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 Tufts University. He is a specialist in accounting and finance and has written on corporate bankruptcy, firm performance, international accounting, mergers, and more.

• About the Authors xiiiAcknowledgments xvPreface xviiChapter 1 Introduction 1Two Markets: Product and Capital 2The Basics: Tools and Techniques 3A Diagram of Corporate Finance 4A Brief History of Modern Finance 5Reading This Book 6Part One Financial Health of a Firm and Cash Flow ManagementChapter 2 Determining a Firm’s Financial Health (PIPES-A) 11The Conversation with the Banker Is Like a Job Interview 11Starting with the Product Market Strategy 13Is PIPES Profitable? 14Doing the Math 14Sources and Uses of Funds 16Ratio Analysis 20The Cash Cycle 26Summary 28Chapter 3 Pro Forma Forecasts (PIPES-B) 31First, Let’s Take a Closer Look at Ratio Analysis 31Pro Forma Forecasts 33Circular Relationships 40Back to (Forecasting) the Future 42Projecting Out to 2018 and 2019 43Evaluating the Loan 45Summary 50Appendix 3A: Accounting Is Not Economic Reality 52Chapter 4 The Impact of Seasonality on a Firm’s Funding (PIPES-C) 57Monthly Pro Forma Income Statements 58Monthly Pro Forma Balance Sheets 60A Different Picture of the Firm 68Summary 72Appendix 4A: PIPES Monthly Pro Forma Income Statements and Balance Sheets, 2018 73Appendix 4B: PIPES Monthly Pro Forma Income Statements and Balance Sheets, 2019 76Part Two Firm Financing and Financial PoliciesChapter 5 Why Financing Matters (Massey Ferguson) 81Product Market Position and Strategy 81Political Risk and Economies of Scale in Production 82Massey Ferguson, 1971–1976 83Sustainable Growth 85The Period after 1976 87Conrad Runs Away 90The Competitors 91Back to Massey 93Massey’s Restructuring 96Postscript: What Happened to Massey 100Summary 100Appendix 5A: Massey Ferguson Financial Statements 102Chapter 6 An Introduction to Capital Structure Theory 107Optimal Capital Structure 108M&M and Corporate Finance 111Taxes 116Costs of Financial Distress 126The Textbook View of Capital Structure 131The Cost of Capital 133Summary 134Chapter 7 Capital Structure Decisions (Marriott Corporation and Gary Wilson) 137Capital Structure 137The Cost of Capital 144How Firms Set Capital Structure in Practice 147Corporate Financial Policies 148Sustainable Growth and Excess Cash Flow 151What to Do with Excess Cash? 152Summary 154Appendix 7A: Marriott Corporation Income Statements and Balance Sheets 156Appendix 7B: Marriott Corporation Selected Ratios 158Chapter 8 Investment Decisions (Marriott Corporation and Gary Wilson) 159What Is the Correct Price? 160How Should Marriott Buy Its Shares? 160The Loan Covenants 164The Impact of the Product Market on Financial Policies 165The Capital Market Impact and the Future 167Summary 173Chapter 9 Financial Policy Decisions (AT&T: Before and After the 1984 Divestiture) 177Background on AT&T 178M&M and the Practice of Corporate Finance 178Old (pre-1984) AT&T 180New (post-1984) AT&T 195Summary 207Appendix 9A: Development of AT&T Pro Formas, 1984–1988 (Expected-Case) 208Chapter 10 The Impact of Operating Strategy on Corporate Finance Policy (MCI) 211A Brief Summary 211A Brief History of MCI 213Convertible Preferred Stock and Convertible Bonds 218Interest Rates and Debt Ratios 222Leases 223Financing Needs of the New MCI 223MCI’s Financing Choice 234MCI Postscript 235Summary 236Appendix 10A: Development of MCI’s Pro Formas, 1984–1988 238Chapter 11 Dividends and Stock Repurchases (Apple Inc.) 241The Theory of Dividend Policy 241Empirical Evidence 245Apple Inc. and the Decision on Whether to Pay Dividends 248What Did Apple Do about Dividends? 260What Happened Next 261Summary 264Chapter 12 A Continuation of Capital Structure Theory 265The Tax Shield of Debt 266The Costs of Financial Distress 267Transaction Costs, Asymmetric Information, and Agency Costs 269Asymmetric Information and Firm Financing 272Agency Costs: Manager Behavior and Capital Structure 279Leverage and Agency Conflicts between Equity and Debt Holders 281Start with the Amount of Financing Required 286Summary 288Chapter 13 Restructuring and Bankruptcy: When Things Go Wrong (Avaya Holdings) 291When Things Go Wrong 291The Key Economic Principle of Bankruptcy Is to Save Viable Firms 297When Should a Firm File for Bankruptcy? 297The Rules of Bankruptcy 300Maintaining the Value of a Firm in Bankruptcy 303Avaya Emerges from Bankruptcy 304Summary 306Appendix 13A: The Creditors Coordination Problem 308Part Three Investments and ValuationChapter 14 The Time Value of Money: Discounting and Net Present Values 311The Time Value of Money 311Net Present Value (NPV) 316Payback 322Projects with Unequal Lives 323Perpetuities 325Summary 326Chapter 15 Valuation and Cash Flows (Sungreen A) 327Investment Decisions 327How to Value a Project 328The Weighted Average Cost of Capital (WACC) 340Terminal Values 341Summary 343Chapter 16 Valuation (Sungreen B) 345Sungreen’s Projected Cash Flows 345The Weighted Average Cost of Capital (WACC) 346Twin Firms 351The Cost of Equity 354The Cost of Debt 357The Final Valuation 358Strategic Analysis 360Summary 361Chapter 17 Valuation Nuances 363Cash Flow Nuances 363Cost of Capital Nuances 365Nuances on Calculating the Cost of Equity: Levering and Unlevering Beta 371Separating Cash Flows and Terminal Values 376Nuances of Terminal Value Methods 376Other Valuation Techniques: DCF Variations 383Real Options (aka Strategic Choices) 386Summary 389Chapter 18 Leveraged Buyouts and Private Equity Financing (Congoleum) 391Congoleum: A Short History 391Leading up to the LBO: What Makes a Firm a Good LBO Target? 392Details of the Deal 395Postscript: What Happened to LBOs? 409Summary 411The World Keeps Changing 412Appendix 18A: Congoleum’s Pro Formas with and without the LBO 414Appendix 18B: Highlights of the Lazard Fairness Opinion 420Chapter 19 Mergers and Acquisitions: Strategic Issues (The Dollar Stores) 423The Three Main Competitors 423Recent History 424Shopping a Firm/Finding a Buyer 428Summary 431Chapter 20 Valuing an Acquisition: Free Cash Flows to the Firm (The Dollar Stores) 433The Bid for Family Dollar 433Free Cash Flows to the Firm 435Estimating the Cost of Capital 443Discounted Cash Flows 448Terminal Values 448The Three Pieces 451Summary 452Appendix 20A: Family Dollar Pro Forma Financial Statements with Authors’ Constant Debt Ratio 453Chapter 21 Understanding Free Cash Flows (The Dollar Stores) 455Comparing the Free-Cash-Flows Formulas 455Back to Discount Rates 457On to Free Cash Flows to Equity 459Discounting the Free Cash Flows to Equity 462Summary 463Appendix 21A: Family Dollar Pro Forma Free Cash Flows to Equity with Constant Debt Ratio 464Chapter 22 Mergers and Acquisitions: Execution (The Dollar Stores) 465The Time Line 465Managerial Discretion 468Activist Shareholders 470The Federal Trade Commission (FTC) 472Shareholder Lawsuits 473The Vote 474Summary 475Appendix 22A: Key Events in the Bidding for Family Dollar, 2014–2015 476Chapter 23 Review 477Chapters 2–4: Cash Flow Management—Financial Tools 478Chapters 5–13: Financing Decisions and Financial Policies 478Chapters 14–22: Valuation 482Tools and Concepts Discussed in This Book 485Finance as Art, Not Science 486Bottom Lines 487An Intelligent Approach to Finance 487Keeping Current 488Larry’s Last (Really a True) Story 489Paul’s Theory of Pies 490Rules to Live By 490Glossary 493Index 503

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