Foundations of Financial Management,

18e ISE - eBook PDF

Visit to download the full and correct content document:
https://ebooksecure.com/download/foundations-of-financial-management-18e-ise-ebo
ok-pdf/
 Final PDF to printer

Foundations of
Financial Management
EIGHTEENTH EDITION

Stanley B. Block
Texas Christian University

Geoffrey A. Hirt
DePaul University

Bartley R. Danielsen
North Carolina State University

blo9762x_fm_i-xxxii.indd i 10/08/21 10:41 PM

 Final PDF to printer

FOUNDATIONS OF FINANCIAL MANAGEMENT

Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10019. Copyright ©2023 by
McGraw Hill LLC. All rights reserved. Printed in the United States of America. 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 LLC, 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 LWI 27 26 25 24 23 22
ISBN 978-1-265-07465-4
MHID 1-265-07465-8
Cover Image: (Woman at computer) Mark Adams/123RF; (Laptop) Rawpixel.com/Shutterstock;
(Downtown Chicago) chicagoview/Alamy Stock Photo; (Double Exposure) Mincase/Shutterstock

All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.
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 LLC, and McGraw Hill LLC does not guarantee the
accuracy of the information presented at these sites.

mheducation.com/highered

blo74658_fm_ise.indd ii 10/08/21 10:40 PM

Meet the Authors
Stanley B. Block
Texas Christian University

Courtesy of Stanley B. Block

Geoffrey A. Hirt
DePaul University

Courtesy of Geoffrey A. Hirt

Bartley R. Danielsen
North Carolina State University

Courtesy of Bartley R. Danielsen

Dedication
Our dear friend, colleague, and coauthor Stan Block passed away on July 11, 2021. Stan’s influence
on our textbook began when he created one of the first student-managed educational investment funds
to give students a real-world experience. One of his favorite phrases was “I want the students to hit the
ground running.” Thanks to Stan, blending financial theory and practice continues to be the focus of our
textbook and we think it gives our students a running start in the real world of finance.
 Preface
Many years have passed since we began writing the first edition of this text, and many
things have changed during that time including the author team.
First of all, the field of finance has become much more analytical, with the empha-
sis on decision-oriented approaches to problems rather than the old, descriptive
approach. We have increased the use of analytical approaches to financial problems
in virtually every chapter of the book. But we also have stayed with our basic mission
of making sure students are able to follow us in our discussions throughout the text.
While the 18th edition is considerably more sophisticated than the initial edition, it is
still extremely “reader friendly.” As the analytical skills demanded of students have
increased, so has the authors’ care in presenting the material.
The use of spreadsheets and calculators has become considerably more important,
and this is also reflected in the 18th edition where we have added Excel tables and
calculator keystroke solutions within key chapters. We offer Web Exercises at the
end of every chapter, URL citations throughout the text, a library of course materi-
als for students and faculty, computerized testing software and ­PowerPoint® for the
faculty, McGraw Hill Connect®, an online assignment and assessment s­ olution, and
SmartBook, a truly innovative adaptive study tool and eBook.
One of the secrets to the longevity of this text is that it is a leader in bringing the
real world into the classroom, and this has never been more apparent than in the 18th
edition. Each chapter opens with a real-world vignette, and the Finance in Action
boxes (found in virtually every chapter) describe real-world activities and decisions
made by actual businesses. We are also up-to-date on the latest tax and financial
reporting legislation.
The international world of finance has expanded with the creation of the European
Union and the rise of China as a global economic power and enactment of world trade
agreements across the globe. To reflect these changes, the text has expanded its inter-
national coverage. Where there is an international application for a financial issue, you
are very likely to find it in this text.
Furthermore, the 18th edition continues to give modest coverage to the reces-
sion and liquidity crisis that engulfed the U.S. and world economies in the latter part
of the 2000–2009 decade and, where appropriate, we have highlighted the effects
of the COVID-19 pandemic on financial decisions. Special attention is given to
the banking sector and the critical need for funding that almost all businesses face.
The issue of changing regulations is also covered.
However, there is one thing that has not changed since the first edition, we still
write the entire book and all of the problems ourselves! We believe our devotion of
time, energy, and commitment over these years is the reason for our reputation for hav-
ing produced a high-quality and successful text—edition after edition.

iv
 Preface v

Employers of business graduates report that the most successful analysts, planners, Reinforcing
and executives are both effective and confident in their financial skills. We concur. Prerequisite
One of the best ways to increase your facility in finance is to integrate your knowl- Knowledge
edge from prerequisite courses. Therefore, the text is designed to build on your basic
knowledge from courses in accounting and economics. By applying tools learned in
these courses, you can develop a conceptual and analytical understanding of financial
management.
We realize that for some students, time has passed since you have completed
your accounting courses. Therefore, we have included Chapter 2, a thorough review
of accounting principles, finance terminology, and financial statements. With a
working knowledge of Chapter 2, you will have a more complete understanding
of the impact of business decisions on financial statements. Online financial data
sources provide a wealth of financial ratios, and after mastering the ratios and con-
cepts in Chapter 3, the information provided by online sources such as FactSet and
Standard and Poor’s will be easy to understand. Furthermore, as you are about to
begin your career, you will be much better prepared when called upon to apply
financial concepts.

In general, tables and figures with real-world numbers have been updated or replaced, Content
and the discussions concerning those tables and figures have been rewritten accordingly. Improvements

Chapter-by-Chapter Changes
Chapter 1 This chapter has been substantially revised. Time value of money is
now introduced here, and the future value of a single amount is calculated. Three
new end-of-chapter problems reinforce this future value learning objective. The
addition of these end-of-chapter problems offers the instructor an opportunity
to assign a mathematical problem in the first week of class so that students can
immediately begin doing finance-type problems. The end-of-chapter problems
in the chapter are relatively simple so that students can focus on the home-
work process before more difficult material is introduced in Chapter 2. This
feature should be particularly valuable for instructors who use the text’s Con-
nect resources and who want students to be able to navigate the Connect system
independently.
The chapter also offers an overview of the job market for finance students
and distinguishes between the two main subcategories of finance: corporate
finance vs. investments. A new Finance in Action box discusses the purpose of
the corporation in the context of social responsibility. The impact of the COVID-
19 pandemic on corporate finance is discussed several times in this and other
chapters.
vi Preface

Chapter 2 The introduction has been updated and all of the tables have been
updated or revised. For the Kramer Corporation example, the number of com-
mon shares outstanding has been changed so that the earnings per share is not
exactly $1. An EPS of $1 causes the firm’s share price and P/E ratio to be identi-
cal, an equality that produced confusion for students. The new EPS value carries
throughout the chapter examples. The subsection titled “Price-Earnings Ratios
and Earnings per Share” has been rewritten for clarity. The financial statement
impact of deducting R&D costs (rather than capitalizing them) is now discussed
in the context of market-to-book ratios. A new Finance in Action box discusses
tax competition between countries and states.
Chapter 3 The introduction comparing Colgate-Palmolive with Procter & Gamble
has been updated. The comparison of Target to Walmart in the DuPont model
has been updated using current financial statements. Table 3-2 updates this
comparison with 2020 data. The discussion of liquidity ratios has been revised.
Ratio trend analysis of Apple and IBM has been replaced with a comparison
of Advanced Micro Devices and Intel Inc. The Finance in Action box has been
replaced with a new box called “Are Ratios Good Predictors of a Company’s
Value?” The IBM Web Exercise has also been revised.
Chapter 4 The introduction has been updated as well as the Finance in Action box
describing the interaction of Tesla’s marketing and financial forecasting activi-
ties. Table 4-10 has been revised for clarity. The Web Exercise on Barnes &
Noble has been replaced by a Web Exercise for Barnes and Noble Education.
Chapter 5 The introduction has been revised with an analogy between financial
leverage and the leverage used by a child on a playground teeter-totter to lift
a heavier parent off the ground. The introduction also includes a discussion
of leverage in the airline industry. The Apple Finance in Action box has been
updated. The United Airlines Web Exercise has been updated.
Chapter 6 A Finance in Action box has been replaced with a box highlighting
Shopify’s influence on small retailers. Seasonality is discussed using Harley
Davidson sales as an example, rather than Briggs and Stratton, which filed for
bankruptcy and is no longer a publicly traded company. Figure 6-2 now features
Harley Davidson data and the discussion describes the cyclicality of the firm’s
sales. Figure 6-3, comparing seasonal sales and earnings per share of Macy’s
and Target, has been updated with new data, and the analysis is revised to be
consistent with the new figure. All of the tables have been updated in an Excel
format, and references to cell values by row and column identifiers make the
analysis easier to follow. Figures 6-9 and 6-10 and the data and discussion about
yield curves and interest rates have been updated, including the Web Exercise at
the end of the problem set.
Chapter 7 The introduction has been revised to include the effects of the COVID-
19 pandemic on current asset management. The Finance in Action box on work-
ing capital management has been replaced with “The Cloud, B2B, and Working
Capital Management.” Data on automated clearing houses and international
funds transfers using SWIFT have been updated. Table 7-2 has been deleted and
subsequent tables renumbered. Just-in-time inventory methods now include the
 Preface vii

impact of COVID-19 on how inventory management is affected by unexpected

events. The Web Exercise at the end of the chapter is new and focuses on B2B
using SAP-Ariba.
Chapter 8 The chapter introduction featuring YUM! Brands credit agreements
has been revised to reflect new agreements. The section on bank credit includes
how banks have coped with the COVID-19 pandemic compared to the financial
crisis of 2007–2009. We revised the data on LIBOR as well as updating the
transition to a new measure. The Finance in Action box on LIBOR—“What Will
Replace LIBOR?”—is new. Figures 8-1 and 8-2 as well as Table 8-1 have been
revised with new data and discussion of interest rates and commercial paper. The
Finance in Action box about online credit has been updated.
Chapter 9 The Excel and Google Sheets content is expanded to give students a
better understanding of how to use the TVM functions. The Finance in Action
box has been rewritten to include the March 2019 Powerball jackpot winner of
$768.4 million. The Web Exercise has been rewritten and improved.
Chapter 10 The introduction has been rewritten to feature DuPont de Nemours,
AMETEK Inc., and Bio-Techne Corp. Tables 10-1 and 10-2 are updated as Excel
spreadsheets. Material related to P/E ratios and valuation has been updated.
Figure 10-4 has been revised to present Coca-Cola Company’s stock quotation
data as displayed in Yahoo Finance, a source easily accessed by students online.
The Web Exercise featuring ExxonMobil has been revised to coincide with
changes to the website.
Chapter 11 The information in Table 11-3 has been replaced with new data, and
Table 11-4 on long-term debt has been updated. A new Finance in Action box on
Green Bonds is included. The Web Exercise has been changed to be consistent
with changes with Intel’s website.
Chapter 12 The second half of the chapter has been significantly revised. The
investment decision example has been updated with new values, and Tables 12-13
through 12-19 have been modified accordingly. Tables have been reformatted as
Excel spreadsheets, and the textual material has been updated with clear refer-
ences to individual Excel cells. The text in the “Replacement Decision” section
has been completely rewritten with Excel-formatted tables. Material has been
color-coded for clarity. The section on the NPV profile has been removed from
the main chapter and placed in a new Appendix 12A. The Web Exercise featur-
ing Texas Instruments has been updated.
Chapter 13 Apache Corporation’s prices have been adjusted in the introduction.
Table 13-2 has been changed to include a comparison of beta values over two
time periods to demonstrate the lack of stability. The Finance in Action box on
energy as a high-risk industry has been modified and revised. The Web Exercise
at the end of the chapter has been updated.
Chapter 14 The introduction added the stock market’s surprising reaction to the
COVID-19 virus and work-from-home stocks. We mention that former presi-
dent Trump renegotiated NAFTA and that Britain exited the European Union.
Figure 14-1 has been updated to world market capitalizations of equity mar-
kets. Table 14-1 and Figure 14-2 were updated with new data. The discussion of
viii Preface

the major exchanges was significantly revised to reflect the changing structure of
the markets. Table 14-2 was added to show the major exchanges of ICE, CBOE,
and NASDAQ and their respective ownership structure. Former Table 14-2
(now Table 14-3) was restructured and updated. The Finance in Action box was
revised to explain the three different types of dark pools. Finally, the Web Exer-
cise was revised to reflect changes in the NYSE website.
Chapter 15 New IPOs were added to the introduction for currency. Table 15-1
was revised with new companies. Table 15-2 was updated with new rankings of
global investment bankers. Tables 15-3 and 15-4 were updated with 2020 data
for banking leaders based on fees by products, regions, and industries. The sec-
tion on debt versus equity offerings was updated with a revised Table 15-7 on
global debt and equity bookrunner rankings. A Finance in Action box was added
on SPACs: Special Purpose Acquisition Companies. A new Web Exercise on
IPOs replaced the former exercise.
Chapter 16 The second half of the chapter has been extensively revised. In partic-
ular, the section on the bond refunding decision has been rewritten and six new
Excel tables have been created. The tables are color-coded, and students will
find the new exposition easier to follow. Other changes in the chapter include
revision of the introductory text. Figures 16-1 and 16-3, along with related dis-
cussions, have been updated. Tables 16-1 and 16-3 have been revised, as has
the text related to these tables. A new Finance in Action box related to negative
interest rates has been added, and new Table 16-11 showing examples of Euro-
bonds replaces old Table 16-5.
Chapter 17 Tower Semiconductor data was updated in the introduction and Table 17-1
on institutional ownership was updated. We added Facebook, Alphabet, and
Palantir as new examples of “founders’ shares” with special voting rights. The
Finance in Action box on corporate governance was significantly revised. Table
17-2 on rights offerings was revised and updated and Table 17-3 on depository
receipts was updated. The Web Exercise on 3M was significantly revised to
reflect changes in 3M’s website and its new feature called “Interactive Analyst
Center.”
Chapter 18 The introduction was shortened, and Altria’s data were updated. The
table on corporate dividend policy was revised with new data and companies.
The Finance in Action box on dividend-paying aristocrats was revised and now
includes dividend kings as well as aristocrats. Figure 18-2 showing the trend
of earnings and dividends was updated with commentary on how COVID-19
impacted corporate dividends. A new table showing taxes on long-term capital
gains and qualified dividends replaced the old one. The example on dividend
payment procedures was updated. Table 18-8 on billion-dollar stock repurchases
was updated with new companies with 2021 information. We added a discus-
sion of the banking industry and Federal Reserve guidelines on their ability to
repurchase stock because of capital requirements caused by COVID-19 worries.
Chapter 19 Introductory material on BioMarin was updated. Table 19-1 was sig-
nificantly revised and simplified. Information on the size of the convertible bond
 Preface ix

market was revised and convertible exchange-traded funds were added to the
discussion. Table 19-2 was replaced by a new table listing the largest convertible
bond issues of 2020 with familiar names like Wayfair and Uber. Table 19-3 was
significantly revised with new companies and a new format. The warrant sec-
tion was simplified by eliminating Table 19-5 and replacing it with Figure 19-3
showing an Occidental Petroleum warrant due in August 2027. Using the Occi-
dental example, we are able to present all the concepts related to warrants with
one example. The Web Exercise was revised to reflect changes in the CBOE
website.
Chapter 20 The introduction highlights the Bristol Myers Squibb purchase of
Celgene Corp. Table 20-1 replaced the old table with a list of the largest merg-
ers and acquisitions worldwide, and this is followed up with a revision of
Figure 20-1 showing the number and value of M&A in North America.
Figure 20-3 was updated with current hostile takeover data. A new Finance in Action
box on SPACs replaced the old one. The discussion of premium offers and stock
price movements was revised and expanded and includes Figure 20-4 on premiums.
Chapter 21 We now cover the revision of the North America Free Trade Agree-
ment and Britain leaving the E.U. Additionally, Figure 21-1 on exchange rates
has been updated and Table 21-1 has been updated. Table 21-2 updated all
four exchange rates for Canada, Switzerland, Japan, and Sweden. The section
on cross rates has been significantly revised and Table 21-2 replaces the old
table with cross rates by geographic regions. The Finance in Action box about
Argentina was replaced by a new box on purchasing power parity using the “Big
Mac Index.” We discuss the merger of Overseas Private Investment Corporation
(OPIC) into the Development Credit Authority of the U.S. Agency for Interna-
tional Development (USAID) and revised the Web Exercise by replacing the
OPIC exercise with a similar exercise using the USAID.

Successful improvements from the previous editions that we have built on in the 18th
edition include:
Functional Integration We have taken care to include examples that are not just
applicable to finance students but also to marketing, management, and account-
ing majors.
Computational Integration Almost all of our calculations in the text are high-
lighted with calculator keystrokes and, in most cases, appear in a spreadsheet
layout, many of which will be assignable content in Connect.
Small Business Since over two-thirds of the jobs created in the U.S. economy
are from small businesses, we have continued to note when specific financial
techniques are performed differently by large and small businesses.
Comprehensive International Coverage We have updated and expanded coverage
of international companies, markets, and events throughout the text.
Contemporary Coverage The 18th edition continues to provide updated real-world
examples, using companies easily recognized by students to illustrate financial
concepts presented in the text.
x Preface

Acknowledgments
We are extremely grateful to the following instructors for their valuable reviews on
previous editions:

Alan Adams Walter R. Dale Bharat Jain

Ahmed Al Asfour Jeffrey S. Dean Jerry James
Dwight C. Anderson Andrea DeMaskey Joel Jankowski
Eric Anderson James Demello Victoria Javine
Andreas Andrikopoulos Erik Devos Gerald S. Justin
Antonio Apap Bob Diberio Fredric S. Kamin
Kavous Ardalan Clifford A. Diebold Moonsoo Kang
John Backman Darla Donaldson Peppi Kenny
Charles Barngrover Jeff Donaldson Peter R. Kensicki
Larry Barraza Tom Downs Tom Kewley
Brian T. Belt David Durst Jim Keys
James Benedum Fred Ebeid Robert Kleiman
Omar Benkato Scott Ehrhorn Ken Knauf
Michael Bentil Jeff Eicher Raj Kohli
Joseph Bentley Marumbok Etta Rick Koza
William J. Bertin Michael Evans Charles Kronche
Debela Birru Gregory Fallon Ronald Kudla
Robert Boatler Barry Farber Morris Lamberson
Walter Boyle George Fickenworth Linda Lange
Wendell Bragg Mike Fioccoprile Joe Lavely
Alka Bramhandkar Gary Florence Sharon Lee
Jeb Briley O. L. Fortier Joseph Levitsky
Dallas Brozik Mohamed Gaber John H. Lewis
Georgia Buckles Robert Gaertner Terry Lindenberg
Richard Burton Jim Gahlon Joe Lipscomb
Richard Butler Ashley Geisewite John P. Listro
Ezra Byler James Gentry Wilson Liu
Kevin Cabe Elizabeth Goins Jim Lock
Rosemary Carlson Bernie J. Grablowsky Doug Lonnstrom
Alan J. Carper Bill Greer Leslie Lukasik
Cheryl Chamblin Debbie Griest Claude Lusk
Leo Chan Kidane Habteselassie Kelly Manley
Rolf Christensen John R. Hall Ken Mannino
Steven Christian Thomas R. Hamilton Paul Marciano
Andreas Christofi Walt Hammond John D. Markese
E. Tylor Claggett Frank Harber Peter Marks
Margaret Clark Carole Harris Thomas Maroney
Henry Co Eric Haye Kooros Maskooki
Nanette Cobb Charles Higgins Bill Mason
Allan Conway Eric Hoogstra Joe Massa
Tom Copeland Stanley Jacobs John Masserwick
 Preface xi

Patricia Matthews James Racic Diane Suhler

Michael Matukonis Kamala Raghavan Mark Sunderman
K. Gary McClure David Rankin Robert Swanson
Grant McQueen Dan Raver Tom Szczurek
Wayne E. McWee Robert Rittenhouse Glenn Tanner
Stuart Michelson Mauricio Rodriguez Richard Taylor
Vassil Mihov Frederick Rommel Robert Taylor
Jerry D. Miller Marjorie Rubash Francesca Toscano
David Minars Gary Rupp Mike Toyne
Vianka Maria Miranda Philip Russel Mike Tuberose
Mike Moritz Gayle Russell Cathyann Tully
Heber Moulton Robert Saemann Lana Tuss
Hassan Moussawi Olgun Fuat Sahin Donald E. Vaughan
Matt Muller Monica Salomon Mark Vaughan
Vivian Nazar Ajay Samant Andrew Waisburd
Srinivas Nippani Atul Saxena Ken Washer
Kenneth O’Brien Timothy Scheppa William Welch
Bryan O’Neil Sandra Schickele Gary Wells
Dimitrios Pachis James Scott Larry White
Coleen C. Pantalone Abu Selimuddin Howard R. Whitney
Robert Pavlik Gowri Shankar Linda Wiechowski
Rosemary C. Peavler Dennis Shea Philip L. Wiggle
Mario Picconi Joanne Sheridan Matt Wirgau
Beverly Piper Fred Shipley David Wolfe
Micki Pitcher Larry Simpson Lawrence Wolken
Harlan Platt Michael Slates Annie Wong
Ralph A. Pope Larry Smith Don Wort
Roger Potter William Smith Ergun Yener
Franklin Potts Jan R. Squires Lowell Young
Dev Prasad Sundaram Srinivasan Emily Zeitz
Cynthia Preston Cliff Stalter Charles Zellerbach
Chris Prestopino Jack Stone Miranda Zhang
Frances A. Quinn Thad Stupi Terry Zivney
Marisa Evans, David Golder, Henry Stilley, Chelsea Tate, ­Chase Crone, Ashley Smith,
Ford Danielsen, and Mary Gray Danielsen have been invaluable in assisting with text,
solutions, and Connect content. We would also like to thank Christina K
­ ouvelis, senior
product developer; Chuck Synovec, portfolio director; Amy Gehl, content project man-
ager; Trina Maurer, executive marketing manager; Xin Lin, digital product analyst;
Emily Windelborn, assessment content project manager; Matt Diamond, designer; and
the entire team at McGraw Hill for its feedback, support, and enduring commitment
to excellence.
Stanley B. Block
Geoffrey A. Hirt
Bartley R. Danielsen
Distinguishing Features
Confirming Pages

Integration of Learning Objectives to

Discussion Questions and Problems
LEARNING OBJECTIVES
3 Confirming Pages

The Learning Objectives (LOs) presented LO 3-1 Recognize that ratio analysis provides a
meaningful comparison of a company to
its industry.

at the beginning of each chapter serve as a LO 3-2

Explain what ratios are used for and what
they measure.
LO 3-3
Recall that the DuPont system of analysis
Financial Chapter 2 Review of Accounting 45

quick introduction to the material students DISCUSSION assets QUESTIONS

identifies the true sources of return on
and return to stockholders.
Analysis
1. LODiscuss
3-4 some
Detail whatfinancial variables
trend analysis shows. that affect the price-earnings (P/E) ratio. (LO2-2)
will learn and should understand fully before LO 3-5
2. What is
Explain why reported income must be
the evaluated.
further difference between book value per share of common stock and
market value per share? Why does this disparity occur? (LO2-3)
moving to the next chapter. Every discus- 3. Explain how depreciation generates actual cash flows for the company. (LO2-5)
4. What is the difference between accumulated depreciation and depreciation
sion question and problem at the end of each expense? How are they related? (LO2-5)

I
f you’re in the market for dental products, look no further than Colgate-Palmolive. The
5. How is the income statement related to the balance sheet? (LO2-1 & 2-3)
chapter refers back to the learning objective firm has it all: every type of toothpaste you can imagine (tartar control, cavity protection,
6. Comment on why inflation
whitening enhancement),
normally
ting ready forpresented.
as wellmay
(LO2-3)
the day, also
restrict
as every shape the
andusefulness of the While
size of toothbrush. balance
consider its soaps, shampoos, and deodorants (Tom’s of Maine,
sheet
you’re get-as

to which it applies. 7. Speed

Explain Stick, Lady Speed Stick, etc.). If you decide to clean your apartment or dorm room,
why the statement of cash flows provides useful information that goes
Colgate-Palmolive will provide you with Ajax, Palmolive dish soap, and a long list of other
beyondproducts.
income statement and balance sheet data. (LO2-4)
cleaning
8. What areis the
All this three primary
somewhat interesting,sections of the statement
but why mention of cash
these subjects flows?text?
in a finance In what
Well,
section would the
Colgate-Palmolive has payment
had someof a cash dividend
interesting be shown?
profit numbers recently. Its profit margin in
(LO2-4)
2020 was 16.4 percent, and its return on assets was 16.9 percent. While these numbers are
9. higher
Whatthan is free cash flow? Why is it important to leveraged buyouts? Confirming Pages
those of the average company, the 2020 number that blows analysts (LO2-4)
away is its
10. return
Whyon is stockholders’
interest expense
equity said
of overto 245
costpercent
the firm(thesubstantially
norm is 15–20less thanInthe
percent). fact,actual
this
ROE is so high
expense, and unrealistic
while dividendsthat some
cost financial
it 100 services
percent list the
of the number
outlay? as not meaningful
(LO2-1)
(NMF). The major reason for this abnormally high return is its high debt-to-total-assets ratio

Expanded! Finance in Action Boxes

of over 93 percent. This means that the firm’s debt represents more than 95 percent of total
assets and stockholders’ equity less than 7 percent. Almost any amount of profit will appear
PRACTICE PROBLEMS
Tesla’s Sales Forecast: Where Marketing
high in regard to the low value AND SOLUTIONS
of stockholders’ equity.
Finance in
In contrast, its largest competitor, Procter & Gamble, has a different capital structure.
1. LeBron
Procter &Furniture
and Finance Come Together Gamble is Company has61.1 thepercent
following debtfinancial
and 38.9 data. Prepare an income ACTION
Determination of

These boxed readings highlight specific

financed with percent equity. Because
statement
of this moreand computecapital
conservative earnings structure,per share.the company See Table reports 2-1 as anpercent
a 27.8 example.
return on profitability
stockholders’ equity. One capital structure is not necessarily better than the other, but this (LO2-1)
Managerial
topics of interest that relate to four main
All the financial analysis analysisin the world will be can prove instock
examined fell over 30 percent. Although sales pro-
kind of..................................................................................................................................
financial this chapter.
Sales $1,300,000
useless if aInfirm
Chapter does2,not we haveexamined a meaningful
the basic assumptions jections of had previously
accounting and the been for compo-
various 500,000
Depreciation expense ................................................................................................... 70,000
sales projection.
nents that To make theupextentthe financialthat statements
the firm ofcars by 2020,
the firm. We now new useprojections
this fundamental werematerial
for only

areas: managerial decisions, global

Cost
has an incorrectof goodssalessold
as a springboard into.........................................................................................................
projection,
financial ananalysis—to
inappro- evaluate 300,000. the Another
financial problemperformance for Tesla 800,000
of thewas
firm.that the
Interest
priate amount expense
of
The format for.............................................................................................................
inventory will be isaccumu-
the chapter twofold. In the public firstpredictions
part, we use madefinancialby Elon Musk,
ratios 30,000
the CEO,
to evaluate
lated, projections andofadministrative
the relative
Selling accounts
success of the receivable
firm. Various andmeasures had always such provedas net income to be way
expense........................................................................... too optimistic,
to sales and140,000 with
current
situations, technology issues, and ethics. accountsCommon
payable
assets
light
and cashTaxes will
will be
to shares
current
be offnorms
wrong,will
liabilities
outstanding
target.and
and beprofits
past trends.
Although
computedthe for actual results falling
a hypothetical
a cor- Surprisingly, on January 4, 2021, the New
company short
......................................................................................
flowof..................................................................................................................................
industry
and of projections.
examined
60,000
75,000
in
York

The inclusion of ethics is relevant given

porate treasurer may understand all the vari- Times reported that Tesla really had sold
Preferred stock dividends ............................................................................................ 5,000
ables influencing income statements, balance 500,000 cars in 2020, or, to be exact, 499,550,
sheets, cash budgets, and so on, she is out of but who is going to argue over missing the target

the many recent corporate scandals and the luck if the sales projection is wrong.
2. example,
For NorthernTesla Energy Motors Company produces hasand assetsbut
by 450 cars. Sales were up 36 percent in 2020,
ofwill$7,000,000,
this continue? liabilities
How many of $4,000,000,
cars will Tesla
55
Determination of
and $500,000 in preferred stockwas outstanding. Four2022, hundred and thousand common
resulting governance issues. Web addresses
sells electric cars. In 2014 the Tesla story sell in 2021, beyond? That is the profitability
all aboutstock
gas prices, and
shares have been issued.it was thought that question the chief financial officer would like to (LO2-2)
as gas prices went up so did Tesla sales, but know because it will affect all the financial state-
by 2021,a.thisCompute book valuetoper be share.
are included in applicable boxes for easy becauseb.
assumption
the Ifdemand
the firm
blo9762X_ch03_055-093.indd
stronger thanstockever, even
forhas
proved
Tesla vehicles was
false ments you will study in this and future chapters.
55 earnings per share of $1.10 and a P/E ratio of 15, what is the
Over the last two decades, the marketing 06/12/21 01:53 PM
pricethough per share? gas prices had profession has developed many sophisticated
Confirming Pages
access to more information on that topic or fallen. The truth is that people like electric and techniques for analyzing and projecting future
c. What is the ratio of market value per
hybrid cars. Consumers like Tesla’s styling and sales, but it is important for financial managers
share to book value per share?

company.
its computer systems that have changed the to realize that projections are often inherently
way cars are driven and that have the potential risky. The financial manager must look to the
for autonomous driving. Tesla was and still is a marketing staff to help project sales, but a good
step ahead of the competition. financial analyst will also seek to determine how
When a Morgan Stanley auto analyst esti- risky these sales projections may prove to be.
mated that Tesla would sell 40 percent fewer Worst-case scenarios must be recognized so
128 cars2thanFinancial
Part had previously Analysisbeen forecast, and Planning Tesla’s that surprises do not become financial disasters.

We will add the projected quantity of unit sales for the next six months to our
Pulling It Together with Color
Table 5-3 Volume–cost–profit analysis: Conservative firm
desired ending inventory
blo9762X_ch02_022-054.indd 45 and subtract our stock of beginning inventory (in units) to 06/12/21 12:32 PM
determine our production requirements. This process is illustrated below.
Total Operating
Throughout the 18th edition, the authors
Units
Units Variable Fixed Total Total Income
+ Projected sales
Sold Costs Costsinventory
+ Desired ending Costs Revenue (Loss)

make color an integral part of the presentation 0 $ 0

− Beginning inventory
$12,000
= Production requirements
$ 12,000 $ 0 $(12,000)

of finance concepts. Color is applied consis-

20,000 32,000 12,000 44,000 40,000 (4,000)
Following
30,000 this process,
48,000in Table 4-3 12,000
we see a required 60,000
production level of60,000
1,015 0
wheels and 2,020 casters.
tently across illustrations, text, and examples 40,000
Table
60,000
64,000
4-3 Production
12,000
requirements for six
96,000 months
12,000
76,000 80,000
108,000 120,000
4,000
12,000
in order to enhance the learning experience. 16 80,000 128,000
A
12,000
B
Wheels 140,000
Casters
C D
160,000 20,000
100,000
17 Projected unit sales 160,000
(Table 4-1) 12,000 +1,000 172,000
+2,000 200,000 28,000
We hope that the color in this edition assists 18
Desired ending inventory (assumed to represent
10% of unit sales for the time period) +100 +200

your understanding and retention of the

19 Beginning inventory (Table 4-2) −85 −180
20 Units to be produced 1,015 2,020
The Risk Factor 97

concepts discussed. Whether management follows the path of the leveraged firm or of the more conservative
firm depends on its perceptions of the future. If the vice president of finance is apprehen-
sive about economic conditions, the conservative plan may be undertaken. For a growing
business in times of relative prosperity, management might maintain a more 06/12/21
blo9762X_ch04_094-122.indd 97
aggressive,
12:35 PM

leveraged position. The firm’s competitive position within its industry will also be a fac-
xii tor. Does the firm desire to merely maintain stability or to become a market leader? To a
certain extent, management should tailor the use of leverage to meet its own risk-taking
desires. Those who are risk-averse (prefer less risk to more risk) should anticipate a par-
ticularly high return before contracting for heavy fixed costs. Others, less averse to risk,
may be willing to leverage under more normal conditions. Simply taking risks is not a
virtue—our prisons are full of risk takers. The important idea, which is stressed through-
 n=4
[ i ]
[ ]
where
(1 + 0.10) 4 − 1
FVA = futureFV A=
value an annuity _____________ = $4,641
of $1,000
A = the annuity payment 0.10
Because thisi =problem involves
the interest rate an annuity rather than a single payment, when solving FINANCIAL
n = the number of payments CALCULATOR
with a financial calculator, the value that we enter for the key is −$1,000.
Using Formula 9-5 to calculate the future value of our annuity payments,
Now we enter a zero for the PV key. As we computed earlier using the future value
PMT
FV of Annuity Distinguishing Features xiii
A = $1,000 Enter Function
of an annuity equation, we find that when the interest rate is 10%, the future value N
i = 10% 4
of a 4-year, $1,000
n = 4 annuity is $4,641. I/Y
10
Excel’s FV function can also produce
FV function assumes that each [
(1 + 0.10
at the ]end of a period as shown in the pre-
the) 4future
−1
FVA = $1,000 _____________ = $4,641
payment is0.10
value of an annuity stream. The
−1000 PMT Excel, Calculator Solutions,
vious timeline. The
Because thisannuity amount
problem involves is entered
an annuity as the
rather than pmt
a single argument.
payment, when solving FINANCIAL
The function
CALCULATOR
in
0
Function
PV
Solution
and Formulas
with cell
cell D1 uses a financial calculator,
references forthethevalue that we enter
arguments for theB1
in cells key isThe
to B4. −$1,000.
functionFV ofin cell
PMT
Now we enter a zero for the PV key. As we computed earlier using the future value Annuity CPT
D5 uses hardcoded
of an annuity values.
equation, The values produced byrate
theis FV
10%,function are identical to
In Chapters 9, 10, and 12, the authors have
Enter Function
we find that when the interest the future value N
FV 4,641.00
4
the calculator solution,
of a 4-year, but hardcoded
$1,000 annuity is $4,641. solutions should be avoided in preference I/Y
10
to
Excel’s FV
cell-referenced solutions. function can also produce the future value of an annuity stream.
FV function assumes that each payment is at the end of a period as shown in the pre-
The
−1000 PMT
0 PV
included discussions on how the examples are
vious timeline. The annuity amount is entered as the pmt argument. The function in
cell D1 uses cell references for the arguments in cells B1 to B4. The function in cell
Function Solution
CPT
solved using Excel, financial calculators, and
D5 uses hardcodedB values. The values produced by the FV function areEidentical to

1 rate
A
10.00%
C D
the calculator solution, but hardcoded solutions should be avoided in preference to
=FV(B1,B2,B3,B4)
FVF 4,641.00
formulas. Newly formatted spreadsheet tables
cell-referenced solutions.
2 nper 4.00 FV(rate, nper, pmt, [pv], [type]) and screen captures detail the step-by-step
method to solve the examples. The financial
3 pmt −1000 $4,641.00
A B C D E F
4 pv 1 rate 0
10.00% =FV(B1,B2,B3,B4)

5 2
3
nper
pmt
4.00
−1000
=+FV(0.1,4,−1000,0)
FV(rate, nper, pmt, [pv], [type])
$4,641.00
calculator keystrokes in the margins give
6 FV(rate, nper, pmt, [pv], [type])
7
4
5
pv 0
$4,641.00
=+FV(0.1,4,−1000,0)
instructors and students additional flexibility.
The material can be presented using
6 FV(rate, nper, pmt, [pv], [type])
7 $4,641.00

traditional methods without loss of clarity

blo9762x_ch09_251-298.indd 261
blo9762x_ch09_251-298.indd
because the margin content supplements
261 05/24/21 03:55 PM
the prior content, which has been retained.
05/24/21 03:55 PM

First Pages
The book and solutions manual provide
Excel, calculator, and formula explanations
Digital Illustrations of Time Value of for these very important calculations.
Money (Chapter 9)
First Pages
Chapter 9 The Time Value of Money 275

The concept of the “time value of money” is

A B C D E F G
1 Future Value of an Annuity Due

one of the most difficult topics in any

2
3 10.00%
i n
4
pmt
−1000
FVAD
$5,105.10 =+FV(A3,B3,C3,0,1)
266 Part 4 The Capital Budgeting Process

financial management course for professors

4
5
FV(rate, nper, pmt, [pv], [type])
Figure 9-5 Present value of $1.00 at 10%

to communicate to students. We think we

6
7
Present Value of an Annuity Due
i n pmt PVAD
The PV of a 2-year annuity
is simply the present value
$3.50
have created a visual method for teaching
of one payment at the end of
8 10.00% 4 −1000 $3,486.85 =+PV(A8,B8,C8,0,1)
period 1 and one payment PV of a 4-year
9 PV(rate, nper, pmt, [fv], [type]) at the end of period 2 annuity

future value and present value of money that 3.00 3.17

PV of $1.00

will
LIST OFhelp
TERMS you understand the concept simply 2.50
2.49
0.909 to be received
in 1 year
future value 253 present value of an annuity 262
and quickly.
present value 256 The 18th edition compounded includes
semiannually 271 2.00
0.909
discount rate 256 annuity due 274 PV of $1.00

interactive
annuity 260 digital illustrations of 284
interest factor four key 1.74
0.826 to be received
in 2 years
ordinary annuity 260 yield 289 1.50

figures
future value in
of anthe text260that visually relate future
annuity 0.909
0.826 PV of $1.00

values and present values. We hope you

1.00 0.751 to be received
0.909 in 3 years
DISCUSSION QUESTIONS
agree
1. How that thisvaluevisual
is the future related to presentation helps
the present value of a single sum? those
(LO9-1) 0.50
0.909 0.826 0.751 0.683
PV of $1.00
to be received
2. How is the present value of a single sum related to the present value of an
students who are less comfortable with the math.
in 4 years
annuity? (LO9-3) 0.00
3. Why does money have a time value? (LO9-1) 1 period 2 periods 3 periods 4 periods

4. Does inflation have anything to do with making a dollar today worth more than a
dollar tomorrow? (LO9-1) Log in to Connect to
access an interactive
5. Adjust the annual formula for a future value of a single amount at 12 percent for version of this figure
be received at the end of the second period. In the third column we add the present
10 years to a semiannual compounding formula. What are the interest factors
value of $0.751, received at the end of the third year, to end up with the present value
(FVIF) before and after? Why are they different? (LO9-5)
of a three-period annuity equaling $2.49. The fourth column adds another $0.683 to
6. If, as an investor, you had a choice of daily, monthly, or quarterly compounding, column 3 and illustrates the present value of four $1.00 payments equaling $3.17.
which would you choose? Why? (LO9-5) This $3.17 is the sum of each present value. The color coding helps illustrate
7.
8.
What is a deferred annuity? (LO9-4)
List five different financial applications of the time value of money. (LO9-1)
Practice Problems and Solutions
the relationships. The top box is always $0.909 and represents the present value of
$1.00 received at the end of the first period; the second box from the top is always
$0.826 and is the present value of the $1.00 received at the end of the second year;
the box third from the top is $0.751 and is the present value of the $1.00 received at
PRACTICE PROBLEMS AND SOLUTIONS Two practice problems are featured at the
the end of the third year; and finally, the present value of the $1.00 received at the
end of the fourth year is $0.683.
end of each chapter. They review concepts
1. a. You invest $12,000 today at 9 percent per year. How much will you have Future value
after 15 years? Present value
(LO9-2 & 9-3) Future Value Related to the Future Value of an Annuity
b. What is the current value of $100,000 after 10 years if the discount rate is
12 percent?
illustrated within the chapter and enable the
The next relationship is between the future value of a single sum and the future value of
c. You invest $2,000 a year for 20 years at 11 percent. How much will you have
after 20 years?
student
that is growing at a 10 percent rate ofwhether
to determine return each period.the material
If we start with a present has
an annuity. We start with Figure 9-6, which graphically depicts the future value of $1.00
value

beenof2 we$1.00
understood prior to completion oftothe
today (period 0), at the end of period 1 we will have $1.10; at the end of period
will have $1.21; and at the end of period 3 the $1.00 will have grown $1.33.

problem
of a $1.00 sets.
annuity isDetailed solutions
that they have different to the the timing of
One of the confusing features between the future value of $1.00 and the future value
assumptions concerning

practice problems are found immediately

blo9762x_ch09_251-298.indd 275 05/24/21 03:55 PM
following each problem.
blo9762x_ch09_251-298.indd 266 05/24/21 03:55 PM
 Chapter 11 Cost of Capital 367

xiv Distinguishing Features a. Compute Ki (required rate of return on common equity based on the capital
asset pricing model).
b. Compute Ke (required rate of return on common equity based on the divi-
dend valuation model).
Comprehensive Problems C O M P R E H E N S I V E P R O B L E M

Medical Research Corporation is expanding its research and production capacity to Medical Research
Several chapters have comprehensive introduce a new line of products. Current plans call for the expenditure of $100 million Corporation
on four projects of equal size ($25 million each), but different returns. Project A is in (Marginal cost
problems that integrate and require the blood clotting proteins and has an expected return of 18 percent. Project B relates to a of capital and
hepatitis vaccine and carries a potential return of 14 percent. Project C, dealing with a investment returns)
application of several financial concepts cardiovascular compound, is expected to earn 11.8 percent, and Project D, an invest- (LO11-5)
ment in orthopedic implants, is expected to show a 10.9 percent return.
into one problem. Additional comprehensive The firm has $15 million in retained earnings. After a capital structure with
$15 million in retained earnings is reached (in which retained earnings represent
problems are included in the Instructor’s Rev. Confirming Pages
60 percent of the financing), all additional equity financing must come in the form of
new common stock.
Manual for select chapters. Common stock is selling for $25 per share and underwriting costs are estimated at
$3 if new shares are issued. Dividends for the next year will be $0.90 per share (D1),
80 Part 2 Financial Analysis and Planning
and earnings and dividends have grown consistently at 11 percent per year.
b. In 20X2, sales increased to $5,740,000 and the assets for that year were as
The yield on comparative bonds has been hovering at 11 percent. The investment
follows: banker feels that the first $20 million of bonds could be sold to yield 11 percent while
Cash ................................................................................................... $ 163,000
additional debt might require a 2 percent premium and be sold to yield 13 percent. The
Accounts receivable ...................................................................... 924,000 corporate tax rate is 25 percent. Debt represents 40 percent of the capital structure.
Inventory ........................................................................................... 1,063,000
Net plant and equipment ............................................................. 520,000 a. Based on the two sources of financing, what is the initial weighted average cost
Total assets ................................................................................ $2,670,000
of capital? (Use Kd and Ke.)
Once again, compute the four ratios. b. At what size capital structure will the firm run out of retained earnings?
c. Indicate if there is an improvement or a decline in total asset turnover, and
based on the other ratios, indicate why this development has taken place.
c. What will the marginal cost of capital be immediately after that point?

Overall ratio
22. The balance sheet for Revolution Clothiers is shown below. Sales for the year
were $2,400,000, with 90 percent of sales sold on credit.
d.
e.
Excel Problems
At what size capital structure will there be a change in the cost of debt?
What will the marginal cost of capital be immediately after that point?
analysis
(LO3-2) REVOLUTION CLOTHIERS f. Based on the information about potential returns on investments in the first para-

Assets
Balance Sheet 20X1

Liabilities and Equity

Cash ....................................................
Accounts receivable .......................
Inventory ............................................
Select chapters feature Excel problems, denoted
graph and information on marginal cost of capital (in parts a, c, and e), how large
a capital investment budget should the firm use?
with an icon, to provide practice for working with
$ 60,000
Accounts payable ........................... $ 220,000
240,000
Accrued taxes .................................. 30,000 g. Graph the answer determined in part f.
350,000
Bonds payable (long-term) ........... 150,000

C O Mspreadsheets.
P R E H E N S I V E New P R O to E M 18th edition, the Excel
B L the
Plant and equipment ...................... 410,000
Common stock ................................. 80,000
Paid-in capital ................................... 200,000
Retained earnings ........................... 380,000
Total assets ............................... $ 1,060,000 Total liabilities and equity ..... $1,060,000
problems featured in the book will be available as
Masco Oil and Gas Company is a very large company with common stock listed on Masco Oil and Gas
the New York Stock Exchange and bonds traded over the counter. As of the current (Cost of capital with
®
assignable content within McGraw Hill changing Connect
Compute the following ratios:
balance sheet, it has three bond issues outstanding: financial
a. Current ratio
b. Quick ratio needs)
c. Debt-to-total-assets ratio
d. Asset turnover
using the Integrated Excel tool, providing
$150 million of 10 percent series ........
$50 million of 7 percent series ..............
2036
assessment
(LO11-1)
2030
e. Average collection period
23. The Lancaster Corporation’s income statement is given below. opportunities to facilitate mastery in working with
$75 million of 5 percent series .............. 2026

Excel. Additional Excel problems are also available

Debt utilization a. What is the times-interest-earned ratio?
ratios b. What would be the fixed-charge-coverage ratio?
(LO3-2)
LANCASTER CORPORATION

Sales ............................................................................................ $246,000

via Connect.
Cost of goods sold ................................................................... 122,000
Gross profit ................................................................................ $124,000
Fixed charges (other than interest) ...................................... 27,500
blo9762x_ch11_337-375.indd 367 05/26/21 05:18 PM
Income before interest and taxes ........................................ $ 96,500
Interest ........................................................................................ 21,800
Income before taxes ................................................................ $ 74,700
Taxes (35%) ................................................................................ 26,145
Income after taxes ................................................................... $ 48,555

blo9762X_ch03_055-093.indd 80 08/17/21 09:56 AM

NEW! Integrated Excel: A live seamless

experience
The power of Microsoft Excel meets the power of
McGraw Hill Connect® in our all-new Integrated
Excel assignments. In this new assignment type,
Excel opens seamlessly inside Connect®, with no
need for uploading or downloading any additional
files or software. Instructors choose their preferred
auto-graded solution, with the option for either grad-
ing for formula accuracy or for the solution value.
Supplements
Instructor Resources
The Connect Instructor Resource Library is your reposi-
tory for additional resources to improve student engage-
ment in and out of class. The following ancillaries are
available for quick download and convenient access:
∙ Instructor’s Manual Revised by author
Geoff Hirt, the manual helps instructors
integrate the graphs, tables, perspectives, and
problems into a lecture format. Each chapter
opens with a brief overview and a review
of key chapter concepts. The chapter is then
outlined in an annotated format to be used as
an in-class reference guide by the instructor.
∙ Solutions Manual Updated by author Bart
Danielsen, the manual includes detailed solu-
tions to all of the questions and problems, set in
a larger type font to facilitate their reproduction
in the classroom. Calculator, Excel, and formula
solutions are included for all relevant problems.
∙ Test Bank This question bank includes over
1,500 multiple-choice and true/false questions,
with revisions and updates made by Katie
Landgraf, University of Hawaii. Updates to
the questions correspond to the revisions
in the 18th ­edition. Also included are short
answer questions and matching quizzes. The
test bank is assignable in Connect and EZ Test
Online and available as Word files.
∙ PowerPoint Presentations These slides,
updated by Leslie Rush, University
of Hawaii, contain lecture outlines and se-
lected exhibits from the book in a four-color,
electronic format that you can customize for
your own lectures.
Test Builder in Connect
Available within Connect, Test Builder is a cloud-
based tool that enables instructors to format tests
that can be printed or administered within an LMS.
Test Builder offers a modern, streamlined interface
for easy content configuration that matches course
needs, without requiring a download.
Test Builder allows you to:
∙ Access all test bank content from a particular title.
∙ Easily pinpoint the most relevant content
through robust filtering options.
∙ Manipulate the order of questions or scramble
questions and/or answers.
∙ Pin questions to a specific location within a test.
∙ Determine your preferred treatment of algo-
rithmic questions.
∙ Choose the layout and spacing.
∙ Add instructions and configure default settings.
Test Builder provides a secure interface for bet-
ter protection of content and allows for just-in-time
updates to flow directly into assessments.
Remote Proctoring & Browser-Locking
Capabilities
New remote proctoring and browser-locking capabili-
ties, hosted by Proctorio within Connect, provide con-
trol of the assessment environment by enabling security
options and verifying the identity of the student.
Seamlessly integrated within Connect, these ser-
vices allow instructors to control students’ assess-
ment experience by restricting browser activity,
recording students’ activity, and verifying students
are doing their own work.
Instant and detailed reporting gives instructors an
at-a-glance view of potential academic integrity con-
cerns, thereby avoiding personal bias and supporting
evidence-based claims.
Student Study Materials
The Connect Student Study Center (www.mhhe.com/
block18e) is the place for students to access addi-
tional resources. The Student Study Center:
∙ Offers students quick access to lectures, course
materials, eBooks, and more.
∙ Provides instant practice material and study
questions, easily accessible on the go.
xv
Instructors: Student Success Starts with You
Tools to enhance your unique voice
Want to build your own course? No problem. Prefer to use an
OLC-aligned, prebuilt course? Easy. Want to make changes throughout
65%
Less Time
the semester? Sure. And you’ll save time with Connect’s auto-grading too.
Grading

Study made personal

Incorporate adaptive study resources like
SmartBook® 2.0 into your course and help your
students be better prepared in less time. Learn
more about the powerful personalized learning
experience available in SmartBook 2.0 at
www.mheducation.com/highered/connect/smartbook

Laptop: McGraw Hill; Woman/dog: George Doyle/Getty Images

Affordable solutions, Solutions for

added value your challenges
Make technology work for you with A product isn’t a solution. Real
LMS integration for single sign-on access, solutions are affordable, reliable,
mobile access to the digital textbook, and come with training and
and reports to quickly show you how ongoing support when you need
each of your students is doing. And with it and how you want it. Visit www.
our Inclusive Access program you can supportateverystep.com for videos
provide all these tools at a discount to and resources both you and your
your students. Ask your McGraw Hill students can use throughout the
representative for more information. semester.

Padlock: Jobalou/Getty Images Checkmark: Jobalou/Getty Images

Students: Get Learning that Fits You
Effective tools for efficient studying
Connect is designed to help you be more productive with simple, flexible, intuitive tools that maximize
your study time and meet your individual learning needs. Get learning that works for you with Connect.

Study anytime, anywhere “I really liked this

Download the free ReadAnywhere app and access app—it made it easy
your online eBook, SmartBook 2.0, or Adaptive to study when you
Learning Assignments when it’s convenient, even don't have your text-
if you’re offline. And since the app automatically
syncs with your Connect account, all of your work is book in front of you.”
available every time you open it. Find out more at
www.mheducation.com/readanywhere - Jordan Cunningham,
Eastern Washington University

Everything you need in one place

Your Connect course has everything you need—whether reading on
your digital eBook or completing assignments for class, Connect makes
it easy to get your work done.

Calendar: owattaphotos/Getty Images

Learning for everyone

McGraw Hill works directly with Accessibility Services
Departments and faculty to meet the learning needs
of all students. Please contact your Accessibility
Services Office and ask them to email
accessibility@mheducation.com, or visit
www.mheducation.com/about/accessibility
for more information.
Top: Jenner Images/Getty Images, Left: Hero Images/Getty Images, Right: Hero Images/Getty Images
Brief Contents
PART 1 | INTRODUCTION PART 5 | LONG-TERM FINANCING
1 The Goals and Activities of Financial 14 Capital Markets 449
Management 2 15 Investment Banking 471
16 Long-Term Debt and Lease
Financing 502
PART 2 | F INANCIAL ANALYSIS AND 17 Common and Preferred Stock
PLANNING Financing 540
2 Review of Accounting 23 18 Dividend Policy and Retained
3 Financial Analysis 55 Earnings 571
4 Financial Forecasting 94 19 Convertibles, Warrants, and
5 Operating and Financial Leverage 123 Derivatives 601

PART 3 | WORKING CAPITAL PART 6 | E

 XPANDING THE PERSPECTIVE OF
MANAGEMENT CORPORATE FINANCE
6 Working Capital and the Financing 20 External Growth through Mergers 628
Decision 156 21 International Financial
7 Current Asset Management 188 Management 653
8 Sources of Short-Term Financing 223
Appendices A-1
Glossary G-1
PART 4 | T
 HE CAPITAL BUDGETING Indexes I-1
PROCESS
9 The Time Value of Money 252
10 Valuation and Rates of Return 299
11 Cost of Capital 337
12 The Capital Budgeting Decision 376
13 Risk and Capital Budgeting 415

xviii
Contents
PART 1 | INTRODUCTION PART 2 | FINANCIAL ANALYSIS
AND PLANNING
1 The Goals and Activities of Financial
Management 2 2 Review of Accounting 23

The Field of Finance 3 Income Statement 24

Investments vs. Corporate Finance 3 Return to Capital 25
The Value of Studying Finance 4 Price-Earnings Ratios and Earnings per
Activities of Financial Management 5 Share 25
Forms of Organization 5 Limitations of the Income Statement 27
Sole Proprietorship 6 Balance Sheet 27
Partnership 6 Interpretation of Balance Sheet Items 27
Corporation 6 Concept of Book Value 29
Corporate Governance 8 Limitations of the Balance Sheet 30
The Time Value of Money 9 Statement of Cash Flows 31
Goals of Financial Management 11 Developing an Actual Statement 32
A Valuation Approach 11 Determining Cash Flows from Operating
Maximizing Shareholder Wealth 12 Activities 33
Management and Stockholder Determining Cash Flows from Investing
Wealth 13 Activities 35
Social Responsibility and Ethical Determining Cash Flows from Financing
Behavior 13 Activities 35
The Role of the Financial Markets 15 Combining the Three Sections of the
Structure and Functions of the Financial Statement 36
Markets 16 Depreciation and Funds Flow 38
Allocation of Capital 16 Free Cash Flow 40
Internationalization of the Financial Income Tax Considerations 40
Markets 17 Corporate Tax Rates 40
Format of the Text 18 Cost of a Tax-Deductible Expense 42
Parts 18 Depreciation as a Tax Shield 43
1. Introduction 18 Summary 44
2. Financial Analysis and Planning 18 List of Terms 44
3. Working Capital Management 18 Discussion Questions 45
4. The Capital Budgeting Process 18 Practice Problems and Solutions 45
5. Long-Term Financing 19 Problems 46
6. Expanding the Perspective of Web Exercise 54
Corporate Finance 19
3 Financial Analysis 55
List of Terms 19
Discussion Questions 20 Ratio Analysis 56
Practice Problems and Solutions 20 Classification System 56
Problems 21 The Analysis 57
Web Exercise 21 A. Profitability Ratios 58

xix
xx Contents

B. Asset Utilization Ratios 61 5 Operating and Financial Leverage 123

C. Liquidity Ratios 62
D. Debt Utilization Ratios 63 Leverage in a Business 123
Trend Analysis 64 Operating Leverage 124
Impact of Inflation on Financial Analysis 67 Break-Even Analysis 124
An Illustration 68 A More Conservative Approach 126
Disinflation Effect 69 The Risk Factor 128
Deflation 70 Cash Break-Even Analysis 128
Other ­Elements of Distortion in Reported Degree of Operating Leverage 129
Income 70 Leveraged Firm 129
Explanation of Discrepancies 71 Conservative Firm 130
Sales 71 Limitations of Analysis 131
Cost of Goods Sold 71 Financial Leverage 131
Net Income 71 Impact on Earnings 132
Summary 72 Degree of Financial Leverage 134
List of Terms 72 Plan A (Leveraged) 135
Discussion Questions 72 Plan B (Conservative) 135
Practice Problems and Solutions 73 Limitations to Use of Financial
Problems 76 Leverage 135
Comprehensive Problems 87 Combining Operating and Financial
Web Exercise 92 Leverage 135
Degree of Combined Leverage 137
4 Financial Forecasting 94 A Word of Caution 138
Summary 139
Constructing Pro Forma Statements 95
Review of Formulas 140
Pro Forma Income Statement 96
List of Terms 141
Establish a Sales Projection 96
Discussion Questions 141
Determine a Production Schedule and the
Practice Problems and Solutions 141
Gross Profit 96
Problems 143
Cost of Goods Sold 98
Comprehensive Problems 152
Other Expense Items 99
Web Exercise 154
Actual Pro Forma Income
Statement 99
Cash Budget 100
Cash Receipts 100 PART 3 | WORKING CAPITAL
Cash Payments 101 MANAGEMENT
Actual Budget 102
Pro Forma Balance Sheet 103 6 Working Capital and the Financing
Explanation of Pro Forma Balance Decision 156
Sheet 105
Analysis of Pro Forma The Nature of Asset Growth 157
Statement 106 Controlling Assets—Matching Sales
Percent-of-Sales Method 106 and Production 158
Summary 109 Temporary Assets under Level
List of Terms 109 Production—an Example 161
Discussion Questions 110 Patterns of Financing 166
Practice Problems And Solutions 110 Alternative Plans 167
Problems 111 Long-Term Financing 167
Comprehensive Problems 120 Short-Term Financing (Opposite
Web Exercise 122 Approach) 168

The Financing Decision 169
Term Structure of Interest Rates 169
A Decision Process 174
Introducing Varying Conditions 175
Expected Value 175
Toward an Optimal Policy 176
Summary 178
List of Terms 179
Discussion Questions 179
Practice Problems and Solutions 179
Problems 181
Web Exercise 187
7 Current Asset Management 188
Cash Management 189
Reasons for Holding Cash
Balances 189
Cash Flow Cycle 189
Collections and Disbursements 191
Float 192
Improving Collections 193
Extending Disbursements 193
Cost-Benefit Analysis 193
Electronic Funds Transfer 194
International Cash Management 195
Marketable Securities 197
Management of Accounts Receivable 201
Accounts Receivable as an
Investment 201
Credit Policy Administration 202
Credit Standards 202
Terms of Trade 205
Collection Policy 205
An Actual Credit Decision 205
Inventory Management 206
Level versus Seasonal Production 207
Inventory Policy in Inflation
(and Deflation) 207
The Inventory Decision Model 207
Carrying Costs 208
Ordering Costs 208
Economic Ordering Quantity 209
Safety Stock and Stockouts 210
Just-in-Time Inventory Management 211
Cost Savings from Lower
Inventory 212
Other Benefits 212
The Downside of JIT 212
Summary 213
Contents xxi
List of Terms 214
Discussion Questions 214
Practice Problems and Solutions 215
Problems 216
Comprehensive Problems 221
Web Exercise 222
8 Sources of Short-Term Financing 223
Trade Credit 224
Payment Period 224
Cash Discount Policy 224
Net Credit Position 225
Bank Credit 225
Prime Rate and LIBOR 226
Compensating Balances 226
Maturity Provisions 229
Cost of Commercial Bank Financing 229
Interest Costs with Compensating
Balances 230
Rate on Installment Loans 230
Annual Percentage Rate 231
The Credit Crunch Phenomenon 231
Financing through ­Commercial Paper 232
Advantages of Commercial Paper 234
Limitations on the Issuance of Commercial
Paper 234
Foreign Borrowing 235
Use of ­Collateral in Short-Term
Financing 236
Accounts Receivable Financing 236
Pledging Accounts Receivable 237
Factoring Receivables 237
Asset-Backed Public Offerings of
Receivables 238
Inventory Financing 239
Stages of Production 239
Nature of Lender Control 239
Blanket Inventory Liens 239
Trust Receipts 239
Warehousing 239
Appraisal of Inventory Control
Devices 240
Hedging To Reduce ­Borrowing Risk 241
Summary 242
List of Terms 243
Discussion Questions 243
Practice Problems and Solutions 244
Problems 245
Web Exercise 250
xxii Contents

PART 4 | T
 HE CAPITAL BUDGETING 10 Valuation and Rates of Return 299
PROCESS Valuation Concepts 300
Valuation of Bonds 300
9 The Time Value of Money 252 Present Value of Interest
Payments 302
Relationship to the Capital Outlay
Present Value of Principal Payment
Decision 252
(Par Value) at Maturity 302
Future Value—Single Amount 253
Bond Valuation Using a Financial
Present Value—Single Amount 256
Calculator 302
Interest Rate—Single Amount 258
Using Excel’s PV Function to Calculate a
Number of Periods—Single Amount 259
Bond Price 303
Future Value—Annuity 260
Concept of Yield to Maturity 303
Present Value—Annuity 262
Changing the Yield to Maturity and the
Alternative Calculations: Using TVM
Impact on Bond Valuation 305
Tables 263
Increase in Inflation Premium 305
Graphical Presentation of Time Value
Decrease in Inflation Premium 306
Relationships 263
Time to Maturity 307
The Relationship between Present Value
Determining Yield to Maturity from the
and Future Value 263
Bond Price 307
The Relationship between the Present
Semiannual Interest and Bond Prices 311
Value of a Single Amount and the Present
Valuation and Preferred Stock 311
Value of an Annuity 265
Determining the Required Rate of Return
Future Value Related to the Future Value of
(Yield) from the Market Price 313
an Annuity 266
Valuation of Common Stock 314
Determining the Annuity Value 268
No Growth in Dividends 314
Annuity Equaling a Future Value 268
Constant Growth in Dividends 314
Annuity Equaling a Present Value 268
Stock Valuation Based on Future Stock
Finding Annuity Payments with a Financial
Value  316
Calculator or Excel 269
Determining the Required Rate of Return
Finding Interest Rates and the Number of
from the Market Price 317
Payments 270
The Price-Earnings Ratio Concept and
Finding Annuity Interest Rates 270
Valuation 318
Finding the Number of Annuity
Variable Growth in Dividends 319
Payments 271
Summary and Review of Formulas 321
Compounding over Additional Periods 271
List of Terms 323
Patterns of Payment with a Deferred
Discussion Questions 323
Annuity 272
Practice Problems And Solutions 324
Annuities Due 274
Problems 325
List of Terms 275
Comprehensive Problems 332
Discussion Questions 275
Web Exercise 333
Practice Problems and Solutions 275
APPENDIX 10A Valuation of a Supernormal
Problems 277
Growth Firm 334
Comprehensive Problems 282
Web Exercise 283
APPENDIX 9A Alternative Calculations:
11 Cost of Capital 337
Using TVM Tables 284
APPENDIX 9B Yield and Payment Examples The Overall Concept 337
Using TVM Tables 287 Cost of Debt 338
APPENDIX 9C Using Calculators for Cost of Preferred Stock 340
Financial Analysis 290 Cost of Common Equity 341
 Contents xxiii

Valuation Approach 341 Elective Expensing 397

Required Return on Common Stock Using
the Capital Asset Pricing Model 342
Cost of Retained Earnings 343
Cost of New Common Stock 344
Overview of Common Stock Costs 345
Optimum Capital Structure—Weighting
Costs 345
Capital Acquisition and Investment
Decision Making 347
Cost of Capital in the Capital Budgeting
Decision 348
The Marginal Cost of Capital 350
Summary 354
Review of Formulas 355
List of Terms 356
Discussion Questions 356
Practice Problems and Solutions 357
Problems 359
Comprehensive Problems 367
Web Exercise 368
APPENDIX 11A Cost of Capital and the
Capital Asset Pricing Model 369
List of Terms 375
Discussion Questions 375
Problems 375
12 The Capital Budgeting Decision 376
Administrative Considerations 377
Accounting Flows versus Cash Flows 377
Methods of Ranking Investment
Proposals 379
Payback Method 380
Net Present Value 381
Internal Rate of Return 383
Selection Strategy 385
Reinvestment Assumption 386
Modified Internal Rate of Return 387
Capital Rationing 388
Combining Cash Flow Analysis and
Selection Strategy 389
The Rules of Depreciation 389
The Tax Rate 392
Actual ­Investment Decision 392
The Replacement Decision 393
Sale of Old Asset 395
Tax Benefit on the Sale of Old
Asset 395
Incremental Depreciation 396
Summary 398
List of Terms 398
Discussion Questions 398
Practice Problems and Solutions 399
Problems 400
Comprehensive Problems 408
Web Exercise 409
APPENDIX 12A New Present Value
Profile 410
13 Risk and Capital Budgeting 415
Definition of Risk in Capital
Budgeting 415
The Concept of Risk-Averse 417
Actual Measurement of Risk 417
Risk and the Capital Budgeting
Process 421
Risk-Adjusted Discount Rate 421
Increasing Risk over Time 422
Qualitative Measures 424
Example—Risk-Adjusted Discount
Rate 424
Simulation Models 425
Decision Trees 426
The Portfolio Effect 427
Portfolio Risk 427
Evaluation of Combinations 431
The Share Price Effect 432
Summary 432
Review of Formulas 433
List of Terms 433
Discussion Questions 433
Practice Problems and Solutions 434
Problems 435
Comprehensive Problems 445
Web Exercise 447
PART 5 | LONG-TERM
 FINANCING
14 Capital Markets 449
International Capital Markets 450
Competition for Funds in the U.S. Capital
Markets 453
Government Securities 453
U.S. Government Securities 453
xxiv Contents
Federally Sponsored Credit
Agencies 453
State and Local Securities 454
Corporate Securities 454
Corporate Bonds 454
Preferred Stock 455
Common Stock 455
Internal versus External Sources of
Funds 455
The Supply of Capital Funds 457
The Role of the Security Markets 458
The Organization of the Security
Markets 459
Traditional Organized Exchanges 459
Listing Requirements for Firms 460
The Major Exchanges 460
ICE 461
CBOE Global Markets 461
The NASDAQ Market 461
Foreign Exchanges 462
Other Financial Exchanges 462
Electronic Communication Networks
(ECNs) 463
Market Efficiency 464
The Efficient Market Hypothesis 464
Regulation of the Security Markets 465
The Securities Act of 1933 466
The Securities Exchange Act of 1934 467
The Securities Acts Amendments of
1975 467
The Sarbanes–Oxley Act of 2002 468
Summary 468
List of Terms 469
Discussion Questions 469
Web Exercise 470
15 Investment Banking 471
The Role of Investment Banking 473
Investment Banking Competition 473
Enumeration of Functions 473
Underwriter 473
Market Maker 474
Advisor 474
Agency Functions 474
The ­Distribution Process 476
The Spread 477
Pricing the Security 479
Debt versus Equity Offerings 479
Dilution 480
Market Stabilization 480
Aftermarket 482
Shelf Registration 484
The Gramm–Leach–Bliley Act Repeals
the Glass–Steagall Act 484
Public ­versus Private Financing 485
Advantages of Being Public 485
Disadvantages of Being
Public 485
Public Offerings 486
A Classic Example—Rosetta Stone Goes
Public 486
Private Placement 489
Going Private and Leveraged
Buyouts 489
International Investment Banking
Deals 491
Privatization 491
Summary 492
List of Terms 492
Discussion Questions 492
Practice Problems and Solutions 493
Problems 494
Comprehensive Problem 500
Web Exercise 501
16 Long-Term Debt and Lease
Financing 502
The Expanding Role of Debt 502
The Debt Contract 504
Par Value 504
Coupon Rate 504
Maturity Date 504
Security Provisions 504
Unsecured Debt 505
Methods of Repayment 506
Serial Payments 506
Sinking-Fund Provision 506
Conversion  506
Call Feature  506
An Example: Eli Lilly’s 6.77 Percent
Bond 507
Bond Prices, Yields, and Ratings 508
Bond Yields 509
Nominal Yield (Coupon Rate)   509
Current Yield 510
Yield to Maturity 510

Bond Ratings 510
Examining Actual Bond Ratings 511
The Refunding Decision 512
A Capital Budgeting Problem 512
Step A—Identification of Cash Inflows and
Outflows 513
Step B—Calculating Each Cash
Flow 513
Aftertax Interest Savings 513
Aftertax Call Premium Cost 514
New Underwriting Costs and Tax
Benefits of Amortization 514
Accelerated Tax Benefits from
Unamortized Underwriting Cost on
Original Bond
515
Loss of Amortization Tax Benefits from
the Original Bond Underwriting 515
Step C—Net Present Value of Combined
Cash Flows 516
Other Forms of Bond Financing 517
Advantages and Disadvantages of
Debt 519
Benefits of Debt 519
Drawbacks of Debt 520
Eurobond Market 520
Leasing as a Form of Debt 520
Finance Lease versus Operating
Lease 522
Income Statement Effect 522
Advantages of Leasing 523
Summary 524
List of Terms 524
Discussion Questions 525
Practice Problems and Solutions 526
Problems 528
Comprehensive Problems 533
Web Exercise 533
APPENDIX 16A Financial Alternatives
for Distressed Firms 534
17 Common and Preferred Stock
Financing 540
Common Stockholders’ Claim to
Income 541
The Voting Right 543
Cumulative Voting 543
The Right to Purchase New
Shares 546
Contents xxv
The Use of Rights in Financing 547
Rights Required 548
Monetary Value of a Right 549
Effect of Rights on Stockholder’s
Position 550
Desirable Features of Rights Offerings 551
Poison Pills 552
American Depository Receipts 553
Preferred Stock Financing 554
Justification for Preferred Stock 555
Investor Interest 555
Summary of Tax Considerations 556
Provisions Associated with Preferred
Stock 556
1. Cumulative Dividends 556
2. Conversion Feature  556
3. Call Feature 557
4. Participation Provision 557
5. Floating Rate 557
6. Auction Rate Preferred Stock 557
7. Par Value 558
Comparing Features of Common and
Preferred Stock and Debt 558
Summary 560
Review of Formulas 560
List of Terms 561
Discussion Questions 561
Practice Problems And Solutions 562
Problems 563
Comprehensive Problems 568
Web Exercise 570
18 Dividend Policy and Retained
Earnings 571
The Marginal Principle of Retained
Earnings 572
Life Cycle Growth and Dividends 572
Dividends as a Passive Variable 572
An Incomplete Theory 573
Arguments for the Relevance of
Dividends 574
Dividend Stability 575
Other ­Factors Influencing Dividend
Policy 578
Legal Rules 578
Cash Position of the Firm 579
Access to Capital Markets 579
Desire for Control 579
Tax Position of Shareholders 579
xxvi Contents

Dividend Payment Procedures 581 PART 6 | E

 XPANDING THE PERSPECTIVE OF
Stock Dividend 582
CORPORATE FINANCE
Accounting Considerations for a Stock
Dividend 582
20 External Growth through Mergers 628
Value to the Investor 583
Possible Value of Stock Dividends 584 Motives for Business Combinations 630
Use of Stock Dividends 584 Financial Motives 630
Stock Splits 584 Portfolio Effect 630
Reverse Stock Splits 585 Access to Financial Markets 631
Repurchase of Stock as an Alternative to Tax Inversions 631
Dividends 586 Tax Loss Carryforward 632
Other Reasons for Repurchase 587 Nonfinancial Motives 634
Dividend Reinvestment Plans 589 Motives of Selling Stockholders 634
Summary 590 Terms of Exchange 634
List of Terms 590 Cash Purchases 635
Discussion Questions 590 Stock-for-Stock Exchange 636
Practice Problems and Solutions 591 Portfolio Effect 637
Problems 592 Accounting Considerations in Mergers and
Comprehensive Problems 599 Acquisitions 638
Web Exercise 600 Negotiated versus Tendered Offers 639
Premium Offers and Stock Price
19 Convertibles, Warrants, and Movements 642
Derivatives 601 Two-Step Buyout 643
Summary 645
Convertible Securities 602
List of Terms 645
Value of the Convertible Bond 602
Discussion Questions 645
Is This Fool’s Gold? 605
Practice Problems and Solutions 646
Advantages and Disadvantages to the
Problems 647
Corporation 606
Web Exercise 652
Forcing Conversion 607
Accounting Considerations with 21 International Financial Management 653
Convertibles 608
Financing through Warrants 610 The Multinational Corporation: Nature and
Valuation of Warrants 613 Environment 656
Use of Warrants in Corporate Exporter 656
Finance 614 Licensing Agreement 656
Accounting Considerations with Joint Venture 656
Warrants 614 Fully Owned Foreign
Derivative Securities 615 Subsidiary 656
Options 615 Foreign Exchange Rates 657
Futures 616 Factors Influencing Exchange
Summary 617 Rates 657
Review of Formulas 618 Purchasing Power Parity 658
List of Terms 618 Interest Rates 660
Discussion Questions 618 Balance of Payments 660
Practice Problems and Solutions 619 Government Policies 660
Problems 620 Other Factors 660
Comprehensive Problems 625 Spot Rates and Forward Rates 661
Web Exercise 626 Cross Rates 662

Managing Foreign Exchange Risk 664
Forward Exchange Market Hedge 665
Money Market Hedge 665
Currency Futures Market Hedge 666
Foreign Investment Decisions 667
Analysis of Political Risk 669
Financing International Business
Operations 670
Funding of Transactions 671
Eximbank (Export-Import Bank) 671
Loans from the Parent Company or a
Sister Affiliate 671
Eurodollar Loans 673
Eurobond Market 673
International Equity Markets 674
The International Finance
Corporation 675
Some Unsettled Issues in International
Finance 675
Summary 676
List of Terms 677
Contents xxvii
Discussion Questions 677
Practice Problems and Solutions 678
Problems 679
Web Exercise 680
APPENDIX 21A Cash Flow Analysis and
the Foreign Investment Decision 681
Appendices A-1
Appendix A Future Value of $1, FVIF A-2
Appendix B Present Value of $1, PVIF A-4
Appendix C Future Value of an Annuity
of $1, FVIFA A-6
Appendix D Present Value of an Annuity of
$1, PVIFA A-8
Appendix E Keystrokes for HP 12C and HP
10bii Calculators A-10
Glossary G-1
Indexes I-1
 Finance in
ACTION

Managerial

List of Selected Real-World Managerial

Examples and Boxes
Chapter Subject, Title, Table Number, or Company Name Page

1 3M and the Pandemic Response 2

Finance in Action—The Purpose of the Corporation 14
2 Price-Earnings Ratios for Selected U.S. Companies—Table 2-3 26
Intellectual Property and Accounting 30
Comparison of Market Value to Book Value per Share in
January 2021—Table 2-5 31
Finance in Action—Taxes a Strategic Tool for Competition between
Countries and States 41
3 Colgate vs. Procter & Gamble Return on Equity 55
DuPont Method of Analysis Comparing Walmart and Target—Table 3-2 61
Intel vs. Advanced Micro Devices—Figure 3-3 66
Finance in Action: Are Ratios Good Predictors of a Company’s Value? 67
4 Dollar General Corporate Strategy 94
Finance in Action—Tesla’s Sales Forecasts: Where Marketing and Finance
Come Together 97
Finance in Action—Pro Forma Financial Statements: A Critical Tool for
Entrepreneurs 108
5 The Airline Industry and Leverage 123
Ford Motor Company, American Airlines 129
Finance in Action—Give Shareholders a Slice of the Apple and Leverage
Rises 138
6 McDonalds, Walmart, Harley-Davidson, and Ericsson and Supply
Chain Management 156
Finance in Action—The Future of Commerce—Shopify 158
Harley Davidson Quarterly Sales and Earnings—Figure 6-2 160
Target and Macy’s Quarterly Sales and Earnings—Figure 6-3 162
Treasury Yield Curve—Figure 6-9 172
Long- and Short-Term Annual Interest Rates—Figure 6-10 173
Finance in Action—Working Capital Problems in a Small Business
(Calloway’s Nursery) 177
7 Retail Christmas Sales 188
Finance in Action—The Cloud, B2B, and Working Capital Management 192
Types of Short-Term Investments—Table 7-1 199
Dun & Bradstreet D-U-N-S Numerical Tracking System—Figure 7-7 204
Finance in Action—NASA Experiments with Inventory Tracking on the
International Space Station (ISS) 211

xxviii
8 Yum! Brands’s Short-Term Financing 223
The Prime Rate vs. LIBOR—Figure 8-1 227
Finance in Action—What Will Replace LIBOR? 228
Total Commercial Paper Outstanding—Figure 8-2 233
Comparison of Commercial Paper Rate to Prime Rate—Table 8-1 235
Finance in Action—How About Going to the Internet to Borrow Money? 240
9 An Example of an Individual Retirment Account 252
Finance in Action—Powerball Jackpot Decisions 262
10 Valuation of DuPont de Nemours, AMETEK Inc., and Bio-Techne Corp. 299
Comparing Price-Earnings Ratios for Tesla and General Motors 318
Coca-Cola P/E Ratio Figure—10-4 319
Finance in Action—An Important Question: What’s a Small Business
Really Worth? 320
11 Corporate Debt to Equity from S&P Capital IQ Net Advantage—Table 11-3 340
2018 and 2021 Long-Term Debt as a Percentage of Debt + Equity—
Table 11-4 347
Finance in Action—Do Green Bonds Have a Lower Cost of Capital? 351
12 Texas Instruments, Rapid Data Systems, IBM, and Others in the Calculator and
Computer Industries 376
Finance in Action—Capital Budgeting Practices Utilized by Smaller,
Privately Held Businesses 381
13 Risk and Oil Drilling—The Case of Apache Corp. 415
Average Betas for a Five-Year Period—Table 13-2 420
Finance in Action: Energy: A High-Risk Industry 423
Finance in Action—Real Options Add a New Dimension to Capital Budgeting 430
14 Stay at home stock—Microsoft, Dropbox, Zoom, and Apple 449
Domestic Market Capitalization—Figure 14-1 451
Internally Generated Funds—Corporate Profits, Dividends, and Retained
Earnings—Figure 14-2 456
Flow of Funds through the Economy—Figure 14-3 457
Finance in Action—The World’s Biggest Exchange: Hatched from an Egg? 458
Competing Exchanges Headquartered in the United States—Table 14-2 460
World Markets by Geographic Region—Table 14-3 463
Finance in Action—Dark Pools—Market Efficiency or a Question of Ethics? 465
15 International Companies’ IPOs on U.S. Exchanges 471
Examples of Global Equity IPOs 2014–2021—Table 15-1 472
Global Rankings of Investment Bankers, 2019 vs. 2020—Table 15-2 474
Investment Banking Leaders by Products, Regions, and Industries—Table 15-3 475
Global Underwriting Fees and Number of Deals by Quarter and
Product—Table 15-4 476
Global Debt and Equity Capital Markets Bookrunner Rankings—Table 15-7 480
Finance in Action—SPACs: Special Purpose Acquisition Companies 481
Facebook IPO Example 482
A Classic Example of Instant Wealth—Rosetta Stone Goes Public 486
Finance in Action—Tulip Auctions and the Google IPO 490
16 Macy’s Earnings before Interest and Taxes—Figure 16-1 503
Eli Lilly Bond Offering—Table 16-1 507
Finance in Action: Soccer Bonds Bounce Back 508
Long-Term Yields on Debt—Figure 16-3 510

xxix
 Outstanding Bond Issues—Table 16-3 512
Zero-Coupon Bonds—Table 16-10 518
Finance in Action—Negative Interest Rates Give Lenders Less Than
They Pay for 519
Eurobonds—Table 16-11 520
17 Tower Semiconductor Inc. Common Stock 540
Institutional Ownership of U.S. Companies—Table 17-1 542
Ford Motor Company, Facebook, Alphabet, and Palantir Founders’ Shares 543
Finance in Action—Corporate Goverance and Capital Allocation—Apple and
Facebook Inc. 545
Selected Rights Offerings from Around the World 547
18 Philip Morris Dividend Policy 571
Corporate Dividend Policy of Actual Companies—Table 18-1 575
Standard & Poor’s 500 Index Quarterly Earnings and
Dividends—Figure 18-2 576
Finance in Action—Being an Aristocrat Is Pretty Good 577
Reverse Stock Split by Lucent Technologies 586
Recent Examples of Billion-Dollar Stock Repurchases—Table 18-8 588
19 BioMarin Pharmaceutical Convertible Notes 601
Price Movement Pattern for a Convertible Bond—Figure 19-1 604
Largest Convertible Bond Issues of 2020—Table 19-2 607
Successful Convertible Bond Issues—Table 19-3 608
Occidental Petroleum Warrants—Figure 19-3 612
Finance in Action—Enticing Investors through Convertibles and Warrants 614
20 Berkshire Hathaway’s Mergers and Acquisitions 628
Largest Mergers and Acquisitions Worldwide—Table 20-1 629
Mergers & Acquisitions: North America—Figure 20-1 630
Sears’s Divestitures 631
Finance in Action—Are Diversified Firms Winners or Losers? 633
Merger and Acquisitions: Hostile Takeovers—Figure 20-3 640
Johnson & Johnson Buys Neutrogena Corporation 642
M&A Takeover Premiums for U.S. and Non-U.S. Deals
(2014–2019)—Figure 20-4 642

xxx
 Finance in
ACTION
Global

List of Selected Global

Examples and Boxes
Chapter Subject, Title, Table Number, or Company Name Page

1 Internationalization of the Financial Markets 17

2 Finance in Action—International Accounting Standards vs. U.S. GAAP 37
Finance in Action—Taxes a Strategic Tool for Competition between
Countries and States 41
7 SWIFT International Electronic Funds Transfer 195
Eurodollar Certificates of Deposit 200
Data Universal Number System (D-U-N-S) 204
8 The Prime Rate vs. LIBOR—Figure 8-1 227
Hedging Activities—Procter & Gamble and ExxonMobil 242
Hedging the Yen 242
13 Risk Categories and Associated Discount Rates—New Product in
Foreign Market—Table 13-3 424
14 International Capital Markets 450
Major World Markets by Capitalization—Figure 14-1 451
World Federation of Exchanges Members—Table 14-1 452
World Markets by Geographic Region—Table 14-3 463
15 International Companies’ IPOs on U.S. Exchanges 471
Examples of Global Equity IPOs 2014–2021—Table 15-1 472
Global Ranking of Investment Bankers, 2019 vs. 2020—Table 15-2 474
Investment Banking Leaders by Products, Regions, and Industries—
Table 15-3 475
Global Underwriting Fees and Number of Deals by Quarter and Product—
Table 15-4 476
Global Debt and Equity Capital Markets Bookrunner Rankings—Table 15-7 480
Privatization of Companies in Foreign Markets 491
16 Eurobonds—Table 16-11 520
17 Selected Rights Offerings from Around the World 547
Finance in Action—HSBC Holdings plc Rights Offering 552
American Depository Receipts and Foreign Stock Ownership 553
20 Largest Mergers and Acquisitions Worldwide—Table 20-1 629
M&A Takeover Premiums for U.S. and Non-U.S. Deals (2014–2019)—
Figure 20-4 642
21 Dependence of Financial Markets 653
Euro vs. U.S. Dollar—Figure 21-1 654
International Sales of Selected U.S. Companies—Table 21-1 655
Factors Influencing Exchange Rates 657
Four Countries’ Exchange Rates to the Dollar—Figure 21-2 658

xxxi
 Finance in Action—Taking a Bite Out of Purchasing Power Parity with the
Big Mac 659
Spot Rates and Forward Rates 661
Foreign Exchange Cross Rates of Major World Currencies—Table 21-2 663
Currency Futures Hedging—Table 21-3 666
Finance in Action—Coca-Cola Manages Currency Risk 667
Risk Reduction from International Diversification—Figure 21-3 668
Eurodollar Loans 673
International Equity Markets 674

xxxii
 PART

ONE
Introduction
CHAPTER 1
The Goals and Activities of Financial Management

1
 1 LEARNING OBJECTIVES

LO 1-1 List some of the concepts the field of

The Goals
finance covers.
LO 1-2 Recognize that a firm can have many
different forms of organization.

and Activities
LO 1-3 Describe how the relationship of risk to
return is a central focus of finance.
LO 1-4 Explain the primary goal of financial
managers.

of Financial
LO 1-5 Recall that financial managers attempt
to achieve wealth maximization through
daily activities such as credit and inventory

Management
management and through ­longer-term
decisions related to raising funds.
LO 1-6 Explain future and present value and how
they relate to the time value of money.

W
hen the COVID-19 pandemic struck in 2020, 3M Company rushed to set up new
production lines for ventilator masks, respirators, and other personal protective
equipment. The medical community, where 3M’s products are highly regarded,
appreciated these efforts. But 3M isn’t just a medical products company. Most students have
used 3M’s Scotch tape and Post-It notes products. In fact, 3M sells over 55,000 different
products in 26 different business lines. The company has always been known for its ability
to create new products and markets, and, at times, as much as 35 percent of its sales have
been generated from products developed in the previous five years. To accomplish these
goals, 3M’s research and development has to be financed, the design and production func-
tions funded, and the products marketed and sold worldwide. This process involves all the
functions of business.
Did you ever stop to think about the importance of the finance function for a $100 b
­ illion
multinational company like 3M where 60 percent of sales are international? Someone has
to manage the international cash flow, bank relationships, payroll, purchases of plant and
equipment, and acquisition of capital. Financial decisions must be made concerning the fea-
sibility and profitability of the continuous stream of new products developed through 3M’s
creative research and development efforts. The finance team needs to keep an eye on inter-
est rates and foreign exchange rates.
To have a competitive and flexible multinational company, the financial team must man-
age 3M’s global affairs and react quickly to changes in both product markets and financial
markets. But what processes do companies use to make effective financial decisions? If you
would like to do some research on 3M, you can access its home page at www.3m.com.
If you would like to understand more about how businesses make good financial decisions,
keep reading.

2
 Chapter 1 The Goals and Activities of Financial Management 3

The Field of Finance

In a sense, the field of finance fits between the fields of economics and accounting.
Economics provides a broad picture of the economic environment in which businesses
operate. For example, economists consider how consumers and producers change
their behaviors in response to price changes and other incentives. In fact, finance is so
closely tied to economics that many of the best-known winners of the Nobel Prize for
Economics were actually financial economists. These finance pioneers were primarily
concerned with how investors might measure various risks and how these investors
should set the price of stocks, bonds, and other assets (like options) once they under-
stand the nature of those risks. Obviously, a financial manager needs to be concerned
with issues like these.
Accounting is sometimes said to be the language of finance because it provides
financial data through income statements, balance sheets, and the statement of cash
flows. A financial manager needs to know how to interpret and use these statements
to extract clues about how to allocate resources so that they generate the best return
possible in the long run. Finance is so closely tied to accounting that the chief financial
officer (CFO) at most large businesses is not only charged with financial planning, but
is also responsible for the firm’s accounting and tax systems.
One important difference between the finance function and accounting is that
accounting generally measures the results of a business’s past activities and conveys
this information through financial statements to management, stockholders, regula-
tors, and others. In contrast, finance is generally forward-looking. The future is still
unknown and filled with risks and opportunities. Finance principles must be used to
decide which path to choose from among many competing future investment options.
After a path has been selected, the accounting function will record the results.

Investments vs. Corporate Finance

Finance is such a broad topic that the field is often divided into two general subcategories,
investments and corporate finance. A somewhat simplistic way to distinguish between
these two subcategories of finance is to consider who is most likely to practice each.
Let’s consider Apple, the large computer, phone, and technology company. Investors use
investment principles to value the stock and bonds of many companies, including those of
Apple. Then these investors choose which stocks and bonds to buy. They may choose to
buy Apple stock, or Apple’s bonds, or the stock and bonds of other companies. Actually,
investors often invest in a portfolio of securities issued by multiple companies. Notice
that these investors are not likely to be employees or even consultants to Apple. They
operate completely outside of the corporate enterprise.
In contrast, corporate finance is of daily concern to many people who are employed
by Apple. Corporate finance principles are used to determine which assets the firm
should develop or buy, which securities Apple should issue (stocks vs. bonds), how
management compensation should be structured, and other “inside the company” issues.
Most students of finance start out exploring corporate finance and later extend
their studies to investments. Notice that this book is titled Foundations of Financial
Management. The term financial management can be used interchangeably with
4 Part 1 Introduction

corporate finance. Thus, true to its name, this text is primarily concerned with intro-
ductory corporate finance topics. However, financial managers can’t work successfully
while staying inside a bubble. They must also be familiar with various investments
topics. It would be almost impossible to satisfy the firm’s shareholders and bankers if
management is unaware of how outside investors evaluate the company. Thus, you will
be introduced to various investments-related topics as they are needed for the training
of a novice financial manager.

The Value of Studying Finance

Many students approaching the field of finance for the first time might wonder what
career opportunities exist. For those who develop the necessary skills and training,
jobs include corporate financial officer, banker, stockbroker, financial analyst, portfo-
lio manager, investment banker, financial consultant, or personal financial planner. As
we progress through the text, you will become increasingly familiar with the important
role of the various participants in the financial decision-making process. A financial
manager addresses such varied issues as decisions on plant location, the raising of
capital, or simply how to get the highest return on the firm’s cash cushion between five
o’clock this afternoon and eight o’clock tomorrow morning.
For students who have no intention of pursuing a job in the field of finance, an
understanding of finance is still important. For students of management, you should be
aware that the top management job in a business is held by the chief executive officer
(CEO). The CEO reports directly to the board of directors and is responsible for man-
aging the overall business. According to the international consulting firm McKinsey
& Company, about a fifth of all CEOs of publicly traded companies in the United
Kingdom and the United States once served as CFO. All other CEOs have almost
certainly had some training in finance because managing a firm is almost impossible
without it.
Over time, the field of marketing has also become more closely linked to finance.
Marketing managers today are interested in the return on investment from money spent
on marketing initiatives. Also, inputs provided by marketing specialists are often key
variables used to assess the viability of various proposed projects. Financial analysts
need to know what level of sales and revenue can be expected if a course of action is
undertaken, and marketing professionals often take the lead in proposing new product
lines. Moving a product from proposal to production requires an assessment that the
product will be financially viable. No marketing professional wants to be uninformed
about how their product’s financial viability is being determined.
For many readers, the most personal reason that you will want to study finance is
because you will be faced with important financial decisions in your own life. After
graduation, some students will consider taking out a student loan to attend gradu-
ate school. Graduating with an advanced degree sometimes results in greater earning
potential, but when the time comes to pay off the loan, what will the payments be?
Will the student be able to look back on the borrowing decision as a good one? On a
different note, once you begin a career, most businesses no longer provide pensions
that guarantee a defined benefit for retiring employees. Instead, employers deposit
funds into a 401(k) account, or some other defined contribution account. How much
 Chapter 1 The Goals and Activities of Financial Management 5

an employee can expect to receive in retirement benefits is dependent upon how well
the funds are invested over the individual’s career.
Throughout your life, you will be faced with financial decisions, and the more
financially successful you become, the more financial decisions you will be asked to
make, in both your personal life and your business life. Hopefully, you will find good
mentors along the way. But for now, this text is a good place to begin your quest for
financial literacy.

Activities of Financial Management

Financial managers perform a wide array of activities. Some of their responsibilities must
be addressed virtually every day. Others are addressed quarterly or annually. On a daily
basis, financial managers monitor cash balances, manage credit decisions to determine
which customers should be allowed to purchase on credit, monitor inventory levels to
ensure product is available to customers, and collect and distribute cash in the course of
daily operations. Less routine functions encompass negotiations with banks for loans to
finance business operations, the sale of stocks and bonds, and the establishment of capital
budgeting and dividend plans. Some financial activities are so infrequent that they might
only take place once in a financial manager’s career. Helping to determine whether to sell
a subsidiary or whether to take a private company public are two possible examples.
As indicated in Figure 1-1, all these functions are carried out while balancing the
profitability and risk components of the firm.
The appropriate risk-return trade-off must be determined to maximize the market
value of the firm for its shareholders. The risk-return decision will influence not only
the operational side of the business (capital versus labor or Product A versus Product B)
but also the financing mix (stocks versus bonds versus retained earnings).

Figure 1-1 Functions of the financial manager

Daily Occasional Profitability

Credit management Stock issue Goal:

Inventory control Bond issue Maximize
Trade-off
Receipt and disburse- Capital budgeting shareholder
ment of funds Dividend decision wealth

Risk

Forms of Organization
The finance function may be carried out within a number of different forms of organiza-
tions. Of primary interest are the sole proprietorship, the partnership, and the c­ orporation.
There are many reasons to choose one of these forms of organization. The number of
people in the organization is one factor. The liability of the owners is another. Other
reasons are the complexity involved with state and federal regulations and how these
organizations are taxed. This is borne out by the 2017 Tax Cuts and Jobs Act, which
significantly modified taxation for all these forms of organizations.
6 Part 1 Introduction

Sole Proprietorship The sole proprietorship form of organization represents single-

person ownership and offers the advantages of simplicity of decision making and low
organizational and operating costs. Most small businesses with 1 to 10 employees are
sole proprietorships. The major drawback of the sole proprietorship is that there is
unlimited liability to the owner. In settlement of the firm’s debts, the owner can lose
not only the capital that has been invested in the business but also personal assets.
This drawback can be serious, and you should realize that few lenders are willing to
advance funds to a small business without a personal liability commitment.
The profits or losses of a sole proprietorship are taxed as though they belong to the
individual owner. Thus, if a sole proprietorship makes $50,000, the owner will claim
the profits on his or her tax return. (In the corporate form of organization, the corpo-
ration pays a tax on profits, and then the owners of the corporation pay a tax on any
distributed profits.) Approximately 72 percent of the 30 million business firms in this
country are organized as sole proprietorships.

Partnership The second form of organization is the partnership, which is similar to

a sole proprietorship except there are two or more owners. Multiple ownership makes
it possible to raise more capital and to share ownership responsibilities. Most part-
nerships are formed through an agreement between the participants, known as the
articles of partnership, which specify the ownership interest, the methods for dis-
tributing profits, and the means for withdrawing from the partnership. For taxing pur-
poses, partnership profits or losses are allocated directly to the partners, and there is
no double taxation as there is in the corporate form.
Like the sole proprietorship, the partnership arrangement carries unlimited liability
for the owners. While the partnership offers the advantage of sharing possible losses,
it presents the problem of owners with unequal wealth having to absorb losses. If three
people form a partnership with a $10,000 contribution each and the business loses
$100,000, one wealthy partner may have to bear a disproportionate share of the losses
if the other two partners do not have sufficient personal assets.
To circumvent this shared unlimited liability feature, a special form of partnership,
called a limited liability partnership, can be utilized. Under this arrangement, one or
more partners are designated general partners and have unlimited liability for the debts
of the firm; other partners are designated limited partners and are liable only for their
initial contribution. The limited partners are normally prohibited from being active in
the management of the firm. You may have heard of limited partnerships in real estate
syndications in which a number of limited partners are doctors, lawyers, and CPAs and
there is one general partner who is a real estate professional. Not all financial institu-
tions will extend funds to a limited partnership.

Corporation In terms of revenue and profits produced, the corporation is by far the
most important type of economic unit. While only about 20 percent of U.S. business
firms are corporations, they are dominated by large corporations like Apple, Micro-
soft, Amazon, Exxon, and Walmart. Approximately 80 percent of sales and 70 percent
of profits can be attributed to the corporate form of organization. The corporation
is unique—it is a legal entity unto itself. Thus, the corporation may sue or be sued,
 Chapter 1 The Goals and Activities of Financial Management 7

engage in contracts, and acquire property. A corporation is formed through articles of

incorporation, which specify the rights and limitations of the entity.
A corporation is owned by shareholders who enjoy the privilege of limited
liability, meaning their liability exposure is generally no greater than their initial
investment.1 A corporation also has a continual life and is not dependent on any one
shareholder for maintaining its legal existence.
A key feature of the corporation is the easy divisibility of the ownership interest
by issuing shares of stock. While it would be nearly impossible to have more than
10,000 or 20,000 partners in most businesses, a corporation may have several ­hundred
­thousand shareholders. For example, General Electric has 8.8 billion shares of common
stock outstanding with 63.6 percent institutional ownership (pension funds, mutual
funds, etc.), while Microsoft, with 7.6 billion shares outstanding, has 74 ­percent insti-
tutional ownership.
The shareholders’ interests are ultimately managed by the corporation’s board of
directors. The directors may include key management personnel of the firm as well as
directors from outside the firm. Directors serve in a fiduciary capacity for the share-
holders and may be liable for the mismanagement of the firm. After the collapse of
very large publicly traded corporations such as Enron and WorldCom due to fraud, the
role of outside directors became much more important, and corporations were moti-
vated to comply with more stringent corporate governance laws mandated by Con-
gress. Outside directors may make a few thousand dollars per year for serving on the
board of small companies, but directors serving on the boards of S&P 500 companies
earn fees of more than $250,000 per year, on average. Directors serving on the audit
and compensation committees are frequently paid additional fees.
Because the corporation is a separate legal entity, it reports and pays taxes on its own
income. As previously mentioned, any remaining income that is paid to the shareholders
in the form of dividends will require the payment of a second tax by the ­shareholders.
One of the key disadvantages to the corporate form of organization is this potential
­double taxation of earnings. The company pays taxes on its income and, when stock-
holders receive their dividends, they pay a second tax. The federal tax on dividends
ranges from 0 percent for low-income individuals to 15 percent and finally 23.8 percent
for people in the highest tax bracket. States also tax dividends at various rates.
The federal corporate tax rate has changed over the years. Relatively recently,
the 2017 Tax Cuts and Jobs Act cut the U.S. corporate tax rate from 35 percent to
21 percent. This put U.S. companies on a competitive footing with companies head-
quartered in other countries. Prior to this tax cut, several U.S.-based companies had
moved their operations overseas to avoid the higher U.S. rate. Whether tax rates will
rise or fall further is an open question. With more employees working online, the head-
quarters operations for most multinational companies can be placed almost anywhere.
Recognizing this, countries around the world have slashed tax rates in an effort to
attract and retain businesses. Most governments probably would like to increase cor-
porate taxes, but they don’t want to drive businesses out of their jurisdiction.

1
An exception to this rule is made if shareholders buy their stock at less than par value. Then they would be liable
for up to the par value.
8 Part 1 Introduction

There is a way for corporations to completely avoid corporate income taxes, and
that is through formation of an S corporation. With an S ­corporation, the income is
taxed as direct income to the stockholders and thus is taxed only once as normal income,
similar to a partnership. Nevertheless, the shareholders receive all the organizational
benefits of a corporation, including limited liability. The S corporation designation can
apply to domestic corporations that have up to 100 stockholders and have only one class
of stock with allowable shareholders being individuals, estates, and certain trusts.
The limited liability company (LLC) has become a popular vehicle for conducting
business because of its highly flexible structure. An LLC is not technically a corpora-
tion, but like a corporation it provides limited liability for the owners. LLCs can be
taxed as sole proprietorships, partnerships, corporations, or S corporations, depending
upon elections made by the owners.
While the proprietorship, traditional partnership, and various forms of limited
partnerships are all important, the corporation is given primary emphasis in this text.
Because of the all-pervasive impact of the corporation on our economy, and because
most growing businesses eventually become corporations, the effects of most deci-
sions in this text are often considered from the corporate viewpoint.

Corporate Governance
As we learned in the previous section, the corporation is governed by the board of
directors, led by the chairman of the board. In many companies, the chairman of the
board is also the CEO, or chief executive officer. During the stock market ­collapse
of 2000–2002, many companies went bankrupt due to mismanagement or, in some
cases, financial statements that did not accurately reflect the financial c­ ondition of
the firm because of deception as well as outright fraud. Companies such as W ­ orldCom
reported over $9 billion of incorrect or fraudulent financial entries on their income
statements.
Enron also declared bankruptcy after it became known that its accountants kept
many financing transactions “off the books.” The company had more debt than most
of its investors and lenders knew about. Many of these accounting manipulations
were too sophisticated for the average analyst, banker, or board member to under-
stand. In the Enron case, the U.S. government indicted its auditor, Arthur Ander-
sen, and because of the indictment, the Andersen firm was dissolved. In response to
these scandals and audit failures, in 2002 Congress passed the Sarbanes–Oxley Act
which created new legally binding standards for public companies related to audi-
tor independence and independence of the board of directors in their relationships
with management. The major focus of the act was to make sure that publicly traded
­corporations accurately present their assets, liabilities, equity, and income on their
financial statements.
Nevertheless, in the financial crisis in 2007–2009 it appeared that boards of direc-
tors of many large financial firms didn’t understand the risk that their management
had taken in extending mortgages to high credit risks. Even senior management
didn’t understand the risk embodied in some of the mortgage-backed securities that
their organizations had bought for investments. This total lack of risk management
 Chapter 1 The Goals and Activities of Financial Management 9

oversight continued to put a focus on corporate governance issues. With these two
events coming so close together, many questioned the ability of large companies and
financial institutions to regulate themselves. Why didn’t the boards of directors know
what was going on and stop it? Why didn’t they fire members of management and
clean house? Why did they allow such huge bonuses and executive compensation
when companies were performing so poorly? In response to the financial crisis, Con-
gress passed the Dodd–Frank Act, officially known as the Wall Street Reform and
­Consumer Protection Act of 2010. Dodd–Frank was the first major financial regula-
tory change in the United States since the Great Depression. While the legislation is
complex, its goal was to grant regulators more effective tools to identify and reduce
systemic risks that might undermine the stability of the U.S. financial system. While
Dodd–Frank outlines several broad goals and assigns regulatory responsibility, the
actual rulemaking and implementation have been largely left to the different agencies
charged with enforcement.
Many issues of corporate governance are really agency problems. Agency ­theory
examines the relationship between the owners and the managers of the firm. In ­privately
owned firms, management and owners are usually the same people. M ­ anagement
operates the firm to satisfy its own goals, needs, financial requirements, and the like.
However, as a company moves from private to public ownership, management now
represents all the owners. This places management in the agency position of making
decisions that should be in the best interests of all shareholders. Because of diversified
ownership interests, conflicts between managers’ and shareholders’ interests can arise.
When the chairman is also the chief executive of the firm, stockholders recognize that
the executive may act in his or her own best interests rather than those of the stock-
holders of the firm. In the prior bankruptcy examples, that is exactly what happened.
Management filled their own pockets and left the stockholders with little or no value
in the company’s stock. In the WorldCom case, a share of common stock fell from the
$60 range to eventually being worthless, and Bernie Ebbers, the CEO and chairman of
the board, ended up in jail. Because of these potential conflicts of interest, many hold
the view that the chairman of the board of directors should be from outside a company
rather than an executive of the firm.
Because institutional investors such as pension funds and mutual funds own a
large percentage of stock in major U.S. companies, these investors are having more to
say about the way publicly owned corporations are managed. As a group they have the
ability to vote large blocks of shares for the election of a board of directors. The threat
of their being able to replace poorly performing boards of directors makes institutional
investors quite influential. Since pension funds and mutual funds represent individual
workers and investors, they have a responsibility to see that firms are managed in an
efficient and ethical way.

The Time Value of Money

The most fundamental concept in all of finance is the time value of money (TVM).
This is the idea that a dollar received today is worth more than a dollar that we expect to
receive at some date in the future. Similarly, a dollar that is received today can be invested
10 Part 1 Introduction

so that it will grow in value over the course of time. Thus, the future value of a dollar is
greater than a dollar. Today’s dollar value is referred to as the present value. The rela-
tionship between future value and present value is given by the following formula:
FV = PV(1 + i )n (1-1)

FV = Future value
PV = Present value
i = Interest rate
n = Number of periods
Here is a simple example. If $100 can be invested for one year and grow at an inter-
est rate of 10 percent, then the future value of that investment is $110.

​FV = $100 × ​(1 + 0.10 )​​ 1​= $110​

One hundred dollars today is worth the same thing as $110 held one year from
today. If the $100 investment could earn 10 percent for 2 years, the future value of
$100 two years from today is $121, as illustrated in the following timeline:

n=2 l = 10%
PV = $100 FV = $100 × (1 + 0.10)2 = $121

0 1 2

Future value equation (1-1) can also be reorganized as present value equation (1-2)
as follows:

[​(1 + i )​​  n​]

1
​PV = FV​​ _
​​​   ​​ ​​​​ (1-2)

Thus, if an investor expects to receive $121 in 2 years while interest rates are
10 percent, then the present value of the investment is $100.

PV = $121 × [ 1
]
(1 + 0.10)2
= $100
n=2 l = 10%
FV = $121

0 1 2

We will devote an entire chapter (Chapter 9) to exploring the complexities related

to TVM. For now, the most important TVM idea for us to understand is that when an
investment is expected to earn money at some date in the future, we can calculate the
value of that investment today. Today’s value is the present value.
The present value concept has many applications. For example, the value of an apart-
ment building is based on the present value of all the future rents that the owner expects
to receive from tenants. The value of a farm today is based on the present value of future
crops that the farmer expects to raise and sell, and the value of a share of stock today is
the present value of all future expected dividends that the stockholder will receive.
 Chapter 1 The Goals and Activities of Financial Management 11

This insight is important for us to understand the financial goals of a business.

We discuss the goals of financial management in the next section.

Goals of Financial Management

Let us look at several alternative goals for the financial manager as well as the other
managers of the firm. One may suggest that the most important goal for financial
management is to “earn the highest possible profit for the firm.” Under this criterion,
each decision would be evaluated on the basis of its overall contribution to the firm’s
profits. While this seems to be a desirable approach, there are some serious drawbacks
to profit maximization as the primary goal of the firm.
First, a change in profit may also represent a change in risk. A conservative firm
that earned a profit of $1.25 per share may be a less desirable investment if its earnings
per share increase to $1.50, but the risk inherent in the operation increases even more.
A second possible drawback to the goal of maximizing profit is that it fails to consider
the timing of the benefits. For example, if we could choose between the following two
alternatives, we might be indifferent if our emphasis were solely on maximizing earnings.

Earnings per Share

Period Period
One Two Total
Alternative A $1.50 $2.00 $3.50
Alternative B 2.00 1.50 3.50

Both investments would provide $3.50 in total earnings, but Alternative B is clearly
superior because the larger benefits occur earlier. As we discussed in the prior section,
a dollar received today is worth more than a dollar received next year. We could rein-
vest the difference in earnings for Alternative B one period sooner.
Finally, the goal of maximizing profit suffers from the almost impossible task of
accurately measuring the key variable in this case: profit. As you will observe through-
out the text, there are many different economic and accounting definitions of profit, each
open to its own set of interpretations. Furthermore, problems related to inflation and
international currency transactions complicate the issue. Constantly improving methods
of financial reporting offer some hope in this regard, but many problems remain.
A simple example should convince you that maximizing current profits should not
be the primary goal of management. Tesla Inc. was incorporated in 2003, but it never
earned an accounting profit until 2020. By then, Tesla was one of the world’s most
valuable companies, with a market value of over $400 billion. If Elon Musk had pri-
oritized current profits over long-run results, he would not have built the world’s most
valuable automotive company.

A Valuation Approach
While there is no question that profits are important, the key issue is how to use them
in setting a goal for the firm. The ultimate measure of performance is not simply what
the firm earns but how the earnings are valued by investors. This is why the time value
12 Part 1 Introduction

of money concept is so important. Businesses are valued in the present (present value)
even though most of the cash flows that a business produces will not be realized for
many years. Shareholders are not simply interested in current profits; they are also
interested in all of the firm’s future earnings.2 Investors want managers to adopt a
long-term perspective because all of those future earnings are part of the firm’s pres-
ent value today. The firm’s current overall value is really the present value of all the
firm’s future cash flows. When management considers a course of action, they can
adopt a simple rule: If the decision increases the firm’s overall value, it is acceptable
from a financial viewpoint; otherwise, it should be rejected.

Maximizing Shareholder Wealth

Corporations have both shareholders and debtholders (banks or bondholders). Share-
holders own the firm, and they control it. However, as a general rule, debtholders’
claims, which are for a fixed amount, must be fully satisfied before the business can
distribute cash to shareholders. The shareholders have a residual claim, meaning that
the value of their claims is not fixed. Shareholders actually can claim everything that
is left over after the debtholders are paid.
As a result, when managers maximize the value of the firm, they are also maximiz-
ing the wealth of the shareholders. The broad goal of the firm can be brought into
focus if we say the financial manager should attempt to maximize the wealth of the
firm’s shareholders through achieving the highest possible value for the firm. For the
most part, this means that managers should maximize the price of the firm’s stock
because the firm’s stock price is really the present value of everything that sharehold-
ers expect to receive from the business over the long haul.
Shareholder wealth maximization is not a simple task because the financial
manager cannot directly control the firm’s stock price but can only act in a way that
is consistent with the desires of the shareholders. Since stock prices are affected by
expectations of the future as well as by the current economic environment, much of
what affects stock prices is beyond management’s direct control. Even firms with good
earnings and favorable financial trends do not always perform well in a declining stock
market over the short term.
The concern is not so much with daily fluctuations in stock value as with long-term
wealth maximization. This can be difficult in light of changing investor expectations.
In the 1970s and 1980s, investors tended to highly value lower-risk companies with
steady earnings and high current dividend payments. By the late 1990s, investors val-
ued companies very highly when the firms seemed to have opportunities for commer-
cial applications on the new Internet. Some highly valued companies had a great story
but no actual sales, yet their stock sold at extremely high prices. Some analysts in the
financial community said that the old valuation models were dead, didn’t work, and
were out of date; earnings and cash flow didn’t matter anymore. Alan Greenspan, then
chairman of the Federal Reserve Board, made the now-famous remark that the high-
priced stock market was suffering from “irrational exuberance.” By late 2000, many

2
Later in the text, we will learn that investors are actually interested in the firm’s future cash flows, but for now
we will assume that future earnings and future cash flows are the same thing.
Another random document with
no related content on Scribd:
reputation of being great drunkards. The Houssa caravans pass
close to the north side of the town, but seldom halt here. It was
deserted last year, when Edrisi was driven here with his army; the
inhabitants flying to Ingastrie in Youri, and to the province of Wawa;
but are now mostly returned.
Sunday, 16th.—I was visited by the sirtain fada this morning, who
had just returned from seeing the Fellatas safe out of Koolfu: he told
me that the Benin people, before the civil war began, came here to
trade; that the Quorra ran into the sea, behind Benin, at Fundah; that
the Nyffe people and those of Benin were the same people; that
Benin paid tribute to Nyffe—(this is common with all negroes, to exalt
their native country above all others, in their accounts to strangers).
He said they got their salt from a town called Affaga, near the sea:
this is the Laro or Alaro of Yourriba, and in possession of the
Fellatas. In the evening an eunuch, a messenger, arrived from the
king, to take me to the Sanson, or gathering-place, where he was;
and to stop the taya.
Monday, 17th.—This morning a messenger of the king of Youri
arrived, bringing me a present of a camel, to assist in carrying my
baggage to Kano. He said the king, before he left Youri, had shown
him two books, very large, and printed, that had belonged to the
white men, that were lost in the boat at Boussa; that he had been
offered a hundred and seventy mitgalls of gold for them, by a
merchant from Bornou, who had been sent by a Christian on
purpose for them. I advised him to tell the king, that he ought to have
sold them; that I would not give five mitgalls for them; but that if he
would send them, I would give him an additional present; and that he
would be doing an acceptable thing to the king of England by
sending them, and that he would not act like a king if he did not. I
gave him for his master one of the mock-gold chains, a common
sword, and ten yards of silk, and said I would give him a handsome
gun and some more silk, if he would send the books. On asking him
if there were any books like my journal, which I showed him, he said
there was one, but that his master had given it to an Arab merchant
ten years ago; but the merchant was killed by the Fellatas on his way
to Kano, and what had become of that book afterwards he did not
know. He also told me, that the fifteen men whom I had seen at
Wawa belonging to Dahomey were slave-merchants; that they had
bought a hundred slaves at Youri; that they also bought small red
beads that came from Tripoli; that at Wawa they were to get a
hundred more slaves, when they would return to Dahomey; that
these people bring cloths, earthen ware, brass and pewter dishes,
and sell them in Houssa, Nyffe, and Youri, for slaves and beads.
Wednesday, 19th.—Dull and cloudy this morning. The eunuch
came with his horse ready saddled, but without one for me. I told him
I was all ready, but would not go until he brought me a horse. He
then pretended that he was going, and asked if I had no present to
send to the king. I said I had, but should give it myself when I saw
him; not until then. He then departed; when a Fellata, calling himself
a messenger from Bello, residing with the king, came and said he
would make the eunuch stop, and removed my baggage and myself
to a good and quiet house, as the one I was in was much disturbed
by women and children; and it is settled that I am to go with him to
the king to-morrow. I have offered two hundred thousand cowries to
have my baggage carried, but I cannot even get a letter conveyed to
Kano; either so jealous are they of me, or they have an eye to my
baggage, about which they have formed anxious conjectures. I had a
present from the king’s sister of a sheep, for which she modestly
requested a dollar and some beads. My new house is very snug and
comfortable. I have three rooms for myself and servants, with
houses for my horse and mare, an old man and his wife to look after
it, and I can keep out all idle persons.
Thursday, 20th.—Morning clear and warm. I had to remain to-day
also, as my guide and messenger, the black eunuch, is gone to the
Koolfu market again. At sunset he and Omar Zurmie (or Omar the
Brave), the messenger of Bello, waited on me, and told me that they
would leave this for the Sanson, or camp, in the course of the night,
if I was ready, and that Zurmie had a horse ready for me. I said I was
ready at a moment’s notice, and had been the last four days. In the
night we had a tornado, with thunder, lightning, and rain.
Friday, 21st.—This morning I left Tabra in company of Omar the
Brave, a black eunuch, and Mohamed Ben Ahmet, the Morzukie, as
my interpreter and servant; and having travelled twenty-seven miles,
came to a village called Kitako, where we passed the night.
Saturday, 22d.—At 1.30 A.M. left Kitako. The moon through the
thick clouds just enabling us, by the assistance of two Amars
(spearmen) who went a-head, to thread our way through the thick
woods, and over some of the most ticklish wooden bridges that ever
man and horse passed over. The morning was raw and cold, and the
path slippery and wet. At 4.30 I got so unwell and unable to bear the
motion of the horse, that I dismounted, and lay down on the wet
ground without covering, or any thing underneath me; for there are
times when a man, to get rid of his present sickness, will try any
remedy, whatever may be the after consequences: this was my
case, and I lay until six, when I rose much better of my sickness, but
with severe pains in the bones. A short while after starting, I crossed
over the wall of a ruined town called Jinne, or Janne, through
plantations of indigo and cotton, choked up with weeds. The morning
was raw and cloudy. A few of the ragged inhabitants were up; two or
three of the most miserable starved horses I ever saw were tied to
stakes close to the few huts that were rebuilt, their backs dreadfully
lacerated, the skin being nearly off from the shoulder to the rump,
and their eyes running with matter. Only for the verdure of the trees
at this season, and a beautiful stream of clear water, whose banks
were planted with plantain and palm-oil trees, this would have been
one of the most miserable scenes I ever saw in my life. After passing
the stream twice, without bridges, whose banks were very steep and
slippery, with several deep round holes, as man traps, on each side
the road, I ascended the plain above, from whence I saw the ruins of
several other towns and villages along the banks of the ravine. At
eight passed the ruins of another town; and at nine I met, attended
by a great rabble, armed with pickaxes, hoes, and hatchets,
Mohamed El Magia, or the would-be king, mounted on horseback,
and halted under a tree. When they told me there was the Magia
waiting to receive me, I rode up and shook hands with him. He asked
me after my health, and how I had fared on the road, and then told
the eunuch who was with me to take me to his house; he then rode
past, as I was informed, to complete the ruin of the last, as I thought
already ruined, town I had passed through. He was mounted on a
good bay horse, whose saddle was ornamented with pieces of silver
and brass; the breastpiece with large silver plates hanging down
from it, like what is represented in the prints of Roman and eastern
emperors’ horses. He is a tall man, with a sort of stupid expression
of countenance, having a large mouth and snagged teeth, with which
he makes himself look worse when he attempts to smile, and looks
indeed like any thing but a king or a soldier. He wore a black velvet
cap, with two flaps over the ears, and trimmed with red silk, a blue
and white striped tobe, red boots, part of leather and part red cloth,
in rags; in his hand he had a black staff, with a silver head; his
slaves were carrying a coast-made umbrella and his sword. I paid
him every decent respect, and put on as many smiles as I was able,
as I know that those ragged and dirty rogues, when they have power,
have more pride than a real king, and expect a great deal more
respect, and cannot bear a man to look serious. At ten I arrived at
the Sanson, or camp, where I was lodged in the eunuchs’ part,
having a small unoccupied hut separated from the rest allotted for
me to live in. Here I was left to myself until 3 P.M., when the eunuch
came and told me the king had arrived, and wished to see me. I went
directly, taking a present, which I displayed before him. When the
articles were taken away by an eunuch, I told him who and what I
was, where I was going, and that I wanted his assistance and
protection to the governors of Guari or Zegzeg, in Houssa; that I had
been well treated by every king and governor between Badagry on
the sea-coast, to Tabra in his dominions, and I hoped for the same
favourable reception from him. He said it was easy to do all that I
had asked, and he would do it.
Sunday, 23d.—This morning I was much better, having shut my
little straw hut up as close as possible, so that I was as if in a steam
bath all night. I have ever found this and fasting a good cure for most
disorders.
The king went through the camp, attended by a great rabble, a
slave carrying the umbrella I had given him over his head. He paid
me a visit, and began, as soon as he had seated himself, to show
me his staff of authority, a black stick, about four feet long, with a
silver head. He said I had got some of the same kind, and he wanted
one. I said I could not indulge him with one, unless I gave him that
intended for Bello. He then begged my travelling knife and fork. I
said, “What, then, I am to go without, and eat with my fingers! he had
better go to Tabra, and take all I had.” He observed he would
certainly not do that; that he would send me to Kano, and that I
should go in five or six days after this. He then went home, and sent
me, as a present, a small country horse, which will do well enough
for Pascoe to ride. I have now two horses and a mare.
The Sanson, or camp, is like a large square village, built of small
bee-hive-like huts, thatched with straw, having four large broad
streets, and with a square or clear place near the huts of the king.
Only for the number of horses feeding, and some picketed near the
huts, and the men all going armed, and numbers of drums beating, it
would pass for a well-inhabited village. Here are to be seen weavers,
taylors, women spinning cotton, others reeling off, some selling foo-
foo and accassons, others crying yams and paste, little markets at
every green tree, holy men counting their beads, and dissolute
slaves drinking roa bum.
Monday, 24th.—Morning cool and cloudy. In the early part of the
morning I went to take leave of the king, whom I found in his hut,
surrounded by Fellatas, one of whom was reading the Koran aloud
for the benefit of the whole; the meaning of which not one of them
understood, not even the reader. This may seem odd to an
Englishman; but it is very common for a man, both in Bornou and
Houssa, to be able to read the Koran fluently, and not understand a
word in it but “Allah,” or able to read any other book. They left off
reading when I came in; and as soon as the compliments of the
morning were over, the king begged me to give him my sword, which
I flatly refused, but promised to give him the five dollars, the staff,
and the pistol, whenever I was permitted to leave this for Kano,
which he promised I should do, and pointed out a person whom he
said he would send with me as a messenger; and that a merchant
from Koolfu would come and agree about the price he was to have
for carrying my baggage. I thanked him, and took my leave. He is
one of the most beggarly rogues I have yet met with; every thing he
saw or heard that I was possessed of he begged, not like a person
that wished to have them because they were scarce or rare, but with
a mean greediness that was disgusting. Though I had given him a
better present than he had ever got in his life before, he told me that
I said “No, no,” to every thing he asked for. He has been the ruin of
his country by his unnatural ambition, and by calling in the Fellatas,
who will remove him out of the way the moment he is of no more use
to them; even now he dares not move without their permission. It is
said that he has put to death his brother and two of his sons.
Through him the greater part of the industrious population of Nyffé
have either been killed, sold as slaves, or fled from their native
country. To remove him now would be charity; and the sooner the
better for his country.
At 8.30 in the morning I left the Sanson, and riding on ahead of
old Malam Fama, the Morzukie, I halted under a tree at eleven to let
the horses feed, and the Malam to come up with the sheep. At noon,
Mahomed having joined, I started with a plundering party who were
going the same road. They told me they were going to seize some
villagers who had returned to build up their ruined huts and sow a
little millet without first praying for leave to the Magia. On crossing
one of the small rivers and ascending the steep and slippery bank,
the chief of this band checked his horse, and both horse and rider
fell souse into the water. He was close behind me, but I left his
companions to pick him up. On the 25th we once more reached
Tabra.
I have observed more people with bad teeth and the loss of the
front teeth in Nyffé than any other country in Africa, or indeed any
other country. The males mostly are those who lose their teeth.
Whether it may arise from the universal custom of chewing snuff
mixed with natron or not, I do not pretend to say. The white of the
eye in the black population is in general bilious-looking and
bloodshot. There is scarcely one exception, unless it be in those
below eighteen or twenty years of age.
Tuesday, May 2.—This morning I left Tabra, and travelling along
the banks of the May-yarrow, passed the walled village of Gonda.
Having crossed a stream coming from the north, and running into the
May-yarrow, I entered the walled town of Koolfu, the greatest market
town in this portion of Nyffé, and resorted to by trading people from
all parts of the interior. I was provided with a good house; and the
head man of the town, a plausible fellow, was very officious, but at
the same time giving broad hints for a present. Mohamed Kalu, the
madagoo or head man of the goffle from Bornou, has to remain here
until after the Rhamadan. I was visited by all the principal people in
the place, as a matter of curiosity, though many of them had seen
me at Tabra.
Monday, 8th.—Clear and cool. The house in which I live is one of
the best in Koolfu. I have three separate coozies parted off from the
rest of the house, and a place for my stud, which now amounts to
two horses and a mare. My landlady is a widow, large, fat, and deaf,
with an only child, a daughter, about five years old; a spoiled child.
The widow Laddie, as she is called, is considered to be very rich.
She is a merchant; sells salt, natron, and various other articles: but
what she is most famed for is her booza and roa bum, as the palm
wine is called; and every night the large outer hut is filled with the
topers of Koolfu, who are provided with music as well as drink, and
keep it up generally until the dawn of morning separates them. Their
music consists of the drum, erbab, or guitar of the Arabs, the Nyffé
harp, and the voice. Their songs are mostly extempore, and allude to
the company present. The booza is made from a mixture of doura, or
Guinea corn, honey, Chili pepper, the root of a coarse grass on
which the cattle feed, and a proportion of water: these are thrown in
equal proportions into large earthen jars, open at top, and are
allowed to ferment near a slow fire for four or five days, when the
booza is fit to drink, and is put into earthen jars. It is a very fiery and
intoxicating beverage; but, whether Mohamedan or pagan, they all
drink, and agree very well together when in their cups. At first neither
I nor my servants could sleep for their noise, but now I have got used
to it. This night the new moon was seen, and Mohamedan and
pagan joined in the cry of joy. My landlady had thirteen pieces of
wood, on each of which was written by the Bornou malem the word
“Bismillah,” the only word he could write. These boards she then
washed and drank the water, and gave to her family to drink. She
offered some of it to me; but I said I never drank dirty water: and I
thought that if she and her servants had taken a comfortable cup of
booza or bum it would have done them more good than drinking the
washings of a board written over with ink; for the man was a rogue
who had made her pay for such stuff. “What!” says she, “do you call
the name of God dirty water? it was good to take it.” These rogues,
who call themselves malems, impose on the poor ignorant people
very much; and the pagans are as fond of having these charms as
the Mohamedans. These dirty draughts are a cure for all evils,
present and to come, and are called by the people dua. Some of
their fighting men will confine themselves to their houses for thirty or
forty days, fasting during the day, and only drinking and washing with
this dirty stuff. If a man is fortunate, or does any feat above the
common, it is attributed to the dua, or medicine: neither his wit nor
the grace of God gains a man any thing.
Tuesday, 9th.—Clear and warm. The new moon having been
seen last night put an end to the fast of the Rhamadan; and this day
is kept throughout the northern interior by Mohamedan and Kafir.
Every one was dressed in his best, paying and receiving visits,
giving and receiving presents, parading the streets with horns,
guitars, and flutes; groups of men and women seated under the
shade at their doors, or under shady trees, drinking roa bum or
booza. I also had my share of visitors: the head man of the town
came to drink hot water, as they call my tea. The chief of Ingaskie,
the second town in Youri, only a day’s journey distant, sent me a
present of a sheep, some rice, and a thousand gora nuts, for which
he expects double the amount in return. The women were dressed
and painted to the height of Nyffé perfection; and the young and
modest on this day would come up and salute the men as if old
acquaintances, and bid them joy on the day; with the wool on their
heads dressed, plaited, and dyed with indigo; their eyebrows painted
with indigo, the eyelashes with khol, the lips stained yellow, the teeth
red, and their feet and hands stained with henna; their finest and
gayest clothes on; all their finest beads on their necks; their arms
and legs adorned with bracelets of glass, brass, and silver, their
fingers with rings of brass, pewter, silver, and copper; some had
Spanish dollars soldered on the back of the rings. They, too, drank of
the booza and roa bum as freely as the men, joining in their songs,
whether good or bad. In the afternoon, parties of men were seen
dancing: free men and slaves all were alike; not a clouded brow was
to be seen in Koolfu; but at nine in the evening the scene was
changed from joy and gladness to terror and dismay; a tornado had
just began, and the hum of voices and the din of people putting their
things under cover from the approaching storm had ceased at once.
All was silent as death, except the thunder and the wind. The
clouded sky appeared as if on fire; each cloud rolling towards us as
a sea of flame, and only surpassed in grandeur and brightness by
the forked lightning, which constantly seemed to ascend and
descend from what was now evidently the town of Bali on fire, only a
short distance outside the walls of Koolfu. When this was
extinguished a new scene began, if possible worse than the first.
The wind had increased to a hurricane; houses were blown down;
roofs of houses going along with the wind like chaff, the shady trees
in the town bending and breaking; and, in the intervals between the
roaring of the thunder, nothing heard but the war-cry of the men and
the screams of women and children, as no one knew but that an
enemy was at hand, and that we should every instant share in the
fate of Bali. I had the fire-arms loaded when I learned this, and
stationed Richard and Pascoe at the door of each hut, and took the
command of my landlady’s house, securing the outer door, and
putting all the fires out. One old woman roasting ground nuts, quite
unconcerned, made as much noise as if she had been going to be
put to death when the water was thrown over her fire. At last the rain
fell: the fire in Bali had ceased by its being wholly burnt down. In our
house we escaped with the roof blown off one coozie, and a shed
blown down. All was now quiet; and I went to rest with that
satisfaction every man feels when his neighbour’s house is burnt
down and his own, thank God! has escaped.
Sunday, 14th.—Mohamed, the Fezzanie, whom I had hired at
Tabra, and whom I had sent to the chief of Youri for the books and
papers of the late Mungo Park, returned, bringing me a letter from
that person, which contained the following account of the death of
that unfortunate traveller: that not the least injury was done to him at
Youri, or by the people of that country; that the people of Boussa had
killed them, and taken all their riches; that the books in his
possession were given him by the Imam of Boussa; that they were
lying on the top of the goods in the boat when she was taken; that
not a soul was left alive belonging to the boat; that the bodies of two
black men were found in the boat chained together; that the white
men jumped overboard; that the boat was made of two canoes
joined fast together, with an awning or roof behind; that he, the
sultan, had a gun, double-barrelled, and a sword, and two books that
had belonged to those in the boat; that he would give me the books
whenever I went to Youri myself for them, not until then.
Monday, 15th.—I am still very weak; Richard worse. I had a letter
from the learned Abdurahman, of Kora, a noted chief of banditti, and
who once, with his followers, overran Nyffé, and held possession of
the capital six months. He now keeps the town of Kora, a day’s
journey to the north-east, and is much feared by Mohamedan and
Kafir. He is a native of Nyffé. He is particularly anxious that I should
visit him, as he wants my acquaintance, and begs I will give him the
Psalms of David in Arabic, which he hears I have got. His letter was
written on part of the picture of the frontispiece of an European book,
apparently Spanish or Portuguese. He says he has something to
communicate to me, which cannot be done but by a personal
interview; but unless he come to Koolfu I told his messenger, I could
not see him.
Tuesday, 23d.—Cool and cloudy. A large caravan arrived from
Yourriba. They had come through Borgoo, where they sold what
natron they had remaining after they left Yourriba. They were in
Katunga when I was there; but were forbidden to hold any
communication with us, on pain of having their throats cut. They told
me that my friend the fat eunuch had endeavoured to hire a man to
assassinate me, but that they were all afraid. There are strong
reports of a war between the Sheik El Kanami and the Fellatas. They
say the sheik has taken the city of Hadija, and that the governor of
Kano is gone out to meet him, as he is advancing upon Kano.
Whether it is a report to please the Nyffé people, who cannot bear
the Fellatas, or not, I do not know. We had a number of such reports
when in Bornou last journey. In the evening a messenger from the
sultan of Boussa arrived, bringing me a present of a beautiful little
mare. The messenger of the sultan was accompanied by another
person from the midaki, a female slave, bringing me rice, yams, and
butter. He brought a message from the sultan desiring me to kill a
she-goat, and distribute the flesh amongst the inhabitants of Koolfu
the day before I left it; that he had distributed gora nuts and salt for
me at Boussa, which would do for Koolfu. I was also desired not to
eat any meat that came cooked from the west, and which would be
sent by the Magia’s female relations from Tabra, as they intended to
take away my life by poison. Through the night continual rain,
thunder, and lightning.
Thursday, 25th.—Sent Sheeref Mohamed to Raba, a town
possessed by the Fellatas, three days south of this, on the banks of
the Quorra, with a message to the late Imam of Boussa, who, he
says, has got some of the books belonging to the late Mungo Park:
one, he tells me, was carried to Yourriba by a Fellata, as a charm
and preservative against musket balls. He is either to buy them, or I
will give him Arabic books for them in exchange.
Friday, June 17th.—This evening I was talking with a man that is
married to one of my landlady’s female slaves, called her daughter,
about the manners of the Cumbrie and about England; when he
gave the following account of the death of Park and his companions,
of which he was an eye-witness: He said that when the boat came
down the river, it happened unfortunately just at the time that the
Fellatas first rose in arms, and were ravaging Goober and Zamfra;
that the sultan of Boussa, on hearing that the persons in the boat
were white men, and that the boat was different from any that had
ever been seen before, as she had a house at one end, called his
people together from the neighbouring towns, attacked and killed
them, not doubting that they were the advance guard of the Fellata
army then ravaging Soudan, under the command of Malem
Danfodio, the father of the present Bello; that one of the white men
was a tall man with long hair; that they fought for three days before
they were all killed; that the people in the neighbourhood were very
much alarmed, and great numbers fled to Nyffé and other countries,
thinking that the Fellatas were certainly coming among them. The
number of persons in the boat was only four, two white men and two
blacks: that they found great treasure in the boat; but that the people
had all died who eat of the meat that was found in her. This account I
believe to be the most correct of all that I have yet got; and was told
without my putting any questions, or showing any eagerness for him
to go on with his story. I was often puzzled to think, after the
kindness I had received at Boussa, what could have caused such a
change in the minds of these people in the course of twenty years,
and of their different treatment of two European travellers. I was
even disposed at times to flatter myself that there was something in
me that belonged to nobody else, to make them treat me and my
people with so much kindness; for the friendship of the king of
Boussa I consider as my only protection in this country.
Koolfu, or, as it is called by many, Koolfie, is the principal town for
trade in Nyffé at present; and at all times a central point for trade in
this part of the interior. It is situated on the north bank of the river
May-yarrow; and it is surrounded by a clay wall about twenty feet
high, and has four gates. It is built in the form of an oblong square,
having its longest diameter from east to west; there is a long
irregular street runs through it, from which lead a number of smaller
streets. There are two large open spaces near the east and west
ends of the town, in which are booths, and large shady trees, to
protect the people from the heat of the sun, when attending the
markets, which are daily held in those places: there are, besides the
daily markets, two weekly markets on Mondays and Saturdays,
which are resorted to by traders and people inhabiting the sea coast.
Ajoolly and the other towns in Yourriba, Cubbi, Youri, Borgoo,
Sockatoo, and Zamfra on the north, Bornou and Houssa on the east,
and, before the civil war, people from Benin, Jabbo, and the southern
parts of Nyffé, used to resort to this town as a central point of trade,
where the natives of the different countries were sure to get a ready
sale for their goods; either selling them for cowries, or exchanging
them for others by way of barter. Those who sold their goods for
cowries attend the market daily, and when they have completed their
sale, buy at once the goods or wares they want, and return home.
Such is the way of the small traders, who are nine out of ten women,
and are principally from the west part of the Quorra, even as far off
as Niki: they carry their goods on their heads in packages, from sixty
to eighty and a hundred pounds weight. The goods these people
bring from the west are principally salt, and cloths worn by the
women round their loins, of about six yards in length and two in
breadth, made of the narrow striped cloth, in which red silk is
generally woven, and a great deal of blue cotton; this is called
Azane, and the best are worth about three thousand to five thousand
cowries, or two dollars:—Jabbo cloths, which are about the same
length as the others, and about the breadth of our sail-cloth, are
worn by slaves, and have a stripe or two of blue in them; the poor
classes also wear them, men and women:—Peppers, called
monsoura, shitta, and kimba; monsoura is like our East India pepper;
shitta is the malagetta pepper of the coast; kimba is a small thin
pepper, growing on a bush, near the sea coast, in Yourriba, of a red
colour, like Chili pepper:—Red wood from Benin, which is pounded
to a powder and made into a paste; women and children are rubbed
with this, mixed with a little grease, every morning; and very
frequently a woman is to be seen with a large score of it on her face,
arms, or some part of her body, as a cure for some imaginary pain or
other:—A small quantity of calico or red cloth is sometimes brought,
which is of European manufacture. They take back principally
natron, beads made at Venice of various kinds, and come by the way
of Tripoli and Ghadamis, and unwrought silk of various colours,
principally red, of about one ounce in weight, and is sold here at
three thousand cowries; it and natron are as good as cowries.
The caravans from Bornou and Houssa, which always halt here a
considerable time, bring horses, natron, unwrought silk, beads, silk
cords, swords that once belonged to Malta, exchanged for bullocks
at Bengazie, in the regency of Tripoli, sent to Kano and remounted,
and then sold all over the desert and the interior; these swords will
sell for ten or twenty dollars a piece or that value, and sometimes
more; cloths made up in the Moorish fashion; looking-glasses of
Italian manufacture from about a penny a piece to a shilling in Malta;
tobes or large shirts undyed, made in Bornou; khol or lead used as
blacking for the eye-lids; a small quantity of ottar of roses, much
adulterated; sweet smelling gum from Mecca; a scented wood also
from the East; silks the manufacture of Egypt; turbans; red Moorish
caps with blue silk tassels; and sometimes a few tunics of checked
silk and linen made in Egypt: the last are generally brought by Arabs.
A number of slaves are also brought from Houssa and Bornou, who
are either sold here or go further on. The Bornou caravans never go
further than this place, though generally some of their number
accompany the Houssa merchants to Agolly in Yourriba, Gonja, and
Borgoo, from which they bring Kolla or Gora nuts, cloth of woollen,
printed cottons, brass and pewter dishes, earthenware, a few
muskets, a little gold, and the wares mentioned before as brought
from Yourriba. They carry their goods on bullocks, asses, and mules;
and a great number of fine women hire themselves to carry loads on
their heads; their slaves, male and female, are also loaded. The
Bornou merchants, during their stay, stop in the town in the houses
of their friends or acquaintances, and give them a small present on
their arrival and departure, for the use of the house. The Houssa
merchants stop outside the walls in little straw huts or leathern tents,
which they erect themselves. They sell their goods and wares in their
houses or tents; the small wares they send to the market and round
to the different houses by their slaves to sell; there are also a
number of male and female brokers in the town, whom they also
intrust. The pedlers or western merchants always live in the houses
of the town, and attend the markets daily, employing their spare time
in spinning cotton, which they provide themselves with on their
arrival, and support themselves by this kind of labour. There have
been no fewer than twenty-one of these mercantile women living in
my landlady’s house at one time, all of them from Yourriba and
Borgoo: these women attend the markets at the different towns
between this and their homes, buying and selling as they go along.
The caravans from Cubbi, Youri, and Zamfra, bring principally slaves
and salt, which they exchange for natron, Gora nuts, beads, horses,
tobes dyed of a dark blue, having a glossy and coppery tinge. The
slaves intended for sale are confined in the house, mostly in irons,
and are seldom allowed to go out of it, except to the well or river
every morning to wash; they are strictly guarded on a journey, and
chained neck to neck; or else tied neck to neck in a long rope of raw
hide, and carry loads on their heads consisting of their master’s
goods, or his household stuff; these loads generally from fifty to sixty
pounds weight. A stranger may remain a long time in a town without
seeing any of the slaves, except by accident, or making particular
inquiry. The duties which traders pay here are collected by the
people of Tabra, who take twenty cowries from every loaded person,
forty for an ass, and fifty for a loaded bullock.
The inhabitants may amount to from twelve to fifteen thousand,
including all classes, the slave and the free; they are mostly
employed in buying and selling, though there are a great number of
dyers, tailors, blacksmiths, and weavers, yet all these are engaged in
buying and selling; few of these descriptions ever go on distant
journeys to trade, and still fewer attend the wars, except it be to buy
slaves from the conquerors. I have seen slaves exposed for sale
here, the aged, infirm, and the idiot, also children at the breast,
whose mothers had either fled, died, or been put to death. The
domestic slaves are looked upon almost as the children of the family,
and if they behave well, humanely treated: the males are often freed,
and the females given in marriage to freemen, at other times to the
male domestic slaves of the family; when such is the case a house is
given to them, and if he be a mechanic, he lives in the town, and
works at his trade; if not, in the country, giving his owner part of the
produce, if not made free; in both cases they always look upon the
head of such owner’s family as their lord, and call him or her father
or mother.
The food of the free and the slave is nearly the same; perhaps the
master or mistress may have a little fat flesh, fish, or fowl, more than
their slaves, and his meat is served in a separate place and dish; but
the greatest man or woman in the country is not ashamed at times to
let their slaves eat out of the same dish, but a woman is never
allowed to eat with a man. Their food consists of ground maize,
made into puddings or loaves, and about half a pound each, sold at
five cowries each in the market; of flummery, or, as they call it in
Scotland, sowens, made from the ground millet, which is allowed to
stand covered with water, until it gets a little sour; it is then well
stirred and strained through a strainer of basketwork into another
vessel, when it is left to settle, and the water being strained off, it is
dried in the sun; when perfectly dry, it is broken into lumps and kept
in a sack or basket; when used it is put into boiling water, and well
stirred, until of a sufficient thickness; this makes a very pleasant and
healthy breakfast with a little honey or salt, and is sold in the market
at two cowries a pint every morning, and is called Koko. They have a
pudding made of ground millet, boiled in the ley of wood ashes,
which gives a red colour; this is always eaten with fat or stewed
meat, fish, or fowl. They always stew or grill their meat: when we
have it in any quantity it is half grilled and smoked, to preserve until it
is wanted to be used. Boiled beans made up in papers of a pound or
a half pound each, and wrapped in leaves, sold for two cowries
each, and called waki. Beans dried in the sun sold at one cowrie a
handful. Small balls of boiled rice, mixed with rice flower, called
Dundakaria, a cowrie a piece, mixed with water, and serves as meat
and drink. Small balls of rice, mixed with honey and pepper, called
Bakaroo, sold at five cowries each. Small balls made from bean
flowers, fried in fat, like a bunch of grapes. Their intoxicating
draughts are the palm wine called roa bum, bouza, and aquadent,
very much adulterated and mixed with pepper.
At daylight the whole household arise: the women begin to clean
the house, the men to wash from head to foot; the women and
children are then washed in water, in which the leaf of a bush has
been boiled called Bambarnia: when this is done, breakfast of cocoa
is served out, every one having their separate dish, the women and
children eating together. After breakfast the women and children rub
themselves over with the pounded red wood and a little grease,
which lightens the darkness of the black skin. A score or patch of the
red powder is put on some place where it will show to the best
advantage. The eyes are blacked with khol. The mistress and the
better looking females stain their teeth and the inside of the lips of a
yellow colour with gora, the flower of the tobacco plant, and the bark
of a root: the outer part of the lips, hair, and eye-brows, are stained
with shuni, or prepared indigo. Then the women who attend the
market prepare their wares for sale, and when ready go. The elderly
women prepare, clean, and spin cotton at home and cook the
victuals; the younger females are generally sent round the town
selling the small rice balls, fried beans, &c. and bringing a supply of
water for the day. The master of the house generally takes a walk to
the market, or sits in the shade at the door of his house, hearing the
news, or speaking of the price of natron or other goods. The weavers
are daily employed at their trade; some are sent to cut wood, and
bring it to market; others to bring grass for the horses that may
belong to the house, or to take to the market to sell; numbers, at the
beginning of the rainy season, are employed in clearing the ground
for sowing the maize and millet; some are sent on distant journeys to
buy and sell for their master or mistress, and very rarely betray their
trust. About noon they return home, when all have a mess of the
pudding called waki, or boiled beans, and about two or three in the
afternoon they return to their different employments, on which they
remain until near sunset, when they count their gains to their master
or mistress, who receives it, and puts it carefully away in their strong
room. They then have a meal of pudding and a little fat or stew. The
mistress of the house, when she goes to rest, has her feet put into a
cold poultice of the pounded henna leaves. The young then go to
dance and play, if it is moonlight, and the old to lounge and converse
in the open square of the house, or in the outer coozie, where they
remain until the cool of the night, or till the approach of morning
drives them into shelter.
Their marriages are the same amongst the Mohamedans as they
are in other countries, where they profess that faith. The pagan part
first agree to go together, giving the father and mother a present,
and, if rich, the present is sent with music, each separate article
being borne on the head of a female slave. The Mohamedans bury
in the same manner as they do in other parts of the world. The
pagans dig a round hole like a well, about six feet deep, sometimes
in the house, sometimes in the threshold of the door, and sometimes
in the woods: the corpse is placed in a sitting posture, with the wrists
tied round the neck, the hams and legs close to the body: a hole is
left at the mouth of the grave, and the relations and acquaintances
leave tobes, cloth, and other articles at the small round hole, and
telling the dead persons to give this to so and so: these things are
always removed before the morning by the priest. The majority of the
inhabitants of Koolfu profess to be Mahometans, the rest Pagans,
whose mode of worship I never could learn, except that they, like the
inhabitants of the other towns in Nyffé, attended once a year in one
of the southern provinces, where there was a high hill, on which they
sacrificed a black bull, a black sheep, and a black dog. The figures
on their houses of worship are much the same as in Yourriba: the
lizard, crocodile, the tortoise, and the boa-serpent, with sometimes
men and women. Their language is a dialect of the Yourriba, but the
Houssa tongue is the language of the market. Their houses and
court are kept very clean, as also the court-yard, which is sprinkled
every morning with water, having the shell of the bean of the mitta
tree boiled in it, which stains it of a dark brown colour; and each side
of the doors of the coozies or huts are stained with indigo and
ornamented with figures. The women have the stone for grinding the
corn, pepper, &c. raised on a clay bench inside the house, so that
they can stand upright while they grind the corn; an improvement to
be seen in no other part of the interior, or in Fezzan, the women
having to sit on their knees when grinding corn. Their gourd dishes
are also of the first order for cleanliness, neatness, and good carving
and staining, as also their mats, straw bags, and baskets.
They are civil, but the truth is not in them, and to be detected in a
lie is not the smallest disgrace, it only causes a laugh. They are also
great cheats. The men drink very hard, even the Mahometans; and
the women are generally of easy virtue. Notwithstanding all this
against them, they are a people of a natural good disposition; for
when it is considered that they have been twice burnt out of the town
by the enemy within the last six years, and that they have had a civil
war desolating the country for the last seven years, and been subject
to the inroads of the Fellatas during twenty years, and having neither
established law nor government but what a present sense of right
and wrong dictates, I am surprised that they are as good as they are.
I witnessed while here several acts of real kindness and goodness
of heart to one another. When the town of Bali was burnt down,
every person sent next day what they could spare of their goods, to
assist the unfortunate inhabitants. My landlady, who has given away
a number of her female slaves to freemen for wives, looks upon
them as her own children, attending them when sick; and one who
had a child while I was here, at the giving it a name, she sent
seventy different dishes of meat, corn, and drink, to assist at the
feast on that occasion. In all my dealings with them they tried and
succeeded in cheating me, but they had an idea that I was
possessed of inexhaustible riches; and besides, I differed with them
in colour, in dress, in religion, and in my manner of living. I was
considered therefore as a pigeon for them to pluck. Had they been
rogues, indeed, they might have taken all I had; but, on the contrary,
I never had an article stolen, and was even treated with the most
perfect respect and civility they were masters of.
I believe it is generally considered in England, that when a negro
slave is attached to his master, he will part with his life for him.
Instances of this kind are not so common as they ought to be, when
it is considered that all of these slaves are brought up from their
childhood, and know no other parent or protector; and if they were to
run away, or behave so ill as to cause him to sell them, they would
never be so well off as they were before. Those who are taken when
grown-up men or women, and even boys and girls, run whenever an
opportunity offers, and, whenever they can, take their owner’s goods
or cattle to assist them on their journey. Instances of this kind
happened every night.
They have very few bullocks, sheep, or goats, in the country; but
that is owing to the desolating war. Corn they have in abundance, as
that cannot be driven away by plundering parties. The surrounding
country is a level plain, well cultivated, and studded with little walled
towns and villages, along the banks of the May-yarrow, and another
little river running into it from the north. It is subject to the Majia, but
never visited by him or his people, except to attend the market, or
collect the duties from the traders. The town of Kufu, at a short
distance (not a mile), has a quarrel with another little town about half
a mile from it, called Lajo, the latter having taken the wife of a man,
whom they thought they had killed and left for dead, and selling her;
hence arose a regular system of retaliation; and they take and sell
one another whenever they have an opportunity. Every other night
almost the war-cry was raised about stealing asses, oxen, or murder;
and sometimes the inhabitants of Koolfu would join in the fray,
always siding with Kufu.
Monday, 19th.—Having been detained thus long at Koolfu, by my
own and my servant Richard’s illness, we left it this morning,
accompanied by the head man and the principal inhabitants of
Koolfu, who went with me as far as the walled and warlike village of
Kufu, where I stopped for the night. Here the head man of Koolfu
introduced me to the head man of Kufu, who provided me with a
good house, and made me a present of a sheep and some cooked
meat. I had also presents of meat sent me by the principal
inhabitants. The people of Kufu, not satisfied with having frequently
seen me and my servants at Koolfu, are in the habit of mounting
some trees growing on a small hill close to and overlooking my
house and court-yard, to get another and a last look: party came
after party until sunset, when they went away.
My landlady, the widow Laddie, also accompanied me to Kufu,
where she remained all night. I thought it had been out of a great
regard for me; but I was soon let into the secret, by five of her slaves
arriving with booza and bum, which she began selling in my court-
yard to the different merchants, bullock-drivers, and slaves
assembled here, who are going to the eastward.
The village of Kufu is walled, and only about two musket shots
from the other walled village, which is to the south, and with whom
they are at heavy war. The space between is generally occupied by
the caravans bound to the eastward, who usually halt here for a
week to complete their purchases at the market of Koolfu before they
start. The country around has a rich and clay soil, planted with
indigo, cotton, Indian corn, and yams.
Tuesday, 20th.—Having given the head man of Kufu thirty Gora
nuts, with which he was well pleased, and loaded the bullocks,
horse, ass, and camel, at 6 A.M. left Kufu. The path, or road, through
a woody country: the trees consisting mostly of the micadania, or
butter tree, which does not grow to a large size; the largest only
about the size of our apple trees in Europe, and this only seldom:
their girth is not above two or three feet. The path was winding; the
soil a deep red clay, covered with a thin layer of sand.
Wednesday, 21st.—After passing a great number of towns and
villages, we arrived at a walled town called Bullabulla, where we
encamped outside. As soon as my tent was pitched, I was
surrounded by the inhabitants. They were quite amused with my hat;