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GLEN ARNOLD BSc(Econ), PhD
DEBORAH LEWIS BA, MBA, FCA, SFHEA
CORPORATE FINANCIAL MANAGEMENT
SIXTH EDITION
KAO Two
KAO Park
Harlow CM17 9NA
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Web: www.pearson.com/uk
First published in Great Britain under the Financial Times Pitman Publishing imprint in 1998 (print)
Second edition published 2002 (print)
Third edition published 2005 (print)
Fourth edition published 2008 (print)
Fifth edition published 2013 (print and electronic)
Sixth edition published 2019 (print and electronic)
The rights of Glen Arnold and Deborah Lewis to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.
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ISBN: 978-1-292-14044-5 (print)
978-1-292-14047-6 (PDF) 978-1-292-14048-3 (ePub)
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LC record available at https://urldefense.proofpoint.com/v2/url?u=https-3A__lccn.loc.gov_2018025913&d=DwIFAg&c= 0YLnzTkWOdJlub_y7qAx8Q&r=Q1huLr_hfN5hBmNklTyEbqNkqKPJUy4ujVI9zNDFILM&m= VR8NGw69pHRJJiX5cv67FTKvTLiw9fgpvabMVzd01eQ&s=txGOpxXfVn_XxRZdc9gyeJ1E49b5sHATBL82A3QixTI&e=
Print edition typeset in 10/11.5 pt Sabon MT Pro by Pearson CSC Printed and bound by L.E.G.O. S.p.A., Italy
NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION
Dedicated to Lesley my wife, for her loving support and encouragement. Glen Arnold
Lecturer Resources
For password-protected online resources tailored to suppor t the use of this textbook in teaching, please visit www.pearsoned.co.uk/arnold
Topics covered in the book
Foreign exchange risk management CHAPTER 22
Derivatives used for reducing risk and speculating CHAPTER 21
Mergers CHAPTER 20
Proportion of proļ¬t paid out as dividends CHAPTER 19
Proportion of capital raised by selling shares or debt CHAPTER 18
Share valuation and corporate valuation CHAPTER 17
The objective of the ļ¬rm The ļ¬nancial system
The role of the ļ¬nancial manager CHAPTER 1
Project appraisal: the analysis of major investment proposals within the ļ¬rm CHAPTERS 2, 3, 4, and 5
The relationship between risk and return CHAPTERS 6, 7 and 8
ACHIEVEMENT OF THE FIRMāS OBJECTIVE
Stock markets and share capital CHAPTERS 9 and 10
debt capital CHAPTER 11
Short-term and mediumterm ļ¬nance CHAPTER 12
The cost of capital ā the required rate of return CHAPTER 16
Value metrics CHAPTER 15
The e ciency of stock markets in pricing shares CHAPTER 13
Value management CHAPTER 14
SOURCES OF FINANCE
Introduction to the book
Aims of the book
If there is one lesson that the 2008 financial crisis and the Great Recession taught us, it is that there is good and bad financial practice. Unfortunately, many of the basic tenets of finance get forgotten by corporate managers, bankers and leaders of financial institutions from time to time. Important financial issues, such as adopting sensible levels of debt, or simply being aware of risk levels, or checking the validity of the assumptions made when investing in the business, valuing a financial security or embarking on a merger, can be very badly handled.
This book has been updated to emphasise the basic lessons from hundreds of years of finance practice and theory, so that you might be more aware of the difference between good practice and what is plain stupid; so that you can avoid the errors made by countless business leaders. The book assumes no knowledge of finance. It is comprehensive and provides the key elements needed by business management, accounting and other undergraduates, postgraduates and practising managers. Finance theory and practice are integrated throughout the text, reflecting the extent to which real-world practice has been profoundly shaped by theoretical developments. Some of the features in this sixth edition are listed below.
ā While the underlying principles of finance have not altered since the publication of the fifth edition some further changes have occurred for example in regulation, legislation and the operation of financial markets. These are explained.
ā Where appropriate, illustrations from more recent corporate events, many of which draw on Financial Times articles, have been incorporated.
ā The evidence gathered in the twenty-first century on the usefulness of beta as defined by the Capital Asset Pricing Model has been overwhelmingly negative. When this is combined with the theoretical problems, a much more sceptical line on the CAPM-beta is called for.
ā Trillions of pounds are now placed with investment funds buying share portfolios drawing on stock market inefficiency evidence ā called āsmart betaā funds. The academic work providing the impetus for this (even though it has now been taken too far) is examined.
ā Fintech developments, including crowdfunding and peer-to-peer lending, have brought new ways of raising funds for businesses.
ā Surveys of business practice are used through the text, not least in the cost of capital and share valuation sections, where the deviations from pure theory illustrate the compromises that must be made in the real world.
ā Statistics on the financial markets and instruments, have been updated.
ā The jargon-busting glossary has been extended and updated.
Themes in the book
Practical orientation
Every chapter describes and illustrates how financial techniques are used in the practical world of business. Throughout the text insight is offered into how and why practice may sometimes differ from sound theory. For example, in making major investment decisions, managers still use
techniques with little theoretical backing (e.g. payback) alongside the more theoretically acceptable approaches. We explore the reasons for the retention of these simple rule-of-thumb methods. This book uses theory, algebra and economic models where these are considered essential to assist learning about better decision making. Where these are introduced, however, they must always have passed the practicality test: āIs this knowledge sufficiently useful out there, in the real world, to make it worthwhile for the reader to study it?ā If it is not, then it is not included.
Clear, accessible style
Great care has been taken to explain sometimes difficult topics in an interesting and comprehensible way. An informal language style, and an incremental approach, which builds knowledge in a series of easily achieved steps, leads the reader to a high level of knowledge with as little pain as possible. The large panel of reviewers of the book assisted in the process of developing a text that is, we hope, comprehensive and easy to read.
Integration with other disciplines
Finance should never be regarded as a subject in isolation, separated from the workings of the rest of the organisation. This text, when considering the link between theoretical methods and practical financial decision making, recognises a wide range of other influences, from strategy to psychology.
Real-world relevance
Experience of teaching finance to undergraduates, postgraduates and managers on short courses has led to the conclusion that, in order to generate enthusiasm and commitment to the subject, it is vital continually to show the relevance of the material to what is going on in the world beyond the textbook. Therefore, this book incorporates vignettes/short case studies as well as examples of real companies making decisions drawing on the models, concepts and ideas of financial management.
A UK/international perspective
There is a primary focus on the UK, but also regular reference to international financial markets and institutions. The international character of the book has been enhanced by the detailed evaluation of each chapter by a number of respected academics teaching at universities in Europe, Asia, Australasia and Africa. The global world of modern finance requires that a text of this nature reflects the commonality of financial principles in all countries, as well as interactions and the impact of vast capital flows across borders.
A re-evaluation of classical finance theory
There is considerable debate about the validity of the theories of the 1950s and 1960s upon which much of modern finance was developed, stimulated by fresh evidence generated over the last two decades. For example, the theories concerning the relationship between the risk of a financial security and its expected return are under dispute, with some saying the old measure of risk, beta, is dead or dying. This issue and other financial economics theories are presented along with their assumptions and a consideration of recent revisions.
Real-world case examples
It has been possible to include much more than the usual quantity of real-world case examples in this book by drawing on material from the Financial Times. The aim of these extracts is to bring the subject of finance to life for readers. A typical example is shown in ExhibitĀ 1, which is used to illustrate some of the financial issues explored in the book. This article touches on many of the financial decisions which are examined in greater detail later in the book. Expanding a retail empire requires a lot of money. In the summer of 2017, Quiz Clothing raised more money
Quiz Clothing soars on IPO to reach Ā£245m market value
By Hannah Murphy
Quiz Clothing, the womenswear retailer, jumped more than 20 per cent on its trading debut on Friday. The company, which was founded in Glasgow in 1993, priced its initial public offering at 161p. The shares leapt 22 per cent to 197p in early trading, pushing its market value up to Ā£245m from Ā£200m.
Quiz said it had raised Ā£102.7m from the float, Ā£92.1m of which it earmarked for selling shareholders, while the remaining Ā£10.6m it said would be used to āaccelerate growthā.
The successful listing is the latest by a new breed of fashion retailers aimed at millennials. Quiz describes itself as focused on womenās āoccasion wear and dressy casual wearā for 16-35-year-olds and says it has adopted āfast fashionā processes that allow it to bring designs into shops quickly.
While small in comparison, it will rival the likes of online retailers Asos, now up more than 30,000 per cent to Ā£58.53 since its listing in 2001, and Boohoo, whose shares have risen 360 per cent to 233p since it first floated in 2014. Asos and Boohoo are valued at Ā£4.85bn and Ā£2.68bn respectively.
Financial Times, 28 July 2017. All Rights Reserved.
Unlike the two larger retailers, Quiz has 73 standalone stores in the UK, more than 165 concessions in the regions and Republic of Ireland and 65 franchise stores across 19 countries. But it is focused on boosting its online offering.
āThereās still good growth in stores ā¦ but the real growth story over the next few years will be international and online,ā founder and chief executive Tarak Ramzan said.
The company had chosen to float partly as a way to ābring in new talentā, he added, citing the appointment of Peter Cowgill, chair of sportswear retailer JD Sports, to the board as part of its entry to the stock market.
Still, the company believes there is life in bricks and mortar, and said earlier this year that it saw potential for 40-50 more stores across the UK in āthe medium to long termā.
Just over half of the company, 51.2 per cent, is now in public hands.
to invest in the next stage of its development. There are four vital financial issues facing management:
1 Raising finance and knowledge of financial markets. Quiz grew its business using family money for 24 years until it turned to the London Stock Exchange (LSE) to sell newly created shares raising Ā£9.4m (after expenses) to invest in the business. Also, the Ramzan family sold a proportion of their shares, thus benefiting from their hard work. Being listed on the LSE will enhance its ability to raise more capital in the future because of the additional credibility that flows from being on the exchange. Companies have a wide range of options when it comes to raising finance to allow growth ā sources of finance are considered in ChaptersĀ 9ā13.
2 Investment in real assets, tangible or intangible. The directors of Quiz believe that they have investment opportunities in online retailing as well as high street stores. The company intends to invest in new websites in Spain, Australia and the USA, to open six stores in Spain and 20 in the UK in the months following the flotation. Around Ā£6m is earmarked for online marketing and advertising and Ā£2m for capital expenditure on physical items to go in shops. It will also invest in its people and bring in new talent. There are sound techniques which help in the process of deciding whether to make a major investment ā these are discussed early in the book (ChaptersĀ 2ā6).
3 Creating and measuring shareholder value. Quiz will need to consider the strategic implications of its actions, such as the current and likely future return on capital in the markets it may
