Corporate Finance, Global Edition

1172 Pages·2016·15.347 MB·English

by  Berk Jonathan

SSttoocckkss •• EETTFFss •• MMuuttuuaall FFuunnddss •• BBoonnddss
Get $500,000
With the purchase of this book, you are entitled to a
and simulate managing a portfolio
25% discount to StockTrak.com, the leading stock
of ssimtoulcatkiosn, fobr othne dunsi,v earsnitdy e mduucattuiona lm faurknetd! s.
Virtual Cash
To take advantage of this exclusive offer, ask your
professor to register on StockTrak.com and create
a custom trading challenge for your class.
When you receive an HTML link from your professor, you
will be asked to enter this code to receive your discount:
BDMC-0916
If your professor is not using StockTrak.com as part of the
class, you can still register as an individual and save 25%!
NYSE • NASDAQ • CBOE • CME
NYMEX • TSX • LSE • Euronext
A01_BERK0160_04_GE_FM.indd 1 8/24/16 6:36 PM
Berk-DeMarzo_CF2e_EP_FRONT 12/11/09 1:46 AM Page 02
COMMON SYMBOLS AND NOTATION
A market value of assets, premerger P price of security i
i
total value of acquirer P/E price-earnings ratio
APR annual percentage rate PMT annuity spreadsheet notation
B risk-free investment for cash flow
in the replicating portfolio PV present value; annuity spreadsheet
C cash flow, call option price notation for the initial amount
Corr(R ,R ) correlation between returns of iand j q dividend yield
i j
Cov(R ,R ) covariance between returns of iand j p risk-neutral probability
i j
CPN coupon payment r interest rate, discount rate of cost
D market value of debt of capital
d debt-to-value ratio Ri return of security i
Divt dividends paid in year t Rmkt return of the market portfolio
dis discount from face value RP return on portfolio P
E market value of equity RATE annuity spreadsheet notation
for interest rate
EAR effective annual rate
r , r equity and debt costs of capital
EBIT earnings before interest and taxes E D
r risk-free interest rate
EBITDA earnings before interest, taxes, f
depreciation, and amortization ri required return or cost of capital
of security i
EPS earnings per share on date t
t
r unlevered cost of capital
E[R ] expected return of security i U
i
r weighted average cost of capital
F, F one-year and T-year forward wacc
T
exchange rate S stock price, spot exchange rate,
value of all synergies
FCF free cash flow at date t
t
SD(R ) standard deviation (volatility)
FV future value, face value of a bond i
of return of security i
g growth rate
T option expiration date, maturity date,
I initial investment or initial capital
market value of target
committed to the project
U market value of unlevered equity
Int interest expense on date t
t V enterprise value on date t
IRR internal rate of return t
Var(R) variance of return R
K strike price
x portfolio weight of investment in i
k interest coverage ratio, compounding i
YTC yield to call on a callable bond
periods per year
YTM yield to maturity
L leasepayment,marketvalueofliabilities
α alpha of security i
ln natural logarithm i
β β beta of debt or equity
MV total market capitalization of security i D, E
i
β beta of security iwith respect to
N number of cash flows, terminal date, i
the market portfolio
notational principal of a swap contract
βP beta of security iwith respect to
N number of shares outstanding of s
i portfolio P
security i
β beta of unlevered firm
NPER annuity spreadsheet notation U
for the number of periods or dates Δ shares of stock in the replicating portfolio;
of the last cash flow sensitivity of option price
to stock price
NPV net present value
σ volatility
P price, initial principal or deposit,
or equivalent present value, τ tax rate
put option price τ marginal corporate tax rate
c
A01_BERK0160_04_GE_FM.indd 2 8/24/16 6:36 PM
The NaTure aNd
Corporate
ProPerTies of soils
FinanCe
fifTeeNTh ediTioN
Global ediTioN
FOURTH EdiTiOn
GlOBal EdiTiOn
Ray R. Weil
Professor of Soil Science
University of Maryland
JOnaTHan BERk
Nyle C. Brady (late)
STanFORd UnivERSiTy
Professor of Soil Science, Emeritus
Cornell University
PETER d maRzO
e
STanFORd UnivERSiTy
HHaarrllooww,, EEnnggllaanndd •• LLoonnddoonn •• NNeeww YYoorrkk •• BBoossttoonn •• SSaann FFrraanncciissccoo •• TToorroonnttoo •• SSyyddnneeyy •• DDuubbaaii •• SSiinnggaappoorree •• HHoonngg KKoonngg
TTookkyyoo •• SSeeoouull •• TTaaiippeeii •N Newew D Deelhlhi i• •C Caappee T Toowwnn • •S Saaoo P Paauulolo • •M Meexxicicoo C Citityy • • M Maaddrriidd •• AAmmsstteerrddaamm •• MMuunniicchh •• PPaarriiss •• MMiillaann
A01_BRAD2232_04_SE_FM.indd 3A01_BERK0160_04_GE_FM.indd 3 7/29/16 8:06 PM 8/24/16 6:36 PM
To Rebecca, natasha, and Hannah, for the love and for being there —J. B.
To kaui, Pono, koa, and kai, for all the love and laughter —P. d.
Vice President, Business Publishing: Donna Battista Senior Manufacturing Controller, Production, Global Edition:
Editor-in-Chief: Adrienne D’Ambrosio Trudy Kimber
Acquisitions Editor: Kate Fernandes Operations Specialist: Carol Melville
Editorial Assistant: Kathryn Brightney Creative Director: Blair Brown
Vice President, Product Marketing: Roxanne McCarley Art Director: Jonathan Boylan
Product Marketing Manager: Katie Rowland Vice President, Director of Digital Strategy and Assessment:
Field Marketing Manager: Ramona Elmer Paul Gentile
Product Marketing Assistant: Jessica Quazza Manager of Learning Applications: Paul DeLuca
Team Lead, Program Management: Ashley Santora Digital Editor: Brian Hyland
Program Manager: Nancy Freihofer Director, Digital Studio: Sacha Laustsen
Team Lead, Project Management: Jeff Holcomb Digital Studio Manager: Diane Lombardo
Project Manager: Meredith Gertz Digital Studio Project Managers: Melissa Honig, Alana Coles,
Project Manager, Global Edition: Nitin Shankar Robin Lazrus
Associate Acquisitions Editor, Global Edition: Digital Content Team Lead: Noel Lotz
Ananya Srivastava Digital Content Project Lead: Miguel Leonarte
Senior Project Editor, Global Edition: Daniel Luiz Full-Service Project Management and Composition: SPi Global
Manager, Media Production, Global Edition: Cover Image: Shutterstock
M. Vikram Kumar Cover Printer: Lego, Italy
Microsoft and/or its respective suppliers make no representations about the suitability of the information contained in the documents and
related graphics published as part of the services for any purpose. All such documents and related graphics are provided “as is” without war-
ranty of any kind. Microsoft and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information,
including all warranties and conditions of merchantability, whether express, implied or statutory, fitness for a particular purpose, title and
non-infringement. In no event shall Microsoft and/or its respective suppliers be liable for any special, indirect or consequential damages
or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action,
arising out of or in connection with the use or performance of information available from the services.
The documents and related graphics contained herein could include technical inaccuracies or typographical errors. Changes are periodically
added to the information herein. Microsoft and/or its respective suppliers may make improvements and/or changes in the product(s)
and/or the program(s) described herein at any time. Partial screen shots may be viewed in full within the software version specified.
Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A. and other countries. This book is not
sponsored or endorsed by or affiliated with the Microsoft Corporation.
Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
England
and Associated Companies throughout the world
Visit us on the World Wide Web at:
www.pearsonglobaleditions.com
The rights of Jonathan Berk and Peter DeMarzo to be identified as the authors of this work have been asserted by them in accordance with
the Copyright, Designs and Patents Act 1988.
Authorized adaptation from the United States edition, entitled Corporate Finance, 4th edition, ISBN 978-0-13-408327-8, by Jonathan Berk and
Peter DeMarzo, published by Pearson Education © 2017.
Copyright © 2017, 2014, 2011, 2007 by Jonathan Berk and Peter DeMarzo. All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom
issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS.
All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or
publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorse-
ment of this book by such owners.
ISBN 10: 1-292-16016-0
ISBN 13: 978-1-292-16016-0
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library.
10 9 8 7 6 5 4 3 2 1
14 13 12 11 10
A01_BERK0160_04_GE_FM.indd 4 8/29/16 5:25 PM
Detailed Contents
■ International Financial Reporting
part 1 introDUCtion
Standards 56
■ inTERviEw with Ruth Porat 57
Chapter 1 the Corporation 34
Types of Financial Statements 58
1.1 the Four types of Firms 35
2.2 the Balance Sheet 58
Sole Proprietorships 35
Assets 59
Partnerships 36
Liabilities 60
Limited Liability Companies 37
Stockholders’ Equity 61
Corporations 37
Market Value Versus Book Value 61
Tax Implications for Corporate Entities 38
Enterprise Value 62
■ Corporate Taxation Around
the World 39 2.3 the income Statement 62
Earnings Calculations 63
1.2 ownership Versus Control of
Corporations 39 2.4 the Statement of Cash Flows 64
The Corporate Management Team 39 Operating Activity 65
■ inTERviEw with David Viniar 40 Investment Activity 66
The Financial Manager 41 Financing Activity 66
■ GlOBal FinanCial CRiSiS
2.5 other Financial Statement
The Dodd-Frank Act 42
information 67
The Goal of the Firm 42
Statement of Stockholders’ Equity 67
The Firm and Society 43
Management Discussion and
Ethics and Incentives within
Analysis 68
Corporations 43
Notes to the Financial
■ GlOBal FinanCial CRiSiS
Statements 68
The Dodd-Frank Act on Corporate
Compensation and Governance 44 2.6 Financial Statement analysis 69
■ Citizens United v. Federal Election Profitability Ratios 69
Commission 44 Liquidity Ratios 70
■ Airlines in Bankruptcy 46 Working Capital Ratios 71
1.3 the Stock Market 46 Interest Coverage Ratios 72
Primary and Secondary Stock Markets 47 Leverage Ratios 73
Traditional Trading Venues 47 Valuation Ratios 75
■ inTERviEw with ■ COmmOn miSTakE
Frank Hatheway 48 Mismatched Ratios 75
New Competition and Market Operating Returns 76
Changes 49 The DuPont Identity 78
Dark Pools 50
2.7 Financial reporting in practice 80
MyFinanceLab 51 ■ Key Terms 51 ■ Enron 80
Further Reading 52 ■ Problems 52 WorldCom 80
Sarbanes-Oxley Act 81
Chapter 2 introduction to Financial ■ GlOBal FinanCial CRiSiS
Statement analysis 55 Bernard Madoff’s Ponzi Scheme 82
Dodd-Frank Act 82
2.1 Firms’ Disclosure of Financial
i nformation 56 MyFinanceLab 83 ■ Key Terms 84 ■
Preparation of Financial Further Reading 85 ■ Problems 85 ■
Statements 56 Data Case 92
5
A01_BERK0160_04_GE_FM.indd 5 8/24/16 6:36 PM
6 Contents
Rule 2: Moving Cash Flows Forward
Chapter 3 F inancial Decision Making
in Time 133
and the Law of one price 93
Rule 3: Moving Cash Flows Back
in Time 134
3.1 Valuing Decisions 94
■ Rule of 72 135
Analyzing Costs and Benefits 94
Applying the Rules of Time Travel 136
Using Market Prices to Determine Cash
Values 95 4.3 Valuing a Stream of Cash Flows 138
■ When Competitive Market Prices 4.4 Calculating the net present Value 141
Are Not Available 97
■ USinG EXCEl Calculating Present
3.2 interest rates and the time Value Values in Excel 142
of Money 97 4.5 perpetuities and annuities 143
The Time Value of Money 97 Perpetuities 143
The Interest Rate: An Exchange Rate ■ Historical Examples of Perpetuities 144
Across Time 97
■ COmmOn miSTakE Discounting One
3.3 present Value and the npV Decision Too Many Times 146
rule 100 Annuities 146
Net Present Value 100 ■ Formula for an Annuity Due 149
The NPV Decision Rule 101 Growing Cash Flows 149
NPV and Cash Needs 103 4.6 Using an annuity Spreadsheet
or Calculator 154
3.4 arbitrage and the Law of one price 104
Arbitrage 104 4.7 non-annual Cash Flows 156
Law of One Price 105 4.8 Solving for the Cash payments 157
3.5 no-arbitrage and Security prices 105 4.9 the internal rate of return 160
Valuing a Security with the Law ■ USinG EXCEl
of One Price 105 Excel’s IRR Function 163
■ An Old Joke 109 MyFinanceLab 164 ■ Key Terms 165 ■
The NPV of Trading Securities Further Reading 166 ■ Problems 166 ■
and Firm Decision Making 109
Data Case 172
Valuing a Portfolio 110
appendix Solving for the number of periods 173
■ GlOBal FinanCial CRiSiS
Liquidity and the Informational
Role of Prices 111
Chapter 5 interest rates 175
■ Arbitrage in Markets 112
Where Do We Go from Here? 113
5.1 interest rate Quotes and
MyFinanceLab 114 ■ Key Terms 115 ■ a djustments 176
Further Reading 115 ■ Problems 115 The Effective Annual Rate 176
■ COmmOn miSTakE Using the Wrong
appendix the price of risk 119
Discount Rate in the Annuity
Risky Versus Risk-Free Cash Flows 119 Formula 177
Arbitrage with Transactions Costs 124 Annual Percentage Rates 178
5.2 application: Discount rates
and Loans 180
part 2 tiMe, MoneY, anD
5.3 the Determinants of interest
intereSt rateS
rates 181
■ GlOBal FinanCial CRiSiS Teaser
Chapter 4 the time Value of Money 130 Rates and Subprime Loans 182
Inflation and Real Versus Nominal
4.1 the timeline 131 Rates 182
4.2 the three rules of time travel 132 Investment and Interest Rate
Rule 1: Comparing and Combining Policy 183
Values 132 The Yield Curve and Discount Rates 184
A01_BERK0160_04_GE_FM.indd 6 8/24/16 6:36 PM
Contents 7
The Yield Curve and the Economy 186 6.5 Sovereign Bonds 224
■ COmmOn miSTakE Using the ■ GlOBal FinanCial CRiSiS The
Annuity Formula When Discount Credit Crisis and Bond Yields 225
Rates Vary by Maturity 186 ■ GlOBal FinanCial CRiSiS
■ inTERviEw with European Sovereign Debt Yields:
Kevin M. Warsh 188 A Puzzle 227
5.4 risk and taxes 189 ■ inTERviEw with
Carmen M. Reinhart 228
Risk and Interest Rates 190
After-Tax Interest Rates 191 MyFinanceLab 229 ■ Key Terms 230 ■
5.5 the opportunity Cost of Capital 192 Further Reading 231 ■ Problems 231 ■
■ COmmOn miSTakE States Dig Data Case 235 ■ Case Study 236
a $3 Trillion Hole by Discounting appendix Forward interest rates 238
at the Wrong Rate 193
Computing Forward Rates 238
MyFinanceLab 194 ■ Key Terms 195 ■ Computing Bond Yields from Forward
Further Reading 195 ■ Problems 195 ■ Rates 239
Data Case 200
appendix Continuous rates
part 3 V aLUinG proJeCtS
and Cash Flows 202
Discount Rates for a Continuously anD FirMS
Compounded APR 202
Continuously Arriving Cash Flows 202
Chapter 7 investment Decision rules 244
7.1 npV and Stand-alone
Chapter 6 Valuing Bonds 205
projects 245
6.1 B ond Cash Flows, prices, Applying the NPV Rule 245
and Yields 206 The NPV Profile and IRR 245
Bond Terminology 206 Alternative Rules Versus the NPV
Zero-Coupon Bonds 206 Rule 246
■ GlOBal FinanCial CRiSiS ■ inTERviEw with Dick Grannis 247
Negative Bond Yields 208
7.2 the internal rate of return rule 248
Coupon Bonds 209
Applying the IRR Rule 248
6.2 Dynamic Behavior of Bond prices 211 Pitfall #1: Delayed Investments 248
Discounts and Premiums 211 Pitfall #2: Multiple IRRs 249
Time and Bond Prices 212 ■ COmmOn miSTakE
Interest Rate Changes and Bond IRR Versus the IRR Rule 251
Prices 214 Pitfall #3: Nonexistent IRR 251
■ Clean and Dirty Prices for Coupon
7.3 the payback rule 252
Bonds 215
Applying the Payback Rule 252
6.3 the Yield Curve and Bond
Payback Rule Pitfalls in Practice 253
arbitrage 217
■ Why Do Rules Other Than the NPV
Replicating a Coupon Bond 217
Rule Persist? 254
Valuing a Coupon Bond Using Zero-Coupon
7.4 Choosing Between projects 254
Yields 218
NPV Rule and Mutually Exclusive
Coupon Bond Yields 219
Investments 254
Treasury Yield Curves 220
IRR Rule and Mutually Exclusive
6.4 Corporate Bonds 220 Investments 255
Corporate Bond Yields 221 The Incremental IRR 256
■ Are Treasuries Really Default-Free ■ When Can Returns Be
Securities? 221 Compared? 257
Bond Ratings 223 ■ COmmOn miSTakE
Corporate Yield Curves 224 IRR and Project Financing 259
A01_BERK0160_04_GE_FM.indd 7 8/24/16 6:36 PM
8 Contents
7.5 project Selection with resource MyFinanceLab 296 ■ Key Terms 298 ■
Constraints 259 Further Reading 298 ■ Problems 298 ■
Evaluating Projects with Different Data Case 305
Resource Requirements 259
appendix MaCrS Depreciation 307
Profitability Index 260
Shortcomings of the Profitability
Chapter 9 Valuing Stocks 309
Index 262
MyFinanceLab 262 ■ Key Terms 263 ■ 9.1 the Dividend-Discount Model 310
Further Reading 263 ■ Problems 263 ■ A One-Year Investor 310
Data Case 269 Dividend Yields, Capital Gains, and Total
Returns 311
appendix C omputing the npV profile Using
■ The Mechanics of a Short Sale 312
excel’s Data table Function 270
A Multiyear Investor 313
Chapter 8 F undamentals of Capital The Dividend-Discount Model
Equation 314
Budgeting 271
9.2 applying the Dividend-Discount
8.1 Forecasting earnings 272 Model 314
Revenue and Cost Estimates 272 Constant Dividend Growth 314
Incremental Earnings Forecast 273 Dividends Versus Investment
and Growth 315
Indirect Effects on Incremental
Earnings 275 ■ John Burr Williams’ Theory
■ COmmOn miSTakE The Opportunity of Investment Value 316
Cost of an Idle Asset 276 Changing Growth Rates 318
Sunk Costs and Incremental Limitations of the Dividend-Discount
Earnings 277 Model 320
■ COmmOn miSTakE 9.3 total payout and Free Cash Flow
The Sunk Cost Fallacy 277 Valuation Models 320
Real-World Complexities 278 Share Repurchases and the Total Payout
Model 320
8.2 D etermining Free Cash Flow
and npV 279 The Discounted Free Cash
Flow Model 322
Calculating Free Cash Flow
from Earnings 279 9.4 Valuation Based on Comparable
Calculating Free Cash Flow Directly 281 Firms 326
Calculating the NPV 282 Valuation Multiples 326
■ USinG EXCEl Capital Budgeting Limitations of Multiples 328
Using a Spreadsheet Program 283 Comparison with Discounted Cash Flow
Methods 329
8.3 Choosing among alternatives 284
Stock Valuation Techniques: The Final
Evaluating Manufacturing
Word 330
Alternatives 284
■ inTERviEw with Douglas Kehring 331
Comparing Free Cash Flows for Cisco’s
Alternatives 285 9.5 information, Competition, and Stock
prices 332
8.4 F urther adjustments to Free
Cash Flow 286 Information in Stock Prices 332
■ GlOBal FinanCial CRiSiS Competition and Efficient Markets 333
The American Recovery and Lessons for Investors and Corporate
Reinvestment Act of 2009 290 Managers 335
8.5 analyzing the project 290 ■ Kenneth Cole Productions—What
Happened? 337
Break-Even Analysis 290
The Efficient Markets Hypothesis Versus
Sensitivity Analysis 291
No Arbitrage 338
■ inTERviEw with David Holland 293
Scenario Analysis 294 MyFinanceLab 338 ■ Key Terms 340 ■
■ USinG EXCEl Project Analysis Further Reading 340 ■ Problems 341 ■
Using Excel 295 Data Case 346
A01_BERK0160_04_GE_FM.indd 8 8/24/16 6:36 PM
Contents 9
part 4 riSK anD retUrn Chapter 11 optimal portfolio Choice
and the Capital asset pricing
Model 389
Chapter 10 C apital Markets and the pricing
of risk 350
11.1 the expected return of a
portfolio 390
10.1 risk and return: insights from 89 Years
of investor History 351 11.2 the Volatility of a two-Stock
portfolio 391
10.2 C ommon Measures of risk
Combining Risks 391
and return 354
Determining Covariance
Probability Distributions 354
and Correlation 392
Expected Return 354
■ COmmOn miSTakE
Variance and Standard Deviation 355
Computing Variance, Covariance,
10.3 H istorical returns of Stocks and Correlation in Excel 394
and Bonds 357 Computing a Portfolio’s Variance
Computing Historical Returns 357 and Volatility 395
Average Annual Returns 359 11.3 the Volatility of a Large portfolio 397
The Variance and Volatility of Large Portfolio Variance 397
Returns 361
Diversification with an Equally Weighted
Estimation Error: Using Past Returns Portfolio 398
to Predict the Future 362
■ inTERviEw with John Powers 400
■ Arithmetic Average Returns Versus
Diversification with General
Compound Annual Returns 364
Portfolios 401
10.4 the Historical trade-off Between risk
11.4 risk Versus return: Choosing
and return 364
an efficient portfolio 401
The Returns of Large Portfolios 365
Efficient Portfolios with Two Stocks 402
The Returns of Individual Stocks 366
The Effect of Correlation 404
10.5 Common Versus independent risk 367 Short Sales 405
Theft Versus Earthquake Insurance: Efficient Portfolios with Many
An Example 367 Stocks 406
The Role of Diversification 368 ■ nOBEl PRizES Harry Markowitz
10.6 Diversification in Stock and James Tobin 407
portfolios 369 11.5 risk-Free Saving and Borrowing 409
Firm-Specific Versus Systematic Risk 370 Investing in Risk-Free Securities 409
No Arbitrage and the Risk Borrowing and Buying Stocks
Premium 371 on Margin 410
■ GlOBal FinanCial CRiSiS Identifying the Tangent Portfolio 411
Diversification Benefits During
11.6 the efficient portfolio and required
Market Crashes 373
returns 413
■ COmmOn miSTakE A Fallacy
Portfolio Improvement: Beta
of Long-Run Diversification 374
and the Required Return 413
10.7 Measuring Systematic risk 375
Expected Returns and the Efficient
Identifying Systematic Risk: The Market Portfolio 415
Portfolio 375
11.7 the Capital asset pricing Model 417
Sensitivity to Systematic Risk: Beta 375
The CAPM Assumptions 417
10.8 Beta and the Cost of Capital 378
Supply, Demand, and the Efficiency
Estimating the Risk Premium 378 of the Market Portfolio 418
■ COmmOn miSTakE Optimal Investing: The Capital
Beta Versus Volatility 378 Market Line 418
The Capital Asset Pricing Model 380
11.8 Determining the risk premium 419
MyFinanceLab 380 ■ Key Terms 382 ■ Market Risk and Beta 419
Further Reading 382 ■ Problems 382 ■ ■ nOBEl PRizE William Sharpe
Data Case 387 on the CAPM 421
A01_BERK0160_04_GE_FM.indd 9 8/24/16 6:36 PM