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  • 1. Finance Corporate Fiance Volume 1 David Whitehurst UMIST abc McGraw-Hill/IrwinMcGraw−Hill PrimisISBN: 0−390−32000−5Text:Corporate Finance, Sixth EditionRoss−Westerfield−Jaffe
  • 2. This book was printed on recycled paper.Finance ©2003 by The McGraw−Hill Companies, Inc. All rightsreserved. Printed in the United States of America. Except aspermitted under the United States Copyright Act of 1976, no partof this publication may be reproduced or distributed in any formor by any means, or stored in a database or retrieval system,without prior written permission of the publisher.This McGraw−Hill Primis text may include materials submitted toMcGraw−Hill for publication by the instructor of this course. Theinstructor is solely responsible for the editorial content of suchmaterials.111 FINA ISBN: 0−390−32000−5
  • 3. FinanceVolume 1Ross−Westerfield−Jaffe • Corporate Finance, Sixth Edition Front Matter 1 Preface 1 I. Overview 8 Introduction 8 1. Introduction to Corporate Finance 9 2. Accounting Statements and Cash Flow 29 II. Value and Capital Budgeting 51 Introduction 51 3. Financial Markets and Net Present Value: First Principles of Finance (Adv.) 52 4. Net Present Value 72 5. How to Value Bonds and Stocks 108 6. Some Alternative Investment Rules 146 7. Net Present Value and Capital Budgeting 175 8. Strategy and Analysis in Using Net Present Value 206 III. Risk 225 Introduction 225 9. Capital Market Theory: An Overview 226 10. Return and Risk: The Capital−Asset−Pricing Model 248 11. An Alternative View of Risk and Return: The Arbitrage Pricing Theory 291 12. Risk, Cost of Capital, and Capital Budgeting 313 IV. Capital Structure and Dividend Policy 343 Introduction 343 13. Corporate−Financing Decisions and Efficient Capital Markets 345 14. Long−Term Financing: An Introduction 377 15. Capital Structure: Basic Concepts 396 16. Capital Structure: Limits to the Use of Debt 428 17. Valuation and Capital Budgeting for the Levered Firm 474 18. Dividend Policy: Why Does It Matter? 501 V. Long−Term Financing 539 Introduction 539 19. Issuing Securities to the Public 540 iii
  • 4. 20. Long−Term Debt 56921. Leasing 592VI. Options, Futures, and Corporate Finance 617Introduction 61722. Options and Corporate Finance: Basic Concepts 61823. Options and Corporate Finance: Extensions and Applications 65624. Warrants and Convertibles 68025. Derivatives and Hedging Risk 701VII. Financial Planning and Short−Term Finance 736Introduction 73626. Corporate Financial Models and Long−Term Planning 73727. Short−Term Finance and Planning 75128. Cash Management 77629. Credit Management 803VIII. Special Topics 820Introduction 82030. Mergers and Acquisitions 82131. Financial Distress 85932. International Corporate Finance 877 iv
  • 5. Ross−Westerfield−Jaffe: Front Matter Preface © The McGraw−Hill 1Corporate Finance, Sixth Companies, 2002Edition Preface The teaching and the practicing 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 century, we still see announcements in the financial press about such matters as takeovers, junk bonds, financial restructuring, ini- tial public offerings, bankruptcy, and derivatives. In addition, there is the new recognition of “real” options (Chapters 21 and 22), private equity and venture capital (Chapter 19), and the disappearing dividend (Chapter 18). 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 place 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 mod- ern fundamentals of the theory of finance and make the theory come to life with contem- porary 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. As in the previous editions, our aim is to present corporate finance as the working of a small number of integrated and powerful institutions.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 undergraduate 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 knowl- edge of these areas is not essential. The only mathematics prerequisite is basic algebra.NEW TO THE SIXTH EDITION Following are the key revisions and updates to this edition: • A complete update of all cost of capital discussions to emphasize its usefulness in capital budgeting, primarily in Chapters 12 and 17.
  • 6. 2 Ross−Westerfield−Jaffe: Front Matter Preface © The McGraw−Hill Corporate Finance, Sixth Companies, 2002 Edition Preface vii • A new appendix on performance evaluation and EVA in Chapter 12. • A new section on liquidity and the cost of capital in Chapter 12. • New evidence on efficient markets and CAPM in Chapter 13. • New treatment on why firms choose different capital structures and dividend poli- cies: the case of Qualcomm in Chapters 16 and 18. • A redesign and rewrite of options and derivatives chapters into a new Part VI. • Extension of options theory to mergers and acquisitions in Chapter 22. • An expanded discussion of real options and their importance to capital budgeting in Chapter 23. • New material on carveouts, spinoffs, and tracking stocks in Chapter 30. • Many new end-of-chapter problems throughout all chapters. ATTENTION TO PEDAGOGY Executive Summary Each chapter begins with a “roadmap” that describes the objectives of the chapter and how it connects with concepts already learned in previous chapters. Real company examples that will be discussed are highlighted in this section. Case Study There are 10 case studies that are highlighted in the Sixth Edition that present situations with real companies and how they rationalized the decisions they made to solve various problems. They provide extended examples of the material covered in the chapter. The cases are highlighted in the detailed Table of Contents. In Their Own Words Boxes Located throughout the Sixth Edition, this unique series consists of articles written by dis- tinguished scholars or practitioners on key topics in the text. Concept Questions Included after each major section in a chapter, Concept Questions point to essential mater- ial and allow students to test their recall and comprehension before moving forward. Key Terms Students will note that important words are highlighted in boldface type the first time they appear. They are also listed at the end of the chapter, along with the page number on which they first appear, as well as in the glossary at the end of the book. Demonstration Problems We have provided worked-out examples throughout the text to give students a clear under- standing of the logic and structure of the solution process. These examples are clearly called out in the text. Highlighted Concepts Throughout the text, important ideas are pulled out and presented in a copper box—signal- ing to students that this material is particularly relevant and critical for their understanding. Numbered Equations Key equations are numbered and listed on the back end sheets for easy reference. The end of-chapter material reflects and builds on the concepts learned from the chap- ter and study features:
  • 7. Ross−Westerfield−Jaffe: Front Matter Preface © The McGraw−Hill 3 Corporate Finance, Sixth Companies, 2002 Editionviii Preface Summary and Conclusions The numbered summary provides a quick review of key concepts in the chapter. List of Key Terms A list of the boldfaced key terms with page numbers is included for easy reference. Suggested Readings Each chapter is followed by a short, annotated list of books and articles to which interest- ed students can refer for additional information. Questions and Problems Because solving problems is so critical to a student’s learning, they have been revised, thor- oughly reviewed, and accuracy-checked. The problem sets are graded for difficulty, moving from easier problems intended to build confidence and skill to more difficult problems designed to challenge the enthusiastic student. Problems have been grouped according to the concepts they test on. Additionally, we have tried to make the problems in the critical “con- cept” chapters, such as those on value, risk, and capital structure, especially challenging and interesting. We provide answers to selected problems in Appendix B at the end of the book. Minicase This end-of-chapter feature, located in Chapters 12 and 30, parallels the Case Study feature found in various chapters. These Minicases apply what is learned in a number of chapters to a real-world type of scenario. After presenting the facts, the student is given guidance in rationalizing a sound business decision.SUPPLEMENTS PACKAGE As with the text, developing supplements of extraordinary quality and utility was the pri- mary objective. Each component in the supplement package underwent extensive review and revision.FOR THE INSTRUCTOR Instructor’s Manual (0-07-233882-2) Prepared by John Stansfield, University of Missouri, Columbia, this instructor’s tool has been thoroughly revised and updated. Each chapter includes a list of transparencies/ PowerPoint slides, a brief chapter outline, an introduction, and an annotated outline. The annotated outline contains references to the transparencies/PowerPoint slides, additional explanations and examples, and teaching tips. PowerPoint Presentation System (0-07-233883-0) This presentation system was developed in conjunction with the Instructor’s Manual by the same author, allowing for a complete and integrated teaching package. These slides contain useful outlines, summaries, and exhibits from the text. If you have PowerPoint installed on your PC, you have the ability to edit, print, or rearrange the complete transparency presen- tation to meet your specific needs. Test Bank (0-07-233885-7) The Test Bank, prepared by David Burnie, Western Michigan University, includes an aver- age of 35 multiple-choice questions and problems per chapter, and 5 essay questions per
  • 8. 4 Ross−Westerfield−Jaffe: Front Matter Preface © The McGraw−Hill Corporate Finance, Sixth Companies, 2002 Edition Preface ix chapter. Each question is l