Why Maximizing Shareholder Value Makes Sense 17 2 How to Caiculate Present Values 19 2-1 Future Values and Present Values 19 Calcidating Future Values/Calculating Present Values/Valuing an Investment Opportunity/Net Present Value/Risk and Present Value/Present Values and Rates of Return/Calculating Present Values When There Are Multiple Cash FIows/The Opportunity Cost of Capital 2-2 Looking for Shortcuts-Perpetuities and Annuities 27 How to Value Perpetuities/How to Value Annuities/ Valuing Annuities Due/Calculating Arnual Payments/Future Value ofan Annuity 2-3 More Shortcuts-Growing Perpetuities and Annuities 34 Growing Perpetuities/Growing Annuities 2-4 How Interest Is Paid and Quoted 36 Continuous Compounding Summary 39 • Problem Sets 40 • Finance on the Web 45 3 Valuing Bonds 46 3-1 Using the Present Value Formula to Value Bonds 47 A Short Trip to Paris to Value a Government Bond/ Back to the United States: Semiannual Coupons and Bond Prices 3-2 How Bond Prices Vary with Interest Rates 50 Duration and Volatility 3-3 The Term Structure of Interest Rates 54 Spot Rates, Bond Prices, and the Law of One Price/Measuring the Term Structure/ Why the Discount Factor Declines as Futurity Increases-and a Digression on Money Machines 3-4 Explaining the Term Structure 58 Expectations Theory of the Term Structure/Introducing Risk/Inflation and Term Structure 3-5 Real and Nominal Rates of Interest 60 Indexed Bonds and the Real Rate of Interest/What Determines the Real Rate of lnterest?/Inflationand Nominal Interest Rates 3-6 The Risk of Default 64 Corporate Bonds and Default Risk/Sovereign Bonds and Default Risk Summary 70 -Further Reading 71 • Problem Sets 71 Finance on the Web 75 4 The Value of Common Stocks 76 4-1 How Common Stocks Are Traded 76 Trading Results for GE 4-2 How Common Stocks Are Valued 78 Vcduation by Comparables/Stock Prices and Dividends VIV XX Contents 4-3 Estimating the Cost of Equity Capital 85 Using the DCF Model to Set Gas and Electricity Prices/Dangers Lurk in Constant-Growth Formulas 4-4 The Link Between Stock Price and Earnings per Share 90 Calculating the Present Value of Growth Opportunities for Fledgling Electronics 4-5 Valuing a Business by Discounted Cash Flow 93 Valuing the Concatenator Business/Valuation Format/Estimating Horizon Value/A Further Reality Check/Free Cash Flow, Dividends, and Repurchases Summary 98 • Problem Sets 99 • Finance on the Web 103 Mini-Case: Reeby Sports 104 5 Net Present Value and Other Investment Criteria 105 5-1 A Review of the Basics 105 Net Present Value 's Competitors/Three Points to Remember about NPV/NPV Depends on Cash Flow, Not on Book Returns 5-2 Payback 109 Discounted Payback 5-3 Internal (or Discounted-Cash-Flow) Rate of Return 111 Calculating the IRR/The IRR Rule/Pitfall I-Leriding or Borrowing?/Pitfall2-Multiple Rates of Return/P itfall 3-Mutually Exclusive Projects/Pitfall 4-What Happens When There Is More than One Opportunity Cost of Capital?/The Verdict on IRR 5-4 Choosing Capital Investments When Resources Are Limited 119 An Easy Problem in Capital Rationing/Uses of Capital Rationing Models Summary 123 • Further Reading 124 -Problem Sets 125 • Mini-Case: Vegetron's CFO Calls Again 129
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