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giáo trình Business finance theory and practice 8th edition mclany giáo trình Business finance theory and practice 8th edition mclany giáo trình Business finance theory and practice 8th edition mclany giáo trình Business finance theory and practice 8th edition mclany giáo trình Business finance theory and practice 8th edition mclany giáo trình Business finance theory and practice 8th edition mclany giáo trình Business finance theory and practice 8th edition mclany
Business Finance Business Finance Theory and Practice Eddie McLaney 8th Edition Now in its 8th edition, Business Finance is an essential introduction to financial decision making in businesses Taking a user’s perspective it explores the type of investments a business should make and how they should be financed, and successfully blends the theoretical, analytical and practical aspects of finance and investment This new edition of Business Finance has a real-world flavour, exploring the theories surrounding financial decision making and relating these theories to what happens in the real world Key Features l an extensive range of real-world examples l solid theoretical underpinning in an easily accessible form l excellent blend of theory and practice offering a comprehensive insight into the decision making process within finance and investment l exploration into, and explanation of, any divergence between theory and practice l comprehensive coverage of the latest international issues l improved pedagogy, including an accessible four-colour design l fully updated supplements for lecturers (featuring cases with solutions, progress tests, tutorial questions and powerpoints) and students (revision questions, multiple choice questions and weblinks) Eddie McLaney Eddie McLaney is Visiting Fellow in Accounting and Finance at the University of Plymouth Cover image © ALAMY CVR_MCLA7683_08_SE_CVR.indd www.pearson-books.com Eddie McLaney 8th Edition Business Finance is suitable for undergraduates in accounting and finance and for those on finance and financial management courses It is also appropriate for postgraduate students with an option in accounting and finance and will be highly useful for professional accounting students For additional material visit: www.pearsoned.co.uk/atrillmclaney Business Finance Theory and Practice 8th Edition 2/12/08 10:35:48 BUSF_A01.qxd 11/19/08 9:45 Page i BUSINESS FINANCE Theory and Practice Visit the Business Finance, eighth edition, Companion Website at www.pearsoned.co.uk/atrillmclaney to find valuable student learning material including: ➔ Learning outcomes for each chapter ➔ Multiple choice questions to test your learning ➔ Extensive links to valuable resources on the web ➔ An online glossary to explain key terms BUSF_A01.qxd 11/19/08 9:45 Page ii We work with leading authors to develop the strongest educational materials in business and finance, bringing cutting-edge thinking and best learning practice to a global market Under a range of well-known imprints, including Financial Times Prentice Hall, we craft high quality print and electronic publications that help readers to understand and apply their content, whether studying or at work To find out more about the complete range of our publishing, please visit us on the World Wide Web at: www.pearsoned.co.uk BUSF_A01.qxd 11/19/08 9:46 Page iii Eighth Edition BUSINESS FINANCE Theory and Practice Eddie McLaney BUSF_A01.qxd 11/19/08 9:46 Page iv Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk First published 1986 Second edition published 1991 Third edition published 1994 Fourth edition published 1997 Fifth edition published 2000 Sixth edition published 2003 Seventh edition published 2006 Eighth edition published 2009 © © © © Macdonald & Evans Limited Published as Business Finance for Decision Makers by Pitman Publishing, a division of Longman Group UK Ltd Published as Business Finance for Decision Makers by Pitman Publishing, a division of Longman Group UK Ltd Pitman Publishing, a division of Pearson Professional Limited Pearson Education Ltd Pearson Education Ltd Pearson Education Ltd Pearson Education Ltd E J McLaney 1986, 1991 Longman Group UK Limited 1994 Pearson Professional Limited 1997 Pearson Education Limited 2000, 2009 The right of Eddie McLaney to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988 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 licence 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 ISBN: 978-0-273-71768-3 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data McLaney, E J Business finance : theory and practice / Eddie McLaney – 8th ed p cm Includes bibliographical references and index ISBN 978–0–273–71768–3 Business enterprises–Finance Business enterprises–Finance–Problems, exercises, etc Corporations–Finance Corporations–Finance–Problems, exercises, etc I Title HG4026.M388 2009 658.15–dc22 2008043421 10 11 10 09 Typeset in 9.5/13pt Palatino by 35 Printed and bound by Rotolito Lombarda, Italy The publisher’s policy is to use paper manufactured from sustainable forests BUSF_A01.qxd 11/19/08 9:46 Page v Openmirrors.com Contents Guided tour of the book Preface Plan of the book xii xv xvii Part The business finance environment Introduction Objectives 1.1 The role of business finance 1.2 Risk and business finance 1.3 The relationship between business finance and accounting 1.4 The organisation of businesses – the limited company 1.5 Corporate governance and the role of directors 1.6 Long-term financing of companies 1.7 Liquidation 1.8 Derivatives 1.9 Private equity funds Summary Further reading Relevant websites Review questions 3 6 12 14 15 16 17 18 18 18 A framework for financial decision making 19 Objectives 2.1 Financial decision making 2.2 Business objectives 2.3 Conflicts of interest: shareholders versus managers – the ‘agency’ problem 2.4 Financing, investment and separation 2.5 Theory and practice Summary Further reading Review questions Problem Appendix: Formal derivation of the separation theorem 19 19 21 26 28 31 32 32 33 33 35 v BUSF_A01.qxd 11/19/08 9:46 Page vi Contents Financial (accounting) statements and their interpretation Objectives 3.1 Introduction 3.2 The financial statements 3.3 Definitions and conventions of accounting 3.4 Problems with using accounting information for decision making 3.5 Creative accounting 3.6 Ratio analysis 3.7 Using accounting ratios to predict financial failure Summary Further reading Relevant websites Review questions Problems Appendix: Jackson plc’s income statement and balance sheet for 2007 41 41 41 42 46 49 50 53 66 67 68 68 68 69 75 Part Investment decisions Investment appraisal methods Objectives 4.1 Introduction 4.2 Net present value 4.3 Internal rate of return 4.4 Payback period 4.5 Accounting (unadjusted) rate of return 4.6 Investment appraisal methods used in practice Summary Further reading Review questions Problems Practical aspects of investment appraisal Objectives 5.1 Introduction 5.2 Cash flows or accounting flows? 5.3 Do cash flows really occur at year ends? 5.4 Which cash flows? 5.5 Taxation 5.6 Inflation 5.7 An example of an investment appraisal 5.8 Capital rationing vi 79 79 79 80 87 94 97 99 104 105 106 106 111 111 111 112 115 116 117 120 121 126 BUSF_A01.qxd 11/19/08 9:46 Page vii Contents 5.9 Replacement decisions 5.10 Routines for identifying, assessing, implementing and reviewing investment projects 5.11 Investment appraisal and strategic planning 5.12 Value-based management 5.13 Real options Summary Further reading Relevant website Review questions Problems Risk in investment appraisal Objectives 6.1 Introduction 6.2 Sensitivity analysis 6.3 Use of probabilities 6.4 Expected value 6.5 Systematic and specific risk 6.6 Utility theory 6.7 Attitudes to risk and expected value 6.8 Particular risks associated with making investments overseas 6.9 Some evidence on risk analysis in practice 6.10 Risk – the story so far Summary Further reading Review questions Problems Portfolio theory and its relevance to real investment decisions Objectives 7.1 The relevance of security prices 7.2 The expected value/variance (or mean/variance) criterion 7.3 Security investment and risk 7.4 Portfolio theory 7.5 Capital asset pricing model 7.6 CAPM: an example of beta estimation 7.7 Assumptions of CAPM 7.8 Tests of CAPM 7.9 CAPM – what went wrong? 7.10 How CAPM is used to derive discount rates for real investments 7.11 Use of CAPM in practice 130 132 135 137 143 144 146 146 146 147 153 153 153 154 159 162 165 166 169 174 174 174 175 176 177 177 184 184 184 186 187 189 198 200 202 202 203 204 205 vii BUSF_A01.qxd 11/19/08 9:46 Page viii Contents 7.12 Arbitrage pricing model 7.13 Portfolio theory – where are we now? Summary Further reading Review questions Problems Appendix: Derivation of CAPM 205 206 208 209 209 210 211 Part Financing decisions Sources of long-term finance Objectives 8.1 Introduction 8.2 Ordinary (equity) capital 8.3 Methods of raising additional equity finance 8.4 Preference shares 8.5 Loan notes and debentures 8.6 Convertible loan notes 8.7 Warrants 8.8 Term loans 8.9 Asset-backed finance (securitisation) 8.10 Leasing 8.11 Grants from public funds 8.12 Conclusions on long-term finance Summary Further reading Relevant websites Review questions Problems The secondary capital market (the stock exchange) and its efficiency Objectives 9.1 Introduction 9.2 The London Stock Exchange 9.3 Capital market efficiency 9.4 Tests of capital market efficiency 9.5 The efficient market paradox 9.6 Conclusions on, and implications of, capital market efficiency Summary Further reading Review questions Problems viii 217 217 217 219 223 232 234 240 240 241 241 242 245 245 246 249 249 249 250 252 252 252 253 256 259 267 267 270 271 272 272 BUSF_A01.qxd 11/19/08 9:46 Page ix Contents 10 Cost of capital estimations and the discount rate Objectives 10.1 Introduction 10.2 Cost of individual capital elements 10.3 Weighted average cost of capital ( WACC) 10.4 Practicality of using WACC as the discount rate 10.5 WACC values used in practice Summary Further reading Review questions Problems 11 Gearing, the cost of capital and shareholders’ wealth Objectives 11.1 Introduction 11.2 Is debt finance as cheap as it seems? 11.3 Business risk and financial risk 11.4 The traditional view 11.5 The Modigliani and Miller view of gearing 11.6 Other thoughts on the tax advantage of debt financing 11.7 Capital/financial gearing and operating gearing 11.8 Other practical issues relating to capital gearing 11.9 Evidence on gearing 11.10 Gearing and the cost of capital – conclusion 11.11 The trade-off theory 11.12 Pecking order theory 11.13 Likely determinants of capital gearing 11.14 Weighted average cost of capital revisited Summary Further reading Review questions Problems Appendix I: Proof of the MM cost of capital proposition (pre-tax) Appendix II: Proof of the MM cost of capital proposition (after tax) 12 The dividend decision Objectives 12.1 Introduction 12.2 Modigliani and Miller on dividends 12.3 The traditional view on dividends 12.4 Who is right about dividends? 12.5 Other factors 274 274 274 275 282 287 288 289 290 291 291 294 294 294 295 296 299 300 306 306 307 308 310 312 313 315 315 317 318 319 319 323 324 326 326 326 327 329 330 331 ix BUSF_Z04.qxd 11/19/08 10:34 Page 504 Glossary of its effective life It is a means of raising finance (p 244) Satisficing A business objective that seeks to provide all stakeholders with satisfactory returns, rather than promoting the interests of any single one of them (p 23) Scenario building A decision-analysis tool where various feasible combinations of input data are combined in an attempt to assess possible outcomes In effect, an extension of sensitivity analysis (p 158) Scrip dividend The issue of bonus shares to certain shareholders as an alternative to a cash dividend The expression usually applies only where there is a choice for the shareholders between the shares and cash (p 448) Seasoned equity offering A public issue of shares by a business that has already made at least one previous offering of shares to the public (p 225) Secondary capital market A market in which ‘second-hand’ securities issued by businesses (for example, shares) and other organisations are traded (p 218) Secured creditors People or organisations owed money under a contract that links the obligation with a particular asset of the borrower (p 15) Securities Shares and loan notes of businesses and other organisations (p 184) Securitisation Turning an expected future stream of positive cash flows into a security and selling it as a means of raising finance (p 241) Security market line The straight line on a graph of return against risk (as measured by beta) (p 199) Sell-offs Divestment devices where one business sells part of its undertaking to another business (p 402) Semi-strong-form capital market efficiency A situation where security prices, at all times, rationally reflect all publicly known information about the securities concerned (p 259) Sensitivity analysis An examination of the key variables affecting a project, to see how changes in each input might influence the outcome (p 154) Separation theorem The notion that business financing and investment decisions are strictly separate (p 31) Servicing (of finance) The cost of providing returns to suppliers of finance (for example, interest and dividends) (p 218) Share repurchase Where a business buys some of its own shares from existing shareholders, usually to cancel them (p 334) Shareholder value analysis A method of measuring and managing business value based on the long-term 504 cash flows generated It identifies various factors that are seen as the key ‘value drivers’ (p 137) Short-termism A tendency for managers to make decisions that will provide benefits in the short term, while possibly jeopardising the long-term future of the business (p 27) Signalling A business indicating, through its behaviour (such as having a particular level of capital gearing or paying a particular level of dividend), something about itself to the outside world (p 308) Soft capital rationing This arises where a business’s capital rationing is caused by a self-imposed unwillingness to provide funds to meet all desirable potential investments (p 126) Specific risk That aspect of total risk that arises from factors that are related to the particular investment concerned as opposed to general/macroeconomic factors It can, in theory, be eliminated by diversification of investments (p 165) Spin-off Where a business takes part of its operations and turns it into a separate business Shareholders of the old business are issued with shares in the new business in proportion to the size of their investment in the old business (p 402) Spot (foreign exchange) rate The rate of exchange between two currencies where the foreign exchange transaction is to be completed immediately (p 412) Standard deviation A statistical measure of the dispersion of individual outcomes about their mean or expected value; it is the square root of the variance (p 186) Strategic planning The act of establishing the best area of activity and style of approach for the business (p 135) Strong-form capital market efficiency A situation where security prices, at all times, rationally reflect all publicly and privately known information about the securities concerned (p 259) Subjective probabilities Probabilities based on opinion rather than past data (p 160) SWOT analysis A framework in which many businesses set a position analysis Here the business lists its strengths, weaknesses, opportunities and threats (p 136) Synergy The name given to the phenomenon that when two or more businesses combine, the combined business is more effective and valuable than the sum of the constituent businesses (p 391) Systematic risk That aspect of total risk that arises from general/macroeconomic factors as opposed to factors that are related to the particular investment concerned (p 166) BUSF_Z04.qxd 11/19/08 10:34 Page 505 Glossary Takeover A business amalgamation where one business buys sufficient shares in another business to control it Also known as merger (p 388) Tax shield The value of the asset of the tax benefit of using loans in the long-term finance of the business (p 305) Technical analysis The use of technical rules and charts of past security price movements to spot profitable investment opportunities (p 260) Term loans Loans, typically by a bank or similar institution, usually for a specified period of time (p 241) Trade-off theory A theory of capital/financial gearing that holds that determining the optimum level of gearing requires that a balance is struck between the value of the tax shield, on the one hand, and potential bankruptcy cost, on the other (p 313) Transaction risk The risk that buying or selling a product or service priced in a foreign currency will lead to losses because of an adverse shift in exchange rates between the time of the transaction and the payment or receipt of the foreign currency (p 419) Translation risk The risk that the value of assets held overseas may reduce, in terms of the home currency, as a result of an adverse shift in the exchange rate (p 424) Two-fund separation The notion that all rational risk-averse investors will choose to invest only in a risk-free investment and the market portfolio (p 197) Unadjusted rate of return See Accounting rate of return (p 97) Unsecured creditors People or organisations owed money under a contract that links the obligation with the general assets of the borrower, rather than with a particular one (p 15) Utility Personal satisfaction from some desirable factor (p 36) Value drivers The factors that are seen in shareholder value analysis as being key in generating shareholder value (p 138) Variance A statistical measure of the dispersion of individual outcomes about their mean or expected value; it is the square of the standard deviation (p 186) Venture capital Equity finance provided to support new, expanding and entrepreneurial businesses (p 442) Warrants Options, granted by a business, that entitle the holder to subscribe for a specified quantity of (usually) ordinary shares, for a specified price, on or after a specified date (p 240) Weak-form capital market efficiency A situation where security prices, at all times, reflect all information about the securities concerned implied by their past price movements (p 259) Weighted average cost of capital The average cost of capital for a business, being the average of the costs of the various constituents of capital (such as shares and loan notes), weighted by the market value of each constituent (p 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Finance and Accounting (April/May) Wilson Committee (1980) Committee to Review the Functioning of Financial Institutions (HMSO) 511 BUSF_Z06.qxd 11/19/08 10:35 Page 512 Index Note: Page references in bold type relate to the Glossary abandonment of investment projects 133–4 abnormal returns 259, 264, 267 accountability of directors 10 accounting methods changes in 265, 338 deficiencies of 46–50, 64–5 accounting rate of return (ARR) 97– 9, 102, 440, 500 accounts receivable see trade receivables accruals 48 acid test ratio 58 ‘active’ trading 269 activity ratios 55–7, 67 Adnams plc 443 agency costs 27, 32, 207, 307– 8, 333, 336 –9, 390, 429, 437, 500 aggressive securities 199 Aharony, J 335 Akbar, S 335 Al-Ali, J 121, 204–5, 280, 285 Alcan Inc 395 Alexander, S 263 Alkaraan, F 100, 137, 143, 174, 205 Allen, F 336 Alternative Investment Market (AIM) 232, 442–3 American football 257–8 Amstrad plc 395 Andrade, G 311 ‘angels’ 442, 500 annual general meetings 222 annual reports of companies 9, 25 annuities and annuity tables 85–6, 132, 460, 500 arbitrage pricing model (APM) 205 – 6, 500 Arkwright, T 121, 204 –5, 280, 285 Arnold, G.C 99–100, 126, 134, 439 – 40 Arriva plc 338 Articles of Association asset-backed finance 241–2, 248 512 assets definition and valuation of 46–7 tendency towards overstatement of 52 Associated British Foods (ABF) plc 129, 354–5, 360, 368, 373, 425 Atrill, P.F 116 audit 9–10 see also post audits Automobile Association (AA) 17, 401 bad debts 369, 371 Baker, H 335 balance sheets 43–5, 64, 79, 500 values in 49 Balbirer, S.D 415–16, 427 Balfour Beatty plc 354 Bank of England 121, 412–13, 436, 442 bankruptcy and associated costs 15, 304, 310, 312, 315, 440, 500 Barclay, M 309, 314, 337 Barclays Bank plc 244 Barney, L 339 Bauger Group 402 bear positions 254 Beattie, V 315 Beaver, W.H 257 Benito, A 334 Benkato, O 309–10 Bernardo, A 336 beta (β) analysis 174, 199–204, 500 Blake, D 267 Boardman, C.M 101 boards of companies see also directors bonus shares 224–5, 265, 500 bonuses for directors 26 for managers 142 Boots the Chemist 17, 367 borrowing by businesses 14, 29–30, 294–6 Bradford and Bingley plc 339 brand names 141 Braund, S 121, 243 break-even analysis 158 Brealey, R 263 British Airports Authority (BAA) 395, 400 British Airways plc (BA) 158, 235, 239, 243, 245, 338, 400 British Energy plc 235 British Land Company 229 British Petroleum plc (BP) 129, 283, 338–9 British Sky Broadcasting Group plc 395 British Telecom Group plc (BT) 25, 337–8 Bruner, R 399 budgets, use of 356, 365 buffer stocks 364–5 bull positions 254 Bunn, P 314 business finance in relation to accounting and risk role of business risk 297, 302, 500 Busse, J 266 buy-and-hold policy 269 buy-ins 402, 500 buying back of shares 334–4, 338, 504 Cadbury Schweppes plc 64, 309, 403, 408–9 call options 422 capital allowances 117–19, 243, 500 capital asset pricing model (CAPM) 185, 198–205, 208–9, 264, 280, 500 assumptions of 202 and derivation of discount rates 204–5 practical use of 205 tests of 200–1 weaknesses of 185, 203–4 BUSF_Z06.qxd 11/19/08 10:35 Page 513 Index capital gains tax 223, 331 capital gearing 59–60, 67, 306–7, 315 –17, 500 determinants of 315 capital market line (CML) 198–9, 206, 500 capital rationing 126–9, 145, 500, 502, 504 capitalisation of expenses 51 Carlton plc Carphone Warehouse Group plc 142 Carsberg, B 121 cash, holding of 372–9, 382–3 costs and risks of 373 models for management of 374 –5 practical aspects of 376–9 cash flow statements 45–6, 500 cash flows as distinct from accounting flows 112 –14, 144 forecasting of 117 and investment opportunities 337 planning of 377–9 in real terms 120–1 for small businesses 447 cash surpluses, short-term 376 Caterham Cars Ltd 402 Celec, S.E 101 chance, role of 268–9 ‘chartists’ 260 Chen, S 102, 137 Chicago Daily News 258 City Panel on Takeovers and Mergers 396–7 Clark, R.L 102 Clayton, R 310 clientele effect 306, 308, 332, 336, 339, 500 codes of practice 11–12, 396 Combined Code (on corporate governance) 11–12, 26, 500 Companies House competition, elimination or reduction of 389 Competition Commission 395–6 concealment of losses or liabilities 51 consensus views 257–9 control of companies 222–34, 239 conventions of accounting 47–9 convertible issues 240, 246, 248, 281, 500 Cooper, I 427–8 Coopers and Lybrand 398 corporate governance 9–12, 500 corporate objectives of companies 19–26, 32, 136, 437 corporation tax 139, 243, 331, 438–9 correlation coefficient 190–1, 500 Corven Ventures Ltd 402 cost of capital 117, 120, 126, 139, 274–7, 289, 500 minimisation of 281 see also opportunity cost of capital; weighted average cost of capital Costain Group plc 14, 229, 231 coupon rate 234, 501 covariance of expected returns 198, 501 covenants 238, 501 Craven, B.M 27 creative accounting 50–3, 67, 501 credit granting or denying of 368–70 taking of 379–80 credit ratings 235–6, 310 creditors of companies 14–15 see also trade payables creditworthiness of customers 369–71 Crossland, M 336 cum dividend 278–9, 336, 501 Cunningham, S.W 263 currency futures 422, 430 currency options 421–2, 431, 501 currency swaps 424, 501 current and non-current assets 44, 501 current ratio 57–8 Dann, L 265 Datta, S 400 days trade payables 57 days trade receivables 56–7 dealing charges 303–4 DeAngelo, H 309, 334 DeAngelo, L 334 Debenhams plc 17 debentures 234–5, 247–8, 275, 294, 501 debt financing, tax advantage of 306, 310 debtors see trade receivables decision-making, financial 17–21, 32 on investment and on financing 244 NPV as basis for 80 use of accounting information for 49–50 defensive securities 199 Dell Inc 51 Deloitte 314 Demirag, I 27 Dempsey, M 306, 336 depreciation 44–5, 49, 114–17 derivatives 15–18, 256, 501 Dewenter, K 336 Di Nino, V 421–4 Digital Look Ltd 204 Dimson, E 204, 206–7, 288 Director General of Fair Trading 395, 397 directors of companies 8–14 restrictions on 10, 13, 229, 308 role and responsibilities of 9–10, 14 types 11–12 disclosure 10 discount rates 204–5 discounted cash flow yield see internal rate of return discounting over time and discount rates 84–7, 115–17, 120–1, 174, 204–5, 244, 274–6, 283–8 for small businesses 439–41 techniques of 100–1 discounts on forward currency transactions 417 on new shares 227 for prompt payment 369, 371, 374 dislocation of production 361 diversification 501 international 427–9 of security investment 164–5, 176, 187–9, 195, 206, 208 for small businesses 440–1 through mergers 390–1, 400 within businesses 207, 390, 440–1 divestmemts 400–4, 501 dividend cover ratio 61 dividend yield (DY) 61, 221, 444–5 dividends 12–13, 222–3, 233, 278–81, 326–41 cancellation of 328 companies’ policies on 332–6, 339 effect on share prices 335 ‘home-made’ 327–9 paid by small businesses 448 reinvestment of 339 as a residual 328 scale of 334–5 timing of 329 traditional view of 329–30 Dr Pepper Snapple Group Inc 403 Domino’s Pizza plc 443 Dragons’ Den 442 513 BUSF_Z06.qxd 11/19/08 10:35 Page 514 Index Draper, P 399 Drury, C 121, 243 Dryden, M.M 263 DuPont Corporation 129 earnings of companies see profits earnings per share 60, 137, 302–3, 338 easyJet plc 136, 400 economic risk from exchange rate movements 422–4, 431, 501 economic value for small businesses 447 economic value added (EVA) 137, 140 –2, 501 economies of scale 389–91 efficiency of capital markets 184–5, 197, 253, 256 –71, 303, 501 semi-strong form of 259, 264–6, 504 strong form of 259, 266–7, 332, 504 weak form of 259–64, 505 efficiency of foreign exchange markets 417–18 efficient frontier 194–6, 501 efficient market paradox 267 El-Masry, A 16 Elton, E.J 336 EMI Group plc 337 Enron Corporation 51–2 environmental factors 426 equity finance 12, 59, 219–23, 501 factors for businesses to consider 221–2 factors for potential investors to consider 222–3 raising of 223–32 Eriotis, N 310 Ernst and Young 142 ethical constraints 426 Ettridge, M 338 euro currency 411 Eurobonds 239, 501 European Union 218 ex dividend 278 –9, 336, 501 exchange rate costs 369, 373, 380 exchange rate risk 371–2, 379–81, 418, 430, 501 exchange rates determinants of 412–13 management of 418 theoretical explanations for 414 –17, 429 –30 executive and non-executive directors 11–12 expected returns from investments and loans 206 –7, 295, 299 514 expected value (EV) 162–6, 173, 175–6, 186–7, 189–90, 501 ‘expert’ investors 266–7 differences between industrial sectors 310 evidence on 308–11 Modigliani and Miller’s view of factoring 371 300–6, 309–13, 316–17 Fama, E 203, 263–5, 334–6 optimum level of 299, 310 Ferdinand, Rio 244 for small businesses 447 Ferreira, M and M 428 General Motors Corporation 235 Ferrovial company 395, 400 Givaudan company 401 filter rules 260, 263 Gleason, K 428 finance leases 242–3, 248, 277–8, 501 going concern convention 48–9 financial accounting, role of 112 Goodcare, A 315 financial risk 297, 501 goodwill 141, 361, 370, 373–4, 379 financial statements 39–46, 67 Gordon growth model 280 quality of 52 government securities 204 Financial Times 136, 235 Goyal, V 314 all-share index 203 Graham, J 101–2, 143, 205, 280–3, financing costs 117 310, 314, 316, 336 see also cost of capital Granada plc Finnerty, J 266 grants from public funds 245, 249 First Choice Holidays plc 25, 339, Green, T 266 424 Greene King plc 134 First Group plc 395 Gregory, A 205, 399 Firth, M 265–6 gross profit margin 54 Fisher, Irving 31, 197, 302 growth of companies 23 Fisher, L 265 Gruber, M.J 336 Fisher effect (on real interest rates) 415–16, 501 half-yearly financial statements international 416, 502 Hamada, R.S 309 flat yield 236 Hand, J 335–6 footballers and football clubs 244, Harris, P 399 401, 443 Harvey, C.R 101–2, 143, 205, 280–3, see also American football 310, 314, 316 Ford Motor Company 401–2 Hatzopoulos, P.D 99–100, 126, 134, foreign exchange 411–18, 429 439–40 dealing in 412 hedging problems with 418–25 against inflation 223 see also exchange rates in money markets 421, 431 foreign exchange markets herd insinct 267 efficiency of 417–18 Higgs Report 11 need for 411–12 hire purchase (HP) 244–5, 249, 502 Forum for Private Businesses 435 Hirshleifer, J 31 forward exchange contracts 412, historic cost 47–8, 141 417, 420–1, 430, 501 Hofler, R.A 310 Frank, M 314 Homaifar, G 309–10 Franks, J.R 399 Honda Motor Europe plc 367 French, K 203, 264, 334–6 Hope, A 121 Fuller, K 399 Hughes, C 136 hurdle rates 92, 94, 101, 203 Game Group plc 396 Game Station Ltd 396 Ibbotson, R.C 204–5 GB Airways Ltd 136, 400 Ikenberry, D.L 334–5 gearing 14, 51, 59, 282–3, 286, Imperial Chemicals Ltd 401 295–317, 401 income measurement 49 capital/financial and operating income statements 42–3, 64, 502 indifference curves 166–8 types 306–7 industrial buildings, tax relief on differences between countries 118–19 310 BUSF_Z06.qxd 11/19/08 10:35 Page 515 Index inflation 47, 81, 120 –1, 144, 380, 502 forecasts of 121 hedging against 223 initial public offerings (IPOs) 225 –9, 502 inside information and insider dealing 10, 266–7 institutional investors 10–11, 222, 235, 303 – 4, 440 integer programming 129, 502 interest cover ratio 60 interest foregone 81 interest rate parity 416–17, 502 interest rate risk 238–9, 502 interest rate swaps 239, 502 interest rates on loan notes 237–9 risk-free 196, 203–4, 207, 503 internal rate of return (IRR) 87–94, 99 –101, 104, 203, 439 – 40, 502 International Accounting Standards Board 42 International Financial Reporting Standards 9, 42, 64 internationalisation of business 11, 408 –31 reasons for 409–11 risk associated with 427–9 inventories 359–68, 381–2, 448 models of 361–5 practical management of 365–6 inventories turnover period ratio 56 investment appraisal 153–76 alternative techniques of 80–99 and corporate objectives 99–100 data for 133 international 425–7, 431 methods used in practice 99–103, 105 multiple methods of 100 objectives of 113 and strategic planning 135–7 investment decisions implementation and monitoring of effects of 133 in practice 133–4 for small businesses 439–40 investment opportunities 79–80 and cash flows 337 comparison of 82 identification of 132–3 lasting for more than one year 83 –5 investment overseas 174 investment in securities 187–9, 195, 206, 208 investors’ ratios 60–1, 67, 221, 233, 236 ‘irrational’ behaviour 264, 268 Iskander-Datta, M 400 issue costs 221–2, 228–9, 233, 237, 240, 313, 315, 331 issuing houses 226 ITV Digital plc Jaffe, J 266 Jaguar Cars 401–2 Jarvis plc 227 JD Wetherspoon plc 25–6, 354–5 Jensen, M 24, 265, 308 JP Jenkins Ltd 443 Julio, B 334–5 junk bonds 235, 401, 502 just-in-time systems 366 Kaplan, S.N 311 Kaplanis, E 427–8 Kendall, M.G 261 Kester, W.C 310 Kim, J 338 Kingfisher plc 339 KPMG 399 Kumar, A 336 Ladbrokes plc 134 Laidlaw International Inc 395 Lamont, O 207 land and buildings, sale and leaseback of 244 Land Rover company 401–2 Landsman, W 335–6 law of one price 414–15, 502 Lease, R.C 336 leasing 242–5 see also sale and leaseback Lee, I 228 Leeds United FC 244, 401 lending by businesses 29–30 leverage 14 see also gearing leveraged buy-outs 401 Lewellen, W.G 336 liabilities, concealment of 51 Library House 442 ‘Limited’, use of term 8, 438 limited companies 6–9 limited liability 7, 223 Limmack, R.J 399 linear programming (LP) 128–9, 502 liquidation 502 of businesses 14–15, 220, 222, 304 of investments 223, 232, 234, 239, 253, 441 liquidity 58, 332–3 maintenance of 357 need for 356–7 liquidity ratios 57–9, 67 listed companies 6–7, 225–6, 443 Litzenberger, R 336 loan financing 59 see also secured loans; term loans loan notes 14, 46, 184, 217, 234–40, 247–8, 275–6, 287–9, 294, 297, 502 convertible 240, 281 perpetual 277 use in mergers 392 Lockhead, S 228 London Stock Exchange (LSE) 6, 9–12, 218, 225–6, 229, 232, 235, 253–6, 263, 267, 270, 396, 438, 440 dealing on 254–6 equity issues by listed businesses 226 members of 253–4 ownership of shares listed on 10–11 long-term financing of companies 12–14, 17, 253 influences on decisions about 218 selecting the most appropriate type of 245–6 sources of 217–49 long-term stability of companies 22–3 losses, concealment of 51 Lotus Cars Ltd 402 McClure, K.G 310 McKinsey and Co 134 McLaney, E 116, 205, 274, 280, 288 Mahate, A 399 Majestic Wine plc 443 management buy-outs (MBOs) 401–2, 435, 502 managers, interests of 26–7, 207, 270, 429 market makers 254 market portfolio 197, 199, 203, 502 expected return on 204–5 marketable investments 142, 376 Marks and Spencer plc 25, 338 Marsh, P 204, 206–7, 282, 288 Marston, C.L 27 Masulis, R 309 matching of expenses to revenue 48–9 Mathur, I 428 Mayers, D 265 mean value see expected value 515 BUSF_Z06.qxd 11/19/08 10:35 Page 516 Index Mehrotra, V 314 Memoranda of Association mergers 388–400, 403, 502 appraisals of 394 financing of 391–4 hostile and friendly 394 –9 international 400 reasons for 388–91 reduction in number of 393, 400 regulation of 395–6 steps towards 396–7 success and failure of 398–400 mezzanine finance 402 Mikkelson, W 314 Miller, M.H 300–6, 309–13, 316 –17, 327– 40, 345 – mission 135 Modigliani, F 300–6, 309–13, 316 –17, 327– 40, 345 – Moeller, S 399 Moizer, P 336 ‘Monday effects’ 264 money changes in value of 47 see also inflation time value of 80–1 see also discounting money market hedges 421, 431, 502 money measurement convention 47 monopolies 391 Monopolies and Mergers Commission see Competition Commission Monsoon plc 337 Moody’s credit rating agency 235 Morris, R 265 Morrison, D 448 Mougoue, M 336 Myers, S 313 net asset turnover ratio 53–4 net operating profit after tax (NOPAT) 140–1 net present value (NPV) 80–101, 104, 111–13, 126 –7, 136 –7, 144, 203, 502 adjusted for tax effect of debt finance 316 advantages of 82 compared with ARR 97–9 compared with IRR 88–94 compared with PBR 96–7 and shareholder wealth 86 for small businesses 439–40 systematic understatement of 115 –16, 121 Netter, J 399 516 netting on foreign exchange transactions 420, 430 Next plc 102, 116, 338 Nissan Motors UK Ltd 368 Nissim, D 335–6 no credit period ratio 58–9 Nokia 435 Northcott, D 100, 137, 143, 174, 205 Northern Rock plc 223 offers by prospectus 226 Ooi, T.S 24–5, 100 O’Leary, Michael 337 operating cash cycle 352–3, 381, 502–3 operating leases 242 operating profit margin 138 operating profit margin ratio 55 opportunity cash flows 116 opportunity cost of capital 30, 276, 283, 285, 329, 503 options 15–16, 503 see also currency options; real options order quantities, optimal 365 ordinary shares 12–13, 246–7, 278, 289–90, 503 use in mergers 392 Organisation for Economic Cooperation and Development (OECD) 10 Osborne, P 121 Oswald, D 338 outsourcing 435, 503 over-the-counter (OTC) market 256 overdrafts 59, 375–9 overreaction 263–4 overseas investment and financing 409 overtrading 358–9, 503 Ozkan, A 282, 310 par values 220, 503 Parmalat SpA 52 Partch, M 314 Paudyal, K 399 payback period (PBR) 94–102, 104–5, 440, 503 compared with NPV 96–7 pecking-order theory 313–18, 333, 339, 503 pegging of currencies 411, 413 perfect markets 256 Pettit, R.R 335–6 pharmaceutical manufacturers 22 Picou, A 264 Pike, R.H 24–5, 99–101,133, 205 placing of shares 226–7 plant and machinery, tax relief on 118 ‘plc’ description PLUS market 443 Pointon, J 116, 205, 274, 280, 288 Polk, C 207 portfolio theory and portfolio effect 164, 185–209, 503 international 419, 425, 428–31 position analysis 136, 503 post audits 133–4, 503 Powell, G 335 pre-emption rights 229 preference shares 13–14, 232–4, 247, 278, 289, 503 preferences, trading-off of 166–7 Premier Oil plc 240 present value table 459 price/earnings (P/E) ratio 60–1, 221, 445–6 pricing models see arbitrage pricing model; capital asset pricing model primary capital market 218, 252, 503 primary ratio 54 private equity funds 16–18, 388, 400, 503 private limited companies 8, 438 probabilities, use of 159–62 profit and loss accounts see income statements profit-taking 269 profitability index 127, 503 profitability ratios 53–5, 67 profits definition of 25, 46, 48 economic 140 maximisation of 22 reinvestment of 13 retention of 45, 219, 222–5, 281, 315, 331, 439–42 taxable 117–19 prudence convention 48, 141 public companies public interest 391 public issues of shares 227–9 puchasing power parities (PPPs) 414–15, 426, 503 put options 422 Quest plc 401 quick assets ratio 58 Raab, R 265 Ramaswamy, K 336 Rank Group plc 238 BUSF_Z06.qxd 11/19/08 10:35 Page 517 Index Rao, R 336 Rappaport, A 137 ratio analysis 53–67, 221 caution in interpretation of 63 limitations of 64–5 for management of working capital 358, 365 – 6, 372, 381 use for prediction of financial failure 66 real options 143, 146 realisation convention 47–8 rebalancing of portfolios 269 Reckitt Benckiser plc 25, 134 redemption of loan notes 237 of shares 14, 233 redemption dates 234–5 redemption yield 236 Registrar of Companies 8–9 Reinhart, W.J 101 remittances between countries 426 reorder costs 361 reorder levels 365 repeating patterns 260–1, 268 replacement decisions 130–2, 145 required rates of return 140–1, 270, 284 research and development costs 141 reserves 45 restructuring, corporate 141, 387– 404 Retail Prices Index (RPI) 120 return on capital employed (ROCE) 53 –5, 64, 137 maximisation of 22 return on ordinary share-holders’ funds 54 Ricci, C 421–4 rights issues 222–3, 228–32 pricing of 231 Rio Tinto plc 339, 395 risk 81, 503 as distinct from uncertainty 154 to future dividends 330 importance of taking account of 154 in investment appraisal 153–76 on investment in securities 187–9 reduction of 158–9, 390, 409–10 in relation to return 5, 185, 190–1, 218 –19, 246, 297, 299 for small businesses 440–1 specific and systematic 165 – 6, 188–9, 195, 198, 427, 440, 447, 504 see also business risk; economic risk; financial risk risk analysis for international investment 427 in practice 174, 176 risk aversion 95–6, 169–73, 186, 190, 311, 503 risk-free assets 196–7, 503 risk premia 199, 205–7 risk/return profiles 189–94 Ritter, J 228 Roberts, H 259 Roll, R 265 Rolls-Royce plc 100, 134, 199, 339, 355 Ross, S.A 205–6 Royal Bank of Scotland plc 225 Royal Dutch Shell plc 339 Rutterford, J 205 Ryan, H 142 Ryanair Holdings plc 337 Saga Ltd 401 sale and leaseback 244, 248–9, 503–4 sales revenue 138, 307, 315 ratio to to capital employed 53–4 satisficing 23–4, 504 scenario building 158, 504 Schlarbaum, G.G 336 Schooley, D 339 seasoned equity offerings (SEOs) 225, 227, 229, 504 secondary capital market 223, 252–71, 278, 504 secured loans 15, 219, 245, 504 securitisation 241–2, 248, 504 security market line (SML) 199–200, 504 sell-offs between established businesses 402, 504 sensitivity analysis 154–9, 174–5, 504 separation theorem 31, 504 derivation of 35–40 serial correlation tests 263 settlement periods 56–7, 372 Severn Trent plc 25 Shapiro, A.C 415–16, 427 share issues 46, 185, 221–9, 314–15, 331 in depressed markets 228 see also rights issues share options 26 share prices 13, 326–7, 332 effect of dividends on 335 shareholder value analysis (SVA) 137–40, 504 shareholders 8–10, 14–15, 219–20 capital gains for 331 contribution made to business by 45 prefererred habitats of 332 return on funds of 54 safeguarding the interests of 9–10, 20, 26–8, 307–8 wealth maximisation for 22–8, 173, 253, 269–70, 283, 298–300, 327, 387, 410, 437 wealth related to NPV 86, 137 see also institutional investors shares nominal value of 220, 233 ownership of 10–11 redemption of 14, 233 repurchase of 333–4, 338, 504 transferability of 7, 438 types 12–14 undervaluation of 313–15 see also share issues; share prices Sharpe, W 200 Shell see Royal Dutch Shell Shepherd Neame Ltd 443 Shlingemann, F 399 short-termism 27, 54–5, 504 Siddiqi, M 337 signalling 308, 331–2, 335–6, 504 Singh, M 428 Sinquefield, R 204–5 Skinner, D 334 small businesses 434–51 definition of 434–5 dividends paid by 448 failure of 436–7 importance of 435–6 investment decisions made by 439–40 organisation of 438 sources of finance for 441–4 taxation of 438–9, 447 valuation of 444–7 working capital for 448 Smith, C 309, 314, 337 special purpose entities (SPEs) 51 speed of reaction to market information 259, 265–6, 270 spin-offs 402–3 Standard and Poor’s 235 standard deviation 186–91, 206, 504 Stanley, K.L 336 Stark, A 335 Staunton, M 204, 206–7, 288 Stegemoller, M 399 Stern, Stewart and Company (SS) 140–2 Stiglitz, J.E 304 517 BUSF_Z06.qxd 11/19/08 10:35 Page 518 Index 518 Stock Exchange Automated Quotations (SEAQ) system 254 –5 Stock Exchange Electronic Trading System (SETS) 255 stock in trade see inventories stock markets 184 –5, 252, 441–2 Storey, D 437 strategic planning 135–7, 504 Stulz, R 399 sub-prime loans 241 Sudarsanam, S 399 Sugar, Sir Alan 395 Summers, B 448 Sunder, S 265 supermarkets 58 Surowiecki, J 258–9 survival of businesses 22, 436–7 swaps see currency swaps; interest rate swaps Swary, I 335 SWOT analysis 136, 504 synergy 391 trade payables 379–83 management of 380 for small businesses 448–9 trade receivables 368–72, 382 for small businesses 448 management of 370–2 Trahan, E 142 transaction risk with foreign exchange 419–23, 505 translation risk with foreign exchange 424–5, 431, 505 Tucker, J 205, 274, 280, 288 turbulence in markets 265 turnover ratios 53–6 two-fund separation 197, 505 takeovers 27, 207, 388, 505 see also mergers Tata Group 401 Tate amd Lyle plc 388 tax shield of borrowings 305, 312–13, 505 taxation and tax relief 117–20, 139, 144, 222 – 4, 237, 239, 242 –3, 246, 305 – 6, 309 –15, 331, 426 for small businesses 438–9, 447 Tayles, M 121 technical analysis 260–3, 267, 504 tenders for issue of shares 227–8 term loans 241, 248, 277, 294, 504 Tesco plc 199, 239, 244, 280, 355 Thomas, M 205, 274, 280, 288 Thomson, S 315 time-adjusted measures of financial benefit 86–7 Timmermann, A 267 trade-off theory (between tax shield and costs of bankruptcy) 312 –17, 504 value-based management (VBM) 137–42, 145–6 value drivers 138–40, 505 variance 186, 505 see also standard deviation Vasilou, D 310 Veit, E 335 Ventoura-Neokosmidi, Z 310 venture capital 442, 505 Vodafone Group plc 256, 427 uncertainty, nature of 154 underdeveloped countries 253 underutilisation of assets 390 underwriting of share issues 227 Unilever plc 339 utility curves 195–7 utility theory 166–9, 176, 505 Walker, M 207, 399 warrants 240–1, 248, 282, 505 Warther, V 336 Watts, R 309, 337 wealth of companies 42, 45 tendency towards understatement of 49, 64 wealth of shareholders see shareholders weighted average cost of capital (WACC) 274, 282–90, 298–316, 505 tendency to be forward-looking 287 used as the discount rate 283–8 values used in practice 288–9 Welch, I 267, 336 West Cornwall Pasty Co Ltd 401 Weston, J.F 309 Whistles retail chain 402 Who Wants To Be A Millionaire? 258–9 Wilson, N 448 Wilson Committee report (1980) 441 ‘window dressing’ 269 withholding of unfavourable information 270 Wolfe, M 99 Wolseley plc 199 working capital 113, 139, 349–83, 505 decisions on 355–6 financing of 349–50, 357–8 general attitude to 356 link with long-term investment and financing 351–3 and liquidity 356–8 management of 350, 358 need for 349 scale of 354–5 for small businesses 448 working capital cycle 350–1 WorldCom 51 Xerox Corporation 51 Yield see discounted cash flow yield; dividend yield; flat yield; redemption yield Young, G 314, 334 Young, S 338 Young and Co’s Brewery plc 221 Z-scores 66, 505 Zaman, M 205 Zeitz, J 309–10 Zhao, Q 228 Ziv, A 335–6 ... Second edition published 1991 Third edition published 1994 Fourth edition published 1997 Fifth edition published 2000 Sixth edition published 2003 Seventh edition published 2006 Eighth edition. .. Business finance : theory and practice / Eddie McLaney – 8th ed p cm Includes bibliographical references and index ISBN 978–0–273–71768–3 Business enterprises Finance Business enterprises Finance Problems,... Page iii Eighth Edition BUSINESS FINANCE Theory and Practice Eddie McLaney BUSF_A01.qxd 11/19/08 9:46 Page iv Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated