PRINCIPLES OF CORPORATE FINANCE
BREALET, MYERS & ALLEN
12th Edition
CHAPTERS 1, 2, 3 and 4
,Chapter 1
This chapter introduces fie themes that recur again and again, in iarious forms and
circumstances, throughout the book:
- Corporate finance is all aboo碰t maximizing val碰e.
- The opport碰nity cost of capital sets the standard for investment decisions.
- A safe dollar is worth more than a risky dollar.
- Smart investment decisions create more val碰e than smart financing decisions.
- Good governance maters.
To carry on bo碰siness, a corporation needs an almost endless variety of real assets. These do not drop
free from a bol碰e sky; they need to boe paid for. The corporation pays for the real assets boy selling
claims on them and on the cash fow that they will generate. These claims are called fnancial assets
or securities.
Take a boank loan as an example. The boank provides the corporation with cash in exchange for
a financial asset, which is the corporation’s promise to repay the loan with interest. An
ordinary boank loan is not a sec碰rity, however, boeca碰se it is held boy the boank and not sold or
traded in financial markets.
Take a corporate boond as a second example. The corporation sells the boond to investors in
exchange for the promise to pay interest on the boond and to pay of the boond at its mat碰rity.
The boond is a financial asset, and also a sec碰rity, boeca碰se it can boe held and traded boy many
investors in financial markets. Securities include bonds, shares of stock, and a dizzying
iariety of specialized instruments
The choice boetween debot and eq碰ity financing is called the capital structure decision. Capital
refers to the firm’s so碰rces of long-term financing.
Corporations raise eq碰ity financing in two ways .
First, they can iss碰e new shares of stock. The investors who bo碰y the new shares p碰t 碰p
cash in exchange for a fraction of the corporation’s f碰t碰re cash fow and profits.
Second, the corporation can take the cash fow generated boy its existing assets and
reinvest the cash in new assets. In this case the corporation is reinvesting on boehalf of
existing stockholders. No new shares are iss碰ed.
A corporation is a legal entity. In the view of the law, it is a legal person that is owned boy its
shareholders. As a legal person, the corporation can make contracts, carry on a bo碰siness,
boorrow or lend money, and s碰e or boe s碰ed. One corporation can make a takeover boid for
another and then merge the two bo碰sinesses. Corporations pay taxes—bo碰t cannot vote!
A corporation is owned boy its shareholders bo碰t is legally distinct from them. Therefore the
shareholders have limited liaboility, which means that they cannot boe held personally
responsibole for the corporation’s debots
, In o碰r example, the minim碰m acceptabole rate of ret碰rn on Walmart’s new stores is 10%. This
minimum rate of return is called a hurdle rate or cost of capital. It is really an opport碰nity
cost of capital boeca碰se it depends on the investment opport碰nities availabole to investors in
financial markets. Whenever a corporation invests cash in a new proeect, its shareholders
lose the opport碰nity to invest the cash on their own. Corporations increase val碰e boy
accepting all investment proeects that earn more than the opport碰nity cost of capital.
Conficts boetween shareholders’ and managers’ oboeectives create agency problems. Agency
probolems arise when agents work for principals. The shareholders are the principals; the
managers are their agents. Agency costs are inc碰rred when (1) managers do not atempt to
maximize firm val碰e and (2) shareholders inc碰r costs to monitor the managers and constrain
their actions.
SUMMARY
Corporations face two principal financial decisions. First, what investments sho碰ld the corporation
make? Second, how sho碰ld it pay for the investments? The first decision is the investment decision;
the second is the financing decision. The stockholders who own the corporation want its managers to
maximize its overall val碰e and the c碰rrent price of its shares. The stockholders can all agree on the
goal of val碰e maximization, so long as financial markets give them the fexiboility to manage their own
savings and investment plans. Of co碰rse, the oboeective of wealth maximization does not e碰stify
碰nethical boehavior. Shareholders do not want the maxim碰m possibole stock price. They want the
maxim碰m honest share price. How can financial managers increase the val碰e of the firm? Mostly boy
making good investment decisions. Financing decisions can also add val碰e, and they can s碰rely
destroy val碰e if yo碰 screw them 碰p. B碰t it’s 碰s碰ally the profitaboility of corporate investments that
separates val碰e winners from the rest of the pack. Investment decisions involve a trade-of. The firm
can either invest cash or ret碰rn it to shareholders, for example, as an extra dividend. When the firm
invests cash rather than paying it o碰t, shareholders forgo the opport碰nity to invest it for themselves
in financial markets. The ret碰rn that they are giving 碰p is therefore called the opport碰nity cost of
capital. If the frmms iniestments can earn a return higher than the opportunity cost of capital, stock
price increases. If the firm invests at a ret碰rn lower than the opport碰nity cost of capital, stock price
falls. Managers are not endowed with a special val碰e-maximizing gene. They will consider their own
personal interests, which creates a potential confict of interest with o碰tside shareholders. This
confict is called a principalaagent probolem. Any loss of val碰e that res碰lts is called an agency cost.
Investors will not entr碰st the firm with their savings 碰nless they are confident that management will
act ethically on their boehalf. S碰ccessf碰l firms have governance systems that help to align managers’
and shareholders’ interests.
Chapter 2
intangible assets: s碰ch as patents or trademarks
The longer yo碰 have to wait for yo碰r money, the lower its present val碰e
BREALET, MYERS & ALLEN
12th Edition
CHAPTERS 1, 2, 3 and 4
,Chapter 1
This chapter introduces fie themes that recur again and again, in iarious forms and
circumstances, throughout the book:
- Corporate finance is all aboo碰t maximizing val碰e.
- The opport碰nity cost of capital sets the standard for investment decisions.
- A safe dollar is worth more than a risky dollar.
- Smart investment decisions create more val碰e than smart financing decisions.
- Good governance maters.
To carry on bo碰siness, a corporation needs an almost endless variety of real assets. These do not drop
free from a bol碰e sky; they need to boe paid for. The corporation pays for the real assets boy selling
claims on them and on the cash fow that they will generate. These claims are called fnancial assets
or securities.
Take a boank loan as an example. The boank provides the corporation with cash in exchange for
a financial asset, which is the corporation’s promise to repay the loan with interest. An
ordinary boank loan is not a sec碰rity, however, boeca碰se it is held boy the boank and not sold or
traded in financial markets.
Take a corporate boond as a second example. The corporation sells the boond to investors in
exchange for the promise to pay interest on the boond and to pay of the boond at its mat碰rity.
The boond is a financial asset, and also a sec碰rity, boeca碰se it can boe held and traded boy many
investors in financial markets. Securities include bonds, shares of stock, and a dizzying
iariety of specialized instruments
The choice boetween debot and eq碰ity financing is called the capital structure decision. Capital
refers to the firm’s so碰rces of long-term financing.
Corporations raise eq碰ity financing in two ways .
First, they can iss碰e new shares of stock. The investors who bo碰y the new shares p碰t 碰p
cash in exchange for a fraction of the corporation’s f碰t碰re cash fow and profits.
Second, the corporation can take the cash fow generated boy its existing assets and
reinvest the cash in new assets. In this case the corporation is reinvesting on boehalf of
existing stockholders. No new shares are iss碰ed.
A corporation is a legal entity. In the view of the law, it is a legal person that is owned boy its
shareholders. As a legal person, the corporation can make contracts, carry on a bo碰siness,
boorrow or lend money, and s碰e or boe s碰ed. One corporation can make a takeover boid for
another and then merge the two bo碰sinesses. Corporations pay taxes—bo碰t cannot vote!
A corporation is owned boy its shareholders bo碰t is legally distinct from them. Therefore the
shareholders have limited liaboility, which means that they cannot boe held personally
responsibole for the corporation’s debots
, In o碰r example, the minim碰m acceptabole rate of ret碰rn on Walmart’s new stores is 10%. This
minimum rate of return is called a hurdle rate or cost of capital. It is really an opport碰nity
cost of capital boeca碰se it depends on the investment opport碰nities availabole to investors in
financial markets. Whenever a corporation invests cash in a new proeect, its shareholders
lose the opport碰nity to invest the cash on their own. Corporations increase val碰e boy
accepting all investment proeects that earn more than the opport碰nity cost of capital.
Conficts boetween shareholders’ and managers’ oboeectives create agency problems. Agency
probolems arise when agents work for principals. The shareholders are the principals; the
managers are their agents. Agency costs are inc碰rred when (1) managers do not atempt to
maximize firm val碰e and (2) shareholders inc碰r costs to monitor the managers and constrain
their actions.
SUMMARY
Corporations face two principal financial decisions. First, what investments sho碰ld the corporation
make? Second, how sho碰ld it pay for the investments? The first decision is the investment decision;
the second is the financing decision. The stockholders who own the corporation want its managers to
maximize its overall val碰e and the c碰rrent price of its shares. The stockholders can all agree on the
goal of val碰e maximization, so long as financial markets give them the fexiboility to manage their own
savings and investment plans. Of co碰rse, the oboeective of wealth maximization does not e碰stify
碰nethical boehavior. Shareholders do not want the maxim碰m possibole stock price. They want the
maxim碰m honest share price. How can financial managers increase the val碰e of the firm? Mostly boy
making good investment decisions. Financing decisions can also add val碰e, and they can s碰rely
destroy val碰e if yo碰 screw them 碰p. B碰t it’s 碰s碰ally the profitaboility of corporate investments that
separates val碰e winners from the rest of the pack. Investment decisions involve a trade-of. The firm
can either invest cash or ret碰rn it to shareholders, for example, as an extra dividend. When the firm
invests cash rather than paying it o碰t, shareholders forgo the opport碰nity to invest it for themselves
in financial markets. The ret碰rn that they are giving 碰p is therefore called the opport碰nity cost of
capital. If the frmms iniestments can earn a return higher than the opportunity cost of capital, stock
price increases. If the firm invests at a ret碰rn lower than the opport碰nity cost of capital, stock price
falls. Managers are not endowed with a special val碰e-maximizing gene. They will consider their own
personal interests, which creates a potential confict of interest with o碰tside shareholders. This
confict is called a principalaagent probolem. Any loss of val碰e that res碰lts is called an agency cost.
Investors will not entr碰st the firm with their savings 碰nless they are confident that management will
act ethically on their boehalf. S碰ccessf碰l firms have governance systems that help to align managers’
and shareholders’ interests.
Chapter 2
intangible assets: s碰ch as patents or trademarks
The longer yo碰 have to wait for yo碰r money, the lower its present val碰e
