,Contents
Part I: Introduction
81 81
Chapter 181 The Corporation and Financial Markets
81 81 81 81 1
Chapter 281 Introduction to Financial Statement Analysis
81 81 81 81 5
Part II: Tools
81 81
Chapter 381 Arbitrage and Financial Decision Making
81 81 81 81 15
Chapter 481 The Time Value of Money
81 81 81 81 26
Chapter 581 Interest Rates 81 49
Part III: Basic Valuation
81 81 81
Chapter 681 Valuing Bonds 81 65
Chapter 781 Valuing Stocks 81 77
Chapter 881 Investment Decision les 81 8181 85
Chapter 981 Fundamentals of Capital Budgeting 81 81 81 100
Part IV: Risk and Return
81 81 81 81
Chapter 10
81 Capital Markets and the Pricing of Risk 81 81 81 81 81 81 108
Chapter 11
81 Optimal Portfolio Choice and the Capital Asset Pricing Model81 81 81 81 81 81 81 81 117
Chapter 12
81 Estimating the Cost of Capital 81 81 81 81 131
Chapter 13
81 Investor Behaviour and Capital Market Efficiency 81 81 81 81 81 137
Part V: Options
81 81
Chapter 14
81 Financial Options 81 143
Chapter 15
81 Option Valuation81 152
Chapter 16
81 Real Options
81 162
Part VI: Capital St cture and Dividend Policy
81 81 81 81 81 81 81
Chapter 17
81 Capital St cture in a Perfect Market 81 81 81 81 81 81 185
Chapter 18
81 Debt and Taxes 81 81 192
Chapter 19
81 Financial Distress, Managerial Incentives, and Information 81 81 81 81 81 199
Chapter 20
81 Payout Policy 81 207
Part VII: Valuation
81 81
Chapter 21
81 Capital Budgeting and Valuation with Leverage
81 81 81 81 81 213
Chapter 22
81 Valuation and Financial Modelling: A Case Study
81 81 81 81 81 81 227
Part VIII: Long-Term Financing
81 81 81
Chapter 23
81 Raising Equity Capital 81 81 235
Chapter 24
81 Debt Financing 81 239
Chapter 25
81 Leasing 242
Part IX: Short-Term Financing
81 81 81
Chapter 26
81 Working Capital Management 81 81 248
Chapter 27
81 Short-Term Financial Planning 81 81 253
Part X: Special Topics
81 81 81
Chapter 28
81 Mergers and Acquisitions 81 81 257
Chapter 29
81 Corporate Governance 81 260
Chapter 30
81 Risk Management 81 263
Chapter 31
81 International Corporate Finance 81 81 272
,Chapter 1 81
The Corporation and Financial Markets
81 81 81 81
1-
1. 8 A corporation is a legal entity separate from its owners. This means ownership shares in the
1 8 1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
corporation can be freely traded. None of the other organizational forms share this characteristic.
1 81 81 81 81 81 81 81 81 81 81 81 81 81
1-
2. 8 Owners’ liability is limited to the amount they invested in the firm. Shareholders are not respo
1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
nsible for any encumbrances of the firm; in particular, they cannot be required to pay back any debts
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
incurred by the firm. 81 81 81
1-
3. Corporations (all shareholders have limited liability). Limited partnerships provide limited liabilit
8 1 8 1 81 81 81 81 81 81 81 81 81 81
y for the limited partners, but not for the general partners.
81 81 81 81 81 81 81 81 81 81
1-
4. Advantages: Limited liability, liquidity, infinite life. Disadvantages: Double taxation, sep
8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1
aration of ownership and control.
8 1 81 81 81
1-
5. 8 The corporation that only holds real estate must pay corporate income taxes. The real estate inv
1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
estment t st (REIT) does not pay corporate taxes but must pass through substantially all of the income
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
to the t st unit holders to whom it is taxable.
81 81 81 81 81 81 81 81 81 81 81
1-6. 8 1 8 1First, the corporation pays the taxes. After taxes, $2 × (1 –
81 81 81 81 81 81 81 81 81 81 81
0.34) = $1.32 per share is left to pay dividends. Once the dividend is paid, personal tax on this must
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
be paid, leaving $1.32 × (1 –
1 81 81 81 81 81 81
0.18) = $1.0824 per share. So after all the taxes are paid, you are left with $1.0824 per share.
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
1-
7. 8 As a real estate investment t st (REIT) pays no corporate tax, the full amount of $2 per unit
1 8 1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
can be paid out to you as a t st unit holder. You must then pay personal income tax on the distributio
1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
n. So you are left with
81 81 81 81 81
$2 × (1 – 0.4) = $1.20 per unit.
81 81 81 81 81 81 81 81
1-8. As the manager of an iPhone applications developer, you will make three types of financial decisions.
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
i. You will make investment decisions such as determining which type of iPhone application projects
81 81 81 81 81 81 81 81 81 81 81 81 81 81
will offer your company a positive NPV and should, therefore, be developed by your company.
81 81 81 81 81 81 81 81 81 81 81 81 81 81
ii. You will make the decision on how to fund your iPhone application investments and what mix of
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
debt and equity your company will have.
81 81 81 81 81 81 81
iii. You will be responsible for the cash management of your company, ensuring that your company ha
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
s the necessary funds to make investments, pay interest on loans, and pay your employees.
81 81 81 81 81 81 81 81 81 81 81 81 81 81
1-9. Shareholders can 81
i. ensure that employees are paid with company stock and/or stock options.
81 81 81 81 81 81 81 81 81 81
ii. ensure that underperforming managers are fired.
81 81 81 81 81
iii. write contracts that ensure that the interests of the managers and shareholders are closely aligned.
81 81 81 81 81 81 81 81 81 81 81 81 81 81
iv. mount hostile takeovers. 81 81
1-
10. 8 1 8 1 This will affect and hurt the customers. It will have a negative impact on the customers, for t
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
, hey will likely get sour milk. It will also have a negative impact on shareholders because, in the long
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
n, customers will realize that the supermarket sells sour milk and will switch to other supermarkets.
181 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
Thus, the value today of the future income and cash flow streams generated by the supermarket will
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
drop because of the long-
81 81 81 81
term loss of customers caused by this strategy. This will negatively affect the current stock price as s
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
hareholders anticipate these long-term drawbacks.
81 81 81 81
Part I: Introduction
81 81
Chapter 181 The Corporation and Financial Markets
81 81 81 81 1
Chapter 281 Introduction to Financial Statement Analysis
81 81 81 81 5
Part II: Tools
81 81
Chapter 381 Arbitrage and Financial Decision Making
81 81 81 81 15
Chapter 481 The Time Value of Money
81 81 81 81 26
Chapter 581 Interest Rates 81 49
Part III: Basic Valuation
81 81 81
Chapter 681 Valuing Bonds 81 65
Chapter 781 Valuing Stocks 81 77
Chapter 881 Investment Decision les 81 8181 85
Chapter 981 Fundamentals of Capital Budgeting 81 81 81 100
Part IV: Risk and Return
81 81 81 81
Chapter 10
81 Capital Markets and the Pricing of Risk 81 81 81 81 81 81 108
Chapter 11
81 Optimal Portfolio Choice and the Capital Asset Pricing Model81 81 81 81 81 81 81 81 117
Chapter 12
81 Estimating the Cost of Capital 81 81 81 81 131
Chapter 13
81 Investor Behaviour and Capital Market Efficiency 81 81 81 81 81 137
Part V: Options
81 81
Chapter 14
81 Financial Options 81 143
Chapter 15
81 Option Valuation81 152
Chapter 16
81 Real Options
81 162
Part VI: Capital St cture and Dividend Policy
81 81 81 81 81 81 81
Chapter 17
81 Capital St cture in a Perfect Market 81 81 81 81 81 81 185
Chapter 18
81 Debt and Taxes 81 81 192
Chapter 19
81 Financial Distress, Managerial Incentives, and Information 81 81 81 81 81 199
Chapter 20
81 Payout Policy 81 207
Part VII: Valuation
81 81
Chapter 21
81 Capital Budgeting and Valuation with Leverage
81 81 81 81 81 213
Chapter 22
81 Valuation and Financial Modelling: A Case Study
81 81 81 81 81 81 227
Part VIII: Long-Term Financing
81 81 81
Chapter 23
81 Raising Equity Capital 81 81 235
Chapter 24
81 Debt Financing 81 239
Chapter 25
81 Leasing 242
Part IX: Short-Term Financing
81 81 81
Chapter 26
81 Working Capital Management 81 81 248
Chapter 27
81 Short-Term Financial Planning 81 81 253
Part X: Special Topics
81 81 81
Chapter 28
81 Mergers and Acquisitions 81 81 257
Chapter 29
81 Corporate Governance 81 260
Chapter 30
81 Risk Management 81 263
Chapter 31
81 International Corporate Finance 81 81 272
,Chapter 1 81
The Corporation and Financial Markets
81 81 81 81
1-
1. 8 A corporation is a legal entity separate from its owners. This means ownership shares in the
1 8 1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
corporation can be freely traded. None of the other organizational forms share this characteristic.
1 81 81 81 81 81 81 81 81 81 81 81 81 81
1-
2. 8 Owners’ liability is limited to the amount they invested in the firm. Shareholders are not respo
1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
nsible for any encumbrances of the firm; in particular, they cannot be required to pay back any debts
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
incurred by the firm. 81 81 81
1-
3. Corporations (all shareholders have limited liability). Limited partnerships provide limited liabilit
8 1 8 1 81 81 81 81 81 81 81 81 81 81
y for the limited partners, but not for the general partners.
81 81 81 81 81 81 81 81 81 81
1-
4. Advantages: Limited liability, liquidity, infinite life. Disadvantages: Double taxation, sep
8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1 8 1
aration of ownership and control.
8 1 81 81 81
1-
5. 8 The corporation that only holds real estate must pay corporate income taxes. The real estate inv
1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
estment t st (REIT) does not pay corporate taxes but must pass through substantially all of the income
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
to the t st unit holders to whom it is taxable.
81 81 81 81 81 81 81 81 81 81 81
1-6. 8 1 8 1First, the corporation pays the taxes. After taxes, $2 × (1 –
81 81 81 81 81 81 81 81 81 81 81
0.34) = $1.32 per share is left to pay dividends. Once the dividend is paid, personal tax on this must
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
be paid, leaving $1.32 × (1 –
1 81 81 81 81 81 81
0.18) = $1.0824 per share. So after all the taxes are paid, you are left with $1.0824 per share.
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
1-
7. 8 As a real estate investment t st (REIT) pays no corporate tax, the full amount of $2 per unit
1 8 1 8 1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
can be paid out to you as a t st unit holder. You must then pay personal income tax on the distributio
1 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
n. So you are left with
81 81 81 81 81
$2 × (1 – 0.4) = $1.20 per unit.
81 81 81 81 81 81 81 81
1-8. As the manager of an iPhone applications developer, you will make three types of financial decisions.
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
i. You will make investment decisions such as determining which type of iPhone application projects
81 81 81 81 81 81 81 81 81 81 81 81 81 81
will offer your company a positive NPV and should, therefore, be developed by your company.
81 81 81 81 81 81 81 81 81 81 81 81 81 81
ii. You will make the decision on how to fund your iPhone application investments and what mix of
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
debt and equity your company will have.
81 81 81 81 81 81 81
iii. You will be responsible for the cash management of your company, ensuring that your company ha
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
s the necessary funds to make investments, pay interest on loans, and pay your employees.
81 81 81 81 81 81 81 81 81 81 81 81 81 81
1-9. Shareholders can 81
i. ensure that employees are paid with company stock and/or stock options.
81 81 81 81 81 81 81 81 81 81
ii. ensure that underperforming managers are fired.
81 81 81 81 81
iii. write contracts that ensure that the interests of the managers and shareholders are closely aligned.
81 81 81 81 81 81 81 81 81 81 81 81 81 81
iv. mount hostile takeovers. 81 81
1-
10. 8 1 8 1 This will affect and hurt the customers. It will have a negative impact on the customers, for t
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
, hey will likely get sour milk. It will also have a negative impact on shareholders because, in the long
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 8
n, customers will realize that the supermarket sells sour milk and will switch to other supermarkets.
181 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
Thus, the value today of the future income and cash flow streams generated by the supermarket will
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
drop because of the long-
81 81 81 81
term loss of customers caused by this strategy. This will negatively affect the current stock price as s
81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81 81
hareholders anticipate these long-term drawbacks.
81 81 81 81
