5th edition

FINANCIAL MANAGEMENT
Principles and Applications

5th edition

FINANCIAL MANAGEMENT
Principles and Applications
Clive Wilson BA, CPA, ACIS Bruce Keers Dip. Fin. Man., Dip. Teach. (Tech), CA Andrew Medlen BComm, Grad. Dip. VET, CPA Brian Walters BBus, MEc, Grad. Dip. Tech. Educ., CPA

Copyright Pearson Education Australia (a division of Pearson Australia Group Pty Ltd) 2007 Pearson Education Australia Unit 4, Level 3 14 Aquatic Drive Frenchs Forest NSW 2086 www.pearsoned.com.au The Copyright Act 1968 of Australia allows a maximum of one chapter or 10% of this book, whichever is the greater, to be copied by any educational institution for its educational purposes provided that that educational institution (or the body that administers it) has given a remuneration notice to Copyright Agency Limited (CAL) under the Act. For details of the CAL licence for educational institutions contact: Copyright Agency Limited, telephone: (02) 9394 7600, email: info@copyright.com.au All rights reserved. Except under the conditions described in the Copyright Act 1968 and subsequent amendments, no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. Acquisitions Editor: Andrew Brock Project Editor: Sandra Goodall Copy Editor: Felicity McKenzie Proofreader: Bree DeRoche Cover design by Christa Moffitt Typeset by Midland Typesetters, Australia Printed in China 1 2 3 4 5 11 10 09 08 07 National Library of Australia Cataloguing-in-Publication Data Financial management : principles and applications. 5th ed. Bibliography. Includes index. For tertiary students ISBN 9780733978708 (pbk). 1. Corporations Finance. 2. Business enterprises Finance. I. Wilson, Clive. 658.15 Every effort has been made to trace and acknowledge copyright. However, should any infringement have occurred, the publishers tender their apologies and invite copyright owners to contact them.

An imprint of Pearson Education Australia

contents
How to use this book Preface Training package competencies
Chapter 1 Goal and function of financial management Learning objectives Overview The financial manager Forms of business organisation Financial reporting The finance function Objective of the firm Ethics Summary Problems Notes Website addresses Chapter 2 Financial mathematics Learning objectives Overview Interest rates and inflation Simple interest Flat rate interest Compound interest Present value Annuities Determining the effective rate of interest Summary Problems Note Chapter 3 Sources of financing Learning objectives Overview Short-term financing

xi xiii xv
1 1 1 1 2 4 7 8 14 14 15 16 16 18 18 19 19 20 21 22 26 28 44 46 47 53 54 54 55 55
CONTENTS

Long-term financing Other sources of equity funds Debt funds Hybrids of debt and equity Summary Problems Note Chapter 4 Analysis of financial statements Learning objectives Overview Purpose of ratios Interpretation of ratios Case study Liquidity ratios Activity ratios Profitability ratios Leverage ratios Equity valuation and performance ratios Case studyApplication Comments Du Pont system Limitations of ratio analysis Summary Problems Chapter 5 Communication and financial management Learning objectives Overview Assessing the needs of the client Analyse data for the client Preparing advice for the client Communication strategies Summary Problems Note Chapter 6 Working capital management Learning objectives Overview General concepts in working capital management The operating cycle

61 64 64 70 72 73 74 76 76 77 77 78 79 81 82 86 90 93 96 97 98 100 100 101 114 114 115 115 118 119 122 124 125 125 126 126 127 127 128

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F I N A N C I A L M A N A G E M E N T: P R I N C I P L E S A N D A P P L I C AT I O N S

The matching principle Current assets management Inventory management Accounts receivable management Cash and liquid asset management Cash budgets Summary Problems Chapter 7 Cost of capital Learning objectives Overview Measuring the cost of capital Weighted average cost Summary Problems Chapter 8 Capital structure decisions Learning objectives Overview Leverage effects on profits Capital structure and earnings per share Indifference point Optimal capital structure Summary Problems Chapter 9 Capital investment techniques Learning objectives Overview Administrative aspects Types of decisions Evaluation methods Net present value versus internal rate of return Unequal lives Capital rationing Summary Problems Chapter 10 Capital investment applications Learning objectives Overview Estimating cash flows Replacement decisions

129 131 131 138 143 146 171 172 182 182 183 183 190 193 194 198 198 199 199 203 205 209 211 212 216 216 217 217 219 219 228 229 231 233 234 240 240 241 241 245
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Retirement decisions Net working capital requirements Risk Summary Problems Chapter 11 Financing asset acquisitions Learning objectives Overview Leases Types of lease The lease or purchase decision Summary Problems

248 250 250 251 252 256 256 257 257 258 259 265 266 270 270 271 271 276 279 280 282 283 285 286 286 287 287 289 300 304 307 308 309 316 316 317 317 319

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Chapter 12

Dividend policy Learning objectives Overview Factors affecting dividend policy Dividend effects on share prices Alternative dividend policies Non-cash forms of dividend Summary Problems Notes

Chapter 13

Portfolio theory Learning objectives Overview Return on investment Measurement of risk The capital asset pricing model Valuation of shares Dividend imputation Summary Problems

Chapter 14

Financial intermediaries Learning objectives Overview The Australian capital market Components of the Australian capital market

F I N A N C I A L M A N A G E M E N T: P R I N C I P L E S A N D A P P L I C AT I O N S

Financial institutions Market efficiency Summary Problems Chapter 15 Securities and derivatives markets Learning objectives Overview The securities market Regulation of the securities market The stock exchanges Right issues Private placements SEATS trading Off-SEATS trading The derivatives market Types of derivatives Summary Problems Chapter 16 Managed funds Learning objectives Overview Investment outcomes Investment markets Direct investments Indirect investments Unit trusts Retirement funds Summary Problems Note Chapter 17 Valuation of non-listed companies Learning objectives Overview Valuation of goodwill Valuation of shares Summary Problems

320 323 324 325 326 326 327 327 328 329 330 333 334 334 339 339 344 345 348 348 349 349 350 351 353 354 357 361 362 362 364 364 365 365 369 374 375

CONTENTS

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Appendix A

Portfolio exercise

379 379 380

Learning objectives Exercise Appendix B Tables

381 392 424 437

Solutions to self-testing questions Glossary Index

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F I N A N C I A L M A N A G E M E N T: P R I N C I P L E S A N D A P P L I C AT I O N S

how to use this book

The following features and icons have been carefully designed to aid learning as you progress through the book.

Learning objectives
at the beginning of each chapter detail the learning goals relevant to the chapter and help you focus on the chapter content.

Overview
maps out the ensuing chapter.

Key terms
are highlighted to indicate important words and definitions. Concise definitions of all key terms are included in the Glossary at the back of the book.

Self-testing questions
enable you to assess your competency as you progress through each chapter. Solutions to the self-test questions are included at the back of the book.

Examples and solutions

apply theory to practice. The examples and solutions in each chapter develop the competencies for each learning objective. These solutions use arithmetic techniques in a pencil and paper approach, including the use of financial tables. These solutions use a financial calculator. The symbols in the solutions match the keys on the Sharp EL735.

Chapter summary
provides a concise review of the chapter contenthelping you revise the concepts you have learned.

Case studies
illustrate key theories in the chapter with a practical example.

End-of-chapter problems
are included to assist you to revise and consolidate your skills.
HOW TO USE THIS BOOK

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preface
The original text of Financial Management: Principles and Applications was first published in 1987. The fifth edition of this book continues with the successful format of previous editions by providing students with an introduction to the complexities of corporate financial management using a clear and practical approach. The fifth edition has also been designed to meet the competencies and learning objectives (elements) contained in the national accounting training packages. In addition to content updates, the new edition includes a new chapter on the role of communication in financial management. It also continues to use the style and presentation that is useful in finance courses designed for people who have a non-accounting background. The book is developed in a logical sequence by introducing each new concept as a stepping stone followed by examples and worked solutions. At appropriate stages throughout a chapter, students are able to assess their understanding by attempting self-testing questions. Students can find the solutions to these questions at the back of the book. For further practice, a large number of problems are provided at the end of each chapter. The first chapter of the book introduces the concept of maximisation of shareholders wealth as the objective for financial management. This objective is then applied to the three main decision areas of financial management: finance decisions, investment decisions and operating decisions. The chapters covering financing decisions provide information on sources of short- and long-term finance within the framework of the Australian capital market, examine the impact of capital structure decisions and evaluate lease finance options. Chapters 9 and 10 focus on investment decisions. These chapters explain the main techniques used to evaluate and decide on the most profitable combination of assets to be used in the firm based on the cost of finance. In the area of operating decisions, the book examines the analysis of financial statements, management of working capital and

PREFACE

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dividend policy. To support the portfolio theory chapter, a special student exercise has been added as Appendix A. Our thanks to the editorial and production staff of Pearson Education for their assistance and support to enable the publication of this book. Special appreciation and thanks go to our respective families for their continued encouragement and support over the years. CLIVE WILSON BRUCE KEERS ANDREW MEDLEN BRIAN WALTERS

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training package competencies

The following table maps the elements contained in the Financial Services Training Package competencies to the relevant chapter in this book: FNSACCT501A Provide financial and business performance information FNSACCT608A Evaluate organisations financial performance FNSACCT609A Evaluate financial risk
FNSACCT501A Provide financial and business performance information

Element 1. Assess client needs

Relevant chapter Chapter 1 Goal and function of financial management Chapter 3 Sources of financing Chapter 5 Communication and financial management Chapter 6 Working capital management Chapter 8 Capital structure decisions Chapter 9 Capital investment techniques Chapter 10 Capital investment applications Chapter 12 Dividend policy Chapter 14 Financial intermediaries Chapter 15 Securities and derivatives market

2. Analyse data

Chapter 1 Goal and function of financial management Chapter 2 Financial mathematics Chapter 4 Analysis of financial statements Chapter 5 Communication and financial management Chapter 6 Working capital management Chapter 8 Capital structure decisions Chapter 9 Capital investment techniques Chapter 10 Capital investment applications Chapter 11 Financing asset acquisitions Chapter 13 Portfolio theory Chapter 17 Valuation of non-listed companies

TRAINING

PA C K A G E

COMPETENCIES

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3. Prepare advice

Chapter 1 Goal and function of financial management Chapter 3 Sources of financing Chapter 4 Analysis of financial statements Chapter 5 Communication and financial management Chapter 6 Working capital management Chapter 7 Cost of capital Chapter 8 Capital structure decisions Chapter 9 Capital investment techniques Chapter 10 Capital investment applications Chapter 11 Financing asset acquisitions Chapter 13 Portfolio theory Chapter 16 Managed funds

FNSACCT608A Evaluate organisations financial performance

Element

Relevant chapter Chapter 7 Cost of capital Chapter 9 Capital investment techniques

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1. Evaluate returns to operations Chapter 6 Working capital management

2. Determine short- and long-term needs

Chapter 2 Financial mathematics Chapter 3 Sources of financing Chapter 4 Analysis of financial statements Chapter 6 Working capital management Chapter 7 Cost of capital Chapter 9 Capital investment techniques Chapter 12 Dividend policy

3. Review performance

Chapter 1 Goal and function of financial management Chapter 3 Sources of financing Chapter 6 Working capital management Chapter 7 Cost of capital

FNSACCT609A Evaluate financial risk

Element

Relevant chapter Chapter 8 Capital structure decisions Chapter 10 Capital investment applications Chapter 11 Financing asset acquisitions Chapter 12 Dividend policy Chapter 13 Portfolio theory

1. Assess financial risk exposure Chapter 6 Working capital management

F I N A N C I A L M A N A G E M E N T: P R I N C I P L E S A N D A P P L I C AT I O N S

2. Develop risk management processes

Chapter 5 Communication and financial management Chapter 6 Working capital management Chapter 8 Capital structure decisions Chapter 9 Capital investment techniques Chapter 11 Financing asset acquisitions Chapter 12 Dividend policy Chapter 14 Financial intermediaries Chapter 15 Securities and derivatives markets Chapter 16 Managed funds Chapter 17 Valuation of non-listed companies

3. Analyse financial histories

Chapter 4 Analysis of financial statements Chapter 5 Communication and financial management Chapter 6 Working capital management Chapter 10 Capital investment applications Chapter 11 Financing asset acquisitions

4. Establish processes to minimise risk

Chapter 5 Communication and financial management Chapter 6 Working capital management Chapter 8 Capital structure decisions Chapter 9 Capital investment techniques Chapter 11 Financing asset acquisitions Chapter 13 Portfolio theory Chapter 17 Valuation of non-listed companies

TRAINING

PA C K A G E

COMPETENCIES

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