Principles of Corporate Finance, Fourteenth Edition
By Richard A. Brealey, Stewart C. Myers, Franklin Allen and Alex Edmans
Contents:
Preface vii
I Part One: Value
1 Introduction to Corporate Finance 1
1-1 Corporate Investment and Financing Decisions 2
Investment Decisions/Financing Decisions/What Is a Corporation?/The Role of the Financial Manager
1-2 The Financial Goal of the Corporation 8
Shareholders Want Managers to Maximize
Market Value/A Fundamental Result: Why
Maximizing Shareholder Wealth Makes Sense/
Should Managers Maximize Shareholder Wealth?/
The Investment Trade-Off/Agency Problems and Corporate Governance
1-3 Key Questions in Corporate Finance 14
Key Takeaways 15 • Problem Sets 16 • Solutions to
Self-Test Questions 18 • Appendix: Why Maximizing
Shareholder Value Makes Sense 19
2 How to Calculate Present Values 21
2-1 How to Calculate Future and Present Values 22
Calculating Future Values/Calculating Present
Values/Valuing an Investment Opportunity/Net
Present Value/Risk and Present Value/Present
Values and Rates of Return/Calculating Present
Values When There Are Multiple Cash Flows/The
Opportunity Cost of Capital
2-2 How to Value Perpetuities and Annuities 30
How to Value Perpetuities/How to Value Annuities/
Valuing Annuities Due/Calculating Annual
Payments/Future Value of an Annuity
2-3 How to Value Growing Perpetuities and Annuities 37
Growing Perpetuities/Growing Annuities
2-4 How Interest Is Paid and Quoted 39
Continuous Compounding
Key Takeaways 44 • Problem Sets 45 • Solutions to
Self-Test Questions 50 • Finance on the Web 51
3 Valuing Bonds 52
3-1 Using the Present Value Formula to Value Bonds 53
A Short Trip to Paris to Value a Government Bond/
Back to the United States: Semiannual Coupons and Bond Prices
3-2 How Bond Prices Vary with Yields 57
Duration and Interest-Rate Sensitivity
3-3 The Term Structure of Interest Rates 62
Spot Rates, Bond Prices, and the Law of One
Price/Measuring the Term Structure/Why the
Discount Factor Declines as Futurity Increases
3-4 Explaining the Term Structure 68
Expectations Theory of the Term Structure/Interest Rate Risk/Inflation Risk
3-5 Real and Nominal Interest Rates 70
Indexed Bonds and the Real Rate of Interest/What
Determines the Real Rate of Interest?/Inflation and Nominal Interest Rates
3-6 The Risk of Default 74
Corporate Bonds and Default Risk/Sovereign
Bonds and Default Risk
Key Takeaways 77 • Further Reading 78 • Problem
Sets 78 • Solutions to Self-Test Questions 83 • Finance on the Web 83
4 Valuing Stocks 84
4-1 How Stocks Are Traded 85
Trading Results for Cummins/Market Price vs. Book Value
4-2 Valuation by Comparables 88
4-3 Dividends and Stock Prices 90
Dividends and Capital Gains/Two Versions of the Dividend Discount Model
4-4 Dividend Discount Model Applications 95
Using the Constant-Growth DCF Model to Set
Water, Gas, and Electricity Prices/DCF Models
with Two or More Stages of Growth
4-5 Income Stocks and Growth Stocks 101
Calculating the Present Value of Growth
Opportunities for Establishment Electronics
4-6 Valuation Based on Free Cash Flow 105
Valuing the Concatenator Business/Valuation
Format/Estimating Horizon Value
Key Takeaways 110 • Problem Sets 112 • Solutions to
Self-Test Questions 116 • Finance on the Web 117 • Mini-Case: Reeby Sports 117
5 Net Present Value and Other Investment Criteria 119
5-1 A Review of the Net Present Value Rule 119
Net Present Value’s Competitors/Five Points to
Remember about NPV
5-2 The Payback and Accounting Rate of Return Rules 123
The Payback Rule/Accounting Rate of Return
5-3 The Internal Rate of Return Rule 126
Calculating the IRR/The IRR Rule/Pitfall 1—
Lending or Borrowing?/Pitfall 2—Multiple Rates
of Return/Pitfall 3—Mutually Exclusive Projects/
Pitfall 4—What Happens When There Is More
Than One Opportunity Cost of Capital/The Verdict on IRR
5-4 Choosing Capital Investments When Resources Are Limited 135
How Important Is Capital Rationing in Practice?
Key Takeaways 139 • Further Reading 140 • Problem
Sets 140 • Solutions to Self-Test Questions 145 •
Mini-Case: Vegetron’s CFO Calls Again 146
6 Making Investment Decisions with the Net Present Value Rule 149
6-1 Forecasting a Project’s Cash Flows 150
Rule 1: Discount Cash Flows, Not Profits/Rule 2:
Discount Incremental Cash Flows and Ignore Non-
Incremental Cash Flows/Rule 3: Treat Inflation
Consistently/Rule 4: Separate Investment and
Financing Decisions/Rule 5: Forecast Cash Flows after Taxes
6-2 Corporate Income Taxes 157
Depreciation Deductions/Tax on Salvage Value/Tax Loss Carry-Forwards
6-3 A Worked Example of a Project Analysis 159
The Three Components of Project Cash Flows/Cash
Flow from Capital Investment/Operating Cash Flow/
Investment in Working Capital/How to Construct a
Set of Cash Flow Forecasts: An Example/Capital
Investment/Operating Cash Flow/Investment in
Working Capital/Accelerated Depreciation and
First-Year Expensing/Project Analysis
6-4 How to Choose between Competing Projects 165
Problem 1: The Investment Timing Decision/
Problem 2: The Choice between Long- and Short-
Lived Equipment/Problem 3: When to Replace an
Old Machine/Problem 4: Cost of Excess Capacity
Key Takeaways 171 • Further Reading 172 • Problem
Sets 172 • Solutions to Self-Test Questions 180 •
Mini-Case: New Economy Transport (A) 181 • New
Economy Transport (B) 182
I Part Two: Risk
7 Introduction to Risk, Diversification, and Portfolio Selection 184
7-1 The Relationship between Risk and Return 184
Over a Century of Capital Market History/Using
Historical Evidence to Evaluate Today’s Cost of Capital
7-2 How to Measure Risk 190
Variance and Standard Deviation/Calculating Risk/Estimating Future Risk
7-3 How Diversification Reduces Risk 195
Specific and Systematic Risk/Diversification with Many Stocks
7-4 Systematic Risk Is Market Risk 201
Portfolio Choice with Borrowing and Lending/Market Risk
7-5 Should Companies Diversify? 209
Key Takeaways 210 • Further Reading 211 • Problem
Sets 212 • Solutions to Self-Test Questions 219 •
Finance on the Web 220
8 The Capital Asset Pricing Model 222
8-1 Market Risk Is Measured by Beta 222
The Market Portfolio/Why Betas Determine Portfolio Risk
8-2 The Relationship between Risk and Return 228
What If a Stock Did Not Lie on the Security Market
Line?/The Capital Market Line and the Security
Market Line/The Logic behind the Capital Asset
Pricing Model/Intuition: Why Do High Beta and
High Returns Go Together?/Applying the Capital Asset Pricing Model
8-3 Does the CAPM Hold in the Real World? 233
How Large Is the Return for Risk?/Are Returns
Unrelated to All Other Characteristics?
8-4 Some Alternative Theories 237
Arbitrage Pricing Theory/A Comparison of the
Capital Asset Pricing Model and Arbitrage Pricing
Theory/The Three-Factor Model
Key Takeaways 241 • Further Reading 242 • Problem
Sets 242 • Solutions to Self-Test Questions 246 •
Finance on the Web 247
9 Risk and the Cost of Capital 248
9-1 Company and Project Costs of Capital 249
Company Cost of Capital for CSX/Three
Warnings/What about Investments That Are
Not Average Risk?/Perfect Pitch and the Cost of Capital
9-2 Estimating Beta and the Company Cost of Capital 254
Estimating Beta/Portfolio Betas
9-3 Analyzing Project Risk 257
The Determinants of Asset Betas/2. Don’t
Be Fooled by Diversifiable Risk/3. Avoid Fudge
Factors in Discount Rates/Discount Rates for International Projects
9-4 Certainty Equivalents 263
Key Takeaways 266 • Further Reading 268 • Problem
Sets 268 • Solutions to Self-Test Questions 273 •
Finance on the Web 273 • Mini-Case: The Jones Family Incorporated 273
I Part Three: Best Practices in Capital Budgeting
10 Project Analysis 276
10-1 Sensitivity and Scenario Analysis 277
Value of Information/Limits to Sensitivity Analysis/ Stress Tests and Scenario Analysis
10-2 Break-Even Analysis and Operating Leverage 281
Break-Even Analysis/Operating Leverage
10-3 Real Options and the Value of Flexibility 284
The Option to Expand/The Option to Abandon/
Production Options/Timing Options/More on
Decision Trees/Pro and Con Decision Trees
Key Takeaways 291 • Further Reading 292 • Problem
Sets 292 • Solutions to Self-Test Questions 298 •
Mini-Case: Waldo County 299
11 How to Ensure That Projects Truly Have Positive NPVs 301
11-1 Behavioral Biases in Investment Decisions 302
11-2 Avoiding Forecast Errors 303
11-3 How Competitive Advantage Translates into Positive NPVs 308
11-4 Marvin Enterprises Decides to Exploit a New Technology—An Example 312
Forecasting Prices of Gargle Blasters/The Value
of Marvin’s New Expansion/Alternative Expansion
Plans/The Value of Marvin Stock/The Lessons of Marvin Enterprises
Key Takeaways 319 • Further Reading 319 • Problem
Sets 320 • Solutions to Self-Test Questions 325 •
Mini-Case: Ecsy-Cola 326
I Part Four: Financing Decisions and Market Efficiency
12 Efficient Markets and Behavioral Finance 327
12-1 Differences between Investment and Financing Decisions 328
NPV Matters for Both Investment and
Financing Decisions/The NPV of Financing
Decisions Is Zero in Efficient Markets/The
NPV of Financing Decisions in Inefficient Markets
12-2 The Efficient Market Hypothesis 330
Forms of Market Efficiency/Why Do We Expect Markets to Be Efficient?
12-3 Implications of Market Efficiency 335
What Market Efficiency Does Not Imply/What if
Markets Are Not Efficient? Implications for the Financial Manager
12-4 Are Markets Efficient? The Evidence 345
Weak-Form Efficiency/Semistrong-Form
Efficiency/Strong-Form Efficiency
12-5 Behavioral Finance 352
Sentiment/Limits to Arbitrage/Agency and Incentive Problems
Key Takeaways 360 • Further Reading 361 • Problem
Sets 362 • Solutions to Self-Test Questions 366 •
Finance on the Web 367
13 An Overview of Corporate Financing 368
13-1 Patterns of Corporate Financing 369
How Much Do Firms Borrow?
13-2 Equity 372
Ownership of the Corporation/Preferred Stock
13-3 Debt 375
The Different Kinds of Debt/A Debt by Any Other Name
13-4 The Role of the Financial System 378
The Payment Mechanism/Borrowing and Lending/
Pooling Risk/Information Provided by Financial Markets
13-5 Financial Markets and Intermediaries 381
Financial Intermediaries/Investment Funds/ Financial Institutions
13-6 Financial Markets and Intermediaries around the World 387
Conglomerates and Internal Capital Markets
13-7 The Fintech Revolution 391
Payment Systems/Person-to-Person Lending/
Crowdfunding/AI/ML Credit Scoring/Distributed
Ledgers and Blockchains/Cryptocurrencies/Initial Coin Offerings
Key Takeaways 394 • Further Reading 395 • Problem
Sets 396 • Solutions to Self-Test Questions 398 •
Finance on the Web 398
14 How Corporations Issue Securities 399
14-1 Venture Capital 399
The Venture Capital Market
14-2 The Initial Public Offering 404
The Public-Private Choice/Arranging an Initial
Public Offering/The Sale of Marvin Stock/The
Underwriters/Costs of a New Issue/Underpricing
of IPOs/Hot New-Issue Periods/The Long-Run
Performance of IPO Stocks/Alternative Issue
Procedures/Types of Auction: A Digression
14-3 Security Sales by Public Companies 416
Public Offers/The Costs of a Public Offer/Rights
Issues/Market Reaction to Stock Issues
14-4 Private Placements 421
Key Takeaways 422 • Further Reading 423 • Problem
Sets 423 • Solutions to Self-Test Questions 429 •
Finance on the Web 429 • Appendix: Marvin’s
New-Issue Prospectus 430
I Part Five: Payout Policy and Capital Structure
15 Payout Policy 434
15-1 Facts about Payout 435
How Firms Pay Dividends/How Firms Repurchase
Stock/The Information Content of Dividends/The
Information Content of Share Repurchases
15-2 Dividends or Repurchases? Does the Choice
Affect Shareholder Value? 440
Dividends or Repurchases? An Example/Stock
Repurchases and DCF Valuation Models/
Dividends and Share Issues
15-3 Dividend Clienteles 444
15-4 Taxes and Payout Policy 445
Empirical Evidence on Payout Policies and Taxes/
Alternatives to the U.S. Tax System
15-5 Payout Policy and the Life Cycle of the Firm 449
The Agency Costs of Idle Cash/Payout and Corporate Governance
Key Takeaways 452 • Further Reading 453 • Problem
Sets 453 • Solutions to Self-Test Questions 458 • Finance on the Web 458
16 Does Debt Policy Matter? 459
16-1 Financial Leverage and Shareholder Value 460
16-2 Modigliani and Miller’s Proposition 1 461
The Law of the Conservation of Value/An Example of Proposition 1
16-3 Leverage and Expected Returns: MM’s Proposition 2 466
Proposition 2/Leverage and the Cost of Equity/
How Changing Capital Structure Affects the Equity
Beta/Watch Out for Hidden Leverage
16-4 No Magic in Financial Leverage 473
Today’s Unsatisfied Clienteles Are Probably
Interested in Financial Innovation/Imperfections and Opportunities
16-5 A Final Word on the Cost of Capital 476
Key Takeaways 478 • Further Reading 478 • Problem
Sets 479 • Solutions to Self-Test Questions 483 •
Mini-Case: Claxton Drywall Comes to the Rescue 483
17 How Much Should a Corporation Borrow? 485
17-1 Debt and Taxes 486
How Do Interest Tax Shields Contribute to the
Value of Stockholders’ Equity?/Recasting Johnson
& Johnson’s Capital Structure/MM and Corporate
Tax/Corporate and Personal Taxes
17-2 Costs of Financial Distress 492
Bankruptcy Costs/Evidence on Bankruptcy Costs/
Direct versus Indirect Costs of Bankruptcy/Financial
Distress without Bankruptcy/Agency Costs of
Financial Distress/Risk Shifting: The First Game/
Refusing to Contribute Equity Capital: The Second
Game/And Three More Games, Briefly/What the
Games Cost/Costs of Distress Vary with Type of Asset
17-3 The Trade-Off Theory of Capital Structure 503
17-4 The Pecking Order of Financing Choices 505
Debt and Equity Issues with Asymmetric
Information/Implications of the Pecking Order/The
Bright Side and the Dark Side of Financial Slack
17-5 The Capital Structure Decision 509
The Evidence/Is There a Theory of Optimal Capital Structure?
Key Takeaways 512 • Further Reading 513 • Problem
Sets 513 • Solutions to Self-Test Questions 517 •
Finance on the Web 517
18 Financing and Valuation 518
18-1 The After-Tax Weighted-Average Cost of Capital 519
Review of Assumptions/Mistakes People Make in
Using the Weighted-Average Formula
18-2 Valuing Businesses 523
Valuing Rio Corporation/Estimating Horizon
Value/Valuation by Comparables/Liquidation
Value/WACC vs. the Flow-to-Equity Method
18-3 Using WACC in Practice 528
Some Tricks of the Trade/Adjusting WACC when
Debt Ratios and Business Risks Differ/Three-
Step Procedure for Finding WACCs at Different
Debt Ratios/Unlevering and Relevering Betas/
Calculating Divisional WACCs/The Assumption of
a Constant Debt Ratio in the After-Tax WACC/The
Modigliani–Miller Formula
18-4 Adjusted Present Value 536
APV for the Perpetual Crusher/Other Financing
Side Effects/APV for Entire Businesses/APV
and Limits on Interest Deductions/APV for International Investments
18-5 Your Questions Answered 541
Key Takeaways 543 • Further Reading 544 • Problem
Sets 545 • Solutions to Self-Test Questions 549 •
Finance on the Web 550 • Appendix: Discounting
Safe, Nominal Cash Flows 551 • A Consistency Check 553
I Part Six: Corporate Objectives and Governance
19 Agency Problems and Corporate Governance 555
19-1 What Agency Problems Should You Watch Out For? 556
Reduced Effort/Private Benefits/Overinvestment/
Risk Taking/Short-Termism
19-2 Monitoring by the Board of Directors 560
U.S. and U.K. Boards of Directors/European Boards of Directors
19-3 Monitoring by Shareholders 563 Voting/Engagement/Exit
19-4 Monitoring by Auditors, Lenders, and Potential Acquirers 566
Auditors/Lenders/Takeovers
19-5 Management Compensation 568
Compensation Facts and Controversies/The Structure of CEO Pay
19-6 Government Regimes around the World 575
Ownership and Control in Japan/Ownership and
Control in Germany/Ownership and Control in Other Countries
19-7 Do These Differences Matter? 581
Public Market Myopia/Growth Industries and Declining Industries
Key Takeaways 583 • Further Reading 584 • Problem
Sets 585 • Solutions to Self-Test Questions 587 •
Finance on the Web 587
20 Stakeholder Capitalism and Responsible Business 588
20-1 Who Are the Stakeholders? 589
Employees/Customers/Suppliers/Local and
Regional Communities/The Environment/ The Government
20-2 The Case for Shareholder Capitalism 592
Government Policy Ensures Companies Will
Engage in Socially Responsible Behavior/
Maximizing Shareholder Value Allows Investors
to Pursue Social Objectives/Maximizing
Shareholder Value Requires a Company to
Invest in Stakeholders/Enlightened Shareholder
Value/Decision Making under Enlightened Shareholder Value
20-3 The Case for Stakeholder Capitalism 596
Well-Functioning Governments/No Comparative
Advantage in Serving Society/Instrumental
Decision Making Is Effective/The Challenge of
Stakeholder Capitalism/Summary
20-4 Responsible Business 600
Defining Responsible Business/Decision
Making in Responsible Businesses/ Summary
20-5 Responsible Business in Practice 605
Shareholder Primacy in the United States
and United Kingdom/Benefit Corporations/
B Corps/Purpose/Reporting
Key Takeaways 611 • Further Reading 612 • Problem
Sets 612 • Solutions to Self-Test Questions 613 • Finance on the Web 613
18-3 Using WACC in Practice 528
Some Tricks of the Trade/Adjusting WACC when
Debt Ratios and Business Risks Differ/Three-
Step Procedure for Finding WACCs at Different
Debt Ratios/Unlevering and Relevering Betas/
Calculating Divisional WACCs/The Assumption of
a Constant Debt Ratio in the After-Tax WACC/The Modigliani–Miller Formula
18-4 Adjusted Present Value 536
APV for the Perpetual Crusher/Other Financing
Side Effects/APV for Entire Businesses/APV
and Limits on Interest Deductions/APV for International Investments
18-5 Your Questions Answered 541
Key Takeaways 543 • Further Reading 544 • Problem
Sets 545 • Solutions to Self-Test Questions 549 •
Finance on the Web 550 • Appendix: Discounting
Safe, Nominal Cash Flows 551 • A Consistency Check 553
I Part Six: Corporate Objectives and Governance
19 Agency Problems and
Corporate Governance 555
19-1 What Agency Problems Should You Watch Out For? 556
Reduced Effort/Private Benefits/Overinvestment/ Risk Taking/Short-Termism
19-2 Monitoring by the Board of Directors 560
U.S. and U.K. Boards of Directors/European Boards of Directors
19-3 Monitoring by Shareholders 563
Voting/Engagement/Exit
19-4 Monitoring by Auditors, Lenders, and Potential Acquirers 566
Auditors/Lenders/Takeovers
19-5 Management Compensation 568
Compensation Facts and Controversies/The Structure of CEO Pay
19-6 Government Regimes around the World 575
Ownership and Control in Japan/Ownership and
Control in Germany/Ownership and Control in Other Countries
19-7 Do These Differences Matter? 581
Public Market Myopia/Growth Industries and Declining Industries
Key Takeaways 583 • Further Reading 584 • Problem
Sets 585 • Solutions to Self-Test Questions 587 •
Finance on the Web 587
20 Stakeholder Capitalism and
Responsible Business 588
20-1 Who Are the Stakeholders? 589
Employees/Customers/Suppliers/Local and
Regional Communities/The Environment/ The Government
20-2 The Case for Shareholder Capitalism 592
Government Policy Ensures Companies Will
Engage in Socially Responsible Behavior/
Maximizing Shareholder Value Allows Investors
to Pursue Social Objectives/Maximizing
Shareholder Value Requires a Company to
Invest in Stakeholders/Enlightened Shareholder
Value/Decision Making under Enlightened Shareholder Value
20-3 The Case for Stakeholder Capitalism 596
Well-Functioning Governments/No Comparative
Advantage in Serving Society/Instrumental
Decision Making Is Effective/The Challenge of
Stakeholder Capitalism/Summary
20-4 Responsible Business 600
Defining Responsible Business/Decision
Making in Responsible Businesses/ Summary
20-5 Responsible Business in Practice 605
Shareholder Primacy in the United States
and United Kingdom/Benefit Corporations/
B Corps/Purpose/Reporting
Key Takeaways 611 • Further Reading 612 • Problem
Sets 612 • Solutions to Self-Test Questions 613 •
Finance on the Web 613
I Part Seven: Options
21 Understanding Options 614
21-1 Calls, Puts, and Shares 615
Call Options and Payoff Diagrams/Put Options/
Selling Calls and Puts/Payoff Diagrams Are Not Profit Diagrams
21-2 Financial Alchemy with Options 619 Spotting the Option
21-3 What Determines the Value of a Call Option? 625 Risk and Option Values
Key Takeaways 630 • Further Reading 631 • Problem
Sets 631 • Solutions to Self-Test Questions 636 • Finance on the Web 636
22 Valuing Options 637
22-1 A Simple Option-Valuation Model 638
Why Discounted Cash Flow Won’t Work for
Options/Constructing Option Equivalents from
Common Stocks and Borrowing/Risk-Neutral
Valuation/Valuing the Amazon Put Option/Valuing
the Put Option by the Risk-Neutral Method/The
Relationship between Call and Put Prices
22-2 The Binomial Method for Valuing Options 644
Example: The Two-Step Binomial Method/The
General Binomial Method/The Binomial Method and Decision Trees
22-3 The Black–Scholes Formula 649
Using the Black–Scholes Formula/How Black-
Scholes Values Vary with the Stock Price/The Risk
of an Option/The Black–Scholes Formula and the
Binomial Method/Some Practical Examples
22-4 Early Exercise and Dividend Payments 656
Key Takeaways 658 • Further Reading 659 • Problem
Sets 659 • Solutions to Self-Test Questions 663
Finance on the Web 664 • Mini-Case: Bruce
Honiball’s Invention 664
23 Real Options 666
23-1 The Option to Expand 666
Questions and Answers about Blitzen’s Mark II/
Other Expansion Options
23-2 Options in R&D 670
23-3 The Timing Option 672
Valuing the Malted Herring Option/Optimal Timing for Real Estate Development
23-4 The Abandonment Option 675
Bad News for the Perpetual Crusher/Abandonment
Value and Project Life/Temporary Abandonment
23-5 Flexible Production and Procurement 678
Aircraft Purchase Options
23-6 Valuing Real Options 682
A Conceptual Problem?/What about Taxes?/ Practical Challenges
Key Takeaways 685 • Further Reading 685 •
Problem Sets 686 • Solutions to Self-Test Questions 690
I Part Eight: Debt Financing
24 Credit Risk and the Value
of Corporate Debt 691
24-1 Yields on Corporate Debt 692
Distinguishing Promised and Expected Yields/
What Determines the Yield Spread?
24-2 Valuing the Option to Default 695
Finding Bond Values/The Value of Corporate Equity
24-3 Predicting the Probability of Default 699
Statistical Models of Default/Structural Models of Default
Key Takeaways 706 • Further Reading 706 • Problem
Sets 707 • Solutions to Self-Test Questions 708 •
Finance on the Web 709
25 The Many Different Kinds of Debt 710
25-1 Long-Term Corporate Bonds 711
Bond Terms/Security and Seniority/Asset-Backed
Securities/Call Provisions/Sinking Funds/Bond
Covenants/Privately Placed Bonds/Foreign Bonds and Eurobonds
25-2 Convertible Securities and Some Unusual Bonds 720
The Value of a Convertible at Maturity/
Forcing Conversion/Why Do Companies Issue
Convertibles?/Valuing Convertible Bonds/A
Variation on Convertible Bonds: The Bond–
Warrant Package/Innovation in the Bond Market
25-3 Bank Loans 727
Commitment/Maturity/Rate of Interest/Syndicated
Loans/Security/Loan Covenants
25-4 Commercial Paper and Medium-Term Notes 731
Commercial Paper/Medium-Term Notes
Key Takeaways 733 • Further Reading 734 •
Problem Sets 734 • Solutions to Self-Test
Questions 739 • Mini-Case: The Shocking Demise of
Mr. Thorndike 740 • Appendix: Project Finance 741 •
Appendix Further Reading 743
26 Leasing 744
26-1 What Is a Lease? 744
26-2 Why Lease? 746
Sensible Reasons for Leasing/A Dubious Reason for Leasing
26-3 Rentals on an Operating Lease 747
Example of an Operating Lease/Lease or Buy?
26-4 Valuing Financial Leases 750
Example of a Financial Lease/Valuing the Lease
Contract/Comparing the Lease with an Equivalent
Loan/Financial Leases When There Are Limits on
the Interest Tax Shield/Leasing and the Internal Revenue Service
26-5 When Do Financial Leases Pay? 754
Leasing around the World
26-6 Setting Up a Leveraged Lease 756
Key Takeaways 757 • Further Reading 757 • Problem
Sets 758 • Solutions to Self-Test Questions 762
I Part Nine: Risk Management
27 Managing Risk 763
27-1 Why Manage Risk? 764
Reducing the Risk of Cash Shortfalls or Financial
Distress/Agency Costs May Be Mitigated by
Risk Management/The Evidence on Risk Management
27-2 Insurance 767
27-3 Reducing Risk with Financial Options 769
27-4 Forward and Futures Contracts 770
A Simple Forward Contract/Futures Exchanges/
The Mechanics of Futures Trading/Trading
and Pricing Financial Futures Contracts/Spot
and Futures Prices—Commodities/More about Forwards and Futures
27-5 Interest Rate Risk 776
Forward Rates of Interest and the Term Structure/
Borrowing and Lending at Forward Interest Rates/
Forward Rate Agreements/Interest Rate Futures
27-6 Swaps 779
Interest Rate Swaps/Currency Swaps/Some Other Swaps
27-7 How to Set Up a Hedge 783
Hedging Interest Rate Risk/Hedge Ratios and Basis Risk
27-8 Is “Derivative” a Four-Letter Word? 787
Key Takeaways 788 • Further Reading 789 • Problem
Sets 790 • Solutions to Self-Test Questions 795 •
Finance on the Web 796 • Mini-Case: Rensselaer Advisers 796
28 International Financial Management 799
28-1 The Foreign Exchange Market 799
28-2 Some Basic Relationships 802
Interest Rates and Exchange Rates/The Forward
Premium and Changes in Spot Rates/Changes in
the Exchange Rate and Inflation Rates/Interest
Rates and Inflation Rates/Is Life Really That Simple?
28-3 Hedging Currency Risk 812
Transaction Exposure and Economic Exposure
28-4 International Investment Decisions 814
The Cost of Capital for International Investments
28-5 Political Risk 817
Key Takeaways 820 • Further Reading 821 • Problem
Sets 822 • Solutions to Self-Test 825 • Finance on the
Web 826 • Mini-Case: Exacta, s.a. 826
I Part Ten: Financial Planning and Working Capital Management
29 Financial Analysis 828
29-1 Understanding Financial Statements 829
The Balance Sheet/The Income Statement
29-2 Measuring Company Performance 833
Economic Value Added/Accounting Rates of
Return/Problems with EVA and Accounting Rates of Return
29-3 Measuring Efficiency 838
The DuPont Formula/Other Efficiency Measures
29-4 Measuring Leverage 841
Leverage and the Return on Equity
29-5 Measuring Liquidity 844
29-6 Interpreting Financial Ratios 846
Key Takeaways 849 • Further Reading 849 • Problem
Sets 850 • Solutions to Self-Test Questions 855 •
Finance on the Web 855
30 Financial Planning 857
30-1 What Are the Links between Short-Term and
Long-Term Financing Decisions? 857
30-2 Tracing and Forecasting Changes in Cash 860
Tracing Changes in Cash/Forecasting Dynamic’s Cash Needs
30-3 Developing a Short-Term Financial Plan 866
Dynamic Mattress’s Financing Plan/Evaluating the
Plan/Short-Term Financial Planning Models
30-4 Using Long-Term Financial Planning Models 869
Why Build Financial Plans?/A Long-Term
Financial Planning Model for Dynamic Mattress/
Pitfalls in Model Design/Choosing a Plan
30-5 Long-Term Planning Models and Company Valuation 874
30-6 The Relationship between Growth and External Financing 875
Key Takeaways 877 • Further Reading 877 • Problem
Sets 878 • Solutions to Self-Test Questions 885 • Finance on the Web 887
31 Working Capital Management 888
31-1 The Working Capital Requirement 888
The Cash Cycle
31-2 Managing Inventories 892
31-3 Accounts Receivable Management 894
Terms of Sale/Credit Analysis/The Credit Decision/ Collection Policy
31-4 Cash Management 900
How Purchases Are Paid For/Changes in Check
Usage/Speeding Up Check Collections/Electronic
Payment Systems/International Cash Management/ Paying for Bank Services
31-5 Investing Surplus Cash 904
Investment Choices/Calculating the Yield on
Money Market Investments/Returns on Money
Market Investments/The International Money
Market/Money Market Instruments
Key Takeaways 909 • Further Reading 910 • Problem
Sets 910 • Solutions to Self-Test Questions 916 • Finance on the Web 917
I Part Eleven: Mergers, Corporate Control, and Governance
32 Mergers 918
32-1 Types of Merger 919
32-2 Some Sensible Motives for Mergers 919
Economies of Scale and Scope/Economies of
Vertical Integration/Complementary Resources/
Changes in Corporate Control/Industry
Consolidation/Logic Does Not Guarantee Success
32-3 Some Dubious Motives for Mergers 923
Diversification/Increasing Earnings per Share:
The Bootstrap Game/Lower Borrowing Costs/ Management Motives
32-4 Estimating Merger Gains and Costs 928
Estimating NPV When the Merger Is Financed
by Cash/Estimating NPV When the Merger Is
Financed by Stock/Asymmetric Information/More
on Estimating Costs—What If the Target’s Stock
Price Anticipates the Merger?/Right and Wrong
Ways to Estimate the Benefits of Mergers
32-5 The Mechanics of a Merger 932
Mergers, Antitrust Law, and Popular Opposition/
The Form of Acquisition/Merger Accounting/Some Tax Considerations
32-6 Takeovers and the Market for Corporate Control 936
32-7 Merger Waves and Merger Profitability 938
Merger Waves/Who Gains and Loses from
Mergers?/Buyers vs. Sellers/Mergers and Society
Key Takeaways 942 • Further Reading 943 • Problem
Sets 943 • Solutions to Self-Test Questions 946 •
Finance on the Web 947 • Appendix: Conglomerate
Mergers and Value Additivity 948
33 Corporate Restructuring 950
33-1 Leveraged Buyouts 950
The RJR Nabisco LBO/Barbarians at the Gate?/ Leveraged Restructurings
33-2 The Private-Equity Market 956
Private-Equity Partnerships/Are Private-Equity
Funds Today’s Conglomerates?
33-3 Fusion and Fission in Corporate Finance 961
Spin-Offs/Carve-Outs/Asset Sales/Privatization and Nationalization
33-4 Bankruptcy 967
Is Chapter 11 Efficient?/Workouts/Alternative Bankruptcy Procedures
Key Takeaways 973 • Further Reading 973 • Problem
Sets 974 • Solutions to Self-Test Questions 976
I Part Twelve: Conclusion
34 Conclusion: What We Do
and Do Not Know about Finance 977
34-1 What We Do Know: The Seven Most Important Ideas in Finance 977
Net Present Value/2. The Capital Asset Pricing
Model/3. Efficient Capital Markets/4. Value
Additivity and the Law of Conservation of Value/
Capital Structure Theory/6. Option Theory/ Agency Theory
34-2 What We Do Not Know: 10 Unsolved Problems in Finance 980
What Determines Project Risk and Present Value?/2. Risk and Return—What Have We
Missed?/3. How Important Are the Exceptions to
the Efficient-Market Theory?/4. Is Management
an Off-Balance-Sheet Liability?/5. How Can We
Explain the Success of New Securities and New
Markets?/6. How Can We Resolve the Payout
Controversy?/7. What Risks Should a Firm
Take?/8. What Is the Value of Liquidity?/9. How
Can We Explain Merger Waves?/10. Why Are
Financial Systems So Prone to Crisis?
34-3 A Final Word 986
GLOSSARY G-1
INDEX I-1
Note: Present value tables are available in Connect.