorage

page iv

M: FINANCE, FOURTH EDITION

Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2019 by McGraw-Hill Education. All rights reserved. Printed in

the United States of America. Previous editions © 2016, 2014 and 2012. 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 the prior written consent of McGraw-Hill Education, including, but not limited to, in any

network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

1 2 3 4 5 6 7 8 9 0 LMN 21 20 19 18

ISBN 978-1-259-91963-3

MHID 1-259-91963-3

All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.

Portfolio Manager: Noelle Bathurst

Lead Product Developers: Michele Janicek, Kristine Tibbetts

Product Developer: Allison McCabe

Marketing Manager: Trina Maurer

Content Project Managers: Brian Nacik

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Compositor: SPi Global

Library of Congress Control Number: 2017043716

The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors

or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

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page v

a note from the authors

“There is a lot to cover in this course so I focus on the core concepts, theories, and problems.”

“I like to teach the course by using examples from their own individual lives.”

“My students come into this course with varying levels of math skills.”

How many of these quotes might you have said while teaching the undergraduate corporate finance course? Our

many years of teaching certainly reflect such sentiments, and as we prepared to write this book, we conducted many

market research studies that confirm just how much these statements—or ones similar—are common across the

country. This critical course covers so many crucial topics that instructors need to focus on core ideas to ensure that

students are getting the preparation they need for future classes—and for their lives beyond college.

We did not set out to write this book to change the way finance is taught, but rather to parallel and support the

way that instructors from across the country currently teach finance. Well over 600 instructors teaching this course

have shared their class experiences and ideas via a variety of research methods that we used to develop the

framework for this text. We are excited to have authored a book that we think you will find fits your classroom style

perfectly.

KEY THEMES

This book’s framework emphasizes three themes. See the next section in this preface for a description of features in

our book that support these themes.

Finance is about connecting core concepts. We all struggle with fitting so many topics into this course, so this

text strives to make it easier for you by getting back to the core concepts, key research, and current topics. We

realize that today’s students expect to learn more in class from lectures than in closely studying their textbooks, so

we’ve created brief chapters that clearly lead students to crucial material that they need to review if they are to

understand how to approach core financial concepts. The text is also organized around learning goals, making it

easier for you to prep your course and for students to study the right topics.

Finance can be taught using a personal perspective. Most long-term finance instructors have often heard

students ask “How is this course relevant to me?” on the first day of class. We no longer teach classes dedicated

solely to finance majors; many of us now must teach the first finance course to a mix of business majors. We need

to give finance majors the rigor they need while not overwhelming class members from other majors. For

years, instructors have used individual examples to help teach these concepts, but this is the first text to

integrate this personal way of teaching into the chapters.

Finance focuses on solving problems and decision making. This isn’t to say that concepts and theories aren’t

important, but students will typically need to solve some kind of mathematical problem—or at least understand the

impact of different numerical scenarios—to make the right decision on common finance issues. If you, as an

instructor, either assign problems for homework or create exams made up almost entirely of mathematical material,

you understand the need for good problems (and plenty of them). You also understand from experience the number

of office hours you spend tutoring students and grading homework. Students have different learning styles, and this

text aims to address that challenge to allow you more time in class to get through the critical topics.

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page viii

changes in the fourth edition

Based on feedback from users and reviewers, we undertook an ambitious revision in order to make the book follow

your teaching strategy even more closely. Below are the changes we made for this fourth edition, broken out by

chapter.

OVERALL

Simplified figures where appropriate and added captions to emphasize the main “takeaways”

Updated data, company names, and scenarios to reflect latest available data and real-world changes

Cross-referenced numbered examples with similar end-of-chapter problems and self-test problems so students can

easily model their homework

Updated the numbers in the end-of-chapter problems to provide variety and limit the transfer of answers from

previous classes

chapter one

INTRODUCTION TO FINANCIAL MANAGEMENT

Updated the Personal Application with information on firms that have filed for bankruptcy more recently

Changed Learning Goal 1-9 to address the ramifications of China’s slowdown and the drop in the price of oil

Revised the Finance at Work—Markets box to discuss quantitative easing in the United States and around the

world

Revised the Finance at Work—Corporate box to cover the proposed merger of AB InBev and SABMiller

Updated the data in Example 1-2 on executive compensation

Replaced Section 1.7 on the financial crisis with a new Section 1.7: Big Picture Environment, including discussions

of the ramifications of plummeting oil prices and China’s economic slowdown

chapter two

REVIEWING FINANCIAL STATEMENTS

Added a discussion of difference between EBIT and operating income

Included extended definitions of net sales, cost of goods sold, and operating expenses

Added a discussion of the interpretation of a cash-based income statement

Added a new Finance at Work box

chapter three

ANALYZING FINANCIAL STATEMENTS

Added more discussion of debt ratios

chapter four

TIME VALUE OF MONEY 1: ANALYZING SINGLE CASH FLOWS

Updated the data in Figure 4.5 on gold prices

Added equation functions to Table 4.2 and Table 4.4

Revised the data for the end-of-chapter Excel problem

page ix

Added a new end-of-chapter Excel problem

chapter five

TIME VALUE OF MONEY 2: ANALYZING ANNUITY CASH FLOWS

Revised the chapter introduction to discuss Boeing

Added equation functions to Tables 5.1, 5.2, 5.5, and 5.6

Updated the present value of multiple annuities example to discuss the new David Price contract with the Boston

Red Sox

Changed the Finance at Work—Behavioral box to address the record Powerball jackpot of $1.5 billion on January

12, 2016

Added a new end-of-chapter Excel problem

chapter six

UNDERSTANDING FINANCIAL MARKETS AND INSTITUTIONS

Updated all figures, tables, and values in the body of the chapter

Added a section on the loanable funds theory/determination of equilibrium interest rates

Added new end-of-chapter problems

Decreased the coverage of the financial crisis (detailed information is available in the Web Appendix for Chapter 6

available in Connect or at mhhe.com/Cornett4e)

chapter seven

VALUING BONDS

Updated the Personal Application with new data

Updated Figures 7.1–7.5 on bond issuance, interest rate path, yield to maturities, new bond quotes, and a summary

of the bond market

Added equation functions to Tables 7.3 and 7.5

Revised the data for the end-of-chapter Excel problem

Added a new end-of-chapter Excel problem

chapter eight

VALUING STOCKS

Updated all table and figure values in the body of the chapter

Updated the coverage of the stock market exchange in Section 8.2 to discuss the changes that have occurred in the

NYSE and elsewhere

Revised Example 8-1 to include new Coca-Cola data

Updated Example 8-4 with new P/E data for Caterpillar

Added a new end-of-chapter Excel problem

chapter nine

CHARACTERIZING RISK AND RETURN

Revised the example that runs throughout the chapter to discuss Staples

Updated all table and figure values in the body of the chapter

Added equation functions to Table 9.3 and Table 9.5

page x

Updated Example 9-2 to include new Mattel data

Updated the data in the Finance at Work—Markets box

Revised the data for the end-of-chapter Excel problem

Added a new end-of-chapter Excel problem

chapter ten

ESTIMATING RISK AND RETURN

Updated values and data in Tables 10.1–10.4

Added a new end-of-chapter Excel problem

chapter eleven

CALCULATING THE COST OF CAPITAL

Clarified and expanded the discussion of use of market values versus book values in the calculation of WACC

Expanded the discussion of when to use CAPM versus the constant-growth model when estimating the cost of

equity

Expanded the discussion of computation of marginal tax rate for WACC

Enhanced the discussion of use of firm versus project WACCs

Enhanced the discussion of appropriateness of divisional WACCs

chapter twelve

ESTIMATING CASH FLOWS ON CAPITAL BUDGETING PROJECTS

Clarified the definition of salvage value

Expanded the discussion of substitutionary and complementary effects

Enhanced the discussion of income tax shield from a project having taxable losses

Enhanced the discussion of NWC changes “leading” changes in sales

Expanded the discussion of the half-year convention in depreciation

chapter thirteen

WEIGHING NET PRESENT VALUE AND OTHER CAPITAL BUDGETING CRITERIA

Clarified the discussion of the goal of capital budgeting decision rules and the differing environments of

investment and capital budgeting decisions

Expanded the discussion of why using rate-based and time-based decision statistics to choose across projects can

be misleading with regards to NPV

chapter fourteen

WORKING CAPITAL MANAGEMENT AND POLICIES

Expanded the discussion of the rationale for NWC and the tradeoffs inherent in having too little or too much

Refined discussion of cash flows vs. the cash account

page xi

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utilizes learning science and award-winning adaptive tools to prove student results.

Homework and Adaptive Learning

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The Connect eBook makes it easy for students to access their reading material on smartphones and tablets.

They can study on the go and don’t need internet access to use the eBook as a reference, with full

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Multimedia content such as videos, simulations, and games drive student engagement and critical thinking

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into how to achieve the results you want with Connect.

www.mheducation.com/connect

page xiii

brief contents

part one

INTRODUCTION 3

chapter 1 Introduction to Financial Management 3

part two

FINANCIAL STATEMENTS 27

chapter 2 Reviewing Financial Statements 27

chapter 3 Analyzing Financial Statements 59

part three

VALUING OF FUTURE CASH FLOWS 89

chapter 4 Time Value of Money 1: Analyzing Single Cash Flows 89

chapter 5 Time Value of Money 2: Analyzing Annuity Cash Flows 115

part four

VALUING OF BONDS AND STOCKS 147

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chapter 6 Understanding Financial Markets and Institutions 147

Appendix 6A: The Financial Crisis: The Failure of Financial Institution Specialness (located at

www.mhhe.com/Cornett4e) 186

chapter 7 Valuing Bonds 199

chapter 8 Valuing Stocks 233

part five

RISK AND RETURN 261

chapter 9 Characterizing Risk and Return 261

chapter 10 Estimating Risk and Return 289

part six

CAPITAL BUDGETING 315

chapter 11 Calculating the Cost of Capital 315

chapter 12 Estimating Cash Flows on Capital Budgeting Projects 339

Appendix 12A: MACRS Depreciation Tables 362

chapter 13 Weighing Net Present Value and Other Capital Budgeting Criteria 369

part seven

WORKING CAPITAL MANAGEMENT AND FINANCIAL PLANNING 399

chapter 14 Working Capital Management and Policies 399

Appendix 14A: The Cash Budget 422

page xv

contents

CHAPTER 1 INTRODUCTION TO FINANCIAL MANAGEMENT 3

1.1 • FINANCE IN BUSINESS AND IN LIFE 4

What Is Finance? 5

Subareas of Finance 8

Application and Theory for Financial Decisions 9

Finance versus Accounting 10

1.2 • THE FINANCIAL FUNCTION 11

The Financial Manager 11

Finance in Other Business Functions 11

Finance in Your Personal Life 12

1.3 • BUSINESS ORGANIZATION 12

Sole Proprietorships 12

Partnerships 13

Corporations 14

Hybrid Organizations 15

1.4 • FIRM GOALS 15

1.5 • AGENCY THEORY 17

Agency Problem 17

Corporate Governance 18

The Role of Ethics 19

1.6 • FINANCIAL MARKETS, INTERMEDIARIES, AND THE FIRM 21

1.7 • BIG PICTURE ENVIRONMENT 21

Oil Prices Plummet 21

China Slows Down 22

CHAPTER 2 REVIEWING FINANCIAL STATEMENTS 27

2.1 • BALANCE SHEET 28

Assets 29

Liabilities and Stockholders’ Equity 29

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Managing the Balance Sheet 30

2.2 • INCOME STATEMENT 33

Debt versus Equity Financing 35

Corporate Income Taxes 36

2.3 • STATEMENT OF CASH FLOWS 38

GAAP Accounting Principles 39

Noncash Income Statement Entries 39

Sources and Uses of Cash 40

2.4 • FREE CASH FLOW 42

2.5 • STATEMENT OF RETAINED EARNINGS 44

2.6 • CAUTIONS IN INTERPRETING FINANCIAL STATEMENTS 44

CHAPTER 3 ANALYZING FINANCIAL STATEMENTS 59

3.1 • LIQUIDITY RATIOS 60

3.2 • ASSET MANAGEMENT RATIOS 62

Inventory Management 62

Accounts Receivable Management 63

Accounts Payable Management 63

Fixed Asset and Working Capital Management 64

Total Asset Management 64

3.3 • DEBT MANAGEMENT RATIOS 66

Debt versus Equity Financing 66

Coverage Ratios 67

3.4 • PROFITABILITY RATIOS 68

3.5 • MARKET VALUE RATIOS 70

3.6 • DUPONT ANALYSIS 71

3.7 • OTHER RATIOS 75

Spreading the Financial Statements 75

Internal and Sustainable Growth Rates 76

3.8 • TIME SERIES AND CROSS-SECTIONAL ANALYSES 77

3.9 • CAUTIONS IN USING RATIOS TO EVALUATE FIRM PERFORMANCE 78

CHAPTER 4 TIME VALUE OF MONEY 1: ANALYZING SINGLE CASH FLOWS 89

4.1 • ORGANIZING CASH FLOWS 90

4.2 • FUTURE VALUE 91

Single-Period Future Value 91

Compounding and Future Value 92

4.3 • PRESENT VALUE 98

Discounting 98

4.4 • USING PRESENT VALUE AND FUTURE VALUE 101

Moving Cash Flows 101

4.5 • COMPUTING INTEREST RATES 103

Return Asymmetries 105

4.6 • SOLVING FOR TIME 105

CHAPTER 5 TIME VALUE OF MONEY 2: ANALYZING ANNUITY CASH FLOWS 115

5.1 • FUTURE VALUE OF MULTIPLE CASH FLOWS 116

Finding the Future Value of Several Cash Flows 116

Future Value of Level Cash Flows 118

Future Value of Multiple Annuities 119

5.2 • PRESENT VALUE OF MULTIPLE CASH FLOWS 122

Finding the Present Value of Several Cash Flows 122

Present Value of Level Cash Flows 123

Present Value of Multiple Annuities 124

Perpetuity—A Special Annuity 127

5.3 • ORDINARY ANNUITIES VERSUS ANNUITIES DUE 127

5.4 • COMPOUNDING FREQUENCY 129

Effect of Compounding Frequency 129

5.5 • ANNUITY LOANS 133

What Is the Interest Rate? 133

Finding Payments on an Amortized Loan 134

CHAPTER 6 UNDERSTANDING FINANCIAL MARKETS AND INSTITUTIONS 147

6.1 • FINANCIAL MARKETS 148

Primary Markets versus Secondary Markets 148

Money Markets versus Capital Markets 151

Other Markets 153

6.2 • FINANCIAL INSTITUTIONS 155

Unique Economic Functions Performed by Financial Institutions 156

6.3 • INTEREST RATES AND THE LOANABLE FUNDS THEORY 159

Supply of Loanable Funds 161

Demand for Loanable Funds 162

Equilibrium Interest Rate 163

Factors That Cause the Supply and Demand Curves for Loanable Funds to Shift 163

Movement of Interest Rates over Time 167

6.4 • FACTORS THAT INFLUENCE INTEREST RATES FOR INDIVIDUAL SECURITIES 167

Inflation 168

Real Risk-Free Rate 168

Default or Credit Risk 169

Liquidity Risk 170

Special Provisions or Covenants 171

Term to Maturity 171

6.5 • THEORIES EXPLAINING THE SHAPE OF THE TERM STRUCTURE OF INTEREST RATES 174

Unbiased Expectations Theory 174

Liquidity Premium Theory 176

Market Segmentation Theory 177

6.6 • FORECASTING INTEREST RATES 179

Appendix 6A The financial Crisis: The Failure of Financial Institution Specialness 186

CHAPTER 7 VALUING BONDS 199

7.1 • BOND MARKET OVERVIEW 200

Bond Characteristics 200

Bond Issuers 202

Other Bonds and Bond-Based Securities 204

Reading Bond Quotes 207

7.2 • BOND VALUATION 209

Present Value of Bond Cash Flows 209

Bond Prices and Interest Rate Risk 211

page xvii

7.3 • BOND YIELDS 213

Current Yield 213

Yield to Maturity 214

Yield to Call 215

Municipal Bonds and Yield 217

Summarizing Yields 218

7.4 • CREDIT RISK 219

Bond Ratings 219

Credit Risk and Yield 221

7.5 • BOND MARKETS 222

Following the Bond Market 223

CHAPTER 8 VALUING STOCKS 233

8.1 • COMMON STOCK 234

8.2 • STOCK MARKETS 235

Tracking the Stock Market 238

Trading Stocks 240

8.3 • BASIC STOCK VALUATION 241

Cash Flows 241

Dividend Discount Models 243

Preferred Stock 245

Expected Return 246

8.4 • ADDITIONAL VALUATION METHODS 248

Variable-Growth Techniques 248

The P/E Model 251

Estimating Future Stock Prices 254

CHAPTER 9 CHARACTERIZING RISK AND RETURN 261

9.1 • HISTORICAL RETURNS 262

Computing Returns 262

Performance of Asset Classes 265

9.2 • HISTORICAL RISKS 266

Computing Volatility 266

Risk of Asset Classes 269

Risk versus Return 270

9.3 • FORMING PORTFOLIOS 271

Diversifying to Reduce Risk 271

Modern Portfolio Theory 274

CHAPTER 10 ESTIMATING RISK AND RETURN 289

10.1 • EXPECTED RETURNS 290

Expected Return and Risk 290

Risk Premiums 292

10.2 • MARKET RISK 294

The Market Portfolio 294

Beta, a Measure of Market Risk 295

The Security Market Line 296

Finding Beta 298

Concerns about Beta 300

10.3 • CAPITAL MARKET EFFICIENCY 301

Efficient Market Hypothesis 302

Behavioral Finance 303

10.4 • IMPLICATIONS FOR FINANCIAL MANAGERS 304

Using the Constant-Growth Model for Required Return 304

CHAPTER 11 CALCULATING THE COST OF CAPITAL 315

11.1 • THE WACC FORMULA 316

Calculating the Component Cost of Equity 317

Calculating the Component Cost of Preferred Stock 318

Calculating the Component Cost of Debt 318

Choosing Tax Rates 319

Calculating the Weights 321

11.2 • FIRM WACC VERSUS PROJECT WACC 322

Project Cost Numbers to Take from the Firm 323

Project Cost Numbers to Find Elsewhere: The Pure-Play Approach 324

11.3 • DIVISIONAL WACC 326

Pros and Cons of a Divisional WACC 326

Subjective versus Objective Approaches 328

11.4 • FLOTATION COSTS 330

Adjusting the WACC 331

CHAPTER 12 ESTIMATING CASH FLOWS ON CAPITAL BUDGETING PROJECTS

339

12.1 • SAMPLE PROJECT DESCRIPTION 340

12.2 • GUIDING PRINCIPLES FOR CASH FLOW ESTIMATION 341

Opportunity Costs 342

Sunk Costs 342

Substitutionary and Complementary Effects 342

Stock Dividends and Bond Interest 343

12.3 • TOTAL PROJECT CASH FLOW 343

Calculating Depreciation 343

Calculating Operating Cash Flow 344

Calculating Changes in Gross Fixed Assets 345

Calculating Changes in Net Working Capital 346

Bringing It All Together 348

12.4 • ACCELERATED DEPRECIATION AND THE HALF-YEAR CONVENTION 349

MACRS Depreciation Calculation 349

Section 179 Deductions 350

page xviii

Impact of Accelerated Depreciation 351

12.5 • “SPECIAL” CASES AREN’T REALLY THAT SPECIAL 352

12.6 • CHOOSING BETWEEN ALTERNATIVE ASSETS WITH DIFFERING LIVES: EAC 354

12.7 • FLOTATION COSTS REVISITED 356

APPENDIX 12A: MACRS DEPRECIATION TABLES 362

CHAPTER 13 WEIGHING NET PRESENT VALUE AND OTHER CAPITAL

BUDGETING CRITERIA 369

13.1 • THE SET OF CAPITAL BUDGETING TECHNIQUES 371

13.2 • THE CHOICE OF DECISION STATISTIC FORMAT 372

13.3 • PROCESSING CAPITAL BUDGETING DECISIONS 373

13.4 • PAYBACK AND DISCOUNTED PAYBACK 374

Payback Statistic 374

Payback Benchmark 375

Discounted Payback Statistic 375

Discounted Payback Benchmark 376

Payback and Discounted Payback Strengths and Weaknesses 378

13.5 • NET PRESENT VALUE 378

NPV Statistic 378

NPV Benchmark 378

NPV Strengths and Weaknesses 380

13.6 • INTERNAL RATE OF RETURN AND MODIFIED INTERNAL RATE OF RETURN 381

Internal Rate of Return Statistic 382

Internal Rate of Return Benchmark 382

Problems with Internal Rate of Return 383

IRR and NPV Profiles with Non-Normal Cash Flows 384

Differing Reinvestment Rate Assumptions of NPV and IRR 385

Modified Internal Rate of Return Statistic 385

IRRs, MIRRs, and NPV Profiles with Mutually Exclusive Projects 385

MIRR Strengths and Weaknesses 389

13.7 • PROFITABILITY INDEX 390

Profitability Index Statistic 390

Profitability Index Benchmark 390

CHAPTER 14 WORKING CAPITAL MANAGEMENT AND POLICIES 399

14.1 • REVISITING THE BALANCE-SHEET MODEL OF THE FIRM 400

14.2 • TRACING CASH AND NET WORKING CAPITAL 401

The Operating Cycle 402

The Cash Cycle 402

14.3 • SOME ASPECTS OF SHORT-TERM FINANCIAL POLICY 403

The Size of the Current Assets Investment 403

Alternative Financing Policies for Current Assets 404

14.4 • THE SHORT-TERM FINANCIAL PLAN 407

Unsecured Loans 407

Secured Loans 408

Other Sources 408

14.5 • CASH MANAGEMENT 409

Reasons for Holding Cash 409

Determining the Target Cash Balance: The Baumol Model 409

Determining the Target Cash Balance: The Miller-Orr Model 410

Other Factors Influencing the Target Cash Balance 411

14.6 • FLOAT CONTROL: MANAGING THE COLLECTION AND DISBURSEMENT OF CASH 413

Accelerating Collections 414

Delaying Disbursements 414

Ethical and Legal Questions 415

14.7 • INVESTING IDLE CASH 415

Why Firms Have Surplus Cash 416

What to Do with Surplus Cash 416

14.8 • CREDIT MANAGEMENT 416

Credit Policy: Terms of the Sale 416

Credit Analysis 416

Collection Policy 417

APPENDIX 14A THE CASH BUDGET 422

VIEWPOINTS REVISITED 426

CHAPTER EQUATIONS 434

INDEX 439

page 1

finance 4e

Part One

page 2

page 3

D

chapter one

introduction to

financial management

© John Lamb/Getty Images/Photodisc

o you know: What finance entails? How financial management functions within the business world?

Why you might benefit from studying financial principles? This chapter is the ideal place to get

answers to those questions. Finance is the study of applying specific value to things we own, services

we use, and decisions we make. Examples are as varied as shares of stock in a company, payments on a

home mortgage, the purchase of an entire firm, and the personal decision to retire early. In this text, we

focus primarily on one area of finance, financial management, which concentrates on valuing things from the

perspective of a company, or firm.

finance The study of applying specific value to things we own, services we use, and decisions we make.

financial management The process for and the analysis of making financial decisions in the business context.

page 4

LEARNING GOALS

LG1-1 Define the major areas of finance as they apply to corporate financial management.

LG1-2 Show how finance is at the heart of sound business decisions.

LG1-3 Learn the financial principles that govern your personal decisions.

LG1-4 Examine the three most common forms of business organization in the United States today.

LG1-5 Distinguish among appropriate and inappropriate goals for financial managers.

LG1-6 Identify a firm’s primary agency relationship and discuss the possible conflicts that may arise.

LG1-7 Discuss how ethical decision making is part of the study of financial management.

LG1-8 Describe the complex, necessary relationships among firms, financial institutions, and financial markets.

LG1-9 Explain the business ramifications of the decline in the price of oil and China’s economic slowdown.

viewpoints

business APPLICATION

Caleb has worked very hard to create and expand his juice stand at the mall. He has finally perfected his products and feels that he is

offering the right combination of juice and food. As a result, the stand is making a nice profit. Caleb would like to open more stands at

malls all over his state and eventually all over the country.

Caleb knows he needs more money to expand. He needs money to buy more equipment, buy more inventory, and hire and train

more people. How can Caleb get the capital he needs to expand? (See the solution at the end of the book.)

Financial management is critically important to the success of any business organization, and

throughout the text we concentrate on describing the key financial concepts in corporate finance. As a

bonus, you will find that many tools and techniques for handling the financial management of a firm also

apply to broader types of financial problems, such as personal finance decisions.

In finance, cash flow is the term that describes the process of paying and receiving money. It makes

sense to start our discussion of finance with an illustration of various financial cash flows. We use simple

graphics to help explain the nature of finance and to demonstrate the different subareas of the field of

finance.

After we have an overall picture of finance, we will discuss three important variables in the business

environment that can and do have significant impact on the firm’s financial decisions. These are (1) the

organizational form of the business, (2) the agency relationship between the managers and owners of a

firm, and (3) ethical considerations as finance is applied in the real world.

1.1 • FINANCE IN BUSINESS AND IN LIFE LG1-1

If your career leads you to making financial decisions, then this book will be indispensable. If not, it is likely that

your activities in a business will involve interacting with the finance functions. After all, the important investments

of a firm involve capital and, therefore, finance. Expanding marketing channels, developing new products, and

upgrading a factory all cost money. A firm spends its capital on these projects to foster growth. Understanding how

finance professionals evaluate those projects will help you be successful in your business focu