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ISBN 10: 0134997565
ISBN 13: 9780134997568
Author: Jonathan Berk, Peter DeMarzo
An emphasis on modern theory blended with practice elevates students’ financial decision making
Using the valuation framework based on the Law of One Price, top researchers Jonathan Berk and Peter DeMarzo have set the new canon for corporate finance textbooks. Corporate Finance: The Core, 5th Edition blends coverage of time-tested principles and the latest advancements with the practical perspective of the financial manager. Students have the opportunity to “practice finance to learn finance” by solving quantitative business problems like those faced by today’s professionals. With built-in resources to help students master the core concepts, students develop the tools they need to make sound financial decisions in their careers.
Corporate Finance: The Core, 5th Edition fits programs and individual professors who desire a streamlined book that is specifically tailored to the topics covered in the first one-semester course. For those who would like to use a text in a two semester, or more course, please see Corporate Finance, 5th Edition by the same authors.
Corporate Finance 5th Table of contents:
Part 1 Introduction
Chapter 1 The Corporation and Financial Markets
1.1 The Four Types of Firms
Sole Proprietorships
Partnerships
Limited Liability Companies
Corporations
Formation of a Corporation
Ownership of a Corporation
Tax Implications for Corporate Entities
S Corporations
1.2 Ownership Versus Control of Corporations
The Corporate Management Team
The Financial Manager
Investment Decisions
Financing Decisions
Cash Management
The Goal of the Firm
The Firm and Society
Ethics and Incentives within Corporations
Agency Problems
The CEO’s Performance
Corporate Bankruptcy
1.3 The Stock Market
Primary and Secondary Stock Markets
Traditional Trading Venues
New Competition and Market Changes
Dark Pools
1.4 Fintech: Finance and Technology
Telecommunications
Security and Verification
Automation of Banking Services
Big Data and Machine Learning
Competition
Key Terms
Further Reading
Problems
The Four Types of Firms
Ownership Versus Control of Corporations
The Stock Market
Fintech: Finance and Technology
Chapter 2 Introduction to Financial Statement Analysis
2.1 Firms’ Disclosure of Financial Information
Preparation of Financial Statements
Types of Financial Statements
2.2 The Balance Sheet
Assets
Current Assets
Long-Term Assets
Liabilities
Current Liabilities
Long-Term Liabilities
Stockholders’ Equity
Market Value Versus Book Value
Market-to-Book Ratio
Enterprise Value
2.3 The Income Statement
Earnings Calculations
Gross Profit
Operating Expenses
Earnings before Interest and Taxes
Pretax and Net Income
2.4 The Statement of Cash Flows
Operating Activity
Investment Activity
Financing Activity
2.5 Other Financial Statement Information
Statement of Stockholders’ Equity
Management Discussion and Analysis
Notes to the Financial Statements
2.6 Financial Statement Analysis
Profitability Ratios
Liquidity Ratios
Working Capital Ratios
Interest Coverage Ratios
Leverage Ratios
Valuation Ratios
Operating Returns
The DuPont Identity
2.7 Financial Reporting in Practice
Enron
WorldCom
Sarbanes-Oxley Act
Dodd-Frank Act
Key Terms
Further Reading
Problems
Firms’ Disclosure of Financial Information
The Balance Sheet
The Income Statement
The Statement of Cash Flows
Other Financial Statement Information
Financial Statement Analysis
Financial Reporting in Practice
Data Case
Chapter 3 Financial Decision Making and the Law of One Price
Notation
3.1 Valuing Decisions
Analyzing Costs and Benefits
Using Market Prices to Determine Cash Values
3.2 Interest Rates and the Time Value of Money
The Time Value of Money
The Interest Rate: An Exchange Rate Across Time
Value of Investment in One Year
Value of Investment Today
Present Versus Future Value
Discount Factors and Rates
3.3 Present Value and the NPV Decision Rule
Net Present Value
The NPV Decision Rule
Accepting or Rejecting a Project
Choosing among Alternatives
NPV and Cash Needs
3.4 Arbitrage and the Law of One Price
Arbitrage
Law of One Price
3.5 No-Arbitrage and Security Prices
Valuing a Security with the Law of One Price
Identifying Arbitrage Opportunities with Securities
Determining the No-Arbitrage Price
Determining the Interest Rate from Bond Prices
The NPV of Trading Securities and Firm Decision Making
Valuing a Portfolio
Value Additivity
Value Additivity and Firm Value
Where Do We Go from Here?
Key Terms
Further Reading
Problems
Valuing Decisions
Interest Rates and the Time Value of Money
Present Value and the NPV Decision Rule
Arbitrage and the Law of One Price
No-Arbitrage and Security Prices
Data Case Arbitraging Bitcoin
Chapter 3 Appendix The Price of Risk
Notation
Risky Versus Risk-Free Cash Flows
Risk Aversion and the Risk Premium
The No-Arbitrage Price of a Risky Security
Risk Premiums Depend on Risk
Risk Is Relative to the Overall Market
Risk, Return, and Market Prices
Arbitrage with Transactions Costs
Key Terms
Problems
Risky Versus Risk-Free Cash Flows
Arbitrage with Transactions Costs
Part 2 Time, Money, and Interest Rates
Chapter 4 The Time Value of Money
Notation
4.1 The Timeline
4.2 The Three Rules of Time Travel
Rule 1: Comparing and Combining Values
Rule 2: Moving Cash Flows Forward in Time
Rule 3: Moving Cash Flows Back in Time
Applying the Rules of Time Travel
4.3 Valuing a Stream of Cash Flows
4.4 Calculating the Net Present Value
4.5 Perpetuities and Annuities
Perpetuities
Annuities
Present Value of an Annuity
Future Value of an Annuity
Growing Cash Flows
Growing Perpetuity
Growing Annuity
4.6 Using an Annuity Spreadsheet or Calculator
4.7 Non-Annual Cash Flows
4.8 Solving for the Cash Payments
4.9 The Internal Rate of Return
Key Terms
Further Reading
Problems
The Timeline
The Three Rules of Time Travel
Valuing a Stream of Cash Flows
Calculating the Net Present Value
Perpetuities and Annuities
Non-Annual Cash Flows
Solving for the Cash Payments
The Internal Rate of Return
Data Case
Chapter 4 Appendix Solving for the Number of Periods
Problems
Chapter 5 Interest Rates
Notation
5.1 Interest Rate Quotes and Adjustments
The Effective Annual Rate
Adjusting the Discount Rate to Different Time Periods
General Equation for Discount Rate Period Conversion
Annual Percentage Rates
5.2 Application: Discount Rates and Loans
5.3 The Determinants of Interest Rates
Inflation and Real Versus Nominal Rates
Investment and Interest Rate Policy
Monetary Policy, Deflation, and the 2008 Financial Crisis
The Yield Curve and Discount Rates
The Yield Curve and the Economy
Interest Rate Determination
Interest Rate Expectations
5.4 Risk and Taxes
Risk and Interest Rates
After-Tax Interest Rates
5.5 The Opportunity Cost of Capital
Key Terms
Further Reading
Problems
Interest Rate Quotes and Adjustments
Application: Discount Rates and Loans
The Determinants of Interest Rates
Risk and Taxes
The Opportunity Cost of Capital
Data Case Florida’s Pension Plan Liability
Chapter 5 Appendix Continuous Rates and Cash Flows
Notation
Discount Rates for a Continuously Compounded APR
Continuously Arriving Cash Flows
Chapter 6 Valuing Bonds
Notation
6.1 Bond Cash Flows, Prices, and Yields
Bond Terminology
Zero-Coupon Bonds
Yield to Maturity
Risk-Free Interest Rates
Coupon Bonds
6.2 Dynamic Behavior of Bond Prices
Discounts and Premiums
Time and Bond Prices
Interest Rate Changes and Bond Prices
6.3 The Yield Curve and Bond Arbitrage
Replicating a Coupon Bond
Valuing a Coupon Bond Using Zero-Coupon Yields
Coupon Bond Yields
Treasury Yield Curves
6.4 Corporate Bonds
Corporate Bond Yields
No Default
Certain Default
Risk of Default
Bond Ratings
Corporate Yield Curves
6.5 Sovereign Bonds
Key Terms
Further Reading
Problems
Bond Cash Flows, Prices, and Yields
Dynamic Behavior of Bond Prices
The Yield Curve and Bond Arbitrage
Corporate Bonds
Sovereign Bonds
Data Case Corporate Yield Curves
Case Study The 2012 Greek Default and Subsequent Debt Restructuring6
Chapter 6 Appendix Forward Interest Rates
Notation
Computing Forward Rates
Computing Bond Yields from Forward Rates
Forward Rates and Future Interest Rates
Key Terms
Problems
Part 3 Valuing Projects and Firms
Chapter 7 Investment Decision Rules
Notation
7.1 NPV and Stand-Alone Projects
Applying the NPV Rule
The NPV Profile and IRR
Alternative Rules Versus the NPV Rule
7.2 The Internal Rate of Return Rule
Applying the IRR Rule
Pitfall #1: Delayed Investments
Pitfall #2: Multiple IRRs
Pitfall #3: Nonexistent IRR
7.3 The Payback Rule
Applying the Payback Rule
Payback Rule Pitfalls in Practice
7.4 Choosing between Projects
NPV Rule and Mutually Exclusive Investments
IRR Rule and Mutually Exclusive Investments
Differences in Scale
Differences in Timing
Differences in Risk
The Incremental IRR
7.5 Project Selection with Resource Constraints
Evaluating Projects with Different Resource Requirements
Profitability Index
Shortcomings of the Profitability Index
Key Terms
Further Reading
Problems
NPV and Stand-Alone Projects
The Internal Rate of Return Rule
The Payback Rule
Choosing between Projects
Project Selection with Resource Constraints
Data Case
Chapter 7 Appendix Computing the NPV Profile Using Excel’s Data Table Function
Chapter 8 Fundamentals of Capital Budgeting
Notation
8.1 Forecasting Earnings
Revenue and Cost Estimates
Incremental Earnings Forecast
Capital Expenditures and Depreciation
Interest Expenses
Taxes
Unlevered Net Income Calculation
Indirect Effects on Incremental Earnings
Opportunity Costs
Project Externalities
Sunk Costs and Incremental Earnings
Fixed Overhead Expenses
Past Research and Development Expenditures
Unavoidable Competitive Effects
Real-World Complexities
8.2 Determining Free Cash Flow and NPV
Calculating Free Cash Flow from Earnings
Capital Expenditures and Depreciation
Net Working Capital (NWC)
Calculating Free Cash Flow Directly
Calculating the NPV
8.3 Choosing among Alternatives
Evaluating Manufacturing Alternatives
Comparing Free Cash Flows for Cisco’s Alternatives
8.4 Further Adjustments to Free Cash Flow
8.5 Analyzing the Project
Break-Even Analysis
Sensitivity Analysis
Scenario Analysis
Key Terms
Further Reading
Problems
Forecasting Earnings
Determining Free Cash Flow and NPV
Choosing among Alternatives
Further Adjustments to Free Cash Flow
Analyzing the Project
Data Case
Chapter 8 Appendix MACRS Depreciation
Chapter 9 Valuing Stocks
Notation
9.1 The Dividend-Discount Model
A One-Year Investor
Dividend Yields, Capital Gains, and Total Returns
A Multiyear Investor
The Dividend-Discount Model Equation
9.2 Applying the Dividend-Discount Model
Constant Dividend Growth
Dividends Versus Investment and Growth
A Simple Model of Growth
Profitable Growth
Changing Growth Rates
Limitations of the Dividend-Discount Model
9.3 Total Payout and Free Cash Flow Valuation Models
Share Repurchases and the Total Payout Model
The Discounted Free Cash Flow Model
Valuing the Enterprise
Implementing the Model
Connection to Capital Budgeting
9.4 Valuation Based on Comparable Firms
Valuation Multiples
The Price-Earnings Ratio
Enterprise Value Multiples
Other Multiples
Limitations of Multiples
Comparison with Discounted Cash Flow Methods
Stock Valuation Techniques: The Final Word
9.5 Information, Competition, and Stock Prices
Information in Stock Prices
Competition and Efficient Markets
Public, Easily Interpretable Information
Private or Difficult-to-Interpret Information
Lessons for Investors and Corporate Managers
Consequences for Investors
Implications for Corporate Managers
The Efficient Markets Hypothesis Versus No Arbitrage
Key Terms
Further Reading
Problems
The Dividend-Discount Model
Applying the Dividend-Discount Model
Total Payout and Free Cash Flow Valuation Models
Valuation Based on Comparable Firms
Information, Competition, and Stock Prices
Data Case
Part 4 Risk and Return
Chapter 10 Capital Markets and the Pricing of Risk
Notation
10.1 Risk and Return: Insights from 92 Years of Investor History
10.2 Common Measures of Risk and Return
Probability Distributions
Expected Return
Variance and Standard Deviation
10.3 Historical Returns of Stocks and Bonds
Computing Historical Returns
Calculating Realized Annual Returns
Comparing Realized Annual Returns
Average Annual Returns
The Variance and Volatility of Returns
Estimation Error: Using Past Returns to Predict the Future
Standard Error
Limitations of Expected Return Estimates
10.4 The Historical Tradeoff Between Risk and Return
The Returns of Large Portfolios
The Returns of Individual Stocks
10.5 Common Versus Independent Risk
Theft Versus Earthquake Insurance: An Example
Types of Risk
The Role of Diversification
10.6 Diversification in Stock Portfolios
Firm-Specific Versus Systematic Risk
No Arbitrage and the Risk Premium
10.7 Measuring Systematic Risk
Identifying Systematic Risk: The Market Portfolio
Sensitivity to Systematic Risk: Beta
Real-Firm Betas
Interpreting Betas
10.8 Beta and the Cost of Capital
Estimating the Risk Premium
The Market Risk Premium
Adjusting for Beta
The Capital Asset Pricing Model
Key Terms
Further Reading
Problems
Common Measures of Risk and Return
Historical Returns of Stocks and Bonds
The Historical Tradeoff Between Risk and Return
Common Versus Independent Risk
Diversification in Stock Portfolios
Measuring Systematic Risk
Beta and the Cost of Capital
Data Case
Chapter 11 Optimal Portfolio Choice and the Capital Asset Pricing Model
Notation
11.1 The Expected Return of a Portfolio
11.2 The Volatility of a Two-Stock Portfolio
Combining Risks
Determining Covariance and Correlation
Covariance
Correlation
Computing a Portfolio’s Variance and Volatility
11.3 The Volatility of a Large Portfolio
Large Portfolio Variance
Diversification with an Equally Weighted Portfolio
Diversification with General Portfolios
11.4 Risk Versus Return: Choosing an Efficient Portfolio
Efficient Portfolios with Two Stocks
Identifying Inefficient Portfolios
Identifying Efficient Portfolios
The Effect of Correlation
Short Sales
Efficient Portfolios with Many Stocks
11.5 Risk-Free Saving and Borrowing
Investing in Risk-Free Securities
Borrowing and Buying Stocks on Margin
Identifying the Tangent Portfolio
11.6 The Efficient Portfolio and Required Returns
Portfolio Improvement: Beta and the Required Return
Expected Returns and the Efficient Portfolio
11.7 The Capital Asset Pricing Model
The CAPM Assumptions
Supply, Demand, and the Efficiency of the Market Portfolio
Optimal Investing: The Capital Market Line
11.8 Determining the Risk Premium
Market Risk and Beta
The Security Market Line
Beta of a Portfolio
Summary of the Capital Asset Pricing Model
Key Terms
Further Reading
Problems
The Expected Return of a Portfolio
The Volatility of a Two-Stock Portfolio
The Volatility of a Large Portfolio
Risk Versus Return: Choosing an Efficient Portfolio
Risk-Free Saving and Borrowing
The Efficient Portfolio and Required Returns
The Capital Asset Pricing Model
Determining the Risk Premium
Data Case
Chapter 11 Appendix The CAPM with Differing Interest Rates
The Efficient Frontier with Differing Saving and Borrowing Rates
The Security Market Line with Differing Interest Rates
Chapter 12 Estimating the Cost of Capital
Notation
12.1 The Equity Cost of Capital
12.2 The Market Portfolio
Constructing the Market Portfolio
Market Indexes
Examples of Market Indexes
Investing in a Market Index
The Market Risk Premium
Determining the Risk-Free Rate
The Historical Risk Premium
A Fundamental Approach
12.3 Beta Estimation
Using Historical Returns
Identifying the Best-Fitting Line
Using Linear Regression
12.4 The Debt Cost of Capital
Debt Yields Versus Returns
Debt Betas
12.5 A Project’s Cost of Capital
All-Equity Comparables
Levered Firms as Comparables
The Unlevered Cost of Capital
Unlevered Beta
Cash and Net Debt
Industry Asset Betas
12.6 Project Risk Characteristics and Financing
Differences in Project Risk
Financing and the Weighted Average Cost of Capital
Perfect Capital Markets
Taxes—A Big Imperfection
The Weighted Average Cost of Capital
12.7 Final Thoughts on Using the CAPM
Key Terms
Further Reading
Problems
The Equity Cost of Capital
The Market Portfolio
Beta Estimation
The Debt Cost of Capital
A Project’s Cost of Capital
Project Risk Characteristics and Financing
Data Case
Chapter 12 Appendix Practical Considerations When Forecasting Beta
Time Horizon
The Market Proxy
Beta Variation and Extrapolation
Outliers
Other Considerations
Data Case
Chapter 13 Investor Behavior and Capital Market Efficiency
Notation
13.1 Competition and Capital Markets
Identifying a Stock’s Alpha
Profiting from Non-Zero Alpha Stocks
13.2 Information and Rational Expectations
Informed Versus Uninformed Investors
Rational Expectations
13.3 The Behavior of Individual Investors
Underdiversification and Portfolio Biases
Excessive Trading and Overconfidence
Individual Behavior and Market Prices
13.4 Systematic Trading Biases
Hanging on to Losers and the Disposition Effect
Investor Attention, Mood, and Experience
Herd Behavior
Implications of Behavioral Biases
13.5 The Efficiency of the Market Portfolio
Trading on News or Recommendations
Takeover Offers
Stock Recommendations
The Performance of Fund Managers
Fund Manager Value-Added
Returns to Investors
The Winners and Losers
13.6 Style-Based Techniques and the Market Efficiency Debate
Size Effects
Excess Return and Market Capitalizations
Excess Return and Book-to-Market Ratio
Size Effects and Empirical Evidence
Momentum
Implications of Positive-Alpha Trading Strategies
Proxy Error
Behavioral Biases
Alternative Risk Preferences and Non-Tradable Wealth
13.7 Multifactor Models of Risk
Using Factor Portfolios
Smart Beta
Long-Short Portfolios
Selecting the Portfolios
Market Capitalization Strategy
Book-to-Market Ratio Strategy
Past Returns Strategy
Fama-French-Carhart Factor Specification
The Cost of Capital with Fama-French-Carhart Factor Specification
13.8 Methods Used in Practice
Financial Managers
Investors
Key Terms
Further Reading
Problems
Competition and Capital Markets
Information and Rational Expectations
The Behavior of Individual Investors
Systematic Trading Biases
The Efficiency of the Market Portfolio
Style-Based Techniques and the Market Efficiency Debate
Multifactor Models of Risk
Chapter 13 Appendix Building a Multifactor Model
Part 5 Capital Structure
Chapter 14 Capital Structure in a Perfect Market
Notation
14.1 Equity Versus Debt Financing
Financing a Firm with Equity
Financing a Firm with Debt and Equity
The Effect of Leverage on Risk and Return
14.2 Modigliani-Miller I: Leverage, Arbitrage, and Firm Value
MM and the Law of One Price
Homemade Leverage
The Market Value Balance Sheet
Application: A Leveraged Recapitalization
14.3 Modigliani-Miller II: Leverage, Risk, and the Cost of Capital
Leverage and the Equity Cost of Capital
Capital Budgeting and the Weighted Average Cost of Capital
Computing the WACC with Multiple Securities
Levered and Unlevered Betas
14.4 Capital Structure Fallacies
Leverage and Earnings per Share
Equity Issuances and Dilution
14.5 MM: Beyond the Propositions
Key Terms
Further Reading
Problems
Equity Versus Debt Financing
Modigliani-Miller I: Leverage, Arbitrage, and Firm Value
Modigliani-Miller II: Leverage, Risk, and the Cost of Capital
Capital Structure Fallacies
Data Case
Chapter 15 Debt and Taxes
Notation
15.1 The Interest Tax Deduction
15.2 Valuing the Interest Tax Shield
The Interest Tax Shield and Firm Value
The Interest Tax Shield with Permanent Debt
The Weighted Average Cost of Capital with Taxes
The Interest Tax Shield with a Target Debt-Equity Ratio
15.3 Recapitalizing to Capture the Tax Shield
The Tax Benefit
The Share Repurchase
No Arbitrage Pricing
Analyzing the Recap: The Market Value Balance Sheet
15.4 Personal Taxes
Including Personal Taxes in the Interest Tax Shield
Determining the Actual Tax Advantage of Debt
Valuing the Interest Tax Shield with Personal Taxes
15.5 Optimal Capital Structure with Taxes
Do Firms Prefer Debt?
Limits to the Tax Benefit of Debt
Growth and Debt
Other Tax Shields
The Low Leverage Puzzle
Key Terms
Further Reading
Problems
The Interest Tax Deduction
Valuing the Interest Tax Shield
Personal Taxes
Optimal Capital Structure with Taxes
Data Case
Chapter 16 Financial Distress, Managerial Incentives, and Information
Notation
16.1 Default and Bankruptcy in a Perfect Market
Armin Industries: Leverage and the Risk of Default
Scenario 1: New Product Succeeds
Scenario 2: New Product Fails
Comparing the Two Scenarios
Bankruptcy and Capital Structure
16.2 The Costs of Bankruptcy and Financial Distress
The Bankruptcy Code
Direct Costs of Bankruptcy
Indirect Costs of Financial Distress
Overall Impact of Indirect Costs
16.3 Financial Distress Costs and Firm Value
Armin Industries: The Impact of Financial Distress Costs
Who Pays for Financial Distress Costs?
16.4 Optimal Capital Structure: The Tradeoff Theory
The Present Value of Financial Distress Costs
Optimal Leverage
16.5 Exploiting Debt Holders: The Agency Costs of Leverage
Excessive Risk-Taking and Asset Substitution
Debt Overhang and Under-Investment
Cashing Out
Estimating the Debt Overhang
Agency Costs and the Value of Leverage
The Leverage Ratchet Effect
Debt Maturity and Covenants
16.6 Motivating Managers: The Agency Benefits of Leverage
Concentration of Ownership
Reduction of Wasteful Investment
Leverage and Commitment
16.7 Agency Costs and the Tradeoff Theory
The Optimal Debt Level
R&D-Intensive Firms
Low-Growth, Mature Firms
Debt Levels in Practice
16.8 Asymmetric Information and Capital Structure
Leverage as a Credible Signal
Issuing Equity and Adverse Selection
Implications for Equity Issuance
Implications for Capital Structure
16.9 Capital Structure: The Bottom Line
Key Terms
Further Reading
Problems
Default and Bankruptcy in a Perfect Market
The Costs of Bankruptcy and Financial Distress
Financial Distress Costs and Firm Value
Optimal Capital Structure: The Tradeoff Theory
Exploiting Debt Holders: The Agency Costs of Leverage
Motivating Managers: The Agency Benefits of Leverage
Agency Costs and the Tradeoff Theory
Asymmetric Information and Capital Structure
Chapter 17 Payout Policy
Notation
17.1 Distributions to Shareholders
Dividends
Share Repurchases
Open Market Repurchase
Tender Offer
Targeted Repurchase
17.2 Comparison of Dividends and Share Repurchases
Alternative Policy 1: Pay Dividend with Excess Cash
Alternative Policy 2: Share Repurchase (No Dividend)
Genron’s Future Dividends
Investor Preferences
Alternative Policy 3: High Dividend (Equity Issue)
Modigliani-Miller and Dividend Policy Irrelevance
Dividend Policy with Perfect Capital Markets
17.3 The Tax Disadvantage of Dividends
Taxes on Dividends and Capital Gains
Optimal Dividend Policy with Taxes
17.4 Dividend Capture and Tax Clienteles
The Effective Dividend Tax Rate
Tax Differences Across Investors
Clientele Effects
17.5 Payout Versus Retention of Cash
Retaining Cash with Perfect Capital Markets
Taxes and Cash Retention
Adjusting for Investor Taxes
Issuance and Distress Costs
Agency Costs of Retaining Cash
17.6 Signaling with Payout Policy
Dividend Smoothing
Dividend Signaling
Signaling and Share Repurchases
17.7 Stock Dividends, Splits, and Spin-Offs
Stock Dividends and Splits
Spin-Offs
Key Terms
Further Reading
Problems
Distributions to Shareholders
Comparison of Dividends and Share Repurchases
The Tax Disadvantage of Dividends
Dividend Capture and Tax Clienteles
Payout Versus Retention of Cash
Signaling with Payout Policy
Stock Dividends, Splits, and Spin-Offs
Data Case
Part 6 Advanced Valuation
Chapter 18 Capital Budgeting and Valuation with Leverage
Notation
18.1 Overview of Key Concepts
18.2 The Weighted Average Cost of Capital Method
Using the WACC to Value a Project
Summary of the WACC Method
Implementing a Constant Debt-Equity Ratio
18.3 The Adjusted Present Value Method
The Unlevered Value of the Project
Valuing the Interest Tax Shield
Summary of the APV Method
18.4 The Flow-to-Equity Method
Calculating the Free Cash Flow to Equity
Valuing Equity Cash Flows
Summary of the Flow-to-Equity Method
18.5 Project-Based Costs of Capital
Estimating the Unlevered Cost of Capital
Project Leverage and the Equity Cost of Capital
Determining the Incremental Leverage of a Project
Cash Is Negative Debt
A Fixed Equity Payout Policy Implies 100% Debt Financing
Optimal Leverage Depends on Project and Firm Characteristics
Safe Cash Flows Can Be 100% Debt Financed
18.6 APV with Other Leverage Policies
Constant Interest Coverage Ratio
Predetermined Debt Levels
A Comparison of Methods
18.7 Other Effects of Financing
Issuance and Other Financing Costs
Security Mispricing
Financial Distress and Agency Costs
18.8 Advanced Topics in Capital Budgeting
Periodically Adjusted Debt
Leverage and the Cost of Capital
The WACC or FTE Method with Changing Leverage
Personal Taxes
Key Terms
Further Reading
Problems
Overview of Key Concepts
The Weighted Average Cost of Capital Method
The Adjusted Present Value Method
The Flow-to-Equity Method
Project-Based Costs of Capital
APV with Other Leverage Policies
Other Effects of Financing
Advanced Topics in Capital Budgeting
Data Case
Chapter 18 Appendix Foundations and Further Details
Deriving the WACC Method
The Levered and Unlevered Cost of Capital
Target Leverage Ratio
Predetermined Debt Schedule
Risk of the Tax Shield with a Target Leverage Ratio
Solving for Leverage and Value Simultaneously
The Residual Income and Economic Value Added Valuation Methods
Chapter 19 Valuation and Financial Modeling: A Case Study
Notation
19.1 Valuation Using Comparables
19.2 The Business Plan
Operational Improvements
Capital Expenditures: A Needed Expansion
Working Capital Management
Capital Structure Changes: Levering Up
19.3 Building the Financial Model
Forecasting Earnings
Working Capital Requirements
Forecasting Free Cash Flow
The Balance Sheet and Statement of Cash Flows (Optional)
19.4 Estimating the Cost of Capital
CAPM-Based Estimation
Unlevering Beta
Ideko’s Unlevered Cost of Capital
19.5 Valuing the Investment
The Multiples Approach to Continuation Value
The Discounted Cash Flow Approach to Continuation Value
APV Valuation of Ideko’s Equity
A Reality Check
IRR and Cash Multiples
19.6 Sensitivity Analysis
Key Terms
Further Reading
Problems
Valuation Using Comparables
The Business Plan
Building the Financial Model
Estimating the Cost of Capital
Valuing the Investment
Chapter 19 Appendix Compensating Management
Notation
Part 7 Options
Chapter 20 Financial Options
Notation
20.1 Option Basics
Understanding Option Contracts
Interpreting Stock Option Quotations
Options on Other Financial Securities
20.2 Option Payoffs at Expiration
Long Position in an Option Contract
Short Position in an Option Contract
Profits for Holding an Option to Expiration
Returns for Holding an Option to Expiration
Combinations of Options
Straddle
Butterfly Spread
Portfolio Insurance
20.3 Put-Call Parity
20.4 Factors Affecting Option Prices
Strike Price and Stock Price
Arbitrage Bounds on Option Prices
Option Prices and the Exercise Date
Option Prices and Volatility
20.5 Exercising Options Early
Non-Dividend-Paying Stocks
Dividend-Paying Stocks
20.6 Options and Corporate Finance
Equity as a Call Option
Debt as an Option Portfolio
Credit Default Swaps
Pricing Risky Debt
Agency Conflicts
Key Terms
Further Reading
Problems
Option Basics
Option Payoffs at Expiration
Put-Call Parity
Factors Affecting Option Prices
Exercising Options Early
Options and Corporate Finance
Data Case
Chapter 21 Option Valuation
Notation
21.1 The Binomial Option Pricing Model
A Two-State Single-Period Model
The Binomial Pricing Formula
A Multiperiod Model
Making the Model Realistic
21.2 The Black-Scholes Option Pricing Model
The Black-Scholes Formula
European Put Options
Dividend-Paying Stocks
Implied Volatility
The Replicating Portfolio
21.3 Risk-Neutral Probabilities
A Risk-Neutral Two-State Model
Implications of the Risk-Neutral World
Risk-Neutral Probabilities and Option Pricing
21.4 Risk and Return of an Option
21.5 Corporate Applications of Option Pricing
Beta of Risky Debt
Agency Costs of Debt
Key Terms
Further Reading
Problems
The Binomial Option Pricing Model
The Black-Scholes Option Pricing Model
Risk-Neutral Probabilities
Risk and Return of an Option
Corporate Applications of Option Pricing
Chapter 22 Real Options
Notation
22.1 Real Versus Financial Options
22.2 Decision Tree Analysis
Representing Uncertainty
Real Options
Solving Decision Trees
22.3 The Option to Delay: Investment as a Call Option
An Investment Option
Factors Affecting the Timing of Investment
Investment Options and Firm Risk
22.4 Growth and Abandonment Options
Valuing Growth Potential
The Option to Expand
The Option to Abandon
22.5 Investments with Different Lives
22.6 Optimally Staging Investments
22.7 Rules of Thumb
The Profitability Index Rule
The Hurdle Rate Rule
22.8 Key Insights from Real Options
Key Terms
Further Reading
Problems
Decision Tree Analysis
The Option to Delay: Investment as a Call Option
Growth and Abandonment Options
Investments with Different Lives
Optimally Staging Investments
Rules of Thumb
Part 8 Long-Term Financing
Chapter 23 Raising Equity Capital
23.1 Equity Financing for Private Companies
Sources of Funding
Angel Investors
Venture Capital Firms
Private Equity Firms
Institutional Investors
Corporate Investors
Venture Capital Investing
Venture Capital Financing Terms
Liquidation Preference
Seniority
Participation Rights
Anti-Dilution Protection
Board Membership
Exiting an Investment in a Private Company
23.2 The Initial Public Offering
Advantages and Disadvantages of Going Public
Types of Offerings
Primary and Secondary Offerings
Best-Efforts, Firm Commitment, and Auction IPOs
The Mechanics of an IPO
Underwriters and the Syndicate
SEC Filings
Valuation
Pricing the Deal and Managing Risk
23.3 IPO Puzzles
Underpricing
Cyclicality and Recent Trends
Cost of an IPO
Long-Run Underperformance
23.4 The Seasoned Equity Offering
The Mechanics of an SEO
Price Reaction
Issuance Costs
Key Terms
Further Reading
Problems
Equity Financing for Private Companies
The Initial Public Offering
IPO Puzzles
The Seasoned Equity Offering
Data Case
Chapter 24 Debt Financing
Notation
24.1 Corporate Debt
Public Debt
The Prospectus
Bearer Bonds and Registered Bonds
Types of Corporate Debt
Seniority
Bond Markets
Private Debt
Term Loans
Private Placements
24.2 Other Types of Debt
Sovereign Debt
Municipal Bonds
Asset-Backed Securities
24.3 Bond Covenants
24.4 Repayment Provisions
Call Provisions
Sinking Funds
Convertible Provisions
Key Terms
Further Reading
Problems
Corporate Debt
Other Types of Debt
Bond Covenants
Repayment Provisions
Data Case
Chapter 25 Leasing
Notation
25.1 The Basics of Leasing
Examples of Lease Transactions
Lease Payments and Residual Values
Leases Versus Loans
End-of-Term Lease Options
Other Lease Provisions
25.2 Accounting, Tax, and Legal Consequences of Leasing
Lease Accounting
The Tax Treatment of Leases
Leases and Bankruptcy
25.3 The Leasing Decision
Cash Flows for a True Tax Lease
Lease Versus Buy (An Unfair Comparison)
Lease Versus Borrow (The Right Comparison)
The Lease-Equivalent Loan
A Direct Method
The Effective After-Tax Lease Borrowing Rate
Evaluating a True Tax Lease
Evaluating a Non-Tax Lease
25.4 Reasons for Leasing
Valid Arguments for Leasing
Tax Differences
Reduced Resale Costs
Efficiency Gains from Specialization
Reduced Distress Costs and Increased Debt Capacity
Transferring Risk
Mitigating Debt Overhang
Improved Incentives
Suspect Arguments for Leasing
Avoiding Capital Expenditure Controls
Preserving Capital
Reducing Leverage Through Off-Balance-Sheet Financing
Key Terms
Further Reading
Problems
The Basics of Leasing
Accounting, Tax, and Legal Consequences of Leasing
The Leasing Decision
Reasons for Leasing
Part 9 Short-Term Financing
Chapter 26 Working Capital Management
26.1 Overview of Working Capital
The Cash Cycle
Firm Value and Working Capital
26.2 Trade Credit
Trade Credit Terms
Trade Credit and Market Frictions
Cost of Trade Credit
Benefits of Trade Credit
Trade Credit Versus Standard Loans
Managing Float
Collection Float
Disbursement Float
Electronic Check Processing
26.3 Receivables Management
Determining the Credit Policy
Establishing Credit Standards
Establishing Credit Terms
Establishing a Collection Policy
Monitoring Accounts Receivable
Accounts Receivable Days
Aging Schedule
26.4 Payables Management
Determining Accounts Payable Days Outstanding
Stretching Accounts Payable
26.5 Inventory Management
Benefits of Holding Inventory
Costs of Holding Inventory
26.6 Cash Management
Motivation for Holding Cash
Transactions Balance
Precautionary Balance
Compensating Balance
Alternative Investments
Key Terms
Further Reading
Problems
Overview of Working Capital
Trade Credit
Receivables Management
Payables Management
Inventory Management
Cash Management
Data Case
Chapter 27 Short-Term Financial Planning
Notation
27.1 Forecasting Short-Term Financing Needs
Seasonalities
Negative Cash Flow Shocks
Positive Cash Flow Shocks
27.2 The Matching Principle
Permanent Working Capital
Temporary Working Capital
Financing Policy Choices
27.3 Short-Term Financing with Bank Loans
Single, End-of-Period Payment Loan
Line of Credit
Bridge Loan
Common Loan Stipulations and Fees
Commitment Fees
Loan Origination Fee
Compensating Balance Requirements
27.4 Short-Term Financing with Commercial Paper
27.5 Short-Term Financing with Secured Financing
Accounts Receivable as Collateral
Pledging of Accounts Receivable
Factoring of Accounts Receivable
Inventory as Collateral
Floating Lien
Trust Receipt
Warehouse Arrangement
Key Terms
Further Reading
Problems
Forecasting Short-Term Financing Needs
The Matching Principle
Short-Term Financing with Bank Loans
Short-Term Financing with Commercial Paper
Short-Term Financing with Secured Financing
Part 10 Special Topics
Chapter 28 Mergers and Acquisitions
Notation
28.1 Background and Historical Trends
Merger Waves
Types of Mergers
28.2 Market Reaction to a Takeover
28.3 Reasons to Acquire
Economies of Scale and Scope
Vertical Integration
Expertise
Monopoly Gains
Efficiency Gains
Tax Savings from Operating Losses
Diversification
Risk Reduction
Debt Capacity and Borrowing Costs
Asset Allocation
Liquidity
Earnings Growth
Managerial Motives to Merge
Conflicts of Interest
Overconfidence
28.4 Valuation and the Takeover Process
Valuation
The Offer
Merger “Arbitrage”
Tax and Accounting Issues
Board and Shareholder Approval
28.5 Takeover Defenses
Poison Pills
Staggered Boards
White Knights
Golden Parachutes
Recapitalization
Other Defensive Strategies
Regulatory Approval
28.6 Who Gets the Value Added from a Takeover?
The Free Rider Problem
Toeholds
The Leveraged Buyout
The Freezeout Merger
Competition
Key Terms
Further Reading
Problems
Background and Historical Trends
Market Reaction to a Takeover
Reasons to Acquire
Valuation and the Takeover Process
Takeover Defenses
Who Gets the Value Added from a Takeover?
Chapter 29 Corporate Governance
29.1 Corporate Governance and Agency Costs
29.2 Monitoring by the Board of Directors and Others
Types of Directors
Board Independence
Board Size and Performance
Other Monitors
29.3 Compensation Policies
Stock and Options
Pay and Performance Sensitivity
29.4 Managing Agency Conflict
Direct Action by Shareholders
Shareholder Voice
Shareholder Approval
Proxy Contests
Activist Funds
Management Entrenchment
The Threat of Takeover
29.5 Regulation
The Sarbanes-Oxley Act
The Cadbury Commission
Dodd-Frank Act
Insider Trading
29.6 Corporate Governance Around the World
Protection of Shareholder Rights
Controlling Owners and Pyramids
Dual Class Shares and the Value of Control
Pyramid Structures
The Stakeholder Model
Cross-Holdings
29.7 The Tradeoff of Corporate Governance
Key Terms
Further Reading
Problems
Corporate Governance and Agency Costs
Monitoring by the Board of Directors and Others
Compensation Policies
Managing Agency Conflict
Regulation
Corporate Governance Around the World
Chapter 30 Risk Management
30.1 Insurance
The Role of Insurance: An Example
Insurance Pricing in a Perfect Market
The Value of Insurance
Bankruptcy and Financial Distress Costs
Issuance Costs
Tax Rate Fluctuations
Debt Capacity
Managerial Incentives
Risk Assessment
The Costs of Insurance
Insurance Market Imperfections
Addressing Market Imperfections
The Insurance Decision
30.2 Commodity Price Risk
Hedging with Vertical Integration and Storage
Hedging with Long-Term Contracts
Hedging with Futures Contracts
Eliminating Credit Risk
Marking to Market: An Example
Deciding to Hedge Commodity Price Risk
30.3 Exchange Rate Risk
Exchange Rate Fluctuations
Hedging with Forward Contracts
Cash-and-Carry and the Pricing of Currency Forwards
The Law of One Price and the Forward Exchange Rate
Advantages of Forward Contracts
Hedging with Options
Options Versus Forward Contracts
Currency Option Pricing
30.4 Interest Rate Risk
Interest Rate Risk Measurement: Duration
Duration-Based Hedging
Savings and Loans: An Example
A Cautionary Note
Swap-Based Hedging
Combining Swaps with Standard Loans
Using a Swap to Change Duration
Key Terms
Further Reading
Problems
Insurance
Commodity Price Risk
Exchange Rate Risk
Interest Rate Risk
Chapter 31 International Corporate Finance
Notation
31.1 Internationally Integrated Capital Markets
31.2 Valuation of Foreign Currency Cash Flows
WACC Valuation Method in Domestic Currency
Application: Ityesi, Inc
Forward Exchange Rates
Free Cash Flow Conversion
The Value of Ityesi’s Foreign Project with WACC
Using the Law of One Price as a Robustness Check
31.3 Valuation and International Taxation
The TCJA: A New Approach to International Taxation
Harmonizing the Tax Treatment of Exports: GILTI and FDII
Avoiding Base Erosion: BEAT
31.4 Internationally Segmented Capital Markets
Differential Access to Markets
Macro-Level Distortions
Implications
31.5 Capital Budgeting with Exchange Risk
Key Terms
Further Reading
Problems
Internationally Integrated Capital Markets
Valuation of Foreign Currency Cash Flows
Valuation and International Taxation
Internationally Segmented Capital Markets
Capital Budgeting with Exchange Risk
Data Case
Glossary
Index
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Tags: Jonathan Berk, Peter DeMarzo, Corporate Finance