,Contents
Part I: Introduction
x x
Chapter 1 x The Corporation and Financial Markets
x x x x 1
Chapter 2 x Introduction to Financial Statement Analysis
x x x x 5
Part II: Tools
x x
Chapter 3 x Arbitrage and Financial Decision Making
x x x x 15
Chapter 4 x The Time Value of Money
x x x x 26
Chapter 5 x Interest Rates x 49
Part III: Basic Valuation
x x x
Chapter 6 x Valuing Bonds x 65
Chapter 7 x Valuing Stocks x 77
Chapter 8 x Investment Decision les x xx 85
Chapter 9 x Fundamentals of Capital Budgeting x x x 100
Part IV: Risk and Return
x x x x
Chapter 10 x Capital Markets and the Pricing of Risk x x x x x x 108
Chapter 11 x Optimal Portfolio Choice and the Capital Asset Pricing Model
x x x x x x x x 117
Chapter 12 x Estimating the Cost of Capital x x x x 131
Chapter 13 x Investor Behaviour and Capital Market Efficiency x x x x x 137
Part V: Options
x x
Chapter 14 x Financial Options x 143
Chapter 15 x Option Valuation
x 152
Chapter 16 x Real Options
x 162
Part VI: Capital St cture and Dividend Policy
x x x x x x x
Chapter 17 x Capital St cture in a Perfect Market x x x x x x 185
Chapter 18 x Debt and Taxes x x 192
Chapter 19 x Financial Distress, Managerial Incentives, and Informationx x x x x 199
Chapter 20 x Payout Policy x 207
Part VII: Valuation
x x
Chapter 21 x Capital Budgeting and Valuation with Leverage
x x x x x 213
Chapter 22 x Valuation and Financial Modelling: A Case Study
x x x x x x 227
Part VIII: Long-Term Financing
x x x
Chapter 23 x Raising Equity Capital x x 235
Chapter 24 x Debt Financing x 239
Chapter 25 x Leasing 242
Part IX: Short-Term Financing
x x x
Chapter 26 x Working Capital Management x x 248
Chapter 27 x Short-Term Financial Planning x x 253
Part X: Special Topics
x x x
Chapter 28 x Mergers and Acquisitions
x x 257
Chapter 29 x Corporate Governance x 260
Chapter 30 x Risk Management
x 263
Chapter 31 x International Corporate Finance x x 272
,Chapter 1 x
The Corporation and Financial Markets
x x x x
1-
1. A corporation is a legal entity separate from its owners. This means ownership shares in the corporation
x x x x x x x x x x x x x x x x x x x
can be freely traded. None of the other organizational forms share this characteristic.
x x x x x x x x x x x x x
1-
2. Owners’ liability is limited to the amount they invested in the firm. Shareholders are not responsible for a
x x x x x x x x x x x x x x x x x x x
ny encumbrances of the firm; in particular, they cannot be required to pay back any debts incurred by the firm
x x x x x x x x x x x x x x x x x x x
.
1-
3. Corporations (all shareholders have limited liability). Limited partnerships provide limited liability for th
x x x x x x x x x x x x x x
e limited partners, but not for the general partners.
x x x x x x x x
1-
4. Advantages: Limited liability, liquidity, infinite life. Disadvantages: Double taxation, separation of
x x x x x x x x x x x x x
ownership and control. x x
1-
5. The corporation that only holds real estate must pay corporate income taxes. The real estate investment t
x x x x x x x x x x x x x x x x x x x
st (REIT) does not pay corporate taxes but must pass through substantially all of the income to the t st unit hol
x x x x x x x x x x x x x x x x x x x x x
ders to whom it is taxable.
x x x x x
1-6. x x First, the corporation pays the taxes. After taxes, $2 × (1 –
x x x x x x x x x x x
x0.34) = $1.32 per share is left to pay dividends. Once the dividend is paid, personal tax on this must be paid, le
x x x x x x x x x x x x x x x x x x x x x x
aving $1.32 × (1 – x x x x
x0.18) = $1.0824 per share. So after all the taxes are paid, you are left with $1.0824 per share.
x x x x x x x x x x x x x x x x x x
1-
7. As a real estate investment t st (REIT) pays no corporate tax, the full amount of $2 per unit can be paid o
x x x x x x x x x x x x x x x x x x x x x x x x x
ut to you as a t st unit holder. You must then pay personal income tax on the distribution. So you are left with
x x x x x x x x x x x x x x x x x x x x x x x
$2 × (1 – 0.4) = $1.20 per unit.
x x x x x x x x
1-8. As the manager of an iPhone applications developer, you will make three types of financial decisions.
x x x x x x x x x x x x x x x
i. You will make investment decisions such as determining which type of iPhone application projects will o
x x x x x x x x x x x x x x x
ffer your company a positive NPV and should, therefore, be developed by your company.
x x x x x x x x x x x x x
ii. You will make the decision on how to fund your iPhone application investments and what mix of debt an
x x x x x x x x x x x x x x x x x x
d equity your company will have.
x x x x x
iii. You will be responsible for the cash management of your company, ensuring that your company has the n
x x x x x x x x x x x x x x x x x
ecessary funds to make investments, pay interest on loans, and pay your employees.
x x x x x x x x x x x x
1-9. Shareholders can x
i. ensure that employees are paid with company stock and/or stock options.
x x x x x x x x x x
ii. ensure that underperforming managers are fired. x x x x x
iii. write contracts that ensure that the interests of the managers and shareholders are closely aligned.
x x x x x x x x x x x x x x
iv. mount hostile takeovers. x x
1-
10. This will affect and hurt the customers. It will have a negative impact on the customers, for they will lik
x x x x x x x x x x x x x x x x x x x x x
ely get sour milk. It will also have a negative impact on shareholders because, in the long n, customers will re
x x x x x x x x x x x x x x x x xx x x x
, alize that the supermarket sells sour milk and will switch to other supermarkets. Thus, the value today of the f
x x x x x x x x x x x x x x x x x x x
uture income and cash flow streams generated by the supermarket will drop because of the long-
x x x x x x x x x x x x x x x
term loss of customers caused by this strategy. This will negatively affect the current stock price as sharehold
x x x x x x x x x x x x x x x x x
ers anticipate these long-term drawbacks.
x x x x
Part I: Introduction
x x
Chapter 1 x The Corporation and Financial Markets
x x x x 1
Chapter 2 x Introduction to Financial Statement Analysis
x x x x 5
Part II: Tools
x x
Chapter 3 x Arbitrage and Financial Decision Making
x x x x 15
Chapter 4 x The Time Value of Money
x x x x 26
Chapter 5 x Interest Rates x 49
Part III: Basic Valuation
x x x
Chapter 6 x Valuing Bonds x 65
Chapter 7 x Valuing Stocks x 77
Chapter 8 x Investment Decision les x xx 85
Chapter 9 x Fundamentals of Capital Budgeting x x x 100
Part IV: Risk and Return
x x x x
Chapter 10 x Capital Markets and the Pricing of Risk x x x x x x 108
Chapter 11 x Optimal Portfolio Choice and the Capital Asset Pricing Model
x x x x x x x x 117
Chapter 12 x Estimating the Cost of Capital x x x x 131
Chapter 13 x Investor Behaviour and Capital Market Efficiency x x x x x 137
Part V: Options
x x
Chapter 14 x Financial Options x 143
Chapter 15 x Option Valuation
x 152
Chapter 16 x Real Options
x 162
Part VI: Capital St cture and Dividend Policy
x x x x x x x
Chapter 17 x Capital St cture in a Perfect Market x x x x x x 185
Chapter 18 x Debt and Taxes x x 192
Chapter 19 x Financial Distress, Managerial Incentives, and Informationx x x x x 199
Chapter 20 x Payout Policy x 207
Part VII: Valuation
x x
Chapter 21 x Capital Budgeting and Valuation with Leverage
x x x x x 213
Chapter 22 x Valuation and Financial Modelling: A Case Study
x x x x x x 227
Part VIII: Long-Term Financing
x x x
Chapter 23 x Raising Equity Capital x x 235
Chapter 24 x Debt Financing x 239
Chapter 25 x Leasing 242
Part IX: Short-Term Financing
x x x
Chapter 26 x Working Capital Management x x 248
Chapter 27 x Short-Term Financial Planning x x 253
Part X: Special Topics
x x x
Chapter 28 x Mergers and Acquisitions
x x 257
Chapter 29 x Corporate Governance x 260
Chapter 30 x Risk Management
x 263
Chapter 31 x International Corporate Finance x x 272
,Chapter 1 x
The Corporation and Financial Markets
x x x x
1-
1. A corporation is a legal entity separate from its owners. This means ownership shares in the corporation
x x x x x x x x x x x x x x x x x x x
can be freely traded. None of the other organizational forms share this characteristic.
x x x x x x x x x x x x x
1-
2. Owners’ liability is limited to the amount they invested in the firm. Shareholders are not responsible for a
x x x x x x x x x x x x x x x x x x x
ny encumbrances of the firm; in particular, they cannot be required to pay back any debts incurred by the firm
x x x x x x x x x x x x x x x x x x x
.
1-
3. Corporations (all shareholders have limited liability). Limited partnerships provide limited liability for th
x x x x x x x x x x x x x x
e limited partners, but not for the general partners.
x x x x x x x x
1-
4. Advantages: Limited liability, liquidity, infinite life. Disadvantages: Double taxation, separation of
x x x x x x x x x x x x x
ownership and control. x x
1-
5. The corporation that only holds real estate must pay corporate income taxes. The real estate investment t
x x x x x x x x x x x x x x x x x x x
st (REIT) does not pay corporate taxes but must pass through substantially all of the income to the t st unit hol
x x x x x x x x x x x x x x x x x x x x x
ders to whom it is taxable.
x x x x x
1-6. x x First, the corporation pays the taxes. After taxes, $2 × (1 –
x x x x x x x x x x x
x0.34) = $1.32 per share is left to pay dividends. Once the dividend is paid, personal tax on this must be paid, le
x x x x x x x x x x x x x x x x x x x x x x
aving $1.32 × (1 – x x x x
x0.18) = $1.0824 per share. So after all the taxes are paid, you are left with $1.0824 per share.
x x x x x x x x x x x x x x x x x x
1-
7. As a real estate investment t st (REIT) pays no corporate tax, the full amount of $2 per unit can be paid o
x x x x x x x x x x x x x x x x x x x x x x x x x
ut to you as a t st unit holder. You must then pay personal income tax on the distribution. So you are left with
x x x x x x x x x x x x x x x x x x x x x x x
$2 × (1 – 0.4) = $1.20 per unit.
x x x x x x x x
1-8. As the manager of an iPhone applications developer, you will make three types of financial decisions.
x x x x x x x x x x x x x x x
i. You will make investment decisions such as determining which type of iPhone application projects will o
x x x x x x x x x x x x x x x
ffer your company a positive NPV and should, therefore, be developed by your company.
x x x x x x x x x x x x x
ii. You will make the decision on how to fund your iPhone application investments and what mix of debt an
x x x x x x x x x x x x x x x x x x
d equity your company will have.
x x x x x
iii. You will be responsible for the cash management of your company, ensuring that your company has the n
x x x x x x x x x x x x x x x x x
ecessary funds to make investments, pay interest on loans, and pay your employees.
x x x x x x x x x x x x
1-9. Shareholders can x
i. ensure that employees are paid with company stock and/or stock options.
x x x x x x x x x x
ii. ensure that underperforming managers are fired. x x x x x
iii. write contracts that ensure that the interests of the managers and shareholders are closely aligned.
x x x x x x x x x x x x x x
iv. mount hostile takeovers. x x
1-
10. This will affect and hurt the customers. It will have a negative impact on the customers, for they will lik
x x x x x x x x x x x x x x x x x x x x x
ely get sour milk. It will also have a negative impact on shareholders because, in the long n, customers will re
x x x x x x x x x x x x x x x x xx x x x
, alize that the supermarket sells sour milk and will switch to other supermarkets. Thus, the value today of the f
x x x x x x x x x x x x x x x x x x x
uture income and cash flow streams generated by the supermarket will drop because of the long-
x x x x x x x x x x x x x x x
term loss of customers caused by this strategy. This will negatively affect the current stock price as sharehold
x x x x x x x x x x x x x x x x x
ers anticipate these long-term drawbacks.
x x x x
