Contents

Part One: An Introduction 10

1 Finance – An Overview 11
1.1 Financial Objectives and Shareholder Wealth 11
1.2 Wealth Creation and Value Added 13
1.3 The Investment and Finance Decision 14
1.4 Decision Structures and Corporate Governance 17
1.5 The Developing Finance Function 18
1.6 The Principles of Investment 22
1.7 Perfect Markets and the Separation Theorem 24
1.8 Summary and Conclusions 28
1.9 Selected References

Part Two: The Investment Decision 30

2 Capital Budgeting Under Conditions Of Certainty 31
2.1 The Role of Capital Budgeting 32
2.2 Liquidity, Profitability and Present Value 33
2.3 The Internal Rate of Return (IRR) 39
2.4 The Inadequacies of IRR and the Case for NPV 40
2.5 Summary and Conclusions 42
3 Capital Budgeting and the Case for NPV 43
3.1 Ranking and Acceptance Under IRR and NPV 44
3.2 The Incremental IRR 46
3.3 Capital Rationing, Project Divisibility and NPV 46
3.4 Relevant Cash Flows and Working Capital 47
3.5 Capital Budgeting and Taxation 49
3.6 NPV and Purchasing Power Risk 50
3.7 Summary and Conclusions 53

4 The Treatment of Uncertainty 54
4.1 Dysfunctional Risk Methodologies 55
4.2 Decision Trees, Sensitivity and Computers 55
4.3 Mean-Variance Methodology 56
4.4 Mean-Variance Analyses 58
4.5 The Mean-Variance Paradox 60
4.5 Certainty Equivalence and Investor Utility 62
4.6 Summary and Conclusions 64
4.7 Reference 64

Part Three: The Finance Decision 65

5 Equity Valuation and the Cost of Capital 66
5.1 The Capitalisation Concept 67
5.2 Single-Period Dividend Valuation 68
5.3 Finite Dividend Valuation 68
5.4 General Dividend Valuation 69
5.5 Constant Dividend Valuation 69
5.6 The Dividend Yield and Corporate Cost of Equity 70
5.7 Dividend Growth and the Cost of Equity 71

5.8 Capital Growth and the Cost of Equity 72
5.9 Growth Estimates and the Cut-Off Rate 73
5.10 Earnings Valuation and the Cut-Off Rate 75
5.11 Summary and Conclusions 78
5.12 Selected References 78
6 Debt Valuation and the Cost of Capital 79
6.1 Capital Gearing (Leverage): An Introduction 80
6.2 The Value of Debt Capital and Capital Cost 80
6.3 The Tax-Deductibility of Debt 84
6.4 The Impact of Issue Costs 87
6.5 Summary and Conclusions 89
7 Capital Gearing and the Cost of Capital 91
7.1 The Weighted Average Cost of Capital (WACC) 92
7.2 WACC Assumptions 93
7.3 The Real-World Problems of WACC Estimation 95
7.4 Summary and Conclusions 100
7.5 Selected Reference 100

Part Four: The Wealth Decision 101

8 Shareholder Wealth and Value Added 102
8.1 The Concept of Economic Value Added (EVA) 103
8.2 The Concept of Market Value Added (MVA) 104
8.3 Profit and Cash Flow 104
8.4 EVA and Periodic MVA 105
8.5 NPV Maximisation, Value Added and Wealth 106
8.6 Summary and Conclusions 112
8.7 Selected References