Full download ebooks at ebooksecure.

com

(eBook PDF) Finance Essentials 1st Edition

Australia by David Kidwell

For dowload this book click LINK or Button below

http://ebooksecure.com/product/ebook-pdf-finance-
essentials-1st-edition-australia-by-david-kidwell/

OR CLICK BUTTON

DOWLOAD EBOOK

Download More ebooks from https://ebooksecure.com

More products digital (pdf, epub, mobi) instant
download maybe you interests ...

(eBook PDF) Marketing, 4th Edition Australia by David

Waller

http://ebooksecure.com/product/ebook-pdf-marketing-4th-edition-
australia-by-david-waller/

(Original PDF) Experiencing MIS Australia 4e By David

Kroenke

http://ebooksecure.com/product/original-pdf-experiencing-mis-
australia-4e-by-david-kroenke/

Fundamentals of Corporate Finance 2e Australia by

Jonathon Berk

http://ebooksecure.com/product/fundamentals-of-corporate-
finance-2e-australia-by-jonathon-berk/

(eBook PDF) Principles of Managerial Finance 6th

Australia by Gitman

http://ebooksecure.com/product/ebook-pdf-principles-of-
managerial-finance-6th-australia-by-gitman/
(eBook PDF) Fundamentals of Corporate Finance by David
Hillier

http://ebooksecure.com/product/ebook-pdf-fundamentals-of-
corporate-finance-by-david-hillier/

Progress in Heterocyclic Chemistry Volume 29 1st

Edition - eBook PDF

https://ebooksecure.com/download/progress-in-heterocyclic-
chemistry-ebook-pdf/

(eBook PDF) Multinational Business Finance 15th Edition

by David K. Eiteman

http://ebooksecure.com/product/ebook-pdf-multinational-business-
finance-15th-edition-by-david-k-eiteman/

(Original PDF) Fundamentals of Corporate Finance 3rd

Australia

http://ebooksecure.com/product/original-pdf-fundamentals-of-
corporate-finance-3rd-australia/

(eBook PDF) MIS Essentials 4th Edition by David M.

Kroenke

http://ebooksecure.com/product/ebook-pdf-mis-essentials-4th-
edition-by-david-m-kroenke/
 FINANCE
ESSENTIALS
KIDWELL | BRIMBLE | MAZZOLA | MORKEL-KINGSBURY | JAMES
9.3 General dividend valuation 10.4 Estimating cash flows in practice 304
model 258 Five general rules for incremental after‐tax
Growth share pricing paradox 259 FCF calculations 304
9.4 Share valuation: some simplifying Tax rates and depreciation 307
assumptions 260 Calculating the terminal‐year FCF 309
Zero growth dividend model 260 Summary 312
Constant growth dividend model 261 Summary of key equations 313
Calculating future share prices 264 Key terms 313
Relationship between R and g 266 Acknowledgements 314
Mixed (supernormal) growth dividend
model 266 MODULE 11
9.5 Valuing preference shares 270 Cost of capital and working
Preference shares with a fixed maturity 270
Perpetuity preference shares 272
capital management 315
Summary 273 Module preview 316
Summary of key equations 274 11.1 Overall cost of capital 316
Key terms 274 Estimating the cost of capital 317
Endnotes 274 Debt financing 318
Acknowledgements 275 Estimating the cost of debt 319
Tax and the cost of debt 321
MODULE 10 Estimating the average cost of debt 321
Capital budgeting and cash Cost of equity 322
11.2 Using the weighted average cost of
flows 276 capital 328
Module preview 277 Calculating WACC: an example 329
10.1 Introduction to capital budgeting 277 Limitations of using WACC as a discount
Importance of capital budgeting 278 rate 331
Capital budgeting process 278 11.3 Working capital basics 333
Sources of information 279 Working capital terms and concepts 334
Classification of investment projects 279 Working capital accounts and
Basic capital budgeting terms 280 trade-offs 334
10.2 Capital budgeting methods 280 Operating and cash conversion cycles 335
Net present value 281 Operating cycle 337
Payback period 285 11.4 Financing working capital 340
Accounting rate of return 288 Strategies for financing working
Internal rate of return 289 capital 340
When IRR and NPV methods agree — Sources of short-term financing 342
independent projects and conventional cash Summary 344
flows 291 Summary of key equations 344
When IRR and NPV methods disagree — mutually Key terms 345
exclusive projects and unconventional cash Endnotes 345
flows 292 Acknowledgements 346
IRR versus NPV: a final comment 295
Capital budgeting in practice 295 MODULE 12
10.3 Project cash flows 296
Capital budgeting is forward looking 297
Capital structure and dividend
Incremental after‐tax free cash flows 297 policy 347
FCF calculation 298 Module preview 348
Cash flows from operations 299 12.1 Choosing a capital structure 348
Cash flows associated with investments 300 Capital structure theories 349
FCF calculation: an example 300 The empirical evidence 351

vi CONTENTS
12.2 Benefits and costs of using Bonus share issues 370
debt 352 Share splits 371
Benefits of debt 352 12.5 Setting a dividend policy 372
Costs of debt 357 What managers tell us 372
12.3 Dividends 360 Practical considerations 373
Dividends reduce shareholders’ investment Summary 374
in a company 362 Summary of key equations 375
Dividends and taxation 362 Key terms 375
Dividend payment process 363 Endnotes 376
Benefits and costs of dividends 366 Acknowledgements 376
Share price reactions to dividend
announcements 369 Appendix 377
12.4 Other types of distributions to
shareholders 370
Share buy‐backs 370

CONTENTS vii
MODULE 1

Finance in business
LEA RNIN G OBJE CTIVE S

After studying this module, you should be able to:

1.1 understand the importance of finance, money and markets
1.2 identify the basic forms of business structures
1.3 discuss the financial goals of a business
1.4 identify the key financial decisions facing the financial manager
1.5 describe the typical organisation of the financial function in a large company
1.6 discuss the relevance of ethics in business.
Module preview
This text provides an introduction to finance. In it we focus on the responsibilities of the financial
manager, who oversees the accounting and treasury functions, and sets the overall financial strategy
for the company. We pay special attention to the financial manager’s role as a decision‐maker. To that
end, we emphasise the mastery of fundamental finance concepts and the use of a set of financial tools
which will result in sound financial decisions that create value for shareholders. These financial concepts
and tools apply not only to business organisations but also to other organisations, such as government
entities, not‐for‐profit groups and sometimes even your own personal finances. We also examine the
financial markets in terms of their roles, the types of markets and the financial instruments that are
traded on them. Finally, the regulatory architecture is reviewed and the importance of having an efficient
and effective financial system discussed.

We open this module by discussing the importance of understanding finance and the role that finance
plays in society and in business. Next, we describe common forms of business structures. We then dis­
cuss the major responsibilities of the financial manager including the three major types of decisions
that a financial manager makes: capital budgeting decisions, financing decisions and working capital
management decisions. After next discussing how the financial function is managed in a large company,
we explain why maximising the price of the company’s shares is an appropriate goal of the business.
Finally, we discuss the importance of ethical conduct in business, describing the conflicts of interest that
can arise between shareholders and financial managers, and the mechanisms that help align the interests
of these two groups.

1.1 Understanding finance, money and markets

LEARNING OBJECTIVE 1.1 Understand the importance of finance, money and markets.
Whether we like it or not, money is an important element of modern society. On one hand, money is
required for transactions that allow us to conduct our daily affairs — to purchase food, pay the rent, buy
the morning coffee or take the family out to the local fun park. On the other hand, accumulating money
allows us to build savings and wealth for that next big purchase or activity, to prepare for retirement or
to provide a degree of security and comfort that, if financial resources are needed, they are available.

2 Finance essentials
Money is thus simply a means of exchanging value between parties; just imagine what it would be like
with no money (neither hard currency nor electronic currency). We would be forced to barter in order
to transact, which might work well for some transactions, but for everyday activity would be inefficient.
It is therefore not surprising that transacting has moved with technology and now happens not just
through our wallets, but through our phones, watches and the internet. Indeed, financial technology is
one of the fastest growing industries in the world. The efficient, timely and reliable transfer of money
between parties underpins economic activity and heavily influences how we conduct our daily activities.
The importance of this becomes clear when we consider how many transactions occur on a daily basis
across the nation. Even a small economy like Australia has over 975  000 points of access (e.g. ATMs,
bank branches, EFTPOS terminals) to the financial system, through which more than 430 million debit
card transactions worth more than $23 billion are transacted every month.1 Indeed, there are more than
16.6 million credit card accounts in Australia, through which a further 220 million transactions worth
$27.6 billion take place.2 Without money to operationalise these transactions, there would need to be a
lot of bartering going on!
In order for this trade to occur, markets are required to facilitate buyers and sellers interacting,
agreeing on the terms of a transaction and executing that transaction. This could be a physical market,
such as a shopping centre, where buyers and sellers come together in person to exchange money for
goods and services. Alternatively, there are online or virtual markets, where this interaction occurs elec­
tronically and thus buyers and sellers do not physically meet. Either way, markets are a key component
of facilitating trade. There are a range of markets in the financial system, including the market for cash,
the share market, the bond market and the foreign exchange market, where different financial products
are bought and sold. Each has its own purpose, rules of trade and mechanisms for allowing that trade
to occur. We look at the detail of these (and other) markets later to illustrate the diversity in market
characteristics.
The term finance is a broad term that is widely used in society. It refers to both the study of how
money is managed and the process of acquiring money. This text deals with both of these com­
ponents by examining the elements of the financial system that facilitate individuals, businesses and
governments managing and transacting their money. We also examine how these parties finance these
activities, for example by borrowing money in the form of loans, accumulating internal resources
(savings) or utilising the financial markets to raise funds by issuing shares, bonds or other financial
instruments. The financial system offers a range of ways to finance our activities. The job of the
finance manager at home, in business and in government is to work out the best way to structure our
finances and thus make effective financial decisions. This is easy to say, but in practice is much more
difficult!
A key task of the financial system is to ensure finance, money and markets operate efficiently to
allow the economy to work and individuals to make effective decisions. In many respects we often take
these systems for granted. Many consumers live in blissful ignorance of the financial system archi­
tecture that allows us to transact in the modern economy — we simply put the card in the wall and
wait for the cash to come out! To some extent this ignorance is a good thing, as it means the system is
working and we have confidence in it. But all we have to do is recall the last time the EFTPOS machine
was down and we had no cash in our wallet, and we realise how dependent we are on the financial
system. This, of course, does not happen by itself. Rather, it is the result of the efficient operation of
the components of the financial system — money, markets, financial institutions, financial regulation
and market participants.
In Australia, we are lucky that we have not had any major financial system failures in recent decades.
While we have had our issues (the failure of HIH Insurance in the early 2000s, securities trader Opes
Prime Stockbroking Limited’s failure in 2008 and Storm Financial Limited’s collapse in 2009), we
have not had the large bank failures and the widespread lack of confidence in the system that much of
the northern hemisphere has recently endured. As you progress through this text, you will encounter
many of the reasons for this. You would be well advised to learn as much as you can about finance,

MODULE 1 Finance in business 3

money and markets for both your own personal financial decision‐making and your career — because
the financial system will influence both!

Finance in society
The importance of finance in society is driven by the economic principle of scarcity. There is only so
much money available in the economy and thus individuals, businesses and governments need to use
what they have wisely and make decisions carefully in relation to the future acquisition and use of it.
At the level of the economy, a key task of the financial system is to ensure this scarce resource is used
effectively and thus allocated to purposes that will build wealth over time for the economy, maintaining
and improving our living standards. The complexity of the financial system means this may not happen
for every transaction, but over the longer term the system is designed to achieve this.
It should also be noted that the financial system evolves over time as the economy develops, regu­
lation changes, technology advances and other factors, such as consumer trends and environmental
change, shift. Examples of such changes that have affected the operation of the financial system include
the complexity of products and services, technological advances, the ageing population and financial
illiteracy.
In terms of the complexity of the financial system, we just have to read a product disclosure statement
(PDS) for an everyday financial product or service to understand this (look up a PDS for your bank and
have a read!). They are typically long documents, written in legalese, that try to explain the terms and
conditions of the product/service of relevance. While increased disclosure is generally a good thing,
the complexity and length of these documents make them difficult for many consumers to use. This is
exacerbated by the sheer range of financial products available, the heavy use of jargon and acronyms,
and the general low knowledge base and lack of confidence that many consumers bring to financial
decision‐making. Thus, the financial system has evolved to (for example) increase disclosure, place
more obligation on product providers to explain their services to consumers, encourage consumers to
obtain independent advice, and p­ rovide cooling‐off periods. At the same time, increased regulation and
oversight of the finance sector have been put in place, all with a view to protecting consumers and
building their confidence in the system.
Technological advancement is occurring at a somewhat frightening pace: from branch banking to
ATMs, online banking, micro/app‐based investing, paying with our mobile phones and robo advice in
only a few decades. While these advances may have improved the efficiency of and access to the system,
it is important that they maintain consumer confidence and protection at the same time. Thus, it is
interesting to note that the regulatory environment is struggling to keep up with the pace of change in
some jurisdictions and more innovative and more collaborative regulatory design approaches are being
used (e.g. look up the Australian Securities and Investments Commission’s (ASIC) regulatory sandbox
approach to financial technology).
A compounding issue is the ageing population. As the baby boomer population bubble moves into
retirement, the mix of retirees and workers is changing (more retirees and fewer workers). Further­
more, life expectancy is increasing and those in retirement are living more active lives. This places more
emphasis on industries such as health services, aged care and the superannuation sector, while govern­
ments will simply not be able to afford to provide a pension system to meet the needs of the population
as a result. Thus the move over time from a state‐funded retirement system to a self‐funded system is
in motion. For individuals, this places significant emphasis on accumulating wealth to fund retirement,
which in turn is a critical issue for society in relation to our overall living standards and the ability of
the government to provide services. Hence, making long‐term financial decisions that allow individuals/
households to accumulate wealth is a societal imperative. The multi‐million‐dollar question for everyone
to ask themselves is: How much will I need to save? (Look up a retirement calculator online to see your
expected number!)
A final issue is financial illiteracy. This has received a lot of attention from governments and
other agencies around the world in recent years. Financial literacy is essentially the combination of

4 Finance essentials
knowledge and behaviour that underpins effective financial decision‐making. Unfortunately, too many
people are not sufficiently equipped in one or both of these areas, increasing the risk of insufficient
wealth accumulation over time, greater susceptibility to schemes and scams, and higher levels of finan­
cial stress. Thus, improving financial literacy, protecting consumers through financial system design
and encouraging consumers to seek financial advice are important economic and social elements of
the financial system.
In summary, finances are of great economic and social importance. At the macro level, they drive the
operation and performance of the economy. For governments, they influence the fiscal position of the
nation and the ability of the government to provide services, and thus influence our living standards. For
business, finance heavily influences profitability and the long‐term sustainability of the enterprise, while
for consumers our ability to make effective financial decisions and accumulate wealth over the long term
is influenced. All in all, knowing more about the financial system is important for everyone. We hope
this text will help you in this regard!

Finance in business
Finance is a key factor in the success or otherwise of any business and, accordingly, a sound under­
standing of finance concepts and techniques is essential for any manager. Businesses need finance to:
•• start up — this involves expenditures such as paying rent in advance on premises and purchasing the
equipment and materials required to produce the business’s products or services
•• operate — it is important that a business has sufficient cash on hand to pay staff wages and suppliers
as these expenses fall due
•• expand — this might necessitate the purchase of new machinery to increase production capacity,
research and development costs for new products, or marketing costs associated with identifying and
entering new markets.
A major concern for all businesses is the way they are financed. It is important for managers to
select appropriate funding, as all entities need funding, no matter how small or large their turnover
or asset base. Australian businesses tend to look to the financial institutions, in the first instance, as
suppliers of intermediated finance. While larger entities with standing in the community are able to
access the financial markets and financial institutions for funds, smaller entities typically approach one
or several financial institutions for long‐term funding.
Entities wanting to raise debt finance from the Australian market have corporate bonds, notes and
debentures to choose from as methods of finance. To a great extent, these securities are similar methods
of financing; the differences mainly lie in their historical roles. Essentially, borrowing entities issue
bonds, notes or debentures as proof that debts exist. After that, if these securities are traded, the security
itself (the physical piece of paper) or the proof of registration with issues which is electronically
recorded, merely acts as proof of current ownership. Naturally, the owner of a bond at maturity is the
entity that receives the repayment of face value from the issuer.
Owners may at times wish to expand their entities or liquidate some or all of their ownership rights.
They achieve this by selling ownership rights to other investors; that is, raising equity finance. The
media by which ownership rights are packaged, sold (and bought) and transferred are ordinary shares
and preference shares. Ordinary shares are by far the more common of the two. All companies issue
ordinary shares; some, but not all, companies issue preference shares.
The size of a business and the nature of its ownership often determine the finance options available
to it. Businesses can be owned by sole operators, partnerships of two to twenty people or perhaps some
hundreds, or thousands of individual shareholders and large investment institutions in the case of listed
public corporations.
This text discusses the financial decisions faced by all these businesses, no matter how small or large
and no matter how they are owned. In practice, however, it is likely that small businesses will take a
less rigorous approach to decision‐making and financial analyses than is advocated here because these

MODULE 1 Finance in business 5

businesses tend not to employ people trained in finance. Additionally, the managements of many small
businesses judge that the benefits of employing a financial manager or a financial consultant do not
exceed the costs.
Every business has reasons for being. Because of their different sizes and ownership structures, it is to
be expected that there are a range of goals among businesses. For example, a family partnership which
owns a small auto‐electrical business might want to earn enough to live comfortably, put away some
funds to educate the children, not work on Saturdays or Sundays, and develop a reputation for doing
good work on time and at reasonable cost. Eventually, the family might want to sell the business to fund
a comfortable retirement. In contrast, the ownership of a large corporation is much more removed from
the operations of the company. The owners are you and me — through our direct shareholdings and
indirectly through our superannuation funds and managed funds. Because the owners are not closely
connected with the everyday operations of the business, it is likely that their goals are simplified and
focused largely on financial metrics, such as profit maximisation and shareholder returns.
This text presents the financial concepts and techniques that assist businesses to achieve their financial
goals, whatever these may be.

BEFORE YOU GO ON

1. Explain the role of money in an economy.

2. Discuss the key functions of financial markets.
3. Why is it important for everyone to have at least a basic understanding of the financial system?
4. Explain why finances are important to society and business.

1.2 Business structures and finance

LEARNING OBJECTIVE 1.2 Identify the basic forms of business structures.
In this section, we look at the ways companies organise in order to conduct their business activities. The
owners of a business usually choose the structure that will help management to maximise the value of
the business entity. Important considerations are the size of the business, the manner in which income
from the business is taxed, the legal liability of the owners and their ability to raise cash to finance
the business.
Most start‐ups and small businesses operate as either sole traders or partnerships, because of their
small operating scale and capital requirements. Large businesses in Australia, such as Woolworths
­Limited, are most often organised as companies. As a business grows larger, the benefits to organising as
a company become greater and are more likely to outweigh any disadvantages.

Sole traders
A sole trader is a business owned by one person, typically consisting of the trader and a handful of
employees. Becoming a sole trader offers several advantages. It is the simplest type of business to start
and it is the least regulated. In addition, sole traders keep all the profits from the business and do not
have to share decision‐making authority. From the taxation point of view, business losses can be written
off against the sole trader’s tax from other employment under certain circumstances.
On the downside, a sole trader has unlimited liability for all the business’s debts and other obli­
gations. This means that creditors can look beyond the assets of the business to the trader’s personal
wealth for payment. Another disadvantage is that the amount of equity capital that can be invested in
the business is limited to the owner’s personal wealth, which may restrict the possibilities for growth.
Finally, it is difficult to transfer ownership of a sole trader because there are no shares or other such
interests to sell.

6 Finance essentials
Partnerships
A partnership consists of two or more owners who have
joined together legally in order to manage a business.
Partnerships are typically larger than sole trader busi­
nesses. In forming a partnership, it is recommended that a
formal partnership agreement is drawn up on the roles and
authority of each partner, how much capital each partner
will contribute, how key management decisions will be
made, how the profits will be divided, who has limited lia­
bility, how the partnership will be closed down and assets
distributed, and how disputes will be dealt with.
The key advantages of partnerships are similar to
those of sole traders. In addition, partnerships have
access to more capital, and the pooling of knowledge,
experience and skills. The key drawbacks of partnerships
are possible disputes among the partners over profit‐
sharing, administration and business development. Also,
each partner is personally responsible for business debts
and liabilities incurred by the other partners.
The problem of unlimited liability can be avoided
in a limited partnership, which consists of general and
limited partners. Here, one or more general partners
have unlimited liability and actively manage the busi­
ness, while the limited partners are liable for business
obligations only up to the amount of capital they have contributed to the partnership. In other words, the
limited partners have limited liability. To qualify for limited‐partner status, a partner cannot be actively
engaged in managing the business.

Companies
Most large businesses are companies. A company is an independent legal entity able to do business
in its own right. In a legal sense, it is a ‘person’ distinct from its owners. Companies can sue and be
sued, enter into contracts, issue debt, borrow money and own assets. The owners of a company are its
shareholders.
Starting a company is more costly than starting a business as a sole trader or partnership. Those
starting the company, for example, must set out a memorandum that details its powers and articles
of association to describe who can use these powers. All companies are registered with and regulated
by ASIC.
A major advantage of the company form of business structure is that shareholders have limited
liability for the debts and other obligations of the company. However, directors and employees are
personally liable under the Corporations Act 2001 if found to be committing fraudulent, negligent
or reckless acts. The major disadvantages of the company form are the cost of establishment and
registration, and the higher compliance costs and stricter record‐keeping requirements as compared to
other business structures.
A company can also list on a stock exchange, such as the Australian Securities Exchange (ASX), as
a public company in order to attract investors. In contrast, private companies are typically owned by
a small number of key managers and shareholders. Over time, as the company grows in size and needs
larger amounts of capital, management may decide that the company should ‘go public’ in order to gain
access to the public markets.

MODULE 1 Finance in business 7

 BEFORE YOU GO ON

1. Why are many businesses operated as sole traders?

2. What are some advantages and disadvantages of operating as a partnership?
3. What are some advantages and disadvantages of operating as a company?

1.3 The financial goals of a business

LEARNING OBJECTIVE 1.3 Discuss the financial goals of a business.
For business owners, it is important to determine the appropriate goal for financial management decisions.
Should the goal be to keep costs as low as possible? Or to maximise sales or market share? Or to achieve
steady growth and earnings? Let’s look at this fundamental question more closely.

What should management maximise?

Suppose you own and manage a pizza restaurant. Depending on your preferences and tolerance for risk,
you can set any goal for the business that you want. For example, you might have a fear of insolvency
and losing money. To minimise the risk of insolvency, you could focus on keeping your costs as low as
possible, by paying low wages, avoiding borrowing, advertising minimally and remaining cautious about
expanding the business. In short, you avoid any action that increases your business’s risk. You will sleep
well at night, but you may eat poorly because of meagre profits.
Conversely, you could focus on maximising market share and becoming the largest pizza place in
town. Your strategy might include cutting prices to increase sales, borrowing heavily to open new pizza
outlets, spending lavishly on advertising and developing menu items using exotic toppings. In the short
term, your high‐risk, high‐growth strategy will have you both eating poorly and sleeping poorly as you
push the business to the edge. In the long term, you will either become very rich or become insolvent!
There must be a better operational goal than either of these extremes.

Why not maximise profits?

One goal for financial decision‐making that seems reasonable is profit maximisation. After all, don’t
shareholders and business owners want their companies to be profitable? However, although profit
maximisation may seem a logical goal for a business, it has some serious drawbacks.
One problem with profit maximisation is that it is hard to pin down what is meant by ‘profit’. To
the average businessperson, profits are just revenues minus expenses. To an accountant, however, a
decision that increases profit under one set of accounting rules can reduce it under another. This is
the origin of the term creative accounting. A second problem is that accounting profits are not n­ ecessarily
the same as cash flows. For example, many companies recognise revenues at the time a sale is made,
which is typically before the cash payment for the sale is received. Ultimately the owners of a business
want cash because only cash can be used to make investments or to buy goods and services.
Yet another problem with profit maximisation as a goal is that it does not distinguish between
­getting a dollar today and getting a dollar sometime in the future. In finance, the timing of cash flows
is extremely important. For example, the longer we go without paying our credit card balance, the
more interest we must pay the bank for the use of the money. The interest accrues because of the
time value of money; the longer we have access to money, the more we have to pay for it. The time
value of money is one of the most important concepts in finance and is the focus of two modules in
this text.
Finally, profit maximisation ignores the uncertainty (or risk) associated with cash flows. A basic
principle of finance is that there is a trade‐off between expected return and risk. When given a choice

8 Finance essentials
between two investments that have the same expected returns but different risks, most people choose the
less risky one. This makes sense because people do not like bearing risk and, as a result, must be com­
pensated for taking it. The profit maximisation goal ignores differences in value caused by differences in
risk. We return to the important topics of risk, its measurement and the trade‐off between risk and return
in a later module. What is important here is that you understand that investors do not like risk and must
be compensated for bearing it.

The timing of cash flows affects their value

A dollar today is worth more than a dollar in the future because, if you have a dollar today, you can
invest it and earn interest. For businesses, cash flows can involve large sums of money and receiving
money just one day late can cost a great deal. For example, if a bank has $100 billion of consumer loans
outstanding and the average annual interest payment is 5 per cent, it would cost the bank $13.7 million
if every consumer decided to make an interest payment one day later.

The riskiness of cash flows affects their value

A risky dollar is worth less than a safe dollar. The reason is because investors do not like risk and so must
be compensated for bearing it. For example, if two investments have the same return — say 5 per cent —
most people will choose the investment with the lower risk. Thus, the more risky an investment’s cash
flows, the less it is worth.
In summary, it appears that profit maximisation is not an appropriate goal for a company because
the concept is difficult to define and does not directly account for the company’s cash flows. What we
need is a goal that looks at a company’s cash flows and considers both their timing and their riskiness.
­Fortunately, we have just such a measure: the market value of the company’s shares.

Maximise the value of the company’s shares

The underlying value of any asset is determined by the future cash flows generated by that asset. This prin­
ciple holds whether we are buying a bank certificate of deposit, a corporate bond or an office building.
Furthermore, as we will discuss in the module on share valuation, when security analysts and investors
determine the value of a company’s shares, they consider: (1) the size of the expected cash flows; (2) the
timing of the cash flows; and (3) the riskiness of the cash flows. Note that the mechanism for determining
share values overcomes all the cash flow objections we raised with regard to profit maximisation as a goal.
Thus, an appropriate goal for financial management is to maximise the current value of the company’s
shares. By maximising the current share price, the financial manager is maximising the value of the
shareholders’ shares. Note that maximising share value is an unambiguous objective and it is easy to
measure. We simply look at the market value of the shares in the news on a given day to determine the
value of the shareholders’ shares and whether it has gone up or down. Publicly traded securities are
ideally suited for this task because public markets are wholesale markets with large numbers of buyers
and sellers where securities trade near their true value.
What about companies whose equity is not publicly traded, such as private companies and partner­
ships? The total value of the shares in such a company is equal to the value of the shareholders’ equity.
Thus, our goal can be restated for these companies as: maximise the current value of equity. The only
other restriction is that the entities must be for‐profit businesses.
The financial manager’s goal is to maximise the value of the
company’s shares
The goal for financial managers is to make decisions that maximise the company’s share price. By
maximising share price, management will help to maximise shareholders’ wealth. To do this, managers
must make investment and financing decisions so that the total value of cash inflows exceeds the total
value of cash outflows by the greatest possible amount (benefits > costs). Note that the focus is on
maximising the value of cash flows, not profits.

MODULE 1 Finance in business 9

Can management decisions affect share prices?
An important question is whether management decisions actually affect the company’s share price.
­Fortunately, the answer is yes. As noted earlier, a basic principle in finance is that the value of an asset
is determined by the future cash flows it is expected to generate. As shown in figure 1.1, a company’s
management makes many decisions that affect its cash flows. For example, management decides what
type of products or services to produce and what productive assets to purchase. The company’s share
price is affected by a number of factors and management can control only some of them. Managers
exercise little control over external conditions (blue boxes) such as the general economy, although they
can closely observe these conditions and make appropriate changes in strategy. Managers make many
other decisions that do directly affect the company’s expected cash flows (red boxes) — and hence the
price of the company’s shares.
Managers also make decisions concerning the mix of debt to equity, debt collection policies and
policies for paying suppliers, to mention a few. In addition, cash flows are affected by how efficient
management is in making products, the quality of the products, management’s sales and marketing skills,
and the company’s investment in research and development of new products. Some of these decisions
affect cash flows over the long term, such as a decision to build a new plant, while other decisions have
a short‐term impact on cash flows, such as launching an advertising campaign.
Of course, the company also must deal with a number of external factors over which it has little or
no control, such as economic conditions (recession or expansion), war or peace and new government
regulations. External factors are constantly changing and management must weigh the impact of these
changes and adjust its strategy and decisions accordingly.

FIGURE 1.1 Major factors that affect share prices

Economic shocks
1. Wars
2. Natural disasters The economy
Current
Business environment 1. Level of economic
share
activity
1. Corporate laws market
2. Level of interest rates
2. Environmental regulations conditions
3. Consumer sentiment
3. Procedural and safety
regulations
4. Tax

The company
1. Line of business
2. Financial management
decisions Expected cash flows
a. Capital budgeting
1. Magnitude Share
b. Financing the company
2. Timing price
c. Working capital
3. Risk
management
3. Product quality and cost
4. Marketing and sales
5. Research and development

The important point here is that, over time, management makes a series of decisions when execu­
ting the company’s strategy that affect the company’s cash flows and, hence, the price of the com­
pany’s shares. Companies that have a better business strategy are more nimble, make better business

10 Finance essentials
decisions and can execute their plans well will have a higher share price than similar companies that
just can’t get these right.
When taking into consideration a long‐term horizon, the only corporate objective that maximises the
economic interests of all stakeholders over time is for management to make decisions that maximise
the wealth of shareholders. For example, in April 2012 Telstra issued a press release announcing that
it expected to generate $2–3 billion in excess free cash flows over the next three years. The company
also confirmed that its capital management strategy priorities were to maximise returns for shareholders
(through both dividends and capital growth), maintain financial strength and retain financial flexibility.
If these priorities are executed well, this will enable Telstra to serve its existing customers better, grow
customer numbers, maintain its A credit rating and build new growth businesses. As you can see from
this example, even though Telstra’s main priority is to maximise the wealth of its shareholders, other
stakeholders such as customers, employees and lenders will also benefit from the implementation of its
capital management strategies.3

1.4 The financial manager

LEARNING OBJECTIVE 1.4 Identify the key financial decisions facing the financial manager.
While the term corporate finance implies that these topics are only relevant to corporations, this is not
the case. The topics covered in this section are basic financial principles that apply to all forms of busi­
ness structure. However, the corporate structure is used because it is easier to explain these topics when
the parties involved are distinctly separate from each other, which is usually not the case in small busi­
ness entities. Now we look at the role of the financial manager and three fundamental decisions they
make when running a business. These decisions will be covered throughout the text. We then discuss
how the financial function is managed in large corporations. The ultimate goal of the business is then
justified.

The financial manager

The financial manager is responsible for making decisions that are in the best interests of the business’s
owners, whether it is a start‐up business with a single owner or a billion‐dollar company owned by
thousands of shareholders. The decisions made by the financial manager and owners should be one and
the same. In most situations this means the financial manager should make decisions that maximise the
value of the owners’ shares. This helps maximise the owners’ wealth. Our underlying assumption in this
text is that most people who invest in businesses do so because they want to increase their wealth. In the
following discussion, we describe the responsibilities of the financial manager in a new business in order
to illustrate the types of decisions that such a manager makes.

Stakeholders
Before we discuss the new business, you may want to look at figure 1.2, which shows the cash flows
between a company and its owners (in a company, the shareholders) and various stakeholders. A
­stakeholder is someone other than an owner who has a claim on the cash flows of the company: man-
agers, who want to be paid salaries and performance bonuses; creditors, who want to be paid interest
and principal; employees, who want to be paid wages; suppliers, who want to be paid for goods or
services; and the government, which wants the company to pay tax. Stakeholders may have interests
that differ from those of the owners. When this is the case, they may exert pressure on management to
make decisions that benefit them. We will return to these types of conflict of interest later. For now, we
are primarily concerned with the overall flow of cash between the company and its shareholders and
stakeholders.

MODULE 1 Finance in business 11

 FIGURE 1.2 Cash flows between the company and its stakeholders and owners

Stakeholders and
The company shareholders
A Company’s
Managers
Cash flows are generated management Cash paid as
and other
by productive assets invests in assets wages and salaries
employees
through the sale of
Current assets
goods and services.
• Cash
• Inventory Cash paid to
Suppliers
• Accounts suppliers
receivable

Productive assets Cash paid

Government
• Plant as tax
• Equipment
• Buildings
• Technology Cash paid as
Creditors
• Patents interest and principal

B Shareholders
Residual cash flow

Cash flow reinvested Dividends paid to

in business shareholders

It’s all about cash flows

To produce its goods or services, a new company needs to acquire a variety of assets. Most will be long‐
term assets or productive assets. Productive assets can be tangible assets, such as equipment, machinery
or a manufacturing facility, or intangible assets, such as patents, trademarks, technical expertise or other
types of intellectual capital. Regardless of the type of asset, the company tries to select assets that will
generate the greatest profits. The decision‐making process through which the company purchases long‐
term productive assets is called capital budgeting and it is one of the most important decision processes
in a company.
Making business decisions is all about cash flows, because only cash can be used to pay bills and to
buy new assets. Cash initially flows into the company as a result of the sale of goods or services. The
company uses these cash inflows in a number of ways: to invest in assets, to pay wages and salaries, to
buy supplies, to pay taxes and to repay creditors. Any cash that is left over (residual cash flows) can be
reinvested in the business or paid as dividends to shareholders.
Once the company has selected its productive assets, it must raise money to pay for them. Financing
decisions are concerned with the ways that companies obtain and manage long‐term financing to
acquire and support their productive assets. There are two basic sources of funds: debt and equity.
Every company has some equity, because equity represents ownership in the company. It consists
of capital contributions by the owners plus earnings that have been reinvested in the company. In
addition, most companies borrow from a bank or issue some type of long‐term debt to finance
productive assets.
After the productive assets have been purchased and the business is operating, the company tries
to produce products at the lowest possible cost while maintaining quality. This means buying raw

12 Finance essentials
materials at the lowest possible cost, holding production and labour costs down, keeping manage­
ment and administrative costs to a minimum, and seeing that shipping and delivery costs are com­
petitive. In addition, the company must manage its day‐to‐day finances so that it has sufficient cash
on hand to pay salaries, purchase supplies, maintain inventories, pay tax and cover the myriad other
expenses necessary to run a business. The management of current assets, such as money owed by
customers who purchase on credit, and inventory, and current liabilities, such as money owed to
suppliers, is called working capital management. From accounting, current assets are assets that
will be converted into cash within 1 year and current liabilities are liabilities that must be paid
within 1 year.
A company generates cash flows by selling the goods and services it produces. A company is suc­
cessful when these cash inflows exceed the cash outflows needed to pay operating expenses, creditors
and tax. After meeting these obligations, the company can pay the remaining cash, called residual cash
flows, to the owners as a cash dividend or it can reinvest the cash in the business. The reinvestment of
residual cash flows back into the business to buy more productive assets is a very important concept.
If these funds are invested wisely, they provide the foundation for the company to grow and provide
larger residual cash flows in the future for the owners. The reinvestment of cash flows (earnings) is the
most fundamental way that businesses grow in size. Figure 1.2 illustrates how the revenue generated by
productive assets ultimately becomes residual cash flow.
A company is unprofitable when it fails to generate sufficient cash inflows to pay operating expenses,
creditors and tax. Companies that are unprofitable over time will be forced into insolvency by their
creditors if the owners do not shut them down first. In insolvency, the company will be reorganised or
its assets will be liquidated, whichever is more valuable. If the company is liquidated, creditors are paid
in a priority order according to the structure of the company’s financial contracts and prevailing insol­
vency law. If anything is left after all creditor and tax claims have been satisfied, which usually does not
happen, the remaining cash, or residual value, is distributed to the owners.

Cash flows matter most to investors

Cash is what investors ultimately care about when making an investment. The value of any asset —
shares, bonds or a business — is determined by the future cash flows it will generate. To understand this
concept, consider how much you would pay for an asset from which you could never expect to obtain
any cash flows. Buying such an asset would be like giving your money away. It would have a value of
exactly zero. Conversely, as the expected cash flows from an investment increase, you would be willing
to pay more and more for it.

Three fundamental decisions in financial management

Based on our discussion so far, we can see that financial managers are concerned with three fundamental
decisions when running a business:
1. capital budgeting decisions — identifying the productive assets the company should buy
2. financing decisions — determining how the company should finance or pay for assets
3. working capital management decisions — determining how day‐to‐day financial matters should be
managed so the company can pay its bills, and how surplus cash should be invested.
Figure 1.3 shows the impact of each decision on the company’s balance sheet. (Note that the bal­
ance sheet can also be called the statement of financial position but the term balance sheet will be used
throughout this text.) We briefly introduce each decision here and discuss them in greater detail in later
modules.

MODULE 1 Finance in business 13

 FIGURE 1.3 How the financial manager’s decisions affect the balance sheet

Balance sheet

Assets Liabilities and equity

Working capital
management decisions Current liabilities
deal with day-to-day financial (including
Current assets matters and affect current short-term debt and
(including cash, assets, current liabilities and accounts payable)
inventory and net working capital.
accounts receivable)
Net working capital — the
difference between current
assets and current liabilities
Long-term debt
Capital budgeting (debt with a
decisions maturity of over
determine what long-term 1 year)
productive assets the
Long-term company will purchase.
assets (including Financing decisions
productive assets; determine the company’s
may be tangible capital structure — the
or intangible) combination of long-term
Shareholders’
debt and equity that will
equity
be used to finance the
company’s long-term
productive assets.

Capital budgeting decisions

A company’s capital budget is simply a list of the productive (capital) assets that management wants to
purchase over a budget cycle, typically 1 year. The capital budgeting decision process addresses which
productive assets the company should purchase and how much money it can afford to spend. As shown
in figure 1.3, capital budgeting decisions affect the asset side of the balance sheet and are concerned with
a company’s long‐term investments.
Capital budgeting decisions, as we mentioned earlier, are among management’s most important
decisions. Over the long run, they have a large impact on the company’s success or failure. The reason is
twofold. First, capital assets generate most of the cash flows for the company. Second, capital assets are
long term in nature. Once they are purchased, the company owns them for a long time and they may be
hard to sell without taking a financial loss.
The fundamental question in capital budgeting is this: Which productive assets should the company
purchase? A capital budgeting decision may be as simple as a movie theatre’s decision to buy a pop­
corn machine or as complicated as Airbus’s decision to invest more than $10 billion into designing and
building the A380 passenger jet. Capital investments may also involve the purchase of an entire busi­
ness, such as Woolworths Limited’s acquisition of hardware distributor Danks to compete with home‐
improvement giant Bunnings.
Regardless of the project, a good capital budgeting decision is one in which the benefits are worth
more to the company than the cost of the asset. Not all investment decisions are successful. Just open
the business news on any day and you will find stories of bad decisions. For example, the 2011 film The
Green Lantern turned out to be a flop despite the popularity of superhero movies, losing US$90 million

14 Finance essentials
for the production company. After failing at the box office, it is unlikely that the movie’s overall cash flow
(from box office takings, DVD sales, merchandise and so on) was worth more than its US$200 million
cost. When, as in this case, the cost exceeds the value of the future cash flows, the project will decrease
the value of the company by that amount.
Sound investments are those where the value of the benefits exceeds their costs
Financial managers should invest in a capital project only if the value of its future cash flows exceeds
the cost of the project (benefits > cost). Such investments increase the value of the company and thus
increase shareholders’ (owners’) wealth. This rule holds whether you are making the decision to purchase
new machinery, build a new plant or buy an entire business.

Financing decisions
Financing decisions concern how companies raise cash to pay for their investments, as shown in
figure 1.3. Productive assets, which are long term in nature, are financed by long‐term borrowing, equity
investment or both. Financing decisions involve trade‐offs between advantages and disadvantages to the
company.
A major advantage of debt financing is that debt payments are tax deductible for many companies.
However, debt financing increases a company’s risk, because it creates a contractual obligation to make
periodic interest payments and, at maturity, to repay the amount that is borrowed. Contractual obli­
gations must be paid regardless of the company’s operating cash flow, even if it suffers a financial loss.
If the company fails to make payments as promised, it defaults on its debt obligation and could be forced
into insolvency.
In contrast, equity has no maturity and there are no guaranteed payments to equity investors. In a
company, the board of directors has the right to decide whether dividends should be paid to share­
holders. This means that if the board decides to omit or reduce a dividend payment, the company will
not be in default. Unlike interest payments, however, dividend payments to shareholders are not tax
deductible.
The mix of debt and equity on the balance sheet is known as a company’s capital structure. The term
capital structure is used because long‐term funds are considered capital and these funds are raised in
capital markets — financial markets where equity and debt instruments with maturities of greater than
1 year are traded.
Financing decisions affect the value of the company
How a company is financed with debt and equity affects its value. The reason is that the mix between
debt and equity affects the amount of tax the company pays and the probability that the company will
become insolvent. The financial manager’s goal is to determine the exact combination of debt and equity
that minimises the cost of financing the company.

Working capital management decisions

Management must also decide how to manage the company’s current assets, such as cash, inven­
tory and accounts receivable, and its current liabilities, such as trade credit and accounts payable.
The dollar difference between current assets and current liabilities is called net working capital, as
shown in figure 1.3. As we mentioned earlier, working capital management is the day‐to‐day manage­
ment of the company’s short‐term assets and liabilities. The goals of managing working capital are to
ensure that the company has enough money to pay its bills and to profitably invest any spare cash to
earn interest.
The mismanagement of working capital can cause a company to default on its debt and become
insolvent even though, over the long term, the company may be profitable. For example, a company
that makes sales to customers on credit but is not diligent about collecting the accounts receivable can
quickly find itself without enough cash to pay its bills. If this condition becomes chronic, trade creditors
can force the company into insolvency if it cannot obtain alternative financing.

MODULE 1 Finance in business 15

Another random document with
no related content on Scribd:
"That's good, I don't know how very well."
"You never go out much, do you? That is, you haven't until lately."
"Why, no. I've been too busy—until lately. Perhaps that was a
mistake."
"Perhaps," said Julie cryptically as she turned to the dance floor.
"You're looking very beautiful," said Marc.
"Am I?" Julie continued to look away but she couldn't restrain a faint
smile.
Marc found himself with nothing to say, but continued to stare at Julie.
He couldn't get over the change in her. His mind wandered off into a
lovely, imaginary land without night clubs, in which he and Julie were
the only inhabitants.
 Jack danced on, completely at ease while around him people
started to edge away with startled glances....

This was extremely unfortunate for, out on the dance floor, Jack Snell
suddenly found himself dancing, inexplicably and most
embarrassingly, alone. Toffee had suddenly vanished into thin air. He
also found himself alarmingly confronted by Mrs. Claribel Housing, a
matron of tremendous prominence, in more ways and places than
one. Mrs. Housing understood any misdemeanor perpetrated in the
Spray Club as a personal affront, to be dealt with personally. After all,
it did cast unflattering reflections on her "Set."
"Young man," she boomed. "I wonder if you realize what a disgusting
exhibition you are presenting. I should think that if you must get
roaring drunk, you could do it somewhere less public."
Jack turned to her dazedly. "But I had a girl," he said unhappily. "I
seem to have lost her."
A soft light came into Mrs. Housing's eyes. "He's gone mad," she
shouted, turning to her partner. "He's lost his girl, and it's driven him
crazy."
If there was anything that put life into Claribel Housing, it was
"straightening out" someone else's life. She looked on Jack with the
air of the practiced social worker.
"There, there, son," she roared. "Don't take on so about it. I'm sure
she wasn't half good enough for you." She placed a beefy arm about
his shoulder, and nodded to her partner. "Everett, we must do
something for this poor soul."
Everett Housing had learned to accept his wife's "projects" with
resigned good humor.
"Yes, dear," he sighed, and followed obediently as his wife led the
hapless Jack from the dance floor. It didn't seem to concern the
matron that the dancers were stopping to observe their progress.

Back at the table, Julie, noticing the excitement, reached for Marc's
sleeve.
"Something's happening to Jack and Toffee!" she cried, jumping up.
Marc, jolted from his reverie, followed after her. They reached the
group on the dance floor just in time to witness Toffee's
reappearance.
"What's going on here?" screamed Toffee, confronting Mrs. Housing.
"Please get out of my way," said Mrs. Housing regally.
"Get out of your way!" Toffee flared. "You should be ashamed of
yourself! Picking up a girl's man when her back is turned—and on
public dance floors too! And at your age!"
Mrs. Housing seemed to explode.
"How dare you! I should think that you had caused enough trouble,—
you little floosey!" It was apparent to her that this was the young lady
who had unseated Jack's reason. At this point Jack did, indeed,
appear somewhat demented. Through the ensuing uproar, he tried
valiantly but vainly to make himself heard, and seemed merely to be
babbling to himself. Toffee was beside herself with rage.
"Why, you—you—you old back issue," she yelled. "You outsized pick-
up!" She swung her foot behind her and calculated the distance to
Mrs. Housing's shin. Unfortunately, her heel caught on the rung of Mr.
Kently's chair. That good gentleman, unconcerned of the tumult
raging just behind him, was, at the moment, determinedly offering a
toast to his wife on the occasion of their twenty-fifth anniversary. He
lifted his glass, and with the words: "And to you, my dear—," tossed
its entire contents neatly into Mrs. Kently's face. Toffee had jerked the
chair swiftly from under him. Mrs. Kently shot out of her chair with a
scream designed for blood chilling.
Across the room, a guest, somewhat befogged by too much drink,
raised a heavy head and shouted: "Murder!" at the top of his lungs.
Across from him, his companion looked up with startled eyes and
quietly slid under the table, unconscious. The man looked down at
her without concern.
"Can't stand the sight of blood," he explained to no one in particular.
The center of this excitement suddenly dissipated itself with the
stately, if hurried, departure of Mrs. Housing and her obedient
husband, but the fever of hysteria had already spread to the
remaining guests and was raging unabated. The orchestra, caught in
the spirit of the occasion, struck up a raucous rendition of "The Beer
Barrel Polka." Several guests, similarly inspired, rapped their partners
rather ungently over the head with whatever bottles were at hand.
The door to the manager's office opened briefly and slammed to.
Finally, Marc managed to fight his way through to Toffee.
"Now, see what you've done!" he yelled.
"So this is night clubbing," squealed Toffee delightedly.
"We have to get out of here," Marc guided her away from the dance
floor.
"Just when things were really getting started?" asked Toffee. "Where
are Jack and Julie?"
"They've gone and we'd better do the same."
"Just a moment," replied Toffee and disappeared into the crowd
again. Marc made a grab for her but missed. Presently she returned,
beaming triumphantly. Under her arm, she carried a bottle of
champagne.
"I don't see why we should let it go to waste," she explained. Marc
groaned and hurried her off toward the entrance.
Outside, they were greeted not only by the cool, evening air, but also
by what appeared to be the entire police force. The manager of the
Spar Club stood behind them.
"There they are, boys!" he yelled excitedly. "Grab 'em!"

Toffee was delighted to find herself, once more, the center of

attention. She looked up at the judge with a disarming smile. She felt
a little sorry for the poor little man—he seemed so perplexed by
everything. Marc stood beside her, wondering vaguely if he weren't
dead, and if not, why not. The judge fixed Toffee with a baleful stare.
"Who did you say your parents were?" His voice was that of a martyr.
"A moonlit night and a yearning spirit," said Toffee blandly. The
judge's eyes rolled ceilingward.
"Oh, good Lord," he sighed in pure supplication.
"What she means—," began Marc.
"You stay out of this!" snapped the judge. "I'll hear from you later."
"But judge," said Toffee. "I don't know how I can make it clearer."
"Never mind," replied the judge hotly. "Let's hear no more about it. I
sincerely wish I hadn't brought it up in the first place. Now, perhaps,
you'll tell me what went on in the Spar Club this evening, and never
mind the poetry."
"Well," said Toffee brightly, "it all started when this old fright tried to
steal Mr. Snell from me—right there on the dance floor, too." An
earnest expression crept over her face. "She should be locked up,
judge."
Marc's thoughts raced wildly. If ever there was a time for Toffee to
fade, this was unquestionably it. He clamped his eyes tightly shut and
tried frantically to picture peaceful, pastoral scenes in an attempt to
induce sleep. However, what occurred to him most frequently were
bleak countrysides strewn with assorted wreckage, symbolic of his
future.
"Exactly what is your relationship with this man?" The judge nodded
in Marc's direction without looking at him.
"Well," said Toffee. "You see, I sort of belong to him, in a way."
"You mean he's your guardian?" This appealed to Toffee and she
nodded vigorously. The judge turned to Marc.
"Young man—," he began, then looked questioningly at Toffee.
"What's the matter with him?"
Toffee turned to Marc and sudden anger flashed in her eyes.
"You double-crosser!" she hissed. Swiftly her hand shot to Marc's
unsuspecting rear and two fingers closed wickedly. Instantly, Marc's
eyes flew open and stared wildly at the judge as a piercing scream
rent the courtroom and he leaped frantically forward. A small cry of
terror was heard from the frightened judge as he disappeared
beneath the bench.
"He's attacking me!" he screamed from the floor. "Get him out of here!
Get them both out of here! Lock them up before they kill someone!"
As two official brutes closed in on them, Marc angrily faced Toffee.
"If you ever do anything like this again, I'll deliberately contract
sleeping sickness!" he shouted.
Marc awoke wondering how long he had been asleep, and, in the
grey morning light, began to inspect his quarters without enthusiasm.
The cell that he occupied was like any other, but he had been lucky
enough to have it all to himself. He lay, face up in the lower section of
the steel, double-decker and reviewed the preceding night's activities.
Suddenly, he started forward and propped himself up on one elbow.
There was a form clearly outlined in the mattress above him. He tried
to remember if anyone had been brought into the cell during the
night. As he was thinking about it, the form stirred. Slowly, he
advanced a hand to the mattress and prodded it gingerly. His
suspicions were immediately confirmed.
"Good morning," called Toffee with a hateful cheerfulness as she
peered down at him from the upper.
"I thought they put you in the women's quarters."
"They did, but I decided to materialize here, to be with you."
"But, if they find you here—," Marc gave it up. Things couldn't get any
worse. "I hope you're happy about this." He waved his hand tragically
at the cell.
"Well," said Toffee slowly. "I can think of better places. Let's leave."
"And how do you propose to get out of here?"
"You mean they intend to keep us here?"
"It is likely, considering your performance before the judge last night,
that we shall rot in this place."
"We'll just have to get out." Toffee's brow wrinkled sternly.
Marc looked grieved but made no reply. After several moments of
concentrated thought, his face lit up.
"Now, look Toffee," he said, "You say that you can materialize
anywhere. Suppose I doze off for a while, do you suppose you could
manage to "come to" outside and get the keys to this trap? After all,
they don't have our names, our real ones, on any of the records yet."
"I could do it with my eyes closed," Toffee cried happily.
"Well, don't get fancy about it."
Marc stretched out on the bed and closed his eyes, and everything
became quiet in the cell for a time. Toffee waited expectantly but
nothing happened. Marc swung his legs over the edge of the bed and
cupped his chin in his hands.
"It's no use," he sighed. "I've too much on my mind.
"Try again," urged Toffee.
"It's no use I tell you."
Toffee sat up and glanced down at Marc. Slowly an intense
expression crept over her face. Quietly, she reached down and
removed one of her shoes, and regarded it sadly. She leaned over
the edge of the bed and poised it over Marc's head. Closing her eyes,
she swung the shoe downward as swiftly as she could. Marc slumped
to the floor soundlessly.

Marc had been right in assuming that Joseph wouldn't be there to

open the door for them. He fitted the key into the lock and turned it.
"You needn't have hit me so hard," he grumbled. Toffee looked hurt.
"I got you out of there, didn't I? Of course, maybe I shouldn't have left
that note for the judge." Marc looked alarmed.
"What note?"
"Well, the poor dear was so disturbed about my parentage that I left a
note explaining the whole thing. I guess it wasn't such a good idea."
"What did you tell him?"
"That my father was a Welsh." Toffee smiled mysteriously and
crossed to inspect herself in the mantle mirror.
"I'm a wreck. You miss me while I fix up a bit?"
Marc fell into a chair as she left the room. He sat there regarding the
apartment listlessly. It seemed to reflect his own life. Orderly,
dignified, unexciting and infinitely lonely. Suddenly his reverie was
interrupted by a knock at the door. He crossed and opened it. There,
looking particularly miserable, stood Julie.
"I hope you'll excuse my coming here," she said timidly. "I've been
waiting at the office for you all morning. I tried to call you here several
times but there wasn't any answer. I decided to come over and wait
for you. Its odd that Joseph didn't answer the phone.
"He wasn't in," said Marc. "Is something wrong?"
"Well, no—not exactly." Julie hesitated. "It's just that—well—it's just
that—I want to quit my job with you, Mr. Pillsworth.
"What?" Marc's eyes widened with surprise.
"Yes, Mr. Pillsworth, I want to quit." The words came in a rush. "Now
—today. I don't want to ever have to go back."
"But you mustn't leave." There was an immediacy in Marc's tone.
"How would I get on without you? If it's a matter of salary—."
"No, it isn't that. You give me more than enough to get by on. As a
matter of fact, I don't know where I'll ever get a better job."
Marc looked at her questioningly.
"Well, I don't know just how to explain it. It's just something that's
come over me all of a sudden. I've a strange feeling that I'm wasting
my life there, as if something were closing in on me to cut me off from
everything I really want—as though the job itself were a menace to
my happiness. I guess it came over me yesterday when your cousin
—
"Niece," interrupted Marc.
"—When your niece was in the office. She seemed so gay, so much
that I should be, but am not. It seemed only fair to talk to you first,
before leaving." Marc glanced nervously toward the bedroom door.
"But what has the agency to do with it?"
"I wish I knew," said Julie. "It's just a feeling that I have."
"But I can't let you go, Julie." The note of urgency crept back into
Marc's voice. "And you mustn't envy Toffee. You see, she's just
escaping a dull existence herself—and only momentarily. She'll be
returning soon. Perhaps right away." A sudden light came into Julie's
eyes. "Besides, I know what you feel. I've felt the same thing myself
for years. The trouble was that I let myself get used to it and after a
time, I didn't know the difference. I'm sure I know how to help myself
now and I think that I could help you too—if you'll let me—if you'll
stay. Please don't leave, Julie."
As Julie listened to Marc, her expression became softly radiant.
"Perhaps you're right, Marc," she said quietly.
Marc reached out and took her hand in his. Suddenly, from behind
the bedroom door, came the soft hiss of a shower. Instantly, Julie
drew back.

"Joseph must be back," said Marc quickly.

"Taking a shower?"
"Oh, yes—he often takes showers this time of day. Very clean man.
Says cleanliness is next to Godliness, or something of the sort. Very
clean—spotless, you might say." Marc began to realize that he was
babbling and stopped short.
"Of course," said Julie, smiling. "I should have remembered Joseph. It
gave me rather a start, I thought we were alone.
"You'll be back in the morning then?" Marc asked anxiously. "Please
say you will."
Julie regarded Marc thoughtfully.
"Yes," she said slowly. "It doesn't seem now that there was ever
anything wrong." She turned toward the door.
"Julie—"
"Yes?" She turned, and as she did so Marc caught her in his arms.
He kissed her briefly and released her, stepping back embarrassedly.
Julie smiled up at him for a moment and then said quickly:
"It's a wonderful job, I wouldn't quit for anything." The door closed
softly behind her.
When Toffee entered the living room she found Marc staring out of
the window with a curiously foolish grin. She stood beside him for a
moment and looked out at the city.
"Go put some clothes on," he said. Toffee was wrapped in a huge
towel, draped precariously over one shoulder.
"What for? At this moment, more of me is covered, than at any time
since we met."
"Yes I guess so." For a moment they stood silently before the window.
"Toffee—," Marc began.
"Yes, Marc?"
"Why are you here? What is it you want—really?"
"My wish is for you Marc, it has been from the beginning. If I've
caused you trouble, perhaps it was because you needed it. I'll be
returning soon, but I can't help wanting to linger for a while."
"But how will your return be accomplished?"
"You'll know when the times comes." She smiled up at him. "Maybe
it's time I put those clothes on after all." She went into the bed room.
Marc slumped into a chair. In a way he had enjoyed Toffee and her
trouble, but now she would be in the way. "You'll know when the time
comes," she had said. He was certain that the time had arrived, but
he still hadn't any idea about sending her back to the subconscious.
Perhaps it would be best to go back to the beginning. How had it
started? He reviewed the strange occurrence over and over again.
For the fifth time, he went back to the beginning. Suddenly, he
brought his fist down on the arm of the chair.
"Of course, that's it," he murmured. "Her father was a Welsh." He
laughed shortly. "It's so simple, I should have known all along."
After a time, the bed room door flew open. Toffee was making a
grand entrance. As she moved toward him, Marc thought briefly that
he had never seen her so beguiling. At the center of the room, she
paused.
"Isn't it wonderful? I like it even more than the black one."
"You might say, it leaves everything to be desired," said Marc.
"Oh?"
"—by some young swain," he added.
"Marc there just isn't any hope for you."
"I'd have agreed with you two days ago."
"And now?"
"Who knows?"
"I'm sure I don't."
"That's as it should be." Marc started for the bed room. "I could use a
little sprucing up myself." At the door he turned back. "Suppose we
make a special occasion of dinner tonight—go somewhere, where the
food is especially good? I know a place that serves a wonderful welsh
rarebit. I was there just night before last." Toffee's smile immediately
disappeared and for a moment her eyes searched Marc's face, which
had, suddenly, become quite serious. Her smile reappeared as
suddenly as it had faded, but it seemed a bit more set.
"I'm sure I'll love it," she said.
Marc spoke slowly and his voice carried a touch of sadness.
"And remind me to stop by the drug-store for sleeping tablets. I ran
out the other night."
"Sure Marc." Toffee looked away toward the window as Marc left the
room.
The countryside had somehow reassembled itself—as lovely and
serene as before, with a blue mist playing about the trees. Toffee and
Marc moved down the hillside toward a small valley obscured by the
mist.
"I should be angry with you," said Toffee. "You didn't waste any time
in sending me back, once you knew how."
"You said I'd know when the time came."
"How did you find out?"
"I kept wondering where it had all started, and then I remembered
that foods sometimes cause certain kinds of dreams. Then too, I
remembered that you had said that your father was a Welsh. I didn't
have to be clever to put it all together and get welch rarebit,
especially since it was the very thing I had eaten the first night. It all
seemed pretty silly, but somehow it sort of fitted in with what's
happened. You're not angry are you?" He looked down at her
affectionately.
"Of course not, Marc. There's something you've forgotten. I exist only
in your mind. I am as you see me. If I had stayed longer, if I had come
to stand in the way of your happiness, I should have become ugly
and wretched. I've served my purpose and it's time for me to return.
Really, you haven't so much to do with it as you suppose. It's been a
wonderful adventure for me, Marc."
"I'm glad, Toffee," Marc said simply. "I'll never forget what you've done
for me."
"Just remember Marc, that I'm not so unlike other, ordinary women.
There is none of us who can remain lovely unless she does so in the
eyes of a man whom she loves. Be good to Julie."
"You knew about Julie?"
"Of course," laughed Toffee. "I knew from the beginning, before you
did. I know more about you than you do yourself. That's another point
I hold in common with other women."
They had reached the edge of the valley and suddenly Toffee
stopped.
"This is where I have to leave you." She smiled up at Marc. Suddenly,
he took her in his arms, very tenderly, and kissed her. As he released
her, the bell began to ring in the distance, as it had before.
"Goodbye," Toffee said softly, starting toward the valley.
As she moved, the earth seemed to dissolve behind her, leaving a
narrow chasm between them. With each step the bell became more
and more distinct. Suddenly, impulsively, Marc turned toward her.
"Wait!" he called, and reached out a hand to her.

Marc's hand fell to the alarm clock and he awakened to a bright, new
morning with a vague sense of loss. Suddenly he swung his legs over
the edge of the bed and got to his feet.
Julie would be at the office. He didn't want to be late.
*** END OF THE PROJECT GUTENBERG EBOOK I'LL DREAM OF
YOU ***

Updated editions will replace the previous one—the old editions will
be renamed.

Creating the works from print editions not protected by U.S.

copyright law means that no one owns a United States copyright in
these works, so the Foundation (and you!) can copy and distribute it
in the United States without permission and without paying copyright
royalties. Special rules, set forth in the General Terms of Use part of
this license, apply to copying and distributing Project Gutenberg™
electronic works to protect the PROJECT GUTENBERG™ concept
and trademark. Project Gutenberg is a registered trademark, and
may not be used if you charge for an eBook, except by following the
terms of the trademark license, including paying royalties for use of
the Project Gutenberg trademark. If you do not charge anything for
copies of this eBook, complying with the trademark license is very
easy. You may use this eBook for nearly any purpose such as
creation of derivative works, reports, performances and research.
Project Gutenberg eBooks may be modified and printed and given
away—you may do practically ANYTHING in the United States with
eBooks not protected by U.S. copyright law. Redistribution is subject
to the trademark license, especially commercial redistribution.

START: FULL LICENSE

THE FULL PROJECT GUTENBERG LICENSE
 PLEASE READ THIS BEFORE YOU DISTRIBUTE OR USE THIS WORK

To protect the Project Gutenberg™ mission of promoting the free

distribution of electronic works, by using or distributing this work (or
any other work associated in any way with the phrase “Project
Gutenberg”), you agree to comply with all the terms of the Full
Project Gutenberg™ License available with this file or online at
www.gutenberg.org/license.

Section 1. General Terms of Use and

Redistributing Project Gutenberg™
electronic works
1.A. By reading or using any part of this Project Gutenberg™
electronic work, you indicate that you have read, understand, agree
to and accept all the terms of this license and intellectual property
(trademark/copyright) agreement. If you do not agree to abide by all
the terms of this agreement, you must cease using and return or
destroy all copies of Project Gutenberg™ electronic works in your
possession. If you paid a fee for obtaining a copy of or access to a
Project Gutenberg™ electronic work and you do not agree to be
bound by the terms of this agreement, you may obtain a refund from
the person or entity to whom you paid the fee as set forth in
paragraph 1.E.8.

1.B. “Project Gutenberg” is a registered trademark. It may only be

used on or associated in any way with an electronic work by people
who agree to be bound by the terms of this agreement. There are a
few things that you can do with most Project Gutenberg™ electronic
works even without complying with the full terms of this agreement.
See paragraph 1.C below. There are a lot of things you can do with
Project Gutenberg™ electronic works if you follow the terms of this
agreement and help preserve free future access to Project
Gutenberg™ electronic works. See paragraph 1.E below.
1.C. The Project Gutenberg Literary Archive Foundation (“the
Foundation” or PGLAF), owns a compilation copyright in the
collection of Project Gutenberg™ electronic works. Nearly all the
individual works in the collection are in the public domain in the
United States. If an individual work is unprotected by copyright law in
the United States and you are located in the United States, we do
not claim a right to prevent you from copying, distributing,
performing, displaying or creating derivative works based on the
work as long as all references to Project Gutenberg are removed. Of
course, we hope that you will support the Project Gutenberg™
mission of promoting free access to electronic works by freely
sharing Project Gutenberg™ works in compliance with the terms of
this agreement for keeping the Project Gutenberg™ name
associated with the work. You can easily comply with the terms of
this agreement by keeping this work in the same format with its
attached full Project Gutenberg™ License when you share it without
charge with others.

1.D. The copyright laws of the place where you are located also
govern what you can do with this work. Copyright laws in most
countries are in a constant state of change. If you are outside the
United States, check the laws of your country in addition to the terms
of this agreement before downloading, copying, displaying,
performing, distributing or creating derivative works based on this
work or any other Project Gutenberg™ work. The Foundation makes
no representations concerning the copyright status of any work in
any country other than the United States.

1.E. Unless you have removed all references to Project Gutenberg:

1.E.1. The following sentence, with active links to, or other

immediate access to, the full Project Gutenberg™ License must
appear prominently whenever any copy of a Project Gutenberg™
work (any work on which the phrase “Project Gutenberg” appears, or
with which the phrase “Project Gutenberg” is associated) is
accessed, displayed, performed, viewed, copied or distributed:
 This eBook is for the use of anyone anywhere in the United
States and most other parts of the world at no cost and with
almost no restrictions whatsoever. You may copy it, give it away
or re-use it under the terms of the Project Gutenberg License
included with this eBook or online at www.gutenberg.org. If you
are not located in the United States, you will have to check the
laws of the country where you are located before using this
eBook.

1.E.2. If an individual Project Gutenberg™ electronic work is derived

from texts not protected by U.S. copyright law (does not contain a
notice indicating that it is posted with permission of the copyright
holder), the work can be copied and distributed to anyone in the
United States without paying any fees or charges. If you are
redistributing or providing access to a work with the phrase “Project
Gutenberg” associated with or appearing on the work, you must
comply either with the requirements of paragraphs 1.E.1 through
1.E.7 or obtain permission for the use of the work and the Project
Gutenberg™ trademark as set forth in paragraphs 1.E.8 or 1.E.9.

1.E.3. If an individual Project Gutenberg™ electronic work is posted

with the permission of the copyright holder, your use and distribution
must comply with both paragraphs 1.E.1 through 1.E.7 and any
additional terms imposed by the copyright holder. Additional terms
will be linked to the Project Gutenberg™ License for all works posted
with the permission of the copyright holder found at the beginning of
this work.

1.E.4. Do not unlink or detach or remove the full Project

Gutenberg™ License terms from this work, or any files containing a
part of this work or any other work associated with Project
Gutenberg™.

1.E.5. Do not copy, display, perform, distribute or redistribute this

electronic work, or any part of this electronic work, without
prominently displaying the sentence set forth in paragraph 1.E.1 with
active links or immediate access to the full terms of the Project
Gutenberg™ License.
1.E.6. You may convert to and distribute this work in any binary,
compressed, marked up, nonproprietary or proprietary form,
including any word processing or hypertext form. However, if you
provide access to or distribute copies of a Project Gutenberg™ work
in a format other than “Plain Vanilla ASCII” or other format used in
the official version posted on the official Project Gutenberg™ website
(www.gutenberg.org), you must, at no additional cost, fee or expense
to the user, provide a copy, a means of exporting a copy, or a means
of obtaining a copy upon request, of the work in its original “Plain
Vanilla ASCII” or other form. Any alternate format must include the
full Project Gutenberg™ License as specified in paragraph 1.E.1.

1.E.7. Do not charge a fee for access to, viewing, displaying,

performing, copying or distributing any Project Gutenberg™ works
unless you comply with paragraph 1.E.8 or 1.E.9.

1.E.8. You may charge a reasonable fee for copies of or providing

access to or distributing Project Gutenberg™ electronic works
provided that:

• You pay a royalty fee of 20% of the gross profits you derive from
the use of Project Gutenberg™ works calculated using the
method you already use to calculate your applicable taxes. The
fee is owed to the owner of the Project Gutenberg™ trademark,
but he has agreed to donate royalties under this paragraph to
the Project Gutenberg Literary Archive Foundation. Royalty
payments must be paid within 60 days following each date on
which you prepare (or are legally required to prepare) your
periodic tax returns. Royalty payments should be clearly marked
as such and sent to the Project Gutenberg Literary Archive
Foundation at the address specified in Section 4, “Information
about donations to the Project Gutenberg Literary Archive
Foundation.”

• You provide a full refund of any money paid by a user who

notifies you in writing (or by e-mail) within 30 days of receipt that
s/he does not agree to the terms of the full Project Gutenberg™
License. You must require such a user to return or destroy all