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www.downloadslide.net www.downloadslide.net Foundations of Financial Management SIXTEENTH EDITION Stanley B. Block Texas Christian University Geoffrey A. Hirt DePaul University Bartley R. Danielsen North Carolina State University www.downloadslide.net FOUNDATIONS OF FINANCIAL MANAGEMENT, SIXTEENTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2017 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2014, 2011, and 2009. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 DOW/DOW 1 0 9 8 7 6 ISBN  978-1-25-927716-0 MHID 1-25-927716-X Senior Vice President, Products & Markets: Kurt L. Strand Vice President, General Manager, Products & Markets: Marty Lange Vice President, Content Production & Technology Services: Kimberly Meriwether David Managing Director: James Heine Executive Brand Manager: Chuck Synovec Senior Director, Product Development: Rose Koos Senior Product Developer: Noelle Bathurst Director of Digital Content: Doug Ruby Digital Development Editor: Tobi Philips Digital Product Analyst: Kevin Shanahan Executive Marketing Manager: Melissa S. Caughlin Content Project Managers: Harvey Yep and Kristin Bradley Design: Debra Kubiak Cover Image: Karol Wójcik /EyeEm/Getty Images Typeface: 10.5/13 Times Roman Compositor: SPi Global Printer: R. R. Donnelley All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Block, Stanley B., author. Foundations of financial management / Stanley B. Block, Geoffrey A. Hirt, Bartley R. Danielsen.—Sixteenth edition.   pages cm ISBN 978-1-259-27716-0 (alk. paper) 1. Corporations—Finance. I. Hirt, Geoffrey A., author. II. Danielsen, Bartley R., author. III. Title. HG4026.B589 2017 658.15—dc23 2015025324 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites. mheducation.com/highered www.downloadslide.net About the Authors Stanley B. Block Texas Christian University Geoffrey A. Hirt DePaul University Bartley R. Danielsen North Carolina State University www.downloadslide.net Preface Thirty-nine years have passed since we began writing the first edition of this text, and many things have changed during that time. First of all, the field of finance has become much more analytical, with the emphasis 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 16th 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. Using computers and calculators has become considerably more important over the last quarter century, and this is also reflected in the 16th 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 materials for students and faculty, computerized testing software and ­PowerPoint® for the faculty, Connect, an online assignment and assessment ­solution, and LearnSmart with SmartBook, a truly innovative adaptive study tool and eBook. Throughout the past 39 years, this text has been a leader in bringing the real world into the classroom, and this has never been more apparent than in the 16th 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 become much more important over the last 39 years, and the text has expanded its international coverage tenfold since the first edition. Where there is an international application for a financial issue, you are very likely to find it in this text. Furthermore, the 16th edition gives substantial coverage to the recession and liquidity crisis that has engulfed the U.S. and world economies in the latter part of the 2000–2009 decade (and into the current decade). Special attention is given to the banking sector and the critical need for funding that almost all businesses face. The issue of increased regulation is also covered. However, there is one thing that has not changed over the last 39 years— we still write the entire book and all of the problems ourselves! We believe iv www.downloadslide.net v Preface our devotion of time, energy, and commitment over these years is the reason for our reputation for having produced a high-quality and successful text—edition after edition. Employers of business graduates report that the most successful analysts, planners, and executives are both effective and confident in their financial skills. We concur. One of the best ways to increase your facility in finance is to integrate your knowledge 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, however, 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. Furthermore, as you are about to begin your career you will be much better prepared when called upon to apply financial concepts. Reinforcing Prerequisite Knowledge In general, tables and figures with real-world numbers have been updated or replaced, and the discussions concerning those tables and figures have been rewritten accordingly. Additionally, we have integrated Excel examples and spreadsheet tables throughout the capital budgeting chapters (Chapters 9 through 12 and Chapter 16). The financial forecasting tables in Chapter 4 have also been updated to mirror the references and style used in Excel spreadsheets. Content Improvements Chapter-by-Chapter Changes Chapter 1 Coverage of behavioral finance has been added to the section on “Modern Issues in Finance.” A discussion of the latest cases against hedge funds has been included in the discussion of insider trading. Chapter 2 All of the tables have been updated. The discussion of how depreciation, taxes, and cash flows are linked has been clarified. A new Finance in Action box describes corporate “tax inversions” with an explanation of the tax reduction and cash flow enhancing effects that are enjoyed by companies headquartered outside the United States. Chapter 3 The introduction has been updated with information on Colgate-­Palmolive vs. Procter and Gamble. American Eagle Outfitters has been replaced with ­Abercrombie & Fitch in the DuPont model and in the comparison to Walmart. The Apple and IBM comparisons have been updated, and Dell Computer has been eliminated from the comparison. Chapter 4 The financial forecasting Excel material has been updated using colorcoded conventions that have become standard in many financial settings using www.downloadslide.net vi Preface Excel. A new Finance in Action box has been added to describe the interaction of Tesla’s marketing and financial forecasting activities. A second Finance in Action box has been written to emphasize the importance of forecasting in entrepreneurs’ development of their business plans. Chapter 5 The introductory airline example has been updated. The Finance in Action box on Japanese companies has been deleted, and the Intel Corporation Finance in Action box on leverage has been revised. Chapter 6 The McGraw-Hill example illustrating seasonal sales and inventory has been replaced with a new example using Briggs & Stratton. Macy’s has replaced Limited Brands in the comparison against Target using seasonal sales and earnings per share. Figures 6-9, 10, 11, and all of the data and discussion about yield curves, interest rates, working capital, and current ratios have been updated. Chapter 7 Figure 7-4 and the discussion of SWIFT have been revised. A new quote from the Federal Reserve Board of Governors has been added. Table 7-1 has been updated. Chapter 8 The discussion of General Electric’s GEC (General Electric Capital) has been updated. Figures 8-1 and 8-2, as well as Table 8-1 have been revised with new data. The Finance in Action box on Internet lending with lending club’s initial public offering has been updated. Chapter 9 A new section has been added at the beginning of the financial calculator material describing how to clear the calculator and set the decimal point. The time value of money presentation has been reworked to include more integrated calculator keystrokes, and a new Finance in Action box has been added to discuss present value in relation to the payment options offered to Powerball winners. New interactive digital illustrations have been added to clarify the graphical time value of money relationships. Chapter 10 The tables have been updated, and the calculator discussion in ­Appendix 10-B has been significantly enhanced. Chapter 11 The cost of capital material has been revised to illustrate debt costs with calculator keystrokes, the Excel “rate” function, and Excel’s Goal Seek tool. All of the tables have been updated. Chapter 12 The Finance in Action box on real options has been moved to Chapter 13. Chapter 13 All of the tables have been updated. Table 13-4, Table 13-5, and Figure 13-8 have been converted to Excel formats. A Finance in Action box discussing real options has been added to the chapter. Chapter 14 The entire introduction to the chapter has been revised, and the chapter has been updated to reduce the emphasis on the financial crisis. The discussion of the merger (purchase) of the New York Stock Exchange (NYSE) by the Intercontinental Exchange (ICE) has been updated. Additional information on the BATS Exchange has been added. Figure 14-4 has been eliminated, and the other tables and figures have been updated. The Finance in Action box on Bernie Ebbers has been replaced with a new box on dark pools. www.downloadslide.net Preface Chapter 15 The introduction has been updated to include the IPO by Alibaba and more emphasis on global investment banking. The chapter was heavily revised with new tables and additional discussion of each table. The Finance in Action box on Warren Buffet and Goldman Sachs has been updated. Chapter 16 All tables and real-world examples have been updated. Material linking the time series of Walmart’s leverage levels and times-interest earned ratios to changes in long-term interest rates over the last two decades has been added. Calculator keystrokes have been incorporated throughout the chapter, and IRR calculations are shown using the financial calculator. A Finance in Action box has been added discussing Alibaba’s IPO and six-tranche bond offering. Chapter 17 The introductory example of Ceradyne has been replaced with an example using Tower Jazz, including some global features with plants in Japan. Table 17-1 and the Finance in Action box on Hewlett Packard have been updated. Coverage of global depository receipts has been added to the section on ADRs. Table 17-3 has been replaced with new data and an updated discussion. Chapter 18 The Finance in Action box on Bill Gates has been replaced with a box on Dividend Aristocrats. New Figure 18-2 and Table 18-8 have been added. Tax rate taxes have been modified for 2014, and a discussion about the impact of the Affordable Care Act on dividends for those singles making over $200,000 and those filing jointly making over $250,000 has been added. Chapter 19 New tables and discussions have been added to cover pricing patterns for convertible bonds, characteristics of convertible bonds, successful convertible bonds and preferred stocks not yet called, and warrant prices. Chapter 20 The introduction includes an update on Berkshire Hathaway and information on mergers in the airlines and pharmaceutical companies. A new table and discussion have been added to cover the largest acquisitions ever. Information on tax inversions and hostile merger takeover activities have also been added. Chapter 21 International financial management tables and charts have been updated with current data, and hedging examples using forward and futures contracts have been updated. A new Finance in Action box on how Coca-Cola manages currency risk has been added. Successful improvements from the previous editions that we have built on in the 16th 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 accounting majors. 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 on international companies and events throughout the text. Contemporary Coverage The 16th edition continues to provide updated real-world examples, using companies easily recognizable by students to illustrate financial concepts presented in the text. vii in its industry. Ratios that initially appear good or bad may not retain that characteristic when measured against industry peers. There are four main groupings of ratios. Profitability ratios measure the firm’s ability to earn an adequate return on sales, assets, and stockholders’ equity. The asset utilization ratios tell the analyst how quickly the firm is turning over its accounts receivable, inventory, and longer-term assets. Liquidity ratios measure the firm’s ability to pay off short-term obligations as they come due, and debt utilization ratios indicate the overall debt position of the firm in light of its asset base and earning power. The Du Pont system of analysis first breaks down return on assets between the profit margin and asset turnover. The second step shows how this return on assets is translated into return on equity through the amount of debt the firm has. Throughout the analysis, the analyst can better understand how return on assets and return on equity are derived. Over the course of the business cycle, sales and profitability may expand and contract, and ratio analysis for any one year may not present an accurate picture of the Confirmingover Pages firm. Therefore we look at the trend analysis of performance a period of years. A number of factors may distort the numbers accountants actually report. These include the effect of inflation or disinflation, the timing of the recognition of sales as revenue, the treatment of inventory write-offs, the presence of extraordinary gains and losses, and so on. The well-trained financial analyst must be alert to all of these factors. www.downloadslide.net viii Preface Chapter Features 3 Integration of Learning Objectives to Discussion Questions and Problems The Learning Objectives (LO) presented Confirming Pages at the beginning of each chapter serve as a quick introduction to the material students will learn and should understand fully before moving to the next chapter. Every discussion question and problemLEARNING at theOBJECTIVES end of each chapter refers back to the learning objective to which it applies. This allows instructors to easily emphasize the Learning Objective(s) as they choose. 3 Financial Analysis LO 3-1 LO 3-2 LO 3-3 LO 3-4 LO 3-5 Financial Analysis I I Expanded! Finance in Action Boxes 56 These boxed readings highlight specific topics of interest that relate to four main areas: managerial decisions, global situations, technology issues, and ethics. The inclusion of ethics is relevant given the many recent corporate scandals and the resulting governance issues. Web addresses are included in applicable boxes for easy access to more information on that topic or company. blo7716x_ch03_056-095.indd 56 09/18/15 07:29 PM DISCUSSION QUESTIONS f you’re in the market for dental products, look no further than Colgate-Palmolive. The 1. If we divide users of ratios into short-term lenders, long-term lenders, and firm has it all: every type of toothpaste you can imagine (tartar control, cavity protection, stockholders, which ratios would group be most interested whitening enhancement), as well as every shape andeach size of toothbrush. While you’re in, and for reasons? (LO3-2)its soaps, shampoos, and deodorants (Speed getting ready forwhat the day, also consider Stick, Lady 2. Speed Stick, etc.). Explain how the Du Pont system of analysis breaks down return on assets. Also For those of you who decide to stay home and clean your apartment or dorm room, explain how it breaks down return on stockholders’ equity. (LO3-3) Colgate-Palmolive will provide you with Ajax, Fab, and a long list of other cleaning products. If the interesting, accounts receivable turnover is decreasing, what will be happening All this is3. somewhat but why mention these ratio subjects in a finance text? Well, Colgate-Palmolive somecollection interesting profit numbers over the last three years. Its to has the had average period? (LO3-2) profit margin in 2014 was 13.5 percent, and its return on assets was 31.5 percent. While 4. What advantage does the fixed charge coverage ratio offer over simply using these numbers are higher than those of the average company, the 2014 number that timesisinterest (LO3-2)equity of 167.8 percent (the norm is blows analysts away its returnearned? on stockholders’ 15–20 percent). In fact, this ROE is so high and unrealistic that some financial services list the number as not meaningful (NMF). The major reason for this abnormally high return is its high debt-to-total-asset ratio of 81 percent. This means that the firm’s debt represents 81 percent of total assets and stockholders’ equity only 19 percent. Almost any amount of profit will appear high in regard to the low value of stockholders’ equity. blo7716x_ch03_056-095.indd 74 07/08/15 09:20 AM In contrast, its main competitor, Procter & Gamble, has only a 17.5 percent return on stockholders’ equity, partially because it is heavily financed by stockholders’ equity at 66.2 percent while its debt-to-asset ratio is 33.8 percent. This may be good or bad. This kind of analysis will be found in the financial ratios discussion in this chapter. In Chapter 2, we examined the basic assumptions of accounting and the various components that make up the financial statements of the firm. We now use this fundamental material as a springboard into financial analysis—to evaluate the financial performance of the firm. The format for the chapter is twofold. In the first part we use financial ratios to evaluate the relative success of the firm. Various measures such as net income to sales and current assets to current liabilities will be computed for a hypothetical company and examined in light of industry norms and past trends. In the second part of the chapter we explore the impact of inflation and disinflation on financial operations. You will begin to appreciate the impact of rising prices (or at Ratio analysis provides a meaningful comparison of a company to its industry. Ratios can be used to measure profitability, asset utilization, liquidity, and debt utilization. The Du Pont system of analysis identifies the true sources of return on assets and return to stockholders. Trend analysis shows company performance over time. Reported income must be further evaluated to identify sources of distortion. f you’re in the market for dental products, look no further than Colgate-Palmolive. The firm has it all: every type of toothpaste you can imagine (tartar control, cavity protection, whitening enhancement), as well as every shape and size of toothbrush. While you’re getting ready for the day, also consider its soaps, shampoos, and deodorants (Speed Stick, Lady Speed Stick, etc.). For those of you who decide to stay home and clean your apartment or dorm room, Colgate-Palmolive will provide you with Ajax, Fab, and a long list of other cleaning products. All this is somewhat interesting, but why mention these subjects in a finance text? Well, Colgate-Palmolive has had some interesting profit numbers over the last three years. Its profit margin in 2014 was 13.5 percent, and its return on assets was 31.5 percent. While these numbers are higher than those of the average company, the 2014 number that blows analysts away is its return on stockholders’ equity of 167.8 percent (the norm is 15–20 percent). In fact, this ROE is so high and unrealistic that some financial services list the number as not meaningful (NMF). The major reason for this abnormally high return is its high debt-to-total-asset ratio of 81 percent. This means that the firm’s debt represents 81 percent of total assets and stockholders’ equity only 19 percent. Almost any amount of profit will appear high in regard to the low value of stockholders’ equity. In contrast, its main competitor, Procter & Gamble, has only a 17.5 percent return on stockholders’ equity, partially because it is heavily financed by stockholders’ equity at 66.2 percent while its debt-to-asset ratio is 33.8 percent. This may be good or bad. This kind of analysis will be found in the financial ratios discussion in this chapter. In Chapter 2, we examined the basic assumptions of accounting and the various components that make up the financial statements of the firm. We now use this fundamental material as a springboard into financial analysis—to evaluate the financial performance of the firm. The format for the chapter is twofold. In the first part we use financial ratios to evaluate the relative success of the firm. Various measures such as net income to sales and current assets to current liabilities will be computed for a hypothetical company and examined in light of industry norms and past trends. In the second part of the chapter we explore the impact of inflation and disinflation on financial operations. You will begin to appreciate the impact of rising prices (or at LIST OF TERMS debt utilization ratios profitability ratios LEARNING OBJECTIVES debt to total assets profit margin times ainterest return on assets LO 3-1 Ratio analysis provides meaningfulearned comparison of afixed company to its industry. charge coverage return on equity LO 3-2 Ratios can be used to measure Du Pont system of analysis asset utilization ratios profitability, asset utilization, liquidity, and debt utilization. trend analysis receivable turnover LO 3-3 The Du Pontinflation system of analysis identifies average collection period the true sources of return on assets and replacement costs inventory turnover return to stockholders. LO 3-4 Trend analysis shows company disinflation fixed asset turnover performance over time. deflation total asset turnover LO 3-5 Reported income must be further liquidity ratios evaluated toLIFO identify sources of distortion. FIFO current ratio quick ratio Revised! Chapter Opening Vignettes We bring in current events (such as businessto-business online ventures and competition among air carriers) as chapter openers to illustrate the material to be learned in the upcoming chapter. 56 blo7716x_ch03_056-095.indd 56 09/18/15 07:29 PM First Pages Tesla’s Sales Forecasts: Where Marketing and Finance Come Together All the financial analysis in the world can prove useless if a firm does not have a meaningful sales projection. To the extent that the firm has an incorrect sales projection, an inappropriate amount of inventory will be accumulated, projections of accounts receivable and accounts payable will be wrong, and profits and cash flow will be off target. Although a corporate treasurer may understand all the variables influencing income statements, balance sheets, cash budgets, and so on, she is out of luck if the sales projection is wrong. For example, Tesla Motors produces and sells electric cars, and it may have the potential to become the Apple computer of the car industry. However, Tesla’s success partially depends upon gasoline prices. While expensive gas is harmful to the overall economy, it is a sales elixir for Tesla. When oil prices dropped more than 40 percent in 2014, gas prices Finance in ACTION plunged, and projections produced by Tesla’s marketing group began to look too rosy. A Morgan Stanley auto analyst estimated that Tesla would sell 40 percent fewer cars than had previously been forecast. Although sales projections had previously been for 500,000 cars by 2020, new projections were for only 300,000. With plummeting oil prices, Tesla’s stock fell over 30 percent. Over the last two decades, the marketing profession has developed many sophisticated techniques for analyzing and projecting future sales, but it is important for financial managers to realize that projections are often inherently risky. The financial manager must look to the marketing staff to help project sales, but a good financial analyst will also seek to determine how risky these sales projections may prove to be. Worst-case scenarios must be recognized so that surprises do not become financial disasters. We will add the projected quantity of unit sales for the next six months to our desired ending inventory and subtract our stock of beginning inventory (in units) to determine our production requirements. This process is illustrated below. Units 1 Projected sales 1 Desired ending inventory 2 Beginning inventory 5 Production requirements Following this process, in Table 4-3 we see a required production level of 1,015 wheels and 2,020 casters. Table 4-3 Production requirements for six months A 16 17 18 Projected unit sales (Table 4-1) Desired ending inventory (assumed to represent B C Wheels Casters 11,000 12,000 D Managerial A 5 the annuity payment )n 2 1 1 A(1 1 i )n 2 2 . . . A( 1 1 i )1 1 A(1 1 i )0 FVAinterest 5 A(1 1 irate i 5 the (1 1 i )n 2 1 n 5 the of payments 5 A ___________ FVAnumber [ ] i www.downloadslide.net (9-5) Using Formula 9-5 to calculate the future value of our annuity payments, Where AA 5 $1,000 5 future value of an annuity FV 5 the annuity payment iA 5 10% i 5 the interest rate nn 5 4 5 the number of payments [ ] 4 Preface (1 1 annuity 0.10) payments, 21 Using Formula 9-5 to calculate the future value_____________ of our FVA 5 $1,000 A 5 $1,000 i 5 10% Because n 5 4 this 0.10 5 $4,641 problem involves an annuity rather than a single payment, when solv4 ing with a financial calculator,_____________ value (1the 1 0.10) 21that we enter for the PMT key is 2$1,000. FV 5 $1,000 5 $4,641 Now we enter a zero Afor the PV 0.10 key. As we computed earlier using the future value FINANCIAL thisequation, problem involves an annuity rather than single payment, when solv-the future value of a of anBecause annuity we find that when thea interest rate is 10%, CALCULATOR ing with$1,000 a financial calculator, the value that we enter for the PMT key is 2$1,000. 4-year, annuity is $4,641. FV of Annuity Now we enter a zero for the PV key. As we computed earlier using the future value Enter Function FV function canthatalso produce the future of value an annuity stream. The FV ofExcel’s an annuity equation, we find when the interest rate is 10%,value the future of a N 4 4-year, $1,000 annuity is $4,641. function assumes that each payment is at the end of a period as shown10in theI/Yprevious Excel’s FV function can also produce the future value of an annuity stream. The FV PMT in cell timeline. The annuity amount is entered as the pmt argument. The 21000 function function assumes that each payment is at the end of a period as shown in the previous 0 usesPVnumbers D1timeline. references the arguments in cells B1 toargument. B4. TheThe function cell D5 The annuity amount is entered as the pmt function in in cell Function Solution D1 references arguments in cells B1 to cases, B4. The the function in cellproduced D5 uses numbers instead of cellthereferences. In both values by the FV CPT function are instead ofto cell references. In both cases, the values produced by the FV function are FV 4,641.00 identical the calculator solution. [ ] identical to the calculator solution. AA 1 1 2 4.00 21000 3 nper pmt 3 4 pv pmt 4 5 6 C B 10.00% nper 2 5 B rate rate C D ED E F 5FV(B1,B2,B3,B4) FV(rate, nper, pmt, [pv], [type]) 4.00 $4,641.00 FV(rate, nper, pmt, [pv], [type]) 0 21000 pv F 5FV(B1,B2,B3,B4) 10.00% $4,641.00 51FV(0.1,4,21000,0) 0 FV(rate, nper, pmt, [pv], [type]) 7 $4,641.00 6 51FV(0.1,4,21000,0) FV(rate, nper, pmt, [pv], [type]) 7 $4,641.00 First Pages blo7716x_ch09_255-294.indd 130 265 blo7716x_ch09_255-294.indd 07/08/15 09:25 AM 265 FINANCIAL CALCULATOR ix Excel, Calculator Solutions, and Formulas FV of Annuity Enter Function N 4 I/Y 10 21000 PMT PV 0 Function CPT FV In Chapters 9, 10, and 12, the authors have included new discussions on how the examples are solved using Excel, financial calculators, and formulas. Newly formatSolution ted spreadsheet tables and screen captures 4,641.00 detail the step-by-step method to solve the examples. The financial calculator keystrokes in the margins give instructors and students additional flexibility. The material can be presented using traditional methods without loss of clarity because the margin content supplements the prior content, which has been retained. The book and solutions manual provide Excel, calculator, and formula explanations for these very important calculations. 07/08/15 09:25 AM Part 2 Financial Analysis and Planning Table 5-3 Units Sold 0 20,000 30,000 40,000 60,000 80,000 100,000 Pulling It Together with Color Volume-cost-profit analysis: Conservative firm Total Variable Costs Fixed Costs Total Costs 0 32,000 48,000 $12,000 12,000 12,000 $ 12,000 44,000 60,000 64,000 96,000 128,000 160,000 12,000 12,000 12,000 12,000 76,000 108,000 140,000 172,000 $ Total Revenue $ Operating Income (Loss) 0 40,000 60,000 $(12,000) (4,000) 0 80,000 120,000 160,000 200,000 4,000 12,000 20,000 28,000 The Risk Factor 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 apprehensive about economic conditions, the conservative plan may be undertaken. For a growing business in times of relative prosperity, management might maintain a more aggressive, leveraged position. The firm’s competitive position within its industry will also be a factor. 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 particularly 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 throughout the text, is to match an acceptable return with the desired level of risk. Cash Break-Even Analysis Our discussion to this point has dealt with break-even analysis in terms of accounting flows rather than cash flows. For example, depreciation has been implicitly included in fixed expenses, but it represents a noncash accounting entry rather than an explicit expenditure of funds. To the extent that we were doing break-even analysis on a strictly cash basis, depreciation would be excluded from fixed expenses. In the previous example of the leveraged firm in Formula 5-1, if we eliminate $20,000 of “assumed” depreciation from fixed costs, the break-even level is reduced from 50,000 units to 33,333 units. ($60,000 2 $20,000) $40,000 FC _______ 5 __________________ 5 _______ 5 33,333 units P 2 VC $2.00 2 $0.80 $1.20 Other adjustments could also be made for noncash items. For example, sales may initially take the form of accounts receivable rather than cash, and the same can be said for the purchase of materials and accounts payable. An actual weekly or monthly cash budget would be necessary to isolate these items. While cash break-even analysis is helpful in analyzing the short-term outlook of the firm, particularly when it may be in trouble, break-even analysis is normally Throughout the 16th edition, the authors make color an integral part of the presentation of finance concepts. Color is applied consistently across illustrations, text, and examples in order to enhance the learning experience. We hope that the color in this edition assists your understanding and retention of the concepts discussed. New! Digital Illustrations of Time Value of Money (Chapter 9) The concept of the “time value of money” is one of the most difficult topics in any financial management course for professors to communicate to students. We think we have created a visual method for teaching future value and present value of money that will help you understand the concept simply and quickly. The 16th edition includes new interactive digital illustrations of four key figures in the text that visually relate future values and present values. We hope you agree that this visual presentation helps those students who are less comfortable with the math.