## Fundamentals of Corporate Finance, Ninth Edition

By Richard A. Brealey, Stewart C. Myers and Alan J. Marcus

**Contents:**

**Part One: Introduction**

Chapter 1

Goals and Governance of the Corporation 2

1.1 Investment and Financing Decisions 4

The Investment (Capital Budgeting) Decision 6

The Financing Decision 6

1.2 What Is a Corporation? 8

Other Forms of Business Organization 9

1.3 Who Is the Financial Manager? 10

1.4 Goals of the Corporation 12

Shareholders Want Managers to Maximize Market Value 12

1.5 Agency Problems, Executive Compensation, and

Corporate Governance 15

Executive Compensation 16

Corporate Governance 17

1.6 The Ethics of Maximizing Value 18

1.7 **Careers in Finance** 21

1.8 Preview of Coming Attractions 22

1.9 Snippets of Financial History 23

Summary 25

Questions and Problems 26

Chapter 2

Financial Markets and Institutions 32

2.1 The Importance of Financial Markets and

Institutions 34

2.2 The Flow of Savings to Corporations 35

The Stock Market 37

Other Financial Markets 38

Financial Intermediaries 40

Financial Institutions 42

Total Financing of U.S. Corporations 43

2.3 Functions of Financial Markets and Intermediaries 44

Transporting Cash across Time 45

Risk Transfer and Diversification 45

Liquidity 46

The Payment Mechanism 46

Information Provided by Financial Markets 47

2.4 The Crisis of 2007–2009 49

Summary 51

Questions and Problems 52

Chapter 3

Accounting and Finance 56

3.1 The Balance Sheet 58

Book Values and Market Values 61

3.2 The Income Statement 63

Income versus Cash Flow 64

3.3 The Statement of Cash Flows 67

Free Cash Flow 69

3.4 Accounting Practice and Malpractice 70

3.5 Taxes 73

Corporate Tax 73

Personal Tax 74

Summary 76

Questions and Problems 76

Chapter 4

Measuring Corporate Performance 86

4.1 How Financial Ratios Relate to Shareholder Value 88

4.2 Measuring Market Value and Market Value

Added 89

4.3 Economic Value Added and Accounting Rates of

Return 91

Accounting Rates of Return 93

Problems with EVA and Accounting Rates of Return 95

4.4 Measuring Efficiency 96

4.5 Analyzing the Return on Assets: The Du Pont System 97

The Du Pont System 98

4.6 Measuring Financial Leverage 100

Leverage and the Return on Equity 102

4.7 Measuring Liquidity 103

4.8 Interpreting **Financial Ratios** 104

4.9 The Role of Financial Ratios 108

Summary 109

Questions and Problems 110

Minicase 116

**Part Two: Value**

Chapter 5

The Time Value of Money 118

5.1 Future Values and Compound Interest 120

5.2 Present Values 123

Finding the Interest Rate 127

5.3 Multiple Cash Flows 128

Future Value of Multiple Cash Flows 128

Present Value of Multiple Cash Flows 130

5.4 Reducing the Chore of the Calculations: Part 1 131

Using Financial Calculators to Solve Simple Time-Value-of-

Money Problems 131

Using Spreadsheets to Solve Simple Time-Value-of-Money

Problems 132

5.5 Level Cash Flows: Perpetuities and Annuities 135

How to Value Perpetuities 135

How to Value Annuities 136

Future Value of an Annuity 140

Annuities Due 143

5.6 Reducing the Chore of the Calculations: Part 2 144

Using Financial Calculators to Solve Annuity

Problems 145

Using Spreadsheets to Solve Annuity Problems 145

5.7 Effective Annual Interest Rates 146

5.8 Inflation and the Time Value of Money 148

Real versus Nominal Cash Flows 148

Inflation and Interest Rates 150

Valuing Real Cash Payments 151

Real or Nominal? 153

Summary 153

Questions and Problems 154

Minicase 165

Chapter 6

Valuing Bonds 166

6.1 The Bond Market 168

Bond Characteristics 168

6.2 Interest Rates and Bond Prices 169

How Bond Prices Vary with Interest Rates 172

Interest Rate Risk 174

6.3 Yield to Maturity 174

Calculating the Yield to Maturity 176

6.4 Bond Rates of Return 176

6.5 The Yield Curve 178

Nominal and Real Rates of Interest 181

6.6 Corporate Bonds and the Risk of Default 182

Protecting against Default Risk 185

Not All Corporate Bonds Are Plain Vanilla 187

Summary 187

Questions and Problems 188

Chapter 7

Valuing Stocks 196

7.1 Stocks and the Stock Market 198

Reading Stock Market Listings 199

7.2 Market Values, Book Values, and Liquidation Values 201

7.3 Valuing Common Stocks 203

Valuation by Comparables 203

Price and Intrinsic Value 204

The Dividend Discount Model 206

7.4 Simplifying the Dividend Discount Model 209

Case 1: The Dividend Discount Model with No Growth 209

Case 2: The Dividend Discount Model with Constant

Growth 209

Case 3: The Dividend Discount Model with Nonconstant

Growth 214

7.5 Valuing a Business by Discounted Cash Flow 218

Valuing the Concatenator Business 218

Repurchases and the Dividend Discount Model 219

7.6 There Are No Free Lunches on Wall Street 220

Random Walks and Efficient Markets 221

7.7 Market Anomalies and Behavioral Finance 225

Market Anomalies 225

Bubbles and Market Efficiency 226

Behavioral Finance 227

Summary 228

Questions and Problems 229

Minicase 236

Chapter 8

Net Present Value and Other Investment

Criteria 238

8.1 Net Present Value 240

A Comment on Risk and Present Value 241

Valuing Long-Lived Projects 242

Choosing between Alternative Projects 244

8.2 The Internal Rate of Return Rule 245

A Closer Look at the Rate of Return Rule 246

Calculating the Rate of Return for Long-Lived Projects 246

A Word of Caution 248

Some Pitfalls with the Internal Rate of Return Rule 248

8.3 The Profitability Index 253

Capital Rationing 254

Pitfalls of the Profitability Index 254

8.4 The Payback Rule 255

Discounted Payback 256

8.5 More Mutually Exclusive Projects 256

Problem 1: The Investment Timing Decision 257

Problem 2: The Choice between Long- and Short-Lived

Equipment 258

Problem 3: When to Replace an Old Machine 260

8.6 A Last Look 261

Summary 262

Questions and Problems 263

Minicase 270

Appendix: More on the IRR Rule 271

Using the IRR to Choose between Mutually Exclusive

Projects 271

Using the Modified Internal Rate of Return When There Are

Multiple IRRs 271

Chapter 9

Using Discounted Cash-Flow Analysis to Make

Investment Decisions 274

9.1 Identifying Cash Flows 276

Discount Cash Flows, Not Profits 276

Discount Incremental Cash Flows 278

Discount Nominal Cash Flows by the Nominal Cost of

Capital 281

Separate Investment and Financing Decisions 282

9.2 Calculating Cash Flow 283

Element 1: Capital Investment 283

Element 2: Operating Cash Flow 283

Element 3: Changes in Working Capital 285

9.3 An Example: Blooper Industries 286

Cash-Flow Analysis 286

Calculating the NPV of Blooper’s Project 288

Further Notes and Wrinkles Arising from Blooper’s

Project 289

Summary 293

Questions and Problems 294

Minicase 301

Chapter 10

Project Analysis 302

10.1 How Firms Organize the Investment Process to Draw on

Their Competitive Strengths 304

The Capital Budget 304

Problems and Some Solutions 305

10.2 Reducing Forecast Bias 305

10.3 Some “What-If” Questions 306

Sensitivity Analysis 307

Scenario Analysis 310

10.4 Break-Even Analysis 310

Accounting Break-Even Analysis 311

NPV Break-Even Analysis 312

Operating Leverage 315

10.5 Real Options and the Value of Flexibility 317

The Option to Expand 317

A Second Real Option: The Option to Abandon 319

A Third Real Option: The Timing Option 319

A Fourth Real Option: Flexible Production Facilities 320

Summary 321

Questions and Problems 322

Minicase 328

**Part Three: Risk**

Chapter 11

Introduction to Risk, Return, and the

Opportunity Cost of Capital 330

11.1 Rates of Return: A Review 332

11.2 A Century of Capital Market History 333

Market Indexes 333

The Historical Record 333

Using Historical Evidence to Estimate Today’s Cost of

Capital 336

11.3 Measuring Risk 338

Variance and Standard Deviation 338

A Note on Calculating Variance 341

Measuring the Variation in Stock Returns 341

11.4 Risk and Diversification 343

Diversification 343

Asset versus Portfolio Risk 344

Market Risk versus Specific Risk 350

11.5 Thinking about Risk 351

Message 1: Some Risks Look Big and Dangerous

but Really Are Diversifiable 351

Message 2: Market Risks Are Macro Risks 352

Message 3: Risk Can Be Measured 353

Summary 354

Questions and Problems 355

Chapter 12

Risk, Return, and Capital Budgeting 360

12.1 Measuring Market Risk 362

Measuring Beta 362

Betas for U.S. Steel and PG&E 365

Total Risk and Market Risk 365

12.2 What Can You Learn from Beta? 367

Portfolio Betas 367

The Portfolio Beta Determines the Risk of a Diversified

Portfolio 370

12.3 Risk and Return 371

Why the CAPM Makes Sense 373

The Security Market Line 374

Using the CAPM to Estimate Expected Returns 375

How Well Does the CAPM Work? 375

12.4 The CAPM and the Opportunity Cost of

Capital 378

The Company Cost of Capital 380

What Determines Project Risk? 380

Don’t Add Fudge Factors to Discount Rates 381

Summary 381

Questions and Problems 382

Chapter 13

The Weighted-Average Cost of Capital and

Company Valuation 390

13.1 Geothermal’s Cost of Capital 392

13.2 The Weighted-Average Cost of Capital 393

Calculating Company Cost of Capital as a Weighted Average 394

Use Market Weights, Not Book Weights 396

Taxes and the Weighted-Average Cost of Capital 396

What If There Are Three (or More) Sources of Financing? 398

The NPV of Geothermal’s Expansion 398

Checking Our Logic 399

13.3 Interpreting the Weighted-Average Cost of Capital 400

When You Can and Can’t Use WACC 400

Some Common Mistakes 400

How Changing Capital Structure Affects Expected Returns 401

What Happens When the Corporate Tax Rate Is Not Zero 401

13.4 Practical Problems: Measuring Capital Structure 401

13.5 More Practical Problems: Estimating Expected Returns 403

The Expected Return on Bonds 403

The Expected Return on Common Stock 404

The Expected Return on Preferred Stock 405

Adding It All Up 406

Real-Company WACCs 406

13.6 Valuing Entire Businesses 406

Calculating the Value of the Deconstruction Business 408

Summary 409

Questions and Problems 410

Minicase 415

**Part Four: Financing**

Chapter 14

Introduction to Corporate Financing 418

14.1 Creating Value with Financing Decisions 420

14.2 Patterns of Corporate Financing 420

Are Firms Issuing Too Much Debt? 423

14.3 Common Stock 424

Ownership of the Corporation 426

Voting Procedures 427

Classes of Stock 428

14.4 Preferred Stock 428

14.5 Corporate Debt 429

Debt Comes in Many Forms 429

Innovation in the Debt Market 432

14.6 Convertible Securities 434

Summary 435

Questions and Problems 436

Chapter 15

How Corporations Raise Venture Capital and

Issue Securities 440

15.1 Venture Capital 442

Venture Capital Companies 443

15.2 The Initial Public Offering 444

Arranging a Public Issue 445

Other New-Issue Procedures 449

The Underwriters 449

15.3 General Cash Offers by Public Companies 450

General Cash Offers and Shelf Registration 451

Costs of the General Cash Offer 452

Market Reaction to Stock Issues 452

15.4 The Private Placement 453

Summary 454

Questions and Problems 454

Minicase 459

Appendix: Hotch Pot’s New-Issue Prospectus 461

**Part Five: Debt and Payout Policy**

Chapter 16

Debt Policy 466

16.1 How Borrowing Affects Value in a Tax-Free

Economy 468

MM’s Argument—A Simple Example 469

How Borrowing Affects Earnings per Share 470

How Borrowing Affects Risk and Return 472

16.2 Debt and the Cost of Equity 473

No Magic in Financial Leverage 476

16.3 Debt, Taxes, and the Weighted-Average Cost of

Capital 477

Debt and Taxes at River Cruises 478

How Interest Tax Shields Contribute to the Value of

Stockholders’ Equity 479

Corporate Taxes and the Weighted-Average Cost of

Capital 480

The Implications of Corporate Taxes for Capital

Structure 481

16.4 Costs of Financial Distress 482

Bankruptcy Costs 482

Costs of Bankruptcy Vary with Type of Asset 484

Financial Distress without Bankruptcy 485

16.5 Explaining Financing Choices 487

The Trade-Off Theory 487

A Pecking Order Theory 488

The Two Faces of Financial Slack 489

Is There a Theory of Optimal Capital Structure? 490

Summary 491

Questions and Problems 492

Minicase 499

Appendix: Bankruptcy Procedures 501

Chapter 17

Payout Policy 504

17.1 How Corporations Pay Out Cash to Shareholders 506

How Firms Pay Dividends 507

Limitations on Dividends 507

Stock Dividends and Stock Splits 508

Stock Repurchases 509

17.2 The Information Content of Dividends and

Repurchases 509

17.3 Dividends or Repurchases? The Payout

Controversy 511

Dividends or Repurchases? An Example 512

Repurchases and the Dividend Discount Model 513

Dividends and Share Issues 514

17.4 Why Dividends May Increase Value 515

17.5 Why Dividends May Reduce Value 517

Taxation of Dividends and Capital Gains under Current Tax

Law 518

Taxes and Payout—A Summary 518

17.6 Payout Policy and the Life Cycle of the Firm 518

Summary 519

Questions and Problems 520

Minicase 526

**Part Six: Financial Analysis and Planning**

Chapter 18

Long-Term Financial Planning 528

18.1 What Is Financial Planning? 530

Why Build Financial Plans? 530

18.2 Financial Planning Models 531

Components of a Financial Planning Model 531

18.3 A Long-Term Financial Planning Model for Dynamic

Mattress 532

Pitfalls in Model Design 537

Choosing a Plan 538

18.4 External Financing and Growth 539

Summary 542

Questions and Problems 543

Minicase 549

Chapter 19

Short-Term Financial Planning 550

19.1 Links between Long-Term and Short-Term

Financing 552

19.2 Tracing Changes in Cash 554

19.3 Cash Budgeting 556

Preparing the Cash Budget 556

19.4 Dynamic’s Short-Term Financial Plan 559

Dynamic Mattress’s Financing Plan 559

Evaluating the Plan 560

A Note on Short-Term Financial Planning Models 561

Summary 563

Questions and Problems 563

Minicase 568

Chapter 20

Working Capital Management 570

20.1 Working Capital 572

Components of Working Capital 572

Working Capital and the Cash Cycle 572

20.2 Accounts Receivable and Credit Policy 575

Terms of Sale 576

Credit Agreements 577

Credit Analysis 578

The Credit Decision 579

Collection Policy 584

20.3 Inventory Management 586

20.4 Cash Management 588

Check Handling and Float 589

Other Payment Systems 590

Electronic Funds Transfer 591

International Cash Management 592

20.5 Investing Idle Cash: The Money Market 593

Money Market Investments 593

Calculating the Yield on Money Market Investments 594

Yields on Money Market Investments 595

The International Money Market 595

20.6 Managing Current Liabilities: Short-Term Debt 596

Bank Loans 596

Commercial Paper 597

Summary 598

Questions and Problems 600

Minicase 608

**Part Seven: Special Topics**

Chapter 21

Mergers, Acquisitions, and Corporate

Control 610

21.1 Sensible Motives for Mergers 612

Economies of Scale 614

Economies of Vertical Integration 614

Combining Complementary Resources 615

Mergers as a Use for Surplus Funds 616

Eliminating Inefficiencies 616

Industry Consolidation 616

21.2 Dubious Reasons for Mergers 617

Diversification 617

The Bootstrap Game 617

21.3 The Mechanics of a Merger 619

The Form of Acquisition 619

Mergers, Antitrust Law, and Popular Opposition 619

Cross-Border Mergers and Tax Inversion 620

21.4 Evaluating Mergers 620

Mergers Financed by Cash 620

Mergers Financed by Stock 622

A Warning 623

Another Warning 623

21.5 The Market for Corporate Control 624

21.6 Method 1: Proxy Contests 625

21.7 Method 2: Takeovers 625

21.8 Method 3: Leveraged Buyouts 627

Barbarians at the Gate? 628

21.9 Method 4: Divestitures, Spin-Offs, and Carve-Outs 630

21.10 The Benefits and Costs of Mergers 630

Merger Waves 630

Summary 632

Questions and Problems 633

Minicase 636

Chapter 22

International Financial Management 638

22.1 Foreign Exchange Markets 640

Spot Exchange Rates 640

Forward Exchange Rates 642

22.2 Some Basic Relationships 643

Exchange Rates and Inflation 643

Real and Nominal Exchange Rates 646

Inflation and Interest Rates 646

The Forward Exchange Rate and the Expected Spot Rate 649

Interest Rates and Exchange Rates 650

22.3 Hedging Currency Risk 651

Transaction Risk 651

Economic Risk 652

22.4 International Capital Budgeting 653

Net Present Values for Foreign Investments 653

Political Risk 655

The Cost of Capital for Foreign Investment 656

Avoiding Fudge Factors 656

Summary 657

Questions and Problems 658

Minicase 663

Chapter 23

Options 664

23.1 Calls and Puts 666

Selling Calls and Puts 668

Payoff Diagrams Are Not Profit Diagrams 669

Financial Alchemy with Options 670

Some More Option Magic 671

23.2 What Determines Option Values? 672

Upper and Lower Limits on Option

Values 672

The Determinants of Option Value 673

Option-Valuation Models 675

23.3 Spotting the Option 678

Options on Real Assets 678

Options on Financial Assets 679

Summary 682

Questions and Problems 683

Chapter 24

Risk Management 692

24.1 Why Hedge? 694

The Evidence on Risk Management 695

24.2 Reducing Risk with Options 696

24.3 Futures Contracts 696

The Mechanics of Futures Trading 699

Commodity and Financial Futures 700

24.4 Forward Contracts 701

24.5 Swaps 702

Interest Rate Swaps 702

Currency Swaps 704

And Some Other Swaps 704

24.6 Innovation in the Derivatives Market 705

24.7 Is “Derivative” a Four-Letter Word? 705

Summary 706

Questions and Problems 707

**Part Eight: Conclusion**

Chapter 25

What We Do and Do Not Know about

Finance 712

25.1 What We Do Know: The Six Most Important Ideas in

Finance 714

Net Present Value (Chapter 5) 714

Risk and Return (Chapters 11 and 12) 714

Efficient Capital Markets (Chapter 7) 715

MM’s Irrelevance Propositions (Chapters 16 and 17) 715

Option Theory (Chapter 23) 715

Agency Theory 716

25.2 What We Do Not Know: Nine Unsolved Problems in

Finance 716

What Determines Project Risk and Present Value? 716

Risk and Return—Have We Missed Something? 717

Are There Important Exceptions to the Efficient-Market

Theory? 718

Is Management an Off-Balance-Sheet Liability? 718

How Can We Explain Capital Structure? 719

How Can We Resolve the Payout Controversy? 719

How Can We Explain Merger Waves? 719

What Is the Value of Liquidity? 720

Why Are Financial Systems Prone to Crisis? 720

25.3 A Final Word 721

Questions and Problems 721

Appendix A A-1

Glossary G-1

Global Index IND-1

Subject Index IND-5