Fundamentals of Corporate Finance, Ninth Edition
By Richard A. Brealey, Stewart C. Myers and Alan J. Marcus
Contents:
Part One: Introduction
Chapter 1
Goals and Governance of the Corporation 2
1.1 Investment and Financing Decisions 4
The Investment (Capital Budgeting) Decision 6
The Financing Decision 6
1.2 What Is a Corporation? 8
Other Forms of Business Organization 9
1.3 Who Is the Financial Manager? 10
1.4 Goals of the Corporation 12
Shareholders Want Managers to Maximize Market Value 12
1.5 Agency Problems, Executive Compensation, and
Corporate Governance 15
Executive Compensation 16
Corporate Governance 17
1.6 The Ethics of Maximizing Value 18
1.7 Careers in Finance 21
1.8 Preview of Coming Attractions 22
1.9 Snippets of Financial History 23
Summary 25
Questions and Problems 26
Chapter 2
Financial Markets and Institutions 32
2.1 The Importance of Financial Markets and
Institutions 34
2.2 The Flow of Savings to Corporations 35
The Stock Market 37
Other Financial Markets 38
Financial Intermediaries 40
Financial Institutions 42
Total Financing of U.S. Corporations 43
2.3 Functions of Financial Markets and Intermediaries 44
Transporting Cash across Time 45
Risk Transfer and Diversification 45
Liquidity 46
The Payment Mechanism 46
Information Provided by Financial Markets 47
2.4 The Crisis of 2007–2009 49
Summary 51
Questions and Problems 52
Chapter 3
Accounting and Finance 56
3.1 The Balance Sheet 58
Book Values and Market Values 61
3.2 The Income Statement 63
Income versus Cash Flow 64
3.3 The Statement of Cash Flows 67
Free Cash Flow 69
3.4 Accounting Practice and Malpractice 70
3.5 Taxes 73
Corporate Tax 73
Personal Tax 74
Summary 76
Questions and Problems 76
Chapter 4
Measuring Corporate Performance 86
4.1 How Financial Ratios Relate to Shareholder Value 88
4.2 Measuring Market Value and Market Value Added 89
4.3 Economic Value Added and Accounting Rates of Return 91
Accounting Rates of Return 93
Problems with EVA and Accounting Rates of Return 95
4.4 Measuring Efficiency 96
4.5 Analyzing the Return on Assets: The Du Pont System 97
The Du Pont System 98
4.6 Measuring Financial Leverage 100
Leverage and the Return on Equity 102
4.7 Measuring Liquidity 103
4.8 Interpreting Financial Ratios 104
4.9 The Role of Financial Ratios 108
Summary 109
Questions and Problems 110
Minicase 116
Part Two: Value
Chapter 5
The Time Value of Money 118
5.1 Future Values and Compound Interest 120
5.2 Present Values 123
Finding the Interest Rate 127
5.3 Multiple Cash Flows 128
Future Value of Multiple Cash Flows 128
Present Value of Multiple Cash Flows 130
5.4 Reducing the Chore of the Calculations: Part 1 131
Using Financial Calculators to Solve Simple Time-Value-of-
Money Problems 131
Using Spreadsheets to Solve Simple Time-Value-of-Money
Problems 132
5.5 Level Cash Flows: Perpetuities and Annuities 135
How to Value Perpetuities 135
How to Value Annuities 136
Future Value of an Annuity 140
Annuities Due 143
5.6 Reducing the Chore of the Calculations: Part 2 144
Using Financial Calculators to Solve Annuity
Problems 145
Using Spreadsheets to Solve Annuity Problems 145
5.7 Effective Annual Interest Rates 146
5.8 Inflation and the Time Value of Money 148
Real versus Nominal Cash Flows 148
Inflation and Interest Rates 150
Valuing Real Cash Payments 151
Real or Nominal? 153
Summary 153
Questions and Problems 154
Minicase 165
Chapter 6
Valuing Bonds 166
6.1 The Bond Market 168
Bond Characteristics 168
6.2 Interest Rates and Bond Prices 169
How Bond Prices Vary with Interest Rates 172
Interest Rate Risk 174
6.3 Yield to Maturity 174
Calculating the Yield to Maturity 176
6.4 Bond Rates of Return 176
6.5 The Yield Curve 178
Nominal and Real Rates of Interest 181
6.6 Corporate Bonds and the Risk of Default 182
Protecting against Default Risk 185
Not All Corporate Bonds Are Plain Vanilla 187
Summary 187
Questions and Problems 188
Chapter 7
Valuing Stocks 196
7.1 Stocks and the Stock Market 198
Reading Stock Market Listings 199
7.2 Market Values, Book Values, and Liquidation Values 201
7.3 Valuing Common Stocks 203
Valuation by Comparables 203
Price and Intrinsic Value 204
The Dividend Discount Model 206
7.4 Simplifying the Dividend Discount Model 209
Case 1: The Dividend Discount Model with No Growth 209
Case 2: The Dividend Discount Model with Constant
Growth 209
Case 3: The Dividend Discount Model with Nonconstant
Growth 214
7.5 Valuing a Business by Discounted Cash Flow 218
Valuing the Concatenator Business 218
Repurchases and the Dividend Discount Model 219
7.6 There Are No Free Lunches on Wall Street 220
Random Walks and Efficient Markets 221
7.7 Market Anomalies and Behavioral Finance 225
Market Anomalies 225
Bubbles and Market Efficiency 226
Behavioral Finance 227
Summary 228
Questions and Problems 229
Minicase 236
Chapter 8
Net Present Value and Other Investment
Criteria 238
8.1 Net Present Value 240
A Comment on Risk and Present Value 241
Valuing Long-Lived Projects 242
Choosing between Alternative Projects 244
8.2 The Internal Rate of Return Rule 245
A Closer Look at the Rate of Return Rule 246
Calculating the Rate of Return for Long-Lived Projects 246
A Word of Caution 248
Some Pitfalls with the Internal Rate of Return Rule 248
8.3 The Profitability Index 253
Capital Rationing 254
Pitfalls of the Profitability Index 254
8.4 The Payback Rule 255
Discounted Payback 256
8.5 More Mutually Exclusive Projects 256
Problem 1: The Investment Timing Decision 257
Problem 2: The Choice between Long- and Short-Lived
Equipment 258
Problem 3: When to Replace an Old Machine 260
8.6 A Last Look 261
Summary 262
Questions and Problems 263
Minicase 270
Appendix: More on the IRR Rule 271
Using the IRR to Choose between Mutually Exclusive
Projects 271
Using the Modified Internal Rate of Return When There Are
Multiple IRRs 271
Chapter 9
Using Discounted Cash-Flow Analysis to Make
Investment Decisions 274
9.1 Identifying Cash Flows 276
Discount Cash Flows, Not Profits 276
Discount Incremental Cash Flows 278
Discount Nominal Cash Flows by the Nominal Cost of
Capital 281
Separate Investment and Financing Decisions 282
9.2 Calculating Cash Flow 283
Element 1: Capital Investment 283
Element 2: Operating Cash Flow 283
Element 3: Changes in Working Capital 285
9.3 An Example: Blooper Industries 286
Cash-Flow Analysis 286
Calculating the NPV of Blooper’s Project 288
Further Notes and Wrinkles Arising from Blooper’s
Project 289
Summary 293
Questions and Problems 294
Minicase 301
Chapter 10
Project Analysis 302
10.1 How Firms Organize the Investment Process to Draw on
Their Competitive Strengths 304
The Capital Budget 304
Problems and Some Solutions 305
10.2 Reducing Forecast Bias 305
10.3 Some “What-If” Questions 306
Sensitivity Analysis 307
Scenario Analysis 310
10.4 Break-Even Analysis 310
Accounting Break-Even Analysis 311
NPV Break-Even Analysis 312
Operating Leverage 315
10.5 Real Options and the Value of Flexibility 317
The Option to Expand 317
A Second Real Option: The Option to Abandon 319
A Third Real Option: The Timing Option 319
A Fourth Real Option: Flexible Production Facilities 320
Summary 321
Questions and Problems 322
Minicase 328
Part Three: Risk
Chapter 11
Introduction to Risk, Return, and the
Opportunity Cost of Capital 330
11.1 Rates of Return: A Review 332
11.2 A Century of Capital Market History 333
Market Indexes 333
The Historical Record 333
Using Historical Evidence to Estimate Today’s Cost of
Capital 336
11.3 Measuring Risk 338
Variance and Standard Deviation 338
A Note on Calculating Variance 341
Measuring the Variation in Stock Returns 341
11.4 Risk and Diversification 343
Diversification 343
Asset versus Portfolio Risk 344
Market Risk versus Specific Risk 350
11.5 Thinking about Risk 351
Message 1: Some Risks Look Big and Dangerous
but Really Are Diversifiable 351
Message 2: Market Risks Are Macro Risks 352
Message 3: Risk Can Be Measured 353
Summary 354
Questions and Problems 355
Chapter 12
Risk, Return, and Capital Budgeting 360
12.1 Measuring Market Risk 362
Measuring Beta 362
Betas for U.S. Steel and PG&E 365
Total Risk and Market Risk 365
12.2 What Can You Learn from Beta? 367
Portfolio Betas 367
The Portfolio Beta Determines the Risk of a Diversified
Portfolio 370
12.3 Risk and Return 371
Why the CAPM Makes Sense 373
The Security Market Line 374
Using the CAPM to Estimate Expected Returns 375
How Well Does the CAPM Work? 375
12.4 The CAPM and the Opportunity Cost of
Capital 378
The Company Cost of Capital 380
What Determines Project Risk? 380
Don’t Add Fudge Factors to Discount Rates 381
Summary 381
Questions and Problems 382
Chapter 13
The Weighted-Average Cost of Capital and
Company Valuation 390
13.1 Geothermal’s Cost of Capital 392
13.2 The Weighted-Average Cost of Capital 393
Calculating Company Cost of Capital as a Weighted Average 394
Use Market Weights, Not Book Weights 396
Taxes and the Weighted-Average Cost of Capital 396
What If There Are Three (or More) Sources of Financing? 398
The NPV of Geothermal’s Expansion 398
Checking Our Logic 399
13.3 Interpreting the Weighted-Average Cost of Capital 400
When You Can and Can’t Use WACC 400
Some Common Mistakes 400
How Changing Capital Structure Affects Expected Returns 401
What Happens When the Corporate Tax Rate Is Not Zero 401
13.4 Practical Problems: Measuring Capital Structure 401
13.5 More Practical Problems: Estimating Expected Returns 403
The Expected Return on Bonds 403
The Expected Return on Common Stock 404
The Expected Return on Preferred Stock 405
Adding It All Up 406
Real-Company WACCs 406
13.6 Valuing Entire Businesses 406
Calculating the Value of the Deconstruction Business 408
Summary 409
Questions and Problems 410
Minicase 415
Part Four: Financing
Chapter 14
Introduction to Corporate Financing 418
14.1 Creating Value with Financing Decisions 420
14.2 Patterns of Corporate Financing 420
Are Firms Issuing Too Much Debt? 423
14.3 Common Stock 424
Ownership of the Corporation 426
Voting Procedures 427
Classes of Stock 428
14.4 Preferred Stock 428
14.5 Corporate Debt 429
Debt Comes in Many Forms 429
Innovation in the Debt Market 432
14.6 Convertible Securities 434
Summary 435
Questions and Problems 436
Chapter 15
How Corporations Raise Venture Capital and
Issue Securities 440
15.1 Venture Capital 442
Venture Capital Companies 443
15.2 The Initial Public Offering 444
Arranging a Public Issue 445
Other New-Issue Procedures 449
The Underwriters 449
15.3 General Cash Offers by Public Companies 450
General Cash Offers and Shelf Registration 451
Costs of the General Cash Offer 452
Market Reaction to Stock Issues 452
15.4 The Private Placement 453
Summary 454
Questions and Problems 454
Minicase 459
Appendix: Hotch Pot’s New-Issue Prospectus 461
Part Five: Debt and Payout Policy
Chapter 16
Debt Policy 466
16.1 How Borrowing Affects Value in a Tax-Free
Economy 468
MM’s Argument—A Simple Example 469
How Borrowing Affects Earnings per Share 470
How Borrowing Affects Risk and Return 472
16.2 Debt and the Cost of Equity 473
No Magic in Financial Leverage 476
16.3 Debt, Taxes, and the Weighted-Average Cost of
Capital 477
Debt and Taxes at River Cruises 478
How Interest Tax Shields Contribute to the Value of
Stockholders’ Equity 479
Corporate Taxes and the Weighted-Average Cost of
Capital 480
The Implications of Corporate Taxes for Capital
Structure 481
16.4 Costs of Financial Distress 482
Bankruptcy Costs 482
Costs of Bankruptcy Vary with Type of Asset 484
Financial Distress without Bankruptcy 485
16.5 Explaining Financing Choices 487
The Trade-Off Theory 487
A Pecking Order Theory 488
The Two Faces of Financial Slack 489
Is There a Theory of Optimal Capital Structure? 490
Summary 491
Questions and Problems 492
Minicase 499
Appendix: Bankruptcy Procedures 501
Chapter 17
Payout Policy 504
17.1 How Corporations Pay Out Cash to Shareholders 506
How Firms Pay Dividends 507
Limitations on Dividends 507
Stock Dividends and Stock Splits 508
Stock Repurchases 509
17.2 The Information Content of Dividends and Repurchases 509
17.3 Dividends or Repurchases? The Payout Controversy 511
Dividends or Repurchases? An Example 512
Repurchases and the Dividend Discount Model 513
Dividends and Share Issues 514
17.4 Why Dividends May Increase Value 515
17.5 Why Dividends May Reduce Value 517
Taxation of Dividends and Capital Gains under Current Tax Law 518
Taxes and Payout—A Summary 518
17.6 Payout Policy and the Life Cycle of the Firm 518
Summary 519
Questions and Problems 520
Minicase 526
Part Six: Financial Analysis and Planning
Chapter 18
Long-Term Financial Planning 528
18.1 What Is Financial Planning? 530
Why Build Financial Plans? 530
18.2 Financial Planning Models 531
Components of a Financial Planning Model 531
18.3 A Long-Term Financial Planning Model for Dynamic Mattress 532
Pitfalls in Model Design 537
Choosing a Plan 538
18.4 External Financing and Growth 539
Summary 542
Questions and Problems 543
Minicase 549
Chapter 19
Short-Term Financial Planning 550
19.1 Links between Long-Term and Short-Term
Financing 552
19.2 Tracing Changes in Cash 554
19.3 Cash Budgeting 556
Preparing the Cash Budget 556
19.4 Dynamic’s Short-Term Financial Plan 559
Dynamic Mattress’s Financing Plan 559
Evaluating the Plan 560
A Note on Short-Term Financial Planning Models 561
Summary 563
Questions and Problems 563
Minicase 568
Chapter 20
Working Capital Management 570
20.1 Working Capital 572
Components of Working Capital 572
Working Capital and the Cash Cycle 572
20.2 Accounts Receivable and Credit Policy 575
Terms of Sale 576
Credit Agreements 577
Credit Analysis 578
The Credit Decision 579
Collection Policy 584
20.3 Inventory Management 586
20.4 Cash Management 588
Check Handling and Float 589
Other Payment Systems 590
Electronic Funds Transfer 591
International Cash Management 592
20.5 Investing Idle Cash: The Money Market 593
Money Market Investments 593
Calculating the Yield on Money Market Investments 594
Yields on Money Market Investments 595
The International Money Market 595
20.6 Managing Current Liabilities: Short-Term Debt 596
Bank Loans 596
Commercial Paper 597
Summary 598
Questions and Problems 600
Minicase 608
Part Seven: Special Topics
Chapter 21
Mergers, Acquisitions, and Corporate
Control 610
21.1 Sensible Motives for Mergers 612
Economies of Scale 614
Economies of Vertical Integration 614
Combining Complementary Resources 615
Mergers as a Use for Surplus Funds 616
Eliminating Inefficiencies 616
Industry Consolidation 616
21.2 Dubious Reasons for Mergers 617
Diversification 617
The Bootstrap Game 617
21.3 The Mechanics of a Merger 619
The Form of Acquisition 619
Mergers, Antitrust Law, and Popular Opposition 619
Cross-Border Mergers and Tax Inversion 620
21.4 Evaluating Mergers 620
Mergers Financed by Cash 620
Mergers Financed by Stock 622
A Warning 623
Another Warning 623
21.5 The Market for Corporate Control 624
21.6 Method 1: Proxy Contests 625
21.7 Method 2: Takeovers 625
21.8 Method 3: Leveraged Buyouts 627
Barbarians at the Gate? 628
21.9 Method 4: Divestitures, Spin-Offs, and Carve-Outs 630
21.10 The Benefits and Costs of Mergers 630
Merger Waves 630
Summary 632
Questions and Problems 633
Minicase 636
Chapter 22
International Financial Management 638
22.1 Foreign Exchange Markets 640
Spot Exchange Rates 640
Forward Exchange Rates 642
22.2 Some Basic Relationships 643
Exchange Rates and Inflation 643
Real and Nominal Exchange Rates 646
Inflation and Interest Rates 646
The Forward Exchange Rate and the Expected Spot Rate 649
Interest Rates and Exchange Rates 650
22.3 Hedging Currency Risk 651
Transaction Risk 651
Economic Risk 652
22.4 International Capital Budgeting 653
Net Present Values for Foreign Investments 653
Political Risk 655
The Cost of Capital for Foreign Investment 656
Avoiding Fudge Factors 656
Summary 657
Questions and Problems 658
Minicase 663
Chapter 23
Options 664
23.1 Calls and Puts 666
Selling Calls and Puts 668
Payoff Diagrams Are Not Profit Diagrams 669
Financial Alchemy with Options 670
Some More Option Magic 671
23.2 What Determines Option Values? 672
Upper and Lower Limits on Option
Values 672
The Determinants of Option Value 673
Option-Valuation Models 675
23.3 Spotting the Option 678
Options on Real Assets 678
Options on Financial Assets 679
Summary 682
Questions and Problems 683
Chapter 24
Risk Management 692
24.1 Why Hedge? 694
The Evidence on Risk Management 695
24.2 Reducing Risk with Options 696
24.3 Futures Contracts 696
The Mechanics of Futures Trading 699
Commodity and Financial Futures 700
24.4 Forward Contracts 701
24.5 Swaps 702
Interest Rate Swaps 702
Currency Swaps 704
And Some Other Swaps 704
24.6 Innovation in the Derivatives Market 705
24.7 Is “Derivative” a Four-Letter Word? 705
Summary 706
Questions and Problems 707
Part Eight: Conclusion
Chapter 25
What We Do and Do Not Know about
Finance 712
25.1 What We Do Know: The Six Most Important Ideas in Finance 714
Net Present Value (Chapter 5) 714
Risk and Return (Chapters 11 and 12) 714
Efficient Capital Markets (Chapter 7) 715
MM’s Irrelevance Propositions (Chapters 16 and 17) 715
Option Theory (Chapter 23) 715
Agency Theory 716
25.2 What We Do Not Know: Nine Unsolved Problems in Finance 716
What Determines Project Risk and Present Value? 716
Risk and Return—Have We Missed Something? 717
Are There Important Exceptions to the Efficient-Market Theory? 718
Is Management an Off-Balance-Sheet Liability? 718
How Can We Explain Capital Structure? 719
How Can We Resolve the Payout Controversy? 719
How Can We Explain Merger Waves? 719
What Is the Value of Liquidity? 720
Why Are Financial Systems Prone to Crisis? 720
25.3 A Final Word 721
Questions and Problems 721
Appendix A A-1
Glossary G-1
Global Index IND-1
Subject Index IND-5