Brief ContentsCHAPTER 1 Corporate Finance and the Financial Manager 2 CHAPTER 2 Introduction to Financial Statement Analysis 23 CHAPTER 3 Time Value of Money: An Introduction 62 CHAPTER
Trang 2Corporate Finance
S E C O N D E D I T I O N
Trang 4Jarrad Harford UNIVERSITY OF WASHINGTON
Trang 5The Capital Budgeting Decision: Economic
Analysis of Investment Projects
Financial Services and Financial Institutions:
Value Creation in Theory and Practice
Financial Management for Public, Health,
and Not-for-Profit Organizations
Trang 6and for being there —J B.
To Kaui, Pono, Koa, and Kai for all the love and laughter —P D.
To Katrina, Evan, and Cole for your love and support —J H.
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Library of Congress Cataloging-in-Publication Data
10 9 8 7 6 5 4 3 2 1
Trang 8Brief Contents
CHAPTER 1 Corporate Finance and the Financial Manager 2
CHAPTER 2 Introduction to Financial Statement Analysis 23
CHAPTER 3 Time Value of Money: An Introduction 62
CHAPTER 4 Time Value of Money: Valuing Cash Flow Streams 83
CHAPTER 5 Interest Rates 117
CHAPTER 6 Bonds 144
CHAPTER 7 Stock Valuation 182
CHAPTER 8 Investment Decision Rules 210
CHAPTER 9 Fundamentals of Capital Budgeting 247
CHAPTER 10 Stock Valuation: A Second Look 282
CHAPTER 11 Risk and Return in Capital Markets 316
CHAPTER 12 Systematic Risk and the Equity Risk Premium 345
CHAPTER 13 The Cost of Capital 381
CHAPTER 14 Raising Equity Capital 410
CHAPTER 15 Debt Financing 438
CHAPTER 16 Capital Structure 460
CHAPTER 17 Payout Policy 498
CHAPTER 18 Financial Modeling and Pro Forma Analysis 534
CHAPTER 19 Working Capital Management 564
CHAPTER 20 Short-Term Financial Planning 591
CHAPTER 21 Option Applications and Corporate Finance 622
CHAPTER 22 Mergers and Acquisitions 648
CHAPTER 23 International Corporate Finance 679
Trang 91.2 The Four Types of Firms 4
Sole Proprietorships 5
Partnerships 5
Limited Liability Companies 6
Corporations 6
Tax Implications for Corporate Entities 7
1.3 The Financial Manager 9
Q Corporate Taxation Around the World 9
Making Investment Decisions 10
Making Financing Decisions 10
Managing Short-Term Cash Needs 10
The Goal of the Financial Manager 11
1.4 The Financial Manager’s Place in the
Corporation 11 The Corporate Management Team 11
Ethics and Incentives in Corporations 12
1.5 The Stock Market 14
The Largest Stock Markets 14
Primary Versus Secondary Markets 14
Physical Stock Markets 15
Over-the-Counter Stock Markets 15
Q NYSE, AMEX, DJIA, S&P 500: Awash in
Listing Standards 16
Other Financial Markets 17
1.6 Financial Institutions 17
The Financial Cycle 17
Types of Financial Institutions 18
Role of Financial Institutions 18
Q International Financial Reporting Standards 26
2.2 The Balance Sheet 26 Assets 27
Liabilities 28 Stockholders’ Equity 28 2.3 Balance Sheet Analysis 30 Market-to-Book Ratio 30 Debt-Equity Ratio 30 Enterprise Value 31 Other Balance Sheet Information 32 2.4 The Income Statement 33 Earnings Calculations 33 2.5 Income Statement Analysis 35 Profitability Ratios 35 Asset Efficiency 36 Working Capital Ratios 36 EBITDA 37
Leverage Ratios 37 Investment Returns 37 The DuPont Identity 38 Valuation Ratios 39
Q COMMON MISTAKE Mismatched Ratios
40
2.6 The Statement of Cash Flows 42 Operating Activity 42
Investment Activity 44 Financing Activity 44 2.7 Other Financial Statement Information 45 Management Discussion and Analysis 45 Statement of Stockholders’ Equity 46 Notes to the Financial Statements 46 2.8 Financial Reporting in Practice 46 Enron 46
The Sarbanes-Oxley Act 47
Q Practitioner INTERVIEW WITH
Sue Frieden, Ernst & Young 48 The Financial Statements: A Useful Starting Point 49
Summary 49 Q Critical Thinking 52 Q Problems 52 Q Data Case 58
PART 1
Detailed Contents
viii
Trang 10Interest Rates and Valuing
Role of the Financial Manager 64
Quantifying Costs and Benefits 64
Q When Competitive Market Prices Are Not
Available 66
3.2 Market Prices and the Valuation Principle 66
The Valuation Principle 67
Why There Can Be Only One Competitive Price
for a Good 67
Q Your Personal Financial Decisions 68
3.3 The Time Value of Money and Interest Rates
68 The Time Value of Money 69
The Interest Rate: Converting Cash Across Time
70 Timelines 72
3.4 Valuing Cash Flows at Different Points in Time
73 Rule 1: Comparing and Combining Values 73
Q COMMON MISTAKE Summing Cash Flows
CHAPTER 4 Time Value of Money: Valuing Cash
Flow Streams 83
Q INTERVIEW WITH Gregory Goin, McFee
Financial Group 84 4.1 Valuing a Stream of Cash Flows 85
Applying the Rules of Valuing Cash Flows to a
Cash Flow Stream 85
Q Using a Financial Calculator: Solving for
Present and Future Values of Cash Flow
4.2 Perpetuities 89
Perpetuities 89
Q Historical Examples of Perpetuities 91
Q COMMON MISTAKE Discounting One Too
4.3 Annuities 92 Present Value of an Annuity 92 Future Value of an Annuity 95 4.4 Growing Cash Flows 96 Growing Perpetuity 96 Growing Annuity 98 4.5 Solving for Variables Other Than Present Value
or Future Value 99 Solving for the Cash Flows 100 Rate of Return 102
Solving for the Number of Periods 104
Summary 106 Q Critical Thinking 108 Q Problems 108 Q Data Case 113
CHAPTER 4 APPENDIX Using a Financial
Calculator 114 Specifying Decimal Places 114 Toggling Between the Beginning and End of a Period 114
Set the Number of Periods per Year 114 General TVM Buttons 114
Solving for the Future Value of an Annuity (Example 4.5) 115
Solving for the Rate of Return 115
CHAPTER 5 Interest Rates 117
Q INTERVIEW WITH Jason Moore, Bradford
& Marzec, LLC 118 5.1 Interest Rate Quotes and Adjustments 119 The Effective Annual Rate 119
Adjusting the Discount Rate to Different Time Periods 120
Annual Percentage Rates 121
Q COMMON MISTAKE Using the EAR
5.2 Application: Discount Rates and Loans 124 Computing Loan Payments 124
Computing the Outstanding Loan Balance 126 5.3 The Determinants of Interest Rates 127 Inflation and Real Versus Nominal Rates 127 Investment and Interest Rate Policy 128
Q How Is Inflation Actually Calculated? 130
The Yield Curve and Discount Rates 130
Q Practitioner INTERVIEW WITH Frederic S.
Mishkin, Columbia University 132
Q COMMON MISTAKE Using the Annuity
The Yield Curve and the Economy 133
PART 2
Trang 115.4 The Opportunity Cost of Capital 136
Q Interest Rates, Discount Rates, and the Cost
6.2 Zero-Coupon Bonds 147
Zero-Coupon Bond Cash Flows 148
Yield to Maturity of a Zero-Coupon Bond 148
Risk-Free Interest Rates 149
6.3 Coupon Bonds 151
Coupon Bond Cash Flows 151
Q The U.S Treasury Market 152
Yield to Maturity of a Coupon Bond 152
Q Finding Bond Prices on the Web 154
Coupon Bond Price Quotes 155
6.4 Why Bond Prices Change 156
Interest Rate Changes and Bond Prices 156
Time and Bond Prices 158
Interest Rate Risk and Bond Prices 160
Q Clean and Dirty Prices for Coupon Bonds
162
Bond Prices in Practice 163
6.5 Corporate Bonds 164
Credit Risk 164
Q Practitioner INTERVIEW WITH Lisa Black,
Teachers Insurance and Annuity Association 165
Corporate Bond Yields 166
Bond Ratings 166
Corporate Yield Curves 166
Q The Credit Crisis and Bond Yields 168
Summary 170
Q Critical Thinking 171 Q Problems 172
Q Data Case 175
CHAPTER 6 APPENDIX A Solving for the Yield
to Maturity of a Bond Using a Financial Calculator 177
CHAPTER 6 APPENDIX B The Yield Curve
and the Law of One Price 178
CHAPTER 7 Stock Valuation 182
Q INTERVIEW WITH Christopher Ellis-Ferrara,
AllianceBernstein 183 7.1 Stock Basics 184
Stock Market Reporting: Stock Quotes 184
Common Stock 185 Preferred Stock 186 7.2 The Mechanics of Stock Trades 187 7.3 The Dividend-Discount Model 188
A One-Year Investor 188 Dividend Yields, Capital Gains, and Total Returns 189
A Multiyear Investor 190 Dividend-Discount Model Equation 191 7.4 Estimating Dividends in the Dividend-Discount Model 192
Constant Dividend Growth 192 Dividends Versus Investment and Growth 193 Changing Growth Rates 195
Q COMMON MISTAKE Forgetting to “Grow”
Value Drivers and the Dividend-Discount Model 198
7.5 Limitations of the Dividend-Discount Model 198
Uncertain Dividend Forecasts 198 Non-Dividend-Paying Stocks 199 7.6 Share Repurchases and the Total Payout Model 200
7.7 Putting It All Together 201
Summary 202
Q Critical Thinking 204 Q Problems 204
PART 2 INTEGRATIVE CASE 207
CHAPTER 8 Investment Decision Rules 210
Q INTERVIEW WITH Scott Ladner, Parsons
Brinckerhoff 211 8.1 The NPV Decision Rule 212 Net Present Value 212 The NPV Decision Rule 213 8.2 Using the NPV Rule 214 Organizing the Cash Flows and Computing the NPV 214
The NPV Profile 215 Measuring Sensitivity with IRR 216 Alternative Rules Versus the NPV Rule 216 8.3 Alternative Decision Rules 216
Q USING EXCEL Computing NPV and IRR 217
The Payback Rule 218 The Internal Rate of Return Rule 219
Q COMMON MISTAKE IRR Versus the IRR Rule
223
PART 3
Trang 12Modified Internal Rate of Return 223
Q Why Do Rules Other Than the NPV Rule
Persist? 224
8.4 Choosing Between Projects 226
Differences in Scale 227
Q Practitioner INTERVIEW WITH
Dick Grannis, QUALCOMM 230 Timing of the Cash Flows 231
8.5 Evaluating Projects with Different Lives 232
Important Considerations When Using the
Equivalent Annual Annuity 234 8.6 Choosing Among Projects When Resources Are
Limited 235 Evaluating Projects with Different Resource
Requirements 235 8.7 Putting It All Together 238
9.2 Forecasting Incremental Earnings 250
Operating Expenses Versus Capital Expenditures
250 Incremental Revenue and Cost Estimates 251
Taxes 252
Incremental Earnings Forecast 252
9.3 Determining Incremental Free Cash Flow 254
Converting from Earnings to Free Cash Flow
255 Calculating Free Cash Flow Directly 258
Calculating the NPV 259
9.4 Other Effects on Incremental Free Cash Flows
260 Opportunity Costs 260
Q COMMON MISTAKE The Opportunity Cost
Q Practitioner INTERVIEW WITH
David Holland, Sports and Entertainment Solutions 268
Scenario Analysis 269 9.6 Real Options in Capital Budgeting 270 Option to Delay 270
Option to Expand 270 Option to Abandon 270
Q INTERVIEW WITH David Mandell, William
Blair & Company 283 10.1 The Discounted Free Cash Flow Model 284 Valuing the Enterprise 284
Implementing the Model 285 Connection to Capital Budgeting 286 10.2 Valuation Based on Comparable Firms 288 Valuation Multiples 288
Limitations of Multiples 293 Comparison with Discounted Cash Flow Methods 294
Stock Valuation Techniques: The Final Word 294
Q Practitioner INTERVIEW WITH
Marilyn Fedak, AllianceBernstein 295 10.3 Information, Competition, and Stock Prices 296
Information in Stock Prices 296 Competition and Efficient Markets 298
Forms of Market Efficiency 298
Lessons for Investors and Corporate Managers 300
The Efficient Markets Hypothesis Versus No Arbitrage 301
10.4 Individual Biases and Trading 302 Excessive Trading and Overconfidence 302 Hanging On to Losers and the Disposition Effect 302
Investor Attention, Mood, and Experience 303
Trang 13Risk and Return 315
CHAPTER 11 Risk and Return in Capital Markets
316
Q INTERVIEW WITH Sunita S Mohanty,
Absolute Return for Kids 317 11.1 A First Look at Risk and Return 318
11.2 Historical Risks and Returns of Stocks 320
Computing Historical Returns 321
Average Annual Returns 323
Q Arithmetic Average Returns Versus
Compound Annual Returns 325
The Variance and Volatility of Returns 326
Q COMMON MISTAKE Mistakes When
Q USING EXCEL Computing the Standard
The Normal Distribution 329
11.3 The Historical Tradeoff Between Risk and
Return 331 The Returns of Large Portfolios 331
The Returns of Individual Stocks 332
11.4 Common Versus Independent Risk 332
Theft Versus Earthquake Insurance: An Example
332 Types of Risk 333
11.5 Diversification in Stock Portfolios 334
Unsystematic Versus Systematic Risk 334
Diversifiable Risk and the Risk Premium 337
The Importance of Systematic Risk 337
Q COMMON MISTAKE A Fallacy of Long-Run
Summary 339
Q Critical Thinking 341 Q Problems 342
CHAPTER 12 Systematic Risk and the Equity Risk
Q INTERVIEW WITH Alexander Morgan,
Pantheon Ventures 346 12.1 The Expected Return of a Portfolio 347
Portfolio Weights 347
Portfolio Returns 347
Expected Portfolio Return 349
12.2 The Volatility of a Portfolio 350
Diversifying Risks 350
Measuring Stocks’ Co-movement: Correlation
352
Q USING EXCEL Calculating the Correlation
Computing a Portfolio’s Variance and Standard Deviation 354
The Volatility of a Large Portfolio 356
Q NOBEL PRIZE Harry Markowitz 357
12.3 Measuring Systematic Risk 358 Role of the Market Portfolio 358 Stock Market Indexes as the Market Portfolio 359
Market Risk and Beta 359
Q Index Funds 360
Q COMMON MISTAKE Mixing Standard
Estimating Beta from Historical Returns 363
Q USING EXCEL Calculating a Stock’s Beta
Q NOBEL PRIZE William Sharpe
The Security Market Line 368 The CAPM and Portfolios 370 Summary of the Capital Asset Pricing Model 371
The Big Picture 371
Summary 372
Q Critical Thinking 373 Q Problems 373
CHAPTER 12 APPENDIX Alternative Models
of Systematic Risk 378
CHAPTER 13 The Cost of Capital 381
Q INTERVIEW WITH John Drum, KPMG LLP
382 13.1 A First Look at the Weighted Average Cost of Capital 383
The Firm’s Capital Structure 383 Opportunity Cost and the Overall Cost of Capital 384
Weighted Averages and the Overall Cost of Capital 384
Weighted Average Cost of Capital Calculations 384
13.2 The Firm’s Costs of Debt and Equity Capital 386
Cost of Debt Capital 386
Q COMMON MISTAKE Using the Coupon Rate
PART 4
Trang 14Cost of Preferred Stock Capital 388
Cost of Common Stock Capital 388
13.3 A Second Look at the Weighted Average Cost
of Capital 390 WACC Equation 391
Weighted Average Cost of Capital in Practice
391 Methods in Practice 392
13.4 Using the WACC to Value a Project 394
Key Assumptions 394
WACC Method Application: Extending the Life of
a DuPont Facility 395 Summary of the WACC Method 396
13.5 Project-Based Costs of Capital 396
Cost of Capital for a New Acquisition 397
Divisional Costs of Capital 397
Q Practitioner INTERVIEW WITH
Shelagh Glaser, Intel 398 13.6 When Raising External Capital Is Costly 399
CHAPTER 14 Raising Equity Capital 410
Q INTERVIEW WITH Sandra Pfeiler, Goldman
Sachs 411 14.1 Equity Financing for Private Companies 412
Sources of Funding 412
Securities and Valuation 414
Exiting an Investment in a Private Company 416
14.2 Taking Your Firm Public: The Initial Public
Offering 416 Advantages and Disadvantages of Going Public
416 Primary and Secondary IPO Offerings 417
Other IPO Types 422
Q Google’s IPO 425
14.3 IPO Puzzles 425
Underpriced IPOs 425
“Hot” and “Cold” IPO Markets 427
Q 2008–2009: A Very Cold IPO Market 427
High Cost of Issuing an IPO 428
Poor Post-IPO Long-Run Stock Performance
429
14.4 Raising Additional Capital: The Seasoned Equity Offering 429
SEO Process 429 SEO Price Reaction 431 SEO Costs 432
Summary 433
Q Critical Thinking 434 Q Problems 434
CHAPTER 15 Debt Financing 438
Q INTERVIEW WITH Eric Hassberger, Strategic
Hotels & Resorts 439 15.1 Corporate Debt 440 Private Debt 440
Q Debt Financing at Hertz: Bank Loans 440
Q Debt Financing at Hertz: Private Placements 441
Public Debt 441
Q Debt Financing at Hertz: Public Debt 443
15.2 Bond Covenants 445 Types of Covenants 445 Advantages of Covenants 445 Application: Hertz’s Covenants 446 15.3 Repayment Provisions 446 Call Provisions 446 Sinking Funds 449 Convertible Provisions 449
Summary 452
Q Critical Thinking 453 Q Problems 453
CHAPTER 15 APPENDIX Using a Financial
Calculator to Calculate Yield to Call 455
PART 5 INTEGRATIVE CASE 456
Capital Structure and Payout
CHAPTER 16 Capital Structure 460
Q INTERVIEW WITH Christopher Cvijic,
Morgan Stanley 461 16.1 Capital Structure Choices 462 Capital Structure Choices Across Industries 462
Capital Structure Choices Within Industries 462 16.2 Capital Structure in Perfect Capital Markets 464
Application: Financing a New Business 465 Leverage and Firm Value 466
PART 6 PART 5
Trang 15The Effect of Leverage on Risk and Return 467
Homemade Leverage 469
Leverage and the Cost of Capital 469
Q COMMON MISTAKE Capital Structure
MM and the Real World 472
Q NOBEL PRIZE Franco Modigliani and Merton
16.3 Debt and Taxes 473
The Interest Tax Deduction and Firm Value 473
Value of the Interest Tax Shield 474
The Interest Tax Shield with Permanent Debt
476 Leverage and the WACC with Taxes 477
Debt and Taxes: The Bottom Line 477
16.4 The Costs of Bankruptcy and Financial Distress
479 Direct Costs of Bankruptcy 479
Q Bankruptcy Can Be Expensive 479
Indirect Costs of Financial Distress 479
16.5 Optimal Capital Structure: The Tradeoff Theory
480 Differences Across Firms 481
Optimal Leverage 481
16.6 Additional Consequences of Leverage: Agency
Costs and Information 482 Agency Costs 483
Q Airlines Use Financial Distress to Their
Advantage 483
Q Financial Distress and Rolling the Dice,
Literally 484
Debt and Information 485
16.7 Capital Structure: Putting It All Together 487
Summary 488
Q Critical Thinking 490 Q Problems 490
CHAPTER 16 APPENDIX The Bankruptcy Code
497
CHAPTER 17 Payout Policy 498
Q INTERVIEW WITH Nitin Garg, Intuit 499
17.1 Cash Distributions to Shareholders 500
Dividends 501
Share Repurchases 502
17.2 Dividends Versus Share Repurchases in a
Perfect Capital Market 503 Alternative Policy 1: Pay a Dividend with Excess
Cash 504 Alternative Policy 2: Share Repurchase (No
Dividend) 504
Q COMMON MISTAKE Repurchases
Alternative Policy 3: High Dividend (Equity Issue) 506
Modigliani-Miller and Dividend Policy Irrelevance 507
Q COMMON MISTAKE The Bird in the Hand
Dividend Policy with Perfect Capital Markets 508 17.3 The Tax Disadvantage of Dividends 509 Taxes on Dividends and Capital Gains 509 Optimal Dividend Policy with Taxes 509 Tax Differences Across Investors 512 17.4 Payout Versus Retention of Cash 514 Retaining Cash with Perfect Capital Markets 514
Retaining Cash with Imperfect Capital Markets 515
17.5 Signaling with Payout Policy 518 Dividend Smoothing 518 Dividend Signaling 519
Q Royal & SunAlliance’s Dividend Cut 520
Signaling and Share Repurchases 520
Q Practitioner INTERVIEW WITH
John Connors, Microsoft (Retired) 521 17.6 Stock Dividends, Splits, and Spin-Offs 522 Stock Dividends and Splits 522
Q Berkshire Hathaway’s A and B Shares 523
Spin-Offs 523 17.7 Advice for the Financial Manager 524
Analyze the Impact of Potential Business Plans 536
Plan for Future Funding Needs 536 18.2 Forecasting Financial Statements: The Percent
of Sales Method 537
PART 7
Trang 16Percent of Sales Method 537
Pro Forma Income Statement 538
Pro Forma Balance Sheet 539
Q COMMON MISTAKE Confusing
Stockholders’ Equity with Retained
Making the Balance Sheet Balance: Net New
Financing 540 Choosing a Forecast Target 542
18.3 Forecasting a Planned Expansion 542
KMS Designs’ Expansion: Financing Needs 543
KMS Designs’ Expansion: Pro Forma Income
Statement 544
Q COMMON MISTAKE Treating Forecasts
Forecasting the Balance Sheet 546
18.4 Growth and Firm Value 547
Sustainable Growth Rate and External Financing
548 18.5 Valuing the Expansion 551
Forecasting Free Cash Flows 551
Q COMMON MISTAKE Confusing Total
KMS Designs’ Expansion: Effect on Firm Value
553 Optimal Timing and the Option to Delay 556
Summary 557
Q Critical Thinking 558 Q Problems 558
CHAPTER 18 APPENDIX The Balance Sheet
and Statement of Cash Flows 562
CHAPTER 19 Working Capital Management
564
Q INTERVIEW WITH Waleed Husain, Comcast
565 19.1 Overview of Working Capital 566
The Cash Cycle 566
Working Capital Needs by Industry 568
Firm Value and Working Capital 569
19.2 Trade Credit 570
Trade Credit Terms 571
Trade Credit and Market Frictions 571
Q COMMON MISTAKE Using APR Instead
of EAR to Compute the Cost of Trade
Stretching Accounts Payable 579 19.5 Inventory Management 580 Benefits of Holding Inventory 580 Costs of Holding Inventory 581
Q Inventory Management Adds to the Bottom Line at Gap 581
19.6 Cash Management 582 Motivation for Holding Cash 582 Alternative Investments 582
Q Cash Balances 584
Summary 584
Q Critical Thinking 586 Q Problems 586
Q Data Case 589
CHAPTER 20 Short-Term Financial Planning 591
Q INTERVIEW WITH Teresa Wendt,
Lockheed Martin 592 20.1 Forecasting Short-Term Financing Needs 593 Application: Springfield Snowboards, Inc 593 Negative Cash Flow Shocks 594
Positive Cash Flow Shocks 594 Seasonalities 595
The Cash Budget 596 20.2 The Matching Principle 598 Permanent Working Capital 598 Temporary Working Capital 598 Permanent Versus Temporary Working Capital 598
Financing Policy Choices 599 20.3 Short-Term Financing with Bank Loans 601 Single, End-of-Period Payment Loan 601 Line of Credit 601
Bridge Loan 602 Common Loan Stipulations and Fees 602 20.4 Short-Term Financing with Commercial Paper 604
Q Short-Term Financing and the Financial Crisis of the Fall of 2008 604
20.5 Short-Term Financing with Secured Financing 606
Accounts Receivable as Collateral 606
Q A Seventeenth-Century Financing Solution 606
Inventory as Collateral 607 20.6 Putting It All Together: Creating a Short-Term Financial Plan 609
Summary 610
Q Critical Thinking 611 Q Problems 612
PART 7 INTEGRATIVE CASE 616
Trang 17Stock Option Quotations 625
Options on Other Financial Securities 627
Q Options Are for More Than Just Stocks 627
21.2 Option Payoffs at Expiration 627
The Long Position in an Option Contract 628
The Short Position in an Option Contract 629
Profits for Holding an Option to Expiration 631
Returns for Holding an Option to Expiration 633
21.3 Factors Affecting Option Prices 634
Strike Price and Stock Price 634
Option Prices and the Exercise Date 634
Option Prices and the Risk-Free Rate 635
Option Prices and Volatility 635
21.4 The Black-Scholes Option Pricing Formula
636 21.5 Put-Call Parity 638
CHAPTER 22 Mergers and Acquisitions 648
Q INTERVIEW WITH Kyle Finegan,
Croft & Bender LLC 649 22.1 Background and Historical Trends 650
Managerial Motives to Merge 658
22.4 The Takeover Process 659 Valuation 659
The Offer 660 Merger “Arbitrage” 662 Tax and Accounting Issues 663 Board and Shareholder Approval 664 22.5 Takeover Defenses 665
Poison Pills 665 Staggered Boards 666 White Knights 667 Golden Parachutes 667 Recapitalization 667 Other Defensive Strategies 667 Regulatory Approval 668
Q Weyerhaeuser’s Hostile Bid for Willamette Industries 668
22.6 Who Gets the Value Added from a Takeover? 669
The Free Rider Problem 669 Toeholds 670
The Leveraged Buyout 670
Q The Leveraged Buyout of RJR-Nabisco by
The Freezeout Merger 673 Competition 673
Summary 674 Q Critical Thinking 676 Q Problems 676
CHAPTER 23 International Corporate Finance
679
Q INTERVIEW WITH Rob Harvey, Cisco
Systems 680 23.1 Foreign Exchange 681 The Foreign Exchange Market 682 Exchange Rates 683
23.2 Exchange Rate Risk 683 Exchange Rate Fluctuations 684 Hedging with Forward Contracts 686 Cash-and-Carry and the Pricing of Currency Forwards 687
Hedging Exchange Rate Risk with Options 691 23.3 Internationally Integrated Capital Markets 692
Q COMMON MISTAKE Forgetting to Flip
23.4 Valuation of Foreign Currency Cash Flows 694
Application: Ityesi, Inc 695
PART 8
Trang 18The Law of One Price as a Robustness Check
697
23.5 Valuation and International Taxation 698
A Single Foreign Project with Immediate
CHAPTERS ON THE WEB
These Web Chapters are on MyFinanceLab at www.myfinancelab.com
WEB CHAPTER 1 LeasingWEB CHAPTER 2 Insurance and Risk
ManagementWEB CHAPTER 3 Corporate Governance
Trang 19Jonathan Berk is the A.P Giannini Professor
of Finance at the Graduate School of Business,Stanford University, and is a Research Associate at theNational Bureau of Economic Research Prior toStanford, he was the Sylvan Coleman Professor ofFinance at the Haas School of Business at theUniversity of California, Berkeley, where he taught theintroductory Corporate Finance course Before earn-ing his PhD from Yale University, he worked as anassociate at Goldman Sachs, where his education infinance really began His research has won a number
of awards including the TIAA-CREF Paul A.Samuelson Award, the Smith Breeden Prize, Best
Paper of the Year in The Review of Financial Studies,
and the FAME Research Prize His paper “A Critique ofSize-Related Anomalies” was selected as one of the
two best papers ever published in The Review of
Financial Studies In recognition of his influence on the practice of finance, he has
received the Bernstein-Fabozzi/Jacobs Levy Award, the Graham and Dodd Award of
Excellence, and the Roger F Murray Prize He served as an Associate Editor of the Journal
of Finance for eight years and is currently an Advisory Editor at the journal Born in
Johannesburg, South Africa, Professor Berk is married, has two daughters, and is an avidskier and biker
Peter DeMarzois the Mizuho Financial Group Professor of Finance and SeniorAssociate Dean for Academic Affairs at Stanford Graduate School of Business He is also
a Research Associate at the National Bureau of Economic Research He currently teachesMBA and PhD courses in Corporate Finance and Financial Modeling Prior to Stanford,
he taught at the Haas School of Business and the Kellogg Graduate School ofManagement, and he was a National Fellow at the Hoover Institution Professor DeMarzoreceived the Sloan Teaching Excellence Award at Stanford in 2004 and 2006 and the Earl
F Cheit Outstanding Teaching Award at the University of California, Berkeley, in 1998
Professor DeMarzo has served as an Associate Editor for The Review of Financial Studies,
Financial Management, and the B.E Journals in Economic Analysis and Policy, as well
as a Director of the American Finance Association He is currently President of theWestern Finance Association Professor DeMarzo has received numerous awards for hisresearch including the Western Finance Association Corporate Finance Award and the
Barclays Global Investors/Michael Brennan Best Paper Award from The Review of
Financial Studies Professor DeMarzo was born in Whitestone, New York, is married, and
has three sons He and his family enjoy hiking, biking, and skiing
xviii
About the Authors
Jonathan Berk, Peter DeMarzo, and Jarrad Harford
Trang 20Jarrad Harfordis the Marion B Ingersoll Professor of Finance at the University ofWashington Prior to Washington, Professor Harford taught at the Lundquist College ofBusiness at the University of Oregon He received his PhD in Finance with a minor inOrganizations and Markets from the University of Rochester Professor Harford hastaught the core undergraduate finance course, Business Finance, for over thirteen years,
as well as an elective in Mergers and Acquisitions, and “Finance for Non-financialExecutives” in the executive education program He has won numerous awards for histeaching, including the UW Finance Professor of the Year (2010), Interfraternity CouncilExcellence in Teaching Award (2007 and 2008), ISMBA Excellence in Teaching Award(2006), and the Wells Fargo Faculty Award for Undergraduate Teaching (2005) He is alsothe Faculty Director of the UW Business School Undergraduate Honors Program
Professor Harford serves as an Associate Editor for The Journal of Financial Economics,
Journal of Financial and Quantitative Analysis, and Journal of Corporate Finance.
Professor Harford was born in State College, Pennsylvania, is married, and has two sons
He and his family enjoy traveling, hiking, and skiing
Trang 21Bridging Theory
and Practice
xx
EXAMPLE 7.1 Stock Prices and Returns
Problem
Suppose you expect Longs Drug Stores to pay an annual dividend of $0.56 per share in the coming year and to trade for $45.50 per share at the end of the year If investments with equivalent risk to Longs’ stock have an expected return of 6.80%, what is the most you would pay today for Longs’ stock? What dividend yield and capital gain rate would you expect at this price?
Solution Plan
We can use Eq 7.1 to solve for the beginning price we would pay now given our expectations about dividends and future price and the return we need to expect to earn to
be willing to invest We can then use Eq 7.2 to calculate the dividend yield and capital gain rate.
Execute
Using Eq 7.1, we have
Referring to Eq 7.2, we see that at this price, Longs’ dividend yield is The expected capital gain is for a capital gain rate of
Evaluate
At a price of $43.13, Longs’ expected total return is which is equal to its equity cost of capital (the return being paid by investments with equivalent risk to Longs’) This amount is than 6.8% and we would rather invest elsewhere.
1.30% + 5.50% = 6.80%, 2.37/43.13 = 5.50%.
a Lottery Prize Annuity
Problem
You are the lucky winner of the $30 million state lottery You can take your prize money either as (a) 30 ments of $1 million per year (starting today), or (b) $15 million paid today If the interest rate is 8%, which option should you take?
pay-Solution Plan
Option (a) provides $30 million in prize money but paid over time To evaluate it correctly, we must convert
it to a present value Here is the timeline:
Because the first payment starts today, the last payment will occur in 29 years (for a total of 30 payments) 2
The $1 million at date 0 is already stated in present value terms, but we need to compute the present value
of the remaining payments Fortunately, this case looks like a 29-year annuity of $1 million per year, so we can use the annuity formula.
◗
◗
Summing Cash Flows Across Time
COMMON MISTAKE
Once you stand the time value of money, our first rule may seem straightforward However, it is very com- mon, especially for those who have not studied finance, to violate this rule, simply treating all cash flows as comparable regardless of when they are received One example is in sports con- tracts In 2007, Alex Rodriguez and the New York Yankees were negotiating what was repeatedly referred to as a “$275 million” contract The
under-$275 million comes from simply adding up all
the payments Rodriguez would receive over the ten years of the contract and an addi- tional ten years of deferred payments— treating dollars received in 20 years the same as dollars received today The same thing occurred when David Beckham signed
a “$250 million” contract with the LA Galaxy soccer team.
Study Aids with a Practical Focus
To be successful, students need to master the core
concepts and learn to identify and solve problems
that today’s practitioners face.
Q TheValuation Principleis presented as the
foundation of all financial decision making: The
central idea is that a firm should take projects or
make investments that increase the value of the
firm The tools of finance determine the impact of
a project or investment on the firm’s value by
comparing the costs and benefits in equivalent
terms The Valuation Principle is first introduced
in Chapter 3, revisited in the part openers, and
integrated throughout the text.
Q Guided Problem Solutions (GPS)are Examples
that accompany every important concept using a
consistent problem-solving methodology that
breaks the solution process into three steps:
Plan, Execute, and Evaluate This approach aids
student comprehension, enhances their ability to
model the solution process when tackling
prob-lems on their own, and demonstrates the
impor-tance of interpreting the mathematical solution.
Q Personal Finance GPSExamples showcase the
use of financial analysis in everyday life by
set-ting problems in scenarios such as purchasing
a new car or house, and saving for retirement.
Q Common Mistakeboxes alert students to
frequently made mistakes stemming from
misunderstanding core concepts and
calcula-tions—in the classroom and in the field.
Trang 22Applications That Reflect
Real Practice
xxi
“As a Senior Strategic Analyst in Intel Corporation’s Data Center Group, I strive to uphold the company’s finance charter by being ‘a full partner in business
decisions to maximize shareholder value,’” says Nicole Wickswat, a 2006 graduate of the University of
Oregon’s Business Honors Program with a degree in finance “I work on a team with engineers and
marketing people, helping them develop products for data center and cloud computer environments that
are competitive, financially feasible, and provide the required return.”
Nicole analyzes the potential financial impact of her group’s business decisions, evaluating the return
to Intel on current and proposed products and making recommendations to management on whether they
continue to add value “A good investment decision should be aligned with the strategic objectives of the
business,” she says “We want the benefits to outweigh the associated costs, and we also take into
account product launch timing and a project’s incremental financial value Then we take a comprehensive
view of the decision on the company as a whole, assessing the impact a decision would have on other
products and/or groups.”
Intel uses present value calculations within all business groups to compare the present values of
costs and benefits that happen at different points in time This gives management a consistent metric to
compare different investments and projects, set priorities, and make tradeoffs where necessary to
allocate funds to the optimal investments The analysis continues throughout the product life cycle “We
assess the competitive landscape and determine whether the cost of adding or removing specific product
features will benefit us in terms of increased market segment share, volume, and/or average selling
price We also look at whether adding the product feature negatively affects other groups or products and,
if so, incorporate that into the analysis.”
Nicole’s analysis helps the Data Center Group establish product cost targets that are aligned with
long-term profitability goals “These cost targets play a key role in product development decisions
because they put pressure on engineers to design with profitability in mind and encourage us to get the
most value out of the product line.”
INTERVIEW WITH Nicole Wickswat
Intel Corporation
University of Oregon, 2006
“A good investment decision should be aligned with the strategic objectives
of the business.”
Shelagh Glaser is the Finance Director for Intel’s Mobility Group, which provides
solutions for the mobile computing market Prior to that she was
Group Controller for Sales & Marketing and co-Group Controller
for Digital Enterprise Group.
QUESTION: Does Intel set the discount rate at the corporate or
project level?
ANSWER : We typically set the discount rate at the corporate level As
a company, Intel makes a broad set of products that sell into
sim-ilar markets, so one hurdle rate makes sense for our core
busi-ness To justify an investment, every project has to earn or exceed
that level of return for our shareholders.
We may use a different discount rate for mergers and acquisitions.
For example, recently we’ve done more software acquisitions That conductors and has different risk factors, so we take those con- siderations into account to set the hurdle rate.
QUESTION: How does Intel compute the cost of capital for new
investment opportunities?
ANSWER : We reexamine our weighted average cost of capital
(WACC) each year to see that we have the right inputs and if any have changed: What is the current market risk premium? Are we
INTERVIEW WITH Shelagh Glaser
The Credit Crisis and Bond Yields
The financial crisis that engulfed the world’s economies in 2008 originated as a credit crisis that
first emerged in August 2007 At that time, problems in the
mort-gage market had led to the bankruptcy of several large mortmort-gage
lenders The default of these firms, and the downgrading of
many of the bonds backed by mortgages these firms had made,
caused many investors to reassess the risk of other bonds in
attempted to move into safer U.S Treasury securities, the prices
of corporate bonds fell and so their credit spreads rose relative
to Treasuries, as shown in Figure 6.7 Panel A of the figure shows
the yield spreads for long-term corporate bonds, where we can see that spreads of even the highest-rated Aaa bonds increased dramatically, from a typical level of 0.5% to over 2% by the fall
of 2008 Panel B shows a similar pattern for the rate banks had
to pay on short-term loans compared to the yields of short-term Treasury bills This increase in borrowing costs made it more costly for firms to raise the capital needed for new investment,
2009 was viewed by many as an important first step in ing the ongoing impact of the financial crisis on the rest of the economy.
mitigat-Applications That Reflect Real Practice
Fundamentals of Corporate Finance features actual companies and practitioners in the field.
Q Chapter-Opening Interviewswith recent college graduates now working in the field of finance underscore the relevance of these concepts to students who are encountering them for the first time.
Q Practitioner Interviewsfrom notable sionals featured in many chapters highlight leaders in the field and address the effects of the financial crisis.
profes-Q General Interestboxes highlight timely material from financial publications that shed light on business problems and real-company practices.
Trang 23Teaching Every Student
to Think Finance
Specifying Decimal Places
Make sure you have plenty of decimal places displayed!
DISP 4
HP-10BII
Chapter 4 APPENDIX Using a Financial Calculator
TI BAII Plus Professional
Toggling Between the Beginning and End of a Period
You should always make sure that your calculator is in end-of-period mode.
2010
74,889
58,413 16,476
5,492 10,984
306 10,678
6,480 12,961
306 12,655 4,429
8,226
Calculation
74,889 1.18 78% of Sales Lines 3 4 7.333% of Sales Lines 5 6 Remains the same Lines 7 8 35% of Line 9 Lines 9 10
Year Income Statement ($000s) Sales
Costs Except Depreciation
USING EXCEL
Computing NPV and IRR
Here we discuss how to use Microsoft Excel to solve for NPV and IRR We also identify some pitfalls to avoid when using Excel.
NPV Function: Leaving Out Date 0
Excel’s NPV function has the format NPV (rate, value1, value2, ),where “rate” is the interest rate per
period used to discount the cash flows, and “value1”, “value2”, etc., are the cash flows (or ranges of cash
flows) The NPV function computes the present value of the cash flows assuming the first cash flow occurs
at date 1 Therefore, if a project’s first cash flow occurs at date 0, we cannot use the NPV function by itself
to compute the NPV We can use the NPV function to compute the present value of the cash flows from date 1 onward, and then we must add the date 0 cash flow to that result to calculate the NPV The screen- shot below shows the difference The first NPV calculation (outlined in blue) is correct: we used the NPV ring at time 0 since it is already in present value The second calculation (outlined in green) is incorrect:
we used the NPV function for all of the cash flows, but the function assumed that the first cash flow occurs
in period 1 instead of immediately.
NPV Function: Ignoring Blank Cells
Another pitfall with the NPV function is that cash flows that are left blank are treated differently from cash
flows that are equal to zero If the cash flow is left blank, both the cash flow and the period are ignored.
For example, the second set of cash flows below is equivalent to the first—we have simply left the cash flow for date 2 blank instead of entering a “0.” However, the NPV function ignores the blank cell at date 2 and assumes the cash flow is 10 at date 1 and 110 at date 2, which is clearly not what is intended and
Simplified Presentation
of Mathematics
Because one of the hardest parts of learning finance
for non-majors is mastering the jargon, math, and
non-standardized notation, Fundamentals of
Corporate Finance systematically uses:
Q Notation Boxes.Each chapter begins with a
Notation box that defines the variables and the
acronyms used in the chapter and serves as a
“legend” for students’ reference.
Q Numbered and Labeled Equations.The first
time a full equation is given in notation form it is
numbered Key equations are titled and revisited
in the summary and in end papers.
Q Timelines.Introduced in Chapter 3, timelines are
emphasized as the important first step in solving
every problem that involves cash flow.
Q Financial Calculatorinstructions, including a
box in Chapter 4 on solving for future and present
values, and appendices to Chapters 4, 6, and 15
with keystrokes for HP-10BII and TI BAII Plus
Professional, highlight this problem-solving tool.
Q Spreadsheet Tables.Select tables are available
on MyFinanceLab as Excel files, enabling
stu-dents to change inputs and manipulate the
underlying calculations.
Q Using Excelboxes describe Excel techniques
and include screenshots to serve as a guide for
students using this technology.
Trang 24$38,000 a year that she anticipates will grow at 3% per year Natasha hopes to retire at age
65 and has just begun to think about the future.
Natasha has $75,000 that she recently inherited from her aunt She invested this money in ten-year Treasury bonds She is considering whether she should further her education and would use her inheritance to pay for it.
She has investigated a couple of options and is asking for your help as a financial planning intern to determine the financial consequences associated with each option.
Natasha has already been accepted to two programs and could start either one soon.
One alternative that Natasha is considering is attaining a certification in network design This certification would automatically promote her to a Tier 3 field service repre- sentative in her company The base salary for a Tier 3 representative is $10,000 more than the salary of a Tier 2 representative, and she anticipates that this salary differential will grow at a rate of 3% a year for as long as she keeps working The certification program requires the completion of 20 Web-based courses and a score of 80% or better on an exam
at the end of the course work She has learned that the average amount of time necessary
to finish the program is one year The total cost of the program is $5,000, due when she
4.1 Valuing a Stream of Cash Flows
The present value of a cash flow stream is:
4.2 Perpetuities
A perpetuity is a stream of equal cash flows C paid every
period, forever The present value of a perpetuity is:
(4.4)
PV 1C in perpetuity2 = C r
consol, p 89 perpetuity, p 89
MyFinanceLab Study Plan 4.2
4.3 Annuities
An annuity is a stream of equal cash flows C paid every
period for N periods The present value of an annuity is:
(4.5) The future value of an annuity at the end of the annuity
Q End-of-chapter problems written personally
by Jonathan Berk, Peter DeMarzo, and Jarrad Harfordoffer instructors the opportunity to assign first-rate materials to students for home- work and practice with the confidence that the problems are consistent with the chapter con- tent All end-of-chapter problems are available in MyFinanceLab, the fully integrated homework and tutorial system Both the problems and solu- tions, which were also written by the authors, have been class-tested and accuracy checked to ensure quality Excel icons indicate the availabil- ity of instructor solutions and student templates
in the Textbook Resources tab of MyFinanceLab.
End-of-Chapter Materials Reinforce Learning
Testing understanding of central concepts is crucial to learning finance.
Q MyFinanceLab Chapter Summary presents the key points and conclusions from each chapter, provides a list of key terms with page numbers, and indicates online practice opportunities.
Q Data Casespresent in-depth scenarios in a business setting with questions designed to guide students’ analysis Many questions involve the use of Internet resources.
Q Integrative Casesoccur at the end of most parts and present a capstone extended problem for each part with a scenario and data for students to analyze based on that subset of chapters.
Trang 25Finance professors are united by their commitment to shaping future generations
of financial professionals as well as instilling financial awareness and skills in non-majors
Our goal with Fundamentals of Corporate Finance is to provide an accessible
presenta-tion for both finance and non-finance majors We know from experience that countlessundergraduate students have felt that corporate finance is challenging It is tempting to
make finance seem accessible by de-emphasizing the core principles and instead
concen-trating on the results In our over 45 years of combined teaching experience, we havefound that emphasizing the core concepts in finance—which are clear and intuitive atheart—is what makes the subject matter accessible What makes the subject challenging
is that it is often difficult for a novice to distinguish between these core ideas and otherintuitively appealing approaches that, if used in financial decision making, will lead toincorrect decisions
The 2007–2009 financial crisis was fueled in part by many practitioners’ poor sion making when they did not understand—or chose to ignore—the core concepts thatunderlie finance and the pedagogy in this book With this point in mind, we presentfinance as one unified whole based on two simple, powerful ideas: (1) valuation drivesdecision making—the firm should take projects for which the value of the benefitsexceeds the value of the costs, and (2) in a competitive market, market prices (rather thanindividual preferences) determine values We combine these two ideas with what we call
deci-the Valuation Principle, and from it we establish all of deci-the key ideas in corporate finance
New to This Edition
In general terms, in our work on the second edition we took great care to update all textdiscussions and figures, tables, and facts to reflect key developments in the field and toprovide the clearest presentation possible Specific highlights include the following:
Q Reorganized Flow of Topics in Chapters 3 and 4.Mastering the tools for discountingcash flows is central to students’ success in the introductory course As always,mastery comes with practice and by approaching complex topics in manageableunits We begin our step-by-step look at the time value of money in Chapter 3, whichprovides intuition for time value concepts, introduces the Valuation Principle, andpresents rules for valuing cash flows Chapter 4 addresses cash flow valuation formulti-period investments
Q New Two-Pronged Approach to Stock Valuation. Immediately following bondvaluation, Chapter 7 opens with key background coverage of stock quotes and themechanics of stock trades and then presents the dividend-discount model We delaythe discussion of the discounted cash flow model until after we have covered capitalbudgeting In Chapter 10, we introduce the discounted cash flow model by building
on concepts already developed in the capital budgeting chapters Chapter 10 alsodiscusses market efficiency and includes a new discussion of investor behavior
Q New and Updated Interviews.A number of new and updated practitioner and recentgraduate interviews support the book’s practical perspective and incorporate timely
Preface
xxiv
Trang 26viewpoints related to the recent financial crisis Our popular interviews with level practitioners incorporate an “inside” perspective on the financial crisis of2007–2009 and include new interviews with Frederic S Mishkin, former FederalReserve Board governor; David Holland, Senior Vice President and Treasurer ofCisco; and Shelagh Glaser, Director for Intel’s Mobility Group.
high-Q Expanded Special Topics Section.The new mergers and acquisitions chapter looks atthe overall market for takeovers, motivations for pursuing acquisitions, and thetypical process Additional chapters now available online—leasing, insurance andrisk management, and corporate governance—allow professors to choose favoritetopics
Q New Problems and MyFinanceLab Upgrade. We added 100 new problems to theSecond Edition, once again personally writing and solving each one In addition,every single problem is available in MyFinanceLab, the groundbreaking homeworkand tutorial system that accompanies the book The system recognizes typicalmistakes and provides immediate feedback, allowing the student to learninstantaneously from the mistake
Emphasis on Valuation
As painful as the financial crisis was, there is a silver lining: with the increasing focus onfinance in the news, today’s undergraduate students arrive in the classroom with an inter-est in finance We strive to use that natural interest and motivation to overcome their fear
of the subject and communicate time-tested core principles Again, we take what hasworked in the classroom and apply it to the text: By providing examples involving famil-iar companies such as Starbucks and Apple, making consistent use of real-world data, anddemonstrating personal finance applications of core concepts, we strive to keep both non-finance and finance majors engaged
By learning to apply the Valuation Principle, students develop the skills to make thetypes of comparisons—among loan options, investments, projects, and so on—that turnthem into knowledgeable, confident financial consumers and managers When studentssee how to apply finance to their personal lives and future careers, they grasp that finance
is more than abstract, mathematically based concepts
Table of Contents Overview
Fundamentals of Corporate Finance offers coverage of the major topical areas for
introductory-level undergraduate courses Our focus is on financial decision makingrelated to the corporation’s choice of which investments to make or how to raise the cap-ital required to fund an investment We designed the book with the need for flexibility andwith consideration of time pressures throughout the semester in mind
Part 1: Introduction
Ch 1: Corporate Finance and the Financial Manager
Ch 2: Introduction to Financial Statement Analysis
Part 2: Interest Rates and Valuing Cash Flows
Ch 3: Time Value of Money: An Introduction
Ch 4: Time Value of Money: Valuing Cash Flow Streams
xxv
Introduces the Valuation Principle and time value of money techniques for single-period investments
Trang 27Ch 5: Interest Rates
Ch 6: Bonds
Ch 7: Stock Valuation
Part 3: Valuation and the Firm
Ch 8: Investment Decision Rules
Ch 9: Fundamentals of Capital Budgeting
Ch 10: Stock Valuation: A Second Look
Part 4: Risk and Return
Ch 11: Risk and Return in Capital Markets
Ch 12: Systematic Risk and the Equity Risk Premium
Ch 13: The Cost of Capital
Part 5: Long-Term Financing
Ch 14: Raising Equity Capital
Ch 18: Financial Modeling and Pro Forma Analysis
Ch 19: Working Capital Management
Ch 20: Short-Term Financial Planning
Part 8: Special Topics
Ch 21: Option Applications and Corporate Finance
Ch 22: Mergers and Acquisitions
Ch 23: International Corporate Finance
Presents how interest rates are quoted and compounding for all frequencies
New chapter introduces stocks and presents the dividend discount model
as an application of the time value of money
Introduces the NPV rule as the “golden rule” against which we evaluate other investment decision rules
Provides a clear focus on the distinction between earnings and free cash flow Builds on capital budgeting material by valuing the ownership claim to the firm’s free cash flows and addresses market efficiency and behavioral finance
Calculates and uses the firm’s overall costs of capital with the WACC method These chapters begin with perfect markets and then show how frictions, including agency costs and asymmetric information, can influence financial policy
Makes the critical distinction between sustainable and value-increasing growth in determining the firm’s value
Opportunities for course customization with online-only chapter offerings
New chapter looks at the overall market for M&A and considers the motivations for and the typical process
of a transaction
Trang 28Video clips available in MyFinanceLab profile well-known firms such as Boeing and Intelthrough interviews and analysis The videos focus on core topical areas such as capitalbudgeting and risk and return
Solutions Manual
The printed Solutions Manual provides students with detailed, accuracy-verified solutions
to the problems in the book The solutions, like the problems, were written by the authorsthemselves Spreadsheet solutions in Excel®, which allow the student to see the effect ofchanges in the input variables on the outcome, are also available to instructors for desig-nated problems at the Instructor Resource Center (www.pearsonhighered.com/irc) and onthe Instructor’s Resource CD-ROM
PowerPoint Presentations
The PowerPoint Presentation, authored by Janet Payne and William Chittenden of TexasState University, is available in lecture form and includes art and tables from the book andadditional examples The PowerPoint presentation includes all tables and figures, exam-ples, key terms, and spreadsheet tables from the textbook All PowerPoint presentationsare included on the Instructor’s Resource CD-ROM and are also available for downloadfrom the Instructor Resource Center at www.pearsonhighered.com/irc
Test Item File
The Test Item File, edited by Janet Payne and William Chittenden of Texas StateUniversity, provides a wealth of accuracy-verified testing material Each chapter offers awide variety of true/false, short answer, and multiple-choice questions contributed bySalil Sarkar of the University of Texas at Arlington, Karan Bhanot of the University ofTexas at San Antonio, and instructional designer David Stuart Questions are verified bydifficulty level and skill type, and correlated to the chapter topics Numerical problemsinclude step-by-step solutions
Every question in the Test Item File is available in TestGen® software for bothWindows®and Macintosh®computers This easy-to-use testing software is a valuable testpreparation tool that allows professors to view, edit, and add questions Both the Test ItemFile and the TestGen computerized test bank are included on the Instructor’s Resource CD-ROM, are available for download from the Instructor Resource Center at
www.pearsonhighered.com/irc, and all questions can be assigned via MyFinanceLab
Instructor’s Manual
The Instructor’s Manual was written by Mary R Brown of the University ofIllinois–Chicago, and contains annotated chapter outlines, lecture launchers and ques-tions for further class discussion It also contains the solutions to the Data Cases and part-ending case problems, as well as answers to the chapter-ending Critical Thinkingquestions in the book As an additional resource to guide instructors with students who
Trang 29are planning to take the CFA exam, CFA learning outcomes met in each chapter are listed.
A section also details how the end-of-chapter problems map to the accreditation standardsset by the Association to Advance Collegiate Schools of Business (AACSB), so that instruc-tors can track students’ mastery of the AACSB standards The Instructor’s Manual isincluded on the Instructor’s Resource CD-ROM and is also available for download asMicrosoft® Word files or as Adobe® PDF files from the Instructor Resource Center at
www.pearsonhighered.com/irc
Instructor’s Resource CD-ROM
The Instructor’s Resource CD-ROM offers the complete set of instructor supplements for
Fundamentals of Corporate Finance, Second Edition, including Microsoft® Word andAdobe®PDF files of the Instructor’s Manual, Solutions Manual, and Microsoft®Word files
of the Test Item Files; complete PowerPoint®presentations; selected Excel®spreadsheetsolutions; and the TestGen®Computerized Test Bank
Acknowledgments
Given the scope of this project, identifying the many people who made it happen is a tallorder This textbook was the product of the expertise and hard work of many talented col-leagues We are especially gratified with the work of those who developed the array ofprint supplements that accompany the book: Janet Payne and William Chittenden for thequestion writing on the Test Item File and PowerPoint presentations; Mary R Brown, forthe Instructor’s Manual; Julie Dahlquist, for the Study Guide; James Linck, for serving asadvisor for the videos; and our MyFinanceLab content development team, includingCarlos Bazan, Shannon Donovan, Michael J Woodworth, Christopher Kelly, Jody Lotz,and Michael P Griffin We’re also deeply appreciative of Marlene Bellamy’s work conduct-ing the lively interviews with recent graduates that open each chapter and Susan White’scontributions to the part-ending cases
Creating a truly error-free text is a challenge we could not have lived up to withoutour team of expert error checkers Anand Goel, Robert James, and Timothy Sullivan eachsubjected the text and problem solutions to their exacting standards We are indebted toour team of Research Assistants—Nathan Walcott, Jared Stanfield, Miguel Palacios, RobSchonlau, Alex Paulsen, and Jonathan Kalodimos—for their adept support throughoutthe writing process
At Prentice Hall, we would like to single out Donna Battista, for her continued ership and market insight; Tessa O’Brien, for her unparalleled commitment to the proj-ect; Rebecca Ferris-Caruso, for her critical eye and uncanny ability to juggle the writing,reviewing, and editing process without missing a beat; and our production team, NancyFreihofer and Gillian Hall, for expertly managing the transformation of our Word filesinto a beautiful bound book We are truly thankful for the indispensable help provided bythese and other professionals, including: Elisa Adams, Alison Eusden, Miguel Leonarte,Kerri McQueen, Melissa Pellerano, Nicole Sackin, and Susan Schoenberg
lead-We are indebted to our colleagues for the time and expertise invested as manuscriptreviewers, class testers, and focus group participants We list all of these contributors onthe following pages, but want to single out one group, our First Edition editorial board,
for special notice: Tom Berry, DePaul University; Elizabeth Booth, Michigan State
University; Julie Dahlquist, the University of Texas–San Antonio; Michặl Dewally, Marquette University; Robert M Donchez, the University of Colorado–Boulder; Belinda
Mucklow, the University of Wisconsin–Madison; Coleen Pantalone, Northeastern
University; and Susan White, the University of Maryland We strived to incorporate every
contributor’s input and are truly grateful for each comment and suggestion The book hasbenefited enormously from this input
Trang 30Pankaj Agrrawal, University of Maine
Daniel Ahern, California State University–Chico
Paul Asabere, Temple University
Ajeyo Banerjee, University of Colorado–Denver
Tom Berry, DePaul University
Karan Bhanot, University of Texas–San Antonio
Rafiqul Bhuyan, California State University–San
Bernardino
Eugene Bland, Texas A&M University–Corpus Christi
Matej Blasko, University of Georgia
Elizabeth Booth, Michigan State University
Mary Brown, University of Illinois–Chicago
Bill Brunsen, Eastern New Mexico University
David G Cazier, Brigham Young University–Provo
Leo Chan, Delaware State University
Cindy Chen, California State University–Long Beach
Haiyu Chen, Youngstown State University
James F Cotter, Wake Forest University
Vicentiu Covrig, California State
University–Northridge
Julie Dahlquist, University of Texas–San Antonio
Pieter de Jong, University of Texas–Arlington
Andrea L DeMaskey, Villanova University
Xiaohui Deng, California State University–Fresno
Michặl Dewally, Marquette University
Robert M Donchez, University of Colorado Boulder
Gang Dong, Rutgers University
Dean Drenk, Montana State University
Robert Dubil, University of Utah
Hsing Fang, California State University–Los Angeles
David O Fricke, University of North
Carolina–Pembroke
Scott Fung, California State University–East Bay
Sharon Garrison, University of Arizona
Rakesh Gupta, Central Queensland University
Joseph D Haley, St Cloud State University
Thomas Hall, Christopher Newport University
Karen L Hamilton, Georgia Southern University
Mahfuzul Haque, Indiana State University
Edward C Howell, Northwood University
Ping Hsiao, San Francisco State University
Xiaoqing Hu, University of Illinois at Chicago
Pankaj Jain, University of Memphis
Robert James, Babson College
Susan Ji, Baruch College, City University of New York
Domingo Joaquin, Illinois State University
Fred R Kaen, University of New Hampshire
Terrill Keasler, Appalachian State University
Howard Keen, Temple University
Brett A King, University of North Alabama
Daniel Klein, Bowling Green State University Gregory Kuhlemeyer, Carroll University Rose Neng Lai, University of Macau Keith Lam, University of Macau Reinhold P Lamb, University of North Florida Douglas Lamdin, University of Maryland–Baltimore
County
Mark J Laplante, University of Georgia Sie Ting Lau, Nanyang Technological University Richard LeCompte, Wichita State University Adam Y.C Lei, Midwestern State University Qian Li, Midwestern State University Wei Liu, Texas A&M University Hugh Marble III, University of Vermont James Milanese, University of North Carolina at
Greensboro
Sunil K Mohanty, University of St Thomas Ted Moorman, Northern Illinois University James Morris, University of Colorado–Denver Belinda Mucklow, University of Wisconsin–Madison Rick Nelson, University of Minnesota
Tom C Nelson, University of Colorado–Boulder Anthony C Ng, Hong Kong Polytechnic University Coleen Pantalone, Northeastern University Daniel Park, Azusa Pacific University Janet Payne, Texas State University Lynn Pi, Hong Kong University of Science and
Technology
J Michael Pinegar, Brigham Young University Annette Poulsen, University of Georgia Eric Powers, University of South Carolina Rose M Prasad, Central Michigan University Shoba Premkumar, Iowa State University Mark K Pyles, College of Charleston A.A.B Resing, Hogeschool Van Amsterdam Greg Richey, California State University, San
Bernardino
David L Robbins, University of New Mexico Andrew Samwick, Dartmouth College Salil K Sarkar, University of Texas–Arlington Oliver Schnusenberg, University of North Florida Kenneth Scislaw, University of Alabama–Huntsville Roger Severns, Minnesota State University–Mankato Tatyana Sokolyk, University of Wyoming
Andrew C Spieler, Hofstra University Timothy G Sullivan, Bentley College Janikan Supanvanij, St Cloud State University Oranee Tawatnuntachai, Pennsylvania State
University–Harrisburg
Robert Terpstra, University of Macau Thomas Thomson, University of Texas–San Antonio Olaf J Thorp, Babson College
Trang 31Emery Trahan, Northeastern University
Joe Ueng, University of St Thomas
Mo Vaziri, California State University–San
Bernardino
Premal P Vora, Pennsylvania State
University–Harrisburg
Hefei Wang, University of Illinois–Chicago
Gwendolyn Webb, Baruch College
Paul M Weinstock, Ohio State University
Susan White, University of Maryland
Annie Wong, Western Connecticut State University
Zhong-gou Zhou, California State
University–Northridge
Kermit C Zieg, Jr., Florida Institute of Technology
Focus Group Participants
Anne-Marie Anderson, Lehigh University
Sung Bae, Bowling Green State University
H Kent Baker, American University
Steven Beach, Radford University
Rafiqul Bhuyan, California State University–San
Bernardino
Deanne Butchey, Florida International University
Leo Chan, Delaware State University
George Chang, Grand Valley State University
Haiwei Chen, California State University–San
Bernardino
Haiyu Chen, Youngstown State University
Massimiliano De Santis, Dartmouth College
Jocelyn Evans, College of Charleston
Kathleen Fuller, University of Mississippi
Xavier Garza Gomez, University of Houston–Victoria
William Gentry, Williams College
Axel Grossmann, Radford University
Pankaj Jain, University of Memphis
Zhenhu Jin, Valparaiso University
Steve Johnson, University of Northern Iowa
Steven Jones, Samford University
Yong-Cheol Kim, University of Wisconsin–Milwaukee
Robert Kiss, Eastern Michigan University
Ann Marie Klingenhagen, DePaul University
Thomas J Krissek, Northeastern Illinois University
Olivier Maisondieu Laforge, University of
Nebraska–Omaha
Douglas Lamdin, University of Maryland–Baltimore
County
D Scott Lee, Texas A&M University
Stanley A Martin, University of Colorado–Boulder
Jamshid Mehran, Indiana University, South Bend
Sunil Mohanty, University of St Thomas
Karyn L Neuhauser, State University of New
University–Harrisburg
Benedict Udemgba, Alcorn State University Rahul Verma, University of Houston–Downtown Angelo P Vignola, Loyola University–Chicago Premal Vora, Pennsylvania State
University–Harrisburg
Eric Wehrly, Seattle University Yan A Xie, University of Michigan–Dearborn Fang Zhao, Siena College
Sophie Zong, California State University–Stanislaus
Class Testers
Tom Berry, DePaul University Eugene Bland, Texas A&M University–Corpus Christi Charles Blaylock, Murray State University
Mary Brown, University of Illinois–Chicago Bill Brunsen, Eastern New Mexico University Sarah Bryant Bower, Shippensburg University of
Pennsylvania
Alva Wright Butcher, University of Puget Sound David G Cazier, Brigham Young University–Provo Asim G Celik, University of Nevada–Reno
Michặl Dewally, Marquette University Richard Gaddis, Oklahoma Wesleyan University TeWhan Hahn, Auburn University–Montgomery Matthew Hood, University of Southern Mississippi Zhenhu Jin, Valparaiso University
Travis Jones, Florida Gulf Coast University Francis E Laatsch, Bowling Green State University Diane Lander, Saint Michael’s College
Vance Lesseig, Texas State University Frances Maloy, University of Washington Jamshid Mehran, Indiana University–South Bend Belinda Mucklow, University of Wisconsin–Madison Kuo-Chung Tseng, California State University–Fresno Kermit C Zieg, Jr., Florida Institute of Technology
Trang 32Valuation Principle Connection.What is corporate finance? No matter
what your role in a corporation, an understanding of why and how financial decisions
are made is essential The focus of this book is how to make optimal corporate
financial decisions In this part of the book, we lay the foundation for our study of
corporate finance In Chapter 1, we begin by introducing the corporation and related
business forms We then examine the role of financial managers and outside investors
in decision making for the firm To make optimal decisions, a decision maker needs
information As a result, in Chapter 2 we review and analyze an important source of
information for corporate decision making—the firm’s accounting statements These
chapters will introduce us to the role and objective of the financial manager and some
of the information the financial manager uses in applying the Valuation Principle to
make optimal decisions Then, in the next section of the book, we will introduce and
begin applying the Valuation Principle
1
1PART
Trang 33Corporate Finance and the Financial Manager
Q Grasp the importance of financial information in both your personal and business lives
Q Understand the important features of the four main types of firms and see why the advantages of the corporate form have led it to dominate economic activity
Q Explain the goal of the financial manager and the reasoning behind that goal, as well as understand the three main types of decisions a financial manager makes
1
Q Know how a corporation is managed and controlled, the financial manager’s place in it, and some of the ethical issues financial managers face
Q Understand the importance of financial markets, such as stock markets, to a corporation and the financial manager’s role as liaison to those markets
Q Recognize the role that financial institutions play in the financial cycle of the economy
2
LEARNING OBJECTIVES
Trang 34Leslie Tillquist, who received a B.S in Business Administration in Finance and Marketing from the University of Colorado, Boulder in 2007, wasn’t sure
what she wanted to do after graduation “I enjoyed marketing’s focus on understanding human motivations
and interactions, but I realized that finance provides a real-world understanding and skill set that leads to
incredibly diverse career paths,” she explains “It is hard to make credible decisions in business or
non-profit organizations without financially supporting and defending them Understanding financial techniques
allows individuals in all careers to pursue opportunities and solve problems in business situations.”
She joined the Denver office of PA Consulting Group, Inc., an international consulting firm based in
London with offices in more than 35 countries “I wanted a high-energy, project-based environment where
I could interact with the decision makers in a rapidly changing industry and also have the opportunity to
work abroad,” she says Her finance degree gave her that opportunity within PA Consulting’s Global Energy
Practice “Within seven months, I have joined in projects for international banks, government, and a
Fortune 500 company Work has taken me across the United States as well as to England and South
Africa.” Her responsibilities include performing financial analysis and energy research that support client
business analysis and the resulting strategic recommendations For example, she uses different metrics
to value assets, contracts, and companies, and creates company financial statements used in acquiring
financing and evaluating opportunities.
Leslie encourages students not to be intimidated by the rigor of finance courses “They give you
essential fundamentals for business analysis in whatever area interests you, as well as the work ethic for
further on-the-job learning,” she says “Although it is sometimes hard to appreciate at the time, finance
classes provide the tools you need to resolve complex financial problems—whether your career is in
finance or not.” She adds that she was very hesitant to study and work in finance “I could not be more
grateful for the opportunities available to me because I stuck with it The work pays off immensely when
I can communicate ideas eloquently and thoughtfully in business discussions.”
This bookfocuses on how people in corporations make financial decisions Despite its name, much
of what we discuss in corporate finance applies to the financial decisions made within any organization,
including not-for-profit entities such as charities and universities In this chapter, we introduce the four
main types of firms We stress corporations, however, because they represent 85% of U.S business
revenue We also highlight the financial manager’s critical role inside any business enterprise What
products to launch, how to pay to develop those products, what profits to keep and how to return profits
to investors—all of these decisions and many more fall within corporate finance The financial manager
makes these decisions with the goal of maximizing the value of the business, which is determined in the
financial markets In this chapter and throughout the book, we will focus on this goal, provide you with the
tools to make financial management decisions, and show you how the financial markets provide funds to
a corporation and produce market prices that are key inputs to any financial manager’s investment
analysis.
University of Colorado, 2007
“Finance classes provide the tools you need to resolve complex financial problems—whether your career is in finance or not.”
PA Consulting Group
Trang 351.1 Why Study Finance?
Finance and financial thinking are everywhere in our daily lives Consider your decision
to go to college You surely weighed alternatives, such as starting a full-time job ately, and then decided that college provided you with the greatest net benefit More andmore, individuals are taking charge of their personal finances with decisions such as:
immedi-Q When to start saving and how much to save for retirement
Q Whether a car loan or lease is more advantageous
Q Whether a particular stock is a good investment
Q How to evaluate the terms of a home mortgage
Our career paths have become less predictable and more dynamic In previous erations, it was common to work for one employer your entire career Today, that would
gen-be highly unusual Most of us will instead change jobs, and possibly even careers, manytimes With each new opportunity, we must weigh all the costs and benefits, financial andotherwise
Some financial decisions, such as whether to pay $2.00 for your morning coffee, aresimple, but most are more complex In your business career, you may face questions suchas:
Q Should your firm launch a new product?
Q Which supplier should your firm choose?
Q Should your firm produce a part of the product or outsource production?
Q Should your firm issue new stock or borrow money instead?
Q How can you raise money for your start-up firm?
In this book, you will learn how all of these decisions in your personal life and inside a
business are tied together by one powerful concept, the Valuation Principle The
Valuation Principle shows how to make the costs and benefits of a decision comparable sothat we can weigh them properly Learning to apply the Valuation Principle will give youthe skills to make the types of comparisons—among loan options, investments, and proj-ects—that will turn you into a knowledgeable, confident financial consumer and man-ager In each chapter you will hear from a former student—someone who opened a booklike this one not that long ago—who talks about his or her job and the critical rolefinance plays in it
From 2007 to 2009 we witnessed a credit freeze, a severe stock market decline, andthe failures of well-known financial institutions Attempts to understand these elements
of the crisis, their origins, and how they affect our businesses and personal finances havehighlighted the need for learning core financial principles and concepts
Whether you plan to major in finance or simply take this one course, you will findthe fundamental financial knowledge gained here to be essential in your personal andbusiness lives
1.2 The Four Types of Firms
We begin our study of corporate finance by examining the types of firms that financialmanagers run There are four major types of firms: sole proprietorships, partnerships,limited liability companies, and corporations We explain each organizational form inturn, but our primary focus is on the most important form—the corporation
Trang 36Sole Proprietorships
A sole proprietorship is a business owned and run by one person Sole proprietorships areusually very small with few, if any, employees Although they do not account for muchsales revenue in the economy, they are the most common type of firm in the world In
2007, an estimated 71% of businesses in the United States were sole proprietorships,although they generated only 5% of the revenue.1
We now consider the key features of a sole proprietorship
1. Sole proprietorships have the advantage of being straightforward to set up.Consequently, many new businesses use this organizational form
2. The principal limitation of a sole proprietorship is that there is no separationbetween the firm and the owner—the firm can have only one owner who runs thebusiness If there are other investors, they cannot hold an ownership stake in thefirm
3. The owner has unlimited personal liability for the firm’s debts That is, if the firmdefaults on any debt payment, the lender can (and will) require the owner to repaythe loan from personal assets An owner who cannot afford to repay a loan forwhich he or she is personably liable must declare personal bankruptcy
4. The life of a sole proprietorship is limited to the life of the owner It is also difficult
to transfer ownership of a sole proprietorship
For most growing businesses, the disadvantages of a sole proprietorship outweigh theadvantages As soon as the firm reaches the point at which it can borrow without theowner agreeing to be personally liable, the owners typically convert the business intoanother form Conversion also has other benefits that we will consider as we discuss theother forms below
Partnerships
A partnership is a business owned and run by more than one owner Key features includethe following:
1. All partners are liable for the firm’s debt That is, a lender can require any partner
to repay all the firm’s outstanding debts
2. The partnership ends in the event of the death or withdrawal of any single partner
3. Partners can avoid liquidation if the partnership agreement provides foralternatives such as a buyout of a deceased or withdrawn partner
Some old and established businesses remain as partnerships or sole proprietorships.Often these firms are the types of businesses in which the owners’ personal reputationsare the basis for the businesses For example, law firms, medical practices, and account-ing firms are frequently organized as partnerships For such enterprises, the partners’personal liability increases the confidence of the firm’s clients that the partners will strive
to maintain the firm’s reputation
A limited partnership is a partnership with two kinds of owners, general partners andlimited partners In this case, the general partners have the same rights and privileges aspartners in any general partnership—they are personally liable for the firm’s debt obliga-tions Limited partners, however, have limited liability—that is, their liability is limited
to their investment Their private property cannot be seized to pay off the firm’s ing debts Furthermore, the death or withdrawal of a limited partner does not dissolve the
outstand-1 U.S Census Bureau National Data Book.
sole proprietorship A
business owned and run
by one person.
partnership A business
owned and run by more
than one owner.
limited partnership A
partnership with two kinds
of owners, general
part-ners and limited partpart-ners.
limited liability When an
investor’s liability is
lim-ited to her investment.
Trang 37partnership, and a limited partner’s interest is transferable However, a limited partnerhas no management authority and cannot legally be involved in the managerial decisionmaking for the business.
Limited Liability Companies
A limited liability company (LLC) is like a limited partnership but without a general
part-ner That is, all the owners (referred to as members) have limited liability, but unlike
lim-ited partners, they can also run the business (as managing members) The LLC is arelatively new phenomenon in the United States The first state to pass a statute allowingthe creation of an LLC was Wyoming in 1977; the last was Hawaii in 1997 Internationally,companies with limited liability are much older and established LLCs first rose to promi-
nence in Germany over 100 years ago as a Gesellschaft mit beschränkter Haftung
(GmbH) and then in other European and Latin American countries An LLC is known inFrance as a Société à responsabilité limitée (SAR), and by similar names in Italy (SRL) andSpain (SL)
Corporations
A corporation is a legally defined, artificial being (a legal entity), separate from its ers As such, it has many of the legal powers that people have It can enter into contracts,acquire assets, and incur obligations, and it enjoys protection under the U.S Constitutionagainst the seizure of its property Because a corporation is a legal entity separate and dis-tinct from its owners, it is solely responsible for its own obligations Consequently, theowners of a corporation (or its employees, customers, etc.) are not liable for any obliga-tions the corporation enters into Similarly, the corporation is not liable for any personalobligations of its owners
own-In the same way that it is difficult to imagine modern business life without e-mail andcell phones, the corporation revolutionized the economy On February 2, 1819, the U.S.Supreme Court established the legal precedent that the property of a corporation, similar
to that of a person, is private and entitled to protection under the U.S Constitution.2Thisdecision led to dramatic growth in the number of U.S corporations from under 1,000 in
1830 to 50,000 in 1890 Today the corporate structure is ubiquitous, not only in theUnited States (where they are responsible for 85% of business revenue), but all over theworld
Formation of a Corporation A corporation must be legally formed, which means that thestate in which it is incorporated must formally give its consent to the incorporation bychartering it Setting up a corporation is therefore considerably more costly than setting
up a sole proprietorship The state of Delaware has a particularly attractive legal ment for corporations, so many corporations choose to incorporate there For jurisdic-tional purposes, a corporation is a citizen of the state in which it is incorporated Mostfirms hire lawyers to create a corporate charter that includes formal articles of incorpo-ration and a set of bylaws The corporate charter specifies the initial rules that govern howthe corporation is run
environ-Ownership of a Corporation There is no limit on the number of owners a corporationcan have Because most corporations have many owners, each owner owns only a fraction
of the corporation The entire ownership stake of a corporation is divided into sharesknown as stock The collection of all the outstanding shares of a corporation is known as
2 The case was Dartmouth vs Woodward and the full text of John Marshall’s decision can be found at
defined, artificial being,
separate from its owners.
stock The ownership or
equity of a corporation
divided into shares.
Trang 38equity The collection of
all the outstanding shares
of a corporation.
the equity of the corporation An owner of a share of stock in the corporation is known as
a shareholder, stockholder, or equity holder Shareholders are entitled to dividend ments; that is, payments made at the discretion of the corporation to its equity holders.Shareholders usually receive a share of the dividend payments that is proportional to theamount of stock they own For example, a shareholder who owns 25% of the firm’s shareswould be entitled to 25% of the total dividend payment
pay-An important feature of a corporation is that there is no limitation on who can ownits stock That is, an owner of a corporation need not have any special expertise or quali-fication This feature allows free and anonymous trade in the shares of the corporationand provides one of the most important advantages of organizing a firm as a corporation.Corporations can raise substantial amounts of capital because they can sell ownershipshares to anonymous outside investors
The availability of outside funding has enabled corporations to dominate the omy Let’s look at one of the world’s largest firms, Microsoft Corporation, as an example.Microsoft reported annual revenue of $58.4 billion over the 12 months from July 2008through June 2009 The total value of the company (the wealth in the company the own-ers collectively owned) as of April 2010 was $267.1 billion The company employed 93,000people Putting these numbers into perspective, treating the sales of $58.4 billion as grossdomestic product (GDP) in 2009 would rank Microsoft (just ahead of Ecuador) as the
econ-sixty-fifth richest country (out of more than 200).3Ecuador has almost 13.5 million ple, about 145 times as many people as employees at Microsoft Indeed, if the number ofMicrosoft employees were used as the “population” of the corporation, Microsoft wouldrank just above Seychelles as the eighteenth least-populous country on earth!
peo-Tax Implications for Corporate Entities
An important difference among the types of corporate organizational forms is the way theyare taxed Because a corporation is a separate legal entity, a corporation’s profits are sub-ject to taxation separate from its owners’ tax obligations In effect, shareholders of a cor-poration pay taxes twice First, the corporation pays tax on its profits, and then when theremaining profits are distributed to the shareholders, the shareholders pay their own per-
sonal income tax on this income This system is sometimes referred to as double taxation.
3 World Development Indicators database, April 13, 2010 For quick reference tables on GDP, go to
made at the discretion of
the corporation to its
Solution
Q Plan
Earnings before taxes: $5.00 Corporate tax rate: 40% Personal dividend tax rate: 15%
To calculate the corporation’s earnings after taxes, first we subtract the taxes paid at the corporate level from the pre-tax earnings of $5.00 The taxes paid will be 40% (the corporate tax rate) of $5.00 Since all
of the after-corporate tax earnings will be paid to you as a dividend, you will pay taxes of 15% on that amount The amount leftover is what remains after all taxes are paid.
Trang 39S Corporations The corporate organizational structure is the only organizational ture subject to double taxation However, the U.S Internal Revenue Code exempts
struc-S corporations from double taxation because they elect subchapter struc-S tax treatment.Under subchapter S tax regulations, the firm’s profits (and losses) are not subject to cor-porate taxes, but instead are allocated directly to shareholders based on their ownershipshare The shareholders must include these profits as income on their individual taxreturns (even if no money is distributed to them) However, after the shareholders havepaid income taxes on these profits, no further tax is due
C Corporations The government places strict limitations on the qualifications for chapter S tax treatment In particular, the shareholders of such corporations must beindividuals who are U.S citizens or residents, and there can be no more than 100 of them.Because most corporations have no restrictions on who owns their shares or the number
sub-of shareholders, they cannot qualify for subchapter S treatment Thus, most corporationsare C corporations, which are corporations subject to corporate taxes
S corporations Those
corporations that elect
subchapter S tax
treat-ment and are exempted
by the U.S Internal
Revenue Service’s tax
code from double taxation.
C corporations
Corporations that have no
restrictions on who owns
their shares or the number
of shareholders; they
can-not qualify for subchapter
S treatment and are
sub-ject to direct taxation.
As we have discussed, there are four main types of firms: sole proprietorships, nerships (general and limited), limited liability companies, and corporations (“S” and
part-“C”) To help you see the differences among them, Table 1.1 compares and contrasts themain characteristics of each
Earnings before taxes: $5.00 Corporate tax rate: 0% Personal tax rate: 30%
In this case, the corporation pays no taxes It earned $5.00 per share In an S corporation, all income is treated as personal income to you, whether or not the corporation chooses to distribute or retain this cash.
As a result, you must pay a 30% tax rate on those earnings.
As a shareholder, you keep $2.55 of the original $5.00 in earnings; the remaining $2.00 + $0.45 = $2.45
is paid as taxes Thus, your total effective tax rate is 2.45/5 = 49%.
Trang 404 Apple, Inc., Notice of 2010 Annual Meeting of Shareholders, January 12, 2010.
Corporate Taxation Around the World
In most countries, there is some relief from double taxation As of August 2010, thirty-one coun-
tries make up the Organization for Economic Co-operation and
Development (OECD), and of these countries, only Ireland and
Switzerland offer no relief from double taxation The United
States offers no relief on dividend income compared to other sources of income As of 2010 dividend income is taxed at the investor’s personal income tax rate A few countries, including Australia, Finland, Mexico, New Zealand, and Norway, offer com- plete relief by effectively not taxing dividend income.
Number of Owners
Liability for Firm’s Debts
Owners Manage the Firm
Ownership Change Dissolves Firm Taxation Sole
Proprietorship
Partnership Unlimited Yes; each partner
is liable for the entire amount
Limited Partnership
At least one general partner (GP), no limit
on limited partners (LP)
GP-Yes LP-No
GP-Yes LP-No
GP-Yes LP-No
Personal
Limited Liability Company
S Corporation At most 100 No No (but they
Different Types of Firms
1 What is a limited liability company (LLC)? How does it differ from a limited partnership?
2 What are the advantages and disadvantages of organizing a business as a corporation?
Concept
Check
As of January 2010, Apple, Inc had just under 906.8 million shares of stock held by 30,476
owners.4Because there are many owners of a corporation, each of whom can freely tradetheir stock, it is often not feasible for the owners of a corporation to have direct control
of the firm It falls to the financial manager to make the financial decisions of the ness for the stockholders Within the corporation, the financial manager has three maintasks:
busi-1. Make investment decisions
2. Make financing decisions
3. Manage short-term cash needs
We will discuss each of these in turn, along with the financial manager’s overarching goal