Fundamentals of corporate finance

915 Pages·2003·8.737 MB·English

by  Stephen A Ross, Randolph Westerfield, Bradford D Jordan

Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill 1
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
Alternate Edition
Fundamentals of
Corporate
FINANCE
2 Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill 3
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
Alternate Edition
Fundamentals of
Corporate
FINANCE
Sixth Edition
Stephen A. Ross
Massachusetts Institute of Technology
Randolph W. Westerfield
University of Southern California
Bradford D. Jordan
University of Kentucky
Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. Louis
Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City
Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
4 Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
Dedication
To our families and friends with love and gratitude.
S.A.R. R.W.W. B.D.J.
McGraw-Hill H i g h e r Education
A Division of The McGraw-HillCompanies
FUNDAMENTALS OF CORPORATE FINANCE
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Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill 5
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate
Consulting Editor Stephen A. Ross Franco Modigliani Professor of Finance and Economics
Sloan School of Management
Massachusetts Institute of Technology
Financial Management White Saunders and Cornett
Benninga and Sarig Financial Analysis with an Electronic Financial Markets and Institutions:
Corporate Finance: AValuation Approach Calculator AModern Perspective
Fourth Edition
Block and Hirt
Foundations of Financial Management
Tenth Edition International Finance
Brealey and Myers Investments Beim and Calomiris
Principles of Corporate Finance Bodie, Kane, and Marcus Emerging Financial Markets
Sixth Edition Essentials of Investments Eun and Resnick
Brealey, Myers, and Marcus Fourth Edition International Financial Management
Fundamentals of Corporate Finance Bodie, Kane, and Marcus Second Edition
Third Edition Investments Levich
Brooks Fifth Edition International Financial Markets:
FinGame Online 3.0 Cohen, Zinbarg, and Zeikel PricesandPolicies
Bruner Investment Analysis and Portfolio Second Edition
Case Studies in Finance: Managing for Management
Corporate Value Creation Fifth Edition
Fourth Edition Corrado and Jordan Real Estate
Chew Fundamentals of Investments: Valuation Brueggeman and Fisher
The New Corporate Finance: Where Theory andManagement Real Estate Finance and Investments
Meets Practice Second Edition Eleventh Edition
Third Edition Farrell Corgel, Ling, and Smith
Grinblatt and Titman Portfolio Management: Theory and Real Estate Perspectives: An Introduction to
Financial Markets and Corporate Strategy Applications Real Estate
Second Edition Second Edition Fourth Edition
Helfert Hirt and Block
Techniques of Financial Analysis: AGuide Fundamentals of Investment Management
to Value Creation Seventh Edition Financial Planning and Insurance
Eleventh Edition Allen, Melone, Rosenbloom, and
Higgins VanDerhei
Analysis for Financial Management Financial Institutions and Markets Pension Planning: Pension, Profit-Sharing,
Sixth Edition Cornett and Saunders and Other Deferred Compensation Plans
Kester, Fruhan, Piper, and Ruback Fundamentals of Financial Institutions Ninth Edition
Case Problems in Finance Management Crawford
Eleventh Edition Rose Life and Health Insurance Law
Nunnally and Plath Commercial Bank Management Eighth Edition (LOMA)
Cases in Finance Fifth Edition Harrington and Niehaus
Second Edition Rose Risk Management and Insurance
Ross, Westerfield, and Jaffe Money and Capital Markets: Financial Hirsch
Corporate Finance Institutions and Instruments in a Global Casualty Claim Practice
Sixth Edition Marketplace Sixth Edition
Ross, Westerfield, and Jordan Seventh Edition Kapoor, Dlabay, and Hughes
Essentials of Corporate Finance Santomero and Babbel Personal Finance
Third Edition Financial Markets, Instruments, and Sixth Edition
Ross, Westerfield, and Jordan Institutions Skipper
Fundamentals of Corporate Finance Second Edition International Risk and Insurance: An
Sixth Edition Saunders Environmental-Managerial Approach
Smith Financial Institutions Management: Williams, Smith, and Young
The Modern Theory of Corporate Finance AModern Perspective Risk Management and Insurance
Second Edition Third Edition Eighth Edition
6 Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
ABOUT THE AUTHORS
Stephen A. Ross Randolph W. Westerfield Bradford D. Jordan
Sloan School of Management, Marshall School of Business, Dean Carol Martin Gatton College of
Franco Modigliani Professor of of the School of Business Business and Economics, National
Finance and Economics, Administration and holder of the City Bank Professor of Finance,
Massachusetts Institute of Robert R. Dockson Dean’s Chair of University of Kentucky
Technology Business Administration, University
Bradford D. Jordan is Professor of
of Southern California
Stephen Ross is presently the Franco Finance and the National City Bank
Modigliani Professor of Finance and Randolph W. Westerfield is Dean of the Professor at the University of
Economics at the Sloan School of University of Southern California Kentucky. He has a long-standing
Management, Massachusetts Institute School of Business Administration and interest in both applied and theoretical
of Technology. One of the most widely holder of the Robert R. Dockson issues in corporate finance and has
published authors in finance and Dean’s Chair of Business extensive experience teaching all levels
economics, Professor Ross is Administration. of corporate finance and financial
recognized for his work in developing He came to USC from The Wharton management policy. Professor Jordan
the Arbitrage Pricing Theory and his School, University of Pennsylvania, has published numerous articles on
substantial contributions to the where he was the chairman of the issues such as cost of capital, capital
discipline through his research in finance department and member of the structure, and the behavior of security
signaling, agency theory, option finance faculty for 20 years. He was the prices. He is a past president of the
pricing, and the theory of the term senior research associate at the Rodney Southern Finance Association, and he is
structure of interest rates, among other L. White Center for Financial Research coauthor (with Charles J. Corrado) of
topics. Apast president of the American at Wharton. His areas of expertise Fundamentals of Investments:
Finance Association, he currently include corporate financial policy, Valuation and Management,a leading
serves as an associate editor of several investment management and analysis, investments text, also published by
academic and practitioner journals. mergers and acquisitions, and stock McGraw-Hill/Irwin.
Heis a trustee of CalTech,a director of market price behavior.
the College Retirement Equity Fund Professor Westerfield serves as a
(CREF), and Freddie Mac. He is also member of the Board of Directors of
the co-chairman of Roll and Ross Asset Health Management Associates
Management Corporation. (NYSE: HMA), William Lyon Homes,
Inc. (NYSE: WLS), the Lord
Foundation, and the AACSB
International. He has been consultant to
a number of corporations, including
AT&T, Mobil Oil, and Pacific
Enterprises, as well as to the United
Nations, the U.S. Department of Justice
vi
and Labor, and the State of California.
Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill 7
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
PREFACE
from the Authors
W
hen the three of us decided to write a book, A Managerial Focus Students shouldn’t lose sight of
we were united by one strongly held princi- the fact that financial management concerns manage-
ple: Corporate finance should be developed ment. We emphasize the role of the financial manager as
in terms of a few integrated, powerful ideas. decision maker, and we stress the need for managerial
We believed that the subject was all too often presented input and judgment. We consciously avoid “black box”
as a collection of loosely related topics, unified primar- approaches to finance, and, where appropriate, the ap-
ily by virtue of being bound together in one book, and proximate, pragmatic nature of financial analysis is
we thought there must be a better way. made explicit, possible pitfalls are described, and limi-
One thing we knew for certain was that we didn’t tations are discussed.
want to write a “me-too” book. So, with a lot of help, In retrospect, looking back to our 1991 first edition
we took a hard look at what was truly important and IPO, we had the same hopes and fears as any entrepre-
useful. In doing so, we were led to eliminate topics of neurs. How would we be received in the market? At the
dubious relevance, downplay purely theoretical issues, time, we had no idea that just 10 years later, we would be
and minimize the use of extensive and elaborate calcu- working on a sixth edition. We certainly never dreamed
lations to illustrate points that are either intuitively ob- that in those years we would work with friends and col-
vious or of limited practical use. leagues from around the world to create country-specific
As a result of this process, three basic themes be- Australian, Canadian, and South African editions, an In-
came our central focus in writing Fundamentals of ternational edition, Chinese, Polish, Portuguese, and
Corporate Finance: Spanish language editions, and an entirely separate book,
Essentials of Corporate Finance, now in its third edition.
Today, as we prepare to once more enter the market,
An Emphasis on Intuition We always try to separate
our goal is to stick with the basic principles that have
and explain the principles at work on a common sense,
brought us this far. However, based on an enormous
intuitive level before launching into any specifics. The
amount of feedback we have received from you and your
underlying ideas are discussed first in very general
colleagues, we have made this edition and its package
terms and then by way of examples that illustrate in
even more flexiblethan previous editions. We offer flex-
more concrete terms how a financial manager might
ibility in coverage, by continuing to offer a variety of
proceed in a given situation.
editions, and flexibility in pedagogy, by providing a
wide variety of features in the book to help students to
A Unified Valuation Approach We treat net present learn about corporate finance. We also provide flexibility
value (NPV) as the basic concept underlying corporate in package options by offering the most extensive col-
finance. Many texts stop well short of consistently inte- lection of teaching, learning, and technology aids of any
grating this important principle. The most basic and im- corporate finance text. Whether you use just the text-
portant notion, that NPVrepresents the excess of market book, or the book in conjunction with other products, we
value over cost, often is lost in an overly mechanical ap- believe you will find a combination with this edition that
proach that emphasizes computation at the expense of will meet your current as well as your changing needs.
comprehension. In contrast, every subject we cover is
firmly rooted in valuation, and care is taken throughout Stephen A. Ross
to explain how particular decisions have valuation Randolph W. Westerfield
effects. Bradford D. Jordan
vii
8 Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
COVERAGE
T
his book was designed and developed explicitly for a first course in business or corporate finance, for both
finance majors and non-majors alike. In terms of background or prerequisites, the book is nearly self-
contained, assuming some familiarity with basic algebra and accounting concepts, while still reviewing im-
portant accounting principles very early on. The organization of this text has been developed to give
instructors the flexibility they need.
As with the previous edition of the
book,we are offering a Standard
STANDARD AND ALTERNATE EDITIONS TABLE OF CONTENTS
Edition with 22 chapters and an
Alternate Edition with 26
chapters. PART ONE
Considers the goals of the Overview of Corporate Finance
corporation,the corporate form of
organization,the agency problem, 1 Introduction to Corporate Finance
and,briefly,financial markets.
2 Financial Statements, Taxes, and Cash Flow
Succinctly discusses cash flow
versus accounting income,market
PART TWO
value versus book value,taxes,
and a review of financial
Financial Statements and Long-Term Financial Planning
statements.
3 Working with Financial Statements
Contains a thorough discussion 4 Long-Term Financial Planning and Growth
of the sustainable growth rate as
a planning tool. PART THREE
Valuation of Future Cash Flows
First of two chapters covering
time value of money,allowing for 5 Introduction to Valuation: The Time Value of Money
a building-block approach to this
concept. 6 Discounted Cash Flow Valuation
7 Interest Rates and Bond Valuation
Contains an extensive discussion 8 Stock Valuation
on NPV estimates.
PART FOUR
Updated to reflect market returns Capital Budgeting
and events through 2000.
9 Net Present Value and Other Investment Criteria
Discusses the expected
return/risk trade-off,and 10 Making Capital Investment Decisions
develops the security market line
11 Project Analysis and Evaluation
in a highly intuitive way that
bypasses much of the usual
portfolio theory and statistics. PART FIVE
New chapter! Introduces the
Risk and Return
important role of options in
corporate finance by covering 12 Some Lessons from Capital Market History
stock options,employee stock
options,real options and their role 13 Return, Risk, and the Security Market Line
in capital budgeting,and the
14 Options and Corporate Finance
many different types of options
found in corporate securities.
viii
Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill 9
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
PART SIX
Cost of Capital and Long-Term Financial Policy
15 Cost of Capital Includes a completely Web-based
illustration of the cost-of-capital
16 Raising Capital
calculation.
17 Financial Leverage and Capital Structure Policy
Provides key developments in the
18 Dividends and Dividend Policy IPO market such as the Internet
“bubble,”the role of “lockup”
agreements,and current thinking
PART SEVEN on IPO underpricing.
Short-Term Financial Planning and Management
19 Short-Term Finance and Planning Presents a general survey of
short-term financial management,
20 Cash and Liquidity Management
which is useful when time does
Appendix 20A Determining the Target Cash Balance not permit a more in-depth
treatment.
21 Credit and Inventory Management
Appendix 21A More on Credit Policy Analysis
PART EIGHT
Topics in Corporate Finance
22 International Corporate Finance Covers important issues in
international finance,including
A Mathematical Tables
the introduction of the euro.
B Key Equations
C Answers to Selected End-of-Chapter Problems
Indexes
ALTERNATE EDITION—ADDITIONAL CHAPTERS Choose this edition if you are
interested in covering the
following additional topics!
PART EIGHT
Topics in Corporate Finance Same chapter as in the Standard
Edition.
22 International Corporate Finance
23 Risk Management: An Introduction to Financial Engineering This increasingly important topic
is presented at a level appropriate
24 Option Valuation
for an introductory class.
25 Mergers and Acquisitions
New chapter! Covers the Black-
26 Leasing
Scholes Option Pricing Formula in
A Mathematical Tables depth and illustrates many
applications in corporate finance.
B Key Equations
C Answers to Selected End-of-Chapter Problems Updated to include important,new
rules regarding pooling of
Indexes interests and goodwill.
ix
10 Ross et al.: Fundamentals Front Matter Preface © The McGraw−Hill
of Corporate Finance, Sixth Companies, 2002
Edition, Alternate Edition
PEDAGOGY
I
n addition to illustrating pertinent concepts and presenting up-to-date coverage, Fundamentals of Corporate
Financestrives to present the material in a way that makes it coherent and easy to understand. To meet the varied
needs of the intended audience, Fundamentals of Corporate Financeis rich in valuable learning tools and support.
Chapter-opening vignettes Vignettes drawn from real-world events introduce students to the chapter
concepts. Questions about these vignettes are posed to the reader to ensure understanding of the concepts in the
end-of-chapter material. For examples, see Chapter 5, page 129; Chapter 6, page 157.
Pedagogical use of color
This learning tool continues NPV Profiles for Mutually Exclusive Investments FIGURE 9.8
to be an important feature NPV ($)
of Fundamentals of
70
Corporate Finance.In
almost every chapter, color 60
plays an extensive, 50
nonschematic, and largely 40 Project B
self-evident role. Aguide to Project A Crossover point (%)
30
the functional use of color 26.34
20
is found on the endsheets of NPVB > NPVA
both the Annotated 10 NPVA > NPVB IRRA = 24%
Instructor’s Edition (AIE) 0 25 R
5 10 15 20 30
and student version. For –10 11.1% IRRB = 21%
examples of this technique,
see Chapter 3, page 58;
Chapter 9, page 295.
In Their Own Words
boxes This series of
In Their Own Words . . .
boxes are the popular
articles updated from Clifford W. Smith Jr. on Market
Incentives for Ethical Behavior
previous editions written by
a distinguished scholar or Ethics is a financially healthy firms. Firms thus have incentives to
topicthat has adopt financial policies that help credibly bond against
practitioner on key topics in
been receiving cheating. For example, if product quality is difficult to
the text. Boxes include increased assess prior to purchase, customers doubt a firm’s claims
interest in the about product quality. Where quality is more uncertain,
essays by Merton Miller on business customers are only willing to pay lower prices. Such firms
community. thus have particularly strong incentives to adopt financial
capital structure, Fischer Much of this policies that imply a lower probability of insolvency.
discussion has Third, the expected costs are higher if information
Black on dividends, and been led by philosophers and has focused on moral about cheating is rapidly and widely distributed to
principles. Rather than review these issues, I want to potential future customers. Thus information services
Roger Ibbotson on capital discuss a complementary (but often ignored) set of like Consumer Reports,which monitor and report on
issues from an economist’s viewpoint. Markets impose product quality, help deter cheating. By lowering the
market history. Acomplete t till bt til t idiid l d t f t til t t it lit h
list of “In Their Own Words” boxes appears on page xxxii.
x