Financial Management for Executives, 2e

by Prag, Wallace

ISBN: 978-1-61853-049-3 | Copyright 2017

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Welcome to Finanacial Management for Executives.

If you have prior business experience, either working for a company or managing your own business, then you know firsthand that an understanding of finance and accounting is essential to achieve your full potential on the job. Although business decisions certainly involve a careful analysis of non-financial factors, they also almost always require analysis of financial information. Initiating a marketing campaign, restructuring a subsidiary, determining the sale price of a new product, or assessing whether to acquire another company (and at what price) are just a few of the business decisions that require an understanding of financial information. This textbook is written to facilitate that understanding and to facilitate the reader’s personal goal of gaining a more complete understanding of finance and its use in business decisions.

Target Audience

Financial Management for Executives is written specifically for the Executive MBA, MBA, and executive training markets. This concise text can be used in a wide variety of course formats, ranging from brief executive programs lasting only a few weekends to more traditional 15-week courses.

Organization

A succinct, flexible 12-chapter structure fits EMBA, full-time, part-time, and evening MBA programs. This book provides students with the tools and insights necessary to make informed business decisions ranging from performance evaluation to firm valuation. The chapters are organized around a decision-focused structure.

The first three chapters introduce the basic financial statements and tools for analyzing accounting information:
I. The foundations of financial accounting and accounting analysis (Chapters 1–3)

The next five chapters provide the student the tools needed, along with a structure for financial valuations.

II. Interest rates and the time value of money (Chapter 4)
III. Risk and return (Chapter 5)
IV. Financial asset valuation (Chapters 6 and 7)
V. Financial markets and financial instruments (Chapter 8)

The following three chapters explore topics of financial corporate decisions.

VI. Capital structure (Chapter 9)
VII. Dividend policy (Chapter 10)
VIII. Mergers and acquisitions and leveraged buyouts (Chapter 11)

The book concludes with an introduction to international finance.

IX. International finance (Chapter 12)

What Makes this Textbook Different from Other Finance Texts?

Clear and Concise

Financial Management for Executives provides an extremely pragmatic approach to teaching what many consider a very difficult subject to grasp. Rather than overwhelming the student with dense theory, the textbook is written in a clear, conversational style with continuous references to real-world application. The combined aspects of readability, concise presentation, and simple organization make the material easy to digest. We find students from disciplines as diverse as financial engineering to art history are amazed at their ability to understand the topics presented in the textbook. We constantly receive comments such as “I was afraid of this class, but now I can honestly say I enjoy it,” or “I can finally understand what the finance people at my place of work are saying."

Grounded in the Context of Corporate Decisions

Financial information is an integral part of decision making at every level in business. Consequently, the book’s discussion of important finance and accounting concepts is grounded in the context of actual corporate decisions. To this end, the book contains an abundance of excerpts and illustrations from actual corporate financial reports and disclosures that highlight the role and impact of financial information in decision making. Following is an example found in the textbook in the context of valuation using the simple price-earnings multiples:

Reflects Contemporary Knowledge

In our experience, EMBAs and MBAs frequently seem interested in exploring realworld questions such “How do companies go public?” or “Does the market really follow fundamental analysis?” We discuss both the theory and the practical applications to these questions using real-world companies, such as Facebook and Green Mountain, to provide context.

Real Data and Examples

Each chapter opens with a vignette based on a real company example that immediately engages the reader in the chapter’s topics. Subsequent examples and end of chapter exercises incorporate real company data, further enhancing student comprehension.

Engaging Pedagogy

A Roadmap to the Chapter

The text includes many tools that reinforce an understanding of the chapter contents, beginning with a framework that orients the student to how the chapter coverage fits in with the rest of the course.

Takeaways define the learning objectives that the student will be able to master after reading the chapter.

Often, students lose sight of the big picture. The Past, Present, Future feature provides students with a snapshot of the topics that were just covered in the previous chapter and those to come.

The Executive Outline visually depicts the layout of the chapter and the key concepts to be covered.

Your Turn! boxes are integrated throughout each chapter as a means of reinforcing the material just presented and lend an interactive feel to the material. Questions are posed around a realistic financial scenario, and solutions are provided at the end of the chapter so students can check their work.

End of Chapter Material

At the end of each chapter, review materials include:

  • Comprehensive Review Problem, with solution
  • Executive Summary
  • Key Terms
  • Exercises
  • Your Turn! Soultions

Expand/Collapse All
About the Authors (pg. iii)
Chapter 1: An Introduction to Financial Statements (pg. 1)
Executive Outline (pg. 2)
BlueBear Beverages: An Extended Case Study (pg. 3)
Just the Facts (pg. 3)
The Beginning Balance Sheet (pg. 4)
The Income Statement and Ending Balance Sheet (pg. 5)
Analyzing the Statements (pg. 7)
Accrual-Based Accounting versus Cash Flows (pg. 9)
Lessons Learned (pg. 12)
A Closer Look at Financial Statements (pg. 15)
Procter & Gamble—Income Statement (pg. 15)
Procter & Gamble—Balance Sheet (pg. 16)
Procter & Gamble—Statement of Cash Flows (pg. 19)
Additional Financial Reporting Information (pg. 21)
Auditor’s Report (pg. 21)
Management Discussion and Analysis (pg. 21)
Notes to Financial Statements (pg. 21)
Four Myths About Financial Accounting (pg. 22)
Executive Summary (pg. 26)
Key Terms (pg. 27)
Exercises (pg. 29)
Chapter 2: Analyzing Financial Statements (pg. 45)
Executive Outline (pg. 46)
Fundamentals of Financial Statement Analysis (pg. 46)
Trend Analysis (pg. 47)
Common-size Statements (pg. 51)
Financial Ratios (pg. 53)
Profitability Ratios (pg. 54)
Asset Management Ratios (pg. 55)
Liquidity Ratios (pg. 58)
Solvency Ratios (pg. 59)
The ROE Model Framework (pg. 61)
Common Stockholder Ratios (pg. 63)
Limitations of Financial Statement Analysis (pg. 66)
Executive Summary (pg. 70)
Key Terms (pg. 71)
Exercises (pg. 73)
Chapter 3: Managing Working Capital and Cash Flow (pg. 85)
Executive Outline (pg. 86)
Growth and Working Capital: An Illustration (pg. 87)
Cash Flow Budgeting (pg. 88)
Cash Collections Budget (pg. 90)
Cash Disbursements Budget (pg. 91)
Cash Flow Budget (pg. 92)
Methods to Manage Working Capital Financing Needs (pg. 94)
Estimating Sustainable Growth (pg. 96)
Sustainable Growth at Home Depot (pg. 97)
Executive Summary (pg. 101)
Key Terms (pg. 102)
Exercises (pg. 102)
Chapter 4: Interest Rates and the Time Value of Money (pg. 109)
Executive Outline (pg. 110)
Time Value of Money (pg. 110)
Present Value (pg. 111)
Comparing Alternative Investments Using Present Value (pg. 111)
Present Value With Two-Year Cash Flows (pg. 112)
Present Value With Multiple Cash Flows (pg. 114)
Present Value With a Three-Year Project (pg. 116)
Compound Interest at the Bank (pg. 118)
Net Present Value (pg. 118)
Net Present Value of a Machine (pg. 118)
Negative Net Present Value (pg. 120)
A Useful Tool—The Timeline (pg. 120)
Not For Profits (pg. 120)
Discount Rates as Borrowing Costs (pg. 121)
Internal Rate of Return—An Alternative to NPV (pg. 123)
Annuities (pg. 124)
Internal Rate of Return of an Annuity (pg. 125)
Determining the Payment on a Mortgage (pg. 125)
Executive Summary (pg. 127)
Key Terms (pg. 127)
Exercises (pg. 128)
Chapter 5: Risk and Return (pg. 131)
Executive Outline (pg. 132)
Diminishing Marginal Utility (pg. 132)
Risk Aversion (pg. 134)
Statistics Overview (pg. 135)
Adding Assets to a Portfolio (pg. 137)
The Statistics of Portfolios (pg. 139)
Only Covariance Matters! (pg. 140)
Portfolio Theory (pg. 142)
CAPM—the Capital Asset Pricing Model (pg. 142)
The Fundamental Source of Risk and the Stand-Alone Principle (pg. 144)
Beta and Leverage (pg. 145)
Weighted Average Cost of Capital (WACC) (pg. 147)
Executive Summary (pg. 149)
Key Terms (pg. 149)
Exercises (pg. 150)
Chapter 6: Financial Asset Pricing—Debt (pg. 155)
Executive Outline (pg. 156)
Pricing Coupon Bonds (pg. 156)
Bond Selling at Par (pg. 157)
Bond Selling at a Premium (pg. 158)
Long-Term Bonds (pg. 159)
Bond Selling at a Discount (pg. 159)
Zero Coupon Bonds (pg. 161)
Computing Discount Rate on a Zero Coupon Bond (pg. 161)
T-Bills (pg. 162)
Current Yield (pg. 163)
Semi-Annual Coupon Payments (pg. 164)
Determining the Discount Rate with Semi-Annual Coupon Payments (pg. 165)
Term Structure (pg. 166)
Interest Rate Risk (pg. 166)
Coupon Rates and Interest Rate Risk (pg. 167)
Duration (pg. 168)
Executive Summary (pg. 170)
Key Terms (pg. 171)
Exercises (pg. 172)
Chapter 7: Valuing a Company’s Common Stock (pg. 177)
Executive Outline (pg. 178)
The Process (pg. 178)
Pro-Forma Financial Statements (pg. 179)
Forecast Sales Revenue (pg. 182)
Forecast Sales Related Income Statement Items (pg. 182)
Forecast Sales Related Balance Sheet Items (pg. 183)
Forecast Balance Sheet Items Based on Turnover Ratios (pg. 183)
Forecast Other Balance Sheet Items (pg. 184)
Forecast Interest Expense and Tax Expense (pg. 184)
Forecast Dividends and Retained Earnings (pg. 185)
Complete the Balance Sheet With a Plug Figure (pg. 185)
Create the Statement of Cash Flows (pg. 186)
Compute Free Cash Flow (pg. 186)
Compute the Discount Rate (pg. 187)
Forecast the Terminal Year (pg. 188)
Free Cash Flow Valuation Model (pg. 188)
Price-Earnings Multiples (pg. 189)
Appendix: Creating a PRO-FORMA Statement of Cash Flows (pg. 191)
Executive Summary (pg. 197)
Key Terms (pg. 198)
Exercises (pg. 198)
Chapter 8: Financial Instruments and Markets (pg. 203)
Executive Outline (pg. 204)
Debt, Default, and Bankruptcy (pg. 204)
Short-Term vs. Long-Term (pg. 205)
The Prospectus (pg. 205)
Bond Covenants and the Stockholder-Bondholder Conflict (pg. 206)
Stockholders Prefer Riskier Projects Than Do Bondholders (pg. 207)
Firms in Distress (pg. 209)
Equity (pg. 209)
Initial Public Offerings and Investment Banks—A Brief Overview (pg. 210)
Options (pg. 212)
Call Option Example (pg. 213)
Put Option Example (pg. 213)
Option Pricing (pg. 214)
Bankruptcy as an Option (pg. 215)
Convertibility Reconsidered (pg. 216)
Real Options (pg. 217)
Executive Summary (pg. 217)
Key Terms (pg. 218)
Exercises (pg. 220)
Chapter 9: Capital Structure (pg. 223)
Executive Outline (pg. 224)
Optimal Capital Structure and WACC (pg. 224)
Modigliani-Miller and Capital Structure Irrelevance (pg. 226)
Capital Market Imperfections (pg. 227)
Taxes (pg. 227)
Transactions Costs (pg. 230)
Direct Bankruptcy Costs (pg. 231)
Corporate bankruptcy: Costly and often worthless (pg. 231)
Indirect Bankruptcy Costs (pg. 231)
Modigliani-Miller in the Real World (pg. 233)
Other Factors in Capital Structure Determination (pg. 235)
Executive Summary (pg. 237)
Key Terms (pg. 237)
Exercises (pg. 238)
Chapter 10: Dividend Policy and Beyond (pg. 243)
Executive Outline (pg. 244)
Dividend Policy (pg. 244)
Modigliani and Miller Revisited (pg. 246)
Imperfect Capital Markets (pg. 247)
Taxes (pg. 247)
Transactions Costs (pg. 248)
Transactions Costs Reconsidered (pg. 249)
Apple, Radio Shack, and ROE (pg. 250)
Tyco, Beatrice, Disney, and the Acquisition Binge (pg. 251)
The Value of Outside Review (pg. 252)
Executive Summary (pg. 253)
Key Terms (pg. 253)
Exercises (pg. 254)
Chapter 11: Takeovers (pg. 259)
Executive Outline (pg. 260)
Takeover Terminology (pg. 261)
Acquisitions (pg. 261)
Proxy Fight (pg. 264)
Going Private (pg. 264)
Reasons for Takeovers (pg. 264)
Taxes (pg. 264)
Taxes and Leveraged Buyouts (pg. 267)
Non-Tax Reasons for Takeovers (pg. 268)
Mismanagement and Inefficient Use of Assets (pg. 268)
Market Power (pg. 269)
Vertical Integration (pg. 270)
Economies of Scale (pg. 271)
Invalid Reasons for Takeovers (pg. 271)
Diversification (pg. 271)
Merging to Lower Borrowing Costs (pg. 272)
Takeover Defense and Related Strategic Moves (pg. 272)
Poison Pills (pg. 273)
Golden Parachutes (pg. 274)
White Knight and Safe Harbor (pg. 274)
Selling the Crown Jewels (pg. 275)
Greenmail (pg. 275)
Executive Summary (pg. 276)
Key Terms (pg. 276)
Exercises (pg. 277)
Chapter 12: International Corporate Finance (pg. 281)
Executive Outline (pg. 282)
Why Invest Abroad (pg. 283)
Cheap Foreign Labor (pg. 283)
Taxes and Regulations (pg. 284)
Other Factors (pg. 284)
Exchange Rates Fundamentals (pg. 285)
Exchange Rate Changes and Returns on Foreign Investments (pg. 287)
Exchange Rates and Inflation (pg. 289)
Inflation and Interest Rates (pg. 290)
Inflation, Exchange Rates and Interest Rates (pg. 291)
Executive Summary (pg. 292)
Key Terms (pg. 293)
Excercises (pg. 293)
Glossary (pg. 297)
Index (pg. 301)
Jay Prag

Jay Prag

Jay Prag is a Clinical Associate Professor at the Peter F. Drucker and Masatoshi Ito Graduate School of Management where he has taught since 1986. He also teaches at Harvey Mudd College, and he previously taught at Claremont McKenna College and Pomona College. He has also taught Corporate Finance as a corporate trainer at Edison International for seven years.

Professor Prag has won twenty-eight teaching awards in his years at the Claremont Colleges. He has also served as Academic Director for the Executive MBA and the Financial Engineering Programs at the Drucker School.

He serves on the Board of Directors of LINC Housing, a nonprofit, low-income housing developer in Long Beach, CA. He previously served on the Board of Directors of Mt. San Antonio Gardens in Claremont, CA, and was actively involved in and served on the boards of several business start-ups.

Professor Prag was a weekly guest on the Lou Desmond Show on KTIE 590 AM for four years, and he published a monthly column in the Los Angeles Newspaper Group newspapers for many years. He has published research papers in the Journal of Macroeconomics, the Review of Financial Economics, and the Journal of Cultural Economics.

He has a PhD in Economics from the University of Rochester (1988), an MA in Economics (1981), and a BBA (1979) from the University of Florida.


James S. Wallace

James S. Wallace

Associate Professor at The Peter F. Drucker and Masatoshi Ito Graduate School of Management at The Claremont Graduate University.

He received his Bachelors of Arts from the University of California, Santa Barbara, his MBA from the University of California, Davis, and his PhD from the University of Washington. Professor Wallace also holds a CPA certification from the state of California. He previously served on the faculty of the University of California, Irvine and has served as a visiting professor at the University of California, San Diego. Professor Wallace's work has appeared in leading academic journals including the Journal of Accounting and Economics, the Journal of Corporate Finance, and Information Systems Research, along with leading applied journals such as the Journal of Applied Corporate Finance, the Journal of Accountancy, Issues in Accounting Education and Accounting Horizons. Prior to his career in academics, Professor Wallace worked in public accounting and in industry with a Fortune 500 company. He has done consulting work with numerous companies in multiple industries.

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