Complete CFO Handbook

Frank J. Fabozzi, PhD, CFA, CPA, is Professor in the Practice of Finance in the School of Management at Yale University. He is a Fellow of the International Center for Finance at Yale University and serves on the Advisory Council for the Department of Operations Research and Financial Engineering at Princeton University. He has authored and edited numerous books in finance.Pamela Peterson Drake, PhD, CFA, is the J. Gray Ferguson Professor of Finance and Department Head of Finance and Business Law at James Madison University, Harrisonburg, Virginia. She is author or coauthor of numerous books and articles.Ralph S. Polimeni, PhD, CPA, is the Vice Provost for Accreditation and Assessment and holds the Chaykin Endowed Chair in Accounting at Hofstra University, Long Island, New York. He has authored numerous articles and books on accounting.

• Preface xvAbout the Authors xixCHAPTER 1The Changing Role of the CFO: From Accounting to Accountable 1SOX Act of 2002 and the CFO 2Expanded Responsibilities of the CFO 6Our Agenda 14Part OneFunding 15CHAPTER 2Capital Structure Decisions 17Debt versus Equity 18Concept of Leverage 21Capital Structure and Financial Leverage 25Financial Leverage and Risk 29Capital Structure and Taxes 31Capital Structure and Financial Distress 37Cost of Capital 41Agency Relationship 43Optimal Capital Structure: Theory and Practice 47A Capital Structure Prescription 51Bottom Line 52Appendix: Capital Structure Theory—The Modigliani-Miller Theory and Beyond 53CHAPTER 3Types of Debt Financing 63General Features of Debt Obligations 64Term Loans 65Syndicated Bank Loans 69Notes and Bonds 71Short-Term Financing 86Off-Balance-Sheet Financing 93Bottom Line 95CHAPTER 4Equity Funding 99Common Stock 100Preferred Stock 115Bottom Line 121CHAPTER 5Structured Financing: Asset Securitization and Structured Notes 123Asset Securitization 124Structured Notes 139Bottom Line 149Part TwoStrategy, Taxes, and Risk Management 151CHAPTER 6Strategy and Financial Planning 153Strategy and Value 155Financial Planning and Budgeting 158Importance of Financial Planning 158Budgeting Process 160Sales Forecasting 161Seasonal Considerations 163Budgeting 165Pro Forma Financial Statements 172Long-Term Financial Planning 179Financial Modeling 179Performance Evaluation 183Strategy and Value Creation 191Bottom Line 195CHAPTER 7Basics of Corporate Taxes and Tax Risk Management 197Tax Management 199Tax Risk 200U.S. Tax Law and Taxation of Corporations 205State and Local Taxes 218Non-U.S. Taxes 218Bottom Line 224CHAPTER 8Corporate Risk Management 227Risk Defined 228Enterprise Risk Management 230Managing Risks 235Risk Transfer 237Bottom Line 255Part ThreePerformance Evaluation 259CHAPTER 9Financial Ratio Analysis 261Ratios and Their Classification 262Return-on-Investment Ratios 264Liquidity 271Profitability Ratios 279Activity Ratios 282Financial Leverage Ratios 284Common-Size Analysis 289Using Financial Ratio Analysis 290Illustration: Pfizer, Inc., 1990–2005 292Bottom Line 307CHAPTER 10Cash Flow Analysis 309Difficulties with Measuring Cash Flow 309Cash Flows and the Statement of Cash Flows 311Free Cash Flow 316Calculating Free Cash Flow 318Net Free Cash Flow 320Usefulness of Cash Flows in Financial Analysis 322Bottom Line 327CHAPTER 11Decentralized Operations and Responsibility Accounting 329Organization Structures and Concepts 330Examples of Types of Organization Structure and Resposibility Reporting 331Decentralization Problems 337Responsibility Accounting 338Controllable Costs 345Costs of Service Departments 346Executive Incentive Compensation Plans and Dysfunctional Decision Making 347Bottom Line 351CHAPTER 12Responsibility Center Performance Evaluation 353Basis for Comparison 354Cost Center Performance Evaluation 356Profit Center Performance Evaluation 364Profit Center Decision Making 372Investment Center Performance Evaluation 373Bottom Line 394Appendix: Gross Profit Analysis 394CHAPTER 13Transfer Pricing 405Transfer Pricing Methods 407Dual Transfer Pricing System 418International Transfer Pricing 419Bottom Line 424Part FourAsset Management 427CHAPTER 14Capital Budgeting and Cash Flow Analysis 429The Investment Problem 430Capital Budgeting 432Cash Flow from Investments 437Bottom Line 454Appendix 14.A: Expected Cash Flows from the Disposition of an Asset 455Appendix 14.B: Expansion of the Williams 5 & 10 457CHAPTER 15Capital Budgeting Techniques 463Evaluation Techniques 464Net Present Value 466Profitability Index 471Internal Rate of Return 472Modified Internal Rate of Return 477Payback Period 480Discounted Payback Period 482Issues in Capital Budgeting 483Comparing Techniques 486Capital Budgeting Techniques in Practice 489Conflicts with Responsibility Center Performance Evaluation Measures 490Capital Budgeting and the Justification of New Technology 491Bottom Line 495CHAPTER 16Capital Budgeting and Risk 497Project Risk 498Measurement of Project Risk 500Measuring a Project’s Market Risk 505Incorporating Risk in the Capital Budgeting Decision 514Real Options 518Certainty Equivalents 525Assessment of Project Risk in Practice 526Bottom Line 528CHAPTER 17Leasing 531How Leasing Works 532Types of Equipment Leases 533Full-Payout Leases versus Operating Leases 535Reasons for Leasing 536Types of Lessors 541Lease Brokers and Financial Advisers 541Lease Programs 542Financial Reporting of Lease Transactions by Lessees 543Leveraged Lease Fundamentals 546Federal Income Tax Requirements for True Lease Transactions 556Synthetic Leases 558Valuing a Lease: The Lease or Borrow-to-Buy Decision 560Bottom Line 574CHAPTER 18Managing Short-Term Assets 579Cash Management 581Marketable Securities 589Receivables Management 591Inventory Management 601Bottom Line 607Part FiveCost and Managerial Accounting 609CHAPTER 19Classifying Costs 611Elements of a Product 612Relationship to Production 615Relationship to Volume 616Ability to Trace 622Department Where Incurred 623Functional Areas 624Period Charge in Income 625Relationship to Planning, Controlling, and Decision Making 626Techniques for New Product Cost Estimation 629Bottom Line 633CHAPTER 20Costing and Control of Materials, Labor, and Factory Overhead 635Materials (Stores) 636Labor 641Factory Overhead Costs 646Activity-Based Costing 660Bottom Line 664CHAPTER 21Job Order and Process Costing 667Comparison of Job Order and Process Cost Accumulation Systems 668Job Order Costing 669Operation Costing 673Project Costing 674Process Costing 676Backflush Costing 694Bottom Line 695Appendix: Spoiled Units, Defective Units, Scrap Material, and Waste Material in Job Order and Process Costing Systems 697CHAPTER 22Joint Product and By-Product Costing 703Joint Products 703By-Products 711Effects of Joint Cost Allocation upon Decision Making 715Bottom Line 716CHAPTER 23Master Budget 719Conventional Master Budget System 721Budgeted Schedules 723Budgeted Summaries 740Bottom Line 744CHAPTER 24Standard Costing 749Actual, Normal, and Standard Costing 750Uses of Standard Costs 751Types of Standards 752Establishment of Standards 753Just-in-Time Philosophy and Cost Accounting 764Variance Analysis 769Disposition of All Variances 786Bottom Line 788CHAPTER 25Direct and Absorption Costing 791Meaning of Direct Costing 791Direct Costing versus Absorption Costing 792Advantages of Direct Costing 802Disadvantages of Direct Costing 805Adjusting Financial Statements for External Reports 807Bottom Line 807Index 809