Corporate finance tenth edition MBA

About This Course

Ross Westerfield Jaffe
corporate finance
tenth edition

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Corporate Finance

The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate
Stephen A. Ross
Franco Modigliani Professor of Finance and Economics Sloan School of Management
Massachusetts Institute of Technology
Consulting Editor
FINANCIAL MANAGEMENT
Block, Hirt, and Danielsen Foundations of Financial Management Fourteenth Edition
Brealey, Myers, and Allen Principles of Corporate Finance Tenth Edition
Brealey, Myers, and Allen
Principles of Corporate Finance, Concise Second Edition
Brealey, Myers, and Marcus Fundamentals of Corporate Finance Seventh Edition
Brooks
FinGame Online 5.0
Bruner
Case Studies in Finance: Managing for Corporate Value Creation
Sixth Edition
Cornett, Adair, and Nofsinger Finance: Applications and Theory Second Edition
Cornett, Adair, and Nofsinger M: Finance
First Edition
DeMello
Cases in Finance Second Edition
Grinblatt (editor)
Stephen A. Ross, Mentor: Influence through Generations
Grinblatt and Titman
Financial Markets and Corporate Strategy Second Edition
Higgins
Analysis for Financial Management Tenth Edition
Kellison
Theory of Interest Third Edition
Ross, Westerfield, and Jaffe Corporate Finance
Tenth Edition
Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications
Third Edition
Ross, Westerfield, and Jordan Essentials of Corporate Finance Seventh Edition
Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Tenth Edition
Shefrin
Behavioral Corporate Finance: Decisions That Create Value
First Edition
White
Financial Analysis with an Electronic Calculator Sixth Edition
INVESTMENTS
Bodie, Kane, and Marcus Essentials of Investments Ninth Edition
Bodie, Kane, and Marcus Investments
Ninth Edition
Hirt and Block
Fundamentals of Investment Management Tenth Edition
Jordan and Miller
Fundamentals of Investments: Valuation and Management
Sixth Edition
Stewart, Piros, and Heisler
Running Money: Professional Portfolio Management
First Edition
Sundaram and Das
Derivatives: Principles and Practice First edition
FINANCIAL INSTITUTIONS
AND MARKETS
Rose and Hudgins
Bank Management and Financial Services Ninth Edition
Rose and Marquis
Financial Institutions and Markets Eleventh Edition
Saunders and Cornett
Financial Institutions Management: A Risk Management Approach
Seventh Edition
Saunders and Cornett
Financial Markets and Institutions Fifth Edition
INTERNATIONAL FINANCE
Eun and Resnick
International Financial Management Sixth Edition
REAL ESTATE
Brueggeman and Fisher
Real Estate Finance and Investments Fourteenth Edition
Ling and Archer
Real Estate Principles: A Value Approach Fourth Edition
FINANCIAL PLANNING
AND INSURANCE
Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches
Tenth Edition
Altfest
Personal Financial Planning First Edition
Harrington and Niehaus
Risk Management and Insurance Second Edition
Kapoor, Dlabay, and Hughes
Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills Fourth Edition
Kapoor, Dlabay, and Hughes Personal Finance
Tenth Edition
Walker and Walker
Personal Finance: Building Your Future First Edition

Corporate Finance
TENTH EDITION
Stephen A. Ross
Sloan School of Management Massachusetts Institute of Technology
Randolph W. Westerfield
Marshall School of Business University of Southern California
Jeffrey Jaffe
Wharton School of Business University of Pennsylvania

CORPORATE FINANCE
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2013, 2010, 2008, 2005, 2002, 1999, 1996, 1993, 1990, 1988 by The McGraw-Hill Companies, Inc. All rights reserved. Printed in the United States of America. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the United States.
This book is printed on acid-free paper.
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ISBN 978-0-07-803477-0 MHID 0-07-803477-9
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Library of Congress Cataloging-in-Publication Data
Ross, Stephen A.
Corporate finance / Stephen A. Ross, Randolph W. Westerfield, Jeffrey Jaffe. — 10th ed.
p. cm. — (The McGraw-Hill/Irwin series in finance, insurance and real estate) Includes index.
ISBN 978-0-07-803477-0 (alk. paper) — ISBN 0-07-803477-9 (alk. paper)
1. Corporations—Finance. I. Westerfield, Randolph. II. Jaffe, Jeffrey F., 1946- III. Title.
HG4026.R675 2013 658.15—dc23
www.mhhe.com
2012014687

To our family and friends with love and gratitude.


About the Authors
STEPHEN A. ROSS Sloan School of Management, Massachusetts Institute of Technology Stephen A. Ross is the Franco Modigliani Professor of Financial Economics at the Sloan School of Management, Massachusetts Institute of Technology. One of the most widely published authors in finance and economics, Professor Ross is recognized for his work in developing the arbitrage pricing theory, as well as for having made substantial contributions to the discipline through his research in signaling, agency theory, option pricing, and the theory of the term struc- ture of interest rates, among other topics. A past president of the American Finance Association, he currently serves as an associate editor of several academic and prac- titioner journals and is a trustee of CalTech.
RANDOLPH W. WESTERFIELD Marshall School of Business, University of Southern California Randolph W. Westerfield is Dean Emeritus of the University of Southern California’s Marshall School of Business and is the Charles B. Thornton Professor of Finance.
Professor Westerfield came to USC from the Wharton School, University of Pennsylvania, where he was the chairman of the finance department and member of the finance faculty for 20 years. He has been a member of several public company boards of directors, including Health Management Associates, Inc., and Oak Tree Finance, LLC. His areas of expertise include corporate financial policy, investment management, and stock market price behavior.
JEFFREY F. JAFFE Wharton School of Business, University of Pennsylvania Jeffrey F. Jaffe has been a frequent contributor to the finance and economics literatures in such journals as the Quarterly Economic Journal, The Journal of Finance, The Journal of Financial and Quantitative Analysis, The Journal of Financial Economics, and The Financial Analysts Journal. His best-known work concerns insider trading, where he showed both that corporate insiders earn abnormal profits from their trades and that regulation has little effect on these profits. He has also made contributions concerning initial public offerings, regulation of utilities, the behavior of market makers, the fluc- tuation of gold prices, the theoretical effect of inflation on interest rates, the empirical effect of inflation on capital asset prices, the relationship between small-capitalization stocks and the January effect, and the capital structure decision.
vii

Preface
viii
The teaching and the practice of corporate finance are more challenging and exciting than ever before. The last decade has seen fundamental changes in financial markets and financial instruments. In the early years of the 21st cen- tury, we still see announcements in the financial press about takeovers, junk bonds, financial restructuring, initial public offerings, bankruptcies, and derivatives. In addition, there are the new recognitions of “real” options, private equity and venture capital, subprime mortgages, bailouts, and credit spreads. As we have learned in the recent global credit crisis and stock market collapse, the world’s financial markets are more integrated than ever before. Both the theory and practice of corporate finance have been moving ahead with uncommon speed, and our teaching must keep pace.
These developments have placed new burdens on the teaching of corporate finance. On one hand, the changing world of finance makes it more difficult to keep materials up to date. On the other hand, the teacher must distinguish the permanent from the temporary and avoid the temptation to follow fads. Our solution to this problem is to emphasize the modern fundamentals of the theory of finance and make the theory come to life with contemporary examples. Increasingly, many of these examples are outside the United States.
All too often the beginning student views corporate finance as a collection of unrelated topics that are unified largely because they are bound together between the covers of one book. We want our book to embody and reflect the main principle of finance: Namely, that good financial decisions will add value to the firm and to shareholders and bad financial decisions will destroy value. The key to understanding how value is added or destroyed is cash flows. To add value, firms must generate more cash than they use. We hope this simple principle is manifest in all parts of this book.
The Intended Audience of This Book
This book has been written for the introductory courses in corporate finance at the MBA level and for the intermediate courses in many undergraduate programs. Some instructors will find our text appropriate for the introductory course at the under- graduate level as well.
We assume that most students either will have taken, or will be concurrently enrolled in, courses in accounting, statistics, and economics. This exposure will help students understand some of the more difficult material. However, the book is self- contained, and a prior knowledge of these areas is not essential. The only mathemat- ics prerequisite is basic algebra.
New to Tenth Edition
All chapter openers and examples have been updated to reflect the financial trends and turbulence of the last several years. In addition, we have updated the end-of- chapter problems and questions in every chapter. We have tried to incorporate the

many exciting new research findings in corporate finance. Several chapters have been extensively rewritten.
• Chapter 9 Stock Valuation. This chapter now adds a description of how dis- counted cash flow can be used to determine the value of an entire enterprise in addition to individual common stocks. We also introduce the important concept of comparable firms and show how to use market data on comparable firms to bolster discounted cash flow methods. We try to organize the material so that instructors can choose which best fits their lesson plan.
• Chapter 10 Risk and Return: Lessons from Market History. We continue to update and internationalize our discussion of historical risk and return since these updates are far from routine. One of our focal points is the equity risk premium (ERP). With better historical data and more countries included, our estimates of the ERP are on stronger footing.
• Chapter 13 has been retitled, from Risk, Cost of Capital, and Capital Budgeting to Risk, Cost of Capital, and Valuation. We introduce the concept of the weighted average cost of capital (R ) and show how it can be used along with discounted
WACC
cash flow to value both an entire enterprise as well as individual projects.
• Chapter 15 Long-Term Financing. The introduction has been extensively rewritten to introduce the basic features of debt and equity as well as recent trends and innovations.
• Chapter 17 Capital Structure: Limits to the Use of Debt has been rewritten to incorporate some new and important empirical and theoretical work on capital structure. It is now much clearer to us that actual capital structures vary a lot over time and are much less stable than previously thought. This instability is strongly correlated to investment needs and opportunities and also suggests a greater need for financial flexibility than was previously thought to be necessary. We incor- porate some recent research on international leverage ratios. Among 39 different countries, the U.S. has the fourth lowest.
• Chapter 19 Dividends and Other Payouts. We introduce the financial life cycle notion that most high-growth firms with external financial needs don’t pay dividends or buy back shares, and low-growth firms with excess cash flows do pay dividends and/or buy back shares. This simple fact sometimes is lost in determin- ing why firms actually pay or do not pay dividends and buy back shares. We use new data incorporating the financial crisis and also when corporate earnings turn negative. Interestingly, in our study, the level of dividends did not change much but share repurchases fell off.
• Chapter 20 has been retitled from Issuing Securities to the Public to Raising Capital. We build on the financial life cycle idea, introducing private equity and venture capital as early ways to raise funds in a firm’s life cycle. Later on, successful firms will do an initial public offering (IPO) and seasoned equity offers (SEO).
ix

Pedagogy
In this edition of Corporate Finance, we have updated and improved our features to pres- ent material in a way that makes it coherent and easy to understand. In addition, Corporate Finance is rich in valuable learning tools and support, to help students succeed in learning the fundamentals of financial management.
PART III: RISK
10.1 Returns
ExcelMaster
coverage online
DOLLAR RETURNS
Suppose the Video Concept Company has several thousand shares of stock out- standing and you are a shareholder. Further suppose that you purchased some of the shares of stock in the company at the beginning of the year; it is now year-end and you want to figure out how well you have done on your investment. The return you get on an investment in stocks, like that in bonds or any other investment, comes in two forms.
As the owner of stock in the Video Concept Company, you are a part owner of the company. If the company is profitable, it generally could distribute some of its profits to the shareholders. Therefore, as the owner of shares of stock, you could receive some cash, called a dividend, during the year. This cash is the income com- ponent of your return. In addition to the dividends, the other part of your return is the capital gain—or, if it is negative, the capital loss (negative capital gain)—on the investment.
For example, suppose we are considering the cash flows of the investment in Figure 10.1, showing that you purchased 100 shares of stock at the beginning of the year at a price of $37 per share. Your total investment, then, was:
C 5$3731005$3,700 0
Suppose that over the year the stock paid a dividend of $1.85 per share. During the year, then, you received income of:
306
Div 5 $1.85 3 100 5 $185
How did the market do today? Find out at finance.yahoo.com.
CHAPTER 10
For updates on the latest happenings in
finance, visit www. rwjcorporatefinance. blogspot.com
Risk and Return
LESSONS FROM MARKET HISTORY
With the S&P 500 Index returning about 2 percent and the NASDAQ Composite Index down about 1 percent in 2011, stock market performance overall was not very good. However, inves- tors in software company eGain Communications had to be happy about the 412 percent gain in that stock, and investors in semiconductor company Silicon Motion Technology had to feel pretty good following that company’s 382 percent gain. Of course, not all stocks increased in value during the year. Stock in First Solar fell 74 percent during the year, and stock in Alpha Natural Resources dropped 66 percent.
These examples show that there were tremendous potential profits to be made during 2011, but there was also the risk of losing money—and lots of it. So what should you, as a stock market inves- tor, expect when you invest your own money? In this chapter, we study more than eight decades of market history to find out.
Chapter Opening
Vignettes
Each chapter begins with a contemporary vignette that highlights the concepts in the chapter and their relevance to real-world examples.
x
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Excel Master Icons
Topics covered in the comprehensive ExcelMaster supple- ment (found on the Online Learning Center) are indicated by an icon in the margin.
6.2 The Baldwin Company: An Example
ExcelMaster
coverage online
This section introduces the VDB function.
We next consider the example of a proposed investment in machinery and related items. Our example involves the Baldwin Company and colored bowling balls.
The Baldwin Company, originally established 16 years ago to make footballs, is now a leading producer of tennis balls, baseballs, footballs, and golf balls. Nine years ago, the company introduced “High Flite,” its first line of high-performance golf balls. Baldwin management has sought opportunities in whatever businesses seem to have
Figure 8.2
Interest Rate Risk and Time to Maturity
2,000
$1,768.62
1,500
1,000
500
30-year bond
$1,047.62
1-year bond
5 10 15 20 Interest rate (%)
Value of a Bond with a 10 Percent Coupon Rate for Different Interest Rates and Maturities
$916.67 $502.11
Bond value ($)
Time to Maturity
Interest Rate 1 Year 30 Years
5% 10
15 20
$1,047.62 1,000.00 956.52 916.67
$1,768.62 1,000.00 671.70 502.11
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EXAMPLE 9.5
Calculating the Required Return Pagemaster Enterprises, the company examined in the pre- vious example, has 1,000,000 shares of stock outstanding. The stock is selling at $10. What is the required return on the stock?
Because the retention ratio is 40 percent, the payout ratio is 60 percent (1 − Retention ratio). The payout ratio is the ratio of dividends∕earnings. Because earnings a year from now will be $2,128,000 ($2,000,000 3 1.064), dividends will be $1,276,800 (.60 3 $2,128,000). Dividends per share will be $1.28 ($1,276,800y1,000,000). Given our previous result that g 5 .064, we calculate R from (9.9) as follows:
.192 = _$_1_._2_8_ + .064 $10.00
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Figures and Tables
This text makes extensive use of real data and presents them in various figures and tables. Explanations in the narrative, examples, and end-of-chapter problems will refer to many of these exhibits.
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Examples
Separate called-out examples are integrated through- out the chapters. Each example illustrates an intuitive or mathematical application in a step-by-step format.There is enough detail in the explanations so students don’t have to look elsewhere for additional information.
In Their Own Words
ROBERT C. HIGGINS ON SUSTAINABLE
GROWTH
12:25 PM
prepared to talk about investment products because management’s problem will be what to do with all the cash that keeps piling up in the till.
Bankers also find the sustainable growth equa- tion useful for explaining to financially inexperienced small business owners and overly optimistic entrepre- neurs that, for the long-run viability of their business, it is necessary to keep growth and profitability in proper balance.
Finally, comparison of actual to sustainable growth rates helps a banker understand why a loan applicant needs money and for how long the need might continue. In one instance, a loan applicant requested $100,000 to pay off several insistent suppli- ers and promised to repay in a few months when he collected some accounts receivable that were coming due. A sustainable growth analysis revealed that the firm had been growing at four to six times its sustain- able growth rate and that this pattern was likely to continue in the foreseeable future. This alerted the banker that impatient suppliers were only a symptom of the much more fundamental disease of overly rapid growth, and that a $100,000 loan would likely prove to be only the down payment on a much larger, multiyear
12 12:2
Sustainable growth is often used by bankers and other external analysts to assess a company’s creditworthiness. They are aided in this exercise by several sophisticated computer software packages that provide detailed analyses of the company’s past financial performance, including its annual sustain- able growth rate.
Bankers use this information in several ways. Quick comparison of a company’s actual growth rate to its sustainable rate tells the banker what issues will be at the top of management’s financial agenda. If actual growth consistently exceeds sustainable growth, man- agement’s problem will be where to get the cash to
5P
M
M
money to make money. Rapid sales growth requires increased assets in the form of accounts receivable, inventory, and fixed plant, which, in turn, require money to pay for assets. They also know that if their company does not have the money when needed, it can literally “grow broke.” The sustain- able growth equation states these intuitive truths explicitly.
o
st financial officers know intuitively that it takes
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“In Their Own Words” Boxes
Located throughout the chapters, this unique series con-
sists of articles written by distinguished scholars or practi- tioners about key topics in the text. Boxes include essays by Edward I. Altman, Robert S. Hansen, Robert C. Higgins, Michael C. Jensen, Merton Miller, and Jay R. Ritter.
3-
30
5.
ind
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81
it t
xi

SPREADSHEET APPLICATIONS
Using a Spreadsheet for Time Value of Money Calculations
More and more, businesspeople from many different areas (not just finance and accounting) rely on spreadsheets to do all the different types of calculations that come up in the real world. As a result, in this section, we will show you how to use a spreadsheet to handle the various time value of money problems we present in this chapter. We will use Microsoft ExcelTM, but the commands are similar for other types of software. We assume you are already familiar with basic spreadsheet operations.
As we have seen, you can solve for any one of the following four potential unknowns: future value, present value, the discount rate, or the number of pe- riods. With a spreadsheet, there is a separate formula for each. In Excel, these are shown in a nearby box.
In these formulas, pv and fv are present and fu- ture value, nper is the number of periods, and rate is the discount, or interest, rate.
Two things are a little tricky here. First, unlike a
financial calculator, the spreadsheet requires that the rate be entered as a decimal. Second, as with most financial calculators, you have to put a negative sign on either the present value or the future value to solve for the rate or the number of periods. For the same reason, if you solve for a present value, the answer will have a negative sign unless you input a negative future value. The same is true when you compute a future value.
To illustrate how you might use these formulas, we will go back to an example in the chapter. If you invest $25,000 at 12 percent per year, how long until you have $50,000? You might set up a spreadsheet like this:
To Find
Enter This Formula
Future value
5 FV (rate,nper,pmt,pv)
Present value
5 PV (rate,nper,pmt,fv)
Discount rate
5 RATE (nper,pmt,pv,fv)
Number of periods
5 NPER (rate,pmt,pv,fv)
1 2 3 4 5 6 7 8 9 10 11 12 13 14
ABCDEFGH
Using a spreadsheet for time value of money calculations
If we invest $25,000 at 12 percent, how long until we have $50,000? We need to solve
for the unknown number of periods, so we use the formula NPER(rate, pmt, pv, fv).
Present value (pv):
$25,000
Future value (fv):
$50,000
Rate (rate):
.12
Periods:
6.1162554
The formula entered in cell B11 is =NPER(B9,0,-B7,B8); notice that pmt is zero and that pv
has a negative sign on it. Also notice that rate is entered as a decimal, not a percentage.
Spreadsheet Applications
Now integrated into select chapters, Spreadsheet Application boxes reintroduce students to Excel, demonstrating how to set up spreadsheets in order to analyze common financial problems—a vital part of every business student’s education. (For even more spreadsheet example problems, check out Excel Master on the Online Learning Center!).
Explanatory
Web site Links
These Web links are specifically se- lected to accompany text material and provide students and instructors with a quick reference to additional information on the Internet.
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25.5 Interest Rate Futures Contracts
In this section we consider interest rate futures contracts. Our examples deal with futures contracts on Treasury bonds because of their high popularity. We first price Treasury bonds and Treasury bond forward contracts. Differences between futures and forward contracts are explored. Hedging examples are provided next.
PRICING OF TREASURY BONDS
As mentioned earlier in the text, a Treasury bond pays semiannual interest over its life. In addition, the face value of the bond is paid at maturity. Consider a 20-year, 8 percent coupon bond that was issued on March 1. The first payment is to occur in six months— that is, on September 1. The value of the bond can be determined as follows:
Pricing of Treasury Bond
P = __$_4_0__ + ___$_4_0___ + ___$_4_0___ + . . . + ___$_4__0___ + __$_1_,_0_4_0__ (25.1) TB 1 + R1 (1 + R2)2 (1 + R3)3 (1 + R39)39 (1 + R40)40
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Key equations are numbered and listed on the back endsheets for easy reference.
QR Codes
These scannable codes, located in each chapter, take you to the latest current events related to key topics, and to chapter quizzes related to key topics.
4779_ch02_020-043.indd 22
To test your
mastery of this material, take a quiz at mhhe. com/rwj
So, what lessons should investors take away from this recent, and very turbulent, bit of capital market history? First, and most obviously, stocks have significant risk! But there is a second, equally important lesson. Depending on the mix, a diversified portfolio of stocks and bonds might have suffered in 2008, but the losses would have been much smaller than those experienced by an all-stock portfolio. In other words, diversification matters, a point we will examine in detail in our next chapter.
2
xii
VALUE VERSUS COST
The accounting value of a firm’s assets is frequently referred to as the carrying value or the book value of the assets.2 Under generally accepted accounting principles (GAAP), audited financial statements of firms in the United States carry the assets at cost.3 Thus the terms carrying value and book value are unfortunate. They specifically say “value,” when in fact the accounting numbers are based on cost. This misleads
The home page
for the Financial Accounting Standards Board (FASB) is www.fasb.org.
Numbered
Equations
12:19 PM

End-of-Chapter Material
Chapter 25 Derivatives and Hedging Risk 799
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Summary and Conclusions
1. Firms hedge to reduce risk. This chapter showed a number of hedging strategies.
2. A forward contract is an agreement by two parties to sell an item for cash at a later date. The price is set at the time the agreement is signed. However, cash changes hands on the
date of delivery. Forward contracts are generally not traded on organized exchanges.
3. Futures contracts are also agreements for future delivery. They have certain advantages, such as liquidity, that forward contracts do not. An unusual feature of futures contracts is the mark-to-the-market convention. If the price of a futures contract falls on a particular day, every buyer of the contract must pay money to the clearinghouse. Every seller of the contract receives money from the clearinghouse. Everything is reversed if the
price rises. The mark-to-the-market convention prevents defaults on futures contracts.
4. We divided hedges into two types: Short hedges and long hedges. An individual or firm that sells a futures contract to reduce risk is instituting a short hedge. Short hedges are generally appropriate for holders of inventory. An individual or firm that buys a futures contract to reduce risk is instituting a long hedge. Long hedges are typically used by
firms with contracts to sell finished goods at a fixed price.
5. An interest rate futures contract employs a bond as the deliverable instrument. Because
of their popularity, we worked with Treasury bond futures contracts. We showed that Treasury bond futures contracts can be priced using the same type of net present value analysis that is used to price Treasury bonds themselves.
6. Many firms face interest rate risk. They can reduce this risk by hedging with interest rate futures contracts. As with other commodities, a short hedge involves the sale of a futures contract. Firms that are committed to buying mortgages or other bonds are likely to institute short hedges. A long hedge involves the purchase of a futures contract. Firms that have agreed to sell mortgages or other bonds at a fixed price are likely to institute long hedges.
7. Duration measures the average maturity of all the cash flows in a bond. Bonds with high duration have high price variability. Firms frequently try to match the duration of their assets with the duration of their liabilities.
8. Swaps are agreements to exchange cash flows over time. The first major type is an interest rate swap in which one pattern of coupon payments, say, fixed payments, is exchanged for another, say, coupons that float with LIBOR. The second major type is a currency swap, in which an agreement is struck to swap payments denominated in one currency for payments in another currency over time.
Concept Questions
1. Hedging Strategies If a firm is selling futures contracts on lumber as a hedging strategy, what must be true about the firm’s exposure to lumber prices?
2. Hedging Strategies If a firm is buying call options on pork belly futures as a hedging strategy, what must be true about the firm’s exposure to pork belly prices?
3. Forwards and Futures What is the difference between a forward contract and a futures
contract? Why do you think that futures contracts are much more common? Are there any
circumstances under which you might prefer to use forwards instead of futures? Explain.
4. Hedging Commodities Bubbling Crude Corporation, a large Texas oil producer, would like to hedge against adverse movements in the price of oil because this is the firm’s primary source of revenue. What should the firm do? Provide at least two reasons why it probably will not be possible to achieve a completely flat risk profile
with respect to oil prices.
The end-of-chapter material reflects and builds upon the concepts learned from the chapter and study features.
Summary and Conclusions
The summary provides a quick review of key concepts in the chapter.
Questions and Problems
Because solving problems is so critical to a student’s learning, new questions and problems have been added, and existing questions and problems have been revised. All problems have also been thoroughly reviewed and checked for accuracy.
Problems have been grouped according to level of difficulty with the levels listed in the margin: Basic, Intermediate, and Challenge.
Additionally, we have tried to make the problems in the critical “concept” chapters, such as those on value, risk, and capital struc- ture, especially challenging and interesting.
We provide answers to selected problems in Appendix B at the end of the book.
www.mhhe.com/rwj
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Excel Master It!
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Included in the end-of-chapter material are problems di- rectly incorporating Excel, and new tips and techniques taught in the chapter’s ExcelMaster supplement.
End-of-Chapter Cases
Excel Problems
Indicated by the Excel icon in the margin, these problems can be found at the end of almost all chapters. Located on the book’s Web site (see Online Resources), Excel templates have been created for each of these problems, where students can use the data in the problem to work out the solution using Excel skills.
25. Calculating Rates of Return You’re trying to choose between two different investments, both of which have up-front costs of $65,000. Investment G returns $125,000 in six years. Investment H returns $185,000 in 10 years. Which of these investments has the higher return?
26. Growing Perpetuities Mark Weinstein has been working on an advanced technology in laser eye surgery. His technology will be available in the near term. He anticipates his first annual cash flow from the technology to be $175,000, received two years from today. Subsequent annual cash flows will grow at 3.5 percent in perpetuity. What is the present value of the technology if the discount rate is 10 percent?
27. Perpetuities A prestigious investment bank designed a new security that pays a quarterly dividend of $4.50 in perpetuity. The first dividend occurs one quarter
Located at the end of almost every chapter, these mini cases focus on common company situations that embody important corporate finance topics. Each case presents a new scenario, data, and a dilemma. Several questions at the end of each case require students to analyze and focus on all of the material they learned in that chapter.
in the country The MBA degree requires two years of full time enrollment at the univer
Excel Master It!
Excel is a great tool for solving problems, but with many time value of money problems, you may still need to draw a time line. For example, consider a classic retirement problem. A friend is celebrating her birthday and wants to start saving for her anticipated retire- ment. She has the following years to retirement and retirement spending goals:
134
Years until retirement
Amount to withdraw each year
Years to withdraw in retirement
Interest rate
$90,000
30
20
8%
133
Mini Case
Part II Valuation and Capital Budgeting THE MBA DECISION
23/08/12 12:21 PM
Ben Bates graduated from college six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA degree would allow him to achieve this goal. After examining schools, he has narrowed his choice to either Wilton University or Mount Perry College. Although internships are encouraged by both schools, to get class credit for the internship, no salary can be paid. Other than internships, neither school will allow its students to work while enrolled in its MBA program.
Ben currently works at the money management firm of Dewey and Louis. His annual sal- ary at the firm is $65,000 per year, and his salary is expected to increase at 3 percent per year until retirement. He is currently 28 years old and expects to work for 40 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 26 percent. Ben has a savings account with enough money to cover the entire cost of his MBA program.
The Ritter College of Business at Wilton University is one of the top MBA programs
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xiii

Comprehensive Teaching
Corporate Finance has many options in terms of the textbook, instructor supplements, student supplements, and multimedia products. Mix and match to create a package that is perfect for your course.
Online Learning Center
Instructor Support
The Online Learning Center (OLC) contains all the necessary supplements—Instructor’s Manual, Test Bank, Computerized Test Bank, and PowerPoint—all in one place. Go to www.mhhe.com/rwj to find:
• Instructor’s Manual
Prepared by Steven Dolvin, Butler University.
This is a great place to find new lecture ideas. The IM has three main sections. The first section contains a chapter outline and other lecture materials. The annotated outline for each chapter includes lecture tips, real-world tips, ethics notes, suggested PowerPoint slides, and, when appropriate, a video synopsis.
• Solutions Manual
Prepared by Joseph Smolira, Belmont University.
This manual contains detailed, worked-out solutions for all of the problems in the end-of-chapter mate- rial. It has been reviewed for accuracy by multiple sources. The Solutions Manual is also available for purchase by your students. (ISBN: 0-07-751134-4)
• Test Bank
Prepared by Patricia Ryan, Colorado State University.
Here’s a great format for a better testing process. The Test Bank has well over 100 questions per chapter that closely link with the text material and provide a variety of question formats (multiple-choice ques- tions/problems and essay questions) and levels of difficulty (basic, intermediate, and challenge) to meet every instructor’s testing needs. Problems are detailed enough to make them intuitive for students, and solutions are provided for the instructor.
• Computerized Test Bank (Windows)
These additional questions are found in a computerized test bank utilizing McGraw-Hill’s EZ Test software to quickly create customized exams. This user-friendly program allows instructors to sort ques- tions by format, edit existing questions or add new ones, and scramble questions for multiple versions of the same test.
• PowerPoint Presentation System
Prepared by Steven Dolvin, Butler University.
Customize our content for your course. This presentation has been thoroughly revised to include more lecture-oriented slides, as well as exhibits and examples both from the book and from outside sources. Applicable slides have Web links that take you directly to specific Internet sites, or a spreadsheet link to show an example in Excel. You can also go to the Notes Page function for more tips on presenting the slides. If you already have PowerPoint installed on your PC, you can edit, print, or rearrange the complete presentation to meet your specific needs.
xiv

and Learning Package
Student Support
• Narrated PowerPoint Examples
Updated by Kay Johnson, exclusively for students as part of the premium content package of this book.
Each chapter’s slides follow the chapter topics and provide steps and explanations showing how to solve key problems. Because each student learns differently, a quick click on each slide will “talk through” its contents with you!
• Excel Templates
Corresponding to most end-of-chapter problems, each template allows the student to work through the
problem using Excel. Each end-of-chapter problem with a template is indicated by an Excel icon in the margin beside it.
• ExcelMaster
Developed for the RWJ franchise, this valuable and comprehensive supplement provides a tutorial for students in using Excel in finance, broken out by chapter sections.
• More
Be sure to check out the other helpful features on the OLC, including self-study quizzes and chapter
appendices.
Options Available for Purchase & Packaging
You may also package either version of the text with a variety of additional learning tools that are available for your students.
Solutions Manual ISBN-10: 0-07-751134-4 / ISBN-13: 978-0-07-751134-0
Prepared by Joseph Smolira, Belmont University.
This manual contains detailed, worked-out solutions for all of the problems in the end-of-chapter material. It has also been reviewed for accuracy by multiple sources. The Solutions Manual is also available for purchase by your students.
FinGame Online 5.0 ISBN-10: 0-07-721988-0 / ISBN-13: 978-0-07-721988-8
By LeRoy Brooks, John Carroll University.
Just $15.00 when packaged with this text. In this comprehensive simulation game, students control a hypothetical company over numerous periods of operation. The game is now tied to the text by exercises found at the Online Learning Center. As students make major financial and operating decisions for their
company, they will develop and enhance skills in financial management and financial accounting state- ment analysis.
xv

McGraw-Hill Connect Finance
Less Managing. More Teaching. Greater Learning.
McGraw-Hill’s Connect Finance is an online assignment and assessment solution that connects students with the tools and resources they will need to achieve success.
Connect helps prepare students for their future by enabling faster learning, more efficient studying, and higher retention of knowledge.
McGraw-Hill Connect Finance Features Connect Finance offers a number of powerful tools and features to make managing assignments easier, so faculty can spend more time teaching. With Connect Finance, stu- dents can engage with their coursework anytime and anywhere, making the learning process more accessible and efficient. Connect Finance offers you the features described below.
Simple assignment management With Connect Finance, creating assignments is easier than ever, so you can spend more time teaching and less time managing. The assignment management function enables you to:
• Create and deliver assignments easily with selectable end-of-chapter questions and test bank items.
• Streamline lesson planning, student progress reporting, and assignment grading to make classroom man-
agement more efficient than ever.
• Go paperless with the eBook and online submission and grading of student assignments.
Smart grading When it comes to studying, time is precious. Connect Finance helps students learn more efficiently by providing feedback and practice material when they need it, where they need it. When it comes to teaching, your time is also precious. The grading function enables you to:
• Have assignments scored automatically, giving students immediate feedback on their work and side-by- side comparisons with correct answers.
• Access and review each response; manually change grades, or leave comments for students to review.
• Reinforce classroom concepts with practice tests and instant quizzes.
Instructor library The Connect Finance Instructor Library is your repository for additional resources to improve student engagement in and out of class. You can select and use any asset that enhances your lecture.
Student study center The Connect Finance Student Study Center is the place for students to access addi- tional resources. The Student Study Center:
• Offers students quick access to lectures, practice materials, eBooks, and more.
• Provides instant practice material and study questions, easily accessible on the go.
• Gives students access to the Self Quiz and Study features described below.
Self Quiz and Study Self Quiz and Study features (SQS) connect each student to the learning resources needed for success in the course. For each chapter, students:
xvi

• Take a practice test to initiate the Study Plan.
• Immediately upon completing the practice test, see how their performance compares to the chapter objec-
tives to be achieved within each section of the chapters.
• Receive a Study Plan that recommends specific readings from the text, supplemental study material, and practice work that will improve their understanding and mastery of each learning objective.
Diagnostic and Adaptive Learning of Concepts: LearnSmart Students want to make the best use of their study time. The LearnSmart adaptive self-study technology within Connect Finance provides students with a seamless combination of practice, assessment, and remediation for every concept in the textbook. LearnSmart’s intelligent software adapts to every student response and automatically delivers concepts that will advance the student’s understanding while reducing the time devoted to the concepts already mastered. The result for every student is the fastest path to mastery of the chapter. LearnSmart:
• Applies an intelligent concept engine to identify the relationships between ideas and to serve new concepts to each student only when he or she is ready.
• Adapts automatically to each student, so students spend less time on the topics they understand and prac- tice more on those they have yet to master.
• Provides continual reinforcement and remediation, but gives only as much guidance as students need.
• Integrates diagnostics as part of the learning experience.
• Enables you to assess which concepts students have efficiently learned on their own, thus freeing class time for more applications and discussion.
Student progress tracking Connect Finance keeps instructors informed about how each student, section, and class is performing, allowing for more productive use of lecture and office hours. The progress-tracking function enables you to:
• View scored work immediately and track individual or group performance with assignment and grade reports.
• Access an instant view of student or class performance relative to learning objectives.
Lecture capture through Tegrity Campus For an additional charge Lecture Capture offers new ways for students to focus on the in-class discussion, knowing they can revisit important topics later. This can be delivered through Connect or separately. See below for more details.
McGraw-Hill Connect Plus Finance McGraw-Hill reinvents the textbook learning experience for the modern student with Connect Plus Finance. A seamless integration of an eBook and Connect Finance, Con- nect Plus Finance provides all of the Connect Finance features plus the following:
• An integrated e-book, allowing for anytime, anywhere access to the textbook.
• Dynamic links between the problems or questions you assign to your students and the location in the
e-book where that problem or question is covered.
• A powerful search function to pinpoint and connect key concepts in a snap.
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In short, Connect Finance offers you and your students powerful tools and features that optimize your time and energies, enabling you to focus on course content, teaching, and student learning. Connect Finance also offers a wealth of content resources for both instructors and students. This state-of-the-art, thoroughly tested system supports you in preparing students for the world that awaits.
For more information about Connect, go to www.mcgrawhillconnect.com, or contact your local McGraw- Hill sales representative.
Tegrity Campus: Lectures 24/7
Tegrity Campus is a service that makes class time available 24/7 by automatically capturing every lecture in a searchable format for students to review when they study and complete assignments. With a simple one-click start-and-stop process,
you capture all computer screens and corresponding audio. Students can replay any part of any class with easy-to-use browser-based viewing on a PC or Mac.
Educators know that the more students can see, hear, and experience class resources, the better they learn. In fact, studies prove it. With Tegrity Campus, students quickly recall key moments by using Tegrity Campus’s unique search feature. This search helps students efficiently find what they need, when they need it, across an entire semester of class recordings. Help turn all your students’ study time into learning moments immediately supported by your lecture.
To learn more about Tegrity, watch a 2-minute Flash demo at http://tegritycampus.mhhe.com.
McGraw-Hill Customer Care Contact Information
At McGraw-Hill, we understand that getting the most from new technology can be challenging. That’s why our services don’t stop after you purchase our products. You can e-mail our product specialists 24 hours a day to get product-training online. Or you can search our knowledge bank of Frequently Asked Questions on our support website. For Customer Support, call 800-331-5094, e-mail [email protected], or visit www.mhhe.com/support. One of our Technical Support Analysts will be able to assist you in a timely fashion.
xviii

The plan for developing this edition began with a number of our colleagues who had an interest in the book and regularly teach the MBA introductory course. We integrated their comments and recommendations throughout the tenth edition. Contributors to this edition include the following:
Amanda Adkisson
Texas A&M University
K. Ozgur Demirtas
Baruch College
Melissa Frye
University of Central Florida–Orlando
Stuart Gillan
Texas Tech University
Bill Hamby
Indiana Wesleyan University
Qing (Grace) Hao
University of Missouri
Jim Howard
University of Maryland–University College
Timothy Michael
University of Houston–Clear Lake
Sheila Moore
California Lutheran University
Angela Morgan
Clemson University
Adam Reed
University of North Carolina–Chapel Hill
Bill Reese
Tulane University
Peter Ritchken
Case Western Reserve University
Denis Sosyura
University of Michigan
Mark Hoven Stohs
California State University–Fullerton
Gary Tripp
University of Southern New Hampshire
Joseph Vu
DePaul University
Over the years, many others have contributed their time and expertise to the development and writing of this text. We extend our thanks once again for their assistance and countless insights:
Lucy Ackert
Kennesaw State University
R. Aggarwal
John Carroll University
Anne Anderson
Lehigh University
Christopher Anderson
University of Missouri–Columbia
James J. Angel
Georgetown University
Nasser Arshadi
University of Missouri–St. Louis
Kevin Bahr
University of Wisconsin–Milwaukee
Robert Balik
Western Michigan University
John W. Ballantine
Babson College
Thomas Bankston
Angelo State University
Brad Barber
University of California–Davis
Michael Barry
Boston College
Swati Bhatt
Rutgers University
Roger Bolton
Williams College
Gordon Bonner
University of Delaware
Oswald Bowlin
Texas Technical University
Ronald Braswell
Florida State University
William O. Brown
Claremont McKenna College
Kirt Butler
Michigan State University
Bill Callahan
Southern Methodist University
Steven Carvell
Cornell University
Indudeep S. Chhachhi
Western Kentucky University
Kevin Chiang
University of Vermont
Andreas Christofi
Monmouth University
Jonathan Clarke
Georgia Institute of Technology
Jeffrey L. Coles
Arizona State University
Mark Copper
Wayne State University
James Cotter
University of Iowa
Jay Coughenour
University of Massachusetts–Boston
Arnold Cowan
Iowa State University
Raymond Cox
Central Michigan University
John Crockett
George Mason University
Mark Cross
Louisiana Technical University
Ron Crowe
Jacksonville University
William Damon
Vanderbilt University
Sudip Datta
Bentley College
Ted Day
University of Texas, Dallas
Marcos de Arruda
Drexel University
Anand Desai
University of Florida
Acknowledgments
xix

Miranda Lam Detzler
University of Massachusetts–Boston
David Distad
University of California–Berkeley
Dennis Draper
University of Southern California
Jean-Francois Dreyfus
New York University
Gene Drzycimski
University of Wisconsin–Oshkosh
Robert Duvic
The University of Texas at Austin
Demissew Ejara
University of Massachusetts–Boston
Robert Eldridge
Fairfield University
Gary Emery
University of Oklahoma
Theodore Eytan
City University of New York–Baruch College
Don Fehrs
University of Notre Dame
Steven Ferraro
Pepperdine University
Eliezer Fich
Drexel University
Andrew Fields
University of Delaware
Paige Fields
Texas A&M University
Adlai Fisher
New York University
Michael Fishman
Northwestern University
Yee-Tien Fu
Stanford University
Partha Gangopadhyay
St. Cloud University
Bruno Gerard
University of Southern California
Frank Ghannadian
Mercer University–Atlanta
Stuart Gillan
Texas Technical University
Ann Gillette
Kennesaw State University
Michael Goldstein
University of Colorado
Indra Guertler
Babson College
Re-Jin Guo
University of Illinois at Chicago
James Haltiner
College of William and Mary
Janet Hamilton
Portland State University
Qing Hao
University of Missouri- Columbia
Robert Hauswald
American University
Delvin Hawley
University of Mississippi
Hal Heaton
Brigham Young University
John A. Helmuth
University of Michigan–Dearborn
John Helmuth
Rochester Institute of Technology
Michael Hemler
University of Notre Dame
Stephen Heston
Washington University
Andrea Heuson
University of Miami
Edith Hotchkiss
Boston College
Charles Hu
Claremont McKenna College
Hugh Hunter
Eastern Washington University
James Jackson
Oklahoma State University
Raymond Jackson
University of Massachusetts– Dartmouth
Prem Jain
Tulane University
Narayanan Jayaraman
Georgia Institute of Technology
Thadavilil Jithendranathan
University of St. Thomas
Jarl Kallberg
New York University
Jonathan Karpoff
University of Washington
Paul Keat
American Graduate School of International Management
Dolly King
University of Wisconsin–Milwaukee
Brian Kluger
University of Cincinnati
Narayana Kocherlakota
University of Iowa
Robert Krell
George Mason University
Ronald Kudla
The University of Akron
Youngsik Kwak
Delaware State University
Nelson Lacey
University of Massachusetts
Gene Lai
University of Rhode Island
Josef Lakonishok
University of Illinois
Dennis Lasser
State University of New York– Binghamton
Paul Laux
Case Western Reserve University
Gregory LeBlanc
University of California, Berkeley
Bong-Su Lee
University of Minnesota
Youngho Lee
Howard University
Thomas Legg
University of Minnesota
James T. Lindley
University of Southern Mississippi
Dennis Logue
Dartmouth College
Michael Long
Rutgers University
xx

Yulong Ma
Cal State–Long Beach
Ileen Malitz
Fairleigh Dickinson University
Terry Maness
Baylor University
Surendra Mansinghka
San Francisco State University
Michael Mazzco
Michigan State University
Robert I. McDonald
Northwestern University
Hugh McLaughlin
Bentley College
Joseph Meredith
Elon University
Larry Merville
University of Texas–Richardson
Joe Messina
San Francisco State University
Roger Mesznik
City College of New York–Baruch College
Rick Meyer
University of South Florida
Vassil Mihov
Texas Christian University
Richard Miller
Wesleyan University
Naval Modani
University of Central Florida
Edward Morris
Lindenwood University
Richard Mull
New Mexico State University
Jim Musumeci
Southern Illinois University– Carbondale
Robert Nachtmann
University of Pittsburgh
Edward Nelling
Georgia Tech
James Nelson
East Carolina University
Gregory Niehaus
University of South Carolina
Peder Nielsen
Oregon State University
Ingmar Nyman
Hunter College
Dennis Officer
University of Kentucky
Joseph Ogden
State University of New York
Darshana Palker
Minnesota State University, Mankato
Venky Panchapagesan
Washington University–St. Louis
Bulent Parker
University of Wisconsin–Madison
Ajay Patel
University of Missouri–Columbia
Dilip Kumar Patro
Rutgers University
Gary Patterson
University of South Florida
Glenn N. Pettengill
Emporia State University
Pegaret Pichler
University of Maryland
Christo Pirinsky
Ohio State University
Jeffrey Pontiff
University of Washington
Franklin Potts
Baylor University
Annette Poulsen
University of Georgia
N. Prabhala
Yale University
Mao Qiu
University of Utah–Salt Lake City
Latha Ramchand
University of Houston
Gabriel Ramirez
Virginia Commonwealth University
Narendar Rao
Northeastern Illinois University
Raghavendra Rau
Purdue University
Steven Raymar
Indiana University
Bill Reese
Tulane University
Kimberly Rodgers
American University
Stuart Rosenstein
East Carolina University
Bruce Rubin
Old Dominion University
Patricia Ryan
Drake University
Jaime Sabal
New York University
Anthony Sanders
Ohio State University
Ray Sant
St. Edwards University
Andy Saporoschenko
University of Akron
William Sartoris
Indiana University
James Schallheim
University of Utah
Mary Jean Scheuer
California State University at Northridge
Kevin Schieuer
Bellevue University
Faruk Selcuk
University of Bridgeport
Lemma Senbet
University of Maryland
Kuldeep Shastri
University of Pittsburgh
Betty Simkins
Oklahoma State University
Sudhir Singh
Frostburg State University
Scott Smart
Indiana University
Jackie So
Southern Illinois University
John Stansfield
Columbia College
Joeseph Stokes
University of Massachusetts, Amherst
John S. Strong
College of William and Mary
xxi

A. Charlene Sullivan
Purdue University
Michael Sullivan
University of Nevada–Las Vegas
Timothy Sullivan
Bentley College
R. Bruce Swensen
Adelphi University
Ernest Swift
Georgia State University
Alex Tang
Morgan State University
Richard Taylor
Arkansas State University
Andrew C. Thompson
Virginia Polytechnic Institute
Timothy Thompson
Northwestern University
Karin Thorburn
Dartmouth College
Satish Thosar
University of Massachusetts– Dorchester
Charles Trzcinka
State University of New York–Buffalo
Haluk Unal
University of Maryland– College Park
Oscar Varela
University of New Orleans
Steven Venti
Dartmouth College
Avinash Verma
Washington University
Lankford Walker
Eastern Illinois University
Ralph Walkling
Ohio State University
F. Katherine Warne
Southern Bell College
Sue White
University of Maryland
Susan White
University of Texas–Austin
Robert Whitelaw
New York University
Berry Wilson
Georgetown University
Robert Wood
Tennessee Tech University
Donald Wort
California State University, East Bay
John Zietlow
Malone College
Thomas Zorn
University of Nebraska–Lincoln
Kent Zumwalt
Colorado State University
xxii
For their help on the tenth edition, we would like to thank Stephen Dolvin, Butler University; Joe Smolira, Belmont University, and Kay Johnson for their work devel- oping the supplements. We also owe a debt of gratitude to Bradford D. Jordan of the University of Kentucky; Edward I. Altman of New York University; Robert S. Hansen of Virginia Tech; Suh-Pyng Ku of the University of Southern California; and Jay R. Ritter of the University of Florida, who have provided several thoughtful comments and immeasurable help.
We thank David Fenz, Steve Hailey, and Nathaniel Graham for their extensive proofing and problem-checking efforts.
Over the past three years readers have provided assistance by detecting and report- ing errors. Our goal is to offer the best textbook available on the subject, so this information was invaluable as we prepared the ninth edition. We want to ensure that all future editions are error-free—and therefore we offer $10 per arithmetic error to the first individual reporting it. Any arithmetic error resulting in subsequent errors will be counted double. All errors should be reported using the Feedback Form on the Corporate Finance Online Learning Center at www.mhhe.com/rwj.

Many talented professionals at McGraw-Hill/Irwin have contributed to the devel- opment of Corporate Finance, Tenth Edition. We would especially like to thank Michele Janicek, Jennifer Lohn, Melissa Caughlin, Christine Vaughan, Pam Verros, Michael McCormick, and Emily Kline.
Finally, we wish to thank our families and friends, Carol, Kate, Jon, Mark, and Lynne, for their forbearance and help.
Stephen A. Ross Randolph W. Westerfield Jeffrey F. Jaffe