Lessons in Corporate Finance

PAUL ASQUITH is the Gordon Y. Billard professor of finance at M.I.T.'s Sloan School. He is a specialist in corporate finance and has written on all areas of corporate finance including mergers, LBOs, equity issues, dividend policy, and more. LAWRENCE A. WEISS is professor of International Accounting at The Fletcher School of Law and Diplomacy at Tufts University. He is a specialist in accounting and finance and has written on corporate bankruptcy, firm performance, international accounting, mergers, and more.

Preface xiii Acknowledgments xv About the Authors xvii CHAPTER 1 Introduction Two Markets: Product and Capital 2 The Basics: Tools and Techniques 2 A Diagram of Corporate Finance 3 A Brief History of Modern Finance 4 Reading This Book 6 CHAPTER 2 Determining a Firm s Financial Health (PIPES-A) The Conversation with the Banker Is Like a Job Interview 7 Starting with the Product Market Strategy 9 Is PIPES Profi table? 10 Doing the Math 10 Sources and Uses of Funds 12 Ratio Analysis 16 The Cash Cycle 21 Summary 24 CHAPTER 3 Pro Forma Forecasts (PIPES-B) First, Let s Take a Closer Look at Ratio Analysis 27 Pro Forma Forecasts 29 Circular Relationships 36 Back to (Forecasting) the Future 38 Projecting Out to 2014 and 2015 39 Evaluating the Loan 41 Summary 45 Appendix 3A: Accounting Is Not Economic Reality 47 CHAPTER 4 The Impact of Seasonality on a Firm s Funding (PIPES-C) 53 Monthly Pro Forma Income Statements 54 Monthly Pro Forma Balance Sheets 56 A Different Picture of the Firm 65 Summary 70 Appendix 4A: PIPES Monthly Pro Forma Income Statements and Balance Sheets 2014 71 Appendix 4B: PIPES Monthly Pro Forma Income Statements and Balance Sheets 2015 74 CHAPTER 5 Why Financing Matters (Massey Ferguson) Product Market Position and Strategy 77 Political Risk and Economies of Scale in Production 78 Massey Ferguson 1971 1976 79 Sustainable Growth 81 The Period after 1976 83 Conrad Runs Away 86 The Competitors 87 Back to Massey 90 Massey s Restructuring 92 Postscript: What Happened to Massey 96 Summary 97 Appendix 5A: Massey Ferguson Financial Statements 99 CHAPTER 6 An Introduction to Capital Structure Theory Optimal Capital Structure 104 M&M and Corporate Finance 107 Taxes 112 Costs of Financial Distress 120 The Textbook View of Capital Structure 125 The Cost of Capital 127 Summary 128 CHAPTER 7 Capital Structure Decisions (Marriott Corporation and Gary Wilson) Capital Structure 131 The Cost of Capital 138 How Firms Set Capital Structure in Practice 141 Corporate Financial Policies 142 Sustainable Growth and Excess Cash Flow 145 What to Do with Excess Cash? 146 Summary 148 Appendix 7A: Marriott Corporation Income Statements and Balance Sheets 150 Appendix 7B: Marriott Corporation Selected Ratios 152 CHAPTER 8 Investment Decisions (Marriott Corporation and Gary Wilson) What Is the Correct Price? 154 How Should Marriott Buy Its Shares? 154 The Loan Covenants 158 The Impact of the Product Market on Financial Policies 159 The Capital Market Impact and the Future 161 Summary 166 CHAPTER 9 Financial Policy Decisions (AT&T: Before and after the 1984 Divestiture) Background on AT&T 172 M&M and the Practice of Corporate Finance 172 Old (Pre-1984) AT&T 174 New (Post-1984) AT&T 189 Summary 202 Appendix 9A: Development of AT&T Pro Formas 1984 1988 (Expected-Case) 203 CHAPTER 10 The Impact of Operating Strategy on Corporate Finance Policy (MCI) A Brief Summary 207 A Brief History of MCI 209 Convertible Preferred Stock and Convertible Bonds 215 Interest Rates and Debt Ratios 218 Leases 219 Financing Needs of the New MCI 220 MCI s Financing Choice 231 MCI Postscript 232 Summary 233 Appendix 10A: Development of MCI s Pro Formas 1984 1988 235 CHAPTER 11 Dividend Policy (Apple Inc.) The Theory of Dividend Policy 239 Empirical Evidence 243 Apple Inc. and the Decision on Whether to Pay Dividends 246 What Did Apple Do? 258 Summary 258 CHAPTER 12 A Continuation of Capital Structure Theory The Tax Shield of Debt 262 The Costs of Financial Distress 263 Transaction Costs, Asymmetric Information, and Agency Costs 265 Asymmetric Information and Firm Financing 268 Agency Costs: Manager Behavior and Capital Structure 274 Leverage and Agency Confl icts between Equity and Debt Holders 277 The Amount of Financing Required 281 Summary: An Integrated Approach 284 CHAPTER 13 The Time Value of Money: Discounting and Net Present Values The Time Value of Money 287 Net Present Value (NPV) 292 Payback 298 Projects with Unequal Lives 299 Perpetuities 301 Summary 302 CHAPTER 14 Valuation and Cash Flows (Sungreen A) Investment Decisions 303 How to Value a Project 304 The Weighted Average Cost of Capital (WACC) 315 Terminal Values 316 Summary 318 CHAPTER 15 Valuation (Sungreen B) Sungreen s Projected Cash Flows 319 The Weighted Average Cost of Capital (WACC) 320 Twin Firms 325 The Cost of Equity 328 The Cost of Debt 330 The Final Valuation 332 Strategic Analysis 333 Summary 334 CHAPTER 16 Valuation Nuances Cash Flow Nuances 337 Cost of Capital Nuances 339 Nuances on Calculating the Cost of Equity: Levering and Unlevering Beta 344 Separating Cash Flows and Terminal Values 348 Nuances of Terminal Value Methods 349 Other Valuation Techniques: DCF Variations 355 Real Options (aka Strategic Choices) 358 Summary 360 CHAPTER 17 Leveraged Buyouts and Private Equity Financing (Congoleum) Congoleum: A Short History 363 Leading Up to the LBO: What Makes a Firm a Good LBO Target? 364 Details of the Deal 367 Postscript: What Happened to LBOs? 381 Summary 382 Appendix 17A: Congoleum s Pro Formas with and without the LBO 385 Appendix 17B: Highlights of the Lazard Fairness Opinion 391 CHAPTER 18 Mergers and Acquisitions: Strategic Issues (The Dollar Stores) The Three Main Competitors 393 Recent History 394 Shopping a Firm/Finding a Buyer 397 Summary 400 CHAPTER 19 Valuing an Acquisition: Free Cash Flows to the Firm (The Dollar Stores) The Bid for Family Dollar 401 Free Cash Flows to the Firm 403 Estimating the Cost of Capital 411 Discounted Cash Flows 415 Terminal Values 416 The Three Pieces 418 Summary 419 Appendix 19A: Family Dollar Pro Forma Financial Statements with Authors Constant Debt Ratio 420 CHAPTER 20 Understanding Free Cash Flows (The Dollar Stores) Comparing the Free-Cash-Flows Formulas 423 Back to Discount Rates 425 On to Free Cash Flows to Equity 427 Discounting the Free Cash Flows to Equity 430 Summary 431 Appendix 20A: Family Dollar Pro Forma Free Cash Flows to Equity with Constant Debt Ratio 432 CHAPTER 21 Mergers and Acquisitions: Execution (The Dollar Stores) The Time Line 433 Managerial Discretion 436 Activist Shareholders 438 The Federal Trade Commission (FTC) 440 Shareholder Lawsuits 441 The Vote 442 Summary 443 Appendix 21.A: Key Events in the Bidding for Family Dollar during 2014 and 2015 444 CHAPTER 22 Review Chapters 2 4: Cash Flow Management Financial Tools 446 Chapters 5 12: Financing Decisions and Financial Policies 446 Chapters 13 21: Valuation 450 Tools and Concepts Discussed in This Book 453 Finance as Art, Not Science 454 Bottom Lines 454 An Intelligent Approach to Finance 455 Keeping Current 456 Larry s Last (Really a True) Story 457 Paul s Theory of Pies 457 Rules to Live By 458 Glossary 461 Index 469