CORPORATE FINANCE Ross • Westerfield • Jaffe eighth edition CORPORATE FINANCE Ross Westerfield Jaffe eighth edition ISBN 978-0-07-310590-1 MHID 0-07-310590-2 Part of ISBN 978-0-07-333718-0 MHID 0-07-333718-8 9 7 8 0 0 7 3 3 3 7 1 8 0 9 0 0 0 0 www.mhhe.com Succeed in your corporate finance course with help from this experienced author team and a text that provides modern theory and cutting-edge examples in corporate finance. • New end-of-chapter mini-cases and questions focus on common company situations that embody important corporate finance topics. • Expanded theory and research, including new content on risk analysis, behavioral finance, and real options capital budgeting. • New problems have been added to the ends of most chapters. • New 4-color design. For more information on the book, its features, and the supplements package, please see the Preface or visit www.mhhe.com/rwj. Corporate Finance gets you moving in the right direction MD DALIM 871603 9/17/06 CYAN MAG YELO BLACK Corporate Finance ros05901_fm.indd iros05901_fm.indd i 10/6/06 9:47:44 AM10/6/06 9:47:44 AM The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate Stephen A. Ross Franco Modigliani Professor of Finance and Economics Sloan School of Management Massachusetts Institute of Technology Consulting Editor Financial Management Adair Excel Applications for Corporate Finance First Edition Benninga and Sarig Corporate Finance: A Valuation Approach Block and Hirt Foundations of Financial Management Twelfth Edition Brealey, Myers, and Allen Principles of Corporate Finance Eighth Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Fifth Edition Brooks FinGame Online 4.0 Bruner Case Studies in Finance: Managing for Corporate Value Creation Fifth Edition Chew The New Corporate Finance: Where Theory Meets Practice Third Edition Chew and Gillan Corporate Governance at the Crossroads: A Book of Readings First Edition DeMello Cases in Finance Second Edition Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition Helfert Techniques of Financial Analysis: A Guide to Value Creation Eleventh Edition Higgins Analysis for Financial Management Eighth Edition Kester, Ruback, and Tufano Case Problems in Finance Twelfth Edition Ross, Westerfi eld, and Jaffe Corporate Finance Eighth Edition Ross, Westerfi eld, Jaffe, and Jordan Corporate Finance: Core Principles and Applications First Edition Ross, Westerfi eld, and Jordan Essentials of Corporate Finance Fifth Edition Ross, Westerfi eld, and Jordan Fundamentals of Corporate Finance Eighth Edition Shefrin Behavioral Corporate Finance: Decisions That Create Value First Edition White Financial Analysis with an Electronic Calculator Sixth Edition Investments Adair Excel Applications for Investments First Edition Bodie, Kane, and Marcus Essentials of Investments Sixth Edition Bodie, Kane, and Marcus Investments Seventh Edition Hirt and Block Fundamentals of Investment Management Eighth Edition Hirschey and Nofsinger Investments: Analysis and Behavior First Edition Jordan and Miller Fundamentals of Investments: Valuation and Management Fourth Edition Financial Institutions and Markets Rose and Hudgins Bank Management and Financial Services Seventh Edition Rose and Marquis Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace Ninth Edition Saunders and Cornett Financial Institutions Management: A Risk Management Approach Fifth Edition Saunders and Cornett Financial Markets and Institutions: An Introduction to the Risk Management Approach Third Edition International Finance Eun and Resnick International Financial Management Fourth Edition Kuemmerle Case Studies in International Entrepreneurship: Managing and Financing Ventures in the Global Economy First Edition Real Estate Brueggeman and Fisher Real Estate Finance and Investments Thirteenth Edition Corgel, Ling, and Smith Real Estate Perspectives: An Introduction to Real Estate Fourth Edition Ling and Archer Real Estate Principles: A Value Approach Second Edition Financial Planning and Insurance Allen, Melone, Rosenbloom, and Mahoney Pension Planning: Pension, Profi t-Sharing, and Other Deferred Compensation Plans Ninth Edition Altfest Personal Financial Planning First Edition Harrington and Niehaus Risk Management and Insurance Second Edition Kapoor, Dlabay, and Hughes Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills First Edition Kapoor, Dlabay, and Hughes Personal Finance Eighth Edition ros05901_fm.indd iiros05901_fm.indd ii 10/6/06 9:47:45 AM10/6/06 9:47:45 AM Corporate Finance Eighth Edition Stephen A. Ross Sloan School of Management Massachusetts Institute of Technology Randolph W. Westerfi eld Marshall School of Business University of Southern California Jeffrey Jaffe Wharton School of Business University of Pennsylvania Boston Burr Ridge, IL Dubuque, IA 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 ros05901_fm.indd iiiros05901_fm.indd iii 10/6/06 9:47:46 AM10/6/06 9:47:46 AM CORPORATE FINANCE Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 DOW/DOW 0 9 8 7 6 ISBN 978-0-07-310590-1 MHID 0-07-310590-2 Editorial director: Brent Gordon Executive editor: Michele Janicek Developmental editor II: Jennifer Rizzi Marketing manager: Julie Phifer Media producer: Jennifer Wilson Lead project manager: Christine A. Vaughan Production supervisor: Gina Hangos Senior designer: Kami Carter Supplement producer: Ira C. Roberts Lead media project manager: Becky Szura Cover and interior design: Pam Verros Cover image: © Corbis Typeface: 10/12 Times Roman Compositor: Interactive Composition Corporation Printer: R. R. Donnelley Library of Congress Cataloging-in-Publication Data Ross, Stephen A. Corporate fi nance / Stephen A. Ross, Randolph W. Westerfi eld, Jeffrey Jaffe. 8th ed. p. cm. (The McGraw-Hill/Irwin series in fi nance, insurance, and real estate) Includes index. ISBN-13: 978-0-07-310590-1 (alk. paper) ISBN-10: 0-07-310590-2 (alk. paper) 1. Corporations Finance. I. Westerfi eld, Randolph. II. Jaffe, Jeffrey F., 1946- III. Title. HG4026.R675 2008 658.15 dc22 2006021608 www.mhhe.com ros05901_fm.indd ivros05901_fm.indd iv 10/6/06 9:47:46 AM10/6/06 9:47:46 AM To our family and friends with love and gratitude. ros05901_fm.indd vros05901_fm.indd v 10/6/06 9:47:47 AM10/6/06 9:47:47 AM About the Authors STEPHEN A. ROSS Sloan School of Management, Massachusetts Institute of Technol- ogy Stephen A. Ross is the Franco Modigliani Professor of Financial Economics at the Sloan School of Management, Massachusetts Institute of Technology. One of the most widely published authors in fi nance and economics, Professor Ross is recognized for his work in developing the arbitrage pricing theory, as well as for having made substantial con- tributions to the discipline through his research in signaling, agency theory, option pricing, and the theory of the term structure of interest rates, among other topics. A past president of the American Finance Association, he currently serves as an associate editor of several academic and practitioner journals. He is a trustee of CalTech and Freddie Mac. RANDOLPH W. WESTERFIELD Marshall School of Business, University of Southern California Randolph W. Westerfi eld is Dean Emeritus of the University of Southern California’s Marshall School of Business and is the Charles B. Thornton Professor of Finance. Professor Westerfi eld came to USC from the Wharton School, University of Pennsylvania, where he was the chairman of the fi nance department and member of the fi nance faculty for 20 years. He is a member of several public company boards of directors, including Health Management Associates, Inc., William Lyon Homes, and the Nicholas Applegate Growth Fund. His areas of expertise include corporate fi nancial policy, invest- ment management, and stock market price behavior. JEFFREY F. JAFFE Wharton School of Business, University of Pennsylvania Jeffrey F. Jaffe has been a frequent contributor to the fi nance and economics literatures in such journals as the Quarterly Economic Journal, The Journal of Finance, The Journal of Fi- nancial and Quantitative Analysis, The Journal of Financial Economics, and The Financial Analysts Journal. His best-known work concerns insider trading, where he showed both that corporate insiders earn abnormal profi ts from their trades and that regulation has little effect on these profi ts. He has also made contributions concerning initial public offerings, regulation of utilities, the behavior of marketmakers, the fl uctuation of gold prices, the theoretical effect of infl ation on interest rates, the empirical effect of infl ation on capital asset prices, the relationship between small-capitalization stocks and the January effect, and the capital structure decision. vi ros05901_fm.indd viros05901_fm.indd vi 10/6/06 9:47:47 AM10/6/06 9:47:47 AM Preface T he teaching and the practice of corporate fi nance are more challenging and excit- ing than ever before. The last decade has seen fundamental changes in fi nancial markets and fi nancial instruments. In the early years of the 21st century, we still see announcements in the fi nancial press about such matters as takeovers, junk bonds, fi nancial restructuring, initial public offerings, bankruptcy, and derivatives. In addition, there is the new recognition of “real” options, private equity and venture capital, and the disappear- ing dividend. The world’s fi nancial markets are more integrated than ever before. Both the theory and practice of corporate fi nance have been moving ahead with uncommon speed, and our teaching must keep pace. These developments place new burdens on the teaching of corporate fi nance. On one hand, the changing world of fi nance makes it more diffi cult to keep materials up to date. On the other hand, the teacher must distinguish the permanent from the temporary and avoid the temptation to follow fads. Our solution to this problem is to emphasize the modern fundamentals of the theory of fi nance and make the theory come to life with contemporary examples. Increasingly, many of these examples are outside the United States. All too often the beginning student views corporate fi nance as a collection of unrelated topics that are unifi ed largely because they are bound together between the covers of one book. As in the previous editions, our aim is to present corporate fi nance as the working of a few integrated and powerful institutions. The Intended Audience of This Book This book has been written for the introductory courses in corporate fi nance at the MBA level and for the intermediate courses in many undergraduate programs. Some instructors will fi nd our text appropriate for the introductory course at the undergraduate level as well. We assume that most students either will have taken, or will be concurrently enrolled in, courses in accounting, statistics, and economics. This exposure will help students understand some of the more diffi cult material. However, the book is self-contained, and a prior knowl- edge of these areas is not essential. The only mathematics prerequisite is basic algebra. New to the Eighth Edition With the eight edition of Corporate Finance, we have done extensive updating and re- working throughout the text. Among the more noticeable changes are opening vignettes for each chapter. Most of these present familiar companies in situations covered by the chapter, thereby motivating the discussion. The end-of-chapter material has been expanded considerably. We now have two separate sets of questions, one that focuses on concepts and critical ideas and another that is more problem oriented. The total number of questions has grown signifi cantly. Finally, almost every chapter now ends with a mini-case that places the student in the position of needing to apply chapter concepts in a common real-world situation. These cases are suitable for a variety of pedagogical purposes, ranging from homework to group assignments to in-class discussions. In addition to these changes and overall updating, a number of chapters have signifi - cant new material. Following are some of the more notable additions and upgrades: Chapter 1: Expanded discussion of goal of the fi rm and agency problems. New material on Sarbanes-Oxley. vii ros05901_fm.indd viiros05901_fm.indd vii 10/6/06 9:47:48 AM10/6/06 9:47:48 AM Chapter 3: Completely rewritten to cover fi nancial statements analysis and long-term fi nancial planning. Chapter 5: New discussion of bond price information, including the NASD TRACE system. Chapter 7: New discussion of alternative defi nitions of project cash fl ows. Chapter 8: Reorganized, with improved discussion of decision trees. Chapter 9: New discussion of geometric versus arithmetic returns. Chapter 12: Expanded discussion on actual cost of capital estimation. Chapter 18: New material on several dividend-related subjects. Chapter 19: New material on Dutch auction IPOs. Chapter 20: New material on bond price quotes and make-whole call provisions. Chapter 22: Expanded discussion on applications of options analysis in corporate fi nance. Chapter 27: New material on fi nancial electronic data interchange and the Check Clearing Act for the 21 st Century. Chapter 29: Completely rewritten with new material on a variety of merger-related topics. Chapter 31: Completely rewritten for clarity. We have also worked to improve the supplements to the text, with the goal of provid- ing far and away the most comprehensive student and instructor support at this level. For example, we now provide fully detailed step-by-step solutions to end-of-chapter problems (and spreadsheets for each one as well). The testbank has grown signifi cantly in terms of the number of questions, and we have worked to provide a wider variety of questions and question types. The PowerPoint set also has grown. The book’s Online Learning Center (OLC) delivers several new and very rich student study aids. There is self-study software with at least 100 questions per chapter. Narrated PowerPoint slides actually talk students through the material. Our Interactive FinSims con- tain simulations of key fi nance concepts in which students are asked to provide values for key variables. These digital assets provide completely new avenues for students to explore and ways for them to comprehend the subject on a deeper level. For a complete look at the new and updated eighth edition features, please see the next section. viii Preface ros05901_fm.indd viiiros05901_fm.indd viii 10/6/06 9:47:49 AM10/6/06 9:47:49 AM ros05901_fm.indd ixros05901_fm.indd ix 10/6/06 9:47:50 AM10/6/06 9:47:50 AM [...]...Pedagogy In this edition of Corporate Finance, we this edition of Corporate Finance, have updated and improved our features to present material in a way that makes it coherent and easy to understand In addition, Corporate Finance is rich in Corporate Finance is rich valuable learning tools and support, to help students succeed in learning... the front cover of this text or visit www.mhhe.com/edumarketinsight Corporate Finance Online As part of the OLC, instructors and students will also have access to Corporate Finance Online, found on the opening page Corporate Finance Online is an exclusive Web tool from McGraw-Hill/Irwin The site provides over 54 exercises for 27 key corporate finance topics, allowing students to complete challenging... Conclusions Concept Questions Questions and Problems Appendix 21A APV Approach to Leasing PA R T VI 623 Chapter 23 624 Options and Corporate Finance: Extensions and Applications 624 624 624 625 626 628 Options, Futures, and Corporate Finance Chapter 22 Options and Corporate Finance 22.1 Options 22.2 Call Options The Value of a Call Option at Expiration 22.3 Put Options The Value of a Put Option at Expiration... percent the day the resignation was announced Understanding Ms Fiorina’s rise from corporate executive to chief executive officer, and finally to exemployee, takes us into issues involving the corporate form of organization, corporate goals, and corporate control, all of which we discuss in this chapter 1.1 What Is Corporate Finance? Suppose you decide to start a firm to make tennis balls To do this you hire... Budgeting 229 PA R T Risk 9 III Risk and Return: Lessons from Market History 256 Options and Corporate Finance: Extensions and Applications 671 Warrants and Convertibles 25 8 197 Options and Corporate Finance 24 Making Capital Investment Decisions 22 23 7 630 Derivatives and Hedging Risk 695 714 P A R T VII Short-Term Finance 10 Return and Risk: The Capital Asset Pricing Model (CAPM) 279 11 An Alternative... Subject Index 911 xxii ros05901_fm.indd xxii 10/6/06 9:48:05 AM Contents PA R T I 2.4 2.5 2.6 Overview Chapter 1 Introduction to Corporate Finance 1.1 1.2 1.3 1.4 1.5 What Is Corporate Finance? The Balance Sheet Model of the Firm Capital Structure The Financial Manager The Corporate Firm The Sole Proprietorship The Partnership The Corporation A Corporation by Another Name The Goal of Financial Management... Management 771 12 Risk, Cost of Capital, and Capital Budgeting 342 28 Credit Management 795 26 Short-Term Finance and Planning P A R T IV Capital Structure and Dividend Policy P A R T VIII Special Topics 13 30 Financial Distress 31 International Corporate Finance 745 29 Mergers and Acquisitions 812 Corporate Financing Decisions and Efficient Capital Markets 368 14 Long-Term Financing: An Introduction 15... error resulting in subsequent errors will be counted double All errors should be reported using the Feedback Form on the Corporate Finance Online Learning Center at www.mhhe.com/rwj Many talented professionals at McGraw-Hill/Irwin have contributed to the development of Corporate Finance, Eighth Edition We would especially like to thank Michele Janicek, Jennifer Rizzi, Julie Phifer, Christine Vaughan,... Financing 1 Introduction to Corporate Finance 1 2 Dividends and Other Payouts 21 Financial Statements Analysis and Long-Term Planning 43 19 Issuing Securities to the Public 20 Long-Term Debt 21 Leasing 549 580 606 P A R T II Valuation and Capital Budgeting P A R T VI 4 Discounted Cash Flow Valuation 89 Options, Futures, 5 How to Value Bonds and Stocks 129 and Corporate Finance 6 Net Present Value and... important corporate finance topics • Excel Templates Corresponding to most end-of-chapter problems, each template allows the student to work through the problem using Excel Each end-of-chapter problem with a template is indicated by an Excel icon in the margin beside it • More Be sure to check out the other helpful features on the OLC, including links to Corporate Finance Online study problems, and Finance . Allen Principles of Corporate Finance Eighth Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Fifth Edition Brooks FinGame Online 4.0 Bruner Case Studies in Finance: Managing for Corporate. and Jordan Essentials of Corporate Finance Fifth Edition Ross, Westerfi eld, and Jordan Fundamentals of Corporate Finance Eighth Edition Shefrin Behavioral Corporate Finance: Decisions That Create. www.mhhe.com/edumarketinsight. Corporate Finance Online As part of the OLC, instructors and students will also have access to Corporate Finance Online, found on the opening page. Corporate Finance Online is