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To my family, friends, colleagues, and God for all the love, support,
and encouragement, and to our country, Canada, where we can take
for granted all the freedoms that are sought after, but often denied,
around the world.
—David Stangeland
To my family for all their love and support.

—András Marosi
Detailed Contents xi
11.2 The Volatility of a Portfolio 385

Diversifying Risks 385
PART 4 Measuring Stocks’ Co-movement:
Correlation 386
Return, Risk, and the USING EXCEL: CALCULATING THE CORRELATION
BETWEEN TWO SETS OF RETURNS 390
Cost of Capital 347 Computing a Portfolio’s Variance and
Standard Deviation 390
Risk versus Return: Choosing an Efficient
10 Risk and Return in Capital

Markets 348
Portfolio with Two Stocks 392
The Effect of Correlation 395
The Volatility of a Large Portfolio 395
NOBEL PRIZE HARRY MARKOWITZ 396
10.1 A First Look at Risk and Return 349
11.3 Measuring Systematic Risk 397
10.2 Historical Risks and Returns of Stocks 351 Role of the Market Portfolio 397
Computing Historical Returns 351
Stock Market Indexes as the Market
Average Annual Returns 355
Portfolio 398
The Variance and Volatility of Returns 357
INDEX FUNDS AND EXCHANGE TRADED
ARITHMETIC AVERAGE RETURNS VERSUS
FUNDS 399
COMPOUND ANNUAL RETURNS 358
Market Risk and Beta 399

COMMON MISTAKE MISTAKES WHEN

COMMON MISTAKE STANDARD DEVIATION
COMPUTING STANDARD DEVIATION 360
VERSUS BETA 401
USING EXCEL: COMPUTING THE STANDARD Estimating Beta from Historical Returns 403
DEVIATION OF HISTORICAL RETURNS 360 USING EXCEL: CALCULATING A STOCK’S
The Normal Distribution 361
BETA 405
10.3 The Historical Trade-Off between Risk and 11.4 Putting It All Together: The Capital Asset
Return 363 Pricing Model 406
The Returns of Large Portfolios 363
The CAPM Equation Relating Risk to
The Returns of Individual Stocks 363
Expected Return 407
10.4 Common versus Independent Risk 365 WHY NOT ESTIMATE EXPECTED RETURNS
Theft versus Earthquake Insurance: An
DIRECTLY? 408
Example 365
The Security Market Line 409
Types of Risk 366
The CAPM and Portfolios 409
10.5 Diversification in Stock Portfolios 367 Summary of the Capital Asset Pricing
Unsystematic versus Systematic Risk 367 Model 412
Diversifiable Risk and the Risk Premium 370 The Big Picture 412
The Importance of Systematic Risk 370 Problems with the CAPM in Practice 412

COMMON MISTAKE A FALLACY OF LONG-RUN NOBEL PRIZE WILLIAM SHARPE 413
DIVERSIFICATION 371
MyLab Finance SUMMARY 414 • REVIEW
MyLab Finance SUMMARY 373 • REVIEW QUESTIONS 416 • PROBLEMS 416
QUESTIONS 374 • PROBLEMS 375 • DATA CASE 379
CHAPTER 11 APPENDIX: ALTERNATIVE MODELS
OF SYSTEMATIC RISK 422
11 Systematic Risk and the Equity

Risk Premium 381
12 Determining the Cost of Capital 425
11.1 The Expected Return of a Portfolio 382

Portfolio Weights 382 12.1 A First Look at the Weighted Average
Portfolio Returns 382 Cost of Capital 426
Expected Portfolio Return 384 The Firm’s Capital Structure 426
xii Detailed Contents
Opportunity Cost and the Overall Cost of 13.3 Factors Affecting Option Prices 466
Capital 427 Strike Price and Stock Price 466
Weighted Averages and the Overall Cost of Option Prices and the Expiration Date 466
Capital 427 Option Prices and the Risk-Free Rate 466
Weighted Average Cost of Capital Option Prices and Volatility 466
Calculations 428
13.4 The Binomial Option Pricing Model 468
12.2 The Firm’s Costs of Debt and Equity The Two-State Single-Period Model: An
Capital 430 Example 468
Cost of Debt Capital 430 The Binomial Pricing Formula 469

COMMON MISTAKE USING THE COUPON RATE 13.5 The Black-Scholes Option Pricing
AS THE COST OF DEBT 431 Formula 470
Cost of Preferred Stock Capital 432 13.6 Put-Call Parity 472
Cost of Common Stock Capital 432 Portfolio Insurance 472
12.3 A Second Look at the Weighted Average 13.7 Options and Corporate Finance 475
Cost of Capital 435
WACC Equation 435 MyLab Finance SUMMARY 477 • REVIEW
Weighted Average Cost of Capital in QUESTIONS 479 • PROBLEMS 479 • DATA CASE 481
Practice 436
Methods in Practice 436
12.4 Using the WACC to Value a Project 439
Key Assumptions 440
WACC Method Application: Extending the PART 5
Life of Facilities at BCE 440
Summary of the WACC Method 441 Financing Decisions 483
12.5 Project-Based Costs of Capital 442

COMMON MISTAKE USING A SINGLE COST OF
CAPITAL IN MULTIDIVISIONAL FIRMS 442 14 Raising Equity Capital 484
Cost of Capital for a New Acquisition 442

Divisional Costs of Capital 443
14.1 Equity Financing for Private Companies 485
12.6 When Raising External Capital Is Costly 445 Sources of Funding 485
Crowdfunding: The Wave of the Future? 488
MyLab Finance SUMMARY 446 • REVIEW Securities and Valuation 489
QUESTIONS 448 • PROBLEMS 449 • DATA CASE 452 Exiting an Investment in a Private
Company 491
14.2 Taking Your Firm Public: The Initial Public
13
Offering 492
Risk and the Pricing of Options 454
Advantages and Disadvantages of Going
Public 492
Primary and Secondary IPO Offerings 494
Other IPO Types 499
13.1 Option Basics 455
Option Contracts 455 GOOGLE’S IPO 502
Stock Option Quotations 456 14.3 IPO Puzzles 503
Options on Other Financial Securities 458 Underpriced IPOs 503
OPTIONS ARE FOR MORE THAN JUST “Hot” and “Cold” IPO Markets 503
STOCKS 459 GLOBAL FINANCIAL CRISIS 2008–2009: A VERY
13.2 Option Payoffs and Profits at Expiration 459 COLD IPO MARKET 505
The Long Position in an Option Contract 459 High Cost of Issuing an IPO 506
The Short Position in an Option Contract 461 Poor Post-IPO Long-Run Stock
Profit from Holding an Option to Performance 507
Expiration 463 14.4 Raising Additional Capital: The Seasoned
Short Sales 464
Equity Offering 507
Detailed Contents xiii
SEO Process 508 16.2 Capital Structure in Perfect Capital Markets 553
SEO Price Reaction 510 Application: Financing a New Business 553
SEO Costs 511 Leverage and Firm Value 554
The Effect of Leverage on Risk and Return 556
MyLab Finance SUMMARY 512 • REVIEW Homemade Leverage 558
QUESTIONS 514 • PROBLEMS 514 • DATA CASE 517 Leverage and the Cost of Capital 558
M&M and the Real World 560

COMMON MISTAKE CAPITAL STRUCTURE
15
FALLACIES 561
Debt Financing 519
NOBEL PRIZE FRANCO MODIGLIANI
AND MERTON MILLER 562
GLOBAL FINANCIAL CRISIS 563
15.1 Corporate Debt 520
Private Debt 520 16.3 Debt and Taxes 564
The Interest Tax Deduction and Firm Value 564
DEBT FINANCING AT HERTZ: BANK LOANS 520 Value of the Interest Tax Shield 566
Public Debt 521 The Interest Tax Shield with Permanent
DEBT FINANCING AT HERTZ: PRIVATE Debt 567
PLACEMENTS 521 Leverage and the WACC with Taxes 569
Debt and Taxes: The Bottom Line 569
DEBT FINANCING AT HERTZ: PUBLIC DEBT 523
16.4 The Costs of Bankruptcy and Financial
15.2 Other Types of Debt 525 Distress 570
Sovereign Debt 525
Direct Costs of Bankruptcy 570
Agency Securities 527
Indirect Costs of Financial Distress 571
Provincial and Municipal Bonds 527
BANKRUPTCY CAN BE EXPENSIVE 571
FINANCIAL CRISIS 528
16.5 Optimal Capital Structure: The Trade-Off
15.3 Bond Covenants 529 Theory 572
Types of Covenants 529 Differences across Firms 573
Advantages of Covenants 530 Optimal Leverage 573
Application: Hertz’s Covenants 530
16.6 Additional Consequences of Leverage: Agency
15.4 Repayment Provisions 530 Costs and Information 574
Call Provisions 530
Agency Costs 575
The Canada Call or Make-Whole Call
Provision 533 AIRLINES USE FINANCIAL DISTRESS TO THEIR
Sinking Funds 534 ADVANTAGE 575
Convertible Provisions 534 MORAL HAZARD AND GOVERNMENT
BAILOUTS 577
MyLab Finance SUMMARY 538 • REVIEW Debt and Information 577
16.7 Capital Structure: Putting It All Together 580
CHAPTER 15 APPENDIX: USING A FINANCIAL
CALCULATOR TO CALCULATE YIELD TO CALL 544 MyLab Finance SUMMARY 581 • REVIEW
PART 5 INTEGRATIVE CASE 545 QUESTIONS 583 • PROBLEMS 584
CHAPTER 16 APPENDIX: THE BANKRUPTCY
CODE 591
16 Capital Structure 549
17 Payout Policy 592
16.1 Capital Structure Choices 550

Capital Structure Choices across
Industries 550 17.1 Distributions to Shareholders 593
Capital Structure Choices within Dividends 594
Industries 551 Share Repurchases 595
xiv Detailed Contents
17.2 Dividends versus Share Repurchases

in a Perfect Capital Market 596
Alternative Policy 1: Pay a Dividend with PART 6
Excess Cash 597
Alternative Policy 2: Share Repurchase
(No Dividend) 598
Financial Planning

COMMON MISTAKE REPURCHASES AND THE and Forecasting 629
SUPPLY OF SHARES 599
18
Modigliani and Miller and Dividend Policy
Irrelevance 600 Financial Modelling and Pro Forma

COMMON MISTAKE THE BIRD IN THE HAND
Analysis 630
FALLACY 601
Dividend Policy with Perfect Capital
Markets 602 18.1 Goals of Long-Term Financial Planning 631
Identify Important Linkages 631
17.3 The Tax Disadvantage of Dividends 602 Analyze the Impact of Potential Business
Taxes on Dividends and Capital Plans 631
Gains 602 Plan for Future Funding Needs 631
Optimal Dividend Policy with Taxes 603
Tax Differences across Investors 607 18.2 Forecasting Financial Statements: The Percent
of Sales Method 632
17.4 Payout versus Retention of Cash 608 Percent of Sales Method 632
Retaining Cash with Perfect Capital Pro Forma Income Statement 632
Markets 608 Pro Forma Balance Sheet 634
Retaining Cash with Imperfect Capital
Markets 609
COMMON MISTAKE CONFUSING STOCKHOLDERS’
EQUITY WITH RETAINED EARNINGS 636
17.5 Signalling with Payout Policy 613 Making the Balance Sheet Balance: Net New
Dividend Smoothing 613
Financing 636
Dividend Signalling 614
Choosing a Forecast Target 638
Signalling and Share Repurchases 615
18.3 Forecasting a Planned Expansion 638
ROYAL & SUNALLIANCE’S DIVIDEND CUT 615
KXS Design’s Expansion: Financing Needs 639
17.6 Stock Dividends, Splits, and Spinoffs 617 KXS Design’s Expansion: Pro Forma Income
Stock Dividends and Splits 617 Statement 640
BERKSHIRE HATHAWAY’S A AND B
COMMON MISTAKE TREATING FORECASTS AS
SHARES 618 FACT 642
Spinoffs 619 Forecasting the Balance Sheet 642
17.7 Advice for the Financial Manager 619 18.4 Growth and Firm Value 644
Sustainable Growth Rate and External
MyLab Finance SUMMARY 620 • REVIEW Financing 644
QUESTIONS 623 • PROBLEMS 623 • DATA CASE 626 18.5 Valuing the Expansion 647
PART 5 INTEGRATIVE CASE 628 Forecasting Free Cash Flows 648

COMMON MISTAKE CONFUSING TOTAL AND
INCREMENTAL NET WORKING CAPITAL 649
KXS Design’s Expansion: Effect on Firm
Value 649
Optimal Timing and the Option to Delay 652

QUESTIONS 655 • PROBLEMS 655
CHAPTER 18 APPENDIX: THE BALANCE SHEET
AND STATEMENT OF CASH FLOWS 659
Detailed Contents xv
20.2 The Matching Principle 694

Permanent Working Capital 694
19 Working Capital Management 661 Temporary Working Capital 694

Permanent versus Temporary Working
Capital 695
Financing Policy Choices 695
19.1 Overview of Working Capital 662
The Cash Cycle 662 20.3 Short-Term Financing with Bank Loans 697
Working Capital Needs by Industry 664 Single End-of-Period-Payment Loan 697
Firm Value and Working Capital 665 Line of Credit 698
Bridge Loan 698
19.2 Trade Credit 667 Common Loan Stipulations and Fees 699
Trade Credit Terms 667
20.4 Short-Term Financing with Commercial

COMMON MISTAKE USING APR INSTEAD OF Paper 701
EAR TO COMPUTE THE COST OF TRADE
20.5 Short-Term Financing with Secured
CREDIT 668
Trade Credit and Market Frictions 668 Financing 702
Managing Float 669 Accounts Receivable as Collateral 702
19.3 Receivables Management 671 A SEVENTEENTH-CENTURY FINANCING

Determining the Credit Policy 671 SOLUTION 703
Inventory as Collateral 703
THE 5 C’S OF CREDIT 671
Monitoring Accounts Receivable 673 20.6 Putting It All Together: Creating a Short-Term
Financial Plan 705
19.4 Payables Management 675
Determining Accounts Payable Days MyLab Finance SUMMARY 706 • REVIEW
Outstanding 675
Stretching Accounts Payable 676
PART 6 INTEGRATIVE CASE 713
19.5 Inventory Management 677
Benefits of Holding Inventory 677
INVENTORY MANAGEMENT ADDS TO THE
BOTTOM LINE AT GAP 678
Costs of Holding Inventory 678
PART 7
19.6 Cash Management 679
Motivation for Holding Cash 679
Special Topics 719
21
CASH BALANCES 680
Alternative Investments 680
Risk Management 720

21.1 Insurance 721
The Role of Insurance: A Simplified
Example 721
20
Insurance Pricing in a Perfect Market 722
Short-Term Financial Planning 688 The Value of Insurance 724
The Costs of Insurance 726
The Insurance Decision 728
20.1 Forecasting Short-Term Financing 21.2 Commodity Price Risk 728

Needs 689 Hedging with Vertical Integration and
Application: Whistler Snowboards Storage 729
Inc. 689 HEDGING STRATEGY LEADS TO PROMOTION . . .
Negative Cash Flow Shocks 690 SOMETIMES 730
Positive Cash Flow Shocks 690 Hedging with Long-Term Contracts 730
Seasonalities 691 Hedging with Futures Contracts 732
The Cash Budget 691 Hedging with Options Contracts 735
xvi Detailed Contents
Comparing Futures Hedging with Options 22.7 Capital Budgeting with Exchange Rate
Hedging 736 Risk 776
Deciding to Hedge Commodity Price Application: Ityesi Inc. 776
Risk 739 Conclusion 778

COMMON MISTAKE MISTAKES WHEN HEDGING
RISK 739
DIFFERING HEDGING STRATEGIES AT
U.S. AIRLINES 740
21.3 Interest Rate Risk 740
Interest Rate Risk Measurement:
Duration 741
Duration-Based Hedging 741
23 Leasing 787
Swap-Based Hedging 741

23.1 The Basics of Leasing 788
MyLab Finance SUMMARY 744 • REVIEW Examples of Lease Transactions 788
QUESTIONS 745 • PROBLEMS 745 Lease Payments and Residual Values 789
Leases versus Loans 790
CALCULATING AUTO LEASE PAYMENTS 791
End-of-Term Lease Options 792
22 International Corporate
Finance 750
Other Lease Provisions 793
23.2 Accounting, Tax, and Legal Consequences of
Leasing 794
Lease Accounting 794
22.1 Currency Exchange Rates 751 The Tax Treatment of Leases 797
The Foreign Exchange Market 752 Leases and Bankruptcy 798
Exchange Rates 752
SYNTHETIC LEASES 798
22.2 Exchange Rate Risk 756
Exchange Rate Fluctuations 756 23.3 The Leasing Decision 799
Hedging with Forward Contracts 758 Cash Flows for a True Tax Lease 800
Cash-and-Carry and the Pricing of Currency Lease versus Buy (an Unfair
Forwards 759 Comparison) 801
Hedging Exchange Rate Risk with Lease versus Borrow (the Right
Options 762 Comparison) 802
Evaluating a True Tax Lease 805
22.3 Internationally Integrated Capital Evaluating a Non-tax Lease 805
Markets 764
23.4 Reasons for Leasing 806
22.4 Valuation of Foreign Currency Cash Valid Arguments for Leasing 806
Flows 766 Suspect Arguments for Leasing 809
Application: Ityesi Inc. 767
The Law of One Price as a Robustness MyLab Finance SUMMARY 810 • REVIEW
Check 769 QUESTIONS 811 • PROBLEMS 812
22.5 Valuation and International Taxation 771
A Single Foreign Project with Immediate
Repatriation of Earnings 771
Multiple Foreign Projects and Deferral of
Earnings Repatriation 772 24 Mergers and Acquisitions 814
22.6 Internationally Segmented Capital

Markets 772
24.1 Background and Historical Trends 815
Differential Access to Markets 773
Merger Waves 815
Macro-Level Distortions 774
Types of Mergers 817
Implications of Internationally Segmented
Capital Markets 776 24.2 Market Reaction to a Takeover 817
Detailed Contents xvii
24.3 Reasons to Acquire 818

Economies of Scale and Scope 819
Vertical Integration 819
Expertise 819
Monopoly Gains 820
25 Corporate Governance 848
Efficiency Gains 820

Tax Savings from Operating Losses 821 25.1 Corporate Governance and Agency Costs 849
Diversification 822 25.2 Monitoring by the Board of Directors and
Earnings Growth 823 Others 850
Managerial Motives to Merge 825 Types of Directors 850
24.4 Valuation and The Takeover Process 826 Board Independence 851
Valuation 826 Board Size and Performance 852
The Offer 827 Other Monitors 852
Merger “Arbitrage” 828 25.3 Compensation Policies 853
Tax and Accounting Issues 830 Stock and Options 853
Board and Shareholder Approval 831 Pay and Performance Sensitivity 854
24.5 Takeover Defences 832 25.4 Managing Agency Conflicts 855
Poison Pills 832 Direct Action by Shareholders 856
Staggered Boards 833 Management Entrenchment 858
White Knights 834 The Threat of Takeover 859
Golden Parachutes 834 25.5 Regulation 859
Recapitalization 834 The Sarbanes-Oxley Act 859
Other Defensive Strategies 835 The Cadbury Commission 860
Regulatory Approval 835 Dodd-Frank Act 861
WEYERHAEUSER’S HOSTILE BID FOR Insider Trading 862
WILLAMETTE INDUSTRIES 836 MARTHA STEWART AND IMCLONE 864
24.6 Who Gets the Value Added from a 25.6 Corporate Governance Around the World 864
Takeover? 837 Protection of Shareholder Rights 864
The Free Rider Problem 837 Controlling Owners and Pyramids 865
Toeholds 838 The Stakeholder Model 867
The Leveraged Buyout 838 Cross Holdings 868
THE LEVERAGED BUYOUT OF RJR NABISCO 25.7 The Trade-off of Corporate Governance 868
BY KKR 841
The Freezeout Merger 841 MyLab Finance SUMMARY 869 • REVIEW
Competition 842 QUESTIONS 872 • PROBLEMS 872

QUESTIONS 845 • PROBLEMS 845 Index I1
About the Authors
Jonathan Berk is the A.P. Giannini Professor of

Finance at the Graduate School of Business, Stanford
University, and is a Research Associate at the National
Bureau of Economic Research. Before coming to Stanford,
he was the Sylvan Coleman Professor of Finance at Haas
School of Business at the University of California, Berke-
ley. Prior to earning his PhD, he worked as an Associate at
Goldman Sachs (where his education in finance really began).
Professor Berk’s research interests in finance include
corporate valuation, capital structure, mutual funds, asset
pricing, experimental economics, and labour economics. His
work has won a number of research awards, including the
TIAA-CREF Paul A. Samuelson Award, the Smith Breeden
Jonathan Berk, Peter DeMarzo, and Jarrad Harford Prize, Best Paper of the Year in The Review of Financial
Studies, and the FAME Research Prize. His paper, “A Cri-
tique of Size-Related Anomalies,” was selected as one of the two best papers ever published in The
Review of Financial Studies. In recognition of his influence on the practice of finance he has received
the Bernstein-Fabozzi/Jacobs Levy Award, the Graham and Dodd Award of Excellence, and the Roger
F. Murray Prize. He served two terms as an associate editor of the Journal of Finance and a term as
a Director of the American Finance Association, the Western Finance Association, and the academic
director of the Financial Management Association. He is a Fellow of the Financial Management Asso-
ciation and a member of the advisory board of the Journal of Portfolio Management.
Born in Johannesburg, South Africa, Professor Berk is married, has two daughters, and is an
avid skier and biker.
Peter DeMarzo is the Mizuho Financial Group Professor of Finance at the Graduate School
of Business, Stanford University. He is the current Vice President of the American Finance Associa-
tion and a Research Associate at the National Bureau of Economic Research. He teaches MBA and
PhD courses in Corporate Finance and Financial Modelling. In addition to his experience at the Stan-
ford Graduate School of Business, Professor DeMarzo has taught at the Haas School of Business and
the Kellogg Graduate School of Management, and he was a National Fellow at the Hoover Institution.
Professor DeMarzo received the Sloan Teaching Excellence Award at Stanford, and the Earl F.
Cheit Outstanding Teaching Award at U.C. Berkeley. Professor DeMarzo has served as an associate
editor for The Review of Financial Studies, Financial Management, and the B.E. Journals in Economic
Analysis and Policy as well as a Director of the American Finance Association. He has served as Vice
President and President of the Western Finance Association. Professor DeMarzo’s research is in the
area of corporate investment and financing, asset securitization, and contracting, as well as market
structure and regulation. His recent work has examined issues of the optimal design of contracts and
xix
xx About the Authors
securities, leverage dynamics and the role of bank capital regulation, and the influence of informa-
tion asymmetries on stock prices and corporate investment. He has received numerous awards,
including the Western Finance Association Corporate Finance Award and the Barclays Global
Investors/Michael Brennan best-paper award from The Review of Financial Studies.
Professor DeMarzo was born in Whitestone, New York, and is married with three boys. He and
his family enjoy hiking, biking, and skiing.
Jarrad Harford is the Paul Pigott - PACCAR Professor of Finance at the University of
Washington. Prior to Washington, Professor Harford taught at the Lundquist College of Business at
the University of Oregon. He received his PhD in Finance with a minor in Organizations and Mar-
kets from the University of Rochester. Professor Harford has taught the core undergraduate finance
course, Business Finance, for over nineteen years, as well as an elective in Mergers and Acquisitions,
and “Finance for Non-financial Executives” in the executive education program. He has won numer-
ous awards for his teaching, including the UW Finance Professor of the Year (2010, 2012, 2016),
Panhellenic/Interfraternity Council Business Professor of the Year Award (2011, 2013), ISMBA Excel-
lence in Teaching Award (2006), and the Wells Fargo Faculty Award for Undergraduate Teaching
(2005). Professor Harford is currently a managing editor of the Journal of Financial and Quantitative
Analysis, and serves as an associate editor for the Journal of Financial Economics and the Journal
of Corporate Finance. His main research interests are understanding the dynamics of merger and
acquisition activity as well as the interaction of corporate cash management policy with governance,
payout, and global tax considerations. Professor Harford was born in Pennsylvania, is married, and
has two sons. He and his family enjoy travelling, hiking, and skiing.
David Stangeland, PhD, BComm (Distinction), CPA, CMA, did his under-
graduate and graduate university education at the University of Alberta in Edmon-
ton. In 1991 he moved to Winnipeg, where he joined the Accounting and Finance
Department at the I. H. Asper School of Business at the University of Manitoba.
Dr. Stangeland is a Professor of Finance and Associate Dean for Professional
Programs. Over his career, he was the Associate Dean responsible for the follow-
ing programs: undergraduate, MBA, Co-op, and International Exchange; he was
Head of the Department of Accounting and Finance for nine years (until 2009), and
he was reappointed Head of the Department of Accounting and Finance effective
July 1, 2015.
Professor Stangeland teaches finance courses at the University of Manitoba
and in the Canadian Executive MBA program at the Warsaw School of Economics
in Poland. His teaching spans undergraduate, MBA, and PhD courses in corporate
finance, investment banking, and international finance.
Professor Stangeland’s research interests are in the areas of corporate gov-
ernance, corporate control, and corporate finance. His work is well cited and has been published in
several journals, including the Journal of Financial and Quantitative Analysis, the Journal of Banking
and Finance, the Journal of Corporate Finance, Financial Management, the Stanford Journal of Law,
Business and Finance, and numerous others.
About the Authors xxi
Dr. Stangeland served on the Board of Directors of CMA Canada and he chaired CMA Canada’s
Pension Committee. He is a member of the Pension Committee and the Investment Committee for
the University of Manitoba Pension Plans and is a member of the Investment Committee for the
Teachers Retirement Allowances Fund (the pension fund for Manitoba teachers). He has also served
on the Independent Review Committees for two mutual fund companies. Professor Stangeland is a
two-time recipient of the CMA Canada Academic Merit Award for Teaching and Research, a four-
time winner of the University of Manitoba Teaching Services Award, and a recipient of the Associates
Award for Research.
Professor Stangeland was born and raised in Edmonton, Alberta, where he learned to appreci-
ate the outdoors through activities, including running, cycling, hiking, and skiing, and in the winter
travelling to warmer climates—Puerto Vallarta is his favourite warm-weather destination.
András Marosi is Executive Professor of Finance at the University of Alberta

and Associate Dean, undergraduate programs. He received his PhD in Finance from
the University of Texas at Austin and MPhil in Finance from the University of Cam-
bridge. Professor Marosi has taught introductory and elective corporate finance
courses for several years to undergraduate, MBA, Executive MBA, and Master of
Financial Management students. He has won several teaching awards, including
the MBA Association Award for Excellence in Teaching (2015 and 2016), the MBA
MacKenzie Teaching Award (2014), and the undergraduate Business Student Asso-
ciation MacKenzie Teaching Award (2004 and 2018). Professor Marosi’s research
has been published in the Journal of Finance and the Journal of Financial and Quan-
titative Analysis, and he received the Jean Perrien Award at the 2012 Administrative
Sciences Association of Canada (ASAC) Conference. Professor Marosi was born in
Hungary and is married, with one daughter. He is a passionate runner and triathlete.
Preface
Finance professors are united by their commitment to shaping future generations of
financial professionals as well as instilling financial awareness and skills in non-majors.
Our goal with Fundamentals of Corporate Finance is to provide an accessible presenta-
tion for both finance and nonfinance majors.
We know that countless undergraduate students have felt that corporate finance
is challenging. It is tempting to make the subject more accessible by de-emphasizing
the core principles and instead concentrating on the results. In our over 90 years of
combined teaching experience, we have found that this approach actually makes the
subject matter less accessible. The core concepts in finance are clear and intuitive.
What makes the subject challenging is that it is often difficult for a novice to dis-
tinguish between these core ideas and other intuitively appealing approaches that,
if used in financial decision making, will lead to incorrect decisions. Therefore, our
primary motivation is to equip students with a solid grounding in the core financial
concepts and tools needed to make good decisions. Such grounding will serve these
students well, whether this is their only course in finance or it is the foundation of
their major.
The field of finance has undergone significant change in the past 30 years. Yet much
of the empirical evidence in financial economics amassed over this period supports the
existing theory and strengthens the importance of understanding and applying corporate
financial principles. The 2007–2009 financial crisis was fuelled in part by many practi-
tioners’ poor decision making when they did not understand—or chose to ignore—the
core concepts that underlie finance and the pedagogy in this book. With this point in
mind, we present finance as one unified whole based on two simple, powerful ideas:
(1) valuation drives decision making—the firm should take projects for which the value
of the benefits exceeds the value of the costs—and (2) in a competitive market, market
prices (rather than individual preferences) determine values. We combine these two ideas
with what we call the Valuation Principle, and from it we establish all the key ideas in
corporate finance.
With the increasing focus on finance in the news, today’s undergraduate students
arrive in the classroom with a greater interest in finance than many of their predeces-
sors. The challenge is to use that natural interest and motivation to overcome their fear
of the subject and communicate these time-tested core principles. Again, we take what
has worked in the classroom and apply it to the text: by providing examples involving
familiar companies such as Starbucks, Air Canada, and Apple; making consistent use of
real-world data; and demonstrating personal finance applications of core concepts, we
strive to keep even nonfinance majors engaged.
Our commitment to setting a new standard for undergraduate corporate finance
textbooks extends beyond the printed page.
Core Concepts
Fundamentals of Corporate Finance provides thorough coverage of core finance
topics to provide students with a comprehensive—but manageable—introduction to
the topic.
xxii
Preface xxiii
Valuation as the Unifying Framework

In our experience, students learn best when the material in a course is presented as one
unified whole rather than a series of separate ideas. As such, this book presents corporate
finance as an application of a subset of simple, powerful ideas. The first is that valuation
drives decision making—the firm should take projects for which the value of the benefits
exceeds the value of the costs. The second is that in a competitive market, market prices
(rather than individual preferences) determine values. The combination of these two
ideas is what we call the Valuation Principle, and from it we establish all the key ideas in
corporate finance, including the NPV rule, security pricing, the relation between risk and
return, and the tradeoffs associated with capital structure and payout policies.
We use the Valuation Principle as a compass; it keeps financial decision makers on
the right track. We introduce it in Chapter 3 along with direct applications. Each part
opener relates the topics in that part to the Valuation Principle running theme.
Emphasis on Application
Applying the Valuation Principle provides skills to make the types of comparisons—
among loan options, investments, and projects—that will turn students into knowl-
edgeable, confident financial consumers and managers. When students see how to apply
finance to their personal lives and future careers, they grasp that finance is more than
abstract, mathematically based concepts.
Reinforcement of the Basic Tools

Mastering the tools for discounting cash flows is central to students’ success in the
introductory course. As always, mastery comes with practice and by approaching com-
plex topics in manageable units. To this end, we focus on time value of money basics in
Part 2. Chapter 3 introduces the time value of money for single cash flows as a criti-
cal component of the Valuation Principle. Chapter 4 then focuses on the time value of
money for cash flows over several periods. Finally, Chapter 5 demonstrates how interest
rates are quoted and determined. We present a methodical approach to the cash flows in
each problem within this framework:
■ Introduce timelines in Chapter 3 and stress the importance of creating timelines for
every problem that involves cash flows.
■ Include a timeline as the critical first step in each example involving cash flows.
■ Incorporate financial calculator keystrokes and Excel techniques into the presentation.
Focus on Capital Budgeting

The capital budgeting decision is one of the most important decisions in corporate
finance. We emphasize it early in the textbook, by comparing benefits and costs in
Chapter 3. Building on this, we formally introduce the NPV rule in Chapter 8 and evalu-
ate it with respect to other investment decision rules. In Chapter 9 on capital budgeting,
we examine the valuation of projects within a firm and provide a clear and systematic
presentation of the difference between earnings and free cash flow. This early introduc-
tion to capital budgeting allows us to present the idea of the cost of capital conceptually,
which then motivates the risk and return coverage in Chapters 10 and 11. In Chapter 12,
we calculate and use the firm’s overall cost of capital with the WACC method.
xxiv Preface
New Ideas
Fundamentals of Corporate Finance carefully balances the latest advancements in
research and practice with thorough coverage of core finance topics. Innovations that
distinguish this textbook include the following:
■ Chapter 7 on stock valuation values a firm’s equity by considering its future divi-
dends, free cash flows, or how its value compares to that of similar, publicly traded
companies.
■ Chapter 13 on the pricing of options lays the foundations for important topics such
as the valuation of convertible securities, the conflict of interest between equity
holders and creditors, and the ability to implement risk management strategies.
The early placement of the options material in the book allows options knowledge
to be used in latter parts—particularly in the discussion of capital structure and the
agency costs of debt.
■ Chapter 17 on payout policy examines the role of asymmetric information between
managers and investors and how payout decisions may signal this information.
■ Chapter 18 distinguishes between sustainable and value-increasing growth with a
focus on determining whether “growth” will increase or decrease the value of the firm.
The Tools Your Students Need to Succeed

Problem-Solving Methodology Guided Problem Solutions (GPS) of worked examples
appear alongside every important concept. Finance is about much more than the numeri-
cal solution: to be successful, students must understand the underlying intuition and
interpret the mathematical solution. To foster this mindset, after the problem statement a
three-step solution p rocess—Plan, Execute, Evaluate—aids students’ comprehension and
models the process they should follow when tackling problems and cases on their own.
We also identify the seminal errors our students have made over the years in Common
Mistake boxes within each chapter.
Applied Approach References to well-known companies, such as Apple, Air Canada,

and Starbucks, add colour and interest to each chapter. We even include two case-
based chapters (14 and 15) that profile Facebook and Hertz. Chapter conclusions offer
bottom-line advice on the key take-away points for financial managers. Interviews with
notable professionals such as John Connors, former Microsoft CFO, support this practi-
cal perspective.
An applied approach also involves presenting the tools on which practitioners rely. Excel
boxes and chapter-ending appendices teach students Excel techniques, whereas designated
Spreadsheet Tables available online enable students to enter their own inputs and formulas.
New to the Third Canadian Edition

A Canadian text should reflect Canadian realities and show how they fit in the bigger
world picture. For instance, the institutional environment in Canada is different. While
Canadian banks came out of the financial crisis with great admiration for their perfor-
mance relative to banks around the world, Canada’s success at corporate law enforcement
(laws relating to competition, insider trading, options backdating, and other aspects of
corporate governance) is sometimes criticized relative to other developed countries. The
Canadian tax system also differs from the United States and other countries. It would be a
pity if students were exposed only to the U.S. tax system and missed the realities of capital
cost allowance, capital gains taxes, tax free savings accounts, and registered retirement
Preface xxv
savings plan accounts—all of which are very important for Canadian investors. We feel
it is important for students to understand the Canadian system but to also be able to
understand that other systems exist too. Other countries’ institutional systems may be
better or worse than what exists in Canada. We believe it is especially important to point
out where other systems seem better than what exists in Canada because our students
will go on to be business and political leaders and may be the instruments to push for
change in Canada that will make us stronger.
David Stangeland and András Marosi are also proud Canadians, and we celebrate the
great success stories that have emerged in Canadian business. We also recognize some
stories of failure and rebirth that have taken place. As such, we feature Canadian busi-
nesses in the text when they make suitable examples. A side benefit for students of this
is that they can learn about some Canadian corporate history and become more familiar
with the firms that may eventually be their employers. We do not exclude non-Canadian
businesses. For example, when we want to look at the dominance of the corporate form
in terms of business revenue in the world, there is only one largest company by revenue,
Walmart (in 2017), so it has its place in the text. Again, though, when appropriate, we
bring in Canadian corporations and their relative position for comparative purposes.
Many firms not headquartered in Canada are so familiar and important to Canadians that
it would be foolish to exclude them when they make good examples. Apple and Starbucks
are two of such firms.
An additional advantage of a Canadian text is that because Canada is a smaller
player on the world scene than the United States, Canadians must think more inter-
nationally. Thus, the Canadian edition has more of an international focus than the
original U.S. edition.
Fundamentals of Corporate Finance offers coverage of the major topical areas for
introductory-level undergraduate courses. Our focus is on financial decision making
related to the corporation’s choice of which investments to make or how to raise the
capital required to fund an investment. We designed the book with the need for flexibility
and with consideration of time pressures throughout the semester in mind.
In response to reviewer’s feedback we retained the sequence of chapters first intro-
duced in the 2nd Canadian edition.
Chapters 3 through 13 focus on valuation and risk, and progress from relatively
easier material to more difficult topics, starting with the Valuation Principle and time
value of money in Chapters 3 and 4 and concluding with the challenging options topic
in Chapter 13. Subsequently, Chapters 14 through 17 examine various aspects of corpo-
rate finance, from raising funds to payoff policy, and make extensive use of the lessons
learned in the preceding valuation and risk chapters. In addition, by bringing forward
the discussion of options we can use such knowledge in other areas of the text that can
be viewed in an options context.
In addition to reorganizing the contents, we have thoroughly updated each of the
chapters in the book.
Chapter 1 Corporate Finance and the Financial Manager includes updates on
Canadian taxes and corporate tax around the world. We also introduced a new table
showing the largest Canadian corporations so students have a better understanding
of the big players in the Canadian economy. We updated the information on stock
exchanges and added information on dark pools. We have included a new hypotheti-
cal case in the end-of-chapter problems that facilitate discussion of shareholder wealth
maximization and the principal-agent problem, as well as stakeholder satisfaction and
corporate social responsibility.
Chapter 2 Introduction to Financial Statement Analysis includes discussion of the
impact of the Sarbanes-Oxley Act, specifically how changes in Canada are different from
those in the United States. We also discuss International Financial Reporting Standards
xxvi Preface
(IFRS) and how convergence toward IFRS has been progressing. Several new end-of-
chapter problems and a new Data Case are also added.
Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making
has been refined in its discussion of the Valuation Principle, and we added four additional
end-of-chapter problems.
Chapter 4 The Time Value of Money has been revised to improve clarity for students.
A new and improved financial calculator appendix has been included. An additional eight
end-of-chapter problems were added, too.
Chapter 5 Interest Rates includes a new summary of how to do interest rate con-
versions, and we revised the box on the cost of capital. We have also updated data and
figures with respect to inflation, interest rates, and yield curves. An additional eight end-
of-chapter problems have been included.
Chapter 6 Bonds includes updates on Canada’s national debt and new summary on
how interest rates and other factors affect bond prices. Chapter 6 is accompanied by a
new appendix—Appendix C—Interest Rate Risk Measurement: Duration.
Chapter 7 Valuing Stocks includes updates on how the forecasts on stock prices
related to what actually occurred. Five new end-of-chapter problems were added, includ-
ing one that relates back to the Chapter 1 end-of-chapter hypothetical case so that further
discussion can be accompanied by detailed calculations; this new problem ties together
the principal-agent problem, shareholder wealth maximization, managerial incentives,
and informational efficiency.
We introduce NPV and IRR in Chapter 8 Investment Decision Rules and have
included additional information on profitability index. In addition, four new end-of-
chapter problems are added.
Chapter 9 Fundamentals of Capital Budgeting now includes a new discussion of
sunk costs and unavoidable competitive effects. Further explanations regarding capital
cost allowance (CCA) asset classes are included.
Chapter 10 Risk and Return in Capital Markets contains new end-of-chapter prob-
lems, updated Excel instructions, and a new Data Case.
Chapter 11 Systematic Risk and the Equity Risk Premium benefits from new end-
of-chapter problems.
The BCE example has been updated throughout Chapter 12 Determining the Cost
of Capital and a new Common Mistake Box and a practitioner interview have been added
as well.
Chapter 13 Risk and the Pricing of Options now refers students to the online option
pricing calculator of the Montreal Exchange (MX). The MX website is a great resource for
those wanting to learn about derivatives.
Chapter 14 Raising Equity Capital includes new information on crowdfunding in
Canada, and has two new end-of-chapter problems included.
Chapter 15 Debt Financing includes standard debt coverage plus references to
option features and to the options chapter to enrich the discussion of callable and con-
vertible bonds. New material on sovereign debt, agency debt, and provincial and munici-
pal bonds is added. In addition to new end-of-chapter problems, a new Data Case and
Integrative Case are included.
Chapter 16 Capital Structure contains a new General Interest Box discussing bank
capital regulation and the ROE fallacy in the context of the 2008 global financial crisis.
Example 16.4 has been replaced; the new example illustrates the calculation the value
of the levered firm rather than just the present value of tax savings. Three new end-of-
chapter problems have also been added.
Chapters 17 Payout Policy and 18 Financial Modelling and Pro Forma Analysis
contain updates to tax rates, data, and figures throughout and more information
on Canadian and U.S. companies that hold large cash balances.
Preface xxvii
Chapter 19 Working Capital Management includes company and data updates.

Chapter 22 International Corporate Finance includes the updates on taxation of
foreign income for Canadian multinationals and constrasts this to the most recent
and significant changes U.S.–based firms have faced regarding their foreign-sourced
income.
And we have thoroughly updated the figures and data in the remaining chapters of
the book.
Part-by-Part Overview
Parts 1 and 2 lay the foundation for our study of corporate finance. In Chapter 1, we
introduce the corporation and related business forms. We then examine the role of
financial managers and outside investors in decision making for the firm. Chapter 2
reviews basic corporate accounting principles and the financial statements on which the
financial manager relies.
Part 2 presents the basic tools that are the cornerstones of corporate finance.
Chapter 3 introduces the Valuation Principle, which underlies all of finance and links
all of the ideas throughout this book. Chapter 4 on the time value of money analyzes
cash flow streams lasting several periods. We explain how to value a series of future cash
flows and derive shortcuts for computing the present value of annuities and perpetuit-
ies. We focus on how interest rates are quoted and determined in Chapter 5, with an
emphasis on how to use market interest rates to determine the appropriate discount
rate for a set of cash flows. In Chapter 6, we demonstrate an application of the time
value of money tools using interest rates: valuing the bonds issued by corporations
and governments. The Appendix C to Chapter 6 discusses interest rate risk and dura-
tion. In Chapter 7, we extend the valuation framework to determining stock prices.
After valuing a firm’s equity with various methods, we discuss market efficiency and its
implications for financial managers.
Part 3 addresses the most important decision financial managers face: the choice of
which investments the corporation should make, driving the value of the firm. Chapter 8
presents the investment decision rules that guide a financial manager’s decision making.
In Chapter 9 on capital budgeting, we outline estimating a project’s incremental cash
flows, which then become the inputs to the NPV decision rule.
Part 4 looks at the critical concept of risk and return. We explain how to measure
and compare risks across investment opportunities to determine the cost of capital
for each investment opportunity. Chapter 10 introduces the key insight that investors
demand a risk premium only for nondiversifiable risk. In Chapter 11, we quantify this
idea, leading to the Capital Asset Pricing Model (CAPM). In Chapter 12, we apply what
we’ve learned to estimate a company’s overall weighted average cost of capital. In Chapter 13,
we discuss options, their pricing, and what affects their value.
Part 5 shows how the firm raises the funds it needs to undertake its invest-
ments. We explain the mechanics of raising equity in Chapter 14 and debt markets in
Chapter 15 (where we also continue the institutional overview of bond markets that
began in Chapter 6). Following the discussions on equity and debt financing, we turn to
capital structure and examine the impact of financing choices on the value of the firm.
Chapter 16 on capital structure opens by intuitively establishing the Modigliani and
Miller result and then turns to the impact of important market imperfections. Payout
policy is the focus of Chapter 17.
Part 6 turns to the details of running the financial side of a corporation on both a
long-term and a day-to-day basis. Chapter 18 develops the tools to forecast the cash flows
and long-term financing needs of a firm. In Chapter 19, we discuss how firms manage
their working capital requirements, whereas Chapter 20 explains how firms finance
their short-term cash needs.
xxviii Preface
Part 7 addresses select special topics in corporate finance. Chapter 21 focuses on

the corporation’s use of options, futures, forwards, insurance, and other methods to
manage risk. Chapter 22 examines the issues a firm faces when making a foreign invest-
ment, including exchange rate risk, and addresses the valuation of foreign projects.
Chapter 23 introduces an alternative to long-term debt financing—leasing. By present-
ing leasing as a financing alternative, we apply the Law of One Price to determine that
the benefits of leasing must derive from the tax differences, incentive effects, or other
market imperfections. The Law of One Price continues to provide a unifying framework
as we consider the topics of mergers and acquisitions in Chapter 24 and corporate gov-
ernance in Chapter 25.
Features: Bridging Theory and Practice

Study Aids with a Practical Focus
To be successful, students need to master the core concepts and learn to identify and
solve problems that today’s practitioners face.
■ The Valuation Principle is presented as the foundation of all financial decision mak-
ing: The central idea is that a firm should take projects or make investments that
increase the value of the firm. The tools of finance determine the impact of a project
or investment on the firm’s value by comparing the costs and benefits in equivalent
terms. The Valuation Principle is first introduced in Chapter 3, revisited in the part
openers, and integrated throughout the text.
■ Guided Problem Solutions (GPS) are examples that accompany every important
concept using a consistent problem-solving methodology that breaks the solution
process into three steps: Plan, Execute, and Evaluate. This approach aids student
comprehension, enhances their ability to model the solution process when tackling
problems on their own, and demonstrates the importance of interpreting the math-
ematical solution.
■ Personal Finance GPS examples showcase the use of financial analysis in everyday
life by setting problems in scenarios such as purchasing a new car or house and
saving for retirement.
■ Common Mistake boxes alert students to frequently made mistakes stemming from
misunderstanding core concepts and calculations—in the classroom and in the field.
■ Using Excel boxes describe Excel techniques and include screenshots to serve as a
guide for students using this technology.
Applications That Reflect Real Practice

Fundamentals of Corporate Finance features actual companies and practitioners in the
field.
■ Practitioner Interviews from notable professionals featured in many chapters high-
light leaders in the field and address the effects of the financial crisis.
■ General Interest boxes highlight timely material from financial publications that
shed light on business problems and real company practices.
Teaching Every Student to Think Finance

With consistency in presentation and an innovative set of learning aids, Fundamentals
of Corporate Finance simultaneously meets the needs of both finance majors and nonfi-
nance business majors. This textbook truly shows every student how to “think finance.”
Preface xxix
Simplified Presentation of Mathematics

Because one of the hardest parts of learning finance is mastering the jargon, math, and
nonstandardized notation, Fundamentals of Corporate Finance systematically uses
■ Notation Boxes. Each chapter begins with a Notation box that defines the variables
and the acronyms used in the chapter and serves as a “legend” for students’ reference.
■ Numbered and Labelled Equations. The first time a full equation is given in notation
form it is numbered. Key equations are titled and revisited in the summary and in
end papers.
■ Financial Calculator instructions, including a box in Chapter 4 on solving for future
and present values, and appendices to Chapters 4, 6, and 15 with keystrokes for HP-
10BII and TI BAII Plus Professional, highlight this problem-solving tool.
■ Spreadsheet Tables. Select tables are available on the MyLab Finance as Excel files,
enabling students to change inputs and manipulate the underlying calculations.
■ Using Excel boxes describe Excel techniques and include screenshots to serve as a
guide for students using this technology.
Practice Finance to Learn Finance

Working problems is the proven way to cement and demonstrate an understanding of
finance.
■ Concept Check questions at the end of each section enable students to test their
understanding and target areas in which they need further review.
■ End-of-chapter problems written personally by Jonathan Berk, Peter DeMarzo,
Jarrad Harford, David Stangeland, and Andras Marosi offer instructors the oppor-
tunity to assign first-rate materials to students for homework and practice with the
confidence that the problems are consistent with the chapter content. All end-of-
chapter problems are available in MyLab Finance, the fully integrated homework
and tutorial system. Both the problems and solutions, which were also written by
the authors, have been class tested and accuracy checked to ensure quality. Selected
end-of-chapter problems are also accompanied by Excel spreadsheets with different
icons indicating what the spreadsheets are for, and where they can be found:
I ndicates that the problem is accompanied by an Excel Solution, which is found in the
Instructor’s Solutions Manual. Blank templates for these Excel Solutions are available for
students on the MyLab Finance.
Indicates that the problem is accompanied by an Auto-Graded Excel Project on Pearson’s
MyLab Finance. Using proven, field-tested technology, these new auto-graded Excel
Projects allow instructors to seamlessly integrate Excel content into their course.
End-of-Chapter Materials Reinforce Learning

Testing understanding of central concepts is crucial to learning finance.
■ MyLab Finance Chapter Summary presents the key points and conclusions from
each chapter, provides a list of key terms with page numbers, and indicates online
practice opportunities.
■ Data Cases present in-depth scenarios in a business setting, with questions designed
to guide students’ analysis. Many questions involve the use of internet resources.
■ Integrative Cases occur at the end of some parts and present a capstone extended
problem with a scenario and data for students to analyze based on that subset of
chapters.
Another random document with
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and violinists could not play two or more notes with ‘one bow.’
Neither did they endeavor to conquer the technical difficulties of
playing on the G string. They made practically no use of the fourth
string until the end of the century. In addition, the instruments were
badly constructed, equipped with strings of inferior quality and tuned
in a low pitch, all of which militated strongly against purity and
accuracy of intonation. Hans Gerle (a flute player of Nuremberg), in
his 'Musica Teutsch, auf die Instrument der grossen und kleinen
Geigen’ (1532), advised that intonation marks be placed on the
fingerboard, and this naïve advice was in use as late as the middle of
the eighteenth century.[45]
The same writer points out that instrumentalists in improvising their

parts were prone to vie with each other in demonstrating their ability
as contrapuntists, a perfectly comprehensible habit, which must have
affected instrumental music in the sixteenth century as badly as the
vagaries of coloratura singers affected operatic music in the
eighteenth.
Gerle’s book, incidentally, contained a number of German, Welsh,

and French songs, and a fugue for four violins. Among other early
books on the violin mention may be made of these:
S. Virdung: Musica getuscht, 1511.
Judenkönig: A truly artistic instruction * * * of learning upon

the lute and violin, 1523. (Contains 25 numbers for violin and
flute.)
Agricola: Musica Instrumentalis, 1528. (Here the author refers

to the vibrato as a device that ‘makes the playing more
sweet.’)
La Franco: Scintille di Musica, 1533.
Silvestro Ganassi: Regola Rubertina che insegna suon di

Viola d’arco, 1543.
Ludovico Zacconi: Prattica di Musica, 1592 (Zacconi stated
here that the compass of the violin was g-ciii).
M. Prätorius: Syntagma Musicum, 1619.
Touching upon the use of the violin in the sixteenth century there is
extant a wealth of historical references. From one of these, for
example, we gather that at a public festival in 1520 viols were used
to accompany songs. We may assume their popularity in England
from the fact that they were used in the family of Sir Thomas More
(1530), an ardent music lover, and that during the reign of Edward VI
the royal musical establishment increased the number of its viols to
eight. Violins were used at public performances in Rouen in 1558; at
a fête in Bayonne for dance music in 1565, and in a performance of a
Mass at Verona in 1580. In the year 1572 Charles XI of France
purchased violins from Cremona and a little later ordered the famous
twenty-four violins from Andrea Amati. In 1579, at the marriage of the
Duke of Joyeuse, violins were used to play for dances, and
Montaigne in his Journal (1580) refers to a marriage ceremony in
Bavaria, where ‘as a newly married couple went out of church, the
violinists accompanied them.’ From this passage of Montaigne we
may infer that, in Germany at least, the popularity of violin music was
not confined to the upper classes. It must be remembered, however,
that the terms ‘viola,’ ‘violin,’ ‘viol,’ etc., were often applied
indifferently to stringed instruments of various kinds, and in view of
this inaccurate nomenclature historical references must be accepted
with a certain amount of reserve.
We know little of the music that was played on the violin before the
last decade of the sixteenth century. Violins, we are aware, were
employed in ensembles, in orchestras, and in unison with voices, and
in looking for violin music we have not necessarily to consider
compositions written especially for violin. By way of illustration we
may cite a collection of French Dances (1617), published for
‘instruments,’ presumably for all kinds of instruments, and a
collection of ‘Songs’ edited in Venice (1539) bearing the remark ‘to
sing and play,’ and indicating no special instruments. Probably much
of this sort of music was played by violin. Among examples of
specific writing for the violin there has come down to us previous to
1539 a Fugue (Fugato rather) for four violins, composed by Gerle. It
is in four parts: Discant (first violin), Alto (second violin), Tenor (viola)
and Bass ('cello), perhaps the earliest specimen of a composition for
string quartet. The style is purely vocal, as we may see from the
theme:
There is no suggestion of the violin idiom in the piece and it throws

no light on the development of violin music. Cortecci and Striggio in
1565 scored their intermezzi for two gravecembali, violins, flutes,
cornets, trombones, and several other instruments. D’Etrée, an oboe
player, wrote down the common lively tunes which had been
previously learned by ear and published them in 1564. As a practical
musician he undoubtedly considered also the violin. In the
performance of Beaulieu’s Circe (1581) ten bands were used and in
the first act ten violin players in costumes appeared. The famous
violinist, Beaujoyeaulx (an Italian in the service of Henry III whose
real name was Baltasarini), wrote ballets (1584), dances, festival
music, and other compositions, which were very successful at the
court. Doubtless he played them himself. Castiglione in his
Cortigiano mentions a composition as being written for 'quattro viole
da arco’ which almost seems to indicate another specimen of early
string quartet. Toward the end of the century we meet with the Balletti
of Gastoldi and of Thomas Morley, some of which are printed without
words and may have been intended for instrumental performances.
Still, they are vocal in character and do not exceed the compass of
the human voice. Besides these, there are other compositions and
collections of dances, etc., that may be considered musical material
for violinists of the time. Most of them, however, deserve no detailed
notice.
Up to 1587 the leading instrument of the orchestra was the Cornetto

(German ‘Zinke,’ an instrument of wood, not of metal). The earliest
instance where the Cornetto alternates with the violins in taking the
lead and where a part was inserted especially for violino is to be
found in Concerto di Andrea e Giovanni Gabrieli—per voci e
strumenti musicali, 1587. Some of G. Gabrieli’s compositions,
however, are still in vocal style, but some are decidedly instrumental
in character, as we may see from the following illustrations.
and
From a Sonata à 3 (1615).
and
(Note the last example, where the intentional contrast between piano
and forte is distinctly indicated.)
In 1593 Florentino Maschera, one of the celebrated organists of his

time, published a book of ‘Songs to play’ (Canzoni a sonar). The
work consisted of seventy-one pieces which had family names for
their titles, a custom that was often repeated in the first half of the
sixteenth century. It is important to note that these pieces were
printed in separate parts, so that they may be considered as the first
specimens of independent though not direct writing for the violin.
These canzoni were vocal in character and there was little that
suggested instrumental technique. The style was that of the vocal
compositions of the time—contrapuntal.
A genuine and daring innovator in the field of violin music was

Claudio Monteverdi (1567-1643), who in some violin passages went
up as high as the fifth position. Besides broadening the technique of
the left hand, he demanded tremolos for dramatic effects in
accompanying recitative:
This passage from Combattimento di Tanceredi e Clorinda (1624)

offered so many difficulties to the musicians that at first they refused
to play it. As we shall see presently, however, Monteverdi was not the
first to introduce this effect (cf. p. 381). Another of his new effects
was the introduction of the pizzicato, which he marked thus: Qui si
lascia l’arco, e si strappano le chorde con duo diti, and afterwards
Qui si ripiglia l’arco. That Monteverdi expected violins to produce a
crescendo with the bow is apparent with the instruction Questa ultima
note va in arcato morendo. ‘Monteverdi with his two violins “alla
Francese” in the score of Orfeo (the first printed reference to the
violin as an orchestral instrument in the modern sense), probably
meant nothing more than that the violins were to be in the fashion of
the French, but in place of accompanying a dance, the character
indicated in the opera was accompanied by two violins in a particular
part of its music.’[46] In other violin pieces by Monteverdi, as in his
Scherzi musicali and Ritornelle (1607), we see his superiority to his
contemporaries, just as in his Sonata sopra Sancta Maria detratta,
etc. (1610), he showed plainly his desire to improve violin music.
III
The first attempt at independent violin composition was made by
Biagio Marini (1590-1660), maestro di cappella in Santa Eufemia in
Brescia and a court concert-master in Germany, who may be
regarded as the first professional composer-violinist. In his early
compositions the violin parts were not difficult for the players. There
were mostly half and quarter notes in slow tempi, displaying the
quality of vocal compositions, and without much use of the G string.
Witness the following example from his Martinenga Corrente (1622):
A passage from his Il Priulino Balletto e Corrente (marked canto

primo, secondo, and basso)
is more instrumental in quality, though the second part of the Balletto

reveals again the character of vocal music. The whole may be played
on the A and E strings. More violinistic passages are to be found in
his sinfonia La Gardana; for example:
Marini’s dance compositions are characteristic of all dance music at

the beginning of the seventeenth century. Among them, however, is
one that possesses particular interest for us from the fact that it is the
first extant composition marked distinctly ‘for violin solo.’ It is entitled
La Romanesca per Violino Solo e Basso (ad libitum), and has four
sections, each consisting of two parts. The first section, Parte prima,
has six measures in the first and second part; the second section has
five measures in the first part and six in the second. The form of the
third section is not so clear as that of the previous ones, although, as
we may see from the basses, the composer endeavored to give
clear-cut melodies. The same may be said of the fourth section,
where the figures are in the bass. The third section—terza parte in
altro modo—with new melodic and rhythmic material, has the
character of a dance. The violin part moves in figures of eight, and
there are sustained notes in the bass. The first few measures of each
section will serve as illustration.
Section I
Section II
Section III
Section IV
In his technique Marini does not go beyond the first position;
consequently the fluency of the melody suffers many a break, for
when he reaches the limit of the first position, he continues the
melody an octave lower. Yet he is responsible for several technical
innovations for the violin. He was the first to mark the bowing (legato
playing) and to introduce—seven years before Monteverdi’s
Combattimento—the coloring effect of the tremolo, thus:
Tremolo con arco.
Other innovations are to be found in his Sonate e Sinfonie Canzoni

(1629) where in a Capriccio ‘two violins play four parts’ (due violini
sonano quattro parti), thus:
and a ‘Capriccio to be played on the violin solo with three strings

after the manner of a lyre’ (Capriccio per sonare il Violino solo con tre
corde a modo di Lyra).
Besides Marini there were others who seriously endeavored to write

in a distinctive violin idiom. Before considering them we may mention
here Paolo Quagliati, who in his Sfera armoniosa (1623) made the
violin accompany the voices and used it also as a solo instrument
with the accompaniment of the theorbo in a toccata of the same
opus. The violin part usually consisted of sustained tones that were
to be embellished by the players according to the custom of the time.
Quagliati himself was not a violinist and this fact serves to explain the
simple technique of his violin parts.
Four years later Carlo Farina, a Saxon chamber virtuoso and concert
master, who may be termed the founder of the race of violin
virtuosos, published a composition for the violin, called Capriccio
stravagante. Here he strove toward new and unusual violinistic
effects. The very title, ‘an extravagant caprice,’ explains his object.
While the piece shows little improvement in form, the technique is
noticeably advanced. Farina goes to the third position and points out
how the change of position should be executed. Besides broadening
violin technique Farina was among the first to venture into the field of
realistic ‘tone painting.’ For he tried to imitate the whistling of a
soldier, the barking of a dog, the calling of a hen, the crying of a cat,
the sound of a clarinet and the trumpet. Farina’s experiments in tone-
painting were, however, rather the product of a desire for sensational
novelty than of a legitimate seeking after artistic expression. He lacks
the genuine qualities of a true artist.
Although Farina did not use the G string, and did not go further than
the third position, he recognized the power of expression latent in the
violin. Besides rapid figures of sixteenth notes and considerable
variety in bowing there are double stops:
and a series of consecutive chords with the instruction that it should

be executed with the stick of the bow:
It was also his idea—not at all a bad one—to mark double stops with
figures:
The fact that he found it necessary to give instruction for the

execution of double stops and tremolos, and the production of the
required effects in his imitations indicates that these devices were
entirely new in violin playing.
According to Gerber he published besides the Capriccio, a collection

of 'Sonatas’ and 'Pavanes’ (1628), which, if they existed at all, are
entirely lost. Of his other compositions (Dances, Arias) we possess
the first violin parts containing the melody. He used the G clef and
the term ‘violino.’
The compositions of Marini, Quagliati and Farina represent the

beginnings of independent violin solo music. The first to write
sonatas for violin solo was the violinist-composer Giovanni Battista
Fontana (1630). His works, compared with the sonatas of Gabrieli,
show a marked improvement in violin technique; they are
characterized by the same polyphonic style, but they are not so
conclusively vocal in character. The following selections will show the
great improvement in violin technique; they virtually comprise the first
‘runs’ composed for the violin:
From a Sonata for Violin Solo.
or
or
or
Fontana strove toward a broader form and in doing so he took a part

in the evolution of the later sonata. But he was not capable of fluent
and even expression, hence the effect of his works on the whole is
stiff and dry. We should not forget, however, that he lived during the
period of transition from the old tonal systems to the new, and that,
while he endeavored to write in the new style, the old one had not
lost its hold upon him. The result was awkwardness in modulation
and a general vagueness and uncertainty.
About the same time (1629) another composer, Bartolomeo Mont’

Albano, published his Sinfonie for one and two violins (and
trombones, with the accompaniment of the organ). These pieces are
incoherent and lack inspiration and power. Their value is far below
that of Fontana’s compositions. Mont’ Albano is only worthy of
mention as showing that Fontana was not absolutely alone in his
attempts to improve violin music. It may be noticed that he called his
compositions Sinfonie, meaning nothing more nor less than Fontana
meant in his sonatas—a proof that the technical terms at that time
were not yet strictly defined.
Great improvement in technique is obvious in the works of Tarquinno
Merula (1633). He used the G string freely, demanded skips from the
G to the E string, also tremolos, changes of position:
and octave passages:
Mont’ Albano’s music was thought out rather than invented and it
would give little pleasure to the modern ear. In the history of the
development of violin music these early compositions should be
considered simply as efforts or studies to advance violin technique
and musical form.
While Merula helped the progress of left hand technique, Marco

Ucellini (1669) made more demands on the bow, writing rapid thirty-
second notes for certain tremolo effects in his sinfonia entitled La
gran Bataglia.
A more pleasing musical quality is to be found in the sonatas of

Massimiliano Neri, who was the first to make a distinction between
the Sonata da chiesa and the Sonata da camera. In his Sonate e
Canzoni a quattro and in his Sonate da suonarsi con vari strumenti,
Neri followed the path of Gabrieli in writing for as many as twelve
instruments. The frequent change of time and the restless rhythm are
also reminiscent of Gabrieli’s peculiarities. Although Neri’s structure
of phrases and periods is more normal, his modulation more fluent,
and his music on the whole more agreeable to the modern ear than
that of Fontana and Merula, his works still belong to the practical
experiments of violin music, and are without great intrinsic merits.
The same may be said of the sonatas of Biagio Marini whom we
have already discussed. He may be termed one of the originators of
the cyclical form of the modern sonata, since his sonatas were in four
movements. The first, usually in slow tempo, was followed by an
Allegro, this by a longer or shorter piece that led to the last
movement (Allegro). While his style was still distinctly polyphonic, the
development of his motives was considerably more pleasing.
Improvement in harmony and modulation is found in the Sonate da
chiesa and Sonate da camera of Giovanni Legrenzi (1655), who did
not otherwise accomplish much in forwarding solo violin music.
Turning to Germany, it is to be regretted that the works, which, to

judge by their titles, might have shed some light on the development
of early violin music, are irretrievably lost to us. They are
Auserlesene Violinen Exercitium aus verschiedener Sonaten nebst
ihre Arien, Balladen, Sarabanden, etc., and Musicalische
Tafelbedienung von fünf Instrumenten, als zwei Violinen, zwei Violen,
nebst den General Bass, by Wilhelm Furcheim (1674), concert-
master at Dresden. The most important figure, among the earliest
German composers for the violin from the standpoint of technical
advance, is evidently Jacob Walter. His twelve Scherzi da violino solo
are in the style of the Sonate da Camera (Suite) or in the form of
variations. Eight of them are called sonatas, and contain three or four
movements, mostly in the same key but in a variety of tempi. From a
musical point of view most of Walter’s compositions are unattractive,
as the form is stiff, the rhythm awkward, modulation poor, and the
melody heavy and clumsy. His importance lies exclusively in the
advanced claims his writings make upon execution, for he ascends
as far as and writes many difficult double stops, chords, and
arpeggios. Walter was also fond of imitating other instruments, birds,
echoes, and so forth. In a set of variations we meet with imitations of
the guitar by playing pizzicato, of the pipes by going up high on the E
string, of fanfares by playing on the G string. In another composition
the imitation of the call of the cuckoo was his chief purpose; but we
would hardly recognize the cuckoo’s call, had he not in every case
taken the pains to mark the imitation. In another instance, in Hortulus
Chelicus, he endeavored to imitate the voice of some other bird. This
work as a piece of art is more valuable, since here he attempted to
write a duet for one violin. Another composition that is characteristic
of Walter’s musical ideas is a Capriccio, where the C major scale is
used as basso ostinato in forty-nine variations, as though the
composer wanted to give as many kinds of motions and figures as he
could.
Stradivarius at Work: Antonio Stradivari.
Walter was not an innovator in the art of tone painting, for Farina had
tried the same devices seventy years before. Still he cannot be
dubbed a mere imitator of Farina, though he was without doubt
strongly influenced by the latter. Walter’s technique is much more
advanced than that of Farina, but at the same time he shows little
improvement in a purely musical way.
IV
There is an obvious advance in musical value in the Correnti e
balletti da camera a due violini, 1666; Balletti, Sonate, 1667, 1669;
Correnti e capricci per camera a due violini e violone, 1683, and
other instrumental pieces by Giovanni Battista Vitali, 'sonatore di
Violino di brazzo’ in the orchestra of Bologna. Vitali’s melodies
contain much more pleasing qualities than those of his
contemporaries. In regard to form, his sonatas, in which rapid
changes from quick to slow movements mark the various sections,
show the transition from the suite to the sonata da camera. Vitali was
one of those early inspired composers, whose greatest merit lies in
their striving toward invention and toward the ideal of pure absolute
music. In technique Vitali does not show any material progress.
Of particular importance is Tommaso Antonio Vitali, a famous

violinist of his time. Of his works, Sonate a tre, due violini e
violoncello, 1693; Sonate a due violini, col basso per l’organo, 1693,
and Concerto di sonate a violino, violoncello e cembalo, 1701, the
most famous and most valuable is his Ciaccona, which is very often
played on the concert stage by present-day violinists. The Ciaccona
is full of poetic moods and its short, pregnant theme shows deep
feeling and genuine inspiration, qualities which we find here for the
first time. The whole is a set of variations upon a short theme,
constituting a series of contrasting pictures. Noteworthy are the
harmony and the advanced treatment of modulation. The ornamental
figures, too, are derived from the logical development of the theme,
hence do not serve the sole purpose of providing the virtuoso with an
opportunity to display his technical skill.
The first representative virtuoso-composer was Giuseppe Torelli

(1658-1708), to whom is ascribed the invention of the concerto, that
is, the application of the sonata form of his time to concerted music.
In Torelli’s concertos the solo-violins were accompanied not only by a
bass as in the sonatas, but by a stringed band, to which sometimes
a lute or organ was added. The solo-violins in his ‘Concerti grossi’
(1686) usually played together, though not always. That he had the
virtuoso in mind when he wrote may be gathered from the following
examples:
In his concertos Torelli was the direct precursor of Corelli, Vivaldi,
and Handel. His influence, however, was not so intense as that of
Giovanni Battista Bassani (1657-1716), whose music had more unity
and definiteness and on the whole ranked very much higher
artistically. This, added to the fact that he was Corelli’s teacher, gives
him a prominent place in the history of violin music. While the single
movements of Bassani’s sonatas on the whole show little
improvement in form, the composer established a higher standard in
the evenness and uniformity of his figures, in the smoothness of his
modulation and chromatics, in rhythms that were far superior to
those of earlier composers, in phrasing that was clear, especially in
slow movements, and in the almost complete abandonment of the
‘fugal’ treatment. His influence upon Corelli is so evident that one
could hardly distinguish one of his later compositions from an early
sonata of his famous pupil.
A few examples of Bassani’s writing may be of interest:
Grave. From a Sonata for two Violins and Bass.

Largo. From a Baletto e Corrente.
Gige
Sarabande. Presto
Before closing our account of the seventeenth century, reference

should be made to the prominent Antonio Veracini, the uncle and
teacher of Francesco Maria Veracini, whose sonatas are still played
by violinists today. Antonio Veracini’s sonatas, composed in the form
of the sonata da chiesa, do not lack a certain amount of beauty,
inspiration, and repose; they show, moreover, clearness, fluency and
roundness. His melodies are original, his modulations and
contrapuntal combinations good. While his Allegro movements show
no improvement in comparison with Bassani’s works, the Adagios
and Largos are of more independent finish.
There were numerous contemporaries, followers, and pupils of the

composers already discussed. Their works, however, were
academic, lacked individuality, and contained little that was worthy of
special consideration. The list of these minor composers includes
Laurenti, Borri, Mazzolini, Bononcini, Buoni, Bernardi, d’Albergati,
Mazzaferrata, Tonini, Grossi, Ruggeri, Vinacesi, Zanata, and others.
V
The first German composer of violin music of æsthetic value was
Heinrich Ignaz Franz von Biber (born 1638), a very prominent
violinist and composer of his time. Although frequently his form is
vague and his ideas often dry, some of his sonatas contain
movements that not only exhibit well-defined forms, but also contain
fine and deeply felt ideas and a style which, though closely related to
that of the best Italians of his time, has something characteristically
German in its grave and pathetic severity. His sonatas on the whole
are of a much higher artistic quality than those of his
contemporaries. His sixth sonata, in C minor, published in 1687, is a
genuinely artistic piece of work. ‘It consists of five movements in
alternately slow and quick time. The first is an introductory largo of
contrapuntal character, with clear and consistent treatment in the
fugally imitative manner. The second is a passacaglia, which
answers roughly to a continuous string of variations on a short, well-
marked period; the third is a rhapsodical movement consisting of
interspersed portions of poco lento, presto, and adagio, leading into
a Gavotte; and the last is a further rhapsodical movement alternating
adagio and allegro. The work is essentially a violin sonata with
accompaniment and the violin parts point to the extraordinary rapid
advances toward mastery. The writing for the instrument is decidedly
elaborate and difficult, especially in the double stops and
contrapuntal passages. In the structure of the movements the fugal
influences are most apparent and there are very few signs of the
systematic repetition of keys which in later times became
indispensable.’[47] It was characteristic of Biber that his ambition was
to create something original and that his works always showed
individuality. He was fond of variations and this form was not lacking
in any of his eight sonatas. Besides the variation form he frequently
used the form of gavotte and giga, which he began and ended with

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Corporate Finance, Third Canadian 3rd

To my family for all their love and support.

11.2 The Volatility of a Portfolio 385

10 Risk and Return in Capital

11 Systematic Risk and the Equity

11.1 The Expected Return of a Portfolio 382

Cost of Capital for a New Acquisition 442

16 Capital Structure 549

17 Payout Policy 592

16.1 Capital Structure Choices 550

17.2 Dividends versus Share Repurchases

MyLab Finance SUMMARY 653 • REVIEW

20.2 The Matching Principle 694

19 Working Capital Management 661 Temporary Working Capital 694

19.3 Receivables Management 671 A SEVENTEENTH-CENTURY FINANCING

MyLab Finance SUMMARY 682 • REVIEW

20.1 Forecasting Short-Term Financing 21.2 Commodity Price Risk 728

Swap-Based Hedging 741

22.6 Internationally Segmented Capital

24.3 Reasons to Acquire 818

Efficiency Gains 820

MyLab Finance SUMMARY 842 • REVIEW

Jonathan Berk is the A.P. Giannini Professor of

András Marosi is Executive Professor of Finance at the University of Alberta

Valuation as the Unifying Framework

Reinforcement of the Basic Tools

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Applied Approach References to well-known companies, such as Apple, Air Canada,

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Chapter 19 Working Capital Management includes company and data updates.

Part 7 addresses select special topics in corporate finance. Chapter 21 focuses on

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End-of-Chapter Materials Reinforce Learning

The same writer points out that instrumentalists in improvising their

Gerle’s book, incidentally, contained a number of German, Welsh,

S. Virdung: Musica getuscht, 1511.

Judenkönig: A truly artistic instruction * * * of learning upon

Agricola: Musica Instrumentalis, 1528. (Here the author refers

La Franco: Scintille di Musica, 1533.

Silvestro Ganassi: Regola Rubertina che insegna suon di

M. Prätorius: Syntagma Musicum, 1619.

There is no suggestion of the violin idiom in the piece and it throws

Up to 1587 the leading instrument of the orchestra was the Cornetto

From a Sonata à 3 (1615).

In 1593 Florentino Maschera, one of the celebrated organists of his

A genuine and daring innovator in the field of violin music was

This passage from Combattimento di Tanceredi e Clorinda (1624)

A passage from his Il Priulino Balletto e Corrente (marked canto

is more instrumental in quality, though the second part of the Balletto

Marini’s dance compositions are characteristic of all dance music at

Tremolo con arco.

Other innovations are to be found in his Sonate e Sinfonie Canzoni

and a ‘Capriccio to be played on the violin solo with three strings

Besides Marini there were others who seriously endeavored to write

and a series of consecutive chords with the instruction that it should

The fact that he found it necessary to give instruction for the

17.2 Dividends versus Share Repurchases

20.1 Forecasting Short-Term Financing 21.2 Commodity Price Risk 728

22.6 Internationally Segmented Capital