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FREQUENTLY USED SYMBOLS
ACP
ADR
APR
AR
b
bL
bU
BEP
BVPS
CAPM
CCC
CF
CFPS
CR
CV
Δ
Dps
Dt
DCF
D/E
DPS
DRIP
DRP
DSO
EAR
EBIT
EBITDA

EPS
EVA
F
FCF
FVN
FVAN
g
I
I/YR
INT
IP
IPO
IRR
LP
M
M/B
MIRR
MRP
MVA
n
N
N(di)
NOPAT
NOWC
NPV
P
Pc

Average collection period
American Depository Receipt

Annual percentage rate
Accounts receivable
Beta coefficient, a measure of an asset’s market risk
Levered beta
Unlevered beta
Basic earning power
Book value per share
Capital Asset Pricing Model
Cash conversion cycle
Cash flow; CFt is the cash flow in Period t
Cash flow per share
Conversion ratio
Coefficient of variation
Difference, or change (uppercase delta)
Dividend of preferred stock
Dividend in Period t
Discounted cash flow
Debt-to-equity ratio
Dividends per share
Dividend reinvestment plan
Default risk premium
Days sales outstanding
Effective annual rate, EFF%
Earnings before interest and taxes; net operating income
Earnings before interest, taxes, depreciation, and amortization
Earnings per share
Economic Value Added
(1) Fixed operating costs
(2) Flotation cost
Free cash flow

Future value for Year N
Future value of an annuity for N years
Growth rate in earnings, dividends, and stock prices
Interest rate; also denoted by r
Interest rate key on some calculators
Interest payment in dollars
Inflation premium
Initial public offering
Internal rate of return
Liquidity premium
(1) Maturity value of a bond
(2) Margin (profit margin)
Market-to-book ratio
Modified Internal Rate of Return
Maturity risk premium
Market Value Added
Number of shares outstanding
Calculator key denoting number of periods
Represents area under a standard normal distribution function
Net operating profit after taxes
Net operating working capital
Net present value
(1) Price of a share of stock in Period t; P0 = price of the stock today
(2) Sales price per unit of product sold
Conversion price

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Pf

Ph
PN
P/E
PMT
PPP
PV
PVAN
Q
QBE
r
¯r
^r
r*
rd
re
rf
rh
ri
rM
rNOM
rps
rPER
rRF
rs
ρ
ROA
ROE
RP
RPM
RR

S

SML

σ
σ2
t
T
TVN
TIE
V
VB
VL
Vop
Vps
VU
VC
w
wd
wps
ws
wce
WACC
X
YTC
YTM

Price of good in foreign country
Price of good in home country
A stock’s horizon, or terminal, value

Price/earnings ratio
Payment of an annuity
Purchasing power parity
Present value
Present value of an annuity for N years
Quantity produced or sold
Breakeven quantity
(1) A percentage discount rate, or cost of capital; also denoted by i
(2) Nominal risk-adjusted required rate of return
“r bar,” historic, or realized, rate of return
“r hat,” an expected rate of return
Real risk-free rate of return
Before-tax cost of debt
Cost of new common stock (outside equity)
Interest rate in foreign country
Interest rate in home country
Required return for an individual firm or security
Return for “the market” or for an “average” stock
Nominal rate of interest; also denoted by iNOM
(1) Cost of preferred stock
(2) Portfolio’s return
Periodic rate of return
Rate of return on a risk-free security
(1) Required return on common stock
(2) Cost of old common stock (inside equity)
Correlation coefficient (lowercase rho); also denoted by R when using historical data
Return on assets
Return on equity
Risk premium
Market risk premium

Retention rate
(1) Sales
(2) Estimated standard deviation for sample data
(3) Intrinsic value of stock (i.e., all common equity)
Security Market Line
Summation sign (uppercase sigma)
Standard deviation (lowercase sigma)
Variance
Time period
Marginal income tax rate
A stock’s horizon, or terminal, value
Times interest earned
Variable cost per unit
Bond value
Total market value of a levered firm
Value of operations
Value of preferred stock
Total market value of an unlevered firm
Total variable costs
Proportion or weight
Weight of debt
Weight of preferred stock
Weight of common equity raised internally by retaining earnings
Weight of common equity raised externally by issuing stock
Weighted averaged cost of capital
Exercise price of option
Yield to call
Yield to maturity

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Corporate Finance:
A Focused Approach

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Corporate Finance:
A Focused Approach
FOURTH EDITION

MICHAEL C. EHRHARDT
University of Tennessee

EUGENE F. BRIGHAM
University of Florida

Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States

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Corporate Finance: A Focused Approach,
Fourth Edition

Michael C. Ehrhardt and Eugene F. Brigham
VP/Editorial Director:
Jack W. Calhoun
Publisher:
Joe Sabatino
Executive Editor:
Mike Reynolds
Developmental Editor:
Michael Guendelsberger
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©2011, 2009 South-Western, a part of Cengage Learning
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Brief Contents
Preface

PART 1

xvi

Fundamental Concepts
of Corporate Finance
1

CHAPTER 1 An Overview of Financial
Management and the Financial
Environment 3
Web Extensions

1A: An Overview of Derivatives

PART 3

Web Extensions

2A: The Federal Income Tax
System for Individuals

CHAPTER 3 Analysis of Financial
Statements 87

PART 2

Web Extensions

123

CHAPTER 7 Stocks, Stock Valuation,
and Stock Market
Equilibrium 267
7A: Derivation of Valuation
Equations
CHAPTER 8 Financial Options and Applications
in Corporate Finance 305

Web Extensions

PART 4

4A: The Tabular Approach
4B: Derivation of Annuity Formulas

4C: Continuous Compounding
CHAPTER 5 Bonds, Bond Valuation, and

Interest Rates 173
Web Extensions

6A: Continuous Probability
Distributions
6B: Estimating Beta with
a Financial Calculator

Fixed Income
Securities 121

CHAPTER 4 Time Value of Money
Web Extensions

215

CHAPTER 6 Risk, Return, and the Capital
Asset Pricing Model 217

1B: A Closer Look at the Stock
Markets
CHAPTER 2 Financial Statements, Cash Flow,
and Taxes 47

Stocks and Options

5A: A Closer Look at Zero
Coupon Bonds
5B: A Closer Look at TIPS:
Treasury Inflation-Protected

Securities
5C: A Closer Look at Bond Risk:
Duration
5D: The Pure Expectations Theory
and Estimation of Forward Rates

Projects and Their
Valuation 333

CHAPTER 9 The Cost of Capital

335

9A: The Required Return
Assuming Nonconstant Dividends
and Stock Repurchases
CHAPTER 10 The Basics of Capital Budgeting:
Evaluating Cash Flows 379

Web Extensions

10A: The Accounting Rate of
Return (ARR)
CHAPTER 11 Cash Flow Estimation and Risk
Analysis 423

Web Extensions

Web Extensions

11A: Certainty Equivalents
and Risk-Adjusted Discount
Rates

v

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vi

Brief Contents

PART 5

Corporate Valuation
and Governance 471

CHAPTER 12 Financial Planning and Forecasting
Financial Statements 473
Web Extensions

12A: Advanced Techniques for
Forecasting Financial Statements
Accounts

CHAPTER 13 Corporate Valuation,
Value-Based Management and
Corporate Governance 511

PART 7

Managing Global
Operations 639

CHAPTER 16 Working Capital
Management 641
16A: Secured Short-Term Financing
CHAPTER 17 Multinational Financial
Management 691

Web Extensions

Appendix

731

Appendix A SolutionstoSelf-TestProblems 731

PART 6

Cash Distributions and
Capital Structure 557

CHAPTER 14 Distributions to Shareholders:
Dividends and Repurchases 559
CHAPTER 15 Capital Structure
Decisions 599
Web Extensions

15A: Degree of Leverage

Appendix B Answers to End-of-Chapter
Problems 753
Appendix C Selected Equations and Data 759
Appendix D Values of the Areas under the
Standard Normal Distribution
Function 771
Glossary 773
Name Index 791
Subject Index 795

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Contents
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvi

PART 1 Fundamental Concepts of Corporate Finance 1
CHAPTER 1
An Overview of Financial Management and the Financial Environment
The Five-Minute MBA

Box: Say Hello to the Global Economic Crisis!
The Corporate Life Cycle

5

5

Box: Columbus Was Wrong—the World Is Flat! And Hot, and Crowded!
The Primary Objective of the Corporation: Value Maximization
Box: Ethics for Individuals and Businesses

An Overview of the Capital Allocation Process
Financial Securities

15

The Cost of Money

19

Financial Markets

Box: Rational Exuberance?

13

Box: Measuring the Market
Stock Market Returns

29

30

31

The Secondary Stock Markets

31

33

34

The Global Economic Crisis

Summary

13

27

Types of Stock Market Transactions

e-Resources

9

23

Trading Procedures in Financial Markets

The Big Picture

6

(Video) L15.1: Different Methods for Working With Text Data

10

Box: Corporate Scandals and Maximizing Stock Price

Financial Institutions

3

4

36

42

43
44

Web Extensions
1A: An Overview of Derivatives
1B: A Closer Look at the Stock Markets

CHAPTER 2
Financial Statements, Cash Flow, and Taxes

47

Box: Intrinsic Value, Free Cash Flow, and Financial Statements
Financial Statements and Reports
The Balance Sheet

48

48

49

Box: Let’s Play Hide-and-Seek!

51
vii

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viii

Contents

The Income Statement

52

Statement of Stockholders’ Equity
Net Cash Flow

53

54

Statement of Cash Flows

55

Box: Financial Analysis on the WEB 56
Modifying Accounting Data for Managerial Decisions
Box: Financial Bamboozling: How to Spot It
MVA and EVA

63

67

Box: Sarbanes-Oxley and Financial Fraud
The Federal Income Tax System
Summary

59

70

71

76

Web Extensions
2A: The Federal Income Tax System for Individuals

CHAPTER 3
Analysis of Financial Statements

87

Box: Intrinsic Value and Analysis of Financial Statements
Financial Analysis

88

88

Liquidity Ratios

89

Asset Management Ratios

92

Box: The Price is Right! (Or Wrong!)
Debt Management Ratios
Profitability Ratios

93

95

98

Box: The World Might be Flat, but Global Accounting is Bumpy!
The Case of IFRS versus FASB 99
Market Value Ratios

100

Trend Analysis, Common Size Analysis, and Percentage Change Analysis
Tying the Ratios Together: The Du Pont Equation
Comparative Ratios and Benchmarking

107

Uses and Limitations of Ratio Analysis

108

Box: Ratio Analysis on the Web
Looking beyond the Numbers
Summary

106

109
110

110

PART 2 Fixed Income Securities 121
CHAPTER 4
Time Value of Money

123

Box: Corporate Valuation and the Time Value of Money 124
Time Lines

125

Future Values

125

Box: Hints on Using Financial Calculators
Box: The Power of Compound Interest
Present Values

133

129

132

102

Contents

Finding the Interest Rate, I

136

Finding the Number of Years, N
Annuities

137

138

Future Value of an Ordinary Annuity
Future Value of an Annuity Due

138

141

Present Value of Ordinary Annuities and Annuities Due
Box: Variable Annuities: Good or Bad?

144

Finding Annuity Payments, Periods, and Interest Rates
Perpetuities

141
144

146

Box: Using the Internet for Personal Financial Planning
Uneven, or Irregular, Cash Flows

147

148

Future Value of an Uneven Cash Flow Stream
Solving for I with Irregular Cash Flows

151

152

Semiannual and Other Compounding Periods

153

Box: Truth in Lending: What Loans Really Cost 156
Fractional Time Periods
Amortized Loans

157

158

Growing Annuities

159

Box: An Accident Waiting to Happen: Option Reset
Adjustable Rate Mortgages 160
Summary

162

Web Extensions

4A: The Tabular Approach
4B: Derivation of Annuity Formulas
4C: Continuous Compounding

CHAPTER 5
Bonds, Bond Valuation, and Interest Rates
Box: Intrinsic Value and the Cost of Debt
Who Issues Bonds?

173

174

174

Key Characteristics of Bonds

175

Box: Betting With or Against the U.S. Government:
The Case of Treasury Bond Credit Default Swaps 176
Bond Valuation

180

Changes in Bond Values over Time
Box: Drinking Your Coupons

187

Bonds with Semiannual Coupons
Bond Yields

184
187

188

The Pre-Tax Cost of Debt: Determinants of Market Interest Rates
The Real Risk-Free Rate of Interest, r*
The Inflation Premium (IP)

192

193

The Nominal, or Quoted, Risk-Free Rate of Interest, rRF
The Default Risk Premium (DRP)

195

195

Box: Insuring with Credit Default Swaps: Let the Buyer Beware!

197

191

ix

x

(Video) Extract Text and Data from Any Document with No Prior ML Experience - AWS Online Tech Talks

Contents

Box: Might the U.S. Treasury Bond Be Downgraded?
Box: Are Investors Rational?
The Liquidity Premium (LP)

201

The Maturity Risk Premium (MRP)

201

The Term Structure of Interest Rates
Financing with Junk Bonds

204

205

Bankruptcy and Reorganization
Summary

199

201

206

207

Web Extensions
5A: A Closer Look at Zero Coupon Bonds
5B: A Closer Look at TIPS: Treasury Inflation-Protected Securities
5C: A Closer Look at Bond Risk: Duration
5D: The Pure Expectations Theory and Estimation of Forward Rates

PART 3 Stocks and Options 215
CHAPTER 6
Risk, Return, and the Capital Asset Pricing Model
Box: Intrinsic Value, Risk, and Return
Returns on Investments
Stand-Alone Risk

217

219

219

220

Box: What Does Risk Really Mean?

227

Box: The Trade-off between Risk and Return

Risk in a Portfolio Context

229

231

Box: How Risky Is a Large Portfolio of Stocks?
Box: The Benefits of Diversifying Overseas
Calculating Beta Coefficients

236

239

243

The Relationship between Risk and Return

246

Box: Another Kind of Risk: The Bernie Madoff Story
Some Concerns about Beta and the CAPM

252

253

Some Concluding Thoughts: Implications for Corporate Managers and Investors
Summary

255

Web Extensions
6A: Continuous Probability Distributions
6B: Estimating Beta with a Financial Calculator

CHAPTER 7
Stocks, Stock Valuation, and Stock Market Equilibrium
Box: Corporate Valuation and Stock Prices

268

Legal Rights and Privileges of Common Stockholders
Types of Common Stock

269

The Market Stock Price versus Intrinsic Value
Stock Market Reporting

272

270

268

267

253

Contents

Valuing Common Stocks

273

Valuing a Constant Growth Stock

276

Expected Rate of Return on a Constant Growth Stock
Valuing Nonconstant Growth Stocks
Market Multiple Analysis

279

281

Stock Valuation by the Free Cash Flow Approach
Preferred Stock

285

285

286

Stock Market Equilibrium

287

The Efficient Markets Hypothesis

290

Box: Rational Behavior versus Animal Spirits, Herding, and Anchoring Bias
Summary

xi

293

294

Web Extensions
7A: Derivation of Valuation Equations

CHAPTER 8
Financial Options and Applications in Corporate Finance
Box: The Intrinsic Value of Stock Options
Overview of Financial Options

306

Box: Financial Reporting for Employee Stock Options

309

The Single-Period Binomial Option Pricing Approach

310

The Single-Period Binomial Option Pricing Formula
The Multi-Period Binomial Option Pricing Model
The Black-Scholes Option Pricing Model (OPM)
Box: Taxes and Stock Options
The Valuation of Put Options

314
316

319

324
325

Applications of Option Pricing in Corporate Finance
Summary

305

306

326

328

PART 4 Projects and Their Valuation 333
CHAPTER 9

The Cost of Capital

335

Box: Corporate Valuation and the Cost of Capital 336
The Weighted Average Cost of Capital
Basic Definitions

337

338

Cost of Debt, rd(1 − T)

340

Cost of Preferred Stock, rps

342

Box: GE and Warren Buffett: The Cost of Preferred Stock 343
Cost of Common Stock, rs
The CAPM Approach

344

345

Dividend-Yield-Plus-Growth-Rate, or Discounted Cash Flow (DCF), Approach
Over-Own-Bond-Yield-Plus-Judgmental-Risk-Premium Approach

353

355

Comparison of the CAPM, DCF, and Over-Own-Bond-Yield-Plus-Judgmental-RiskPremium Methods 356

xii

Contents

Adjusting the Cost of Equity for Flotation Costs

357

Composite, or Weighted Average, Cost of Capital, WACC
Box: Global Variations in the Cost of Capital
Factors That Affect the WACC

361

361

Adjusting the Cost of Capital for Risk

363

Privately Owned Firms and Small Businesses
Four Mistakes to Avoid

Summary

358

366

367

368

Web Extensions
9A: The Required Return Assuming Nonconstant Dividends and Stock Repurchases

CHAPTER 10
The Basics of Capital Budgeting: Evaluating Cash Flows
Box: Corporate Valuation and Capital Budgeting
An Overview of Capital Budgeting
Net Present Value (NPV)

381

383

Internal Rate of Return (IRR)

387

Box: Why NPV Is Better Than IRR

389

Multiple Internal Rates of Return
Reinvestment Rate Assumptions

390
392

(Video) Les Misérables Discussion ||TEXT VS FILM ||BIOGRAPHICAL ||HISTORICAL ||MARXIST ||FEMINIST APPROACH

Modified Internal Rate of Return (MIRR)
NPV Profiles

393

396

Profitability Index (PI)
Payback Period

400

401

Conclusions on Capital Budgeting Methods
Decision Criteria Used in Practice

405

Other Issues in Capital Budgeting

405

Summary

381

403

411

Web Extensions
10A: The Accounting Rate of Return (ARR)

CHAPTER 11
Cash Flow Estimation and Risk Analysis

423

Box: Corporate Valuation, Cash Flows, and Risk Analysis
Conceptual Issues

424

Analysis of an Expansion Project
Risk Analysis in Capital Budgeting
Measuring Stand-Alone Risk
Sensitivity Analysis
Scenario Analysis

424

429

435

436

436
439

Monte Carlo Simulation

442

Box: Are Bank Stress Tests Stressful Enough?
Project Risk Conclusions

445

446

Box: Capital Budgeting Practices in the Asian/Pacific Region
Replacement Analysis

448

447

379

Contents

Real Options 449
Phased Decisions and Decision Trees
Summary 454

451

Appendix 11A Tax Depreciation 468
Web Extensions
11A: Certainty Equivalents and Risk-Adjusted Discount Rates

PART 5 Corporate Valuation and Governance 471
CHAPTER 12
Financial Planning and Forecasting Financial Statements
Box: Corporate Valuation and Financial Planning
Overview of Financial Planning 474
Sales Forecast 476
Additional Funds Needed (AFN) Method

473

474

478

Forecasted Financial Statements Method 482
Forecasting When the Ratios Change 496
Summary

499

Web Extensions
12A: Advanced Techniques for Forecasting Financial Statements Accounts

CHAPTER 13
Corporate Valuation, Value-Based Management and Corporate
Governance 511
Box: Corporate Valuation: Putting the Pieces Together
Overview of Corporate Valuation
The Corporate Valuation Model
Value-Based Management

513
514

521

Managerial Behavior and Shareholder Wealth
Corporate Governance

512

530

531

Box: Let’s Go to Miami! IBM’s 2009 Annual Meeting 533
Box: Would the U.S. Government Be an Effective Board Director?
Box: Shareholder Reactions to the Crisis

538

Box: The Sarbanes-Oxley Act of 2002 and Corporate Governance
Box: International Corporate Governance

540

542

Employee Stock Ownership Plans (ESOPs)
Summary

536

543

546

PART 6 Cash Distributions and Capital Structure 557
CHAPTER 14
Distributions to Shareholders: Dividends and Repurchases
Box: Uses of Free Cash Flow: Distributions to Shareholders
An Overview of Cash Distributions
Procedures for Cash Distributions
Cash Distributions and Firm Value

560
562
564

560

559

xiii

xiv

Contents

Clientele Effect

567

Information Content, or Signaling, Hypothesis
Implications for Dividend Stability

568

569

Box: Will Dividends Ever Be the Same?

570

Setting the Target Distribution Level: The Residual Distribution Model
The Residual Distribution Model in Practice

A Tale of Two Cash Distributions: Dividends versus Stock Repurchases
The Pros and Cons of Dividends and Repurchases

582

Box: Dividend Yields around the World 584
Other Factors Influencing Distributions 584
Summarizing the Distribution Policy Decision
Stock Splits and Stock Dividends

Summary

585

587

Box: Talk about a Split Personality!
Dividend Reinvestment Plans

588

590

591

CHAPTER 15
Capital Structure Decisions

599

Box: Corporate Valuation and Capital Structure
A Preview of Capital Structure Issues

Business Risk and Financial Risk
Capital Structure Theory

600

600

603

609

Box: Yogi Berra on the MM Proposition

611

Capital Structure Evidence and Implications

618

Box: Taking a Look at Global Capital Structures
Estimating the Optimal Capital Structure
Anatomy of a Recapitalization
Box: Deleveraging
Summary

620

621

625

630

630

Web Extensions
15A: Degree of Leverage

PART 7 Managing Global Operations 639
CHAPTER 16
Working Capital Management

641

Box: Corporate Valuation and Working Capital Management
Current Asset Holdings

642

643

Current Assets Financing Policies
The Cash Conversion Cycle

644

648

Box: Some Firms Operate with Negative Working Capital! 653
The Cash Budget

654

Cash Management and the Target Cash Balance
Box: The CFO Cash Management Scorecard
Cash Management Techniques

659

570

572

658

657

573

Contents

Inventory Management

661

(Video) Tutorial 49- How To Apply Naive Bayes' Classifier On Text Data (NLP)- Machine Learning

Box: Supply Chain Management
Receivables Management

662

663

Box: Supply Chain Finance

665

Accruals and Accounts Payable (Trade Credit)
Short-Term Marketable Securities
Short-Term Financing

670

672

676

Use of Security in Short-Term Financing
Summary

667

672

Short-Term Bank Loans
Commercial Paper

xv

677

678

Web Extensions
16A: Secured Short-Term Financing

CHAPTER 17
Multinational Financial Management

691

Box: Corporate Valuation in a Global Context
Multinational, or Global, Corporations

692

692

Multinational versus Domestic Financial Management
Exchange Rates

693

694

Exchange Rates and International Trade

698

The International Monetary System and Exchange Rate Policies

Trading in Foreign Exchange
Interest Rate Parity

703

704

Purchasing Power Parity

706

Box: Hungry for a Big Mac? Go To Malaysia!

708

Inflation, Interest Rates, and Exchange Rates
International Money and Capital Markets

709

710

Box: Greasing the Wheels of International Business
Box: Stock Market Indices around the World
Multinational Capital Budgeting
Box: Consumer Finance in China
International Capital Structures

Appendix
Appendix

Appendix
Appendix

711

713

714
715
718

Multinational Working Capital Management
Summary

699

720

723

A Solutions to Self-Test Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . 731
B Answers to End-of-Chapter Problems . . . . . . . . . . . . . . . . . . . . . . 753
C Selected Equations and Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 759
D Values of the Areas under the Standard Normal
Distribution Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 771
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 773
Name Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791
Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795

Preface
resource
Be sure to visit the
Corporate Finance: A
Focused Approach (4th
Edition) Web site at
www.cengage.com/
finance/ehrhardt. This
site provides access for
instructors and students.

When we wrote the first edition of Corporate Finance: A Focused Approach, we had four
goals: (1) to create a book that would help managers make better financial decisions;
(2) to motivate students by demonstrating that finance is both interesting and relevant; (3) to make the book clear enough for students to go through the material without wasting time trying to figure out what we were trying to say; and (4) to provide a
book that covers the core material necessary for a one-semester introductory MBA
course but without all the other interesting-but-not-essential material that is contained in most MBA texts.
The collapse of the sub-prime mortgage market, the financial crisis, and the global
economic crisis make it more important than ever for students and managers to understand the role that finance plays in a global economy, in their own companies, and
in their own lives. So, in addition to the four goals just listed, this edition has a fifth
goal: to prepare students for a changed world.

INTRINSIC VALUATION

AS A

UNIFYING THEME

Our emphasis throughout the book is on the actions that a manager can and should
take to increase the intrinsic value of the firm. Structuring the book around intrinsic
valuation enhances continuity and helps students see how various topics are related to

one another.
This book combines theory and practical applications. An understanding of finance
theory is absolutely essential for anyone developing and/or implementing effective
financial strategies. But theory alone isn’t sufficient, so we provide numerous examples
in the book and the accompanying Excel spreadsheets to illustrate how theory is
applied in practice. Indeed, we believe that the ability to analyze financial problems
using Excel is absolutely essential for a student’s successful job search and subsequent
career. Therefore, many exhibits in the book come directly from the accompanying
Excel spreadsheets. Many of the spreadsheets also provide brief “tutorials” by way of
detailed comments on Excel features that we have found to be especially useful, such as
Goal Seek, Tables, and many financial functions.
The book begins with fundamental concepts, including background on the economic and financial environment, financial statements (with an emphasis on cash
flows), the time value of money, bond valuation, risk analysis, and stock valuation.
With this background, we go on to discuss how specific techniques and decision rules
can be used to help maximize the value of the firm. This organization provides four
important advantages:
1. Managers should try to maximize the intrinsic value of a firm, which is determined by cash flows as revealed in financial statements. Our early coverage of
financial statements thus helps students see how particular financial decisions
affect the various parts of the firm and the resulting cash flow. Also, financial
statement analysis provides an excellent vehicle for illustrating the usefulness of
spreadsheets.
xvi

Preface

xvii

2. Covering time value of money early helps students see how and why
expected future cash flows determine the value of the firm. Also, it

takes time for students to digest TVM concepts and to learn how to do
the required calculations, so it is good to cover TVM concepts early
and often.
3. Most students—even those who do not plan to major in finance—are
interested in investments. The ability to learn is a function of individual
interest and motivation, so our early coverage of securities and security
markets is pedagogically sound.
4. Once basic concepts have been established, it is easier for students to
understand both how and why corporations make specific decisions in the
areas of capital budgeting, raising capital, working capital management,
mergers, and the like.

INTENDED MARKET

AND

USE

Corporate Finance is designed primarily for use in the introductory MBA finance
course and as a reference text in follow-on case courses and after graduation. The
book can also be used as an undergraduate introductory text with exceptionally good
students.

IMPROVEMENTS

IN THE

FOURTH EDITION

As in every revision, we updated and clarified materials throughout the text and

reviewed the entire book for completeness, ease of exposition, and currency. We
made hundreds of small changes to keep the text up-to-date, with particular emphasis
on updating the real-world examples and including the latest changes in the financial
environment and financial theory. In addition, we made a number of larger changes.
Some of them affect all chapters, some involve reorganizing sections among chapters,
and some modify material covered within specific chapters.

Changes That Affect All Chapters
The global economic crisis. In virtually every chapter we use real-world examples
to show how the chapter’s topics are related to some aspect of the global economic
crisis. In addition, many chapters contain new “Global Economic Crisis” features that
focus on particularly important issues related to the crisis.
The big picture. Students often fail to see the forest for the trees, and this is especially true in finance because they must learn new vocabularies and analytical tools.
To help students understand the big picture and integrate the different parts into an
overall framework, we have added a graphic at the beginning of each chapter (and in
the PowerPoint shows) that clearly illustrates where the chapter’s topics fit into the big
picture. Here is an example from Chapter 9:

www.ebook3000.com

xviii

Preface

Determinants of Intrinsic Value:
The Weighted Average Cost of Capital
Net operating
profit after taxes
Free cash flow

(FCF)

Value =

Required investments
in operating capital

FCF1

+

(1 + WACC)1

FCF2

=

+ …+

(1 + WACC)2

FCF∞

(1 + WACC)∞

Weighted average
cost of capital
(WACC)

Market interest rates

Market risk aversion

Cost of debt
Cost of equity

Firm’s debt/equity mix

Firm’s business risk

Additional integration of the textbook and the accompanying Excel Tool Kit
spreadsheet models for each chapter. Many figures in the textbook are actually
screen shots from the chapter’s Excel Tool Kit model. This makes the analysis more
transparent to the students and better enables them to follow the analysis in the Excel
model.

Significant Reorganization of Some Chapters
Financial markets and performance measures. Chapter 1 still addresses the financial environment, but now it is followed by two chapters that focus on measuring
the firm’s performance in the financial environment by understanding financial statements, calculating free cash flow, and analyzing ratios.
Time value of money and bond valuation. Chapter 4 covers the time value of
money, and Chapter 5 applies these concepts to bond pricing. Thus, students learn
a tool and then immediately use the tool.
Dividends and stock repurchases before capital structure decisions. We now
cover dividends and stock repurchases in Chapter 14 so that students will already understand stock repurchases when we discuss recapitalizations in Chapter 15.

Notable Changes within Selected Chapters
We made too many small improvements within each chapter to mention them all,
but some of the more notable ones are discussed below.

Preface

xix

Chapter 1: An Overview of Financial Management and the Financial
Environment. We updated and extended a box on globalization, “Columbus Was
Wrong, the World Is Flat! And Hot, and Crowded,” and added a new box on the
global economic crisis, “Say Hello to the Global Economic Crisis!” We completely
rewrote the section on financial securities, including a discussion of securitization,
and added a new section on the global crisis. New figures showing the national
debt, trade balances, federal budget deficits and the Case-Shiller real estate index
help us better illustrate different aspects of the global crisis.

Chapter 2: Financial Statements, Cash Flow, and Taxes. A new opening
vignette shows the cash that several different companies generated and the different
ways that they used the cash flow. We added a new box on the global economic crisis
that explains the problems associated with off–balance sheet assets, “Let’s Play Hideand-Seek!” We added a new figure illustrating the uses of free cash flow. We now
have two end-of-chapter spreadsheet problems: one focusing on the articulation between the income statement and statement of cash flows, and one focusing on free
cash flow.
Chapter 3: Analysis of Financial Statements. We added a new box on marking
to market, “The Price is Right! (Or Wrong!),” as well as a new box on international
accounting standards, “The World Might be Flat, but Global Accounting is Bumpy!
The Case of IFRS versus FASB.” We added a brief discussion explaining how to use
the statement of cash flows in financial analysis.
Chapter 4: Time Value of Money. We added three new boxes: (1) “Hints on
Using Financial Calculators,” (2) “Variable Annuities: Good or Bad?” and (3) “An
Accident Waiting to Happen: Option Reset Adjustable Rate Mortgages.”
Chapter 5: Bonds, Bond Valuation, and Interest Rates. We added four new

boxes related to the global economic crisis: (1) “Betting with or against the U.S. Government: The Case of Treasury Bond Credit Default Swaps,” (2) “Insuring with
Credit Default Swaps: Let the Buyer Beware!” (3) “Might the U.S. Treasury Bond
Be Downgraded?” and (4) “Are Investors Rational?” We also added a new table summarizing corporate bond default rates and annual changes in ratings.
Chapter 6: Risk, Return, and the Capital Asset Pricing Model. The new opening vignette discusses the recent stock market and compares the market’s returns to GE’s
returns. We added a new box on the risk that remains even for long-term investors,
“What Does Risk Really Mean?” We added two additional boxes on risk, “How Risky
Is a Large Portfolio of Stocks?” and “Another Kind of Risk: The Bernie Madoff Story.”
Chapter 7: Stocks, Stock Valuation, and Stock Market Equilibrium. A new
opening vignette discusses buy- and sell-side analysts. We added a new box on behavioral issues, “Rational Behavior versus Animal Spirits, Herding, and Anchoring
Bias.” We added a new section, “The Market Stock Price versus Intrinsic Value.”
Chapter 8: Financial Options and Applications in Corporate Finance. We
completely rewrote the description of the binomial option pricing model. In addition
to the hedge portfolio, we also discuss replicating portfolios. We now provide the binomial formula and show the complete solution to the two-period model. To provide
greater continuity, the company used to illustrate the binomial example is now the
same company used to illustrate the Black-Scholes model. Our discussion of put options now includes the Black-Scholes put formula.

xx

Preface

Chapter 9: The Cost of Capital. We added a new figure to highlight the similarities and differences among capital structure weights based on book values, market values, and target values. We added a new box, “GE and Warren Buffett: The Cost of
Preferred Stock.” We completely rewrote our discussion of the market risk premium,
which now includes the impact of stock repurchases on estimating the market risk
premium. We also present data from surveys identifying the market risk premia
used by CFOs and professors.
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows. We

added a new box, “Why NPV Is Better Than IRR.”

Chapter 11: Cash Flow Estimation and Risk Analysis. We now show how to
use tornado diagrams in sensitivity analysis. We rewrote our discussion of Monte
Carlo simulation and show how to conduct a simulation analysis without using addins but instead using only Excel’s built-in features (Data Tables and random number
generators). We have included an example of replacement analysis and an example of
a decision tree showing abandonment. We added a new box, “Are Bank Stress Tests
Stressful Enough?”
Chapter 12: Financial Planning and Forecasting Financial Statements. It is
difficult to do financial planning without using spreadsheet software, so we
completely rewrote the chapter and explicitly integrated the text and the Excel Tool
Kit model. We illustrate the ways that financial policies (i.e., dividend payout and
capital structure choices) affect financial projections, including ways to ensure that
balance sheets balance. The Excel Tool Kit model now demonstrates a simple way to
incorporate financing feedback effects.
Chapter 13: Corporate Valuation, Value-Based Management, and Corporate
Governance. The new opening vignette discusses the role of corporate governance
in the global economic crisis. We also added three new boxes. The first describes
corporate governance issues at IBM, “Let’s Go to Miami! IBM’s 2009 Annual Meeting.” The second discusses leadership at bailout recipients, “Would the U.S. Government Be an Effective Board Director?” The third discusses the 2009 proxy season,
“Shareholder Reactions to the Crisis.”

Chapter 14: Distributions to Shareholders: Dividends and Repurchases. We
consolidated the coverage of stock repurchases that was previously spread over two
chapters and located it here, which now precedes our discussion of capital structure
in Chapter 15. We also use the FCF valuation model to illustrate the different
impacts of stock repurchases versus dividend payments. We added two new boxes.
The first discusses recent dividend cuts, “Will Dividends Ever Be the Same?” and
the second discusses Sun Microsystems’ stock splits and recent reverse split, “Talk
About a Split Personality!”
Chapter 15: Capital Structure Decisions: The Basics. The new opening vignette discusses recent bankruptcies and Black & Decker’s efforts to reduce liquidity
risk by refinancing short-term debt with long-term debt. Because stock repurchases
are now covered in the preceding chapter, we were able to improve our discussion

of recapitalizations within the context of the FCF valuation model. We added a new
box on “Deleveraging” that discusses the changes in leverage many companies and
individuals are making in light of the global economic crisis.
Chapter 16: Working Capital Management. We reorganized the chapter so
that we now discuss working capital holdings and financing before discussing the

Preface

xxi

cash conversion cycle. We rewrote our coverage of the cash conversion cycle to
explain the general concepts and then apply them to actual financial statement data.
We added a new box entitled “Some Firms Operate with Negative Working Capital!” and a new section on the cost of bank loans.

Chapter 17: Multinational Financial Management. We added a new opening
vignette on the global economic crisis and its impact on world economies, foreign
direct investment, and cross-border M&As.

Aplia Finance
Aplia Finance, an interactive learning system, engages students in course concepts,
ensures they practice on a regular basis, and helps them prepare to learn finance
through a series of tutorials. Created by an instructor to help students excel, bookspecific problem sets have instant grades and detailed feedback, ensuring students
have the opportunity to learn from and improve with every question.
Chapter assignments use the same language and tone of the course textbook, giving
students a seamless experience in and out of the classroom. Problems are automatically
graded and offer detailed explanations, helping students learn from every question.
Aplia Finance offers:



Problem Sets: Chapter-specific problem sets ensure that students are completing
finance assignments on a regular basis.
Preparing for Finance Tutorials: Hands-on tutorials solve math, statistics, economics, and accounting roadblocks before they become a problem in the course,
and financial calculator tutorials help students learn to use the tools needed in a
finance course.
News Analyses: Students connect course theories to real-world events by reading
relevant news articles and answering graded questions about the article.
Course Management System
Digital Textbook

For more information, visit http://www.aplia.com/finance.

Thomson ONE—Business School Edition

WWW
To access Thomson ONE—
BSE, go to http://tobsefin
.swlearning.com and follow the instructions shown
there. You will need the
serial number that came on
the card in your textbook.

Thomson ONE—Business School Edition is an online database that draws from the
world-acclaimed Thomson Financial data sources, including the SEC Disclosure,
Datastream, First Call, and Worldscope databases. Now you can give your students

the opportunity to practice with a business school version of the same Internet-based
database that brokers and analysts around the world use every day. Thomson ONE—
BSE provides (1) one-click download of financial statements to Excel, (2) data from
domestic and international companies, (3) 10 years of financial data; and (4) oneclick Peer Set analyses.
Many chapters have suggested problems based on data available at Thomson ONE—
BSE. Following is a brief description of the data provided by Thomson ONE—BSE.

I/B/E/S Consensus Estimates. Includes consensus estimates—averages, means,
and medians; analyst-by-analyst earnings coverage; analysts’ forecasts based on 15 industry standard measures; and current and historic coverage for the selected 500
companies. Current coverage is five years forward plus historic data from 1976 for
U.S. companies and from 1987 for international companies, with current data updated daily and historic data updated monthly.

xxii

Preface

Worldscope. Includes company profiles, financials, accounting results, and market
per share data for the selected 500 companies going back to 1980, all updated daily.
Disclosure SEC Database. Includes company profiles, annual and quarterly company financials, pricing information, and earnings estimates for selected U.S. and Canadian companies—annually from 1987, quarterly for the last 10 years, and monthly for
prices; all updated weekly.
DataStream Pricing. Daily international pricing, including share price information
(open, high, low, close, P/E) plus index and exchange rate data, for the last 10 years.
ILX Systems Delayed Quotes. Includes 20-minute delayed quotes of equities and
indices from U.S. and global tickers covering 130 exchanges in 25 developed
countries.
Comtex Real-Time News. Includes current news releases.
SEC Edgar Filings and Global Image Source Filings. Includes regulatory and
nonregulatory filings for both corporate and individual entities. Edgar filings are
real-time and go back 10 years; image filings are updated daily and go back 7 years.

MAKE IT YOURS:
Your course is unique; create a casebook that reflects it. Let us help you put together a
quality casebook simply, quickly, and affordably.
We want to help you focus on the most important thing – teaching. That’s why we
have made this as simple as possible for you. We have aligned best-selling cases from our
Klein/Brigham and Brigham/Buzzard series at the chapter level to Ehrhardt/Brigham.
We encourage you to visit http://www.cengage.com/custom/makeityours/Ehrhardt
Brigham and select the cases to include in a custom case book. The cases are listed under each chapter title. To review cases, simply click on “view abstract” next to each case
title. If you would like to review the full case, contact your Cengage Learning representative or fill out the form and we will contact you.
For more information about custom publishing options, visit www.cengage.com/
custom.

(Video) Go Beyond Traditional OCR and Extract Text from Financial, Healthcare, and Legal Documents Quickly

THE INSTRUCTIONAL PACKAGE: AN INTEGRATED
LEARNING SYSTEM
Corporate Finance includes a broad range of ancillary materials designed to enhance
students’ learning and to make it easier for instructors to prepare for and conduct classes. All resources available to students are, of course, also available to instructors; in
addition, instructors have access to the course management tools.

Learning Tools Available to Students and Instructors
The Cengage Global Economic Watch (GEW) Resource Center. This is your
source for turning today’s challenges into tomorrow’s solutions. This online portal houses
the most current and up-to-date content concerning the economic crisis. Organized by
discipline, the GEW Resource Center offers the solutions instructors and students need
in an easy-to-use format. Included are an overview and timeline of the historical events
leading up to the crisis, links to the latest news and resources, discussion and testing content, an instructor feedback forum, and a Global Issues Database.

Videos

1. After watching this, your brain will not be the same | Lara Boyd | TEDxVancouver
(TEDx Talks)
2. Nếu bạn muốn biết những gì nó cần để TÌM KIẾM và yêu thích - XEM NÀY!
(Fearless Soul)
3. Why you should define your fears instead of your goals | Tim Ferriss
(TED)
4. Julian Treasure: Nói thế nào để người khác muốn nghe
(TED)
5. Tìm hiểu Cách tạo Bảng điều khiển Doanh số & Lợi nhuận trên Excel
(Excel For Freelancers)
6. Fair Use - Copyright on YouTube
(YouTube Creators)

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