Financial theory and corporate policy [Hauptbd.] PDF
Preview Financial theory and corporate policy [Hauptbd.]
F i Financial Theory and Corporate Policy n a Thomas E. Copeland n c J. Fred Weston Kuldeep Shastri i a l Fourth Edition T h e o r y a n d C o r p o r a t e P o l i c y C o p e l a n d e t a l . ISBN 978-1-29202-158-4 4 e 9 781292 021584 Financial Theory and Corporate Policy Thomas E. Copeland J. Fred Weston Kuldeep Shastri Fourth Edition ISBN 10: 1-292-02158-6 ISBN 13: 978-1-292-02158-4 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.pearsoned.co.uk © Pearson Education Limited 2014 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 licence 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 affi liation with or endorsement of this book by such owners. ISBN 10: 1-292-02158-6 ISBN 13: 978-1-292-02158-4 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Printed in the United States of America 112333441479495057161577315335339 P E A R S O N C U S T O M L I B R AR Y Table of Contents 1. Introduction: Captial Markets, Consumption, and Investment Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 1 2. Investment Decisions: The Certainty Case Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 15 3. Theory of Choice Under Uncertainty: Utility Theory Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 43 4. State Preference Theory Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 73 5. Objects of Choice Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 99 6. Market Equilibrium: CAPM and APT Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 145 7. Pricing Contingent Claims: Option Price Theory and Evidence Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 197 8. Futures Contracts and Markets - Term Structure - Cox, Ingersoll, Ross Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 257 9. Multiperiod Capital Budgeting under Uncertainty: Real Options Analysis Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 303 10. Efficient Captial Markets: Theory Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 351 11. Efficient Captial Markets: Evidence Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 375 12. Information Asymmetry and Agency Theory Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 413 13. Valuation and Tax Policy Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 463 I 566778888921618345703139513957 14. Capital Structure and the Cost of Capital: Theory and Evidence Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 523 15. Dividend Policy: Theory and Empirical Evidence Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 611 16. Applied Issues in Corporate Finance Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 663 17. Acquisitions, Divestitures, Restructuring, and Corporate Governance Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 719 18. International Financial Management Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 785 Appendix: Discounting Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 831 Appendix: Matrix Algebra Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 843 Appendix: An Introduction to Multiple Regression Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 859 Appendix: Calculus and Optimization Thomas E. Copeland/J. Fred Weston,/Kuldeep Shastri 875 Index 907 II . . . Throughthealterationsin theincomestreamsprovided Introduction: byloansorsales,themarginal degreesofimpatienceforall Capital Markets, individualsinthemarketare broughtintoequalitywitheach Consumption, otherandwiththemarketrate ofinterest. and Investment —IrvingFisher, TheTheoryofInterest, Macmillan, NewYork,1930,122. I A. ntroduction T HEOBJECTIVEOFTHISCHAPTERistostudyconsumptionandinvestmentdecisions madebyindividualsandfirmsandtounderstandtheroleofinterestratesinmakingthese decisions. The decision about what projects to undertake and which to reject is perhaps thesinglemostimportantdecisionthatafirmcanmake.Logicaldevelopmentisfacilitatedifwe beginwiththesimplestofallworlds,aone-person/one-goodeconomywithnouncertainty.The decision maker, Robinson Crusoe, must choose between consumption now and consumption in thefuture.Ofcourse,thedecisionnottoconsumenowisthesameasinvestment.ThusRobinson Crusoe’s decision is simultaneously one of consumption and investment. In order to decide, he needstwotypesofinformation.First,heneedstounderstandhisownsubjectivetrade-offsbetween consumptionnowandconsumptioninthefuture.Thisinformationisembodiedintheutilityand indifference curves depicted in Figs. 1 through 3. Second, he must know the feasible trade- offsbetweenpresentandfutureconsumptionthataretechnologicallypossible.Thesearegivenin theinvestmentandproductionopportunitysetsofFigs.4and5. From the analysis of a Robinson Crusoe economy we will find that the optimal consump- tion/investment decision establishes a subjective interest rate for Robinson Crusoe. Shown in Fig. 5, it represents his (unique) optimal rate of exchange between consumption now and in thefuture.Thusinterestratesareanintegralpartofconsumption/investmentdecisions.Onecan thinkoftheinterestrateasthepriceofdeferredconsumptionortherateofreturnoninvestment. Individualshavingdifferentsubjectiveinterestrates(showninFig.6)willselectdifferentcon- sumption/investmentchoices.AftertheRobinsonCrusoeeconomywewillintroduceopportunities toexchangeconsumptionacrosstimebyborrowingorlendinginamultipersoneconomy(shown in Fig. 7). The introduction of these exchange opportunities results in a single market inter- estratethateveryonecanuseasasignalformakingoptimalconsumption/investmentdecisions From Chapter 1 of Financial Theory and Corporate Policy, Fourth Edition. Thomas E. Copeland, J. Fred Weston, Kuldeep Shastri. Copyright © 2005 by Pearson Education, Inc. All rights reserved. 1 Introduction:CapitalMarkets,Consumption,andInvestment (Fig.8).Furthermore,nooneisworseoffinanexchangeeconomywhencomparedwithaRobin- sonCrusoeeconomy,andalmosteveryoneisbetteroff(Fig.9).Thusanexchangeeconomythat usesmarketprices(interestrates)toallocateresourcesacrosstimewillbeseentobesuperiorto aneconomywithoutthepricemechanism. Theobviousextensiontotheintroductorymaterialinthischapteristheinvestmentdecisions madebyfirmsinamultiperiodcontext.Managersneedoptimaldecisionstohelpinselectingthose projectsthatmaximizethewealthofshareholders.Weshallseethatmarket-determinedinterest ratesplayanimportantroleinthecorporateinvestmentandproductiondecisions. C B. onsumption and Investment without Capital Markets The answer to the question “Do capital markets benefit society?” requires that we compare a world without capital markets to one with them and show that no one is worse off and that at least one individual is better off in a world with capital markets. To make things as simple as possible, we assume that all outcomes from investment are known with certainty, that there are no transaction costs or taxes, and that decisions are made in a one-period context. Individuals are endowed with income (manna from heaven) at the beginning of the period, y , and at the end of the period, y . 0 1 They must decide how much to actually consume now,C , and how much to invest in productive 0 opportunities in order to provide end-of-period consumption,C . Every individual is assumed to 1 prefer more consumption to less. In other words, the marginal utility of consumption is always positive. Also, we assume that the marginal utility of consumption is decreasing. The total utility curve (Fig. 1) shows the utility of consumption at the beginning of the period, assuming that the second-period consumption is held constant. Changes in consumption have been marked off in equal increments along the horizontal axis. Note that equal increases in consumption cause total utility to increase (marginal utility is positive), but that the increments in utility become smaller and smaller (marginal utility is decreasing). We can easily construct a similar graph to represent the utility of end-of-period consumption, U(C ). When combined with Fig. 1, the 1 result(thethree-dimensionalgraphshowninFig.2)providesadescriptionoftrade-offsbetween Figure1 Totalutility Total utility = U(C ) 0 ofconsumption. Consumption, C 0 2 Introduction:CapitalMarkets,Consumption,andInvestment Figure 2 Trade-offs U(C ,C ) 0 1 U(C ) betweenbeginning 1 andend-of-period consumption. A B C 1 U(C ) 0 C 0 consumptionatthebeginningoftheperiod,C ,andconsumptionattheendoftheperiod,C .The 0 1 dashed lines represent contours along the utility surface where various combinations of C and 0 C provide the same total utility (measured along the vertical axis). Since all points along the 1 samecontour(e.g.,pointsAandB)haveequaltotalutility,theindividualwillbeindifferentwith respecttothem.Thereforethecontoursarecalledindifferencecurves.LookingatFig.2from above,wecanprojecttheindifferencecurvesontotheconsumptionargumentplane(i.e.,theplane formedbytheC ,andC axesinFig.3).Toreiterate,allcombinationsofconsumptiontoday 0 1 and consumption tomorrow that lie on the same indifference curve have the same total utility. The decision maker whose indifference curves are depicted in Fig. 3 would be indifferent as to point A with consumption (C0a,C1a) and point B with consumption (C0b,C1b). Point A has more consumption at the end of the period but less consumption at the beginning than point B does.PointDhasmoreconsumptioninbothperiodsthandoeitherpointsAorB.PointDlieson anindifferencecurvewithhigherutilitythanpointsAandB;hencecurvestothenortheasthave greatertotalutility.TheslopeofthestraightlinejusttangenttotheindifferencecurveatpointB measurestherateoftrade-offbetweenC andC atpointB.Thistrade-offiscalledthemarginal 0 1 rateofsubstitution(MRS)betweenconsumptiontodayandconsumptiontomorrow.Italsoreveals howmanyextraunitsofconsumptiontomorrowmustbereceivedinordertogiveuponeunitof consumptiontodayandstillhavethesametotalutility.Mathematicallyit’sexpressedas1 (cid:2) ∂C (cid:2) MRSCC01= ∂C01(cid:2)(cid:2)U=const.=−(1+ri). (1) 1Equation (1) can be read as follows: The marginal rate of substitution between consumption today and end-of- (cid:3)p∂eCrio1d(cid:4)∂coCn0s(cid:5)um(cid:2)(cid:2)Up=tcioonns,t.M. TRhSiCCs01i,nistuernquiasletqouathletosltohpeeinodfivaidliunael’tsasnugbejnetcttioveanraitnedoifffteirmenecperecfuerrveencgei,v−en(1co+nsrtia)n.ttotalutility 3 Introduction:CapitalMarkets,Consumption,andInvestment Figure3 Indifference C 1 curves representing the time preference of consumption. C A D 1a C B 1b C C C 0 0a 0b Figure 4 An indi- Marginal vidual’s schedule of rate of return productive investment A opportunities. r B i X I Total investment 0 Note that the subjective rate of time preference is greater at point A than at point B due to the convexityoftheindifferencecurve.TheindividualhaslessconsumptiontodayatpointAandwill thereforedemandrelativelymorefutureconsumptioninordertohavethesametotalutility. Thusfarwehavedescribedpreferencefunctionsthattellushowindividualswillmakechoices among consumption bundles over time. What happens if we introduce productive opportunities that allow a unit of current savings/investment to be turned into more than one unit of future consumption? We assume that each individual in the economy has a schedule of productive investmentopportunitiesthatcanbearrangedfromthehighestrateofreturndowntothelowest (Fig.4).Althoughwehavechosentographtheinvestmentopportunitiesscheduleasastraight line,anydecreasingfunctionwoulddo.Thisimpliesdiminishingmarginalreturnstoinvestment because the more an individual invests, the lower the rate of return on the marginal investment. Also,allinvestmentsareassumedindependentofoneanotherandperfectlydivisible. An individual will make all investments in productive opportunities that have rates of return higher than his or her subjective rate of time preference, ri. This can be demonstrated if we 4 Introduction:CapitalMarkets,Consumption,andInvestment Figure5 Theproduc- C 1 tionopportunityset. X P = C B 1 1 U 2 y1 U1 Slope = – (1 + r) i A C P = C y 0 0 0 0 transform the schedule of productive investment opportunities into the consumption argument plane(Fig.5).2TheslopeofalinetangenttocurveABXinFig.5istherateatwhichadollarof consumptionforegonetodayistransformedbyproductiveinvestmentintoadollarofconsumption tomorrow.Itisthemarginalrateoftransformation(MRT)offeredbytheproduction/investment opportunity set. The line tangent to point A has the highest slope in Fig. 5 and represents the highestrateofreturnatpointAinFig.4.Anindividualendowedwitharesourcebundle(y ,y ) 0 1 thathasutilityU canmovealongtheproductionopportunitysettopointB,wheretheindifference 1 curveistangenttoitandheorshereceivesthemaximumattainableutility,U .Becausecurrent 2 consumption,C ,islessthanthebeginning-of-periodendowment,y ,theindividualhastoinvest. 0 0 Theamountofinvestmentisy −C .Ofcourse,ifC >y ,heorshewilldisinvest. 0 0 0 0 Notethatthemarginalrateofreturnonthelastinvestmentmade(i.e.,MRT,theslopeofaline tangenttotheinvestmentopportunitysetatpointB)isexactlyequaltotheinvestor’ssubjective timepreference(i.e.,MRS,theslopeofalinetangenttohisorherindifferencecurve,alsoatpoint B).Inotherwords,theinvestor’ssubjectivemarginalrateofsubstitutionisequaltothemarginal rateoftransformationofferedbytheproductionopportunityset: MRS=MRT. This will also be true in a Robinson Crusoe world where there are no capital markets (i.e., no opportunitiestoexchange).Theindividualdecisionmakerstartswithaninitialendowment(y ,y ) 0 1 andcomparesthemarginalrateofreturnonadollarofproductiveinvestment(ordisinvestment) withhisorhersubjectivetimepreference.Iftherateoninvestmentisgreater(asitisinFig.5), heorshewillgainutilitybymakingtheinvestment.Thisprocesscontinuesuntiltherateofreturn on the last dollar of productive investment just equals the rate of subjective time preference (at pointB).NotethatatpointBtheindividual’sconsumptionineachtimeperiodisexactlyequalto theoutputfromproduction(i.e.,P =C andP =C ). 0 0 1 1 Withouttheexistenceofcapitalmarkets,individualswiththesameendowmentandthesamein- vestmentopportunitysetmaychoosecompletelydifferentinvestmentsbecausetheyhavedifferent 2SeeProblem6attheendofthechapterforanexampleofhowtomakethetransitionbetweenthescheduleofproductive investmentopportunitiesandtheconsumptionargumentplane. 5
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