CORPORATE FINANCE potx

CORPORATE FINANCE
Ross
•
Westerfield
•
Jaffe
eighth edition
CORPORATE FINANCE
Ross
Westerfield
Jaffe
eighth
edition
ISBN 978-0-07-310590-1
MHID 0-07-310590-2
Part of
ISBN 978-0-07-333718-0
MHID 0-07-333718-8
9 7 8 0 0 7 3 3 3 7 1 8 0
9 0 0 0 0
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Succeed in your corporate finance course with help from this
experienced author team and a text that provides modern
theory and cutting-edge examples in corporate finance.
• New end-of-chapter mini-cases and questions focus on
common company situations that embody important
corporate finance topics.
• Expanded theory and research, including new content on
risk analysis, behavioral finance, and real options capital
budgeting.
• New problems have been added to the ends of most

chapters.
• New 4-color design.
For more information on the book, its features, and the
supplements package, please see the Preface or visit
www.mhhe.com/rwj.
Corporate Finance gets you
moving in the right direction
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Corporate Finance
ros05901_fm.indd iros05901_fm.indd i 10/6/06 9:47:44 AM10/6/06 9:47:44 AM
The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate
Stephen A. Ross
Franco Modigliani Professor of Finance and Economics
Sloan School of Management
Massachusetts Institute of Technology
Consulting Editor
Financial Management
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ros05901_fm.indd iiros05901_fm.indd ii 10/6/06 9:47:45 AM10/6/06 9:47:45 AM
Corporate Finance
Eighth Edition
Stephen A. Ross
Sloan School of Management
Massachusetts Institute of Technology
Randolph W. Westerfi eld
Marshall School of Business
University of Southern California
Jeffrey Jaffe
Wharton School of Business
University of Pennsylvania
Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis
Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City
Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
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CORPORATE FINANCE
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221
Avenue of the Americas, New York, NY, 10020. Copyright © 2008 by The McGraw-Hill Companies, Inc.
All rights reserved. No part of this publication may be reproduced or distributed in any form or by any
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This book is printed on acid-free paper.
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Library of Congress Cataloging-in-Publication Data
Ross, Stephen A.
Corporate fi nance / Stephen A. Ross, Randolph W. Westerfi eld, Jeffrey Jaffe. 8th ed.
p. cm. (The McGraw-Hill/Irwin series in fi nance, insurance, and real estate)
Includes index.
ISBN-13: 978-0-07-310590-1 (alk. paper)
ISBN-10: 0-07-310590-2 (alk. paper)
1. Corporations Finance. I. Westerfi eld, Randolph. II. Jaffe, Jeffrey F., 1946- III. Title.
HG4026.R675 2008
658.15 dc22

2006021608
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To our family and friends with love and gratitude.
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About the Authors
STEPHEN A. ROSS Sloan School of Management, Massachusetts Institute of Technol-
ogy Stephen A. Ross is the Franco Modigliani Professor of Financial Economics at the
Sloan School of Management, Massachusetts Institute of Technology. One of the most
widely published authors in fi nance and economics, Professor Ross is recognized for his
work in developing the arbitrage pricing theory, as well as for having made substantial con-
tributions to the discipline through his research in signaling, agency theory, option pricing,
and the theory of the term structure of interest rates, among other topics. A past president
of the American Finance Association, he currently serves as an associate editor of several
academic and practitioner journals. He is a trustee of CalTech and Freddie Mac.
RANDOLPH W. WESTERFIELD Marshall School of Business, University of Southern
California Randolph W. Westerfi eld is Dean Emeritus of the University of Southern
California’s Marshall School of Business and is the Charles B. Thornton Professor of
Finance.
Professor Westerfi eld came to USC from the Wharton School, University of
Pennsylvania, where he was the chairman of the fi nance department and member of the
fi nance faculty for 20 years. He is a member of several public company boards of directors,
including Health Management Associates, Inc., William Lyon Homes, and the Nicholas
Applegate Growth Fund. His areas of expertise include corporate fi nancial policy, invest-
ment management, and stock market price behavior.
JEFFREY F. JAFFE Wharton School of Business, University of Pennsylvania Jeffrey
F. Jaffe has been a frequent contributor to the fi nance and economics literatures in such
journals as the Quarterly Economic Journal, The Journal of Finance, The Journal of Fi-
nancial and Quantitative Analysis, The Journal of Financial Economics, and The Financial
Analysts Journal. His best-known work concerns insider trading, where he showed both

that corporate insiders earn abnormal profi ts from their trades and that regulation has little
effect on these profi ts. He has also made contributions concerning initial public offerings,
regulation of utilities, the behavior of marketmakers, the fl uctuation of gold prices, the
theoretical effect of infl ation on interest rates, the empirical effect of infl ation on capital
asset prices, the relationship between small-capitalization stocks and the January effect,
and the capital structure decision.
vi
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Preface
T
he teaching and the practice of corporate fi nance are more challenging and excit-
ing than ever before. The last decade has seen fundamental changes in fi nancial
markets and fi nancial instruments. In the early years of the 21st century, we still see
announcements in the fi nancial press about such matters as takeovers, junk bonds, fi nancial
restructuring, initial public offerings, bankruptcy, and derivatives. In addition, there is the
new recognition of “real” options, private equity and venture capital, and the disappear-
ing dividend. The world’s fi nancial markets are more integrated than ever before. Both the
theory and practice of corporate fi nance have been moving ahead with uncommon speed,
and our teaching must keep pace.
These developments place new burdens on the teaching of corporate fi nance. On one
hand, the changing world of fi nance makes it more diffi cult to keep materials up to date. On
the other hand, the teacher must distinguish the permanent from the temporary and avoid
the temptation to follow fads. Our solution to this problem is to emphasize the modern
fundamentals of the theory of fi nance and make the theory come to life with contemporary
examples. Increasingly, many of these examples are outside the United States. All too often
the beginning student views corporate fi nance as a collection of unrelated topics that are
unifi ed largely because they are bound together between the covers of one book. As in the
previous editions, our aim is to present corporate fi nance as the working of a few integrated
and powerful institutions.
The Intended Audience of This Book

This book has been written for the introductory courses in corporate fi nance at the MBA
level and for the intermediate courses in many undergraduate programs. Some instructors
will fi nd our text appropriate for the introductory course at the undergraduate level as well.
We assume that most students either will have taken, or will be concurrently enrolled in,
courses in accounting, statistics, and economics. This exposure will help students understand
some of the more diffi cult material. However, the book is self-contained, and a prior knowl-
edge of these areas is not essential. The only mathematics prerequisite is basic algebra.
New to the Eighth Edition
With the eight edition of Corporate Finance, we have done extensive updating and re-
working throughout the text. Among the more noticeable changes are opening vignettes
for each chapter. Most of these present familiar companies in situations covered by the
chapter, thereby motivating the discussion. The end-of-chapter material has been expanded
considerably. We now have two separate sets of questions, one that focuses on concepts and
critical ideas and another that is more problem oriented. The total number of questions has
grown signifi cantly. Finally, almost every chapter now ends with a mini-case that places
the student in the position of needing to apply chapter concepts in a common real-world
situation. These cases are suitable for a variety of pedagogical purposes, ranging from
homework to group assignments to in-class discussions.
In addition to these changes and overall updating, a number of chapters have signifi -
cant new material. Following are some of the more notable additions and upgrades:
Chapter 1: Expanded discussion of goal of the fi rm and agency problems. New material
on Sarbanes-Oxley.
vii
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Chapter 3: Completely rewritten to cover fi nancial statements analysis and long-term
fi nancial planning.
Chapter 5: New discussion of bond price information, including the NASD TRACE
system.
Chapter 7: New discussion of alternative defi nitions of project cash fl ows.
Chapter 8: Reorganized, with improved discussion of decision trees.

Chapter 9: New discussion of geometric versus arithmetic returns.
Chapter 12: Expanded discussion on actual cost of capital estimation.
Chapter 18: New material on several dividend-related subjects.
Chapter 19: New material on Dutch auction IPOs.
Chapter 20: New material on bond price quotes and make-whole call provisions.
Chapter 22: Expanded discussion on applications of options analysis in corporate fi nance.
Chapter 27: New material on fi nancial electronic data interchange and the Check Clearing
Act for the 21
st
Century.
Chapter 29: Completely rewritten with new material on a variety of merger-related
topics.
Chapter 31: Completely rewritten for clarity.
We have also worked to improve the supplements to the text, with the goal of provid-
ing far and away the most comprehensive student and instructor support at this level. For
example, we now provide fully detailed step-by-step solutions to end-of-chapter problems
(and spreadsheets for each one as well). The testbank has grown signifi cantly in terms of
the number of questions, and we have worked to provide a wider variety of questions and
question types. The PowerPoint set also has grown.
The book’s Online Learning Center (OLC) delivers several new and very rich student
study aids. There is self-study software with at least 100 questions per chapter. Narrated
PowerPoint slides actually talk students through the material. Our Interactive FinSims con-
tain simulations of key fi nance concepts in which students are asked to provide values for
key variables. These digital assets provide completely new avenues for students to explore
and ways for them to comprehend the subject on a deeper level.
For a complete look at the new and updated eighth edition features, please see the next
section.
viii Preface

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In this edition of Corporate Finance, we
have updated and improved our features
to present material in a way that makes
it coherent and easy to understand. In
addition, Corporate Finance is rich in
valuable learning tools and support, to
help students succeed in learning the
fundamentals of fi nancial management.
Pedagogy
Chapter Opening
Vignettes
Each chapter begins with a “roadmap” that
describes the objectives of the chapter
and how it connects with concepts already
learned in previous chapters. Real company
examples that will be discussed are
highlighted in these sections.
In this edition of Corporate Finance, we
have updated and improved our features
to present material in a way that makes
it coherent and easy to understand. In
addition, Corporate Finance is rich in
valuable learning tools and support, to
help students succeed in learning the
fundamentals of fi nancial management.
Pedagogy
Chapter Opening
Vignettes

Each chapter begins with a “roadmap” that
describes the objectives of the chapter and
how it connects with concepts already learned
in previous chapters. Real company examples
that will be discussed are highlighted in these
sections.
Return and Risk
The Capital Asset Pricing Model (CAPM)
Expected returns on common stocks can vary quite a
bit. One important determinant is the industry in which a
company operates. For example, according to recent es-
timates from Ibbotson Associates, the median expected
return for department stores, which includes companies
such as Sears and Kohls, is 11.63 percent, whereas
computer service companies such as Microsoft and
Oracle have a median expected return of 15.46 percent.
Air transportation companies such as Delta and South-
west have a median expected return that is even higher:
17.93 percent.
These estimates raise some obvious questions.
First, why do these industry expected returns differ so
much, and how are these specific numbers calculated?
Also, does the higher return offered by airline stocks
mean that investors should prefer these to, say,
department store stocks? As we will see in this chapter,
the Nobel Prize–winning answers to these questions
form the basis of our modern understanding of risk and
return.
CHAPTER
10

279
10.1 Individual Securities
In the first part of Chapter 10, we will examine the characteristics of individual securities.
In particular, we will discuss:
1. Expected return: This is the return that an individual expects a stock to earn over the
next period. Of course, because this is only an expectation, the actual return may be
either higher or lower. An individual’s expectation may simply be the average return
per period a security has earned in the past. Alternatively, it may be based on a
detailed analysis of a firm’s prospects, on some computer-based model, or on special
(or inside) information.
2. Variance and standard deviation: There are many ways to assess the volatility of a
security’s return. One of the most common is variance, which is a measure of the
squared deviations of a security’s return from its expected return. Standard deviation
is the square root of the variance.
3. Covariance and correlation: Returns on individual securities are related to one
another. Covariance is a statistic measuring the interrelationship between two
securities. Alternatively, this relationship can be restated in terms of the correlation
between the two securities. Covariance and correlation are building blocks to an
understanding of the beta coefficient.
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Figures and Tables
This text makes extensive use of real data and presents
them in various fi gures and tables. Explanations in the
narrative, examples, and end-of-chapter problems will
refer to many of these exhibits.
Examples
Separate called-out examples are integrated throughout
the chapters. Each example illustrates an intuitive or
mathematical application in a step-by-step format. There
is enough detail in the explanations so the student doesn’t

have to look elsewhere for additional information.
“In Their Own Words” Boxes
Located throughout the chapters, this unique series consists
of articles written by distinguished scholars or practitioners
about key topics in the text. Boxes include essays by Edward
I. Altman, Anthony Bourdain, Robert S. Hansen, Robert C.
Higgins, Michael C. Jensen, Richard M. Levich, Merton Miller,
and Jay R. Ritter.
Figures and Tables
This text makes extensive use of real data and presents
them in various fi gures and tables. Explanations in the
narrative, examples, and end-of-chapter problems will
refer to many of these exhibits.
Examples
Separate called-out examples are integrated throughout
the chapters. Each example illustrates an intuitive or
mathematical application in a step-by-step format. There
is enough detail in the explanations so the student doesn’t
have to look elsewhere for additional information.
“In Their Own Words” Boxes
Located throughout the chapters, this unique series consists
of articles written by distinguished scholars or practitioners
about key topics in the text. Boxes include essays by Edward
I. Altman, Anthony Bourdain, Robert S. Hansen, Robert C.
Higgins, Michael C. Jensen, Richard M. Levich, Merton Miller,
and Jay R. Ritter.
xi
Chapter 24 Warrants and Convertibles 705
If Firm Subsequently
Does Poorly

If Firm Subsequently
Prospers
Convertible bonds
(CBs)
No conversion because of low
stock price.
Conversion because of high
stock price.
Compared to:
Straight bonds CBs provide cheap fi nancing be-
cause coupon rate is lower.
CBs provide expensive fi nancing
because bonds are converted,
which dilutes existing equity.
Common stock CBs provide expensive fi nancing
because fi rm could have issued
common stock at high prices.
CBs provide cheap fi nancing
because fi rm issues stock at
high prices when bonds are
converted.
Table 24.2
The Case for and
against Convertible
Bonds (CBs)
EXAMPLE 24.4
Are Convertibles Always Better? The stock price of RW Company is $20. Suppose this
company can issue subordinated debentures at 10 percent. It can also issue convertible bonds at
6 percent with a conversion value of $800. The conversion value means that the holders can convert
a convertible bond into 40 (ϭ $800͞$20) shares of common stock.

A company treasurer who believes in free lunches might argue that convertible bonds should
be issued because they represent a cheaper source of fi nancing than either subordinated bonds or
common stock. The treasurer will point out that if the company does poorly and the price does not
rise above $20, the convertible bondholders will not convert the bonds into common stock. In this
case the company will have obtained debt fi nancing at below-market rates by attaching worthless
equity kickers. On the other hand, if the fi rm does well and the price of its common stock rises to
$25 or above, convertible holders will convert. The company will issue 40 shares. The company will
receive a bond with face value of $1,000 in exchange for issuing 40 shares of common stock, imply-
ing a conversion price of $25. The company will have issued common stock at $25 per share, or
20 percent above the $20 common stock price prevailing when the convertible bonds were issued.
This enables it to lower its cost of equity capital. Thus, the treasurer happily points out, regardless
of whether the company does well or poorly, convertible bonds are the cheapest form of fi nancing.
(continued)
Summary Compared with equity, the fi rm is better off having issued convertible debt if
the underlying stock subsequently does well. The fi rm is worse off having issued convert-
ible debt if the underlying stock subsequently does poorly. We cannot predict future stock
price in an effi cient market. Thus, we cannot argue that issuing convertibles is better or
worse than issuing equity. The preceding analysis is summarized in Table 24.2.
Modigliani–Miller (MM) pointed out that, abstracting from taxes and bankruptcy
costs, the fi rm is indifferent to whether it issues stock or issues debt. The MM relationship
is a quite general one. Their pedagogy could be adjusted to show that the fi rm is indifferent
to whether it issues convertibles or issues other instruments. To save space (and the pa-
tience of students) we have omitted a full-blown proof of MM in a world with convertibles.
However, our results are perfectly consistent with MM. Now we turn to the real-world view
of convertibles.
The “Free Lunch” Story
The preceding discussion suggests that issuing a convertible bond is no better and no worse
than issuing other instruments. Unfortunately, many corporate executives fall into the trap
of arguing that issuing convertible debt is actually better than issuing alternative instru-
ments. This is a free lunch type of explanation, of which we are quite critical.

Chapter 1 Introduction to Corporate Finance 5
The interplay of the firm’s activities with the financial markets is illustrated in Fig-
ure 1.4. The arrows in Figure 1.4 trace cash flow from the firm to the financial markets and
back again. Suppose we begin with the firm’s financing activities. To raise money, the firm
sells debt and equity shares to investors in the financial markets. This results in cash flows
from the financial markets to the firm (A). This cash is invested in the investment activi-
ties (assets) of the firm (B) by the firm’s management. The cash generated by the firm (C)
is paid to shareholders and bondholders (F). The shareholders receive cash in the form of
dividends; the bondholders who lent funds to the firm receive interest and, when the initial
loan is repaid, principal. Not all of the firm’s cash is paid out. Some is retained (E), and
some is paid to the government as taxes (D).
Over time, if the cash paid to shareholders and bondholders (F) is greater than the cash
raised in the financial markets (A), value will be created.
Identification of Cash Flows Unfortunately, it is not easy to observe cash flows di-
rectly. Much of the information we obtain is in the form of accounting statements, and
hfh kffi il lii hfl if i f i
In Their Own Words
SKILLS NEEDED FOR THE CHIEF
FINANCIAL OFFICERS OF
eFINANCE.COM
Chief strategist: CFOs will need to use real-time financial
information to make crucial decisions fast.
Chief deal maker: CFOs must be adept at venture capi-
tal, mergers and acquisitions, and strategic partnerships.
Chief risk officer: Limiting risk will be even more im-
portant as markets become more global and hedging
instruments become more complex.
Chief communicator: Gaining the confidence of Wall
Street and the media will be essential.
SOURCE: BusinessWeek, August 28, 2000, p. 120.

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Key Terms
Students will note that important words
are highlighted in boldface type the fi rst
time they appear.
Numbered
Equations
Key equations are numbered and
listed on the back end sheets for
easy reference.
xii
2.2 The Income Statement
The income statement measures performance over a specific period—say a year. The ac-
counting definition of income is:
Revenue Ϫ Expenses ϵ Income
If the balance sheet is like a snapshot, the income statement is like a video recording of
what the people did between two snapshots. Table 2.2 gives the income statement for the
U.S. Composite Corporation for 2007.
The income statement usually includes several sections. The operations section reports
the firm’s revenues and expenses from principal operations. One number of particular im-
portance is earnings before interest and taxes (EBIT), which summarizes earnings before
taxes and financing costs. Among other things, the nonoperating section of the income
statement includes all financing costs, such as interest expense. Usually a second section
reports as a separate item the amount of taxes levied on income. The last item on the
income statement is the bottom line, or net income. Net income is frequently expressed per
share of common stock—that is, earnings per share.
When analyzing an income statement, the financial manager should keep in mind
GAAP, noncash items, time, and costs.
25.5 Interest Rate Futures Contracts
In this section we consider interest rate futures contracts. Our examples deal with futures

contracts on Treasury bonds because of their high popularity. We fi rst price Treasury bonds
and Treasury bond forward contracts. Differences between futures and forward contracts
are explored. Hedging examples are provided next.
Pricing of Treasury Bonds
As mentioned earlier in the text, a Treasury bond pays semiannual interest over its life. In
addition, the face value of the bond is paid at maturity. Consider a 20-year, 8 percent cou-
pon bond that was issued on March 1. The fi rst payment is to occur in six months—that is,
on September 1. The value of the bond can be determined as follows:
Pricing of Treasury Bond
P
TB
ϭ
$40

______

1 ϩ R
1
ϩ
$40

________

(1 ϩ R
2
)
2
ϩ
$40

________

(1 ϩ R
3
)
3
ϩ
. . .
ϩ
$40

_________

(1 ϩ R
39
)
39
ϩ
$1,040

_________

(1 ϩ R
40
)
40
(25.1)
Because an 8 percent coupon bond pays interest of $80 a year, the semiannual coupon
is $40. Principal and the semiannual coupons are both paid at maturity. As we mentioned in
a previous chapter, the price of the Treasury bond, P

TB
, is determined by discounting each
payment on a bond at the appropriate spot rate. Because the payments are semiannual, each
spot rate is expressed in semiannual terms. That is, imagine a horizontal term structure
where the effective annual yield is 12 percent for all maturities. Because each spot rate, R,
is expressed in semiannual terms, each spot rate is
112 1. −
ϭ 5.83%. Coupon payments
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End-of-Chapter Material
The end-of-chapter material refl ects and builds upon the
concepts learned from the chapter and study features.
Summary and Conclusions
The summary provides a quick review of key concepts in the chapter.
Questions and Problems
Because solving problems is so critical to a student’s learning, new
questions and problems have been added, and existing questions
and problems have been revised. All problems have also been
thoroughly reviewed and accuracy-checked.
Problems have been grouped according to level of diffi culty with
the levels listed in the margin: Basic, Intermediate, and Challenge.
Additionally, we have tried to make the problems in the
critical “concept” chapters, such as those on value, risk, and capital
structure, especially challenging and interesting.
We provide answers to selected problems in Appendix B
at the end of the book.
S&P Problems
Included in the end-of-chapter material are problems directly
incorporating the Educational Version of Market Insight, a
service based on Standard & Poor’s renowned Compustat

database. These problems provide you with an easy method
of including current real-world data in your course.
Excel Problems
Indicated by the Excel icon in the margin, these problems can be
found at the end of almost all chapters. Located on the book’s
Web site (see Online Resources), Excel templates have been
created for each of these problems, where students can use the
data in the problem to work out the solution using Excel skills.
End-of-Chapter Cases
Located at the end of almost every chapter, these mini-cases
focus on common company situations that embody important
corporate fi nance topics. Each case presents a new scenario,
data, and a dilemma. Several questions at the end of each case
require students to analyze and focus on all of the material
they learned in that chapter.
xiii
Chapter 2 Financial Statements and Cash Flow 35
go under financing activities, but unfortunately that is not how the accounting is handled.
The reason is that interest is deducted as an expense when net income is computed. As a
consequence, a primary difference between the accounting cash flow and the financial cash
flow of the firm (see Table 2.5) is interest expense.
Chapter 2 Financial Statements and Cash Flow 35
Besides introducing you to corporate accounting, the purpose of this chapter has been to teach you
how to determine cash flow from the accounting statements of a typical company.
1. Cash flow is generated by the firm and paid to creditors and shareholders. It can be classified as:
a. Cash flow from operations.
b. Cash flow from changes in fixed assets.
c. Cash flow from changes in working capital.
2. Calculations of cash flow are not difficult, but they require care and particular attention to detail in
properly accounting for noncash expenses such as depreciation and deferred taxes. It is especially

important that you do not confuse cash flow with changes in net working capital and net income.
Summary
and
Conclusions
Concept
Questions
1. Liquidity True or false: All assets are liquid at some price. Explain.
2. Accounting and Cash Flows Why might the revenue and cost figures shown on a standard
income statement not represent the actual cash inflows and outflows that occurred during a
period?
3. Accounting Statement of Cash Flows Looking at the accounting statement of cash flows,
what does the bottom line number mean? How useful is this number for analyzing a company?
4. Cash Flows How do financial cash flows and the accounting statement of cash flows differ?
Which is more useful for analyzing a company?
5. Book Values versus Market Values Under standard accounting rules, it is possible for a
company’s liabilities to exceed its assets. When this occurs, the owners’ equity is negative. Can
this happen with market values? Why or why not?
6. Cash Flow from Assets Why is it not necessarily bad for the cash flow from assets to be
negative for a particular period?
7. Operating Cash Flow Why is it not necessarily bad for the operating cash flow to be nega-
tive for a particular period?
8. Net Working Capital and Capital Spending Could a company’s change in net working
capital be negative in a given year? (Hint: Yes.) Explain how this might come about. What
about net capital spending?
9. Cash Flow to Stockholders and Creditors Could a company’s cash flow to stockholders
be negative in a given year? (Hint: Yes.) Explain how this might come about. What about cash
flow to creditors?
10. Firm Values Referring back to the CBS Records example at the beginning of the chapter,
note that we suggested that CBS Records’ stockholders probably didn’t suffer as a result of the
reported loss. What do you think was the basis for our conclusion?

Questions
and Problems
1. Building a Balance Sheet Culligan, Inc., has current assets of $5,000, net fixed assets of
$23,000, current liabilities of $4,300, and long-term debt of $13,000. What is the value of the
shareholders’ equity account for this firm? How much is net working capital?
2. Building an Income Statement Ragsdale, Inc., has sales of $527,000, costs of $280,000,
depreciation expense of $38,000, interest expense of $15,000, and a tax rate of 35 percent.
www.mhhe.com/rwj
BASIC
(Questions 1–10)
www.mhhe.com/edumarketinsight
1. Marginal and Average Tax Rates Download the annual income statements for Sharper
Image (SHRP). Looking back at Table 2.3, what is the marginal income tax rate for Sharper
Image? Using the total income tax and the pretax income numbers, calculate the average tax
rate for Sharper Image. Is this number greater than 35 percent? Why or why not?
2. Net Working Capital Find the annual balance sheets for American Electric Power (AEP)
and HJ Heinz (HNZ). Calculate the net working capital for each company. Is American Elec-
tric Power’s net working capital negative? If so, does this indicate potential financial difficulty
for the company? What about Heinz?
3. Per Share Earnings and Dividends Find the annual income statements for Harley-David-
son (HDI), Hawaiian Electric Industries (HE), and Time Warner (TWX). What are the earnings
per share (EPS Basic from operations) for each of these companies? What are the dividends
per share for each company? Why do these companies pay out a different portion of income in
the form of dividends?
S&P
Problems
Cash Flows at Warf Computers, Inc.
Warf Computers, Inc., was founded 15 years ago by Nick Warf, a computer programmer. The
small initial investment to start the company was made by Nick and his friends. Over the years,
this same group has supplied the limited additional investment needed by the company in the

form of both equity and short- and long-term debt. Recently the company has developed a vir-
tual keyboard (VK). The VK uses sophisticated artificial intelligence algorithms that allow the
user to speak naturally and have the computer input the text, correct spelling and grammatical
errors, and format the document according to preset user guidelines. The VK even suggests
alternative phrasing and sentence structure, and it provides detailed stylistic diagnostics. Based
on a proprietary, very advanced software/hardware hybrid technology, the system is a full gen-
eration beyond what is currently on the market. To introduce the VK, the company will require
significant outside investment.
Nick has made the decision to seek this outside financing in the form of new equity
investments and bank loans. Naturally, new investors and the banks will require a detailed
financial analysis. Your employer, Angus Jones & Partners, LLC, has asked you to examine the
financial statements provided by Nick. Here are the balance sheet for the two most recent years
and the most recent income statement:
Mini Case
15. Convertible Calculations You have been hired to value a new 25-year callable, convertible
bond. The bond has a 6.80 percent coupon rate, payable annually. The conversion price is $150,
and the stock currently sells for $44.75. The stock price is expected to grow at 12 percent per
year. The bond is callable at $1,200; but based on prior experience, it won’t be called unless the
conversion value is $1,300. The required return on this bond is 10 percent. What value would
you assign to this bond?
16. Warrant Value Superior Clamps, Inc., has a capital structure consisting of 4 million shares of
common stock and 500,000 warrants. Each warrant gives its owner the right to purchase one
share of newly issued common stock for an exercise price of $20. The warrants are European
and will expire one year from today. The market value of the company’s assets is $88 million,
and the annual variance of the returns on the fi rm’s assets is 0.04. Treasury bills that mature in
one year yield a continuously compounded interest rate of 7 percent. The company does not
pay a dividend. Use the Black–Scholes model to determine the value of a single warrant.
CHALLENGE
(Questions 15–17)
www.mhhe.com/rwj

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Comprehensive Teaching
Corporate Finance has many options in terms of the textbook, instructor supplements, student
supplements, and multimedia products. Mix and match to create a package that is perfect for your
course.
Instructor Supplements
Instructor’s CD-ROM ISBN-10: 0-07-325735-4 / ISBN-13: 978-0-07-325735-4
This CD contains all the necessary supplements—Instructor’s Manual, Test Bank, Computerized Test Bank, and
PowerPoint—all in one useful product in an electronic format.
• Instructor’s Manual
Prepared by Steven Dolvin, Butler University and Joseph Smolira, Belmont University.
This is a great place to fi nd new lecture ideas. The IM has three main sections. The fi rst section contains a chapter
outline and other lecture materials. The annotated outline for each chapter includes lecture tips, real-world tips,
ethics notes, suggested PowerPoint slides, and, when appropriate, a video synopsis. Detailed solutions for all
end-of-chapter problems appear in section two.
• Test Bank
Prepared by Patricia Ryan, Colorado State University.
Here’s a great format for a better testing process. The Test Bank has well over 100 questions per chapter that closely
link with the text material and provides a variety of question formats (multiple-choice questions/problems and
essay questions) and levels of diffi culty (basic, intermediate, and challenge) to meet every instructor’s testing needs.
Problems are detailed enough to make them intuitive for students, and solutions are provided for the instructor.
• Computerized Test Bank (Windows)
These additional questions are found in a computerized test bank utilizing McGraw-Hill’s EZ Test testing
software to quickly create customized exams. This user-friendly program allows instructors to sort questions by
format; edit existing questions or add new ones; and scramble questions for multiple versions of the same test.
• PowerPoint Presentation System
Prepared by Steven Dolvin, Butler University.
Customize our content for your course. This presentation has been thoroughly revised to include more lecture-
oriented slides, as well as exhibits and examples both from the book and from outside sources. Applicable

slides have Web links that take you directly to specifi c Internet sites, or a spreadsheet link to show an example
in Excel. You can also go to the Notes Page function for more tips on presenting the slides. If you already
have PowerPoint installed on your PC, you can edit, print, or rearrange the complete presentation to meet your
specifi c needs.
Solutions Manual ISBN-10: 0-07-325737-0 / ISBN-13: 978-0-07-325737-2
Prepared by Joseph Smolira, Belmont University.
This manual contains detailed, worked-out solutions for all of the problems in the end-of-chapter material. It has also
been reviewed for accuracy by multiple sources. The Solutions Manual is also available for purchase by your students.
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and Learning Package
Videos ISBN-10: 0-07-326174-2 / ISBN-13: 978-0-07-326174-4
Now available in DVD format: a current set of videos about hot topics! McGraw-Hill/Irwin has produced a series
of fi nance videos that are 10-minute case studies of topics such as fi nancial markets, careers, rightsizing, capital
budgeting, EVA (economic value added), mergers and acquisitions, and foreign exchange. Discussion questions for
these videos, as well as video clips, are available in the Instructor’s Center at www.mhhe.com/rwj.
Digital Solutions
Online Learning Center (OLC): Online Support at www.mhhe.com/rwj
The Online Learning Center (OLC) contains FREE access to additional Web-based study and teaching aids created
for this text, such as the following.
Student Support
• New! Self-Study Software
With this self-study program, students can test their knowledge of one chapter or a number of chapters by using
self-grading questions written specifi cally for this text. There are at least 100 questions per chapter. Students
can set a timer function to simulate a test environment, or they can choose to have answers pop up as they fi nish
each question. Questions were prepared by Kay Johnson, Penn State University–Erie.
• New! Narrated PowerPoint Examples
Created by Kay Johnson, Penn State University–Erie, exclusively for students. Each chapter’s slides follow the
chapter topics and provide steps and explanations showing how to solve key problems. Because each student
learns differently, a quick click on each slide will “talk through” its contents with you!

• New! Interactive FinSims
Created by Eric Sandburg, Interactive Media, each module highlights a key concept of the book and simulates
how to solve its problems, asking the student to input certain variables. This hands-on approach guides students
through diffi cult and important corporate fi nance topics.
• Excel Templates
Corresponding to most end-of-chapter problems, each template allows the student to work through the problem
using Excel. Each end-of-chapter problem with a template is indicated by an Excel icon in the margin beside it.
• More
Be sure to check out the other helpful features on the OLC, including links to Corporate Finance Online study
problems, and Finance around the World.
Teaching Support
Along with having access to all of the same material your students can view on the book’s OLC, you also have password-
protected access to the Instructor’s Manual, solutions to end-of-chapter problems, Instructor’s PowerPoint, Excel
Template Solutions, video clips, video projects and questions, and teaching notes to Corporate Finance Online.
OLCs can be delivered in multiple ways—through the textbook Web site (www.mhhe.com/rwj), through
PageOut, or within a course management system like Blackboard, WebCT, TopClass, or eCollege. Ask your campus
representative for more details.
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Standard & Poor’s Educational Version of Market Insight
McGraw-Hill/Irwin and the Institutional Market Services division of Standard & Poor’s are pleased to announce
an exclusive partnership that offers instructors and students FREE access to the educational version of Standard &
Poor’s Market Insight with each new textbook. The educational version of Market Insight is a rich online resource
that provides six years of fundamental fi nancial data for over 1,000 companies in the database. S&P–specifi c
problems can be found at the end of almost all chapters in this text and ask students to solve a problem by using
research found on this site. For more details, please see the bound-in card inside the front cover of this text or visit
www.mhhe.com/edumarketinsight.
Corporate Finance Online
As part of the OLC, instructors and students will also have access to Corporate Finance Online, found on the

opening page. Corporate Finance Online is an exclusive Web tool from McGraw-Hill/Irwin. The site provides over
54 exercises for 27 key corporate fi nance topics, allowing students to complete challenging exercises and discussion
questions that draw on recent articles, company reports, government data, and other Web-based resources. For
instructors there are also password-protected teaching notes to assist with classroom integration of the material.
PageOut at www.pageout.net
FREE to adopters, this Web page generation software is designed to help you create your own course Web site
without hassle. In just a few minutes even the most novice computer user can have a functioning course Web site.
Simply type your material into the template provided and PageOut instantly converts it to HTML. Next, choose
your favorite of three easy-to-navigate designs and your class Web home page is created, complete with online
syllabus, lecture notes, and bookmarks. You can even include a separate instructor page and an assignment page.
PageOut offers enhanced point-and-click features, including a Syllabus Page that applies a real-world link to
original text material, an automatic grade book, and a discussion board where you and your students can exchange
questions and post announcements. Ask your campus representative to show you a demo.
Options Available for Purchase & Packaging
You may also package either version of the text with a variety of additional learning tools that are available for
your students.
Student Problem Manual ISBN-10: 0-07-326173-4 / ISBN-13: 978-0-07-326173-7
Prepared by Robert Hanson, Eastern Michigan University.
The Student Problem Manual is a direct companion to the text. It is uniquely designed to involve the student in
the learning process. Each chapter contains a mission statement, an average of 20 fi ll-in-the-blank concept test
questions and answers, and an average of 15 problems and worked-out solutions. This product can be purchased
separately or can be packaged with this text.
Solutions Manual
ISBN-10: 0-07-325737-0 / ISBN-13: 978-0-07-325737-2
Prepared by Joseph Smolira, Belmont University.
This manual contains detailed, worked-out solutions for all of the problems in the end-of-chapter material. It has
also been reviewed for accuracy by multiple sources. The Solutions Manual is also available for purchase by your
students.
xvi
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The Wall Street Journal
If you order this package, your students can subscribe to The Wall Street Journal—both print and online versions—
for 15 weeks at a specially priced rate of $20.00 in addition to the price of the text. Students will receive a “How to
Use the WSJ” handbook plus a card explaining how to start the subscription to both versions.
BusinessWeek
Your students can subscribe to 15 weeks of BusinessWeek for a specially priced rate of $8.25 in addition to the price
of the text. Students will receive a pass-code card shrink-wrapped with their new text. The card directs students
to a Web site where they enter the code and then gain access to BusinessWeek’s registration page to enter address
information and set up their print and online subscriptions.
Financial Times
Your students can subscribe to the Financial Times for 15 weeks at a specially priced rate of $10 in addition to the
price of the text by ordering this special package. Students will receive a subscription card shrink-wrapped with
their new text to fi ll in and send to the Financial Times to start receiving their subscription. Instructors, once you
order, make sure you contact your sales representative to receive a complimentary one-year subscription.
Excel Applications for Corporate Finance
ISBN-10: 0-07-298072-9 / ISBN-13: 978-0-07-298072-1
By Troy Adair, University of Michigan–Ann Arbor; can be packaged with the text at a discounted price.
This supplement teaches students how to build fi nancial models in Excel and shows students how to use these
models to solve a variety of common corporate fi nance problems. For more information about this supplement,
visit www.mhhe.com/adair1e.
FinGame Online 4.0 ISBN-10: 0-07-292219-2 / ISBN-13: 978-0-07-292219-6
By LeRoy Brooks, John Carroll University.
Just $15.00 when packaged with this text. In this comprehensive simulation game, students control a hypothetical
company over numerous periods of operation. The game is now tied to the text by exercises found at the Online
Learning Center. As students make major fi nancial and operating decisions for their company, they will develop
and enhance skills in fi nancial management and fi nancial accounting statement analysis.
Financial Analysis with an Electronic Calculator, Sixth Edition
ISBN-10: 0-07-321709-3 / ISBN-13: 978-0-07-321709-3
By Mark A. White, University of Virginia, McIntire School of Commerce.
The information and procedures in this supplementary text enable students to master the use of fi nancial calculators

and develop a working knowledge of fi nancial mathematics and problem solving. Complete instructions are included
for solving all major problem types on three popular models: HP 10-B and 12-C, TI BA II Plus, and TI-84. Hands-
on problems with detailed solutions allow students to practice the skills outlined in the text and obtain instant
reinforcement. Financial Analysis with an Electronic Calculator is a self-contained supplement to the introductory
fi nancial management course.
xvii
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Acknowledgments
The plan for developing this edition began with a number of our colleagues who had an interest in the book and
regularly teach the MBA introductory course.We integrated their comments and recommendations throughout the
Eighth Edition. Contributors to this edition include the following:
R. Aggarwal
John Carroll University
Christopher Anderson
University of Missouri–Columbia
James J. Angel
Georgetown University
Nasser Arshadi
University of Missouri–St. Louis
Kevin Bahr
University of Wisconsin–Milwaukee
Robert Balik
Western Michigan University
John W. Ballantine
Babson College
Thomas Bankston
Angelo State University
Brad Barber
University of California–Davis

Michael Barry
Boston College
Swati Bhatt
Rutgers University
Roger Bolton
Williams College
Gordon Bonner
University of Delaware
Oswald Bowlin
Texas Technical University
Ronald Braswell
Florida State University
William O. Brown
Claremont McKenna College
Kirt Butler
Michigan State University
Bill Callahan
Southern Methodist University
Steven Carvell
Cornell University
Indudeep S. Chhachhi
Western Kentucky University
Andreas Christofi
Monmouth University
Jeffrey L. Coles
Arizona State University
Mark Copper
Wayne State University
James Cotter
University of Iowa

Jay Coughenour
University of Massachusetts–Boston
Arnold Cowan
Iowa State University
Raymond Cox
Central Michigan University
John Crockett
George Mason University
Mark Cross
Louisiana Technical University
Ron Crowe
Jacksonville University
William Damon
Vanderbilt University
Sudip Datta
Bentley College
Anand Desai
University of Florida
Miranda Lam Detzler
University of Massachusetts–Boston
David Distad
University of California–Berkeley
Dennis Draper
University of Southern California
Jean-Francois Dreyfus
New York University
Gene Drzycimski
University of Wisconsin–Oshkosh
Robert Duvic
The University of Texas at Austin

Demissew Ejara
University of Massachusetts–Boston
Robert Eldridge
Fairfi eld University
Gary Emery
University of Oklahoma
Theodore Eytan
City University of New York–Baruch
College
Don Fehrs
University of Notre Dame
Steven Ferraro
Pepperdine University
Janet Hamilton
Portland State University
Robert Hauswald
American University
Robert Krell
George Mason University
Thomas Legg
University of Minnesota
Joseph Meredith
Elon University
Vassil Mihov
Texas Christian University
Edward Morris
Lindenwood University
Betty Simkins
Oklahoma State University
Robert Wood

Tennessee Tech University
Over the years, many others have contributed their time and expertise to the development and writing of this text.
We extend our thanks once again for their assistance and countless insights:
xviii
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Andrew Fields
University of Delaware
Paige Fields
Texas A&M
Adlai Fisher
New York University
Michael Fishman
Northwestern University
Yee-Tien Fu
Stanford University
Bruno Gerard
University of Southern California
Frank Ghannadian
Mercer University–Atlanta
Michael Goldstein
University of Colorado
Indra Guertler
Babson College
James Haltiner
College of William and Mary
Delvin Hawley
University of Mississippi
Hal Heaton
Brigham Young University
John A. Helmuth

University of Michigan–Dearborn
John Helmuth
Rochester Institute of Technology
Michael Hemler
University of Notre Dame
Stephen Heston
Washington University
Andrea Heuson
University of Miami
Edith Hotchkiss
Boston College
Charles Hu
Claremont McKenna College
Hugh Hunter
Eastern Washington University
James Jackson
Oklahoma State University
Raymond Jackson
University of Massachusetts–
Dartmouth
Prem Jain
Tulane University
Narayanan Jayaraman
Georgia Institute of Technology
Brad Jordan
University of Kentucky
Jarl Kallberg
New York University
Jonathan Karpoff
University of Washington

Paul Keat
American Graduate School of
International Management
Dolly King
University of Wisconsin–Milwaukee
Brian Kluger
University of Cincinnati
Narayana Kocherlakota
University of Iowa
Ronald Kudla
The University of Akron
Youngsik Kwak
Delaware State University
Nelson Lacey
University of Massachusetts
Gene Lai
University of Rhode Island
Josef Lakonishok
University of Illinois
Dennis Lasser
State University of New York–
Binghamton
Paul Laux
Case Western Reserve University
Bong-Su Lee
University of Minnesota
Youngho Lee
Howard University
James T. Lindley
University of Southern Mississippi

Dennis Logue
Dartmouth College
Michael Long
Rutgers University
Yulong Ma
Cal State–Long Beach
Ileen Malitz
Fairleigh Dickinson University
Terry Maness
Baylor University
Surendra Mansinghka
San Francisco State University
Michael Mazzco
Michigan State University
Robert I. McDonald
Northwestern University
Hugh McLaughlin
Bentley College
Larry Merville
University of Texas–Richardson
Joe Messina
San Francisco State University
Roger Mesznik
City College of New York–Baruch
College
Rick Meyer
University of South Florida
Richard Miller
Wesleyan University
Naval Modani

University of Central Florida
Richard Mull
New Mexico State University
Jim Musumeci
Southern Illinois University–
Carbondale
Robert Nachtmann
University of Pittsburgh
Edward Nelling
Georgia Tech
Gregory Niehaus
University of South Carolina
Acknowledgments xix
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Peder Nielsen
Oregon State University
Ingmar Nyman
Hunter College
Dennis Offi cer
University of Kentucky
Joseph Ogden
State University of New York
Venky Panchapagesan
Washington University–St. Louis
Bulent Parker
University of Wisconsin–Madison
Ajay Patel
University of Missouri–Columbia
Dilip Kumar Patro

Rutgers University
Gary Patterson
University of South Florida
Glenn N. Pettengill
Emporia State University
Pegaret Pichler
University of Maryland
Christo Pirinsky
Ohio State University
Jeffrey Pontiff
University of Washington
Franklin Potts
Baylor University
Annette Poulsen
University of Georgia
N. Prabhala
Yale University
Mao Qiu
University of Utah–Salt Lake City
Latha Ramchand
University of Houston
Gabriel Ramirez
Virginia Commonwealth University
Narendar Rao
Northeastern Illinois University
Steven Raymar
Indiana University
Stuart Rosenstein
East Carolina University
Bruce Rubin

Old Dominion University
Patricia Ryan
Drake University
Jaime Sabal
New York University
Anthony Sanders
Ohio State University
Andy Saporoschenko
University of Akron
William Sartoris
Indiana University
James Schallheim
University of Utah
Mary Jean Scheuer
California State University at
Northridge
Faruk Selcuk
University of Bridgeport
Lemma Senbet
University of Maryland
Kuldeep Shastri
University of Pittsburgh
Sudhir Singh
Frostburg State University
Scott Smart
Indiana University
Jackie So
Southern Illinois University
John Stansfi eld
Columbia College

John S. Strong
College of William and Mary
A. Charlene Sullivan
Purdue University
Michael Sullivan
University of Nevada–Las Vegas
Timothy Sullivan
Bentley College
R. Bruce Swensen
Adelphi University
Ernest Swift
Georgia State University
Alex Tang
Morgan State University
Richard Taylor
Arkansas State University
Andrew C. Thompson
Virginia Polytechnic Institute
Timothy Thompson
Northwestern University
Karin Thorburn
Dartmouth College
Satish Thosar
University of Massachusetts–
Dorchester
Charles Trzcinka
State University of New York–Buffalo
Haluk Unal
University of Maryland–College Park
Oscar Varela

University of New Orleans
Steven Venti
Dartmouth College
Avinash Verma
Washington University
Lankford Walker
Eastern Illinois University
Ralph Walkling
Ohio State University
F. Katherine Warne
Southern Bell College
Susan White
University of Texas–Austin
Robert Whitelaw
New York University
Berry Wilson
Georgetown University
Thomas Zorn
University of Nebraska–Lincoln
Kent Zumwalt
Colorado State University
xx Acknowledgments
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For their help on the Eighth Edition, we would like to thank Linda De Angelo, Dennis
Draper, Kim Dietrich, Harry De Angelo, Aris Protopapadakis, Suh-Pyng Ku, and Mark
Westerfi eld all of the Marshall School of Business at the University of Southern California;
Jordan Strauss Esq.; Stephen Dolvin, Butler University, for his work on the Instructor’s
Manual and PowerPoint; Patricia Ryan, Colorado State University, for her work on the Test
Bank; Robert Hanson, Eastern Michigan University, for his work on the Student Problem
Manual; Joe Smolira, Belmont University, for his work on the solutions and text; and Kay

Johnson, Penn State University–Erie, for her work on the self-study software and narrated
Student PowerPoint. We also owe a debt of gratitude to Bradford D. Jordan of the University
of Kentucky; Edward I. Altman of New York University; Robert S. Hansen of Virginia
Tech; and Jay R. Ritter of the University of Florida, who have provided several thoughtful
comments and immeasurable help.
We thank Allissa Day, Hinh Khieu, Pankaj Maskara, and Theodore Phillips, Jr., for their
extensive proofi ng and problem-checking efforts.
Over the past three years readers have provided assistance by detecting and reporting
errors. Our goal is to offer the best textbook available on the subject, so this information was
invaluable as we prepared the Eighth Edition. We want to ensure that all future editions are
error-free—and therefore we offer $10 per arithmetic error to the fi rst individual reporting it.
Any arithmetic error resulting in subsequent errors will be counted double. All errors should
be reported using the Feedback Form on the Corporate Finance Online Learning Center at
www.mhhe.com/rwj.
Many talented professionals at McGraw-Hill/Irwin have contributed to the development
of Corporate Finance, Eighth Edition. We would especially like to thank Michele Janicek,
Jennifer Rizzi, Julie Phifer, Christine Vaughan, Kami Carter, Gina Hangos, Jennifer Wilson,
and Beckey Szura.
Finally, we wish to thank our families and friends, Carol, Kate, Jon, Jan, Mark, and
Lynne, for their forbearance and help.
Stephen A. Ross
Randolph W. Westerfi eld
Jeffrey F. Jaffe
Acknowledgments xxi
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Brief Contents
PART I
Overview
1 Introduction to Corporate Finance 1
2 Financial Statements and Cash Flow 21

3 Financial Statements Analysis
and Long-Term Planning 43
PART II
Valuation and Capital Budgeting
4 Discounted Cash Flow Valuation 89
5 How to Value Bonds and Stocks 129
6 Net Present Value and Other Investment Rules 161
7 Making Capital Investment Decisions 197
8 Risk Analysis, Real Options,
and Capital Budgeting 229
P A R T III
Risk
9 Risk and Return: Lessons from Market History 256
10 Return and Risk: The Capital Asset Pricing
Model (CAPM) 279
11 An Alternative View of Risk and Return:
The Arbitrage Pricing Theory 320
12 Risk, Cost of Capital, and Capital Budgeting 342
PART IV
Capital Structure
and Dividend Policy
13 Corporate Financing Decisions and Effi cient
Capital Markets 368
14 Long-Term Financing: An Introduction 405
15 Capital Structure: Basic Concepts 423
16 Capital Structure: Limits to the Use of Debt 455
17 Valuation and Capital Budgeting for the
Levered Firm 488
18 Dividends and Other Payouts 510
PART V

Long-Term Financing
19 Issuing Securities to the Public 549
20 Long-Term Debt 580
21 Leasing 606
PART VI
Options, Futures,
and Corporate Finance
22 Options and Corporate Finance 630
23 Options and Corporate Finance: Extensions
and Applications 671
24 Warrants and Convertibles 695
25 Derivatives and Hedging Risk 714
P A R T VII
Short-Term Finance
26 Short-Term Finance and Planning 745
27 Cash Management 771
28 Credit Management 795
P A R T VIII
Special Topics
29 Mergers and Acquisitions 812
30 Financial Distress 853
31 International Corporate Finance 867
Appendix A: Mathematical Tables 895
Appendix B: Solutions to Selected End-of-Chapter
Problems 905
Name Index 909
Subject Index 911
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Contents

PART I Overview
Chapter 1
Introduction to Corporate Finance 1
1.1 What Is Corporate Finance? 1
The Balance Sheet Model of the Firm 1
Capital Structure 3
The Financial Manager 3
1.2 The Corporate Firm 7
The Sole Proprietorship 7
The Partnership 8
The Corporation 9
A Corporation by Another Name . . . 10
1.3 The Goal of Financial Management 11
Possible Goals 11
The Goal of Financial Management 12
A More General Goal 12
1.4 The Agency Problem and Control
of the Corporation 13
Agency Relationships 13
Management Goals 13
Do Managers Act in the Stockholders’ Interests? 14
Stakeholders 15
1.5 Financial Markets 15
The Primary Market: New Issues 16
Secondary Markets 16
Exchange Trading of Listed Stocks 17
Listing 17
Summary and Conclusions 19
Concept Questions 19
S&P Problems 20

Chapter 2
Financial Statements and Cash Flow 21
2.1 The Balance Sheet 21
Liquidity 22
Debt versus Equity 23
Value versus Cost 23
2.2 The Income Statement 24
Generally Accepted Accounting Principles 25
Noncash Items 25
Time and Costs 26
2.3 Ta xe s 26
Corporate Tax Rates 27
Average versus Marginal Tax Rates 27
2.4 Net Working Capital 29
2.5 Financial Cash Flow 29
2.6 The Accounting Statement of Cash Flows 32
Cash Flow from Operating Activities 33
Cash Flow from Investing Activities 33
Cash Flow from Financing Activities 33
Summary and Conclusions 35
Concept Questions 35
Questions and Problems 35
S&P Problems 40
Chapter 3
Financial Statements Analysis
and Long-Term Planning 43
3.1 Financial Statements Analysis 43
Standardizing Statements 43
Common-Size Balance Sheets 44
Common-Size Income Statements 45

3.2 Ratio Analysis 45
Short-Term Solvency or Liquidity Measures 47
Long-Term Solvency Measures 49
Asset Management or Turnover Measures 50
Profi tability Measures 52
Market Value Measures 53
3.3 The Du Pont Identity 54
A Closer Look at ROE 54
An Expanded Du Pont Analysis 57
3.4 Using Financial Statement Information 58
Choosing a Benchmark 58
Problems with Financial Statement Analysis 63
3.5 Long-Term Financial Planning 64
A Simple Financial Planning Model 64
The Percentage of Sales Approach 66
3.6 External Financing and Growth 70
EFN and Growth 70
Financial Policy and Growth 73
A Note about Sustainable Growth
Rate Calculations 76
3.7 Some Caveats Regarding Financial
Planning Models 77
Summary and Conclusions 79
Concept Questions 79
Questions and Problems 80
S&P Problems 86
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PART II
Valuation and

Capital Budgeting
Chapter 4
Discounted Cash Flow Valuation 89
4.1 Valuation: The One-Period Case 89
4.2 The Multiperiod Case 93
Future Value and Compounding 93
The Power of Compounding: A Digression 96
Present Value and Discounting 97
The Algebraic Formula 101
4.3 Compounding Periods 102
Distinction between Stated Annual
Interest Rate and Effective Annual Rate 104
Compounding over Many Years 104
Continuous Compounding 105
4.4 Simplifi cations 106
Perpetuity 107
Growing Perpetuity 108
Annuity 110
Growing Annuity 115
4.5 What Is a Firm Worth? 116
Summary and Conclusions 117
Concept Questions 118
Questions and Problems 119
S&P Problems 127
Chapter 5
How to Value Bonds and Stocks 129
5.1 Defi nition and Example of a Bond 129
5.2 How to Value Bonds 129
Pure Discount Bonds 129
Level Coupon Bonds 130

Consols 132
5.3 Bond Concepts 133
Interest Rates and Bond Prices 133
Yield to Maturity 134
Bond Market Reporting 134
5.4 The Present Value of Common Stocks 136
Dividends versus Capital Gains 136
Valuation of Different Types of Stocks 137
5.5 Estimates of Parameters in the Dividend
Growth Model 140
Where Does g Come From? 141
Where Does R Come From? 142
A Healthy Sense of Skepticism 143
5.6 Growth Opportunities 144
Growth in Earnings and Dividends
versus Growth Opportunities 146
Dividends or Earnings: Which to Discount? 146
The No-Dividend Firm 147
5.7 The Dividend Growth Model
and the NPVGO Model 147
The Dividend Growth Model 148
The NPVGO Model 148
Summation 149
5.8 Price–Earnings Ratio 150
5.9 Stock Market Reporting 151
Summary and Conclusions 153
Concept Questions 154
Questions and Problems 154
S&P Problems 159
Appendix 5A The Term Structure of

Interest Rates, Spot Rates,
and Yield to Maturity 160
Chapter 6
Net Present Value and Other
Investment Rules 161
6.1 Why Use Net Present Value? 161
6.2 The Payback Period Method 163
Defi ning the Rule 163
Problems with the Payback Method 164
Managerial Perspective 165
Summary of Payback 166
6.3 The Discounted Payback Period Method 166
6.4 The Average Accounting Return Method 166
Defi ning the Rule 166
Analyzing the Average Accounting
Return Method 168
6.5 The Internal Rate of Return 169
6.6 Problems with the IRR Approach 171
Defi nition of Independent and Mutually
Exclusive Projects 171
Two General Problems Affecting Both
Independent and Mutually Exclusive Projects 171
Problems Specifi c to Mutually Exclusive Projects 175
Redeeming Qualities of IRR 180
A Test 180
6.7 The Profi tability Index 181
Calculation of Profi tability Index 181
6.8 The Practice of Capital Budgeting 183
Summary and Conclusions 186
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