Corporate Finance, 4th European Edition
David Hillier, Stephen Ross, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan
Table of Contents
Part 1: Overview 1
1 Introduction to Corporate Finance 2
1.1 What is Corporate Finance? 3
1.2 The Goal of Financial Management 8
1.3 Financial Markets 10
1.4 Corporate Finance in Action:
The Case of Alphabet 15
Summary and Conclusions 17
Questions and Problems 17
Exam Question (45 minutes) 21
Practical Case Study 21
References 21
Additional Reading 22
Endnote 22
2 Corporate Governance 23
2.1 The Corporate Firm 24
2.2 The Agency Problem and Control of the
Corporation 29
2.3 The Governance Structure of
Corporations 37
2.4 Corporate Governance Principles 39
2.5 International Corporate Governance 46
2.6 Corporate Governance in
Action: Starbucks 49
Summary and Conclusions 51
Questions and Problems 51
Exam Question (45 minutes) 53
Mini Case 53
Practical Case Study 53
Reference 54
Additional Reading 54
Part 2: Value and Capital
Budgeting 57
3 Financial Statement Analysis 58
3.1 The Statement of Financial Position 59
3.2 The Income Statement 61
3.3 Taxes 63
3.4 Net Working Capital 64
3.5 Cash Flow 65
3.6 Financial Statement Analysis 66
3.7 Ratio Analysis 67
3.8 The Du Pont Identity 74
3.9 Using Financial Statement Information 76
Summary and Conclusions 78
Questions and Problems 78
Exam Question (45 minutes) 83
Mini Case 84
Practical Case Study 85
Relevant Accounting Standards 85
Additional Reading 85
Detailed Table of Contents
4 Discounted Cash Flow Valuation 86
4.1 Valuation: The One-period Case 87
4.2 Valuation: The Multi-period Case 90
4.3 Compounding Periods 96
4.4 Simplifications 100
Summary and Conclusions 108
Questions and Problems 109
Exam Question (45 minutes) 112
Mini Case 113
Practical Case Study 113
Additional Reading 114
Endnotes 114
5 How to Value Bonds and Stocks 115
5.1 Definition and Example of a Bond 116
5.2 How to Value Bonds 116
5.3 Bond Concepts 119
5.4 The Present Value of Equity 121
5.5 Estimates of Parameters in the
Dividend Growth Model 124
5.6 Growth Opportunities 128
5.7 The Dividend Growth Model and the
NPVGO Model 131
5.8 Stock Market Reporting 132
5.9 Firm Valuation 134
Summary and Conclusions 138
Questions and Problems 140
Exam Question (45 minutes) 144
Mini Case 144
Practical Case Study 145
Relevant Accounting Standards 145
Additional Reading 146
Endnotes 146
6 Net Present Value and Other
Investment Rules 147
6.1 The Net Present Value Method 148
6.2 The Payback Period Method 150
6.3 The Discounted Payback
Period Method 152
6.4 The Average Accounting
Return Method 153
6.5 The Internal Rate of Return 155
6.6 Problems with the IRR Approach 157
6.7 The Profitability Index 163
6.8 Other Investment Appraisal Methods 165
6.9 The Practice of Capital Budgeting 166
Summary and Conclusions 168
Questions and Problems 168
Exam Question (45 minutes) 174
Mini Case 174
Practical Case Study 175
Additional Reading 175
Endnotes 175
7 Making Capital Investment
Decisions 177
7.1 Incremental Cash Flows 178
7.2 Energy Renewables Ltd: An Example 180
7.3 Inflation and Capital Budgeting 186
7.4 Alternative Definitions of Operating
Cash Flow 190
7.5 Investments of Unequal Lives:
The Equivalent Annual Cost Method 191
Summary and Conclusions 195
Questions and Problems 195
Exam Question (45 minutes) 201
Mini Case 202
Practical Case Study 202
Relevant Accounting Standards 203
Additional Reading 204
Endnote 204
8 Risk Analysis, Real Options
and Capital Budgeting 205
8.1 Sensitivity Analysis, Scenario
Analysis and Break-even Analysis 206
8.2 Monte Carlo Simulation 212
8.3 Real Options 216
8.4 Decision Trees 219
Summary and Conclusions 221
Questions and Problems 221
Exam Question (45 minutes) 228
Mini Case 228
Practical Case Study 230
Relevant Accounting Standards 230
Additional Reading 231
Endnotes 231
Part 3: Risk 232
9 Risk and Return: Lessons from
Market History 233
9.1 Returns 234
9.2 Holding Period Returns 237
9.3 Return Statistics 239
9.4 Average Stock Returns and
Risk-free Returns 241
9.5 Risk Statistics 242
9.6 More on Average Returns 245
Summary and Conclusions 248
Questions and Problems 248
Exam Question (45 minutes) 251
Mini Case 252
Practical Case Study 253
Relevant Accounting Standards 253
References 253
Additional Reading 254
Endnote 254
10 Risk and Return: The Capital
Asset Pricing Model 255
10.1 Individual Securities 256
10.2 Expected Return, Variance and Covariance 256
10.3 The Return and Risk for Portfolios 261
10.4 The Efficient Set for Two Assets 265
10.5 The Efficient Set for Many Securities 268
10.6 Diversification: An Example 271
10.7 Riskless Borrowing and Lending 273
10.8 Market Equilibrium 276
10.9 The Capital Asset Pricing Model 279
10.10 Criticisms of the CAPM 283
10.11 Variations of the CAPM 284
Summary and Conclusions 285
Questions and Problems 286
Exam Question (45 minutes) 292
Mini Case 292
Practical Case Study 293
References 293
Additional Reading 294
Endnotes 294
11 Factor Models, the Arbitrage
Pricing Theory, and Other
Alternatives to CAPM 296
11.1 Factor Models: Announcements,
Surprises and Expected Returns 297
11.2 Risk: Systematic and Unsystematic 298
11.3 Systematic Risk and Betas 299
11.4 Portfolios and Factor Models 302
11.5 Betas and Expected Returns 305
11.6 The Capital Asset Pricing Model and
the Arbitrage Pricing Theory 307
11.7 Other Alternatives to CAPM 308
Summary and Conclusions 310
Questions and Problems 311
Exam Question (45 minutes) 317
Mini Case 317
References 318
Additional Reading 318
Endnotes 318
12 Risk, Cost of Capital and Capital
Budgeting 319
12.1 The Cost of Equity Capital 320
12.2 Estimation of Beta 322
12.3 Determinants of Beta 324
12.4 Extensions of the Basic Model 327
12.5 Estimating Carrefour Group’s
Cost of Capital 330
12.6 Reducing the Cost of Capital 331
12.7 How Do Corporations Estimate Cost of
Capital in Practice? 334
12.8 Economic Value Added and the
Measurement of Financial
Performance 336
Summary and Conclusions 338
Questions and Problems 338
Exam Question (45 minutes) 343
Mini Case 343
References 344
Additional Reading 344
Endnotes 345
13 Efficient Capital Markets and
Behavioural Finance 346
13.1 Can Financing Decisions
Create Value? 347
13.2 A Description of Efficient
Capital Markets 348
13.3 The Different Types of Efficiency 350
13.4 The Evidence 353
13.5 The Behavioural Challenge to Market
Efficiency 358
13.6 Empirical Challenges to
Market Efficiency 359
13.7 Behavioural Biases in Corporate Finance 364
Summary and Conclusions 366
Questions and Problems 367
Exam Question (45 minutes) 371
Mini Case 371
Practical Case Study 372
Relevant Accounting Standards 373
References 373
Additional Reading 374
Endnotes 374
Part 4: Long-term Financing 375
14 Long-term Financing: An Introduction 376
14.1 Ordinary Shares: The Basics 377
14.2 Corporate Long-term Debt: The Basics 380
14.3 Preference Shares 382
14.4 Patterns of Financing 383
14.5 Hierarchies in Long-term Financing 385
Summary and Conclusions 386
Questions and Problems 387
Exam Question (45 minutes) 389
Mini Case 389
Practical Case Study 390
Relevant Accounting Standard 390
References 390
Additional Reading 390
Endnote 391
15 Equity Financing 392
15.1 The Public Issue 393
15.2 Alternative Issue Methods 393
15.3 The Cash Offer 394
15.4 The Announcement of New
Equity and the Value of the Firm 401
15.5 The Cost of New Issues 402
15.6 Rights 403
15.7 Shelf Registration 406
15.8 The Private Equity Market 407
Summary and Conclusions 411
Questions and Problems 411
Exam Question (45 minutes) 416
Mini Case 416
Practical Case Study 417
Relevant Accounting Standard 417
References 417
Additional Reading 418
Endnotes 420
16 Debt Financing 421
16.1 Bank Loans 422
16.2 Debt Financing 423
16.3 The Public Issue of Bonds 424
16.4 Bond Refunding 427
16.5 Bond Ratings 430
16.6 Some Different Types of Bonds 433
16.7 Private Placement Compared to
Public Issues 436
16.8 Long-term Syndicated Bank Loans 436
Summary and Conclusions 438
Questions and Problems 438
Exam Question (45 minutes) 441
Mini Case 441
Practical Case Study 442
Relevant Accounting Standards 442
References 443
Additional Reading 443
Endnotes 444
17 Leasing 445
17.1 Types of Lease Financing 446
17.2 Accounting and Leasing 447
17.3 The Cash Flows of Leasing 448
17.4 A Detour for Discounting and Debt
Capacity with Corporate Taxes 450
17.5 NPV Analysis of the Lease-versus-buy
Decision 452
17.6 Does Leasing Ever Pay? 453
17.7 Reasons for Leasing 455
17.8 Some Unanswered Questions
about Leasing 458
Summary and Conclusions 459
Questions and Problems 459
Exam Question (45 minutes) 462
Mini Case 462
Practical Case Study 462
Relevant Accounting Standards 462
References 463
Additional Reading 463
Endnotes 463
Part 5: Capital Structure
and Dividend Policy 464
18 Capital Structure: Basic Concepts 465
18.1 The Capital Structure Question and
the Pie Theory 466
18.2 Maximizing Firm Value versus
Maximizing Shareholder Interests 466
18.3 Financial Leverage and Firm Value:
An Example 468
18.4 Modigliani and Miller: Proposition II
(No Taxes) 472
18.5 Corporate Taxes 479
18.6 Personal Taxes 485
Summary and Conclusions 488
Questions and Problems 488
Exam Question (45 minutes) 493
Mini Case 493
Practical Case Study 494
References 494
Additional Reading 495
Endnotes 495
19 Capital Structure: Limits to the
Use of Debt 497
19.1 Costs of Financial Distress 498
19.2 Description of Financial Distress Costs 498
19.3 Can Costs of Debt Be Reduced? 503
19.4 Integration of Tax Effects and Financial
Distress Costs 504
19.5 Signalling 506
19.6 Shirking, Perquisites and Bad
Investments: A Note on Agency
Cost of Equity 508
19.7 The Pecking Order Theory 510
19.8 Growth and the Debt–equity Ratio 513
19.9 Market Timing Theory 514
19.10 How Firms Establish Capital Structure 514
Summary and Conclusions 518
Questions and Problems 519
Exam Question (45 minutes) 523
Mini Case 523
Practical Case Study 524
References 524
Additional Reading 525
Endnotes 526
20 Valuation and Capital Budgeting
for the Levered Firm 527
20.1 Adjusted Present Value Approach 528
20.2 Flow to Equity Approach 529
20.3 Weighted Average Cost of Capital Method 530
20.4 A Comparison of the APV, FTE and
WACC Approaches 531
20.5 Capital Budgeting When the
Discount Rate Must Be Estimated 533
20.6 APV Example 534
20.7 Beta and Leverage 538
20.8 Net Asset Value 540
Summary and Conclusions 542
Questions and Problems 543
Exam Question (45 minutes) 547
Mini Case 548
Practical Case Study 549
References 549
Additional Reading 549
Endnotes 549
21 Dividends and Other Payouts 551
21.1 Different Types of Dividends 552
21.2 Standard Method of Cash Dividend
Payment 553
21.3 The Benchmark Case: An Illustration of
the Irrelevance of Dividend Policy 555
21.4 Share Repurchases 558
21.5 Personal Taxes and Dividends 560
21.6 Real-world Factors Favouring a
High-dividend Policy 563
21.7 The Clientele Effect 566
21.8 A Catering Theory of Dividends 567
21.9 What We Know and Do Not Know about
Dividend Policy 568
21.10 Stock Dividends and Stock Splits 572
Summary and Conclusions 574
Questions and Problems 574
Exam Question (45 minutes) 579
Mini Case 579
Practical Case Study 580
Relevant Accounting Standards 580
References 580
Additional Reading 581
Endnotes 583
Part 6: Options, Futures
and Corporate Finance 584
22 Options and Corporate Finance 585
22.1 Options 586
22.2 Call Options 586
22.3 Put Options 587
22.4 Writing Options 588
22.5 Option Quotes 589
22.6 Option Combinations 590
22.7 Valuing Options 593
22.8 An Option Pricing Formula 596
22.9 The ‘Greeks’ 603
22.10 Shares and Bonds as Options 604
Summary and Conclusions 609
Questions and Problems 609
Exam Question (45 minutes) 615
Mini Case 615
Relevant Accounting Standards 616
Reference 616
Additional Reading 617
Endnotes 617
23 Options and Corporate Finance:
Extensions and Applications 618
23.1 Executive Share Options 619
23.2 Investment in Real Projects and Options 621
23.3 Valuing a Start-up 623
23.4 More about the Binomial Model 626
23.5 Shutdown and Reopening Decisions 631
23.6 Options and Capital Budgeting 636
Summary and Conclusions 637
Questions and Problems 638
Exam Question (45 minutes) 640
Mini Case 641
Practical Case Study 641
Relevant Accounting Standards 642
References 642
Additional Reading 642
Endnotes 643
24 Warrants and Convertibles 644
24.1 Warrants 645
24.2 The Difference between Warrants and
Call Options 646
24.3 Warrant Pricing and the
Black–Scholes Model 647
24.4 Convertible Bonds 648
24.5 The Value of Convertible Bonds 649
24.6 Reasons for Issuing Warrants and
Convertibles 652
24.7 Why Are Warrants and
Convertibles Issued? 654
24.8 Conversion Policy 656
Summary and Conclusions 657
Questions and Problems 658
Exam Question (45 minutes) 660
Mini Case 661
Practical Case Study 662
Relevant Accounting Standards 662
References 662
Additional Reading 663
Endnotes 664
25 Financial Risk Management with
Derivatives 665
25.1 Derivatives, Hedging and Risk 666
25.2 Forward Contracts 666
25.3 Futures Contracts 667
25.4 Hedging 670
25.5 Interest Rate Derivatives 672
25.6 Duration Hedging 677
25.7 Swaps Contracts 681
25.8 Financial Risk Management in Practice 684
Summary and Conclusions 686
Questions and Problems 686
Exam Question (45 minutes) 690
Mini Case 690
Practical Case Study 691
Relevant Accounting Standards 691
References 691
Additional Reading 691
Endnotes 692
Part 7: Financial Planning and
Short-term Finance 693
26 Short-term Finance and Planning 694
26.1 Tracing Cash and Net Working Capital 695
26.2 Defining Cash in Terms of Other
Elements 695
26.3 The Operating Cycle and the Cash Cycle 696
26.4 Some Aspects of Short-term
Financial Policy 699
26.5 Cash Budgeting 704
26.6 The Short-term Financial Plan 706
Summary and Conclusions 707
Questions and Problems 708
Exam Question (45 minutes) 714
Mini Case 714
Practical Case Study 715
Relevant Accounting Standards 715
References 715
Additional Reading 716
Endnotes 716
27 Short-term Capital Management 717
27.1 Reasons for Holding Cash 718
27.2 Determining the Target Cash Balance 719
27.3 Managing the Collection and
Disbursement of Cash 724
27.4 Investing Idle Cash 725
27.5 Terms of Sale 727
27.6 The Decision to Grant Credit: Risk and
Information 730
27.7 Optimal Credit Policy 732
27.8 Credit Analysis 734
27.9 Collection Policy 735
27.10 How to Finance Trade Credit 736
Summary and Conclusions 737
Questions and Problems 737
Exam Question (45 minutes) 741
Mini Case 741
References 742
Additional Reading 742
Part 8: Special Topics 744
28 Mergers and Acquisitions 745
28.1 The Basic Forms of Acquisition 746
28.2 Synergy 748
28.3 Sources of Synergy 749
28.4 Two ‘Bad’ Reasons for Mergers 752
28.5 A Cost to Shareholders from Reduction
in Risk 756
28.6 The NPV of a Merger 758
28.7 Valuation of Mergers in Practice 760
28.8 Friendly versus Hostile Takeovers 762
28.9 Defensive Tactics 763
28.10 The Diary of a Takeover: Takeda and
Shire plc 765
28.11 Do Mergers Add Value? 770
28.12 Accounting and Tax Considerations 774
28.13 Going Private and Leveraged Buyouts 774
28.14 Divestitures 775
Summary and Conclusions 776
Questions and Problems 776
Exam Question (45 minutes) 782
Mini Case 783
Practical Case Study 784
Relevant Accounting Standards 784
References 784
Additional Reading 785
Endnotes 788
29 Financial Distress 789
29.1 What is Financial Distress? 790
29.2 What Happens in Financial Distress? 792
29.3 Bankruptcy, Liquidation and
Reorganization 795
29.4 Private Workout or Bankruptcy:
Which is Best? 799
29.5 Predicting Financial Distress:
The Z-score Model 800
Summary and Conclusions 802
Questions and Problems 802
Exam Question (45 minutes) 804
Mini Case 805
Practical Case Study 806
Relevant Accounting Standards 807
References 807
Additional Reading 807
Endnotes 808
30 International Corporate Finance 809
30.1 Terminology 811
30.2 Foreign Exchange Markets and
Exchange Rates 812
30.3 Purchasing Power Parity 816
30.4 Interest Rate Parity, Unbiased
Forward Rates and the International
Fisher Effect 820
30.5 International Capital Budgeting 823
30.6 Exchange Rate Risk 825
30.7 Political Risk 827
30.8 Long-term Islamic Financing 828
Summary and Conclusions 831
Questions and Problems 832
Exam Question (45 minutes) 836
Mini Case 836
Practical Case Study 837
Relevant Accounting Standards 838
Additional Reading 838
Endnote 838
Table of Equations 839
Index 851
The Following Can be Accessed
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Appendices
Chapter 3 Appendix Financial Planning
Chapter 4 Appendix Net Present Value: First
Principles of Finance
Chapter 5 Appendix The Term Structure of Interest
Rates, Spot Rates and Yield to Maturity
Chapter 19 Appendix A Some Useful Formulae of
Financial Structure
Appendix A Mathematical Tables
Web Glossary